UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

Form 10-K

 

 

OR

 

 

Commission File Number 0-28018

 

 

YAHOO! INC.

(Exact name of Registrant as specified in its charter)

 

 

701 First Avenue
Sunnyvale, California 94089
(Address of principal executive offices, including zip code)

 

Registrant’s telephone number, including area code:

(408) 349-3300

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

(Title of Class)

 

 

Indicate by check mark if the Registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act. Yes þ  No o

 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o  No þ

 

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 o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

 

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 definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

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

 

As of June 29, 2007, the aggregate market value of voting stock held by non-affiliates of the Registrant, based upon the closing sales price for the Registrant’s common stock, as reported on the NASDAQ Global Select Market, was $32,724,039,883. Shares of common stock held by each officer and director and by each person who owns 10 percent or more of the outstanding common stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for any other purpose.

 

The number of shares of the Registrant’s common stock outstanding as of February 15, 2008 was 1,337,165,049.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

The following documents (or parts thereof) are incorporated by reference into the following parts of this Form 10-K:

 

Proxy Statement for the 2008 Annual Meeting of Stockholders — Part III Items 10, 11, 12, 13 and 14.

 

 

YAHOO! INC.
Form 10-K
Fiscal Year Ended December 31, 2007

 

INDEX

 

 

The trademarks and/or registered trademarks of Yahoo! Inc. and its subsidiaries referred to herein include, but are not limited to, Yahoo!, Y!, del.icio.us, Flickr, HotJobs, Bix, Geocities, Jumpcut, Kelkoo, Launch, Musicmatch, Overture, and their respective logos. All other names are trademarks and/or registered trademarks of their respective owners.

 

 

Yahoo! Inc., together with its consolidated subsidiaries (“Yahoo!,” the “Company,” “our,” “we,” or “us”), is a leading global Internet brand and one of the most trafficked Internet destinations worldwide. Yahoo! is focused on powering its communities of users, advertisers, publishers, and developers by creating indispensable experiences built on trust. We seek to provide Internet services that are essential and relevant to these communities of users, advertisers, publishers, and developers. Publishers, such as eBay Inc. (“eBay”), WebMD, Cars.com, Forbes.com, and the Newspaper Consortium (our strategic partnership with a consortium of over 20 leading United States (“U.S.”) newspaper publishing companies), are a subset of our Affiliates and are primarily Websites and search engines that attract users by providing content of interest, presented on Web pages that have space for advertisements.

 

To users, we provide owned and operated online properties and services (“Yahoo! Properties,” “Offerings,” or “Owned and Operated sites”). We also extend our marketing platform and access to Internet users beyond Yahoo! Properties through our distribution network of third-party entities (referred to as “Affiliates”) who have integrated our advertising offerings into their Websites (referred to as “Affiliate sites”) or their other offerings.

 

Our offerings to users currently fall into five categories — Front Doors; Search; Communications and Communities; Media; and Connected Life. The majority of our offerings are available in more than 20 languages.

 

We focus on expanding our communities of users and deepening their engagement on Yahoo! Properties to enhance the value of our users to advertisers and publishers and thereby increase the spending of advertisers through our Owned and Operated and Affiliate sites. We believe that we can expand our communities of users by offering compelling Internet services and effectively integrating search, community, personalization, and content to create a powerful user experience. We leverage our user relationships and the social community the users create to enhance our online advertising potential, as well as our fee-based services.

 

To advertisers and publishers, we provide a range of marketing solutions and tools that enable businesses to reach users who visit Yahoo! Properties and our Affiliate sites.

 

To developers, we provide an innovative and easily accessible array of Web Services and Application Programming Interfaces (“APIs”), technical resources, tools, and channels to market.

 

We generate revenues by providing marketing services to advertisers across a majority of Yahoo! Properties and Affiliate sites. Additionally, although many of our user services are free, we do charge for a range of premium services that we offer. We classify these revenues as either marketing services or fees revenues.

 

Yahoo! was developed and first made available in 1994 by our founders, David Filo and Jerry Yang, while they were graduate students at Stanford University. We were incorporated in 1995 and are a Delaware corporation. We are headquartered in Sunnyvale, California, and have offices in more than 20 countries, provinces, or territories in which Yahoo! conducts business by offering products or services to local audiences.

 

Yahoo! has embarked on a transformation to meet the needs of our users, advertisers, publishers, and developers. From our original goal as a guide to the Web, our goal today is to build the most open, robust, and vibrant online ad network on the Web to reach the largest and most engaged community of online users. We are currently focusing on three primary strategic multi-year objectives that will be the core of our strategy and operations for the next few years: become the starting point for users on the Internet; establish Yahoo! as the “must buy” for advertisers; and deliver industry-leading platforms that attract developers.

 

Management and Board of Directors Changes

 

During 2007, we made key changes to our executive leadership. Our Board of Directors (the “Board”) appointed Jerry Yang, Yahoo! co-founder and long-time board member, to succeed Terry Semel as Chief Executive Officer. The Board also named Susan Decker as President and Blake Jorgensen, co-founder of Thomas Weisel Partners, as Chief Financial Officer. Terry Semel served as non-executive Chairman of the Board until January 31, 2008. Roy Bostock was elected to serve as non-executive Chairman of our Board on January 31, 2008. Aristotle Balogh joined the Company as our new Chief Technology Officer on February 6, 2008 to lead Yahoo!’s global engineering organization and manage all technical operations.

2007 HIGHLIGHTS

 

The following are some of our key accomplishments during 2007 directed at furthering our objective of providing essential and relevant Internet services to users, advertisers, publishers, and developers:

 

Users — Engagement Services and Offerings

 

 

Advertisers — Marketing Solutions and Tools

 

 

Publishers — Alliances and Partnerships

 

 

 

We expect to continue to acquire or make investments in companies, products, services, and technologies in the future. See Note 3 — “Acquisitions” of the notes to the consolidated financial statements, which appears in Part II, Item 8 of this Annual Report on Form 10-K for additional information related to our acquisitions.

 

Our accomplishments are possible because of our dedicated, highly skilled, and talented employees. We believe that Yahoo! attracts among the most highly qualified and accomplished scientists, engineers, design specialists, marketers, and professionals. We seek to recruit and retain people who thrive on the opportunity Yahoo! provides to engage in technically challenging and innovative products that benefit our users across a range of areas.

 

WHAT WE OFFER OUR USERS

 

Our offerings to users on Yahoo! Properties currently fall into five categories: Front Doors, Search, Communications and Communities, Media, and Connected Life.

 

Front Doors

 

Our Front Doors offerings provide a navigation hub, a personalized start page, known as My Yahoo!, and a Web-browser add-on to users. Each of these is provided free of charge and acts as a starting point into Yahoo! Properties and the Web. Our Front Doors offerings generate revenues primarily from display advertising.

 

Our Front Doors offerings include Yahoo! Front Page, My Yahoo!, and Yahoo! Toolbar:

 

Yahoo! Front Page (www.yahoo.com) serves as a free navigation hub and starting point into the Yahoo! Properties. Among many available features on the page are the ability to perform a Web search, read the latest news, link to Yahoo! Websites, and view promotions from Yahoo!’s advertisers and publishers.

 

My Yahoo! is our free, personalized start page that allows registered members to create a personal profile and organizes and delivers information of personal interest to our users via a user-customized interface. Through personalization, the My Yahoo! platform allows us to deliver targeted advertising and transaction-based services on behalf of our advertisers and publishers.

 

Yahoo! Toolbar is a free Web browser add-on that enables users to conveniently access Yahoo! Properties from anywhere on the Web and provides free security services to enhance the user experience. In 2007, we released updated versions of the Internet Explorer toolbar and the Firefox toolbar, with improved features and the latest bookmarks functionality.

 

Search

 

Our Search offerings are often the starting point for our users navigating the Internet and searching for information, whether from their computer or a mobile device. In Search, our goal is to provide the most valued and trusted search experience for users, advertisers, and publishers. In the emerging areas of social search and media, our goal is to create the most desirable and relevant communities, large and small, to enable people to connect and exchange knowledge, insights, and experiences with each other. Social search and media enable users to leverage their network of friends, interests, and other trusted information sources to improve everyday Web browsing and

searching experiences. Yahoo! generates revenues primarily from users clicking on sponsored search links, paid inclusion, and directory.

 

Our Search offerings include the following:

 

 

Search

 

Yahoo! Search, our proprietary algorithmic search technology, provides users with a free comprehensive and highly relevant online search experience with search results sorted based on relevance to the user’s search query. Yahoo! Search discovers and processes content (including Web pages, documents, images, videos, and audio clips) on the Internet to give users a comprehensive, up-to-date, and relevant search experience. Pages on the Internet are ranked according to their relevance to a particular query by analyzing document features, including text, title and description accuracy, source, associated links, and other unique document characteristics. For example, if the user enters the phrase “hybrid car” into the Yahoo! Search box, the Yahoo! search technology will search its indexed Web pages and return links to what it identifies as the most relevant Websites regarding “hybrid car” on the Internet. A single search gives immediate results from a database that is updated frequently to capture newly created and changing pages, including late breaking news and timely events. The search might also return results from Yahoo! Answers, Yahoo! Video, or Flickr.

 

In 2007, Yahoo! Search launched Yahoo! Search Assist, its assistance technology that helps users refine searches to get straight to the answers they are looking for by offering suggested search terms. The size of the Yahoo! Search index, a measure of how much content from across the Web is searchable, continued to grow significantly making it among the largest search engines available, delivering a comprehensive, up-to-date, and relevant search experience.

 

To further extend our reach in social search products, we now provide users with easy ways to remember, search, organize, and share their favorite Websites and Web pages. Through the popular social bookmarking Website del.icio.us, users are able to access, manage, and share their favorite pages on the Internet from any computer.

 

Local

 

Our Local offerings include three individual search properties whose primary services are available free to users: Yahoo! Yellow Pages, Yahoo! Maps, and Yahoo! Local.

 

Yahoo! Yellow Pages enables users to quickly connect to local and national merchants in the U.S. through business address and phone listings. Yahoo! Yellow Pages generates revenues from our advertisers and publishers by serving sponsored business listings at the top of the search results page.

 

Yahoo! Maps provides interactive maps with zooming, real time traffic conditions, and accident reports, together with integrated driving directions. In 2007, we enhanced our offering with a new display format, customizable printed directions, and improved driving directions. We also released Yahoo! Maps in several additional countries, including Canada, France, India, Germany, and the United Kingdom, as well as a Spanish language version in the U.S. Yahoo! Maps generates revenues by showing display advertising on the site, as well as running “Business Locator” advertisements that automatically search for a particular business in the map view.

 

Yahoo! Local is a stand-alone offering, using content and technology from other properties such as Yahoo! Yellow Pages and Yahoo! Maps to help users find local business listings, recommendations, events, and user reviews. In 2007, we introduced a new layout focused on building our community of users and encouraging contribution of user-generated content, including reviews, helpfulness ratings, comments, and photos. The “City Guides” page was developed to surface popular listings, events, and information in the user’s local area. Yahoo! Local generates revenues from our advertisers and publishers by serving “Featured Listings” placements on our search results page, as well as offering “Enhanced Listings” with enhanced content on a business listings page.

Shopping

 

Yahoo! Shopping provides comprehensive search functionality and comparison-shopping tools for users to find, research, compare, and buy products online. This property also provides a full suite of merchant ratings, product review, and research tools compiled by user-generated and third-party sources. Kelkoo provides product search functionality and an online comparison shopping service with operations in 10 European countries and also powers the Yahoo! Shopping services in Australia and Taiwan. Yahoo! Shopping generates revenues from merchants when users click-through to their Websites and/or through a revenue share of the final selling value when users purchase products. A “click-through” occurs when a user clicks on an advertisers’ listing.

 

Travel

 

Yahoo! Travel is a comprehensive online travel research and booking site for users to find, compare, and conveniently purchase travel products such as airline tickets, hotel rooms, car rentals, vacation packages, and cruises. Yahoo! Travel also includes Yahoo! Trip Planner, a social media product that allows users to document their personal travel experiences with others. Yahoo! Travel generates revenues from our travel partners when users click-through to their Websites and/or through a revenue share of the booking value when users make travel arrangements on Yahoo! Travel.

 

Personals

 

Yahoo! Personals is a leading online dating service. It allows users, free of charge, to post a profile and search for others with whom to communicate within the Yahoo! Personals community. Users can also send short one-time messages to others to communicate their interest without charge. With a paid subscription, Yahoo! Personals’ users can e-mail and use Yahoo! Messenger to communicate with others in the Yahoo! Personals community. The standard Yahoo! Personals subscription service serves a large population of people with a user experience that is tailored to meet the communication needs of today’s online daters. In 2007, Yahoo! Personals was redesigned to deliver a fresh new look and provide easier access to mail and search results. Yahoo! Personals generates revenues primarily from premium user subscription fees.

 

Answers

 

Yahoo! Answers is an online community where anyone can ask and answer questions on any topic. It is a living repository for relevant information made up of real life experiences, advice, and opinions. Yahoo! Answers connects people to the information they are seeking with those who know it. Yahoo! Answers provides a global platform where users around the world share their experience and insight. Yahoo! Answers generates revenues primarily from display advertisements on the site.

 

Communications and Communities

 

Communications and Communities offerings provide a wide range of communication services to users and small businesses across a variety of devices and through our Yahoo! Broadband alliances. We offer some services free of charge to our users and also provide some of our services on a fee or subscription basis.

 

Our Communications and Communities offerings include the following:

 

 

Communications

 

Yahoo! Mail is a free service available in over 20 languages that provides users with a full-featured e-mail functionality and experience including industry-leading spam and virus protection, unlimited free storage, significant attachment size capacity, advanced search capabilities, and robust address book functionality. In addition to our basic e-mail service, for a subscription fee, we offer Yahoo! Mail Plus, a premium mail service providing a number of premium features, including access via e-mail applications such as Outlook, enhanced spam protection, additional attachment size capacity, and a display ad-free interface. In 2007, we released for general availability a new version of Yahoo! Mail that provides a faster experience with enhanced functionality, such as drag and drop e-mail organization and message previews. Yahoo! Mail generates revenues primarily from display advertising and premium user fees.

Zimbra Mail is a messaging and collaboration application for enterprise, service provider, education, and government environments. The powerful Web application integrates e-mail, contacts, shared calendar, and online documents into a single interface. In addition, the service offers seamless compatibility with other clients like Microsoft Outlook, Apple desktop suite, and Mozilla Thunderbird, and a mobility solution that works across a range of devices from the Blackberry to the iPhone. Zimbra Mail generates revenues by selling technology license fees for the application.

 

Yahoo! Messenger instant messaging service provides a free, interactive, and personalized way for people to connect and share experiences with their friends, family, and colleagues on a real-time basis. Yahoo! Messenger’s communications suite integrates leading Yahoo! services including Games, Music, Flickr, and Search. Yahoo! Messenger allows users to stay connected to each other through text IM, e-mail, voice, video, or mobile messaging. Yahoo! Messenger generates revenues primarily from display advertising.

 

Communities

 

Yahoo! Groups is a free service that enables people with shared interests to meet and stay connected and informed. The service provides members with shared access to information such as message archives, photo albums, event calendars, and polls. Yahoo! Groups generates revenues primarily from display advertising.

 

Yahoo! 360^o is a free service providing users with an integrated experience, seamlessly bringing together popular communications, content, and community services such as Yahoo! Messenger, Flickr, Yahoo! Music, and Yahoo! Groups with sharing tools for recommending favorite movies, restaurants, music, and more. Yahoo! 360^o generates revenues primarily from display advertising.

 

Flickr is an online photo management and sharing application that makes it easy for people to upload, store, organize, and share their photos with the people that matter most to them. In addition to the basic service, Flickr offers a premium service with unlimited storage, uploads, and an ad-free browsing and sharing interface. Flickr generates revenues primarily from premium account fees and display advertising.

 

Media

 

Our Media offerings deliver content that is available without charge to our users, and also provide content on a fee or subscription basis.

 

Our Media offerings include the following:

 

 

Information

 

Yahoo! News aggregates news stories from news providers such as the Associated Press, Reuters, Agence France-Presse (AFP), ABC News, CBS, CNN, and Fox News. Through Yahoo! News, users receive free up-to-the-minute news coverage with video, text, photos, and audio from multiple sources and points of view. Yahoo! News provides aggregated content for over 20 topical sections, including World News, US News, Elections, Health, Travel, and Business. In 2007, we launched People of the Web featuring original news coverage on the Internet about interesting people. Local news coverage was further expanded in 2007 bringing local news headlines from Yahoo!’s Newspaper Consortium partners to Yahoo!’s local news section. In 2007, Yahoo! acquired BuzzTracker, a news site that automatically generates news pages for a multitude of topics, both broad and narrow. The acquisition increases Yahoo!’s technological capabilities used to track a wide number of individual news topics.

 

Yahoo! Finance provides a comprehensive set of financial resources that range from investment and company information to personal financial management tools. Free tools are provided to help users manage their personal finances as well as gather data, news, and information for making informed investment decisions. Company conference call transcripts, analyst research reports, and real-time streaming quotes are available through Yahoo! Finance for a fee. Financial news and video coverage were further expanded in 2007 through relationships with a number of providers, including Fox Business News, CNBC, and Portfolio.

Yahoo! Sports provides a fast, live, and interactive online experience for sports fans across all major sports and all levels, from professional to high school and college. Yahoo! Sports offers original free and fee-based fantasy games, up-to-the-minute news, real-time statistics and scoring, broadcast programming, integrated shopping, and an online sports community. Yahoo! Sports has content and marketing relationships with professional sports organizations and media outlets including the National Football League, National Basketball Association, Major League Baseball, National Hockey League, Players Inc., Major League Baseball Players’ Association, Stats, Inc., and the Associated Press. Yahoo! Sports also produces its own original content, including sports stories from its team of exclusive writers and editors and video programming, which includes its SportStream and Fantasy Football Live shows, both of which are offered free to the viewer.

 

Rivals.com is a leading online provider of college and high school sports and recruiting information, primarily focused on football and basketball, that we acquired in 2007. Rivals.com maintains a network of more than 150 individual Websites.

 

Entertainment

 

Yahoo! Music offers a wide selection of free services, including music videos, streaming audio, Internet radio, exclusive artist features, and music news. Yahoo! Music also offers fee-based music services including premium Internet radio and music subscription services. Nissan Live Sets offers exclusive artist features, incorporating original artist performances with social networking elements, allowing users to submit photos, blog, and interact with the artists. In 2007, Yahoo! Music launched a free lyrics site on the Web allowing users to view selected lyrics, as well as new features such as local upcoming concert listings, increased personalization with audio and video playlists, exclusive content, and blogs from industry leaders.

 

Yahoo! Movies and Yahoo! TV offers free entertainment services which include exclusive video content such as trailers, clips and never-before-seen extras, entertainment news, photo galleries, and reviews. Yahoo! Movies features paid-for film promotions for major movie studios, including Disney, Fox, Sony, Universal, and Warner Brothers. Yahoo! Movies also provides coverage of the Oscars and other Red Carpet events. Yahoo! TV partners with key television networks, producers, and content creators to provide users a deeper, more engaging experience with their favorite programs, including guides to Fall TV, the Emmy Awards, and other high-profile television events.

 

Yahoo! Games offers free classic board, card, arcade, and word games along with downloadable games, Web games, game strategy guides, shopping guides, gaming news, tournaments, and leagues. The site also reviews the latest and most popular computer and console videogames, and features video content such as newly-released videogame trailers and exclusive video game walkthroughs. Our integration of games with Yahoo! Messenger allows users to see what games their friends are playing and join the game through Yahoo! Messenger. Yahoo! Games also offers a variety of fee-based premium game downloads and services.

 

Yahoo! Video is an online video destination that enables users to find, view, and share a broad array of professional and user-generated videos. The site also enables individual users and partners to upload video content directly to Yahoo! Video, where it can then be accessed by other users. The site is free and users can upload an unlimited amount of video content.

 

omg! is Yahoo!’s celebrity news site launched in June 2007. The site contains celebrity news and gossip, photo galleries and features, as well as interactive user polls. Content is provided by major news sources including Associated Press and Reuters as well as entertainment partners, X17, and Access Hollywood.

 

Lifestyles

 

Yahoo! Autos enables users to research, price, and compare cars online. Information and services available free of charge to our users include vehicle pricing, specification and option information, used car listings, expert reviews, user reviews and ratings, car comparisons, financing calculators, and new car quotes from dealers. We earn fees on a per lead basis for transactions completed between our users and automotive manufacturers and dealers. In 2007, we re-launched our used car listings section with a new partner, Cars.com.

 

Yahoo! Real Estate provides information and services for users who are looking to buy, sell, or rent a home. Users are able to search across multiple property types such as existing homes, new homes, apartment rentals, foreclosures, and classifieds. Yahoo! Real Estate offers decision-support tools such as interactive maps, home valuation

tools, financial calculators, and content about local neighborhoods, schools, home loans, foreclosures, and finding a real estate agent. Yahoo! Real Estate generates revenues from partners who pay to list their properties on our site.

 

Yahoo! Food is a one-stop online food destination. The site contains free recipes, chef and restaurant information, food video segments, and select blogs dedicated to food topics. Content is provided by recognized authorities and personalities in the food space. Yahoo! Food generates revenues primarily from display advertising.

 

Yahoo! Tech offers users a variety of free information on consumer electronics, including product comparisons and consumer reviews. Yahoo! Tech was developed with the simple philosophy of making technology easy for all Yahoo! users, especially those without a deep understanding of technology and gadgets. Yahoo! Tech generates revenues primarily from display advertising.

 

Yahoo! Kids is a free entertainment and educational Internet guide designed for children ages six to twelve. Yahoo! Kids offerings include games, reference materials, and movie information. Additionally, Yahoo! Kids includes a “study zone” section with resources for classroom and after class exploration. Yahoo! Kids generates revenues primarily from display advertising.

 

Yahoo! Health is a comprehensive healthcare destination. Yahoo! Health provides free information on healthy living, medical conditions, clinical trials, diet, and fitness. The site contains online community tools, complete with groups focused on popular health topics, as well as blogs provided by recognized experts. Yahoo! Health generates revenues primarily from display advertising.

 

Connected Life

 

Our Connected Life offerings include co-branded broadband, Yahoo! Mobile, Yahoo! Digital Home, and Yahoo! Desktop. Connected Life offers services designed to provide consumers with easy access to the open Internet and their Yahoo! content and communities across a variety of Internet-enabled devices including mobile, televisions, and personal computers (“PCs”).

 

Yahoo! Mobile’s goal is to connect people to Internet content via mobile devices and become the premier mobile Internet starting point for users, advertisers, and publishers. Throughout 2007, Yahoo! Mobile focused on creating experiences specifically built for the mobile environment by reinventing mobile search, creating open mobile platforms, and driving mobile advertising opportunities. In early 2007, Yahoo! launched oneSearch, a reinvention of mobile search that provides instant answers and relevant information. oneSearch is currently available in 20 countries. Over the course of the year, Yahoo! Mobile forged over 20 strategic partnerships for oneSearch with leading mobile operators around the world including Telefonica, America Movil, 3 Group, and Globe Telecom Inc. In 2007, we launched Yahoo! Go 2.0 in 17 countries across Europe, Asia, and the Americas. We generate fees revenues by distributing Yahoo! services through mobile operators and advertising revenues by selling mobile search and display advertising to Yahoo! advertising customers.

 

We grew our mobile advertising leadership with the launch of global display advertising in 20 countries and the expansion of search advertising in the U.S., United Kingdom, and Japan. We launched syndicated advertising on Vodafone as its exclusive partner in the United Kingdom. We have become the partner of choice to more than 30 clients, including Coca-Cola, Adidas, Hewlett Packard, Ford, Sony, Procter & Gamble, Hilton, and Paramount.

 

Yahoo! Digital Home is focused on creating the best consumer experiences around open content for television and other devices. In 2007, Yahoo! executed a multi-year development deal with Intel to develop an application for a new Intel digital home set top hardware device and to build consumer services to run on the new application. Other Yahoo! Digital Home initiatives include the launch of Sony’s Bravia Internet Video Link application in the U.S., Canada, and Mexico, and the availability of Yahoo! Sports for TV Major League Baseball to deliver contextual Internet content to enhance the television viewing experience. Yahoo! Digital Home generates revenues primarily from search and display advertising.

 

Yahoo! Desktop services make it easy for users to keep up-to-date on and to interact with their Yahoo! services and other Internet-based information on their PC desktop without using an Internet browser. Yahoo! Widgets is a platform that allows consumers to take advantage of more than 4,400 lightweight applications that may reside on a user’s PC desktop to perform a wide variety of tasks and provide access to an array of information. In 2007, we released Yahoo! Widgets 4.5, making it easier for consumers to discover Widgets and for developers to create them. Yahoo! Desktop generates revenues primarily from search and display advertising.

 

We also generate revenues from some of our marketing services and product offerings as discussed below.

 

HOW WE GENERATE REVENUES

 

As part of our strategy to provide the most efficient and effective marketing services for advertisers and publishers, we are committed to providing a comprehensive set of Internet marketing solutions. There is an ongoing growth in the advertising market and an increasing shift in advertisers’ and publishers’ use of online media, as communities shift toward the Internet from traditional media. We are committed to capitalizing on this shift and helping advertisers and publishers create and execute Internet marketing solutions that both enable users to interact with our advertisers’ and publishers’ brands as well as provide valuable insights to our advertisers and publishers about their customer base. We utilize our continuing research of the marketplace and our understanding of our users and their interests to offer a suite of targeted marketing services for our advertisers and publishers to meet the full range of their needs from brand building to consumer awareness, direct marketing, lead generation, commerce services, and ad inventory monetization. Our offerings enable marketers to display their advertisements in different formats and in different locations on Yahoo! Properties and on our Affiliate sites and to optimize their performance against their marketing objectives.

 

Advertisers and publishers can display advertisements on the pages that are viewed by users across Yahoo! Properties and on our Affiliate sites. Yahoo! offers a broad range of tools available for online display advertising, including rich media, video, and targeting. We work with our advertisers and publishers to maximize the effectiveness of their campaigns by optimizing advertising formats and placement on Yahoo! Properties or our Affiliate sites. We also use our targeting capabilities to help advertisers and publishers reach their desired communities by placing contextually relevant advertising on both our Owned and Operated sites and the sites of our Affiliate partners.

 

We generate revenues by providing marketing services to advertisers across a majority of Yahoo! Properties and Affiliate sites. The majority of our marketing services revenues is from sales of online display advertising. Revenues are generated from several offerings including: the display of rich media advertisements, display of text-based links to an advertiser’s Website, listing-based services, and commerce-based transactions.

 

We recognize revenues from the display of graphical advertisements (“display advertising”) on Yahoo! Properties and on Affiliate sites as “impressions” are delivered. An “impression” is delivered when an advertisement appears in pages viewed by users. We also recognize revenues from the display of text based links to the Websites of our advertisers (“search advertising”) which are placed on Yahoo! Properties and on Affiliate sites. We recognize revenues from these arrangements as “click-throughs” occur.

 

Marketing services revenues also include listings and transaction revenues. Listings revenues are generated from a variety of consumer and business listings-based services, including access to the Yahoo! HotJobs database and classified advertising such as Yahoo! Autos, Yahoo! Real Estate, and other services. We recognize listings revenues when the services are performed. Transaction revenues are generated from facilitating commercial transactions through Yahoo! Properties, principally from Yahoo! Travel and Yahoo! Shopping. We recognize transaction revenues when there is evidence that qualifying transactions have occurred, for example, when travel arrangements are booked through Yahoo! Travel.

 

Fees revenues consist of revenues generated from a variety of consumer and business fee-based services, including Internet broadband services, royalties received from joint venture partners, premium mail, music and personals offerings, as well as services for small businesses. We recognize fees revenues when the services are performed.

 

In 2006, we formed a strategic partnership with the Newspaper Consortium enabling the newspapers to provide advertisers who buy ads in any of the consortium’s newspapers the ability to also post their ads on Yahoo!’s advertising network. In 2007, we expanded the partnership to include over 20 leading U.S. newspaper publishing companies and more than 550 daily and weekly newspapers. We believe this arrangement will continue to expand a powerful local and national advertising marketplace, enabling advertisers to reach a larger, broader audience, and enabling newspapers to increase their overall monetization. In addition, Yahoo! places ads from Yahoo!’s advertisers on these newspapers’ sites. For these advertising services, we earn revenue as “impressions” are delivered.

 

We also provide advertising through a series of search offerings that enable advertisers to display text-based links to their Websites on Yahoo! Properties, as well as on our Affiliate sites. These advertisements are displayed in

response to different user actions — when a keyword is used in a search query initiated by a user or when specific content is being viewed by a user on Yahoo! Properties or on our Affiliate sites. For example, if a user searches using the keyword “television” in the Yahoo! Search box or the search box on the Website of one of our Affiliate sites, two sets of results will appear based upon algorithmic and sponsored search technology. Links to Websites for related advertisers will appear alongside the algorithmic search results. As another example, if the user is reading an article about interest rates, he or she may be presented with advertising links to Websites for mortgage-related advertisers. For these advertising services, we earn revenues when click-throughs occur.

 

As a result of the acquisition of Right Media in 2007, Yahoo! expanded its advertising marketplace to enable advertisers and publishers to find and utilize ad inventory in an open auction. We generate revenues from this exchange, by charging a fee to all exchange clients that participate in a transaction. Through the exchange, advertisers can select and bid on multiple display advertising opportunities across various publishers, enabling them to expand the reach and performance of their campaigns. Publishers can select which inventory they place into the open auction, increasing the potential monetization for their entire inventory. We expect the exchange to be a key component of Yahoo!’s future growth in marketing services by providing more options to advertisers and publishers as well as creating an even larger, more vibrant advertising marketplace.

 

In addition to offering marketing services to advertisers and publishers, we also provide the following services:

 

Yahoo! Broadband has partnered with a number of broadband Internet access providers to provide a suite of Internet services for their customers including portal, search, display advertising, and mail services. We have strategic partnerships with AT&T Inc. (“AT&T”) and Verizon Communications, Inc. in the U.S., BT Telecommunications PLC (“BT”) in the United Kingdom, and Rogers Cable Inc. (“Rogers”) in Canada. We also launched a broadband partnership with Telecom New Zealand in mid-2007. We renewed contracts with Rogers and BT in late 2007, which will be in effect in early 2008.

 

We have structured new Broadband Internet access partnerships to reflect current market dynamics and placed BT, Rogers, and AT&T among our key ad network partners with a revenue sharing model.

 

Yahoo! HotJobs is one of the leaders in the online recruiting industry, providing comprehensive solutions for employers, staffing firms, and job seekers. Yahoo! HotJobs’ tools and advice put job seekers in control of their career search and make it easier and more cost-effective for recruiters and employers to find qualified candidates compared to traditional methods. Yahoo! HotJobs enables job seekers to create an online resume and to search and apply for jobs, and provides access to newsletters, online forums, and salary research, free of charge. Yahoo! HotJobs generates revenues from employers and staffing firms that pay to access our database of job seekers and use our tools to post, track, and manage job openings.

 

Yahoo! Small Business provides a comprehensive and integrated suite of fee-based online services including Yahoo! Domains, Yahoo! Web Hosting, Yahoo! Business Mail, and our e-commerce platform called Yahoo! Merchant Solutions. By integrating one of the leading hosting solutions with business critical services and information, Yahoo! enables our Small Business Partners to easily get online, sell online, and market and promote online. Yahoo! Small Business generates revenues primarily from user subscription fees.

 

GLOBAL BUSINESS

 

We measure our business geographically based on two segments: the United States and International. Additional information required by this item is incorporated herein by reference to Note 15 — “Segments” of the notes to the consolidated financial statements, which appears in Part II, Item 8 of this Annual Report on Form 10-K.

 

We provide services in more than 20 languages in more than 30 countries, regions, and territories, including localized versions of Yahoo! in Argentina, Australia, Austria, Brazil, Canada, China, Finland, France, Germany, Greece, Hong Kong, India, Indonesia, Italy, Japan, Korea, Malaysia, Mexico, Netherlands, New Zealand, Philippines, Russia, Scandinavia (Denmark, Norway, Sweden), Singapore, Spain, Switzerland, Taiwan, Thailand, the United Kingdom and Ireland, the United States, and Vietnam.

 

Outside of native English speaking countries, we provide some of our most popular starting point services through Yahoo! Asia (our English Language portal to Southeast Asia), Yahoo! Chinese (United States Chinese language

site), Yahoo! Telemundo (United States Hispanic site), Yahoo! Canada en Français (French Canadian site), and Yahoo! en Català (part of Yahoo! Spain’s Catalan language offerings).

 

We own a majority or 100 percent interest in all of these international operations (except in Australia, New Zealand, China, and Japan where we have joint ventures and/or minority interests). We have established a network of offices worldwide to facilitate the development of the business globally and we continue to tailor our services and tools with local content and in local languages to meet the needs of our community of users, advertisers, publishers, and developers.

 

Revenue is primarily attributed to individual countries according to the international online property that generated the revenue.

 

SALES

 

We maintain three primary channels for selling our marketing services: direct, online, and telesales. Our direct advertising sales team focuses on selling our marketing services and solutions to leading advertising agencies and marketers in the U.S. We have combined our display and search marketing sales teams under common leadership to better respond to advertisers who are increasingly using both forms of advertising on Yahoo! Properties to achieve their desired marketing goals. Our online channel operates and is fulfilled by a self-service program that enables advertisers to place targeted text-based links to their Websites on Yahoo! Properties as well as on our Affiliate sites. Our telesales channel focuses on sales of marketing services to small-and medium-sized businesses.

 

We employ sales professionals in locations across the U.S., including Atlanta, Boston, Chicago, Dallas, Detroit, Hillsboro, Los Angeles, Miami, New York, San Francisco, and Sunnyvale. Our sales organization consults regularly with agencies and advertisers on design and placement of online advertising, and provides customers with measurements and analysis of advertising effectiveness as well as effective consumer insights that can be turned into marketing campaigns. In addition to our geographic sales structure, we have industry focused sales teams for automotive, consumer packaged goods, entertainment, finance, retail, pharmaceuticals, sports, technology, telecommunications, and travel. In the international markets, we have either our own internal sales professionals or we have established sales agency relationships in more than 30 countries.

 

No individual customer represented more than 10 percent of our revenues in 2005, 2006, or 2007.

 

MARKETING

 

The Yahoo! brand is one of the most widely recognized in the world. Maintaining and growing that brand enables us to attract, retain, and more deeply engage users, advertisers, publishers, and developers. We believe a great brand begins with a great product, services, and content. Yahoo! marketing engages in each step of product and services development, deployment, and management and content design to understand our offerings and how best to market them to our communities of potential and existing users. Our marketing communications’ efforts help accelerate product momentum, awareness, adoption, and engagement. We use online, television, print, radio, and outdoor advertising, and we leverage our global online network and our distribution partnerships to market our products and services to the right people at the right time. With continued investment in global brand and product marketing, we believe we can continue to attract and engage users, advertisers, publishers, and developers.

 

COMPETITION

 

We operate in the Internet products, services, and content markets, which are highly competitive and characterized by rapid change, converging technologies, and increasing competition from companies offering communication, information, and entertainment services integrated into other products and media properties.

 

We compete for users, advertisers, publishers, and developers with many other providers of online services, including Web businesses where expertise in a particular market segment may provide a competitive advantage and with social media and networking competitors. Ad networks (such as Google Inc.’s “Google” Ad sense, Ad.com, and Valueclick), which create specialized marketing solutions for specific advertiser or publishers segments, also compete with us for a share of marketing budgets.

We compete with companies to attract users and developers to Yahoo! Properties as well as attract advertisers and publishers to our marketing services. We expect the market to become increasingly competitive as online marketing continues to grow and gain acceptance on a global basis. The principal competitive factors relating to attracting and retaining users include the usefulness, accessibility, integration, and personalization of the online services that we offer, the quality and relevance of our search results, and the overall user experience on Yahoo! Properties.

 

The principal competitive factors relating to attracting advertisers and publishers are the reach, effectiveness, and efficiency of our marketing services as well as the creativity of the marketing solutions that we offer. Reach is the audience and/or demographic that the Yahoo! network can access. Effectiveness for advertisers is delivering against advertisers targets, measuring those achievements against those targets and optimizing for these across the Yahoo! network. Effectiveness for publishers is our advertising technology platforms and the monetization we are able to offer through our marketing services. Efficiency is simplifying the buying and reporting process across our entire network of Yahoo! and Partner properties for our advertisers and publishers.

 

Our most significant competition is from Google, Microsoft Corporation (“Microsoft”), and Time Warner’s America Online business (“AOL” or “America Online”). In addition, we compete with Facebook and News Corp., owner of MySpace, for users, developers, and advertisers. We also compete with many large traditional media companies such as Disney, CBS, and NBC as they increasingly focus on capturing advertising dollars from their online properties.

 

In international markets, we also compete with local portals that are predominantly supported by local telecommunication providers or local providers of specific locally designed and marketed Internet services, some of which may have a potential competitive advantage due to an existing direct billing relationship with their users.

 

Additional information regarding competition is included in Part I, Item 1A “Risk Factors” of this Annual Report on Form 10-K.

 

PRODUCT DEVELOPMENT

 

Yahoo! continually enhances, expands, and launches products and features to meet evolving user, advertiser, and publisher needs for technological innovation and a deeper, more integrated experience.

 

Most of our software products and features are developed internally. However, we purchase technology and license intellectual property rights when the opportunity is strategically aligned, operationally compatible and economically advantageous. We believe that Yahoo! is not materially dependent upon licenses and other agreements with third parties relating to product development.

 

Yahoo! launched its new search marketing system, known as Project Panama, in the fourth quarter of 2006. This system provides advertisers with additional tools for budgeting, testing, and optimizing their marketing campaigns. This new system also provides a new ranking model launched in early February 2007 as the second phase of Project Panama that ranks ads by relevance in addition to keyword bid price. We believe the new search marketing system provides a more relevant search experience to users, more valuable customer leads to advertisers, and additional opportunities to our distribution partners. We have completed the global roll-out of the technology across all relevant geographies.

 

In order to encourage a broad spirit of openness and innovation on the Yahoo! network of Websites, we sponsor programs such as the Yahoo! Developer network which makes Yahoo!’s infrastructure, platform, and communities accessible to third-parties via APIs. This has established a mutually beneficial environment, in which thousands of developers have used and built upon technology from Yahoo! services, including Yahoo! Search, Yahoo! Photos, and Yahoo! Maps to further increase the relevance of Yahoo! products and services for individual users and the greater community. Another example of this effort is the Hack Yahoo! Program, which is designed to encourage and empower employee and third-party innovation. This global program consists of a speaker series, an intranet site and blog, workshops, and quarterly “Hack Days” that are an ongoing opportunity to foster and celebrate the creativity of our employees and third parties.

 

As a complement to our core engineering and production teams, we also have scientists working in our Yahoo! Research Labs dedicated to developing novel algorithms and technology that empower users, businesses, and

advertisers worldwide to maximize the social and economic potential of the Internet. Yahoo! performs research to address fundamental problems facing users such as: making their search for information on the Internet easier and more relevant; bringing them tools to help solve their problems; finding new and better ways for them to connect and communicate with family and community; and guiding family and friends towards high-quality products, songs, movies, and other resources. We also use technology to match relevant business services with customers most likely to be interested in such services. Yahoo! Research Berkeley is a research facility that operates in a partnership between Yahoo! Research Labs and the University of California at Berkeley (“UCB”). We believe this is a mutually beneficial intellectual property arrangement, and an opportunity for students and staff at UCB to gain access to resource and scale typically not afforded in the academic environment. The mission of Yahoo! Research Berkeley is to explore and invent social media and mobile media technology and applications that will enable people to create, describe, share, find, and remix media on the Web.

 

Our engineering and production teams are primarily located in our Sunnyvale, California headquarters and in Bangalore, India and Burbank, California. Our research teams are located in our Sunnyvale, California headquarters and in Berkeley, California; Burbank, California; New York, New York; Barcelona, Spain; and Santiago, Chile. We have internally developed, acquired, or licensed the products and services we offer. Product development expenses for 2005, 2006, and 2007 totaled approximately $570 million, $833 million, and $1,084 million, respectively, which included stock-based compensation expense of $22 million, $145 million, and $218 million, respectively.

 

INTELLECTUAL PROPERTY

 

We create, own, and maintain a wide array of intellectual property assets that we believe are among our most valuable assets. Our intellectual property assets include patents and patent applications related to our innovations, products and services; trademarks related to our brands, products and services; copyrights in software and creative content; trade secrets; and other intellectual property rights and licenses of various kinds. We seek to protect our intellectual property assets through patent, copyright, trade secret, trademark and other laws of the U.S. and other countries, and through contractual provisions. We enter into confidentiality and invention assignment agreements with our employees and contractors, and non-disclosure agreements with third parties with whom we conduct business in order to secure our proprietary rights and additionally limit access to, and disclosure of, our proprietary information. We consider the Yahoo! trademark and our many related trademarks to be among our most valuable assets and we have registered these trademarks in the U.S. and other countries throughout the world and aggressively seek to protect them. We have licensed in the past, and expect that we may license in the future, certain of our proprietary rights, such as trademark, patent, copyright, and trade secret rights to third parties. Additional information regarding certain risks related to our intellectual property is included in Part I, Item 1A “Risk Factors” of this Annual Report on Form 10-K.

 

EMPLOYEES

 

As of December 31, 2007, we had approximately 14,300 full-time employees. Our future success is substantially dependent on the performance of our senior management and key technical personnel, as well as our continuing ability to attract, maintain the caliber of, and retain highly qualified technical and managerial personnel. Additional information regarding certain risks related to our employees is included in Part I, Item 1A “Risk Factors” of this Annual Report on Form 10-K.

 

AVAILABLE INFORMATION

 

Our Website is located at http://www.yahoo.com. Our investor relations Website is located at http://yhoo.client.shareholder.com/. We make available free of charge on our investor relations Website under “SEC Filings” our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and any amendments to those reports as soon as reasonably practicable after we electronically file or furnish such materials to the U.S. Securities and Exchange Commission (“SEC”). Further, a copy of this annual report on Form 10-K is located at the SEC’s Public Reference Room at 100 F Street, NE, Room 1580, Washington, D.C. 20549. Information on the operation of the Public Reference Room can be obtained by calling the SEC at

1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding our filings at http://www.sec.gov.

 

 

We face significant competition from large-scale Internet content, product and service aggregators, principally Google, Microsoft and AOL.

 

We face significant competition from companies, principally Google, Microsoft, and AOL, that have aggregated a variety of Internet products, services and content in a manner similar to Yahoo!. Google’s Internet search service directly competes with us for Affiliate and advertiser arrangements, both of which are key to our business and operating results. Microsoft’s Internet search service also directly competes with us for Affiliate and advertiser arrangements with paid search, and may release features that may make Internet searching capabilities a more integrated part of its Windows operating system. Additionally, Google and Microsoft both offer many other services that directly compete with our services, including consumer e-mail services, desktop search, local search, instant messaging, photos, maps, video sharing, content channels, mobile applications, and shopping services. AOL has access to content from Time Warner’s movie, television, music, book, periodical, news, sports, and other media holdings; access to a network of cable and other broadband users and delivery technologies; advertising offerings; and considerable resources for future growth and expansion. Some of the existing competitors and possible additional entrants may have greater operational, strategic, financial, personnel or other resources than we do, as well as greater brand recognition either overall or for certain products and services. We expect these competitors increasingly to use their financial and engineering resources to compete with us, individually and potentially in combination with each other. In certain of these cases, most notably AOL, our competition has a direct billing relationship with a greater number of their users through Internet access and other services than we have with our users through our premium services. This relationship may permit such competitors to be more effective than us in targeting services and advertisements to the specific preferences of their users thereby giving them a competitive advantage. If our competitors are more successful than we are in developing compelling products or attracting and retaining users, advertisers, or publishers, then our revenues and growth rates could decline.

 

We also face competition from other Internet service companies, including Internet access providers, device manufacturers offering online services, Internet advertising companies, and destination Websites.

 

Our users must access our services through Internet access providers, including wireless providers and providers of cable and broadband Internet access. To the extent that an access provider or device manufacturer offers online services competitive with those of Yahoo!, the user may elect to use the services or properties of that access provider or manufacturer. In addition, the access provider or manufacturer may make it difficult to access our services by not listing them in the access provider’s or manufacturer’s own directory or by providing Yahoo! with less prominent listings than the access provider, manufacturer, or a competitor’s offerings. Such access providers and manufacturers may prove better able to target services and advertisements to the preferences of their users. If such access providers and device manufacturers are more successful than we are in developing compelling products or attracting and retaining users or advertisers, then our revenues could decline. Further, to the extent that Internet access providers, mobile service providers or network providers increase the costs of service to users or restrict Yahoo!’s ability to deliver products, services and content to advertisers or end users or increase our costs of doing so, our revenues could decline.

 

We also compete for users and advertisers with many other providers of online services, including Internet advertising companies, destination Websites and social media and networking sites. Some of these competitors may have more expertise in a particular segment of the market, and within such segment, have longer operating histories, larger advertiser or user bases, and more brand recognition or technological features than we offer.

 

In the future, competitors may acquire additional competitive offerings, and if we are unable to complete strategic acquisitions or investments, our business could become less competitive. Further, competitors may consolidate with each other to become more competitive, and new competitors may enter the market. If our competitors are more successful than we are in developing compelling products or attracting and retaining users, advertisers or publishers, then our revenues and growth rates could decline.

We face significant competition from traditional media companies which could adversely affect our future operating results.

 

We also compete with traditional media companies for advertising, both offline as well as increasingly with their online assets as media companies offer more content directly from their own Websites. Most advertisers currently spend only a small portion of their advertising budgets on Internet advertising. If we fail to persuade existing advertisers to retain and increase their spending with us and if we fail to persuade new advertisers to spend a portion of their budget on advertising with us, our revenues could decline and our future operating results could be adversely affected.

 

If we are unable to provide search technologies and other services which generate significant traffic to our Websites, or we are unable to enter into or continue distribution relationships that drive significant traffic to our Websites, our business could be harmed, causing our revenues to decline.

 

We have deployed our own Internet search technology to provide search results on our network. We have more limited experience in operating our own search service than do some of our competitors. Internet search is characterized by rapidly changing technology, significant competition, evolving industry standards and frequent product and service enhancements. We must continually invest in improving our users’ experience, including search relevance, speed, and services responsive to users’ needs and preferences, to continue to attract, retain and expand our user base. If we are unable to provide search technologies and other services which generate significant traffic to our Websites, or if we are unable to enter into distribution relationships that continue to drive significant traffic to our Websites, our business could be harmed, causing our revenues to decline.

 

The majority of our revenues are derived from marketing services, and the reduction in spending by or loss of current or potential advertisers would cause our revenues and operating results to decline.

 

For the year ended December 31, 2007, 87 percent of our total revenues came from marketing services. Our ability to continue to retain and grow marketing services revenue depends upon:

 

 

In many cases, our agreements with advertisers have terms of one year or less, or, in the case of search marketing, may be terminated at any time by the advertiser. Search marketing agreements often have payments dependent upon usage or click-through levels. Accordingly, it is difficult to forecast marketing services revenues accurately. In addition, our expense levels are based in part on expectations of future revenues, including occasional guaranteed minimum payments to our Affiliates in connection with search and/or display advertising, and are fixed over the short-term with respect to certain categories. Any reduction in spending by or loss of existing or potential future advertisers would cause our revenues to decline. Further, we may be unable to adjust spending quickly enough to compensate for any unexpected revenue shortfall.

In certain markets, we depend on a limited number of sources to direct a significant percentage of users and businesses to our service to conduct searches and a loss of any of these sources could harm our operating results.

 

A significant percentage of users and businesses that conduct searches and access our search marketing listings come from a limited number of sources in certain markets. In addition to Yahoo! Properties, sources for users are members of our Affiliate network, including portals, browsers and other Affiliates. Our agreements with Affiliates vary in duration, and depending on the agreement, provide varying levels of discretion to the Affiliate in the implementation of search marketing, including the degree to which Affiliates can modify the presentation of the search marketing listings on their Websites or integrate search marketing with their own services. The agreements may be terminable upon the occurrence of certain events, including failure to meet certain service levels, material breaches of agreement terms, changes in control or in some instances, at will. We may not be successful in renewing our Affiliate agreements on as favorable terms or at all. The loss of Affiliates providing significant users or businesses or an adverse change in implementation of search marketing by any of these Affiliates could harm our ability to generate revenue, our operating results and cash flows from operations.

 

We may not be able to generate substantial revenues from our alliances with Internet access providers.

 

Through alliances with Internet access providers, we offer access services that combine customized content and services from Yahoo! (including browser and other communications services) and Internet access from third-party access providers. We may not be able to retain the alliances with our existing Internet access providers or to obtain new alliances with Internet access providers on terms that are reasonable. In addition, these Internet access services compete with many large companies such as AOL, Microsoft, Comcast Corporation and other established Internet access providers. In certain of these cases, our competition has substantially greater market presence (including an existing user base) and greater financial, technical, marketing or other resources. As a result of these and other competitive factors, the Internet access providers with which we have formed alliances may not be able to attract, grow or retain their user bases, which would negatively impact our ability to sell customized content and services through this channel and, in turn, reduce our anticipated revenues from our alliances.

 

Some of our shared revenue arrangements may not generate anticipated revenues.

 

We typically receive co-branded revenue through revenue sharing arrangements or a portion of transactions revenue. In some cases, our revenue arrangements require that minimum levels of user impressions be provided by us. These arrangements expose us to potentially significant financial risks in the event our usage levels decrease, including the following:

 

 

Accordingly, any leveling off or decrease of our user base (or usage by our existing base) or the failure to generate anticipated levels of shared transactions revenue could result in a significant decrease in our revenues.

 

Decreases or delays in advertising spending by our advertisers due to general economic conditions could harm our ability to generate advertising revenues.

 

Expenditures by advertisers tend to be cyclical, reflecting overall economic conditions and budgeting and buying patterns. Since we derive most of our revenues from advertising, any decreases in or delays in advertising spending due to general economic conditions could reduce our revenues or negatively impact our ability to grow our revenues.

Financial results for any particular period do not predict results for future periods.

 

There can be no assurance that the purchasing pattern of advertisers on Yahoo! Properties will not fluctuate, that advertisers will not make smaller and shorter-term purchases, or that market prices for online advertising will not decrease due to competitive or other factors. In addition, there can be no assurance that the volume of searches conducted, the amounts bid by advertisers for search marketing listings or the number of advertisers that bid in our search marketing marketplace will not vary widely from period to period. As revenues from new sources increase, it may become more difficult to predict our financial results based on historical performance. You should not rely on the results for any period as an indication of future performance.

 

We estimate tax liabilities, the final determination of which is subject to review by domestic and international taxation authorities.

 

We are subject to income taxes and other taxes in both the U.S. and the foreign jurisdictions in which we currently operate or have historically operated. We are also subject to review and audit by both domestic and foreign taxation authorities. The determination of our worldwide provision for income taxes and current and deferred tax assets and liabilities requires judgment and estimation. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. Although we believe our tax estimates are reasonable, the ultimate tax outcome may materially differ from the tax amounts recorded in our consolidated financial statements and may materially affect our income tax provision, net income or cash flows in the period or periods for which such determination is made.

 

We rely on the value of our brands, and a failure to maintain or enhance the Yahoo! brands in a cost-effective manner could harm our operating results.

 

We believe that maintaining and enhancing our brands, including those that contain the Yahoo! name as well as those that do not, is an important aspect of our efforts to attract and expand our user, advertiser, and Affiliate base. We also believe that the importance of brand recognition will increase due to the relatively low barriers to entry in the Internet market. We have spent considerable money and resources to date on the establishment and maintenance of our brands, and we anticipate spending increasing amounts of money on, and devoting greater resources to, advertising, marketing and other brand-building efforts to preserve and enhance consumer awareness of our brands. We may not be able to successfully maintain or enhance consumer awareness of our brands and, even if we are successful in our branding efforts, these efforts may not be cost-effective. If we are unable to maintain or enhance customer awareness of our brands in a cost-effective manner, our business, operating results and financial condition could be harmed.

 

If we are unable to license or acquire compelling content at reasonable cost or if we do not develop or commission compelling content of our own, the number of users of our services may not grow as anticipated, or may decline, or users’ level of engagement with our services may decline, all or any of which could harm our operating results.

 

Our future success depends in part upon our ability to aggregate compelling content and deliver that content through our online properties. We license much of the content on our online properties, such as news items, stock quotes, weather reports, maps and audio and video content from third parties. We have been providing increasing amounts of audio and video content to our users, and we believe that users will increasingly demand high-quality audio and video content, such as music, film, speeches, news footage, concerts and other special events. Such content may require us to make substantial payments to third parties from whom we license or acquire such content. For example, our music and entertainment properties rely on major sports organizations, radio and television stations, record labels, music publishers, cable networks, businesses, colleges and universities, film producers and distributors, and other organizations for a large portion of the content available on our properties. Our ability to maintain and build relationships with third-party content providers will be critical to our success. In addition, as new methods for accessing the Internet become available, including through alternative devices, we may need to enter into amended content agreements with existing third-party content providers to cover the new devices. Also, to the extent that Yahoo! develops content of its own, Yahoo!’s current and potential third-party content providers may view our services as competitive with their own, and this may adversely affect their willingness to contract with us.

We may be unable to enter into new, or preserve existing, relationships with the third parties whose content we seek to obtain. In addition, as competition for compelling content increases both domestically and internationally, our content providers may increase the prices at which they offer their content to us, and potential content providers may not offer their content to us at all or may offer it on terms that are not agreeable to us. An increase in the prices charged to us by third-party content providers could harm our operating results and financial condition. Further, many of our content licenses with third parties are non-exclusive. Accordingly, other Webcasters and other media providers, such as radio or television providers, may be able to offer similar or identical content. This increases the importance of our ability to deliver compelling editorial content and personalization of this content for users in order to differentiate Yahoo! from other businesses. If we are unable to license or acquire compelling content at reasonable prices, if other companies broadcast content that is similar to or the same as that provided by Yahoo!, or if we do not develop compelling editorial content or personalization services, the number of users of our services may not grow as anticipated, or may decline, which could harm our operating results.

 

Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our brand image and harm our business and our operating results.

 

We create, own and maintain a wide array of intellectual property assets, including copyrights, patents, trademarks, trade dress, trade secrets and rights to certain domain names, which we believe are among our most valuable assets. We seek to protect our intellectual property assets through patent, copyright, trade secret, trademark and other laws of the U.S. and other countries of the world, and through contractual provisions. The efforts we have taken to protect our intellectual property and proprietary rights may not be sufficient or effective at stopping unauthorized use of those rights. In addition, effective trademark, patent, copyright and trade secret protection may not be available or cost-effective in every country in which our products and media properties are distributed or made available through the Internet. There may be instances where we are not able to fully protect or utilize our intellectual property assets in a manner to maximize competitive advantages. Further, while we attempt to ensure that the quality of our brand is maintained by our licensees, our licensees may take actions that could impair the value of our brand, our proprietary rights or the reputation of our products and media properties. We are aware that third parties have, from time to time, misused or exploited our brands without permission or copied significant content available on Yahoo! for use in competitive Internet services. Protection of the distinctive elements of Yahoo! may not be available under copyright law or trademark law. If we are unable to protect our proprietary rights from unauthorized use, the value of our brand image may be reduced. Any impairment of our brand could negatively impact our business. In addition, protecting our intellectual property and other proprietary rights is expensive and time consuming. Any increase in the unauthorized use of our intellectual property could make it more expensive to do business and consequently harm our operating results.

 

We are, and may in the future be, subject to intellectual property infringement claims, which are costly to defend, could result in significant damage awards, and could limit our ability to provide certain content or use certain technologies in the future.

 

Internet, technology, media companies and patent holding companies often possess a significant number of patents. Further, many of these companies and other parties are actively developing or purchasing search, indexing, electronic commerce and other Internet-related technologies, as well as a variety of online business models and methods. We believe that these parties will continue to take steps to protect these technologies, including, but not limited to, seeking patent protection. In addition, patent holding companies may continue to seek to monetize patents they have purchased or otherwise obtained. As a result, disputes regarding the ownership of technologies and rights associated with online business are likely to continue to arise in the future. From time to time, parties assert patent infringement claims against us. Currently, we are engaged in a number of lawsuits regarding patent issues and have been notified of a number of other potential disputes.

 

In addition to patent claims, third parties have asserted, and are likely in the future to assert, claims against us alleging infringement of copyrights, trademark rights, trade secret rights or other proprietary rights, or alleging unfair competition or violations of privacy rights or failure to maintain confidentiality of user data. In addition, third parties have made, and may continue to make, trademark infringement and related claims against us over the display of search results triggered by search terms that include trademark terms.

As we expand our business and develop new technologies, products and services, we may become increasingly subject to intellectual property infringement claims. In the event that there is a determination that we have infringed third-party proprietary rights such as patents, copyrights, trademark rights, trade secret rights or other third-party rights such as publicity and privacy rights, we could incur substantial monetary liability, be required to enter into costly royalty or licensing agreements or be prevented from using such rights, which could require us to change our business practices in the future and limit our ability to compete effectively. We may also incur substantial expenses in defending against third-party infringement claims regardless of the merit of such claims. In addition, many of our agreements with our customers or Affiliates require us to indemnify them for certain third-party intellectual property infringement claims, which could increase our costs in defending such claims and our damages. The occurrence of any of these results could harm our brand and negatively impact our operating results.

 

We are subject to U.S. and foreign government regulation of Internet, mobile, and Voice over Internet Protocol services which could subject us to claims, judgments and remedies including monetary liabilities and limitations on our business practices.

 

We are subject to regulations and laws directly applicable to providers of Internet, mobile, and Voice over Internet Protocol services both domestically and internationally. The application of existing domestic and international laws and regulations to Yahoo! relating to issues such as user privacy and data protection, defamation, pricing, advertising, taxation, gambling, sweepstakes, promotions, billing, real estate, consumer protection, content regulation, quality of services, telecommunications, mobile and intellectual property ownership and infringement in many instances is unclear or unsettled. In addition, we will also be subject to any new laws and regulations directly applicable to our domestic and international activities. Further, the application of existing laws to Yahoo! or our subsidiaries regulating or requiring licenses for certain businesses of our advertisers including, for example, distribution of pharmaceuticals, alcohol, adult content, tobacco or firearms, as well as insurance and securities brokerage and legal services, can be unclear. Internationally, we may also be subject to laws regulating our activities in foreign countries and to foreign laws and regulations that are inconsistent from country to country. Recently, plaintiffs have attempted to use U.S. statutes in efforts to recover damages against corporations, including Yahoo!, for alleged human rights abuses committed by foreign governments. We may incur substantial liabilities for expenses necessary to defend such litigation or to comply with these laws and regulations, as well as potential substantial penalties for any failure to comply. Compliance with these laws and regulations may also cause us to change or limit our business practices in a manner adverse to our business.

 

A number of U.S. federal laws, including those referenced below, impact our business. The Digital Millennium Copyright Act (“DMCA”) is intended, in part, to limit the liability of eligible online service providers for listing or linking to third-party Websites that include materials that infringe copyrights or other rights of others. Portions of the Communications Decency Act (“CDA”) are intended to provide statutory protections to online service providers who distribute third-party content. Yahoo! relies on the protections provided by both the DMCA and CDA in conducting its business. Any changes in these laws or judicial interpretations narrowing their protections will subject us to greater risk of liability and may increase our costs of compliance with these regulations or limit our ability to operate certain lines of business. The Children’s Online Protection Act and the Children’s Online Privacy Protection Act are intended to restrict the distribution of certain materials deemed harmful to children and impose additional restrictions on the ability of online services to collect user information from minors. In addition, the Protection of Children From Sexual Predators Act of 1998 requires online service providers to report evidence of violations of federal child pornography laws under certain circumstances. The costs of compliance with these regulations may increase in the future as a result of changes in the regulations or the interpretation of them. Further, any failure on our part to comply with these regulations may subject us to significant liabilities.

 

Changes in regulations or user concerns regarding privacy and protection of user data could adversely affect our business.

 

Federal, state, foreign and international laws and regulations may govern the collection, use, retention, sharing and security of data that we receive from our users, advertisers, and Affiliates. In addition, we have and post on our Website our own privacy policies and practices concerning the collection, use and disclosure of user data. Any failure, or perceived failure, by us to comply with our posted privacy policies or with any data-related consent orders, Federal Trade Commission requirements or orders or other federal, state or international privacy or

consumer protection-related laws, regulations or industry self-regulatory principles could result in proceedings or actions against us by governmental entities or others, which could potentially have an adverse effect on our business.

 

Further, failure or perceived failure by us to comply with our policies, applicable requirements, or industry self-regulatory principles related to the collection, use, sharing or security of personal information or other privacy-related matters could result in a loss of user confidence in us, damage to the Yahoo! brands, and ultimately in a loss of users, advertisers, or Affiliates which could adversely affect our business.

 

A large number of legislative proposals pending before the U.S. Congress, various state legislative bodies and foreign governments concern data privacy and retention issues related to our business. It is not possible to predict whether or when such legislation may be adopted. Certain proposals, if adopted, could impose requirements that may result in a decrease in our user registrations and revenues. In addition, the interpretation and application of user data protection laws are currently unsettled. These laws may be interpreted and applied inconsistently from country to country and inconsistently with our current data protection policies and practices. Complying with these varying international requirements could cause us to incur substantial costs or require us to change our business practices in a manner adverse to our business.

 

Acquisitions and strategic investments could result in adverse impacts on our operations and in unanticipated liabilities.

 

We have acquired, and have made strategic investments in, a number of companies (including through joint ventures) in the past, and we expect to make additional acquisitions and strategic investments in the future. Such transactions may result in dilutive issuances of our equity securities, use of our cash resources, and incurrence of debt and amortization expenses related to intangible assets. Our acquisitions and strategic investments to date were accompanied by a number of risks, including:

 

 

We are likely to experience similar risks in connection with our future acquisitions and strategic investments. Our failure to be successful in addressing these risks or other problems encountered in connection with our past or future acquisitions and strategic investments could cause us to fail to realize the anticipated benefits of such acquisitions or investments, incur unanticipated liabilities and harm our business generally.

 

Our failure to manage growth, diversification and changes to our business could harm us.

 

We are continuing to grow, diversify and evolve our business both in the U.S. and internationally. As a result of the diversification of our business, personnel growth, acquisitions and international expansion in recent years, more than one-half of our employees are now based outside of our Sunnyvale, California headquarters. If we are unable to effectively manage a large and geographically dispersed group of employees or to anticipate our future growth and personnel needs, our business may be adversely affected.

 

As we grow and diversify our business, we must also expand and adapt our operational infrastructure. Our business relies on our data systems, billing systems, and other operational and financial reporting and control systems. All of these systems have become increasingly complex in the recent past due to the growing diversification and complexity of our business, to acquisitions of new businesses with different systems and to increased regulation over controls and procedures. To effectively manage our technical support infrastructure, we will need to continue to upgrade and improve our data systems, billing systems, and other operational and financial systems, procedures and controls. In particular, any failure of our billing systems to accommodate increasing numbers of transactions and accurately bill users, advertisers, and Affiliates could adversely affect our business and ability to collect revenue. These upgrades and improvements will require a dedication of resources and in some cases are likely to be complex. If we are unable to adapt our systems in a timely manner to accommodate our growth, our business may be adversely affected.

 

We have announced and are currently implementing on-going strategic initiatives to better and more efficiently manage our business. Implementing these initiatives requires significant time and resource commitments from our senior management. In the event that we are unable to effectively implement these initiatives, we are unable to recruit, maintain the caliber of, or retain key employees as a result of these initiatives or these initiatives do not yield the anticipated benefits, our business may be adversely affected.

 

We have dedicated considerable resources to provide a variety of premium services, which may not prove to be successful in generating significant revenue for us.

 

We offer fee-based enhancements to many of our free services, including e-mail, personals, finance, games, music and sports. The development cycles for these technologies are long and generally require significant investment by us. We have and will continue to invest in new products and services. Some of these new products and services may not be profitable or may not meet anticipated user adoption rates. We have previously discontinued certain non-profitable premium services and may discontinue others. We must, however, continue to provide new services that are compelling to our users while continuing to develop an effective method for generating revenues for such services. General economic conditions as well as the rapidly evolving competitive landscape may affect users’ willingness to pay for such services. If we cannot generate revenues from these services that are greater than the cost of providing such services, our operating results could be harmed.

 

If our operating expenses continue to increase at a rate faster than we grow revenues as we attempt to expand the Yahoo! brand, fund product development, develop media properties and acquire other businesses or technologies, our operating results could be reduced.

 

We currently expect that our operating expenses will continue to increase as we expand our operations in areas of expected growth, continue to develop and extend the Yahoo! brand, fund greater levels of product development, develop and commercialize additional media properties and premium services, and acquire and integrate complementary businesses and technologies. If our expenses continue to increase at a greater pace than our revenues, our operating results could be reduced.

If we are unable to maintain the caliber of our existing senior management and key personnel and to hire new highly skilled personnel, we may not be able to execute our business plan.

 

We are substantially dependent on the continued services of our senior management who have acquired specialized knowledge and skills with respect to Yahoo! and its operations. The loss of any of these individuals could harm our business. Our business is also dependent on our ability to retain, attract, hire and motivate talented, highly skilled personnel. Achieving this objective may be difficult due to many factors, including the intense competition for such highly skilled personnel in the San Francisco Bay Area, where our corporate headquarters and the headquarters of several of our vertical and horizontal competitors, are located, fluctuations in global economic and industry conditions, changes in Yahoo!’s management or leadership, competitors’ hiring practices, and the effectiveness of our compensation programs. If we do not succeed in recruiting, retaining and motivating our key employees and in attracting new key personnel, we may be unable to meet our business plan and as a result, our stock price may decline.

 

More individuals are utilizing non-Personal Computer (“PC”), devices to access the Internet and our services, and versions of our services developed or optimized for these devices may not gain widespread adoption by users, manufacturers or distributors of such devices or may not work on these devices, based on the broad range of unique technical requirements that may be established for each device by their manufacturers and distributors globally.

 

The number of individuals who access the Internet through devices other than a PC, such as personal digital assistants, mobile telephones, televisions and set-top box devices, has increased dramatically, and the trend is likely to continue. Our services were originally designed for rich, graphical environments such as those available on desktop and the PC. The lower resolution, functionality and memory associated with alternative devices currently available may make the use of our services through such devices difficult, and the versions of our services developed for these devices may not be compelling to users, manufacturers or distributors of alternative devices. Each manufacturer or distributor may establish unique technical standards for its devices, and our services may not work or be viewable on these devices as a result. As we have limited experience to date in operating versions of our services developed or optimized for users of alternative devices, and as new devices and new platforms are continually being released, it is difficult to predict the problems we may encounter in developing versions of our services for use on these alternative devices, and we may need to devote significant resources to the creation, support and maintenance of such versions. We may be unable to attract and retain a substantial number of alternative device manufacturers, distributors, and users to our services, or to capture a sufficient share of an increasingly important portion of the market for these services, and, therefore, we may be unsuccessful in attracting both advertisers and premium service subscribers to these services.

 

We plan to expand operations in international markets in which we may have limited experience or rely on business partners.

 

We plan to expand Yahoo! branded online properties and search offerings in international markets. We have currently developed, through joint ventures, strategic investments, subsidiaries and branch offices, localized offerings in over 20 countries outside of the United States. As we expand into new international markets, we will have only limited experience in marketing and operating our products and services in such markets. In other instances, we may rely on the efforts and abilities of foreign business partners in such markets. Certain international markets may be slower than domestic markets in adopting the Internet as an advertising and commerce medium and so our operations in international markets may not develop at a rate that supports our level of investment.

 

In international markets we compete with local Internet service providers that may have competitive advantages.

 

In a number of international markets, especially those in Asia, Europe and Latin America, we face substantial competition from local Internet service providers and other portals that offer search, communications and other commercial services. Many of these companies have a dominant market share in their territories and are owned by local telecommunications providers which give them a competitive advantage. Local providers of competing online services may also have a substantial advantage over us in attracting users in their country due to more

established branding in that country, greater knowledge with respect to the tastes and preferences of users residing in that country and/or their focus on a single market. Further, the local providers may have greater regulatory and operational flexibility than Yahoo! due to the fact that we are subject to both U.S. and foreign regulatory requirements. We must continue to improve our local offerings, become more knowledgeable about our local users and their preferences, deepen our relationships with our local users as well as increase our branding and other marketing activities in order to remain competitive and strengthen our international market position.

 

Our international operations are subject to increased risks which could harm our business, operating results and financial condition.

 

In addition to uncertainty about our ability to continue to generate revenues from our foreign operations and expand our international market position, there are certain risks inherent in doing business internationally, including:

 

 

One or more of these factors could harm our future international operations and consequently, could harm our brand, business, operating results, and financial condition.

 

We may be subject to legal liability for online services.

 

We host a wide variety of services that enable individuals and businesses to exchange information, generate content, advertise products and services, conduct business, and engage in various online activities on a domestic and an international basis. The law relating to the liability of providers of these online services for activities of their users is currently unsettled both within the U.S. and internationally. Claims have been threatened and have been brought against us for defamation, negligence, copyright or trademark infringement, unlawful activity, tort, including personal injury, fraud, or other theories based on the nature and content of information to which we provide links or that may be posted online or generated by our users. In addition, Yahoo! has been and may again in the future be subject to domestic or international actions alleging that the availability of certain content within our services violates laws in domestic and international jurisdictions. Defense of any such actions could be costly and involve significant time and attention of our management and other resources.

 

We also periodically enter into arrangements to offer third-party products, services or content under the Yahoo! brand or via distribution on Yahoo! Properties, including stock quotes and trading information. We may be subject to claims concerning these products, services or content by virtue of our involvement in marketing, branding, broadcasting or providing access to them, even if we do not ourselves host, operate, provide, or provide access to these products, services or content. While our agreements with respect to these products, services and content, often provide that we will be indemnified against such liabilities, the ability to receive such indemnification depends on

the financial resources of the other party to the agreement and any amounts received may not be adequate to cover our liabilities.

 

It is also possible that if any information provided directly by us contains errors or is otherwise negligently provided to users, third parties could make claims against us. For example, we offer Web-based e-mail services, which expose us to potential risks, such as liabilities or claims resulting from unsolicited e-mail, lost or misdirected messages, illegal or fraudulent use of e-mail, or interruptions or delays in e-mail service. We may also face purported consumer class action suits relating to our online services, including our fee-based services. In addition, our customers, third parties or government entities may assert claims or actions against us if our online services are used by third parties to spread or facilitate malicious or harmful applications. Investigating and defending any of these types of claims is expensive, even to the extent that the claims are without merit or do not ultimately result in liability, could subject us to significant monetary liability or cause a change in business practices that could impact our ability to compete.

 

We may have difficulty scaling and adapting our existing technology architecture to accommodate increased traffic and technology advances or requirements of our users, advertisers and publishers.

 

As one of the most highly trafficked Websites on the Internet, Yahoo! delivers a growing number of products, services and page views to an increasing number of users around the world. In addition, the products and services offered by Yahoo! have expanded and changed significantly and are expected to continue to expand and change rapidly in the future to accommodate new technologies and new means of content delivery, such as rich media, audio and video. Our future success will depend on our ability to adapt to rapidly changing technologies, to adapt our products and services to evolving industry standards and to improve the performance and reliability of our products and services. Rapid increases in the levels or types of use of our online properties and services could result in delays or interruptions in our service.

 

Widespread adoption of new Internet, networking or telecommunications technologies or other technological changes could require substantial expenditures to modify or adapt our services or infrastructure. The technology architectures utilized for our services are highly complex and may not provide satisfactory support in the future, as usage increases and products and services expand, change and become more complex. In the future, we may make changes to our architectures and systems, including moving to completely new architectures and systems. Such changes may be technologically challenging to develop and implement, may take time to test and deploy, may cause us to incur substantial costs or data loss, and may cause users, advertisers, and Affiliates to experience delays or interruptions in our service. These changes, delays or interruptions in our service may cause users, advertisers and Affiliates to become dissatisfied with our service and move to competing providers of online services or to engage in litigation. Further, to the extent that demands for our services increase, we will need to expand our infrastructure, including the capacity of our hardware servers and the sophistication of our software. This expansion is likely to be expensive and complex and require additional technical expertise. As we acquire users who rely upon us for a wide variety of services, it becomes more technologically complex and costly to retrieve, store and integrate data that will enable us to track each user’s preferences. Any difficulties experienced in adapting our architectures and infrastructure to accommodate increased traffic, to store user data and track user preferences, together with the associated costs and potential loss of traffic, could harm our operating results, cash flows from operations and financial condition.

 

Our business depends on the continued growth and maintenance of the Internet infrastructure.

 

The success and the availability of our Internet-based products and services depends in part upon the continued growth and maintenance of the Internet infrastructure itself, including its protocols, architecture, network backbone, data capacity and security. Spam, viruses, worms, spyware, denial of service attacks, phishing, and other acts of malice may affect not only the Internet’s speed, reliability and availability but also its continued desirability as a vehicle for commerce, information and user engagement. If the Internet proves unable to meet the new threats and increased demands placed upon it, our business plans, user and advertiser relationships, site traffic and revenues could be adversely affected.

New technologies could block our advertisements or our search marketing listings, which would harm our operating results.

 

Technologies have been developed and are likely to continue to be developed that can block the display of our advertisements or our search marketing listings. Most of our revenues are derived from fees paid to us by advertisers in connection with the display of advertisements or our search marketing listings on Web pages. As a result, advertisement-blocking technology could reduce the number of advertisements and search results that we are able to deliver and, in turn, our advertising revenues and operating results.

 

We rely on third-party providers for our principal Internet connections and technologies, databases and network services critical to our properties and services, and any errors, failures or disruption in the services provided by these third parties could significantly harm our business and operating results.

 

We rely on private third-party providers for our principal Internet connections, co-location of a significant portion of our data servers and network access. Any disruption, from natural disasters, technology malfunctions, sabotage or other factors, in the Internet or network access or co-location services provided by these third-party providers or any failure of these third-party providers to handle current or higher volumes of use could significantly harm our business, operating results and financial condition. We have little control over these third-party providers, which increases our vulnerability to disruptions or problems with their services. Any financial difficulties experienced by our providers may have negative effects on our business, the nature and extent of which we cannot predict. We license technology and related databases from third parties for certain elements of our properties, including, among others, technology underlying the delivery of news, stock quotes and current financial information, chat services, street mapping and telephone listings, streaming capabilities and similar services. We have experienced and expect to continue to experience interruptions and delays in service and availability for such elements. We also rely on a third-party provider for key components of our e-mail service. Furthermore, we depend on hardware and software suppliers for prompt delivery, installation and service of servers and other equipment to deliver our services. Any errors, failures, interruptions or delays experienced in connection with these third-party technologies and information services could negatively impact our relationship with users and adversely affect our brand, our business, and operating results.

 

We rely on distribution agreements and relationships with various third parties, and any failure to obtain or maintain such distribution relationships on reasonable terms could impair our ability to fully execute our business plan.

 

In addition to our relationships with Internet access providers, we have certain distribution agreements and informal relationships with operators of online networks and leading Websites, software companies, electronics companies, and computer manufacturers to increase traffic for our offerings and make them more available and attractive to advertisers and users. Depending on the distributor and the agreement, these distribution arrangements may not be exclusive and may only have a short term. Some of our distributors, particularly distributors who are also competitors or potential competitors, may not renew their distribution agreements with us. In addition, as new methods for accessing the Internet become available, including through alternative devices, we may need to enter into amended distribution agreements with existing distributors to cover the new devices and agreements with additional distributors. In the future, existing and potential distributors may not offer distribution of our properties and services to us on reasonable terms, or at all. If we fail to obtain distribution or to obtain distribution on terms that are reasonable, we may not be able to fully execute our business plan.

 

We rely on third-party providers of rich media products to provide the technologies required to deliver rich media content to our users, and any change in the licensing terms, costs, availability or user acceptance of these products could adversely affect our business.

 

We rely on leading providers of streaming media products to license the software necessary to deliver rich media content to our users. There can be no assurance that these providers will continue to license these products to us on reasonable terms, or at all. Our users are currently able to electronically download copies of the software to play rich media free of charge, but providers of rich media products may begin charging users for copies of their player software or otherwise change their business model in a manner that slows the widespread acceptance of these

products. In order for our rich media services to be successful, there must be a large base of users of these rich media products. We have limited or no control over the availability or acceptance of rich media software, and to the extent that any of these circumstances occur, our business may be adversely affected.

 

If we fail to prevent click fraud, or other malicious applications or activity of others, or if we choose to manage traffic quality in a way that advertisers find unsatisfactory, we could lose the confidence of our advertisers as well as face potential litigation, government regulation or legislation, which could adversely impact our business and profitability.

 

We are exposed to the risk of click fraud or other clicks or conversions that advertisers may perceive as undesirable. If fraudulent or other malicious applications or activity is perpetrated by others and we are unable to detect and prevent it, or if we choose to manage traffic quality in a way that advertisers find unsatisfactory, the affected advertisers may experience or perceive a reduced return on their investment in our advertising programs which could lead the advertisers to become dissatisfied with our advertising programs. This could damage our brand and lead to a loss of advertisers and revenue. Advertiser dissatisfaction has led to litigation alleging click fraud and other types of traffic quality-related claims and could potentially lead to further litigation or government regulation of advertising. We may also issue refunds or credits as a result of such activity. Any increase in costs due to any such litigation, government regulation or legislation, refunds or credits could negatively impact our profitability.

 

Interruptions, delays or failures in the provision of our services could damage our brand and harm our operating results.

 

Our operations are susceptible to outages and interruptions due to fire, flood, power loss, telecommunications failures, cyber attacks, terrorist attacks and similar events. In addition, a significant portion of our network infrastructure is located in Northern California, an area subject to earthquakes. Despite our implementation of network security measures, our servers are vulnerable to computer viruses, worms, physical and electronic break-ins, sabotage and similar disruptions from unauthorized tampering with our computer systems. For example, we are vulnerable to coordinated attempts to overload our systems with data, resulting in denial or reduction of service to some or all of our users for a period of time. We have experienced a coordinated denial of service attack in the past, and may experience such attempts in the future. We do not have multiple site capacity for all of our services and some of our systems are not fully redundant in the event of any such occurrence. In an effort to reduce the likelihood of a geographical or other disaster impacting our business, we have distributed and intend to continue distributing our servers among additional data centers located around the world. Failure to execute these changes properly or in a timely manner could result in delays or interruptions to our service, which could result in a loss of users and damage to our brand, and harm our operating results. We may not carry sufficient business interruption insurance to compensate us for losses that may occur as a result of any events that cause interruptions in our service.

 

We may be required to record a significant charge to earnings if our goodwill, amortizable intangible assets or investments in equity interests become impaired.

 

We are required under generally accepted accounting principles to review our amortizable intangible assets and investments in equity interests for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill is required to be tested for impairment at least annually. Factors that may be considered a change in circumstances indicating that the carrying value of our amortizable intangible assets may not be recoverable include a decline in stock price and market capitalization, and slower growth rates in our industry. Factors that may be considered a change in circumstances indicating that the carrying value of an investment in equity interest may not be recoverable include a decline in the stock price of an equity investee that is a public company or a decline in the operating performance of an equity investee if a private company. We may be required to record a significant charge to earnings in our consolidated financial statements during the period in which any impairment of our goodwill, amortizable intangible assets or investments in equity interests is determined. This could adversely impact our results of operations.

Microsoft’s unsolicited acquisition proposal has created a distraction for our management and uncertainty that may adversely affect our business.

 

On January 31, 2008, we received an unsolicited proposal from Microsoft Corporation (“Microsoft”) to acquire all of the outstanding shares of common stock of the Company. On February 11, 2008, our Board of Directors announced that, after carefully reviewing the proposal, it unanimously concluded that the proposal is not in the best interests of Yahoo! and its stockholders. The Board further indicated that it is continually evaluating all of the Company’s strategic options. The review and consideration of the Microsoft proposal (and any alternate proposals that may be made by other parties) have been, and may continue to be, a significant distraction for our management and employees and have required, and may continue to require, the expenditure of significant time and resources by us. Microsoft’s unsolicited acquisition proposal has also created uncertainty for our employees and this uncertainty may adversely affect our ability to retain key employees and to hire new talent. Microsoft’s unsolicited acquisition proposal may also create uncertainty for current and potential publishers, advertisers and other business partners, which may cause them to terminate, or not to renew or enter into, arrangements with us. Additionally, we and members of our Board of Directors have been named in seven purported stockholder class action complaints relating to the Microsoft proposal as more fully described in Part I, Item 3 “Legal Proceedings” of this Annual Report on Form 10-K. These lawsuits or any future lawsuits may become time consuming and expensive. These consequences, alone or in combination, may harm our business.

 

Our stock price has been volatile historically and may continue to be volatile regardless of our operating performance.

 

The trading price of our common stock has been and may continue to be subject to wide fluctuations. During the year ended December 31, 2007, the closing sale prices of our common stock on the Nasdaq Global Select Market ranged from $22.52 to $33.63 per share and the closing sale price on February 15, 2008 was $29.66 per share. Our stock price may fluctuate in response to a number of events and factors, such as quarterly variations in operating results, announcements and implementations of technological innovations or new services, upgrades and media properties by us or our competitors; changes in financial estimates and recommendations by securities analysts; the operating and stock price performance of other companies that investors may deem comparable to us; the operating performance of companies in which we have an equity investment, including Yahoo! Japan and Alibaba Group Holding Limited; and news reports relating to trends in our markets or general economic conditions.

 

In addition, the stock market in general, and the market prices for Internet-related companies in particular, have experienced volatility that often has been unrelated to the operating performance of such companies. These broad market and industry fluctuations may adversely affect the price of our stock, regardless of our operating performance. Additionally, volatility or a lack of positive performance in our stock price may adversely affect our ability to retain key employees, all of whom have been granted stock options or other stock-based awards.

 

We further believe that, as a result of Microsoft’s unsolicited acquisition proposal, and speculation concerning a potential acquisition, the future trading price of our common stock is likely to be volatile and could be subject to wide price fluctuations. There can be no assurance whether a transaction will occur or at what price. If a transaction does not occur, or the market perceives a transaction as unlikely to happen, our stock price may decline.

 

Anti-takeover provisions could make it more difficult for a third-party to acquire us.

 

We have adopted a stockholder rights plan and initially declared a dividend distribution of one right for each outstanding share of common stock to stockholders of record as of March 20, 2001. As a result of our two-for-one stock split effective May 11, 2004, each share of common stock is now associated with one-half of one right. Each right entitles the holder to purchase one unit consisting of one one-thousandth of a share of our Series A Junior Participating Preferred Stock for $250 per unit. Under certain circumstances, if a person or group acquires 15 percent or more of our outstanding common stock, holders of the rights (other than the person or group triggering their exercise) will be able to purchase, in exchange for the $250 exercise price, shares of our common stock or of any company into which we are merged having a value of $500. The rights expire on March 1, 2011, unless extended by our Board of Directors. Because the rights may substantially dilute the stock ownership of a person or group attempting to take us over without the approval of our Board of Directors, our rights plan could make it more

difficult for a third-party to acquire us (or a significant percentage of our outstanding capital stock) without first negotiating with our Board of Directors regarding that acquisition.

 

In addition, our Board of Directors has the authority to issue up to 10 million shares of Preferred Stock (of which 2 million shares have been designated as Series A Junior Participating Preferred Stock) and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the stockholders.

 

The rights of the holders of our common stock may be subject to, and may be adversely affected by, the rights of the holders of any Preferred Stock that may be issued in the future. The issuance of Preferred Stock may have the effect of delaying, deterring or preventing a change of control of Yahoo! without further action by the stockholders and may adversely affect the voting and other rights of the holders of our common stock. Further, certain provisions of our charter documents, including provisions eliminating the ability of stockholders to take action by written consent and limiting the ability of stockholders to raise matters at a meeting of stockholders without giving advance notice, may have the effect of delaying or preventing changes in control or management of Yahoo!, which could have an adverse effect on the market price of our stock. In addition, our charter documents do not permit cumulative voting, which may make it more difficult for a third-party to gain control of our Board of Directors. Further, we are subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law, which will prohibit us from engaging in a “business combination” with an “interested stockholder” for a period of three years after the date of the transaction in which the person became an interested stockholder, even if such combination is favored by a majority of stockholders, unless the business combination is approved in a prescribed manner. The application of Section 203 also could have the effect of delaying or preventing a change of control or management.

 

 

None.

 

 

Our headquarters is located in Sunnyvale, California and consists of owned and leased space aggregating approximately 1.8 million square feet. In 2006, we purchased additional land in Santa Clara, California, and we are currently reviewing options for its future use. Office space is also leased in Amsterdam, Auckland, Bangalore, Barcelona, Buenos Aires, Calgary, Copenhagen, Dublin, Dusseldorf, Echirolles, Hamburg, Hanoi, Ho Chi Minh City, Hong Kong, Geneva, London, Oslo, Madrid, Melbourne, Mexico City, Milan, Montreal, Mumbai, Munich, New Delhi, Paris, São Paulo, Seoul, Singapore, Stockholm, Sydney, Taipei, Tokyo, Toronto and Trondheim. We also lease offices in various locations in the United States, including Atlanta, Berkeley, Boston, Champaign, Chicago, Dallas, Detroit, Hillsboro, the Los Angeles Area, Miami, New York, Orlando, the San Diego Area, the San Francisco Bay Area, the Seattle Area, Brentwood and Franklin, Tennessee, and Washington, D.C. Our data centers are operated in locations in the United States, Europe, and Asia.

 

We believe that our existing facilities are adequate to meet current requirements, and that suitable additional or substitute space will be available as needed to accommodate any further physical expansion of operations and for any additional sales offices.

 

 

From time to time, third parties assert patent infringement claims against Yahoo!. Currently, we are engaged in several lawsuits regarding patent issues and have been notified of a number of other potential patent disputes. In addition, from time to time we are 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 our e-mail, message boards, auction sites, shopping services and other communications and community features.

 

On May 24, 2001, Arista Records, Inc., Bad Boy Records, BMG Music d/b/a The RCA Records Label, Capitol Records, Inc., Virgin Records America, Inc., Sony Music Entertainment, Inc., UMG Recordings, Inc., Interscope

Records, Motown Record Company, L.P., and Zomba Recording Corporation filed a lawsuit alleging copyright infringement against LAUNCH Media, Inc. (“LAUNCH”) in the United States District Court for the Southern District of New York. The plaintiffs alleged, among other things, that the consumer-influenced portion of LAUNCH’s LAUNCHcast service is “interactive” within the meaning of Section 114 of the Copyright Act and therefore does not qualify for the compulsory license provided for by the Copyright Act. The Complaint sought declaratory and injunctive relief and damages for the alleged infringement. After the lawsuit was commenced, Yahoo! entered into an agreement to acquire LAUNCH, which closed in August 2001, and since that time LAUNCH has been a wholly owned subsidiary of Yahoo!. Because LAUNCH settled the LAUNCH litigation as to all other plaintiffs, BMG Music d/b/a/  The RCA Records Label was the sole remaining plaintiff in this proceeding. On April 27, 2007, after a two week jury trial, the jury returned a unanimous verdict in favor of LAUNCH finding no liability. The plaintiff has filed a notice of appeal to the United States Court of Appeals for the Second Circuit.

 

On July 12, 2001, the first of several purported securities class action lawsuits was filed in the United States District Court, Southern District of New York against certain underwriters involved in Overture Services Inc.’s (“Overture”) initial public offering, Overture, and certain of Overture’s current and former officers and directors. The Court consolidated the cases against Overture. Plaintiffs allege, among other things, violations of the Securities Act of 1933 and the Securities Exchange Act of 1934 involving undisclosed compensation to the underwriters, and improper practices by the underwriters, and seek unspecified damages. Similar complaints were filed in the same court against numerous public companies that conducted initial public offerings of their common stock since the mid-1990s. All of these lawsuits were consolidated for pretrial purposes before Judge Shira Scheindlin. On April 19, 2002, plaintiffs filed an amended complaint, alleging Rule 10b-5 claims of fraud. On July 15, 2002, the issuers filed an omnibus motion to dismiss for failure to comply with applicable pleading standards. On October 8, 2002, the Court entered an Order of Dismissal as to all of the individual defendants in the Overture IPO litigation, without prejudice. On February 19, 2003, the Court denied the motion to dismiss the Rule 10b-5 claims against certain defendants, including Overture. In June 2004, a stipulation of settlement and release of claims against the issuer defendants, including Overture, was submitted to the Court for approval. On August 31, 2005, the Court preliminarily approved the settlement. In December 2006, the appellate court overturned the certification of classes in the six test cases that were selected by the underwriter defendants and plaintiffs in the coordinated proceedings. Since class certification, which was a condition of the settlement, was not met, the parties stipulated to terminate the settlement. On June 25, 2007, the Court entered an order terminating the proposed settlement based upon this stipulation. Plaintiffs have filed amended master allegations and amended complaints in the six test cases. It is uncertain whether there will be any future settlement. If a settlement is not reached, and litigation against Overture continues, we intend to defend the case vigorously.

 

On May 11, 2007, the first of two purported securities class action lawsuits was filed against Yahoo! Inc. and certain of its officers, members of the Board of Directors and former officers. The first lawsuit was filed in the United States District Court, Central District of California by plaintiff Ellen Rosenthal Brodsky and the second lawsuit was filed in the United States District Court, Central District of California by plaintiff Manfred Hacker. The two cases were consolidated in the United States District Court for the Central District of California, and a consolidated complaint was filed on December 21, 2007. In the consolidated amended complaint, the plaintiffs allege, among other things, violation of the Securities Exchange Act of 1934 sections 10(b), 20(a) and 20(A), as well as Rule 10b-5. The plaintiffs generally claim that Yahoo! issued false, deceptive or misleading statements concerning its advertising business, financial results, and sales and growth potential between April 8, 2004 and July 18, 2006. The consolidated amended complaint seeks unspecified compensatory damages, injunctive relief, costs and attorneys’ fees. We believe this case is without merit and intend to defend it vigorously.

 

On May 15, 2007, the first of two shareholder derivative actions was filed in the Superior Court of Santa Clara County by plaintiff Greg Brockwell against certain officers and members of the Board of Directors of Yahoo! Inc. purportedly on behalf of Yahoo! Inc. The second derivative action was filed in the United States District Court for the Central District of California on June 14, 2007 by plaintiff Jill Watkins. The derivative actions, which include allegations of substantially identical facts to the purported securities class action, attempt to state various claims under federal and California law for trading by defendants on alleged material non-public information, and allegations of breaches of fiduciary duties relating to financial reporting, misappropriation of information, abuse of control and waste of corporate assets. The federal derivative action includes an additional claim for alleged

violation of Section 10(b) of the Securities Exchange Act of 1934. The derivative actions seek unspecified damages, equitable and injunctive relief, including, among other things, changes to corporate governance and internal procedures, restitution and disgorgement of profits and compensation received by defendants, costs and attorneys’ fees.

 

Since February 1, 2008, four separate shareholder lawsuits have been filed in the California Superior Court, Santa Clara County, against Yahoo! Inc., members of the Board of Directors and selected former officers by plaintiffs Edward Fritsche, the Thomas Stone Trust, Tom Turberg and the Congregation Beth Aaron (the “California Lawsuits”). The plaintiffs in the California Lawsuits purport to assert class claims on behalf of all Yahoo! stockholders, except defendants and their affiliates. In addition, certain of the plaintiffs in the California Lawsuits purport to assert shareholder derivative claims on behalf of Yahoo! Inc. The complaints allege that the Yahoo! Board of Directors breached fiduciary duties in connection with Microsoft’s unsolicited proposal to acquire Yahoo!. The plaintiffs in two of the California lawsuits allege that Microsoft’s February 1, 2008 unsolicited proposal to acquire Yahoo! is inadequate and that the Yahoo! Board of Directors breached fiduciary duties by favoring Microsoft’s unsolicited proposal. The plaintiffs in the other California Lawsuits allege that the Yahoo! Board of Directors breached fiduciary duties by, among other things, failing to negotiate a transaction with Microsoft or other potential bidders in the past and presently. The complaints in the California Lawsuits seek declaratory and injunctive relief, as well as an award of plaintiffs’ attorneys’ fees and costs. With respect to the derivative claims, no relief is sought from the Company.

 

Since February 11, 2008, three separate shareholder lawsuits have been filed in the Court of Chancery of the State of Delaware against Yahoo! Inc. and members of the Board of Directors by plaintiffs, The Wayne County Employees’ Retirement System, Ronald Dicke, and The Police and Fire Retirement System of the City of Detroit along with The General Retirement System of the City of Detroit (the “Delaware Lawsuits”). The plaintiffs in the Delaware Lawsuits purport to assert class claims on behalf of all Yahoo! stockholders, except defendants and their affiliates. Plaintiffs in the Delaware Lawsuits generally allege that defendants breached fiduciary duties by rejecting Microsoft’s February 1, 2008 unsolicited offer to acquire Yahoo! Inc. without fully informing themselves whether Microsoft would offer additional consideration and that defendants are not acting in the best interests of shareholders and are seeking to entrench themselves. One of the Delaware Lawsuits alleges that the Board of Directors have pursued various blocking transactions, adopted an employee severance plan, and a shareholder rights plan in violation of fiduciary duties. The complaints in the Delaware Lawsuits seek unspecified damages, declaratory relief and injunctive relief, as well as an award of plaintiffs’ attorneys’ fees and costs.

 

We may incur substantial expenses in defending against such claims, and it is not presently possible to accurately forecast their outcome. We do not believe, based on current knowledge, that any of the foregoing legal proceedings or claims are likely to have a material adverse effect on our financial position, results of operations or cash flows. In the event of a determination adverse to Yahoo!, its subsidiaries, directors or officers, we may incur substantial monetary liability, and be required to change our business practices. Either of these could have a material adverse effect on our financial position, results of operations or cash flows.

 

 

No matters were submitted to a vote of security holders during the fourth quarter of 2007.

 

 

Market Information for Common Stock

 

Yahoo! Inc. common stock is quoted on the Nasdaq Global Select Market under the symbol “YHOO.” The following table sets forth the range of high and low per share sales prices as reported for each period indicated:

 

 

Stockholders

 

We had 11,041 stockholders of record as of February 15, 2008.

 

Dividends

 

We have not declared or paid any cash dividends on our common stock. We presently do not have plans to pay any cash dividends in the near future.

 

Issuer Purchases of Equity Securities

 

Stock repurchase activity during the three months ended December 31, 2007 was as follows:

 

 

 

Performance Graph

 

This performance graph shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) or otherwise subject to the liabilities under that Section and shall not be deemed to be incorporated by reference into any filing of Yahoo! Inc. under the Securities Act of 1933, as amended or the Exchange Act.

 

The following graph compares, for the five year period ended December 31, 2007, the cumulative total stockholder return for the Company’s common stock, the Nasdaq Stock Market (U.S. companies) Index (the “Nasdaq Market Index”), the Goldman Sachs Internet Trading Index (the “GIN”) and the Standard & Poor’s 500 Stock Index (the “S&P 500 Index”). Measurement points are the last trading day of each of the Company’s fiscal years ended December 31, 2003, December 31, 2004, December 31, 2005, December 31, 2006, and December 31, 2007. The graph assumes that $100 was invested on December 31, 2002 in the common stock of the Company, the Nasdaq Stock Market Index, the GIN, and the S&P 500 Index and assumes reinvestment of any dividends. The stock price performance on the following graph is not necessarily indicative of future stock price performance.

 

 

 

Consolidated Statements of Income Data:

 

 

 

Consolidated Balance Sheets Data:

 

 

 

 

Forward-Looking Statements

 

In addition to current and historical information, this 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,” other comparable terminology, or the negative of such terms. This Report includes, among others, forward-looking statements regarding our:

 

 

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 1, Item 1A “Risk Factors” of this Annual Report on Form 10-K. 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

 

We are a leading global Internet brand and one of the most trafficked Internet destinations worldwide. We are focused on powering our communities of users, advertisers, publishers, and developers by creating indispensable experiences built on trust. We seek to provide Internet services that are essential and relevant to these communities of users, advertisers, publishers, and developers. Publishers, such as eBay Inc., WebMD, Cars.com, Forbes.com, and the Newspaper Consortium (our strategic partnership with a consortium of over 20 leading United States (“U.S.”) newspaper publishing companies), are a subset of our Affiliates and are primarily Websites and search engines that attract users by providing content of interest, presented on Web pages that have space for advertisements.

 

To users, we provide owned and operated online properties and services (“Yahoo! Properties” or “Offerings” or “Owned and Operated sites”). We also extend our marketing platform and access to Internet users beyond Yahoo! Properties through our distribution network of third-party entities (referred to as “Affiliates”) who have integrated our advertising offerings into their Websites (referred to as “Affiliate sites”) or their other offerings.

 

We focus on expanding our communities of users and deepening their engagement on Yahoo! Properties to enhance the value of our users to advertisers and publishers and thereby increase the spending of advertisers and publishers with us. We believe that we can expand our communities of users by offering compelling Internet services and effectively integrating search, community, personalization, and content to create a powerful user experience. We leverage our user relationships and the social community the users create to enhance our online advertising potential, as well as our fee-based services.

 

To advertisers and publishers, we provide a range of marketing solutions and tools that enable businesses to reach users who visit Yahoo! Properties and our Affiliate sites.

To developers, we provide an innovative and easily accessible array of Web Services and Application Programming Interfaces (“APIs”), technical resources, tools, and channels to market.

 

We generate revenues by providing marketing services to advertisers across a majority of Yahoo! Properties and Affiliate sites. Additionally, although many of our user services are free, we do charge for a range of premium services that we offer. We classify these revenues as either marketing services or fees revenues. See Part I Business — “How We Generate Revenues” for additional information.

 

Our offerings to users currently fall into five categories — Front Doors; Search; Communications and Communities; Media; and Connected Life. See Part I Business — “What We Offer Our Users” for additional information. The majority of our offerings are available in more than 20 languages. We manage and measure our business geographically. Our principal geographies are the United States and International.

 

Revenue Sources

 

Marketing Services Revenues.  The majority of our marketing services revenues is from sales of online display advertising; revenues are generated from several offerings including: the display of rich media advertisements, display of text-based links to an advertiser’s Website, listing-based services, and commerce-based transactions.

 

We recognize revenues from the display of graphical advertisements (“display advertising”) on Yahoo! Properties and on Affiliate sites as “impressions” are delivered. An “impression” is delivered when an advertisement appears in pages viewed by users. We also recognize revenues from the display of text-based links to the Websites of our advertisers (“search advertising”) which are placed on Yahoo! Properties and on Affiliate sites. We recognize revenues from these arrangements as “click-throughs” occur. A “click-through” occurs when a user clicks on an advertiser’s listing.

 

Marketing services revenues also includes listings and transaction revenues. Listings revenues are generated from a variety of consumer and business listings-based services, including access to the Yahoo! HotJobs database and classified advertising such as Yahoo! Autos, Yahoo! Real Estate, and other services. We recognize listings revenues when the services are performed. Transaction revenues are generated from facilitating commercial transactions through Yahoo! Properties, principally from Yahoo! Travel and Yahoo! Shopping. We recognize transaction revenues when there is evidence that qualifying transactions have occurred, for example, when travel arrangements are booked through Yahoo! Travel.

 

Fees Revenues.  Fees revenues consists of revenues generated from a variety of consumer and business fee-based services, including Internet broadband services, royalties received from joint venture partners, premium mail, music and personals offerings, as well as services for small businesses. We recognize fees revenues when the services are performed.

 

2007 Performance Highlights

 

 

 

Our revenue growth for the year ended December 31, 2007, compared to the prior year, can be attributed to an increasing number and activity level of users across our offerings on Yahoo! Properties and through our distribution

network of Affiliates. Marketing services and fees revenues experienced 8 percent and 10 percent year over year growth, respectively.

 

Our revenues for the year ended December 31, 2007 increased 8 percent year over year to approximately $7.0 billion, with fee paying users up 17 percent year over year, and Page Views up 11 percent year over year. Operating income for the year ended December 31, 2007 declined by $246 million. The decline reflects year over year increases in operating expenses of $626 million offset by the impact of additional margin related to year over year revenue growth.

 

Cash generated from our operations is a measure of the cash productivity of our business model and is an area of focus for us. Our operating activities in 2007 generated adequate cash to meet our operating needs. Cash used in investing activities in 2007 included capital expenditures of $602 million, as well as cash consideration for acquisitions of $974 million, offset by the sale of marketable debt securities. Cash used in financing activities in 2007 reflected our net cash used for direct and structured stock repurchases of $1.8 billion, offset by cash proceeds from the issuance of common stock of $375 million as a result of the exercise of employee stock options.

 

During 2007, we determined that income tax benefits of $127 million ($92 million related to 2006 and the remainder related to earlier years) should not have been recorded to additional paid-in capital as tax benefits from stock-based awards because for financial statement ordering purposes, the tax benefits should have been attributed to the utilization of acquired net operating losses first or should not have been recognized at all because the underlying tax amounts should not have been offset by tax benefits from stock-based awards. As a result, in the 2007 statement of cash flows, we reduced by $92 million, excess tax benefits from stock-based awards recorded in cash flows from operating activities with an equivalent reduction to the amount of excess tax benefits recorded in cash flows from financing activities. This reclassification had no impact on overall cash flows. The amounts that impacted income tax expense and earnings in equity interests also increased diluted earnings per share by $0.01 for the year ended December 31, 2007. We believe that the aforementioned amounts are not material to reported amounts for 2007, 2006, or earlier years and therefore we have corrected them in the 2007 consolidated financial statements. See Note 10 — “Income Taxes” in the consolidated financial statements for additional information.

 

Summary

 

We believe the search queries, Page Views, click-throughs, and the related marketing services and fees revenues that we generate correlate to the number and activity level of users across our offerings on Yahoo! Properties and the activity level on our Affiliate sites. In the fourth quarter of 2006, we launched a new search marketing system, referred to as Project Panama, and we have completed our migration plan for our active advertisers worldwide onto the new system. We believe the new search marketing system, including the new ranking model which was launched in all of our major domestic and international markets in 2007, in addition to ongoing enhancements in which we are investing, enables us to provide a more relevant search experience to users, more valuable customer leads to advertisers, and additional opportunities to our Affiliate and distribution partners. By providing a platform for our users that brings together our search technology, content, and community while allowing for personalization and integration across devices, we seek to become more essential to, increase our share of, and deepen the engagement of, our users with our products and services. We believe this deeper engagement of new and existing users and our new search marketing system, coupled with the growth of the Internet as an advertising medium will enable us to increase our revenues in 2008.

 

In the following Management’s Discussion and Analysis, we discuss the following areas of our financial results:

 

 

Results of Operations

 

The following table sets forth selected information on our results of operations as a percentage of revenues for the periods indicated:

 

 

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

 

 

 

As used below, “Page Views” is defined as our internal estimate of the total number of Web pages viewed by users on Owned and Operated sites. “Searches” is defined as online search queries that may yield Internet search results ranked and sorted based on relevance to the user’s search query. “Sponsored search results” are a subset of the overall search results, and provide links to paying advertisers’ Web pages.

 

We currently generate marketing services revenues principally from display advertising on Owned and Operated sites and from sponsored search results generated from searches on Owned and Operated and Affiliate sites. In addition, we receive revenues for Content Match links (advertising on Yahoo! Properties and Affiliate sites which include contextually relevant advertiser links to their respective Websites) on Owned and Operated and Affiliate sites and display advertising on Affiliate sites. The net revenues and related volume metrics from these additional sources are not currently material and are excluded from the discussion and calculation of average revenue per Page View on Owned and Operated sites and average revenue per search on Affiliate sites that follows.

Marketing Services Revenues from Owned and Operated Sites.  Marketing services revenues from Owned and Operated sites for the year ended December 31, 2007 increased by approximately $600 million, or 20 percent, as compared to 2006. Factors leading to growth in overall marketing services revenues included an increase in user activity levels on Yahoo! Properties, which contributed to a higher volume of search queries, click-throughs, Page Views, and ad impression displays. Also our growing audience of users makes Yahoo! Properties more attractive to advertisers and increases their spending on marketing services. We expect marketing services revenues from our Owned and Operated sites to continue growing at a rate faster than total revenues. Marketing services revenues from Owned and Operated sites for the year ended December 31, 2006 increased by approximately $648 million, or 27 percent, as compared to 2005. Our marketing services revenues in 2006 was impacted by declining revenues from our relationship with Microsoft Corporation (“Microsoft”), which completed the transition of its U.S. business search business in-house during 2006. The year over year growth in marketing services revenues in 2006, despite the impact of Microsoft’s transition, can be attributed to a combination of factors that have driven increased marketing services revenues across Yahoo! Properties both domestically and internationally. These included an increase in our user base and activity levels on Yahoo! Properties, which resulted in a higher volume of search queries, ad impression displays, and click-throughs.

 

We periodically review and refine our methodology for monitoring, gathering, and counting Page Views to more accurately reflect the total number of Web pages viewed by users 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 our Owned and Operated sites.

 

Using our updated methodology, for the year ended December 31, 2007 as compared to 2006, Page Views increased 11 percent and revenue per Page View increased 7 percent, and for the year ended December 31, 2006 as compared to 2005, Page Views increased 15 percent and revenue per Page View increased 10 percent.

 

In the table below, we set forth the quarterly and year over year growth in Page Views and revenue per Page View for the year ended December 31, 2007 and the year over year growth in Page Views and revenue per Page View for the year ended December 31, 2006, both as previously reported and as revised to reflect our updated methodology.

 

 

 

 

We believe our growing number of users, advertisers, publishers, and inventory, both on and off our network, over recent years has been driving the increases in our marketing services revenues. We also believe our expanding offerings, including our enhanced algorithmic search technology, contribute to our growing number of users. As our user base increases, we process a higher number of search queries and generate a higher number of Page Views. We also believe that our growing audience of users make Yahoo! Properties more attractive to advertisers and increases their spending on marketing services. Further, we believe the growth in users on Yahoo! Properties and on the Internet overall reflects the increasing acceptance, importance, and dependence of users on the Internet. As a result of this growth in the online audience, we believe advertisers are shifting a greater percentage of their spending from traditional media to the Internet to reach this growing audience.

 

We currently expect marketing services revenues on our Owned and Operated sites to increase in absolute dollars for 2008 compared to 2007 as we seek to increase marketing services revenues on Yahoo! Properties by providing a more relevant search experience to users, providing more relevant and valuable customer leads to advertisers from our new search marketing system, and improving our technologies to expand and improve our offerings.

 

Marketing Services Revenues from Affiliate Sites.  Marketing services revenues from Affiliate sites for the year ended December 31, 2007 decreased $139 million, or 5 percent, as compared to 2006. Marketing services revenues from Affiliate sites for the year ended December 31, 2006 increased $385 million, or 18 percent, as compared to 2005.

 

As more inventory becomes available on the Web it has, and will continue to make, the Affiliate business more competitive; consequently, our portion of revenue share from Affiliate sites is declining. We expect this trend to continue in 2008. However, we also expect to experience some favorable impact from our off-network display initiatives. While this display business is still relatively small, we expect continued growth as our major partnerships gain momentum.

 

The number of searches on Affiliate sites increased by approximately 1 percent for the year ended December 31, 2007, as compared to 2006. The number of searches on Affiliate sites increased by approximately 28 percent for the year ended December 31, 2006, as compared to 2005. The increase in the volume of searches is primarily attributed to the net increase in the number of Affiliates.

 

The average revenue per search on our Affiliate sites decreased by 5 percent for the year ended December 31, 2007, as compared to 2006. The average revenue per search on our Affiliate sites decreased by 9 percent for the year ended December 31, 2006, as compared to 2005. The decline in average revenues per search is primarily as a result of a decline in revenues from certain Affiliate sites.

 

Additionally, during the third quarter of 2007 we sold Overture Japan to Yahoo! Japan. As part of this transaction we also entered into a commercial arrangement with Yahoo! Japan in which we provide advertising and search marketing services to Yahoo! Japan for a service fee. This arrangement began on September 1, 2007 and, beginning on that date, we commenced recording marketing services revenues from Yahoo! Japan for the provision of search marketing services based on a percentage of advertising revenues earned by Yahoo! Japan for the delivery of sponsored search results. The sale of Overture Japan to Yahoo! Japan negatively impacted our net revenues from Affiliate sites by 1 percent for 2007.

 

Fees Revenues.  For the year ended December 31, 2007, fees revenues increased approximately $83 million, or 10 percent, as compared to 2006. The year over year growth is associated with an increase in the number of paying users for our fee-based services, which numbered 19.0 million as of December 31, 2007, compared to 16.3 million as of December 31, 2006, an increase of 17 percent. The impact of this increase in our number of paying users was offset by a reduction in the average monthly revenues per paying user as discussed below. For the year ended December 31, 2006, fees revenues increased approximately $135 million, or 20 percent, as compared to 2005. The year over year growth in 2006 as compared to 2005 is associated with an increase in the number of paying users for our fee-based services, which numbered 16.3 million as of December 31, 2006, compared to 12.6 million as of December 31, 2005, an increase of 29 percent. The impact of this increase in our number of paying users was offset by a reduction in the average monthly revenues per paying user discussed below.

 

Our increased base of paying users grew across most of our offerings. Our fee-based services include Internet broadband services, sports, music, games, personals, and premium mail offerings, as well as our services for small

businesses. Average monthly revenues per paying user decreased to approximately $3.00 for the year ended December 31, 2007, compared to approximately $3.50 and $4.00 for the same periods in 2006 and 2005, respectively. The decline in average monthly revenues per paying user reflects decreases in fees made in the year.

 

Recently, we have been working with our broadband Internet access partners (“partners”) to renew and extend our relationships. As we renew these access relationships, we are seeking to add new opportunities to improve on our historic strengths in portal, search, and mail. The market has moved to an environment in which advertising revenue sharing is the prevailing model, and we are evolving our partnerships accordingly and our partners are re-signing with us due to the strategic importance of our relationships and the products we offer. This will result in a reduction in fees revenues associated with these deals, but should be offset by increased marketing services revenues associated with the display advertising and sponsored search revenue share arrangements.

 

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

 

 

 

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

 

 

See Note 1 — “The Company and Summary of Significant Accounting Policies” and Note 12 — “Employee Benefits” in the consolidated financial statements, as well as our Critical Accounting Policies, Judgments, and Estimates, for additional information about stock-based compensation.

 

Cost of Revenues.  Cost of revenues consists of traffic acquisition costs and other expenses associated with the production and usage of Yahoo! Properties, including amortization of acquired intellectual property rights and developed technology.

 

Traffic Acquisition Costs (“TAC”).  TAC consist of payments made to Affiliates 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 three 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; variable payments based on a percentage of our revenues or based on a certain metric, such as number of searches or paid clicks; or a combination of the two. 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 revenues, number of paid introductions, number of searches, or other metrics are expensed based on the volume of the underlying activity or revenues multiplied by the agreed-upon price or rate.

 

Other Cost of Revenues.  Other cost of revenues consists of fees paid to third parties for content, Internet connection charges, data center costs, server equipment depreciation, technology license fees, amortization of acquired intellectual property rights and developed technology, and compensation related expenses (including stock-based compensation expense).

 

Cost of revenues were as follows (dollars in thousands):

 

 

 

Cost of revenues for the year ended December 31, 2007 increased approximately $163 million, or 6 percent, as compared to 2006. The increase included $172 million in other cost of revenues, offset by a $9 million decrease in TAC. The year over year decrease in TAC of $9 million, as compared to 2006 was primarily due to the sale of Overture Japan to Yahoo! Japan (and the associated elimination of TAC paid to Yahoo! Japan) offset by our growth in average TAC rates. The year over year increase in other cost of revenues of $172 million, or 21 percent, included increases of $81 million in the depreciation of server equipment, maintenance costs, and data center fixtures and fittings, $26 million in Internet and telecom connection charges, and $45 million in amortization of developed technology and intellectual property rights acquired through acquisitions. The increase in the depreciation of server equipment, information technology assets and maintenance costs resulted from our continued investments in information technology assets, server equipment and data centers. Increased Internet and telecom connection charges supported our growing audience of users, traffic, and new offerings on Yahoo! Properties. The increase in the amortization of developed technology and intellectual property rights acquired resulted from our continued investments in, and acquisitions of, businesses and technology.

 

Cost of revenues for the year ended December 31, 2006 increased approximately $580 million, or 28 percent, as compared to 2005. The increase included $304 million of additional TAC, as well as increases of $75 million in server equipment depreciation and maintenance costs, $55 million in content costs, and $49 million in amortization of developed technology and intellectual property rights acquired. Internet connection charges and data center costs also increased by $36 million in 2006, as compared to 2005.

 

Cost of revenues in 2007, 2006, and 2005 were 41 percent, 42 percent, and 40 percent of revenues, respectively. The year over year increases reflected additional expenses associated with our continued acquisition of new technology and server equipment to support our expanded offerings and increased traffic on Yahoo! Properties, slightly offset by the decrease in TAC described above.

 

We currently believe that cost of revenues will continue to increase in absolute dollars in 2008 compared to 2007. TAC is expected to increase in absolute dollars as our marketing services revenues and TAC rates increase in the increasingly competitive advertising market. Additionally, we expect to continue to increase our communities of users and offerings, which drive network usage and in turn higher Internet connection charges and data center costs. Further, we expect higher costs related to the introduction of additional content for new and enhanced services.

 

Sales and Marketing.  Sales and marketing expenses consist primarily of advertising and other marketing related expenses, compensation related expenses (including stock-based compensation expense), sales commissions, and travel costs.

 

Sales and marketing expenses for the year ended December 31, 2007 increased approximately $288 million, or 22 percent, as compared to 2006. The year over year increase was largely due to increases in compensation expense. Compensation expense increased approximately $224 million year over year, including an additional $91 million of

stock-based compensation expense, due to an increase in our sales and marketing headcount primarily as a result of acquisitions. Other sales and marketing expenses increased approximately $30 million primarily due to increased temporary help and expenses related to new and expanded facilities.

 

Sales and marketing expenses for the year ended December 31, 2006 increased approximately $288 million, or 28 percent, as compared to 2005. The year over year increase was largely due to increases in compensation expense. Compensation expense increased approximately $252 million, including an additional $146 million of stock-based compensation expense, compared to 2005. The increase in stock-based compensation expense was due to our adoption of SFAS 123R. In addition to stock-based compensation expense, the growth in compensation expense was also attributable to an increase in our sales and marketing headcount as we expanded our presence in certain territories to support our growing advertiser base. Additionally, year over year spending on marketing and distribution increased by $25 million, reflecting our continued investment in our product branding and development of our distribution channels.

 

Sales and marketing expenses as a percentage of revenues in 2007 was 23 percent (including 4 percent related to stock-based compensation expense), compared to 20 percent in both 2006 and 2005, respectively.

 

We currently believe that sales and marketing expenses will increase in absolute dollars in 2008 compared to 2007, as we continue to grow and expand our reach to advertisers and users.

 

Product Development.  Product development expenses consist primarily of compensation related expenses (including stock-based compensation expense) incurred for the development of, enhancements to and maintenance of Yahoo! Properties, classification and organization of listings within Yahoo! Properties, research and development, and Yahoo!’s technology platforms and infrastructure. Depreciation expense and other operating costs are also included in product development.

 

Product development expenses for the year ended December 31, 2007 increased $251 million, or 30 percent, as compared to 2006. Product development compensation expenses increased by approximately $191 million compared to the prior year, including an additional $73 million of stock-based compensation expense (net of the $8 million incremental increase to stock-based compensation expense related to the departure of an executive officer during the second quarter of 2007). The increased compensation expenses reflected our continued hiring of engineering talent to further develop and enhance new and existing offerings and services on Yahoo! Properties. Depreciation expense increased $14 million mainly due to our continued investments in information technology assets and server equipment. Other product and development expenses increased approximately $20 million primarily due to increased temporary help and expenses related to new and expanded facilities.

 

Product development expenses for the year ended December 31, 2006 increased approximately $264 million, or 46 percent, as compared to 2005. Product development compensation expense increased by approximately $248 million compared to 2005, of which $122 million was additional stock-based compensation expense due to our adoption of SFAS 123R. In addition to stock-based compensation expense, the increased compensation expenses also reflected our continued hiring of engineering talent to further develop and enhance new and existing offerings and services on Yahoo! Properties.

 

Product development expenses as a percentage of revenues in 2007 was 15 percent (including 3 percent related to stock-based compensation expense), compared to 13 percent and 11 percent in 2006 and 2005, respectively.

 

We currently believe that product development expenses will increase in absolute dollars in 2008 compared to 2007, as we believe that continued investments in product development are required to remain competitive.

 

General and Administrative.  General and administrative expenses consist primarily of compensation related expenses (including stock-based compensation expense) related to our legal, finance and human resource organizations and fees for professional services.

 

General and administrative expenses for the year ended December 31, 2007 increased $105 million, or 20 percent, as compared to 2006. Compensation expense increased by $26 million (net of the $16 million reduction in expense due to the second quarter of 2007 reversal of stock-based compensation expense related to Terry Semel’s resignation as Chief Executive Officer of the Company) due to an increase in 2007 in our general and administrative headcount as our infrastructure has grown supporting the underlying growth in our business. Professional services,

including temporary headcount and consulting projects, increased $17 million and our facility related expenses increased $11 million primarily due to our new and expanded facilities. We also incurred costs related to legal settlements in 2007 of $17 million.

 

General and administrative expenses for the year ended December 31, 2006 increased $188 million, or 55 percent, as compared to 2005. The increase was primarily due to an additional $97 million of stock-based compensation expense as a result of the adoption of SFAS 123R. Additionally, fees for professional services increased $32 million and facilities expense increased $25 million for the year ended December 31, 2006, compared to the prior year.

 

General and administrative expenses as a percentage of revenues in 2007 was 9 percent (including 1 percent related to stock-based compensation expense), compared to 8 percent and 6 percent in 2006 and 2005, respectively.

 

We currently believe that general and administrative expenses in absolute dollars will increase in 2008 compared to 2007, as we continue to invest in our infrastructure to support our continued business expansion.

 

Amortization of Intangibles.  We have purchased, and expect to continue purchasing, assets and/or businesses, which may include the purchase of intangible assets. Amortization of developed technology and acquired intellectual property rights is included in the cost of revenues and not in amortization of intangibles.

 

Amortization of intangibles was approximately $107 million, or 2 percent of revenues for the year ended December 31, 2007, compared to $125 million or 2 percent of revenues for 2006 and $109 million or 2 percent of revenues for 2005. The year over year decrease in amortization of intangibles from 2007 compared to 2006 is due to declining amortization expenses as a result of intangible assets that became fully amortized during the year slightly offset by increased amortizable intangible assets from acquisition activity. The increase year over year from 2006 compared to 2005 in amortization of intangibles reflected our continued acquisition activity resulting in increased amortizable intangible assets, which were partially offset by declining amortization expenses due to intangible assets that became fully amortized during the year. As of December 31, 2007, we had net intangible assets of $611 million on our consolidated balance sheet, including acquired intellectual property rights and developed technology which are amortized in cost of revenues.

 

During the years ended December 31, 2007 and December 31, 2006, we acquired $110 million and $6 million, respectively, of patents and intellectual property rights, included in the “Developed and acquired technology and intellectual property rights” category of the intangible assets balance as of December 31, 2007 and December 31, 2006, respectively.

 

Other Income, Net.  Other income, net was as follows (in thousands):

 

 

Other income, net was $154 million for the year ended December 31, 2007, a decrease of $3 million, as compared to 2006. In the year ended December 31, 2007 there was an increase in interest offset by a decrease in investment income, as compared to 2006 as higher average interest rates was more than offset by lower average invested balances. The average interest rate was approximately 4.3 percent in 2007, compared to 3.9 and 2.9 percent in 2006 and 2005, respectively. Our foreign currency transaction gains, net also increased $7 million for the year ended December 31, 2007. Additionally, our recorded non-cash gain arising from the reduction in our ownership in Alibaba Group Holding Limited (“Alibaba” or the “Alibaba Group”), which was treated as an incremental sale of additional equity interests in Yahoo! China was $8 million for the year ended December 31, 2007 compared to non-cash gains of $15 million for this item in 2006 as a result of a reduction in our ownership in Alibaba from approximately 46 percent to 44 percent in 2006 and from 44 percent to 43 percent in 2007. There were non-cash

gains of $338 million included in other income, net in 2005 due to the initial divestiture of Yahoo! China based on the difference between the fair value of Yahoo! China and its carrying value adjusted for our continued ownership in the combined entity.

 

Other income, net may fluctuate in future periods due to realized gains and losses on investments, impairments of investments, changes in our average investment balances, and changes in interest and foreign exchange rates.

 

Income Taxes.  The provision for income taxes for the year ended December 31, 2007 differs from the amount computed by applying the federal statutory income tax rate primarily due to state taxes, foreign income taxed at different rates, and non-deductible stock-based compensation expense. The provisions for income taxes for the years ended December 31, 2006 and 2005 differ from the amounts computed by applying the federal statutory income tax rate primarily due to state taxes. Additionally, in 2005, the provision for income taxes reflected a tax benefit related to a subsidiary restructuring transaction.

 

The following table summarizes the differences between our provision for income taxes and the amount computed by applying the federal statutory income tax rate to income before income taxes (dollars in thousands):

 

 

 

Our effective tax rate for the year ended December 31, 2007 was 40 percent, compared to 42 percent in the prior year. The lower effective tax rate in 2007 was mainly attributable to a benefit resulting from a reduction in nondeductible executive compensation expense, a benefit due to the release of deferred tax liabilities in connection with changes to our worldwide entity structure, foreign tax credits, and R&D tax credits. Our effective tax rate for the year ended December 31, 2006 was 42 percent, compared to 30 percent in 2005. The increased rate was mainly attributable to the tax benefit related to a subsidiary restructuring transaction in 2005. As part of our ongoing efforts to streamline our operational structure, we completed a taxable liquidation of a subsidiary in 2005 that we acquired several years ago. This transaction gave rise to a capital loss for tax purposes, which offset a substantial portion of the gains from sales of equity investments during the year. The resulting tax benefit recorded in 2005 was approximately $248 million. See Note 10 — “Income Taxes” in the consolidated financial statements for additional information.

 

Based on current estimates, we expect our effective tax rate will increase in 2008 compared to 2007.

 

Earnings in Equity Interests.  Earnings in equity interests was approximately $151 million for the year ended December 31, 2007 (net of $7 million related to tax benefits on dividends received and net of $17 million related to the tax benefit of our share of Alibaba’s loss), which consisted of our share of the net income or loss of our equity investments in Yahoo! Japan and Alibaba. Earnings in equity interests for the year ended December 31, 2006 were $112 million (net of $6 million related to tax expense on dividends received and net of $7 million related to the tax

benefit of our share of Alibaba’s loss) as a result of our investment in Yahoo! Japan and Alibaba. Earnings in equity interests for the year ended December 31, 2005 were $128 million, as a result of our investment in Yahoo! Japan. See Note 4 — “Investments in Equity Interests” in the consolidated financial statements for additional information.

 

Minority Interests in Operations of Consolidated Subsidiaries.  Minority interests in operations of consolidated subsidiaries represents the minority holders’ percentage share of income or losses from the subsidiaries in which we hold a majority, but less than 100 percent, ownership interest and consolidate the subsidiaries’ results in our financial statements. Minority interests in operations of consolidated subsidiaries was approximately $3 million in 2007, compared to $1 million and $8 million in 2006 and 2005, respectively. Minority interests recorded in 2007 and 2006 were related to our Yahoo! 7 joint venture arrangement. Minority interests recorded in 2005 were related to our joint ventures in France, Germany, and the United Kingdom (collectively called “Yahoo! Europe”) and Yahoo! Korea. In 2005, we purchased the remaining outstanding shares of Yahoo! Europe and Yahoo! Korea from our partner in these ventures, and accordingly, these entities became our wholly owned subsidiaries. See Note 3 — “Acquisitions” in the consolidated financial statements for additional information.

 

Business Segment Results

 

We manage our business geographically. Our primary areas of measurement and decision-making are the United States and International. Management relies on an internal management reporting process that provides revenues and segment operating income before depreciation, amortization, and stock-based compensation expense for making financial decisions and allocating resources. Segment operating income before depreciation, amortization, and stock-based compensation expense, includes income from operations before depreciation, amortization and stock-based compensation expense. Management believes that segment operating income before depreciation, amortization, and stock-based compensation expense is an appropriate measure for evaluating the operational performance of our segments. However, this measure should be considered in addition to and not as a substitute for, or superior to, income from operations or other measures of financial performance prepared in accordance with generally accepted accounting principles in the United States (“GAAP”).

 

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

 

 

 

Revenue is attributed to individual countries according to the international online property that generated the revenue. No single foreign country accounted for more than 10 percent of revenues in 2007, 2006, or 2005, respectively.

 

United States.  United States revenues for the year ended December 31, 2007 increased approximately $361 million, or 8 percent, as compared to 2006. United States revenues for the year ended December 31, 2006 increased approximately $698 million, or 19 percent, as compared to 2005. The year over year increases in 2007 and 2006 were a result of growth in advertising across Yahoo! Properties, as well as growth from our fee-based services. Approximately 79 percent of the 2007 increase, or $286 million, came from marketing services revenues. Approximately 82 percent of the 2006 increase, or $570 million, came from marketing services revenues and approximately 82 percent of the 2005 increase, or $827 million, came from marketing services revenues. The advertising growth can be attributed to our expanding user base which has been attracting more advertisers and has been contributing to our growth in our advertising revenues. The growth in our fee-based services is due to the increase in our paying users for both existing and new offerings. United States operating income before depreciation, amortization, and stock-based compensation expense for the year ended December 31, 2007 decreased $18 million, or 1 percent, as compared to 2006. United States operating income before depreciation, amortization, and stock-based compensation expense for the year ended December 31, 2006 increased $232 million, or 19 percent, as compared to 2005.

 

International.  International revenues for the year ended December 31, 2007 increased approximately $182 million, or 9 percent, as compared to 2006. International revenues for the year ended December 31, 2006 increased approximately $470 million, or 30 percent, as compared to 2005. More than 95 percent of the international revenues increase in 2007 and 2006 came from marketing services revenues. The year over year growth in international marketing services revenues can be attributed to our increased penetration into existing markets, coupled with continued growth of the global online advertising marketplace. International operating income before depreciation, amortization, and stock-based compensation expense for the year ended December 31, 2007 increased $39 million, or 9 percent, as compared to 2006. International operating income before depreciation, amortization, and stock-based compensation expense for the year ended December 31, 2006 increased $116 million, or 34 percent, as compared to 2005.

 

International revenues accounted for approximately 32 percent of total revenues during both 2007 and 2006 and 30 percent during 2005. The strong performance of our international operations has increased our exposure to foreign currency fluctuations. Revenues and related expenses generated from our international subsidiaries are generally denominated in the currencies of the local countries. Primary currencies include Euros, British Pounds, Japanese Yen, Korean Won, Taiwan Dollars, Australian Dollars, and Canadian Dollars. The statements of income of our international operations are translated into United States dollars at the average exchange rates in each applicable period. To the extent the United States dollar strengthens against foreign currencies, the translation of these foreign currency denominated transactions results in reduced revenues, operating expenses, and net income for our International segment. Similarly, our revenues, operating expenses, and net income will increase for our International segment if the United States dollar weakens against foreign currencies. Using the average foreign currency exchange rates in the year ended December 31, 2006, our international revenues for 2007 would have been lower than we reported by approximately $87 million and our international segment operating income before depreciation, amortization, and stock-based compensation expense would have been lower than we reported by $16 million.

 

Transactions

 

Significant acquisitions and strategic investments completed in the last three years include the following:

 

 

 

See Note 3 — “Acquisitions” and Note 4 — “Investments in Equity Interests” in the consolidated financial statements for additional information relating to these and other acquisitions.

 

We expect to continue to evaluate possible acquisitions of, or strategic investments in, businesses, products, and technologies that are complementary to our business, which may require the use of cash.

 

Liquidity and Capital Resources

 

As of and for each of the three years ended December 31, 2007 (dollars in thousands):

 

 

 

Our operating activities for each year in the three years ended December 31, 2007 have generated adequate cash to meet our operating needs. As of December 31, 2007, we had cash, cash equivalents, and marketable debt securities totaling $2,363 million, compared to $3,537 million as of December 31, 2006. During the year ended December 31, 2007, we invested $1,586 million in direct stock repurchases (of which $2 million related to restricted stock awards net share settlement) and $250 million in structured stock repurchases. Additionally, we invested net $602 million, in capital expenditures and a net $974 million in acquisitions. The cash used for these investments was offset by $1,919 million of cash generated from operating activities, and $375 million from the issuance of common stock as a result of the exercise of employee stock options. In 2007, $35 million of excess tax benefits from stock-based awards were included as a source of cash flows from financing activities. In 2006, excess tax benefits from stock-based awards of $597 million were included as a source of cash flows from financing activities.

 

As of December 31, 2007, approximately $1.0 billion of earnings held by our foreign subsidiaries and a corporate joint venture are designated as indefinitely reinvested outside the United States. If these funds were required for our operations in the United States, we would be required to accrue and pay additional taxes to repatriate these funds. Currently, we do not anticipate a need to repatriate these funds to our United States operations.

 

We invest excess cash predominantly in marketable debt securities that are liquid, of high-quality investment grade, and the majority of which have effective maturities of less than two years. Our marketable debt and equity securities are classified as available-for-sale and are reported at fair value, with unrealized gains and losses, net of tax, recorded in accumulated other comprehensive income (loss). Realized gains or losses and declines in value judged to be other than temporary, if any, on available-for-sale securities are reported in other income, net. The fair value for securities is determined based on quoted market prices as of the valuation date. We also invest excess cash to support our growing infrastructure needs and expand our operations, as consideration for acquisitions and strategic investments, to repurchase shares of our stock, and in other transactions. As of December 31, 2007, certain of our marketable debt securities had a fair value below cost (representing less than $2 million) due to the changes in market rates of interest and yields on these securities. We evaluate these investments periodically for possible other-than-temporary impairment and review factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer, and our ability and intent to hold the investment for a period of time which may be sufficient for an anticipated recovery in market value. We have the intent and ability to hold these securities for a reasonable period of time sufficient for a forecasted recovery of fair value up to (or beyond) the initial cost of the investment and expect to realize the full value of all of these investments upon maturity or sale.

 

We expect to continue to generate positive cash flow from operations in 2008. We use cash generated by operations as our primary source of liquidity because 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 equity, or debt securities, or obtain credit facilities to further enhance our liquidity position, and the sale of additional equity securities could result in dilution to our stockholders.

 

In April 2003, we issued $750 million of zero coupon senior convertible notes (the “Notes”) which mature on April 1, 2008. These Notes are convertible into Yahoo! common stock at a conversion price of $20.50 per share, subject to adjustment upon the occurrence of certain events. Each $1,000 principal amount of the Notes is convertible on or prior to April 1, 2008 if the market price of our common stock reaches a specified threshold ($22.55) for a defined period of time or specified corporate transactions occur. As of January 1, 2008, the specified price threshold had been met and the Notes are convertible at any time through March 31, 2008. The Notes may be convertible on April 1, 2008 depending on whether the specified price threshold is met for the applicable periods or a specified corporate transaction occurs prior to April 1, 2008. We will be required to pay the outstanding principal amount of any Notes not converted by the holders on or before April 1, 2008 in cash. Consequently, the Notes have been classified as short-term debt in the consolidated balance sheet as of December 31, 2007. Although we have sufficient available funds to pay the Notes, in the event the Notes are not converted on or before their maturity date, we may seek financing to fund the repayment of the Notes, as well as to fund other strategic initiatives.

Cash flow changes

 

Cash provided by operating activities is driven by our net income, adjusted for non-cash items, and non-operating gains and losses from sales of investments. Non-cash adjustments include depreciation, amortization of intangible assets, stock-based compensation expense, tax benefits from stock-based awards, deferred income taxes, and earnings in equity interests. Cash provided by operating activities was greater than net income in 2007 mainly due to the net impact of non-cash adjustments to income. In each of the three years ended December 31, 2007, 2006, and 2005, cash flows from operations were reduced by the increase in our accounts receivable balance, mainly reflecting increases in revenues. The days of sales outstanding metric increased over the three years ended December 31, 2007. Additionally, in the years ended December 31, 2007, 2006, and 2005, there were significant increases in accrued expenses and other liabilities that positively impacted cash flow from operations. These increases were mainly due to higher accrual balances for taxes payable and TAC payments to Affiliates, respectively.

 

Cash used in investing activities is primarily attributable to capital expenditures, purchases and sales of marketable debt and equity securities, purchases of intangible assets, as well as acquisitions including our strategic investments. Our capital expenditures totaled $602 million, $689 million, and $409 million in 2007, 2006, and 2005, respectively. Our capital expenditures have been primarily used for purchases and internal development of information technology assets, and real estate to support our expanding offerings, and our increased number of users. We invested a net $974 million in acquisitions, including strategic investments, in 2007, compared to $142 million and $1,698 million in 2006 and 2005, respectively. Acquisitions and investments in 2007 included cash outlays for our acquisitions of Right Media, Inc., Zimbra, Inc., and BlueLithium, Inc. and an investment in Alibaba.com. Our investments in Yahoo! 7, Gmarket Inc., and Right Media Inc. were the main cash outlays in 2006. Our acquisitions in 2005 included net cash consideration of approximately $1.0 billion for our investment in Alibaba, $0.5 billion for the purchase of the outstanding interests in our joint ventures in Europe and Korea and $54 million for the Verdisoft acquisition. Our cash proceeds from the net sales and maturities of marketable debt securities were $1.1 billion in 2007, compared to cash proceeds of $623 million and $318 million in 2006 and 2005, respectively. Additionally, we generated cash in the amount of $1.0 billion in 2005 from the sale of non-strategic marketable equity securities for which there was no comparable activity in 2007 and 2006.

 

Cash used in financing activities is driven by our financing activities relating to employee option exercises and stock repurchases. Our cash proceeds from employee option exercises were $375 million in 2007, compared to $318 million and $747 million in 2006 and 2005, respectively. The increase in 2007 compared to 2006 is primarily the result of an increase in the number of employee exercises in 2007 over 2006. The decrease in 2006 compared to 2005 was primarily the result of a reduced number of employees exercising options year over year.

 

During 2007, we used $1.6 billion in the direct repurchase of 57.9 million shares of our common stock at an average price of $27.34 per share. In addition, certain restricted stock awards that vested during 2007 were subject to statutory tax withholding obligations. The net share settlement had the effect of a stock repurchase of $2 million. During 2006, we used $1.8 billion in the direct repurchase of 61.5 million shares of our common stock at an average price of $28.98 per share. During 2005, we used $388 million in the direct repurchase of 11.7 million shares of our common stock at an average price of $33.20 per share.

 

In 2007, a $250 million structured stock repurchase transaction which was entered into in the first quarter of 2007 settled and matured. On the maturity date, we received 8.4 million shares of our common stock at an effective buy-back price of $29.80 per share. In 2006, we entered into structured stock repurchase transactions resulting in a total cash outlay of $0.5 billion. This $0.5 billion cash outlay was offset by cash receipts of $272 million from the settlement of a structured stock repurchase transaction entered into in 2005, for a net cash usage of $228 million for these transactions in 2006. In 2005, we entered into structured stock repurchase transactions resulting in a total cash outlay of $1.4 billion. This $1.4 billion cash outlay was offset by cash receipts of $0.8 billion from the settlement of structured stock repurchase transactions in 2005, for a net cash usage of $0.6 billion for these transactions in 2005.

 

Upon adoption of SFAS 123R on January 1, 2006, we have included as part of our cash flows from financing activities the benefit of tax deductions related to stock-based awards in excess of the tax benefits expected at the grant date of the related stock-based awards. This amount is shown as a reduction to cash flows from operating activities and an increase to cash flows from financing activities. Net cash flows remain unchanged from what would have been reported prior to the adoption of SFAS 123R.

In 2007, $35 million of excess tax benefits from stock-based awards were included as a source of cash flows from financing activities. In 2006, excess tax benefits from stock-based awards of $597 million were included as a source of cash flows from financing activities.

 

Financing

 

In April 2003, we issued $750 million of zero coupon senior convertible notes which mature on April 1, 2008. These Notes are convertible into Yahoo! common stock at a conversion price of $20.50 per share, subject to adjustment upon the occurrence of certain events. Each $1,000 principal amount of the Notes is convertible on or prior to April 1, 2008 if the market price of our common stock reaches a specified threshold ($22.55) for a defined period of time or specified corporate transactions occur. As of January 1, 2008, the specified price threshold had been met and the Notes are convertible at any time through March 31, 2008. The Notes may be convertible on April 1, 2008 depending on whether the specified price threshold is met for the applicable periods or a specified corporate transaction occurs prior to April 1, 2008. We will be required to pay the outstanding principal amount of any Notes not converted by the holders on or before April 1, 2008 in cash. Consequently, the Notes have been classified as short-term debt in the consolidated balance sheet as of December 31, 2007. Although we have sufficient available funds to pay the Notes, in the event the Notes are not converted on or before their maturity date, we may seek financing to fund the repayment of the Notes as well as to fund other strategic initiatives. See Note 9 — “Short-Term Debt” in the consolidated financial statements for additional information.

 

Stock repurchases

 

In October 2006, our Board of Directors authorized a new stock repurchase program for us to repurchase up to $3.0 billion of our outstanding shares of common stock from time to time over the next five years, depending on market conditions, share price, and other factors. We believe that additional repurchases made under appropriate market conditions are a prudent use of cash currently available to us in order to enhance long-term stockholder value. Repurchases 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.

 

Under this program, during the year ended December 31, 2007, we repurchased 57.9 million shares of common stock at an average price of $27.34 per share. Total cash consideration for the repurchased stock was $1.6 billion. During 2007, a $250 million structured stock repurchase transaction which was entered into in the first quarter of 2007 also matured and settled. On the maturity date, we received 8.4 million shares of our common stock at an effective buy-back price of $29.80 per share from this transaction. In addition, upon the vesting of certain restricted stock awards during the year ended December 31, 2007, we reacquired 70,000 shares of such vested stock to satisfy tax withholding obligations. These repurchased shares were recorded as $2 million of treasury stock and reduced the number of common shares outstanding by 70,000 accordingly. See Note 11 — “Stockholders’ Equity” in the consolidated financial statements for additional information.

 

Treasury stock is accounted for under the cost method.

 

Subsequent to December 31, 2007, we repurchased approximately 3.4 million shares of our common stock under the current stock repurchase program at an average price of $23.39 per share, for a total amount of $79 million.

 

Capital expenditures

 

Capital expenditures have generally comprised purchases of computer hardware, software, server equipment, furniture and fixtures, and real estate. Capital expenditures, net were $602 million in 2007, compared to $689 million in 2006, including $112 million for a land purchase in Santa Clara, California, and $409 million in 2005. Our capital expenditures in 2008 are expected to be slightly higher than 2007 levels as we continue to invest in the expansion of Yahoo! Properties. This level of expenditure, together with the increase in operating lease commitments, is consistent with our operational expansion, and we anticipate that this will continue in the future as business conditions merit.

Contractual obligations and commitments

 

The following table presents certain payments due under contractual obligations with minimum firm commitments as of December 31, 2007 (in millions):

 

 

 

Affiliate Commitments.  In connection with our contracts to provide advertising services to Affiliates, we are obligated to make payments, which represent traffic acquisition costs, to our Affiliates. As of December 31, 2007, these commitments totaled $286 million, of which $91 million will be payable in 2008, $111 million will be payable in 2009, and $84 million will be payable in 2010.

 

Intellectual Property Rights.  In connection with the licensing of certain intellectual property, we are obligated to invest up to $93 million through July 2008. To the extent the licensed intellectual property will benefit future periods, we will capitalize such payments and amortize them over the useful life of the related intellectual property.

 

Other commitments.  In the ordinary course of business, we may provide indemnifications of varying scope and terms to customers, vendors, lessors, business partners, and other parties with respect to certain matters, including, but not limited to, losses arising out of our breach of agreements, services to be provided by us, or from intellectual property infringement claims made by third parties. 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 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 may 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 consolidated financial statements.

In 2006, we reversed an earn-out accrual related to a prior acquisition, which resulted in a $10 million reduction to operating expenses in the consolidated statements of income for which there was no comparable activity in 2007.

 

As of December 31, 2007, 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. As such, we are not exposed to any financing, liquidity, market, or credit risk that could arise if we had engaged in such relationships.

 

Critical Accounting Policies and Estimates

 

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates, judgments, and assumptions that affect the reported amounts of assets, liabilities, revenues 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, the results of which form the basis for making 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 consolidated financial statements. We believe that the following critical accounting policies reflect the more significant estimates and assumptions used in the preparation of the consolidated financial statements.

 

Management has discussed the development and selection of these critical accounting estimates with the Audit Committee of our Board of Directors and the Audit Committee has reviewed the disclosure below. In addition, there are other items within our financial statements that require estimation, but are not deemed critical as defined above. Changes in estimates used in these and other items could have a material impact on our financial statements.

 

Revenue Recognition.  Our revenues are generated from marketing services and fees. Marketing services revenues are generated from several offerings including: the display of textual, rich media advertisements, display of text based links to advertisers’ Websites, listing based services, and commerce-based transactions. Fees revenues includes revenue from a variety of consumer and business fee-based services. While the majority of our revenue transactions contain standard business terms and conditions, there are certain transactions that contain non-standard business terms and conditions. In addition, we may enter into certain sales transactions that involve multiple element arrangements (arrangements with more than one deliverable). We also enter into arrangements to purchase goods and/or services from certain customers. As a result, significant contract interpretation is sometimes required to determine the appropriate accounting for these transactions including: (1) whether an arrangement exists; (2) how the arrangement consideration should be allocated among potential multiple elements; (3) when to recognize revenue on the deliverables; (4) whether all elements of the arrangement have been delivered; (5) whether the arrangement should be reported gross as a principal versus net as an agent; (6) whether we receive a separately identifiable benefit from the purchase arrangements with our customer for which we can reasonably estimate fair value; and (7) whether the arrangement should be characterized as revenue or a reimbursement of costs incurred. In addition, our revenue recognition policy requires an assessment as to whether collection is reasonably assured, which inherently requires us to evaluate the creditworthiness of our customers. Changes in judgments on these assumptions and estimates could materially impact the timing or amount of revenue recognition.

 

Deferred Income Tax Asset Valuation Allowance.  We record a valuation allowance to reduce our deferred income tax assets to the amount that is more likely than not to be realized. In evaluating our ability to recover our deferred income tax assets we consider all available positive and negative evidence, including our operating results, ongoing tax planning and forecasts of future taxable income on a jurisdiction by jurisdiction basis. In the event we were to determine that we would be able to realize our deferred income tax assets in the future in excess of their net recorded amount, we would make an adjustment to the valuation allowance which would reduce the provision for income

taxes. The valuation allowance decreased by $29 million during the year ended December 31, 2007. The decrease is mainly due to adjustments to non-U.S. net operating loss carryforwards.

 

We establish reserves for tax-related uncertainties based on estimates of whether, and the extent to which, additional taxes will be due. These reserves are established when we believe that certain positions might be challenged despite our belief that our tax return positions are in accordance with applicable tax laws. Effective January 1, 2007, we adopted the provisions of FIN 48. See Note 10 — “Income Taxes” in the consolidated financial statements for additional information.

 

Goodwill and Other Intangible Assets.  Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis and between annual tests in certain circumstances. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value of each reporting unit. Significant judgments required to estimate the fair value of reporting units include estimating future cash flows, and determining appropriate discount rates, growth rates and other assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value for each reporting unit which could trigger impairment. See Note 5 — “Goodwill” in the consolidated financial statements for additional information. Based on our 2007 impairment test, there would have to be a significant unfavorable change to our assumptions used in such calculations for an impairment to exist.

 

We amortize other intangible assets over their estimated useful lives. We record an impairment charge on these assets when we determine that their carrying value may not be recoverable. The carrying value is not recoverable if it exceeds the undiscounted future cash flows resulting from the use of the asset and its eventual disposition. When there is existence of one or more indicators of impairment, we measure any impairment of intangible assets based on a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our business model. Our estimates of future cash flows attributable to our other intangible assets require significant judgment based on our historical and anticipated results and are subject to many factors. Different assumptions and judgments could materially affect the calculation of the fair value of our other intangible assets which could trigger impairment.

 

Investments in Equity Interests.  We account for investments in entities in which we can exercise significant influence but do not own a majority equity interest or otherwise control using the equity method. In accounting for these investments we record our proportionate share of these entities’ net income or loss, one quarter in arrears.

 

We review all of our investments in equity interests for impairment whenever events or changes in business circumstances indicate that the carrying amount of the investment may not be fully recoverable. The impairment review requires significant judgment to identify events or circumstances that would likely have a significant adverse effect on the fair value of the investment. Investments identified as having an indication of impairment are subject to further analysis to determine if the impairment is other-than-temporary and this analysis requires estimating the fair value of the investment. The determination of the fair value of the investment involves considering factors such as the following: the stock prices of public companies in which we have an equity investment, current economic and market conditions, the operating performance of the companies including current earnings trends and undiscounted cash flows, quoted stock prices of comparable public companies, and other company specific information including recent financing rounds. The fair value determination, particularly for investments in privately-held companies, requires significant judgment to determine appropriate estimates and assumptions. Changes in these estimates and assumptions could affect the calculation of the fair value of the investments and the determination of whether any identified impairment is other-than-temporary.

 

Stock-Based Compensation Expense.  Effective January 1, 2006, we adopted SFAS 123R using the modified prospective method and therefore have not restated prior periods’ results. Under the fair value recognition provisions of SFAS 123R, we recognize stock-based compensation expense net of an estimated forfeiture rate and therefore only recognize compensation cost for those shares expected to vest over the service period of the award.

 

Calculating stock-based compensation expense requires the input of highly subjective assumptions, including the expected term of the stock-based awards, stock price volatility, and the pre-vesting option forfeiture rate. We estimate the expected life of options granted based on historical exercise patterns, which we believe are representative of future

behavior. We estimate the volatility of our common stock on the date of grant based on the implied volatility of publicly traded options on our common stock, with a term of one year or greater. We believe that implied volatility calculated based on actively traded options on our common stock is a better indicator of expected volatility and future stock price trends than historical volatility. Therefore, expected volatility for the year ended December 31, 2007 was based on a market-based implied volatility. The assumptions used in calculating the fair value of stock-based awards represent our best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future. In addition, we are required to estimate the expected forfeiture rate, as well as the probability that performance conditions that affect the vesting of certain awards will be achieved, and only recognize expense for those shares expected to vest. We estimate the forfeiture rate based on historical experience of our stock-based awards that are granted, exercised, and cancelled. If our actual forfeiture rate is materially different from our estimate, the stock-based compensation expense could be significantly different from what we have recorded in the current period. See Note 12 — “Employee Benefits” in the consolidated financial statements for additional information.

 

Recent Accounting Pronouncements.  In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements, but provides guidance on how to measure fair value by providing a fair value hierarchy used to classify the source of the information. SFAS 157 is effective for fiscal years beginning after November 15, 2007. However, on February 12, 2008, the FASB issued FSP FAS 157-2 which delays the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). This FSP partially defers the effective date of SFAS 157 to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years for items within the scope of this FSP. Effective for 2008, we will adopt SFAS 157 except as it applies to those nonfinancial assets and nonfinancial liabilities as noted in FSP FAS 157-2. The partial adoption of SFAS 157 is not expected to have a material impact on our consolidated financial position, cash flows, or results of operations.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”) which permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. The provisions of SFAS 159 became effective for us on January 1, 2008. The adoption of SFAS 159 is not expected to have a material impact on our consolidated financial position, cash flows, or results of operations.

 

In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”) and SFAS No. 160, “Accounting and Reporting of Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB 51” (“SFAS 160”), which will change the accounting for and reporting of business combination transactions and noncontrolling interests in consolidated financial statements. SFAS 141R and SFAS 160 will be effective for us on January 1, 2009. We are currently evaluating the impact of adopting SFAS 141R and SFAS 160 on our consolidated financial position, cash flows, and results of operations.

 

 

We are exposed to the impact of interest rate changes, foreign currency fluctuations, and changes in the market values of our investments.

 

Interest Rate Risk.  Our exposure to market rate risk for changes in interest rates relates primarily to our investment portfolio. We invest excess cash in marketable debt instruments of the United States Government and its agencies, and in high-quality corporate issuers and, by policy, limit the amount of credit exposure to any one issuer. We protect and preserve invested funds by limiting default, market, and reinvestment risk.

 

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. 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 which have declined in market value due to changes in interest rates. As of December 31, 2007 and 2006, we had investments in short-term marketable debt securities of approximately $488 million and $1,032 million, respectively. Such investments had a weighted-average yield of approximately 4.5 percent and