10-Q 1 d402943d10q.htm QUARTERLY REPORT ON FORM 10-Q QUARTERLY REPORT ON FORM 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

 

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

For the quarterly period ended September 30, 2012

Or

 

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

For the transition period from              to             

Commission file number 000-28018

 

 

Yahoo! Inc.

(Exact name of Registrant as specified in its charter)

 

 

 

Delaware   77-0398689

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

701 First Avenue

Sunnyvale, California 94089

(Address of principal executive offices, including zip code)

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

 

 

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

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

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

 

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

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

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

 

Class

 

Outstanding at October 31, 2012

Common Stock, $0.001 par value   1,182,688,258

 

 

 


Table of Contents

YAHOO! INC.

Table of Contents

 

PART I

  FINANCIAL INFORMATION      3   

Item 1.

 

Condensed Consolidated Financial Statements (unaudited)

     3   
 

Condensed Consolidated Balance Sheets as of December 31, 2011 and September 30, 2012

     3   
 

Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2011 and 2012

     4   
 

Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2011 and 2012

     5   
 

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 and 2012

     6   
 

Notes to Condensed Consolidated Financial Statements

     7   

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     26   

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

     38   

Item 4.

 

Controls and Procedures

     39   

PART II

  OTHER INFORMATION      40   

Item 1.

 

Legal Proceedings

     40   

Item 1A.

 

Risk Factors

     40   

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     53   

Item 3.

 

Defaults Upon Senior Securities

     53   

Item 4.

 

Mine Safety Disclosures

     53   

Item 5.

 

Other Information

     53   

Item 6.

 

Exhibits

     53   
  Signatures      54   

 

2


Table of Contents

PART I — FINANCIAL INFORMATION

 

Item 1. Condensed Consolidated Financial Statements (unaudited)

YAHOO! INC.

Condensed Consolidated Balance Sheets

 

     December 31,
2011
    September 30,
2012
 
     (Unaudited, in thousands
except par values)
 

ASSETS

    

Current assets:

    

Cash and cash equivalents

   $ 1,562,390      $ 7,560,400   

Short-term marketable debt securities

     493,189        852,816   

Accounts receivable, net

     1,037,474        953,671   

Prepaid expenses and other current assets

     359,483        318,892   
  

 

 

   

 

 

 

Total current assets

     3,452,536        9,685,779   

Long-term marketable debt securities

     474,338        1,013,555   

Other long-term investments

     —          802,609   

Property and equipment, net

     1,730,888        1,671,234   

Goodwill

     3,900,752        3,910,245   

Intangible assets, net

     254,600        173,918   

Other long-term assets

     220,628        548,182   

Investments in equity interests

     4,749,044        2,608,605   
  

 

 

   

 

 

 

Total assets

   $ 14,782,786      $ 20,414,127   
  

 

 

   

 

 

 

LIABILITIES AND EQUITY

    

Current liabilities:

    

Accounts payable

   $ 166,595      $ 147,943   

Accrued expenses and other current liabilities

     846,044        3,049,074   

Deferred revenue

     194,722        309,265   
  

 

 

   

 

 

 

Total current liabilities

     1,207,361        3,506,282   

Long-term deferred revenue

     43,639        444,415   

Capital lease and other long-term liabilities

     134,905        127,531   

Deferred and other long-term tax liabilities, net

     815,534        730,378   
  

 

 

   

 

 

 

Total liabilities

     2,201,439        4,808,606   

Commitments and contingencies (Note 11)

     —          —     

Yahoo! Inc. stockholders’ equity:

    

Common stock, $0.001 par value; 5,000,000 shares authorized; 1,244,956 shares issued and 1,217,481 shares outstanding as of December 31, 2011 and 1,259,876 shares issued and 1,185,965 shares outstanding as of September 30, 2012

     1,242        1,257   

Additional paid-in capital

     9,825,899        10,067,211   

Treasury stock at cost, 27,475 shares as of December 31, 2011 and 73,911 shares as of September 30, 2012

     (416,237     (1,132,615

Retained earnings

     2,432,294        6,105,506   

Accumulated other comprehensive income

     697,869        520,144   
  

 

 

   

 

 

 

Total Yahoo! Inc. stockholders’ equity

     12,541,067        15,561,503   

Noncontrolling interests

     40,280        44,018   
  

 

 

   

 

 

 

Total equity

     12,581,347        15,605,521   
  

 

 

   

 

 

 

Total liabilities and equity

   $ 14,782,786      $ 20,414,127   
  

 

 

   

 

 

 

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

 

3


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YAHOO! INC.

Condensed Consolidated Statements of Income

 

     Three Months Ended     Nine Months Ended  
     September 30,
2011
    September 30,
2012
    September 30,
2011
    September 30,
2012
 
     (Unaudited, in thousands except per share amounts)  

Revenue

   $ 1,216,665      $ 1,201,732      $ 3,660,046      $ 3,640,759   

Operating expenses:

        

Cost of revenue — Traffic acquisition costs

     144,991        112,829        447,918        393,945   

Cost of revenue — Other

     239,002        282,081        720,017        814,513   

Sales and marketing

     290,520        269,272        832,827        827,450   

Product development

     229,230        217,301        683,558        645,407   

General and administrative

     129,954        135,249        384,674        395,637   

Amortization of intangibles

     8,435        8,084        25,067        27,893   

Restructuring charges, net

     (2,721     24,727        8,091        159,536   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     1,039,411        1,049,543        3,102,152        3,264,381   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     177,254        152,189        557,894        376,378   

Other income, net

     18,046        4,607,656        17,407        4,630,109   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes and earnings in equity interests

     195,300        4,759,845        575,301        5,006,487   

Provision for income taxes

     (55,731     (1,774,094     (163,480     (1,857,036

Earnings in equity interests

     158,775        175,265        349,857        527,499   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     298,344        3,161,016        761,678        3,676,950   

Less: net income attributable to noncontrolling interests

     (5,053     (778     (8,423     (3,738
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Yahoo! Inc.

   $ 293,291      $ 3,160,238      $ 753,255      $ 3,673,212   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Yahoo! Inc. common stockholders per share — basic

   $ 0.23      $ 2.66      $ 0.59      $ 3.05   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Yahoo! Inc. common stockholders per share — diluted

   $ 0.23      $ 2.64      $ 0.58      $ 3.02   
  

 

 

   

 

 

   

 

 

   

 

 

 

Shares used in per share calculation — basic

     1,253,044        1,186,046        1,287,352        1,205,050   
  

 

 

   

 

 

   

 

 

   

 

 

 

Shares used in per share calculation — diluted

     1,259,576        1,195,085        1,296,040        1,214,430   
  

 

 

   

 

 

   

 

 

   

 

 

 

Stock-based compensation expense by function:

        

Cost of revenue — Other

   $ 956      $ 2,363      $ 2,479      $ 7,871   

Sales and marketing

   $ 16,759      $ 19,876      $ 42,829      $ 59,954   

Product development

   $ 21,093      $ 17,050      $ 64,296      $ 54,329   

General and administrative

   $ 12,139      $ 22,077      $ 35,507      $ 44,749   

Restructuring expense reversals, net

   $ —        $ —        $ (1,278   $ (3,429

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

 

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YAHOO! INC.

Condensed Consolidated Statements of Comprehensive Income

 

     Three Months Ended     Nine Months Ended  
     September 30,
2011
    September 30,
2012
    September 30,
2011
    September 30,
2012
 
     (Unaudited, in thousands)  

Net Income

   $ 298,344      $ 3,161,016      $ 761,678      $ 3,676,950   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income:

        

Unrealized gains (losses) on available-for-sale securities, net of taxes of $2,384 and $(246) for the three months ended September 30, 2011 and 2012, respectively, and $1,582 and $(41) for the nine months ended September 30, 2011 and 2012, respectively

     (5,900     463        (3,129     6,143   

Reclassification adjustment for realized (gains) losses included in net income, net of taxes of $190 and $57 for the three months ended September 30, 2011 and 2012, respectively, and $2,002 and $(5,298) for the nine months ended September 30, 2011 and 2012, respectively

     (285     (98     (3,280     9,260   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net change in unrealized gains (losses) on available-for-sale securities, net of taxes

     (6,185     365        (6,409     15,403   

Foreign currency translation adjustment, net of tax

     (44,689     28,009        127,156        (193,128
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other comprehensive income, net of tax

     (50,874     28,374        120,747        (177,725
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

     247,470        3,189,390        882,425        3,499,225   

Less: comprehensive income attributable to noncontrolling interests

     (5,053     (778     (8,423     (3,738
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income attributable to Yahoo! Inc.

   $ 242,417      $ 3,188,612      $ 874,002      $ 3,495,487   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

 

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YAHOO! INC.

Condensed Consolidated Statements of Cash Flows

 

     Nine Months Ended  
     September 30,
2011
    September 30,
2012
 
     (Unaudited, in thousands)  

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Net income

   $ 761,678      $ 3,676,950   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation

     404,823        401,022   

Amortization of intangible assets

     87,784        84,087   

Stock-based compensation expense, net

     143,833        163,474   

Noncash restructuring charges, net

     —          40,462   

Tax benefits from stock-based awards

     9,974        (9,471

Excess tax benefits from stock-based awards

     (44,715     (30,751

Deferred income taxes

     68,740        (891,288

Earnings in equity interests

     (349,857     (527,499

Dividends received from Yahoo Japan

     75,391        83,648   

Gain from sale of Alibaba Group Shares

     —          (4,603,322

Gain from sales of investments, assets, and other, net

     12,822        (18,308

Changes in assets and liabilities, net of effects of acquisitions:

    

Accounts receivable, net

     156,092        86,942   

Prepaid expenses and other

     10,407        41,059   

Accounts payable

     (27,316     (22,457

Accrued expenses and other liabilities

     (351,081     2,628,962   

Deferred revenue

     (66,103     514,811   
  

 

 

   

 

 

 

Net cash provided by operating activities

     892,472        1,618,321   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Acquisition of property and equipment, net

     (463,006     (355,787

Purchases of marketable debt securities

     (1,613,298     (1,838,860

Proceeds from sales of marketable debt securities

     1,067,229        684,979   

Proceeds from maturities of marketable debt securities

     1,226,892        250,653   

Proceeds related to sale of Alibaba Group Shares, net

     —          6,247,728   

Proceeds from the sale of investments

     21,271        26,132   

Acquisitions, net of cash acquired

     (68,812     —     

Purchases of intangible assets

     (11,020     (3,088

Other investing activities, net

     (5,763     (9,421
  

 

 

   

 

 

 

Net cash provided by investing activities

     153,493        5,002,336   
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Proceeds from issuance of common stock, net

     106,697        116,420   

Repurchases of common stock

     (1,202,504     (716,379

Excess tax benefits from stock-based awards

     44,715        30,751   

Tax withholdings related to net share settlements of restricted stock awards and restricted stock units

     (36,049     (48,097

Other financing activities, net

     (8,333     (3,519
  

 

 

   

 

 

 

Net cash used in financing activities

     (1,095,474     (620,824
  

 

 

   

 

 

 

Effect of exchange rate changes on cash and cash equivalents

     (12,699     (1,823

Net change in cash and cash equivalents

     (62,208     5,998,010   

Cash and cash equivalents at beginning of period

     1,526,427        1,562,390   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 1,464,219      $ 7,560,400   
  

 

 

   

 

 

 

See Note 4 — “Investments in Equity Interests” for information about the non-cash proceeds of $800 million in Alibaba Group Preference Shares.

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

 

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YAHOO! INC.

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 1 THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

Basis of Presentation. The condensed consolidated financial statements include the accounts of Yahoo! Inc. and its majority-owned or otherwise controlled subsidiaries. All significant intercompany accounts and transactions have been eliminated. Investments in entities in which the Company can exercise significant influence, but does not own a majority equity interest or otherwise control, are accounted for using the equity method and are included as investments in equity interests on the condensed consolidated balance sheets. The Company has included the results of operations of acquired companies from the date of the acquisition. Certain prior period amounts have been reclassified to conform to the current period presentation. To conform to the current period presentation, the Company corrected the classification of $25 million and $60 million of costs principally included in product development expenses to cost of revenue—other for the three and nine months ended September 30, 2011, respectively.

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

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

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

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

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

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

 

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Potentially dilutive securities representing approximately 37 million and 44 million shares of common stock for the three and nine months ended September 30, 2012, respectively, and 58 million shares of common stock for both the three and nine months ended September 30, 2011 were excluded from the computation of diluted earnings per share for these periods because their effect would have been anti-dilutive.

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

 

     Three Months Ended     Nine Months Ended  
     September 30,
2011
    September 30,
2012
    September 30,
2011
    September 30,
2012
 

Basic:

        

Numerator:

        

Net income attributable to Yahoo! Inc.

   $ 293,291      $ 3,160,238      $ 753,255      $ 3,673,212   

Less: Net income allocated to participating securities

     (3     (35     (11     (47
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Yahoo! Inc. common stockholders — basic

   $ 293,288      $ 3,160,203      $ 753,244      $ 3,673,165   
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator:

        

Weighted average common shares

     1,253,044        1,186,046        1,287,352        1,205,050   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Yahoo! Inc. common stockholders per share — basic

   $ 0.23      $ 2.66      $ 0.59      $ 3.05   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted:

        

Numerator:

        

Net income attributable to Yahoo! Inc.

   $ 293,291      $ 3,160,238      $ 753,255      $ 3,673,212   

Less: Net income allocated to participating securities

     (3     (34     (11     (46

Less: Effect of dilutive securities issued by equity investees

     (661     (1,334     (1,963     (3,846
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Yahoo! Inc. common stockholders — diluted

   $ 292,627      $ 3,158,870      $ 751,281      $ 3,669,320   
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator:

        

Denominator for basic calculation

     1,253,044        1,186,046        1,287,352        1,205,050   

Weighted average effect of Yahoo! Inc. dilutive securities:

        

Restricted stock and restricted stock units

     4,333        7,587        5,768        7,776   

Stock options and employee stock purchase plan

     2,199        1,452        2,920        1,604   
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator for diluted calculation

     1,259,576        1,195,085        1,296,040        1,214,430   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Yahoo! Inc. common stockholders per share — diluted

   $ 0.23      $ 2.64      $ 0.58      $ 3.02   
  

 

 

   

 

 

   

 

 

   

 

 

 

Note 3 ACQUISITIONS

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

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

The Company did not make any acquisitions during the nine months ended September 30, 2012.

 

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Note 4 INVESTMENTS IN EQUITY INTERESTS

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

 

     December 31,
2011
     September 30,
2012
     Percent
Ownership of
Common Stock as of
September 30, 2012
 

Alibaba Group

   $ 2,521,825       $ 225,152         24

Yahoo Japan

     2,219,946         2,373,219         35

Other

     7,273         10,234         25
  

 

 

    

 

 

    

Total

   $ 4,749,044       $ 2,608,605      
  

 

 

    

 

 

    

Equity Investment in Alibaba Group. The investment in Alibaba Group Holding Limited (“Alibaba Group”) is being accounted for using the equity method, and the total investment, including net tangible assets, identifiable intangible assets and goodwill, is classified as part of the investments in equity interests balance on the Company’s condensed consolidated balance sheets.

The Company’s accounting policy is to record its share of the results of Alibaba Group, and any related amortization expense, one quarter in arrears within earnings in equity interests in the condensed consolidated statements of income. However, due to the materiality of the Initial Repurchase (as defined and described below), the Company accounted for the impact of the Initial Repurchase and related transactions on Alibaba Group’s financial information in the quarter ended September 30, 2012 instead of one quarter in arrears. As of September 30, 2012, Alibaba Group’s common shareholders’ equity is a net deficit as a result of the repurchase of its ordinary shares from the Company at fair value, which was significantly in excess of the book value per share. The Company’s remaining investment balance represents excess cost largely attributable to goodwill.

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

 

     Three Months Ended      Nine Months Ended  
     June 30,
2011
     June 30,
2012
     June 30,
2011
     June 30,
2012
 

Operating data(*):

           

Revenue

   $ 631,216       $ 1,077,045       $ 1,666,663       $ 2,905,752   

Gross profit

   $ 421,173       $ 739,914       $ 1,108,482       $ 1,967,290   

Income from operations

   $ 132,403       $ 371,854       $ 205,654       $ 861,775   

Net income

   $ 137,253       $ 292,928       $ 233,887       $ 781,701   

Net income attributable to Alibaba Group

   $ 118,947       $ 273,043       $ 180,890       $ 730,438   
                   September 30,
2011
     June 30,
2012
 

Balance sheet data(*):

           

Current assets

         $ 3,491,753       $ 4,437,224   

Long-term assets

         $ 2,993,329       $ 3,067,122   

Current liabilities

         $ 1,562,840       $ 2,210,545   

Long-term liabilities

         $ 134,160       $ 1,943,131   

Non-voting participating redeemable securities

         $ 1,415       $ 4,520   

Noncontrolling interests

         $ 406,805       $ 65,374   

 

(*) 

The comparative summary financial information disclosed above is as of June 30, 2012 and, accordingly, does not include the effects of the Initial Repurchase and related transactions. In addition, in the period ended June 30, 2012, Alibaba Group purchased the remaining noncontrolling interest in Alibaba.com, for total consideration of approximately $2.5 billion. The purchase was primarily financed by the issuance of debt. The excess of consideration over book value of the noncontrolling interest was recorded as a reduction to the shareholders’ equity of Alibaba Group, which increased the Company’s excess cost related to its investment in Alibaba Group.

 

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Framework Agreement with Alibaba Group regarding Alipay. Alibaba Group restructured the ownership of Alipay.com Co., Ltd. (“Alipay”) and deconsolidated Alipay in the first quarter of 2011. The impact of the deconsolidation of Alipay was not material to the Company’s financial statements. On July 29, 2011, the Company entered into a Framework Agreement (the “Framework Agreement”) with Alibaba Group, Softbank Corp., a Japanese corporation, Alipay, APN Ltd., a company organized under the laws of the Cayman Islands (“IPCo”), Zhejiang Alibaba E-Commerce Co., Ltd., a limited liability company organized under the laws of the People’s Republic of China (“HoldCo”), Jack Ma Yun, Joseph C. Tsai and certain security holders of Alipay or HoldCo as joinder parties. The Framework Agreement establishes the ongoing financial and other arrangements between Alibaba Group and Alipay. The transactions under the Framework Agreement closed on December 14, 2011.

Pursuant to the terms of the Framework Agreement (1) Alibaba Group will receive certain payments (“Liquidity Event Payment”) upon a liquidity event related to Alipay, such as an initial public offering or sale of Alipay; (2) Alibaba Group received a non-interest bearing promissory note in the principal amount of $500 million with a seven year maturity (the “IPCo Promissory Note”); (3) upon payment in full of the Liquidity Event Payment certain assets used in the Alipay business that were retained by Alibaba Group will be transferred to Alipay; (4) Alibaba Group and Alipay entered into a long-term agreement pursuant to which Alibaba Group will receive payment processing services on preferential terms from Alipay and its subsidiaries; and (5) Alibaba Group licensed to Alipay certain intellectual property and technology and performs certain software technology services for Alipay and in return Alipay pays to Alibaba Group a royalty and software technology services fee.

The royalty and software technology services fee and the payment processing services fees discussed above approximate the estimated fair values of such services and are recognized in Alibaba Group’s financial statements as income or expense, as applicable, as the services are rendered. The Company will record its share, if any, of the results of these transactions as they are recorded by Alibaba Group within Yahoo!’s earnings in equity interests in the condensed consolidated statements of income. Alibaba Group will recognize the Liquidity Event Payment, the payment of the IPCo Promissory Note, and any impact from the transfer of assets, described above, if and when such payments or transfers occur. The Company will record its share, if any, of the results of these transactions as they are recorded by Alibaba Group within the Company’s earnings in equity interests in the condensed consolidated statements of income.

Initial Repurchase by Alibaba Group. On September 18, 2012 (the “Repurchase Closing Date”), Alibaba Group repurchased 523 million of the 1,047 million ordinary shares of Alibaba Group (“Shares”) owned by the Company (the “Initial Repurchase”). The Initial Repurchase was made pursuant to the terms of the Share Repurchase and Preference Share Sale Agreement entered into by Yahoo! Inc., Alibaba Group and Yahoo! Hong Kong Holdings Limited, a Hong Kong corporation and wholly-owned subsidiary of Yahoo! Inc. (“YHK”) on May 20, 2012 (as amended on September 11, 2012, the “Repurchase Agreement”). Yahoo! received $13.54 per Share, or approximately $7.1 billion in total consideration, for the 523 million Shares sold to Alibaba Group. Approximately $6.3 billion of the consideration was received in cash and $800 million was received in Alibaba Group preference shares (the “Alibaba Group Preference Shares”). The Initial Repurchase resulted in a pre-tax gain of approximately $4.6 billion for the three months ended September 30, 2012. The Company will continue to account for its remaining approximately 24 percent ownership interest in Alibaba Group under the equity method.

The Alibaba Group Preference Shares yield semi-annual dividends at a rate per annum of up to 10 percent, with at least 3 percent payable in cash and the remainder accruing and resulting in an increase to the liquidation preference. The dividend rate is subject to certain adjustments. The Alibaba Group Preference Shares will be freely transferable by Yahoo! after 18 months from the Repurchase Closing Date, are callable by Alibaba Group at any time at the liquidation preference, will not be convertible, and are mandatorily redeemable at the liquidation preference (including accrued dividends) by Alibaba Group on the earlier of the tenth anniversary of the Repurchase Closing Date and the occurrence of certain specified events. The Alibaba Group Preference Shares are classified as available for sale securities and included within other long-term investments on the condensed consolidated balance sheets.

The Repurchase Agreement provides that at the time Alibaba Group completes an initial public offering meeting certain specified criteria (a “Qualified IPO”), Yahoo! and YHK will sell, at Alibaba Group’s election (either directly to Alibaba Group or in the Qualified IPO), up to 261.5 million of their remaining Shares. If Shares are sold back to Alibaba Group in the Qualified IPO, the purchase price per Share will be equal to the per share price in the Qualified IPO less specified fees and underwriter discounts.

On the Repurchase Closing Date, the Company and Alibaba Group entered into an amendment of their existing Technology and Intellectual Property License Agreement (the “TIPLA”) pursuant to which Alibaba Group made a payment to the Company of $550 million in satisfaction of certain future royalty payments under the existing TIPLA. The Company will recognize this revenue over the remaining four-year term. For the three months ended September 30, 2012, the Company recognized approximately $5 million in revenue related to the TIPLA. Alibaba Group will continue making royalty payments until the earlier of the fourth anniversary of the effective date of the amendment and a Qualified IPO. Pursuant to the terms of the TIPLA, prior to being amended on the Repurchase Closing Date, the Company recognized revenue of approximately $11 million and $30 million for the three and nine

 

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months ended September 30, 2011, respectively, and $19 million and $51 million for the three and nine months ended September 30, 2012, respectively.

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

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

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

The fair value of the Company’s ownership interest in the common stock of Yahoo Japan, based on the quoted stock price, was approximately $7.7 billion as of September 30, 2012.

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

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

 

     Three Months Ended      Nine Months Ended  
     June 30,
2011
     June 30,
2012
     June 30,
2011
     June 30,
2012
 

Operating data:

           

Revenue

   $ 958,927       $ 1,036,650       $ 2,959,085       $ 3,175,951   

Gross profit

   $ 797,008       $ 877,116       $ 2,452,776       $ 2,693,956   

Income from operations

   $ 446,945       $ 512,994       $ 1,442,131       $ 1,640,935   

Net income

   $ 284,111       $ 315,949       $ 799,995       $ 966,646   

Net income attributable to Yahoo Japan

   $ 282,820       $ 314,726       $ 795,103       $ 962,818   
                   September 30,
2011
     June 30,
2012
 

Balance sheet data:

           

Current assets

         $ 3,622,833       $ 5,136,958   

Long-term assets

         $ 2,907,062       $ 1,738,683   

Current liabilities

         $ 1,117,773       $ 950,823   

Long-term liabilities

         $ 36,009       $ 55,517   

Noncontrolling interests

         $ 31,102       $ 29,148   

Under technology and trademark license and other commercial arrangements with Yahoo Japan, the Company records revenue from Yahoo Japan based on a percentage of advertising revenue earned by Yahoo Japan. The Company recorded revenue from Yahoo Japan of approximately $74 million and $75 million for the three months ended September 30, 2011 and 2012, respectively, and revenue of approximately $211 million for the nine months ended September 30, 2011 and 2012. As of December 31, 2011 and September 30, 2012, the Company had net receivable balances from Yahoo Japan of approximately $42 million and $47 million, respectively.

 

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Note 5 GOODWILL

The Company’s goodwill balance was $3.9 billion as of December 31, 2011 and September 30, 2012, of which $2.9 billion was recorded in the Americas segment, $0.6 billion in the EMEA (Europe, Middle East, and Africa) segment, and $0.4 billion in the Asia Pacific segment. The change in the carrying amount of goodwill of $9 million reflected on the Company’s condensed consolidated balance sheets during the nine months ended September 30, 2012 was primarily due to foreign exchange gain of $8 million.

Note 6 INTANGIBLE ASSETS, NET

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

 

     December 31, 2011      September 30, 2012  
     Net      Gross Carrying
Amount
     Accumulated
Amortization(*)
    Net  

Customer and advertiser-related relationships

   $ 93,683       $ 162,389       $ (92,527   $ 69,862   

Developed technology and patents

     137,668         274,950         (191,233     83,717   

Trade names, trademarks, and domain names

     23,249         50,982         (30,643     20,339   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total intangible assets, net

   $ 254,600       $ 488,321       $ (314,403   $ 173,918   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(*)

Cumulative foreign currency translation adjustments, reflecting movement in the currencies of the underlying entities, increased total intangible assets by approximately $19 million as of September 30, 2012.

The Company recognized amortization expense for intangible assets of $29 million and $24 million for the three months ended September 30, 2011 and 2012, respectively, including $20 million and $16 million, respectively, in cost of revenue — other. For the nine months ended September 30, 2011 and 2012, the Company recognized amortization expense for intangible assets of $88 million and $84 million, respectively, including $62 million and $56 million in cost of revenue — other, respectively. Based on the current amount of intangibles subject to amortization, the estimated amortization expense for the remainder of 2012 and each of the succeeding years is as follows: three months ending December 31, 2012: $21 million; 2013: $62 million; 2014: $42 million; 2015: $22 million; 2016: $5 million; and 2017: $5 million.

Note 7 OTHER INCOME, NET

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

 

     Three Months Ended     Nine Months Ended  
     September 30,
2011
     September 30,
2012
    September 30,
2011
     September 30,
2012
 

Interest and investment income

   $ 3,955       $ 6,402      $ 14,399       $ 15,682   

Gain related to sale of Alibaba Group Shares

     —           4,603,322        —           4,603,322   

Other

     14,091         (2,068     3,008         11,105   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total other income, net

   $ 18,046       $ 4,607,656      $ 17,407       $ 4,630,109   
  

 

 

    

 

 

   

 

 

    

 

 

 

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

The Company recorded a pre-tax gain of approximately $4.6 billion in the three months ended September 30, 2012 related to the sale of Alibaba Group Shares. See Note 4 — “Investments in Equity Interests” for additional information.

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

 

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Note 8 ACCUMULATED OTHER COMPREHENSIVE INCOME

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

 

     December 31,
2011
    September 30,
2012
 

Unrealized (losses) gains on available-for-sale securities, net of tax

   $ (7,538   $ 7,865   

Foreign currency translation, net of tax

     705,407        512,279   
  

 

 

   

 

 

 

Accumulated other comprehensive income

   $ 697,869      $ 520,144   
  

 

 

   

 

 

 

Note 9 INVESTMENTS

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

 

     December 31, 2011  
     Gross
Amortized
Costs
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Estimated
Fair Value
 

Government and agency securities

   $ 599,582       $ 1,054       $ (172   $ 600,464   

Corporate debt securities, commercial paper, and bank certificates of deposit

     366,264         1,025         (226     367,063   

Corporate equity securities

     2,761         —           (1,978     783   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total investments in available-for-sale securities

   $    968,607       $ 2,079       $ (2,376   $    968,310   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

     September 30, 2012  
     Gross
Amortized
Costs
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Estimated
Fair Value
 

Government and agency securities

   $ 779,715       $ 785       $ (3   $ 780,497   

Corporate debt securities, commercial paper, and bank certificates of deposit

     1,084,570         1,476         (172     1,085,874   

Corporate equity securities

     230         —           (28     202   

Other long-term investments

     802,609         —           —          802,609   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total investments in available-for-sale securities

   $ 2,667,124       $ 2,261       $ (203   $ 2,669,182   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

     December 31,
2011
     September 30,
2012
 

Reported as:

     

Short-term marketable debt securities

   $ 493,189       $ 852,816   

Long-term marketable debt securities

     474,338         1,013,555   

Other long-term investments

     —           802,609   

Other assets

     783         202   
  

 

 

    

 

 

 

Total

   $ 968,310       $ 2,669,182   
  

 

 

    

 

 

 

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

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

 

     December 31,
2011
     September 30,
2012
 

Due within one year

   $ 493,189       $ 852,816   

Due after one year through five years

     474,338         1,013,555   
  

 

 

    

 

 

 

Total available-for-sale marketable debt securities

   $ 967,527       $ 1,866,371   
  

 

 

    

 

 

 

 

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

 

     December 31, 2011  
     Less than 12 Months     12 Months or Greater     Total  
     Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
 

Government and agency securities

   $ 138,755       $ (172   $ —         $ —        $ 138,755       $ (172

Corporate debt securities, commercial paper, and bank certificates of deposit

     123,574         (226     —           —          123,574         (226

Corporate equity securities

     —           —          783         (1,978     783         (1,978
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total investments in available-for-sale securities

   $ 262,329       $ (398   $ 783       $ (1,978   $ 263,112       $ (2,376
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

 

     September 30, 2012  
     Less than 12 Months     12 Months or Greater     Total  
     Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
 

Government and agency securities

   $ 27,790       $ (3   $ —         $ —        $ 27,790       $ (3

Corporate debt securities, commercial paper, and bank certificates of deposit

     219,045         (172     —           —          219,045         (172

Corporate equity securities

     202         (28     —           —          202         (28
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total investments in available-for-sale securities

   $ 247,037       $ (203   $   —         $      —         $ 247,037       $ (203
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

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

The Company’s investment in the Alibaba Group Preference Shares is recorded as other long-term investments on the condensed consolidated balance sheets. To estimate the fair value, the Company performed benchmarking by comparing the terms and conditions of the Alibaba Group Preference Shares to dividend rates, subordination terms, and credit ratings of those of similar type instruments. The fair value of $800 million approximates the notional value of the Alibaba Group Preference Shares as of September 30, 2012. For the three and nine months ended September 30, 2012, the Company has recorded approximately $3 million in dividend income related to the Alibaba Group Preference Shares within other income, net on the condensed consolidated statements of income.

 

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

 

     Fair Value Measurements at Reporting Date Using  

Assets:

   Level 1      Level 2     Total  

Money market funds(1)

   $ 418,338       $ —        $ 418,338   

Available-for-sale securities:

       

Government and agency securities(1)

     —           617,316        617,316   

Commercial paper and bank certificates of deposit(1)

     —           47,904        47,904   

Corporate debt securities(1)

     —           318,805        318,805   

Time deposits

     —           216,505        216,505   

Corporate equity securities(2)

     783         —          783   
  

 

 

    

 

 

   

 

 

 

Available-for-sale securities at fair value

   $ 419,121       $ 1,200,530      $ 1,619,651   

Liabilities:

       

Foreign currency derivative contract(3)

     —           (2,817     (2,817
  

 

 

    

 

 

   

 

 

 

Total assets and liabilities at fair value

   $ 419,121       $ 1,197,713      $ 1,616,834   
  

 

 

    

 

 

   

 

 

 

 

(1) 

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

(2)

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

(3)

Foreign currency derivative contracts are classified as part of either other current assets or other current liabilities in the condensed consolidated balance sheets. The notional amount of the foreign currency derivative contract was $92 million as of December 31, 2011.

The amount of cash and cash equivalents as of December 31, 2011 includes $911 million in cash deposited with commercial banks.

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

 

     Fair Value Measurements at Reporting Date Using  

Assets:

   Level 1      Level 2      Level 3      Total  

Money market funds(1)

   $ 3,060,367       $ —         $ —         $ 3,060,367   

Available-for-sale securities:

           

Government and agency securities(1)

     —           4,067,770         —           4,067,770   

Commercial paper and bank certificates of deposit(1)

     —           404,729         —           404,729   

Corporate debt securities(1)

     —           689,150         —           689,150   

Time deposits

     —           534,704         —           534,704   

Other long-term investments

     —           —           802,609         802,609   

Corporate equity securities(2)

     202         —           —           202   
  

 

 

    

 

 

    

 

 

    

 

 

 

Available-for-sale securities at fair value

   $ 3,060,569       $ 5,696,353       $ 802,609       $ 9,559,531   

Foreign currency derivative contracts(3)

     —           16,737         —           16,737   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets at fair value

   $ 3,060,569       $ 5,713,090       $ 802,609       $ 9,576,268   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)

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

(2)

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

(3)

Foreign currency derivative contracts are classified as part of either other current assets or other current liabilities in the condensed consolidated balance sheets. The notional amounts of the foreign currency derivative contracts were $476 million as of September 30, 2012.

The amount of cash and cash equivalents as of September 30, 2012 includes $670 million in cash deposited with commercial banks.

 

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The fair values of the Company’s Level 1 financial assets and liabilities are based on quoted market prices of the identical underlying security. The fair values of the Company’s Level 2 financial assets and liabilities are obtained from readily-available pricing sources for the identical underlying security that may not be actively traded. The Company utilizes a pricing service to assist in obtaining fair value pricing for the majority of this investment portfolio. The Company classifies its investment in the Alibaba Group Preference Shares in other long-term investments within Level 3 because it is valued using significant unobservable inputs. To estimate the fair value, the Company performed benchmarking by comparing the terms and conditions of the Alibaba Group Preference Shares to dividend rates, subordination terms, and credit ratings of those of similar type instruments. The credit rating of Alibaba Group, general business conditions, and market rates could materially affect the fair value of the Alibaba Group Preference Shares. The Company conducts reviews on a quarterly basis to verify pricing, assess liquidity, and determine if significant inputs have changed that would impact the fair value hierarchy disclosure. During the nine months ended September 30, 2012, the Company did not make any transfers between Level 1, Level 2, or Level 3 assets or liabilities. As of December 31, 2011, the Company did not have any significant Level 3 financial assets or liabilities.

Note 10 STOCKHOLDERS’ EQUITY AND EMPLOYEE BENEFITS

Employee Stock Purchase Plan. As of September 30, 2012, there was $30 million of unamortized stock-based compensation expense related to the Company’s Employee Stock Purchase Plan which will be recognized over a weighted average period of 1.2 years.

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

 

     Shares     Weighted Average
Exercise Price per
Share
 

Outstanding at December 31, 2011

     62,439      $ 21.94   

Options granted

     8,854      $ 14.92   

Options exercised(*)

     (5,796   $ 12.09   

Options expired

     (12,608   $ 28.51   

Options cancelled/forfeited

     (9,228   $ 14.81   
  

 

 

   

Outstanding at September 30, 2012

     43,661      $ 21.43   
  

 

 

   

 

(*)

The Company issued new shares to satisfy stock option exercises.

As of September 30, 2012, there was $42 million of unrecognized stock-based compensation expense related to unvested stock options, which is expected to be recognized over a weighted average period of 1.8 years.

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

 

     Stock Options     Purchase Plan (*)  
     Three Months Ended     Three Months Ended  
     September 30,
2011
    September 30,
2012
    September 30,
2011
    September 30,
2012
 

Expected dividend yield

     0.0     0.0     0.0     0.0

Risk-free interest rate

     1.2     0.6     1.4     0.8

Expected volatility

     40.2     31.2     36.1     31.2

Expected life (in years)

     4.25        4.00        0.82        1.86   
     Stock Options     Purchase Plan (*)  
     Nine Months Ended     Nine Months Ended  
     September 30,
2011
    September 30,
2012
    September 30,
2011
    September 30,
2012
 

Expected dividend yield

     0.0     0.0     0.0     0.0

Risk-free interest rate

     1.5     0.7     1.4     1.1

Expected volatility

     36.6     31.9     36.1     33.1

Expected life (in years)

     4.15        4.03        0.96        1.46   

 

 

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(*)

Assumptions for the Employee Stock Purchase Plan relate to the annual average of the enrollment periods.

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

 

     Shares     Weighted Average
Grant Date
Fair Value
Per Share
 

Awarded and unvested at December 31, 2011(*)

     38,775      $ 17.28   

Granted(*)

     21,202      $ 15.26   

Vested

     (8,775   $ 15.94   

Forfeited

     (17,014   $ 15.34   
  

 

 

   

Awarded and unvested at September 30, 2012(*)

     34,188      $ 17.34   
  

 

 

   

 

(*)

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

As of September 30, 2012, there was $296 million of unrecognized stock-based compensation expense related to unvested restricted stock awards and restricted stock units, which is expected to be recognized over a weighted average period of 2.5 years.

During the nine months ended September 30, 2011 and September 30, 2012, 6.3 million shares and 8.8 million shares, respectively, that were subject to previously granted restricted stock awards and restricted stock units vested. These vested restricted stock awards and restricted stock units were net share settled. During the nine months ended September 30, 2011 and September 30, 2012, the Company withheld 2.2 million shares and 3.2 million shares, respectively, based upon the Company’s closing stock price on the vesting date to settle the employees’ minimum statutory obligation for the applicable income and other employment taxes. The Company then remitted cash to the appropriate taxing authorities.

Total payments for the employees’ tax obligations to the relevant taxing authorities were $36 million and $48 million for the nine months ended September 30, 2011 and September 30, 2012, respectively, and are reflected as a financing activity within the condensed consolidated statements of cash flows. The payments were used for tax withholdings related to the net share settlements of restricted stock units and tax withholding related to the reacquisition of shares of restricted stock awards. The payments had the effect of share repurchases by the Company as they reduced the number of shares that would have otherwise been issued on the vesting date and were recorded as a reduction of additional paid-in capital.

CEO 2012 Annual Equity Awards. Marissa A. Mayer, the Company’s Chief Executive Officer, received an equity award for 2012 that will vest over three years. A total of $6 million of this equity award was granted as restricted stock units on July 26, 2012 and will vest over three years. A total of $6 million will be in the form of a performance-based stock option that is expected to be granted in November 2012. The stock option will vest over the two and a half years after July 26, 2012, subject to satisfaction of performance criteria.

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

CEO One-Time Retention Award. Ms. Mayer received a one-time retention equity award that will vest over five years. A total of $15 million of this equity award was granted as restricted stock units on July 26, 2012 and will vest over five years. A total of $15 million of this equity award will be in the form of a performance-based stock option that is expected to be granted in November 2012. The stock option will vest over the four and a half years after July 26, 2012, subject to satisfaction of performance criteria.

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

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

 

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The Company recorded total stock-based compensation expense of $6 million for the nine months ended September 30, 2012 in connection with the equity grants made to Mr. Thompson pursuant to the terms of his employment letter agreement with the Company.

Stock Repurchases. In June 2010, the Board authorized a stock repurchase program allowing the Company to repurchase up to $3 billion of its outstanding shares of common stock from time to time. That repurchase program, which by its terms would have expired in June 2013, was exhausted during the third quarter of 2012. In May 2012, the Board authorized a stock repurchase program allowing the Company to repurchase up to an additional $5 billion of its outstanding shares of common stock from time to time. The May 2012 repurchase program, according to its terms, will expire in June 2015 unless revoked earlier by the Board of Directors. The aggregate amount available under the May 2012 repurchase program was approximately $4.9 billion at September 30, 2012. Repurchases under the repurchase programs may take place in the open market or in privately negotiated transactions, including derivative transactions, and may be made under a Rule 10b5-1 plan. During the nine months ended September 30, 2012, the Company repurchased approximately 46 million shares of its common stock under the June 2010 and May 2012 stock repurchase programs at an average price of $15.43 per share for a total of $716 million.

Note 11 COMMITMENTS AND CONTINGENCIES

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

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

 

     Gross Operating
Lease
Commitments
     Sublease
Income
    Net Operating
Lease
Commitments
 

Three months ending December 31, 2012

   $ 38,072       $ (3,275   $ 34,797   

Years ending December 31,

       

2013

     131,530         (12,937     118,593   

2014

     105,238         (11,165     94,073   

2015

     81,226         (6,751     74,475   

2016

     45,812         (1,335     44,477   

2017

     31,233         (213 )     31,020   

Due after 5 years

     37,882         —          37,882   
  

 

 

    

 

 

   

 

 

 

Total gross and net lease commitments

   $ 470,993       $ (35,676   $ 435,317   
  

 

 

    

 

 

   

 

 

 

 

     Capital Lease
Commitment
 

Three months ending December 31, 2012

   $ 2,177   

Years ending December 31,

  

2013

     8,570   

2014

     8,099   

2015

     8,031   

2016

     8,272   

2017

     8,520   

Due after 5 years

     13,984   
  

 

 

 

Gross lease commitment

   $ 57,653   
  

 

 

 

Less: interest

     (19,430
  

 

 

 

Net lease commitment

   $ 38,223   
  

 

 

 

Affiliate Commitments. In connection with contracts to provide advertising services to Affiliates, the Company is obligated to make payments, which represent traffic acquisition costs (“TAC”), to its Affiliates. As of September 30, 2012, these commitments totaled $97 million, of which $22 million will be payable in the remainder of 2012, and $75 million will be payable in 2013.

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

Other Commitments. In the ordinary course of business, the Company may provide indemnifications of varying scope and terms to customers, vendors, lessors, joint ventures and business partners, purchasers of assets or subsidiaries and other parties with respect to certain matters, including, but not limited to, losses arising out of the Company’s breach of agreements or representations and warranties made by the Company, services to be provided by the Company, intellectual property infringement claims made by

 

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

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

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

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

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

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

Since June 6, 2011, two purported stockholder class actions were filed in the United States District Court for the Northern District of California against the Company and certain officers and directors by plaintiffs Bonato and the Twin Cities Pipe Trades Pension Trust. In October 2011, the District Court consolidated the two actions under the caption In re Yahoo! Inc. Securities Litigation and appointed the Pension Trust Fund for Operating Engineers as lead plaintiff. In a consolidated amended complaint filed December 15, 2011, the lead plaintiff purports to represent a class of investors who purchased the Company’s common stock between April 19, 2011 and July 29, 2011, and alleges that during that class period, defendants issued statements that were materially false or misleading because they did not disclose information relating to Alibaba Group’s restructuring of Alipay. The complaint purports to

 

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assert claims for relief for violation of Section 10(b) and 20(a) of the Exchange Act and for violation of Rule 10b-5 thereunder, and seeks unspecified damages, injunctive and equitable relief, fees and costs. On August 10, 2012, the court granted defendants’ motion to dismiss the consolidated amended complaint. Plaintiffs have appealed.

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

Note 12 SEGMENTS

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

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

 

     Three Months Ended      Nine Months Ended  
     September 30,
2011
    September 30,
2012
     September 30,
2011
     September 30,
2012
 

Revenue by segment:

          

Americas

   $ 791,240      $ 843,731       $ 2,418,209       $ 2,501,515   

EMEA

     148,494        96,473         465,145         358,534   

Asia Pacific

     276,931        261,528         776,692         780,710   
  

 

 

   

 

 

    

 

 

    

 

 

 

Total Revenue

   $ 1,216,665      $ 1,201,732       $ 3,660,046       $ 3,640,759   
  

 

 

   

 

 

    

 

 

    

 

 

 

TAC by segment:

          

Americas

   $ 37,493      $ 41,289       $ 115,038       $ 130,154   

EMEA

     52,197        17,399         167,357         97,248   

Asia Pacific

     55,301        54,141         165,523         166,543   
  

 

 

   

 

 

    

 

 

    

 

 

 

Total TAC

   $ 144,991      $ 112,829       $ 447,918       $ 393,945   
  

 

 

   

 

 

    

 

 

    

 

 

 

Revenue ex-TAC by segment:

          

Americas

   $ 753,747      $ 802,442       $ 2,303,171       $ 2,371,361   

EMEA

     96,297        79,074         297,788         261,286   

Asia Pacific

     221,630        207,387         611,169         614,167   
  

 

 

   

 

 

    

 

 

    

 

 

 

Total Revenue ex-TAC

   $ 1,071,674      $ 1,088,903       $ 3,212,128       $ 3,246,814   
  

 

 

   

 

 

    

 

 

    

 

 

 

Direct costs by segment(1):

          

Americas

     174,697        189,345         508,637         550,080   

EMEA

     42,761        39,167         124,135         120,665   

Asia Pacific

     61,006        56,329         170,057         164,068   

Global operating costs(2)(3)

     415,507        396,269         1,224,169         1,228,686   

Restructuring charges, net

     (2,721     24,727         8,091         159,536   

Depreciation and amortization

     152,223        169,511         474,034         480,498   

Stock-based compensation expense

     50,947        61,366         145,111         166,903   
  

 

 

   

 

 

    

 

 

    

 

 

 

Income from operations

   $ 177,254      $ 152,189       $ 557,894       $ 376,378   
  

 

 

   

 

 

    

 

 

    

 

 

 

 

(1)

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

 

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(2)

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

(3)

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

 

     Three Months Ended      Nine Months Ended  
     September 30,
2011
     September 30,
2012
     September 30,
2011
     September 30,
2012
 

Capital expenditures, net:

           

Americas

   $ 90,381       $ 122,812       $ 336,918       $ 302,139   

EMEA

     18,224         9,238         45,445         22,599   

Asia Pacific

     15,337         7,815         80,643         31,049   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total capital expenditures, net

   $ 123,942       $ 139,865       $ 463,006       $ 355,787   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     December 31,
2011
     September 30,
2012
 

Property and equipment, net:

     

Americas:

     

U.S

   $ 1,486,596       $ 1,460,528   

Other

     2,500         2,064   
  

 

 

    

 

 

 

Total Americas

   $ 1,489,096       $ 1,462,592   
  

 

 

    

 

 

 

EMEA

     79,955         60,788   

Asia Pacific

     161,837         147,854   
  

 

 

    

 

 

 

Total property and equipment, net

   $ 1,730,888       $ 1,671,234   
  

 

 

    

 

 

 

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

Enterprise Wide Disclosures:

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

 

     Three Months Ended      Nine Months Ended  
     September 30,
2011
     September 30,
2012
     September 30,
2011
     September 30,
2012
 

Display

   $ 502,102       $ 506,002       $ 1,548,262       $ 1,552,191   

Search

     466,785         472,537         1,388,580         1,403,903   

Other

     247,778         223,193         723,204         684,665   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

   $ 1,216,665       $ 1,201,732       $ 3,660,046       $ 3,640,759   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Three Months Ended      Nine Months Ended  
     September 30,
2011
     September 30,
2012
     September 30,
2011
     September 30,
2012
 

Revenue:

           

U.S.

   $ 744,526       $ 800,984       $ 2,282,537       $ 2,379,955   

International

     472,139         400,748         1,377,509         1,260,804   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

   $ 1,216,665       $ 1,201,732       $ 3,660,046       $ 3,640,759   
  

 

 

    

 

 

    

 

 

    

 

 

 

Note 13 INCOME TAXES

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

 

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The effective tax rate reported for the three months ended September 30, 2012 was 37 percent compared to 29 percent for the same period in 2011. The effective tax rate for the three months ended September 30, 2012 was higher than in 2011 primarily due to the U.S. taxes on the sale of Alibaba Group Shares. In connection with a review of the Company’s cash position and anticipated cash needs for investment in the Company’s core business, including potential acquisitions and capital expenditures, and stock repurchases, the Company is undertaking a one-time repatriation of cash from certain of its consolidated foreign subsidiaries. This distribution will be completed by the end of the fourth quarter of 2012 and resulted in a net tax benefit of approximately $135 million during the three months ended September 30, 2012 since the foreign tax credits associated with the distribution are greater than the tax due on the distribution of the foreign earnings. Taxes have not been provided on the remaining undistributed foreign earnings, principally $1.9 billion related to the Company’s corporate joint venture with Yahoo Japan, as they will continue to be indefinitely reinvested going forward. If such earnings were to be remitted in the future, any additional U.S. tax cost incurred by the Company would be offset by at least an equivalent amount of foreign tax credits.

The effective tax rate reported for the nine months ended September 30, 2012 was 37 percent compared to 28 percent for the same period in 2011. The rate in 2011 was lower than the U.S. federal statutory rate primarily due to tax reserve reductions attributed to favorably settled tax audits and a shift of the geographic mix of earnings. The effective tax rate for the nine months ended September 30, 2012 was higher than in 2011 primarily due to the U.S. taxes on the gain on the sale of Alibaba Group Shares.

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

The Company’s gross amount of unrecognized tax benefits as of September 30, 2012 is $715 million, of which $709 million is recorded on the condensed consolidated balance sheets. The gross unrecognized tax benefits as of September 30, 2012 increased by $182 million from the recorded balance as of December 31, 2011. While it is difficult to determine when the examinations will be settled or their final outcomes, certain audits in various jurisdictions related to multinational income tax issues are expected to be resolved in the foreseeable future. As a result, it is reasonably possible that the unrecognized tax benefits could be reduced by up to approximately $90 million in the next twelve months.

Note 14 RESTRUCTURING CHARGES, NET

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

 

     Three Months Ended      Nine Months Ended  
     September 30,
2011
    September 30,
2012
     September 30,
2011
    September 30,
2012
 

Employee severance pay and related costs, net

   $ (2,571   $ 11,467       $ 6,340      $ 106,194   

Non-cancelable lease, contract termination, and other charges, net

     (150     11,436         3,029        16,309   

Other non-cash charges

     —          1,824         —          40,462   
  

 

 

   

 

 

    

 

 

   

 

 

 

Sub-total before reversal of stock-based compensation expense

     (2,721     24,727         9,369        162,965   

Reversal of stock-based compensation expense for forfeitures

     —          —           (1,278     (3,429
  

 

 

   

 

 

    

 

 

   

 

 

 

Restructuring charges, net

   $ (2,721   $ 24,727       $ 8,091      $ 159,536   
  

 

 

   

 

 

    

 

 

   

 

 

 

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

2011 and Prior Restructuring Plans. Prior to and into 2011, the Company implemented workforce reductions, a strategic realignment, and consolidation of certain real estate facilities and data centers to reduce its cost structure, align resources with its product strategy, and improve efficiency. During the three months ended September 30, 2011, the Company recorded total pre-tax cash charges of $2 million in severance, facility, and other related costs. The pre-tax cash charges were offset by a reversal of $5 million for adjustments to original estimates. Of the $3 million in net reversals recorded in the three months ended September 30, 2011, $1 million related to the Americas segment and $2 million related to the EMEA segment. During the nine months ended September 30, 2011, the Company recorded total pre-tax cash charges of $19 million in severance, facility, and other related costs. The pre-tax cash charges were offset by a reversal of $11 million for adjustments to original estimates. Of the $8 million in restructuring charges, net recorded in the nine months ended September 30, 2011, $9 million related to net charges in the Americas segment and $1 million related to net reversals in the EMEA segment.

During the three and nine months ended September 30, 2012, the Company recorded total pre-tax cash charges of $2 million and $10 million, respectively, in severance, facility, and other related costs, the majority of which related to the Americas segment.

 

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Q2’12 Restructuring Plan. During the second quarter of 2012, the Company began implementing a plan to reduce its worldwide workforce by approximately 2,000 employees and to consolidate certain real estate and data center facilities (the “Q2’12 Restructuring Plan”). During the three months ended September 30, 2012, the Company recorded total pre-tax cash charges of $35 million in severance and facility related costs and $2 million in non-cash facility and other asset impairment charges. Those total pre-tax charges were offset by a reversal of $14 million for adjustments to original estimates in severance related costs, primarily as a result of redeployments and voluntary resignations of employees prior to their planned severance dates. Of the $23 million in restructuring charges, net recorded in the three months ended September 30, 2012, $11 million related to the Americas segment and $12 million related to the EMEA segment.

During the nine months ended September 30, 2012, the Company recorded total pre-tax cash charges of $127 million in severance and facility related costs and $40 million in non-cash facility and other asset impairment charges. The total pre-tax charges during the nine months ended September 30, 2012 were offset by a reversal of $17 million for adjustments to original estimates. Of the $150 million in restructuring charges, net, recorded in the nine months ended September 30, 2012, $97 million related to the Americas segment, $47 million related to the EMEA segment, and $6 million related to the Asia Pacific segment.

Restructuring Accruals. The $85 million restructuring liability as of September 30, 2012 consists of $53 million for employee severance pay expenses, which the Company expects to pay out by the fourth quarter of 2013, and $32 million for non-cancelable lease costs that the Company expects to pay over the terms of the related obligations, which extend to the fourth quarter of 2021.

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

 

     2011 and Prior
Restructuring
Plans
    Q2’12
Restructuring
Plan
    Total  

Balance as of January 1, 2012

   $ 49,127      $ —        $ 49,127   
  

 

 

   

 

 

   

 

 

 

Employee severance pay and related costs

     5,924        116,874        122,798   

Non-cash reversals of stock-based compensation expense

     —          (3,429     (3,429

Non-cancelable lease, contract termination, and other charges

     6,662        9,948        16,610   

Other non-cash charges

     —          40,462        40,462   

Reversals of previous charges

     (2,609     (14,296     (16,905
  

 

 

   

 

 

   

 

 

 

Restructuring charges, net for the nine months ended September 30, 2012

   $ 9,977      $ 149,559      $ 159,536   
  

 

 

   

 

 

   

 

 

 

Cash paid

     (25,963     (57,309     (83,272

Non-cash reversals of stock-based compensation expense

     —          3,429        3,429   

Other non-cash charges

     (232     (40,148     (40,380

Foreign currency

     (100     (3,034     (3,134
  

 

 

   

 

 

   

 

 

 

Payments/reductions, net for the nine months ended September 30, 2012

   $ (26,295   $ (97,062   $ (123,357
  

 

 

   

 

 

   

 

 

 

Balance as of September 30, 2012

   $ 32,809      $ 52,497      $ 85,306   
  

 

 

   

 

 

   

 

 

 

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

 

     December 31,
2011
     September 30,
2012
 

Americas

   $ 41,199       $ 58,486   

EMEA

     6,948         23,230   

Asia Pacific

     980         3,590   
  

 

 

    

 

 

 

Total restructuring accruals

   $ 49,127       $ 85,306   
  

 

 

    

 

 

 

Note 15 SEARCH AGREEMENT WITH MICROSOFT CORPORATION

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

 

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engine marketing services and their clients, and resellers and their clients seeking assistance with their paid search accounts. The term of the Search Agreement is 10 years from February 23, 2010, subject to earlier termination as provided in the Search Agreement.

During the first five years of the term of the Search Agreement, in the transitioned markets, the Company is entitled to receive 88 percent of the revenue generated from Microsoft’s services on Yahoo! Properties (the “Revenue Share Rate”) and the Company is also entitled to receive 88 percent of the revenue generated from Microsoft’s services on Affiliate sites after the Affiliate’s share of revenue. On the fifth anniversary of February 23, 2010, the date implementation of the Search Agreement commenced, Microsoft will have the option to terminate the Company’s sales exclusivity for premium search advertisers. If Microsoft exercises this option, the Revenue Share Rate will increase to 93 percent for the remainder of the term of the Search Agreement, unless the Company exercises its option to retain the Company’s sales exclusivity, in which case the Revenue Share Rate would be reduced to 83 percent for the remainder of the term. If Microsoft does not exercise such option, the Revenue Share Rate will be 90 percent for the remainder of the term of the Search Agreement. In the transitioned markets, the Company reports as revenue the 88 percent revenue share as the Company is not the primary obligor in the arrangement with the advertisers and publishers. The underlying search advertising services are provided by Microsoft.

As of December 31, 2011 and September 30, 2012, the Company had collected a total amount of $66 million and $70 million, respectively, on behalf of Microsoft and Affiliates, which was included in cash and cash equivalents with a corresponding liability in accrued expenses and other current liabilities. The Company’s uncollected 88 percent share in connection with the Search Agreement was $203 million and $237 million as of December 31, 2011 and September 30, 2012, respectively, which is included in accounts receivable, net.

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

The Company completed the transition of its algorithmic and paid search platforms to the Microsoft platform in the U.S. and Canada in the fourth quarter of 2010. In 2011, the Company completed the transition of algorithmic search in all other markets and the transition of paid search in India. In the second quarter of 2012, the Company completed the transition of paid search in certain EMEA markets, including the United Kingdom, France, and Germany. During October 2012, the Company transitioned paid search in several additional markets. The Company has recently determined to re-evaluate the schedule for the transition of paid search in the remaining markets in order to work with Microsoft on improving the RPS in the transitioned markets. The market-by-market transition of the Company’s paid search platform to Microsoft’s platform and the migration of paid search advertisers and publishers to Microsoft’s platform are expected to continue through 2013, and possibly into 2014.

From February 23, 2010 until the applicable services are fully transitioned to Microsoft in all markets, Microsoft will also reimburse the Company for the costs of operating algorithmic and paid search services subject to specified exclusions and limitations. The Company’s results reflect search operating cost reimbursements from Microsoft under the Search Agreement of $53 million and $164 million for the three and nine months ended September 30, 2011, and $17 million and $51 million for the three and nine months ended September 30, 2012, respectively. Search operating cost reimbursements began during the quarter ended March 31, 2010 and will, subject to specified exclusions and limitations, continue until the Company has fully transitioned to Microsoft’s platform.

The Company’s results for the three and nine months ended September 30, 2011 reflect transition cost reimbursements from Microsoft under the Search Agreement that were equal to the transition costs of $4 million and $27 million, respectively, incurred by Yahoo! related to the Search Agreement in the three and nine months ended September 30, 2011. During the third quarter of 2011, the Company’s cumulative transition costs exceeded Microsoft’s $150 million reimbursement cap under the Search Agreement. Transition costs the Company incurs in excess of the $150 million reimbursement cap are not subject to reimbursement.

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

 

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Note 16 SUBSEQUENT EVENTS

Closure of Korea Business. On October 18, 2012, the Company began notifying employees whose employment will be terminated as a result of the Company’s plan to close its Korean business by December 31, 2012. The decision is part of the Company’s effort to streamline its operations and focus its resources. Approximately 200 employees will be terminated as part of the closure of the Korean business.

The Company expects to incur pre-tax cash charges related to its plan to close its Korean business for severance pay expenses, lease and other contract termination charges. Total charges are expected to include these cash charges and also non-cash charges related to the write-off of goodwill and other assets related to its Korea business. The Company expects it will incur pre-tax cash charges of approximately $5 million related to severance pay expenses and approximately $2 million related to lease termination charges. The Company also expects to recognize pre-tax non-cash charges related to goodwill and other asset impairments totaling approximately $87 million. The Company expects to recognize the majority of the total pre-tax charges in the quarter ending December 31, 2012. The Company is unable at this time to estimate the other contract termination charges, the amount of total cash charges or the total charges it will incur.

Credit Facility. On October 19, 2012, the Company entered into a credit agreement (the “Credit Agreement”) with Citibank, N.A., as Administrative Agent, and the other lenders party thereto from time to time. The Credit Agreement provides for a $750 million unsecured revolving credit facility for a term of 364 days, subject to extension for additional 364-day periods in accordance with the terms and conditions of the Credit Agreement. The Company may elect to increase the revolving credit facility by up to $250 million if existing or new lenders provide additional revolving commitments in accordance with the terms of the Credit Agreement. There are no borrowings outstanding under the Credit Agreement as of the date of this filing. The proceeds from borrowings under the Credit Agreement, if any, are expected to be used for general corporate purposes. Borrowings under the Credit Agreement will bear interest at a rate equal to, at the Company’s option, either (a) a customary London interbank offered rate (a “Eurodollar Rate”), or (b) a customary base rate (a “Base Rate”), in each case plus an applicable margin. The applicable margin for borrowings under the Credit Agreement will be based upon the leverage ratio of the Company and range from 1.25 percent to 1.50 percent with respect to Eurodollar Rate borrowings and 0.25 percent to 0.50 percent with respect to Base Rate borrowings.

Stock Repurchase Transactions. From October 1, 2012 through November 8, 2012, the Company repurchased approximately 13 million shares of its common stock at an average price of $16.87 per share, for a total of $212 million.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

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

 

   

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

 

   

expectations about growth in users;

 

   

expectations about operating expenses;

 

   

anticipated capital expenditures;

 

   

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

 

   

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

 

   

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

 

   

expectations about the closure of our Korean operations;

 

   

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

 

   

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

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

Overview

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

Initial Repurchase of Alibaba Group Holding Limited Ordinary Shares

On September 18, 2012 (the “Repurchase Closing Date”), Alibaba Group repurchased (the “Initial Repurchase”) 523 million of the 1,047 million ordinary shares of Alibaba Group (“Shares”) owned by us. The Initial Repurchase was made pursuant to the terms of the Share Repurchase and Preference Share Sale Agreement entered into by Yahoo! Inc., Alibaba Group and Yahoo! Hong Kong Holdings Limited, a Hong Kong corporation and wholly-owned subsidiary of Yahoo! Inc. (“YHK”) on May 20, 2012 (as amended on September 11, 2012, the “Repurchase Agreement”). We received $13.54 per Share, or approximately $7.1 billion in total consideration, for the 523 million Shares sold to Alibaba Group. Approximately $6.3 billion of the consideration was received in cash and $800 million was received in Alibaba Group preference shares (the “Alibaba Group Preference Shares”). This Initial Repurchase resulted in a pre-tax gain of approximately $4.6 billion for the three months ended September 30, 2012 which is included in other income, net on the condensed consolidated statements of income.

On the Repurchase Closing Date, Alibaba Group paid us $550 million in satisfaction of certain future royalty payments under our existing Technology and Intellectual Property License Agreement (“TIPLA”) with Alibaba Group. In addition, certain existing contractual limitations on our ability to compete in the People’s Republic of China were terminated.

 

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Net cash proceeds after the payment of taxes and fees from the Initial Repurchase and the $550 million TIPLA payment were approximately $4.3 billion. We intend to return $3 billion of the after-tax proceeds to shareholders. This amount is in addition to the $646 million we have already returned to shareholders through share repurchases since the announcement of the Repurchase Agreement on May 20, 2012 through September 30, 2012.

At the time of an initial public offering of Alibaba Group meeting certain specified criteria (“Qualified IPO”), Yahoo! and YHK will sell, at Alibaba Group’s election (either directly to Alibaba Group or in the Qualified IPO), up to an additional 261.5 million of our remaining Shares. If Shares are sold back to Alibaba Group in the Qualified IPO, the purchase price per Share will be equal to the per share price in the Qualified IPO less specified fees and underwriter discounts.

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

Closure of Korea Business. On October 18, 2012, we began notifying employees whose employment will be terminated as a result of our plan to close our Korean business by December 31, 2012. The decision is part of our effort to streamline our operations and focus our resources. Approximately 200 employees will be terminated as part of the closure of the Korean business.

We expect to incur pre-tax cash charges related to our plan to close our Korean business for severance pay expenses, lease and other contract termination charges. Total charges are expected to include these cash charges and also non-cash charges related to the write-off of goodwill and other assets related to our Korea business. We expect we will incur pre-tax cash charges of approximately $5 million related to severance pay expenses and approximately $2 million related to lease termination charges. We also expect to recognize pre-tax non-cash charges related to goodwill and other asset impairments totaling approximately $87 million. We expect to recognize the majority of the total pre-tax charges in the quarter ending December 31, 2012. We are unable at this time to estimate the other contract termination charges, the amount of total cash charges or the total charges we will incur.

Third Quarter Highlights

 

      Three Months Ended      Dollar
Change
    Nine Months Ended      Dollar
Change
 
     September 30,        September 30,     

Operating Highlights

   2011      2012        2011      2012     
     (In thousands)  

Revenue

   $ 1,216,665       $ 1,201,732       $ (14,933   $ 3,660,046       $ 3,640,759       $ (19,287

Income from operations

   $ 177,254       $ 152,189       $ (25,065   $ 557,894       $ 376,378       $ (181,516

 

      Nine Months Ended     Dollar
Change
 
     September 30,    

Cash Flow Results

   2011     2012    
     (In thousands)  

Net cash provided by operating activities

   $ 892,472      $ 1,618,321      $ 725,849   

Net cash provided by investing activities

   $ 153,493      $ 5,002,336      $ 4,848,843   

Net cash used in financing activities

   $ (1,095,474   $ (620,824   $ 474,650   

Our revenue decreased one percent for both the three and nine months ended September 30, 2012 compared to the same periods in 2011. This can be attributed primarily to a decrease in other revenue, which was partially offset by an increase in search revenue. Income from operations decreased 14 percent and 33 percent for the three and nine months ended September 30, 2012, respectively, compared to the same periods in 2011. The decrease in income from operations is due to the decline in revenue as well as an increase in operating expenses primarily driven by an increase in restructuring charges of $27 million and $151 million for the three and nine months ended September 30, 2012, respectively.

Cash generated by operating activities is a measure of the cash productivity of our business model. Our operating activities in the nine months ended September 30, 2012 generated adequate cash to meet our operating needs. Cash, cash equivalents, and investments in marketable debt securities were $9.4 billion at September 30, 2012 compared to $2.5 billion at December 31, 2011, an increase of $6.9 billion. The increase is due to cash proceeds, net of fees, of $6.2 billion received from the sale of Alibaba Group Shares and $550 million from the TIPLA payment. This was partially offset by the repurchase of approximately 46 million shares of our outstanding common stock for $716 million during the nine months ended September 30, 2012.

Search Agreement with Microsoft Corporation

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

During the first five years of the Search Agreement, in the transitioned markets, we are entitled to receive 88 percent of the revenue generated from Microsoft’s services on Yahoo! Properties. We are also entitled to receive 88 percent of the revenue generated

 

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from Microsoft’s services on Affiliate sites after the Affiliate’s share of revenue. In the transitioned markets, for search revenue generated from Microsoft’s services on Yahoo! Properties and Affiliate sites, we report as revenue the 88 percent revenue share, as we are not the primary obligor in the arrangement with the advertisers and publishers.

Under the Search Agreement, for each market, Microsoft generally guarantees Yahoo!’s revenue per search (“RPS Guarantee”) on Yahoo! Properties only for 18 months after the transition of paid search services to Microsoft’s platform in that market. In the fourth quarter of 2011, Microsoft agreed to extend the RPS Guarantee in the U.S. and Canada through March 2013. The RPS Guarantee is calculated based on the difference in revenue per search (“RPS”) between the pre-transition and post-transition periods and certain other factors. We record the RPS Guarantee as search revenue in the quarter the amount becomes fixed, which is typically the quarter in which the associated shortfall in revenue per search occurred. If the RPS Guarantee is not renewed prior to its expiration on March 31, 2013, we currently anticipate that our revenue, cash flows and income will be negatively impacted.

Under the Search Agreement, Microsoft agreed to reimburse us for certain transition costs up to an aggregate total of $150 million during the first three years of the Search Agreement. Our results for the three and nine months ended September 30, 2011 reflect transition cost reimbursements from Microsoft under the Search Agreement that were equal to transition costs of $4 million and $27 million, respectively, incurred by Yahoo! related to the Search Agreement in the those periods. During the third quarter of 2011, our cumulative transition costs exceeded Microsoft’s $150 million reimbursement cap under the Search Agreement. Transition costs we incur in excess of the $150 million reimbursement cap are not subject to reimbursement.

From February 23, 2010 until the applicable services are fully transitioned to Microsoft in all markets, Microsoft will also reimburse us for the costs of operating algorithmic and paid search services subject to specified exclusions and limitations. The Company’s results reflect search operating cost reimbursements from Microsoft under the Search Agreement of $53 million and $164 million for the three and nine months ended September 30, 2011, and $17 million and $51 million for the three and nine months ended September 30, 2012, respectively. The global transition of the algorithmic and paid search platforms to Microsoft’s platform and the migration of the paid search advertisers and publishers to Microsoft’s platform are being done on a market by market basis. Search operating cost reimbursements are expected to decline as we fully transition all markets and, in the long term, the underlying expenses are not expected to be incurred under our cost structure.

We completed the transition of our algorithmic and paid search platforms to the Microsoft platform in the U.S. and Canada in the fourth quarter of 2010. In 2011, we completed the transition of algorithmic search in all other markets and the transition of paid search in India. In the second quarter of 2012, we completed the transition of paid search in certain EMEA (Europe, Middle East, and Africa) markets, including the United Kingdom, France, and Germany. During October 2012, we transitioned paid search in several additional markets. We have recently determined to re-evaluate the schedule for the transition of paid search in the remaining markets in order to work with Microsoft on improving the RPS in the transitioned markets. The market-by-market transition of our paid search platform to Microsoft’s platform and the migration of paid search advertisers and publishers to Microsoft’s platform are expected to continue through 2013, and possibly into 2014.

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

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

Results of Operations

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

 

     Three Months Ended September 30,     Percent
Change
    Nine Months Ended September 30,     Percent
Change
 
     2011      (*)     2012      (*)       2011      (*)     2012      (*)    

Display

   $ 502,102         42   $ 506,002         42     1   $ 1,548,262         42   $ 1,552,191         43     0

Search

     466,785         38     472,537         39     1     1,388,580         38     1,403,903         38     1

Other

     247,778         20     223,193         19     (10 )%      723,204         20     684,665         19     (5 )% 
  

 

 

    

 

 

   

 

 

    

 

 

     

 

 

    

 

 

   

 

 

    

 

 

   

Total revenue

   $ 1,216,665         100   $ 1,201,732         100     (1 )%    $ 3,660,046         100   $ 3,640,759         100     (1 )% 
  

 

 

    

 

 

   

 

 

    

 

 

     

 

 

    

 

 

   

 

 

    

 

 

   

 

(*)

Percent of total revenue.

 

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

 

     Three Months Ended September 30,     Dollar
Change
    Percent
Change
 
     2011     (*)     2012      (*)      

Cost of revenue — TAC

   $ 144,991        12   $ 112,829         9   $ (32,162     (22 )% 

Cost of revenue — Other

   $ 239,002        20   $ 282,081         23   $ 43,079        18

Sales and marketing

   $ 290,520        24   $ 269,272         22   $ (21,248     (7 )% 

Product development

   $ 229,230        19   $ 217,301         18   $ (11,929     (5 )% 

General and administrative

   $ 129,954        11   $ 135,249         11   $ 5,295        4

Amortization of intangibles

   $ 8,435        1   $ 8,084         1   $ (351     (4 )% 

Restructuring charges, net

   $ (2,721     0   $ 24,727         2   $ 27,448        N/

 

     Nine Months Ended September 30,     Dollar
Change
    Percent
Change
 
     2011      (*)     2012      (*)      

Cost of revenue — TAC

   $ 447,918         12   $ 393,945         11   $ (53,973     (12 )% 

Cost of revenue — Other

   $ 720,017         20   $ 814,513         22   $ 94,496        13

Sales and marketing

   $ 832,827         23   $ 827,450         23   $ (5,377     (1 )% 

Product development

   $ 683,558         19   $ 645,407         18   $ (38,151     (6 )% 

General and administrative

   $ 384,674         11   $ 395,637         11   $ 10,963        3

Amortization of intangibles

   $ 25,067         1   $ 27,893         1   $ 2,826        11

Restructuring charges, net

   $ 8,091         0   $ 159,536         4   $ 151,445        N/

 

(*)

Percent of total revenue.

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

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2011      2012      2011     2012  

Cost of revenue — Other

   $ 956       $ 2,363       $ 2,479      $ 7,871   

Sales and marketing

     16,759         19,876         42,829        59,954   

Product development

     21,093         17,050         64,296        54,329   

General and administrative

     12,139         22,077         35,507        44,749   

Restructuring expense reversals, net

     —           —           (1,278     (3,429
  

 

 

    

 

 

    

 

 

   

 

 

 

Total stock-based compensation expense

   $ 50,947       $ 61,366       $ 143,833      $ 163,474   
  

 

 

    

 

 

    

 

 

   

 

 

 

For additional information about stock-based compensation, see Note 10 — “Stockholders’ Equity and Employee Benefits” in the Notes to the condensed consolidated financial statements included elsewhere in this Report as well as “Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K for the year ended December 31, 2011 under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

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

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

 

     Three Months Ended            Nine Months Ended         
     September 30,
2011
     September 30,
2012
     Percent
Change
    September 30,
2011
     September 30,
2012
     Percent
Change
 

Revenue by segment:

                

Americas

   $ 791,240       $ 843,731         7   $ 2,418,209       $ 2,501,515         3

EMEA

     148,494         96,473         (35 )%      465,145         358,534         (23 )% 

Asia Pacific

     276,931         261,528         (6 )%      776,692         780,710         1
  

 

 

    

 

 

      

 

 

    

 

 

    

Total revenue

   $ 1,216,665       $ 1,201,732         (1 )%    $ 3,660,046       $ 3,640,759         (1 )% 
  

 

 

    

 

 

      

 

 

    

 

 

    

 

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     Three Months Ended            Nine Months Ended         
     September 30,
2011
    September 30,
2012
     Percent
Change
    September 30,
2011
     September 30,
2012
     Percent
Change
 

TAC by segment:

               

Americas

   $ 37,493      $ 41,289         10   $ 115,038       $ 130,154         13

EMEA

     52,197        17,399         (67 )%      167,357         97,248         (42 )% 

Asia Pacific

     55,301        54,141         (2 )%      165,523         166,543         1
  

 

 

   

 

 

      

 

 

    

 

 

    

Total TAC

   $ 144,991      $ 112,829         (22 )%    $ 447,918       $ 393,945         (12 )% 
  

 

 

   

 

 

      

 

 

    

 

 

    

Revenue ex-TAC by segment:

               

Americas

   $ 753,747      $ 802,442         6   $ 2,303,171       $ 2,371,361         3

EMEA

     96,297        79,074         (18 )%      297,788         261,286         (12 )% 

Asia Pacific

     221,630        207,387         (6 )%      611,169         614,167         0
  

 

 

   

 

 

      

 

 

    

 

 

    

Total revenue ex-TAC

   $ 1,071,674      $ 1,088,903         2   $ 3,212,128       $ 3,246,814         1
  

 

 

   

 

 

      

 

 

    

 

 

    

Direct costs by segment(1):

               

Americas

     174,697        189,345         8     508,637         550,080         8

EMEA

     42,761        39,167         (8 )%      124,135         120,665         (3 )% 

Asia Pacific

     61,006        56,329         (8 )%      170,057         164,068         (4 )% 

Global operating costs(2)(3)

     415,507        396,269         (5 )%      1,224,169         1,228,686         0

Restructuring charges, net

     (2,721     24,727         N/     8,091         159,536         N/

Depreciation and amortization

     152,223        169,511         11     474,034         480,498         1

Stock-based compensation expense

     50,947        61,366         20     145,111         166,903         15
  

 

 

   

 

 

      

 

 

    

 

 

    

Income from operations

   $ 177,254      $ 152,189         (14 )%    $ 557,894       $ 376,378         (33 )% 
  

 

 

   

 

 

      

 

 

    

 

 

    

 

N/M = Not meaningful

 

(1)

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

(2)

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

(3)

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

Revenue

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

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

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

Display Revenue. Display revenue for the three months ended September 30, 2012 increased by one percent compared to the same period in 2011. Display revenue for the nine months ended September 30, 2012 was flat compared to the same period in 2011. For the three months ended September 30, 2012, our year-over-year increase can be attributed to the inclusion of display revenue from an acquisition in the fourth quarter of 2011 in the Americas region. This increase was partially offset by a decline in display revenue due to a continued downturn in the economy in the EMEA region. For the three and nine months ended September 30, 2012, Display

 

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Page Views decreased 7 percent and 5 percent, respectively, and revenue per Display Page View increased 3 percent and 5 percent, respectively, compared to the same periods in 2011 due to the increase in display revenue and decrease in Display Page Views as discussed above.

Search Revenue. Search revenue for both the three and nine months ended September 30, 2012 increased by one percent compared to the same periods in 2011. Search revenue increased in both periods due to increased search revenue in the Americas region which resulted from an increase in sponsored search on Yahoo! Properties, as well as a higher RPS Guarantee payment. The increase was partially offset by decreased Affiliate search revenue in the EMEA region as well as the required change in GAAP revenue presentation for transitioned markets from a gross to a net (after TAC) basis. For the three and nine months ended September 30, 2012, Search Page Views decreased 16 percent and 13 percent, respectively, compared to the same periods in 2011. For the three and nine months ended September 30, 2012, revenue per Search Page View increased 20 percent and 17 percent, respectively, compared to the same periods in 2011, due to the factors discussed above.

Other Revenue. Other revenue includes listings-based services revenue, transaction revenue, and fees revenue. Other revenue for the three and nine months ended September 30, 2012 decreased by 10 percent and 5 percent, respectively, compared to the same periods in 2011. The decreases, for the three and nine months ended September 30, 2012, are primarily attributable to a decline in revenue from certain of our broadband access partnerships in the Americas region. This decline is partially offset by an increase in the Americas region due to new and amended partner deals, as well as an increase in royalty revenue.

Revenue ex-TAC by Segment

Americas. Americas revenue ex-TAC for the three and nine months ended September 30, 2012 increased $49 million, or 6 percent, and $68 million, or 3 percent, respectively, as compared to the same periods in 2011. For the three and nine months ended September 30, 2012, our year-over-year increase in Americas revenue ex-TAC was primarily attributable to increases in search revenue ex-TAC offset by decreases in other revenue ex-TAC. Search revenue ex-TAC increased due to increases in sponsored search on Yahoo! Properties. Other revenue ex-TAC decreased primarily due to a decline in revenue from certain of our broadband access partnerships. This decline is partially offset by an increase in the Americas region due to new and amended partner deals, as well as an increase in royalty revenue.

Revenue ex-TAC in the Americas accounted for approximately 74 percent and 73 percent of total revenue ex-TAC for the three and nine months ended September 30, 2012, respectively, compared to 70 percent and 72 percent for the three and nine month ended September 30, 2011, respectively.

EMEA. EMEA revenue ex-TAC for the three and nine months ended September 30, 2012 decreased $17 million, or 18 percent, and $37 million, or 12 percent, respectively, as compared to the same periods in 2011. For the three and nine months ended September 30, 2012, the year-over-year declines in EMEA revenue ex-TAC were primarily related to decreased search and display revenue ex-TAC. Search revenue ex-TAC declined due to loss of Affiliates in the region and traffic quality initiatives conducted by Yahoo!. Display revenue ex-TAC on Yahoo! Properties also declined in the region.

Revenue ex-TAC in EMEA accounted for approximately 7 percent and 8 percent of total revenue ex-TAC for the three and nine months ended September 30, 2012, respectively, compared to 9 percent for both the three and nine months ended September 30, 2011.

Asia Pacific. Asia Pacific revenue ex-TAC for the three months ended September 30, 2012 decreased $14 million, or 6 percent, as compared to the same period in 2011. The decrease was primarily due to a decline in fees revenue in Australia and New Zealand. Revenue ex-TAC for the nine months ended September 30, 2012, remained flat as compared to the same period in 2011.

Revenue ex-TAC in Asia Pacific accounted for approximately 19 percent of total revenue ex-TAC for both the three and nine months ended September 30, 2012, compared to 21 percent and 19 percent for the three and nine months ended September 30, 2011, respectively.

Operating Costs and Expenses

Operating costs and expenses consist of cost of revenue — traffic acquisition costs (“TAC”); cost of revenue — other; sales and marketing; product development; general and administrative; amortization of intangible assets; and restructuring charges, net.

Traffic Acquisition Costs for Non-transitioned Search Markets and All Markets for Display. TAC consists of payments made to third-party entities that have integrated our advertising offerings into their Websites or other offerings and payments made to companies that direct consumer and business traffic to Yahoo! Properties. We enter into agreements of varying duration that involve TAC. There are generally two economic structures of the Affiliate agreements: fixed payments based on a guaranteed minimum amount of traffic delivered, which often carry reciprocal performance guarantees from the Affiliate, or variable payments based on a percentage of our revenue or based on a certain metric, such as number of searches or paid clicks. We expense TAC under two

 

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different methods. Agreements with fixed payments are expensed ratably over the term the fixed payment covers, and agreements based on a percentage of revenue, number of searches, or other metrics are expensed based on the volume of the underlying activity or revenue multiplied by the agreed-upon price or rate.

Cost of revenue — other consists of Internet connection charges, and other expenses associated with the production and usage of Yahoo! Properties, including amortization of acquired intellectual property rights and developed technology.

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

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

 

     Compensation     Information
Technology
    Depreciation and
Amortization
    TAC     Facilities     Other     Total  

Cost of revenue — TAC

   $ —        $ —        $ —        $ (32,162   $ —        $ —        $ (32,162

Cost of revenue — Other

     4,139        14,621        7,458        —          (11     16,872        43,079   

Sales and marketing

     (312     206        43        —          1,434        (22,619     (21,248

Product development

     (20,194     (3,638     10,366        —          1,786        (249     (11,929

General and administrative

     9,793        68        (228     —          (3,015     (1,323     5,295   

Amortization of intangibles

     —          —          (351     —          —          —          (351

Restructuring charges, net

     —          —          —          —          —          27,448        27,448   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ (6,574   $ 11,257      $ 17,288      $ (32,162   $ 194      $ 20,129      $ 10,132   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

 

     Compensation     Information
Technology
    Depreciation and
Amortization
    TAC     Facilities     Other     Total  

Cost of revenue — TAC

   $ —        $ —        $ —        $ (53,973   $ —        $ —        $ (53,973

Cost of revenue — Other

     16,298        51,696        4,860        —          951        20,691        94,496   

Sales and marketing

     47,193        56        (797     —          2,415        (54,244     (5,377

Product development

     (25,595     (8,940     5,100        —          (4,838     (3,878     (38,151

General and administrative

     618        1,445        (5,526     —          1,352        13,074        10,963   

Amortization of intangibles

     —          —          2,826        —          —          —          2,826   

Restructuring charges, net

     —          —          —          —          —          151,445        151,445   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 38,514      $ 44,257      $ 6,463      $ (53,973   $ (120   $ 127,088      $ 162,229   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Compensation Expense. Total compensation expense decreased $7 million and increased $39 million for the three and nine months ended September 30, 2012, respectively, as compared to the same periods in 2011. For the three months ended September 30, 2012, the decrease is primarily attributable to lower salaries in the product development function as a result of reduced headcount related to the Q2’12 Restructuring Plan. This is offset by an increase in stock-based compensation expense due to charges recorded for executive separations. For the nine months ended September 30, 2012, the increase is primarily attributable to higher stock-based compensation expense related to charges for executive separations, the impact of awards granted in the second half of 2011 offset by lower Employee Stock Purchase Plan expense due to lower estimated contributions as well as lower salaries in the product development function as a result of reduced headcount related to the Q2’12 Restructuring Plan. Excluding the impact of Microsoft reimbursements, compensation expense for the three and nine months ended September 30, 2012 decreased $20 million and increased $2 million, respectively, compared to the same periods of 2011. Microsoft reimbursements decreased $13 million and $37 million, respectively, during the three and nine months ended September 30, 2012, compared to the same periods of 2011. The decrease in Microsoft reimbursements for the three and nine months ended September 30, 2012 was due to the transition of paid search to the Microsoft platform in additional countries.

Information Technology. Information technology expense increased $11 million and $44 million for the three and nine months ended September 30, 2012, respectively, as compared to the same periods in 2011. The increase in information technology expense for the three and nine months ended September 30, 2012 was primarily attributable to decreased Microsoft reimbursements of $16 million

 

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and $51 million, respectively, compared to the same periods of 2011. Excluding the impact of Microsoft reimbursements, information technology expense for the three and nine months ended September 30, 2012 decreased $5 million and $7 million, respectively, compared to the same periods of 2011. The decrease in Microsoft reimbursements for the three and nine months ended September 30, 2012 was due to the transition of paid search to the Microsoft platform in additional countries.

Depreciation and Amortization. Depreciation and amortization expense increased $17 million and $6 million for the three and nine months ended September 30, 2012, respectively, as compared to the same periods in 2011. The increase for the three and nine months ended September 30, 2012 is primarily attributable to an increase in write-offs of fixed assets, an increase in depreciation related to fixed asset additions, and increased amortization of intangibles related to an acquisition we completed in the fourth quarter of 2011. This increase was partially offset by a decrease in depreciation expense for fully depreciated assets acquired in prior years. Excluding the impact of Microsoft reimbursements, depreciation and amortization expense for the three and nine months ended September 30, 2012 increased $12 million and decreased $10 million, respectively, compared to the same periods of 2011. Microsoft reimbursements decreased $5 million and $16 million, respectively, during the three and nine months ended September 30, 2012, compared to the same periods of 2011. The decrease in Microsoft reimbursements for the three and nine months ended September 30, 2012 was due to the transition of paid search to the Microsoft platform in additional countries.

TAC. TAC decreased $32 million and $54 million for the three and nine months ended September 30, 2012, respectively, as compared to the same periods in 2011. For the three and nine months ended September 30, 2012, the decrease in TAC is primarily attributable to the change in the recording of TAC associated with the transition of paid search in the EMEA region to Microsoft’s search platform. This decline is partially offset by an increase in display TAC in the Americas region resulting from an acquisition we completed in the fourth quarter of 2011.

Facilities and Other Expenses. Facilities and other expenses increased $20 million and $127 million for the three and nine months ended September 30, 2012, compared to the same periods in 2011. Excluding the impact of Microsoft reimbursements, facilities and other expenses for the three and nine months ended September 30, 2012 increased $18 million and $118 million, respectively, primarily due to increases in restructuring charges of $27 million and $151 million for the three and nine months ended September 30, 2012, respectively. These increases were offset by decreased marketing expenses of $18 million and $40 million for the three and nine months ended September 30, 2012, respectively. The increase in facilities and other expenses for the three and nine months ended September 30, 2012 was also attributable to decreased Microsoft reimbursements of $2 million and $9 million compared to the same periods of 2011. The decrease in Microsoft reimbursements for the three and nine months ended September 30, 2012 was due to the transition of paid search to the Microsoft platform in additional countries.

Direct Costs by Segment

Americas. For the three and nine months ended September 30, 2012, direct costs attributable to the Americas segment increased $15 million, or 8 percent, and $41 million, or 8 percent, respectively, compared to the same periods in 2011. For the three and nine months ended September 30, 2012, the year-over-year increases in direct costs were primarily due to higher compensation and content costs offset by lower marketing costs.

EMEA. For the three and nine months ended September 30, 2012, direct costs attributable to the EMEA segment decreased $4 million, or 8 percent, and $3 million, or 3 percent, respectively, as compared to the same periods in 2011. For the three months ended September 30, 2012, the decline was primarily due to decreased compensation costs in the region. For the nine months ended September 30, 2012, the decline was primarily due to decreased compensation costs and marketing expenses in the region.

Asia Pacific. For the three and nine months ended September 30, 2012, direct costs attributable to the Asia Pacific segment decreased $5 million, or 8 percent, and $6 million, or 4 percent, respectively, compared to the same periods in 2011. For the three and nine months ended September 30, 2012, the year-over-year decreases were primarily due to decreased marketing expenses.

 

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

 

     Three Months Ended      Nine Months Ended  
     September 30,
2011
    September 30,
2012
     September 30,
2011
    September 30,
2012
 

Employee severance pay and related costs, net

   $ (2,571   $ 11,467       $ 6,340      $ 106,194   

Non-cancelable lease, contract termination, and other charges, net

     (150     11,436         3,029        16,309   

Other non-cash charges

     —          1,824         —          40,462   
  

 

 

   

 

 

    

 

 

   

 

 

 

Sub-total before reversal of stock-based compensation expense

     (2,721     24,727         9,369        162,965   

Reversal of stock-based compensation expense for forfeitures

     —          —           (1,278     (3,429
  

 

 

   

 

 

    

 

 

   

 

 

 

Restructuring charges, net

   $ (2,721   $ 24,727       $ 8,091      $ 159,536   
  

 

 

   

 

 

    

 

 

   

 

 

 

2011 and Prior Restructuring Plans. Prior to and into 2011, we implemented workforce reductions, a strategic realignment, and consolidation of certain real estate facilities and data centers to reduce our cost structure, align resources with our product strategy and improve efficiency. During the three months ended September 30, 2011, we recorded total pre-tax cash charges of $2 million in severance, facility, and other related costs. The pre-tax cash charges were offset by a reversal of $5 million for adjustments to original estimates. Of the $3 million in net reversals recorded in the three months ended September 30, 2011, $1 million related to the Americas segment and $2 million related to the EMEA segment. During the nine months ended September 30, 2011, we recorded total pre-tax cash charges of $19 million in severance, facility, and other related costs. The pre-tax cash charges were offset by a reversal of $11 million for adjustments to original estimates. Of the $8 million in restructuring charges, net recorded in the nine months ended September 30, 2011, $9 million related to net charges in the Americas segment and $1 million related to net reversals in the EMEA segment.

During the three and nine months ended September 30, 2012, we recorded total pre-tax cash charges of $2 million and $10 million, respectively, in severance, facility, and other related costs, the majority of which related to the Americas segment.

As of September 30, 2012, the aggregate outstanding restructuring liability related to the 2011 and prior restructuring plans was approximately $33 million, most of which relate to non-cancelable lease costs that we expect to pay over the terms of the related obligations, which extend to the second quarter of 2017.

Q2’12 Restructuring Plan. During the second quarter of 2012, we began implementing the Q2’12 Restructuring Plan. During the three months ended September 30, 2012, we recorded total pre-tax cash charges of $35 million in severance and facility related costs and $2 million in non-cash facility and other asset impairment charges. Those total pre-tax charges were offset by a reversal of $14 million for adjustments to original estimates in severance related costs primarily as a result of redeployments and voluntary resignations of employees prior to their planned severance dates. Of the $23 million in restructuring charges, net recorded in the three months ended September 30, 2012, $11 million related to the Americas segment and $12 million related to the EMEA segment.

During the nine months ended September 30, 2012, we recorded total pre-tax cash charges of $127 million in severance and facility related costs and $40 million in non-cash facility and other asset impairment charges. The total pre-tax charges during the nine months ended September 30, 2012 were offset by a reversal of $17 million for adjustments to original estimates. Of the $150 million in restructuring charges, net recorded in the nine months ended September 30, 2012, $97 million related to the Americas segment, $47 million related to the EMEA segment, and $6 million related to the Asia Pacific segment.

As of September 30, 2012, the aggregate outstanding restructuring liability related to the Q2’12 Restructuring Plan was $52 million, most of which relates to severance related costs that we expect will be substantially paid by the fourth quarter of 2013. The remaining liability relates to non-cancelable lease costs that we expect to pay over the terms of the related obligations, which extend to the fourth quarter of 2021.

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

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

The effective tax rate reported for the three months ended September 30, 2012 was 37 percent compared to 29 percent for the same period in 2011. The effective tax rate for the three months ended September 30, 2012 was higher than in 2011 primarily due to the U.S. taxes on the sale of Alibaba Group Shares. In connection with a review of our cash position and anticipated cash needs for investment in our core business, including potential acquisitions and capital expenditures, and stock repurchases,

 

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we are undertaking a one-time repatriation of cash from certain of our consolidated foreign subsidiaries. This distribution will be completed by the end of the fourth quarter of 2012 and resulted in a net tax benefit of approximately $135 million during the three months ended September 30, 2012 since the foreign tax credits associated with the distribution are greater than the tax due on the distribution of the foreign earnings. Taxes have not been provided on the remaining undistributed foreign earnings, principally $1.9 billion related to our corporate joint venture with Yahoo Japan, as they will continue to be indefinitely reinvested going forward. If such earnings were to be remitted in the future, any additional U.S. tax cost incurred by us would be offset by at least an equivalent amount of foreign tax credits.

The effective tax rate reported for the nine months ended September 30, 2012 was 37 percent compared to 28 percent for the same period in 2011. The rate in 2011 was lower than the U.S. federal statutory rate primarily due to tax reserve reductions attributed to favorably settled tax audits and a shift of the geographic mix of earnings. The effective tax rate for the nine months ended September 30, 2012 was higher than in 2011 primarily due to the U.S. taxes on the gain on the sale of Alibaba Group Shares.

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

Our gross amount of unrecognized tax benefits as of September 30, 2012 is $715 million, of which $709 million is recorded on the condensed consolidated balance sheets. The gross unrecognized tax benefits as of September 30, 2012 increased by $182 million from the recorded balance as of December 31, 2011. While it is difficult to determine when the examinations will be settled or their final outcomes, certain audits in various jurisdictions related to multinational income tax issues are expected to be resolved in the foreseeable future. As a result, it is reasonably possible that the unrecognized tax benefits could be reduced by up to approximately $90 million in the next twelve months.

Earnings in Equity Interests. Earnings in equity interests for the three and nine months ended September 30, 2012 was $175 million and $527 million, respectively, compared to $159 million and $350 million for the same periods in 2011. The increases for the three and nine months ended September 30, 2012 were primarily due to improved financial performance for Alibaba Group. We expect the amounts recognized as earnings in equity interests to decline in the fourth quarter of 2012 and beyond due to the reduction of our ownership interest in Alibaba Group from approximately 42 percent to approximately 24 percent in the quarter ended September 30, 2012. See Note 4 — “Investments in Equity Interests” in the Notes to the condensed consolidated financial statements for additional information.

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

Critical Accounting Policies and Estimates

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

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

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

 

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Liquidity and Capital Resources

 

     December 31,
2011
    September 30,
2012
 
     (Dollars in thousands)  

Cash and cash equivalents

   $ 1,562,390      $ 7,560,400   

Short-term marketable debt securities

     493,189        852,816   

Long-term marketable debt securities

     474,338        1,013,555   
  

 

 

   

 

 

 

Total cash, cash equivalents, and marketable debt securities

   $ 2,529,917      $ 9,426,771   
  

 

 

   

 

 

 

Percentage of total assets

     17     46
  

 

 

   

 

 

 

 

     Nine Months Ended
September 30,
 

Cash Flow Highlights

   2011     2012  
     (In thousands)  

Net cash provided by operating activities

   $ 892,472      $ 1,618,321   

Net cash provided by investing activities

   $ 153,493      $ 5,002,336   

Net cash used in financing activities

   $ (1,095,474   $ (620,824

Our operating activities for the nine months ended September 30, 2012 generated adequate cash to meet our operating needs. As of September 30, 2012, we had cash, cash equivalents, and marketable debt securities totaling $9.4 billion, compared to $2.5 billion at December 31, 2011. The increase is due to cash proceeds, net of fees, of $6.2 billion received from the sale of Alibaba Group Shares and $550 million from the TIPLA payment. This was partially offset by the repurchase of approximately 46 million shares of our outstanding common stock for $716 million during the nine months ended September 30, 2012. We estimate that we will pay approximately $2.5 billion in taxes related to the Initial Repurchase by Alibaba Group, the majority of which will be paid in the fourth quarter of 2012.

Net cash proceeds after the payment of taxes and fees from the Initial Repurchase and the $550 million TIPLA payment were approximately $4.3 billion. We intend to return $3 billion of the after-tax proceeds to shareholders. This amount is in addition to the $646 million we have already returned to shareholders through share repurchases since the announcement of the Repurchase Agreement on May 20, 2012 through September 30, 2012.

Our foreign subsidiaries held $799 million of our total $9.4 billion of cash and cash equivalents and marketable debt securities as of September 30, 2012. During the three months ended September 30, 2012, we recorded the tax effect of a one-time distribution of earnings from certain foreign subsidiaries. After this distribution, cumulative earnings remaining in our consolidated foreign subsidiaries and the related potential tax effect of repatriation is not material to the financial statements.

On October 19, 2012, we entered into a credit agreement (the “Credit Agreement”) with Citibank, N.A., as Administrative Agent, and the other lenders party thereto from time to time. The Credit Agreement provides for a $750 million unsecured revolving credit facility for a term of 364 days, subject to extension for additional 364-day periods in accordance with the terms and conditions of the Credit Agreement. We may elect to increase the revolving credit facility by up to $250 million if existing or new lenders provide additional revolving commitments in accordance with the terms of the Credit Agreement. There are no borrowings outstanding under the Credit Agreement as of the date of this filing. The proceeds from borrowings under the Credit Agreement, if any, are expected to be used for general corporate purposes. Borrowings under the Credit Agreement will bear interest at a rate equal to, at our option, either (a) a customary London interbank offered rate (a “Eurodollar Rate”), or (b) a customary base rate (a “Base Rate”), in each case plus an applicable margin. The applicable margin for borrowings under the Credit Agreement will be based upon the leverage ratio of the Company and range from 1.25 percent to 1.50 percent with respect to Eurodollar Rate borrowings and 0.25 percent to 0.50 percent with respect to Base Rate borrowings.

We expect to continue to generate positive cash flows from operations for the fourth quarter of 2012. We use cash generated by operations as our primary source of liquidity, since we believe that internally generated cash flows are sufficient to support our business operations and capital expenditures. We believe that existing cash, cash equivalents, and investments in marketable debt securities, together with any cash generated from operations and borrowings under the Credit Agreement, will be sufficient to meet normal operating requirements including capital expenditures for the next twelve months.

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

 

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Cash flow changes

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

During the nine months ended September 30, 2012, cash provided by investing activities was primarily attributable to the sale of Alibaba Group Shares. In the nine months ended September 30, 2012, we received proceeds from sales and maturities of marketable debt securities of $936 million and cash proceeds, net of fees, of $6.2 billion received from the sale of Alibaba Group Shares which was offset by purchases of marketable debt securities of $1.8 billion and the investment of $356 million in net capital expenditures. During the nine months ended September 30, 2011, cash used in investing activities was primarily attributable to cash used for net capital expenditures and net acquisitions, offset by net proceeds from the sales and maturities of marketable debt securities. In the nine months ended September 30, 2011, we received net proceeds from sales, maturities, and purchases of marketable debt securities of $681 million and proceeds from sale of investments of $21 million, which was offset by the investment of $463 million in net capital expenditures, $69 million for net acquisitions, and $11 million to purchase intangible assets.

Cash used in financing activities is driven by stock repurchases offset by employee stock option exercises and employee stock purchases. Our cash proceeds from employee stock option exercises and employee stock purchases were $116 million for the nine months ended September 30, 2012, compared to $107 million for the same period of 2011. During the nine months ended September 30, 2012, we used $716 million in the direct repurchase of approximately 46 million shares of common stock at an average price of $15.43 per share. We used $48 million for tax withholding payments related to net share settlements of restricted stock units. During the nine months ended September 30, 2011, we used $1.2 billion in the direct repurchase of approximately 82 million shares of common stock at an average price of $14.62 per share. We used $36 million for tax withholding payments related to net share settlements of restricted stock units and tax withholding related reacquisitions of shares of restricted stock.

Capital expenditures

Capital expenditures have generally been comprised of purchases of computer hardware, software, server equipment, furniture and fixtures, and real estate. Capital expenditures, net were $356 million for the nine months ended September 30, 2012, compared to $463 million in the same period of 2011.

Contractual obligations and commitments

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

A summary of lease commitments as of September 30, 2012 is as follows (in thousands):

 

     Gross Operating
Lease Commitments
     Capital Lease
Commitment
 

Three months ending December 31, 2012

   $ 38,072       $ 2,177   

Years ending December 31,

     

2013

     131,530         8,570   

2014

     105,238         8,099   

2015

     81,226         8,031   

2016

     45,812         8,272   

2017

     31,233         8,520   

Due after 5 years

     37,882         13,984   
  

 

 

    

 

 

 

Total gross lease commitments

   $ 470,993       $ 57,653   
  

 

 

    

 

 

 

Less: interest

     —           (19,430
  

 

 

    

 

 

 

Net lease commitments

   $ 470,993       $ 38,223   
  

 

 

    

 

 

 

Affiliate Commitments. In connection with contracts to provide advertising services to Affiliates, we are obligated to make payments, which represent TAC, to our Affiliates. As of September 30, 2012, these commitments totaled $97 million, of which $22 million will be payable in the remainder of 2012 and $75 million will be payable in 2013.

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

 

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Income Taxes. As of September 30, 2012, unrecognized tax benefits of $709 million, including interest and penalties, are recorded on our condensed consolidated balance sheets. As of September 30, 2012, the settlement period for our income tax liabilities cannot be determined.

Other Commitments and Off-Balance Sheet Arrangements. In the ordinary course of business, we may provide indemnifications of varying scope and terms to customers, vendors, lessors, joint venture and business partners, purchasers of assets or subsidiaries and other parties with respect to certain matters, including, but not limited to, losses arising out of our breach of agreements or representations and warranties made by us, services to be provided by us, intellectual property infringement claims made by third parties or, with respect to the sale of assets or a subsidiary, matters related to our conduct of the business and tax matters prior to the sale. In addition, we have entered into indemnification agreements with our directors and certain of our officers that will require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. We have also agreed to indemnify certain former officers, directors, and employees of acquired companies in connection with the acquisition of such companies. We maintain director and officer insurance, which may cover certain liabilities arising from our obligation to indemnify our directors and officers and former directors and officers of acquired companies, in certain circumstances. It is not possible to determine the aggregate maximum potential loss under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Such indemnification agreements might not be subject to maximum loss clauses. Historically, we have not incurred material costs as a result of obligations under these agreements and we have not accrued any liabilities related to such indemnification obligations in our condensed consolidated financial statements.

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

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

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

Interest Rate Exposure

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

Investments in fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if forced to sell securities that have declined in market value due to changes in interest rates. A hypothetical 100 basis point increase in interest rates would result in a $7 million and $20 million decrease in the fair value of our available-for-sale debt securities as of December 31, 2011 and September 30, 2012, respectively.

Foreign Currency Exposure

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

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

Transaction Exposure. Our exposure to foreign currency transaction gains and losses is the result of assets and liabilities (including intercompany transactions) that are denominated in currencies other than the relevant entity’s functional currency. In certain circumstances, changes in the functional currency value of these assets and liabilities create fluctuations in our reported condensed consolidated financial position, cash flows and results of operations. We may enter into derivative instruments, such as foreign currency forward contracts or other instruments to minimize the impact of the short-term foreign currency fluctuations on such

 

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assets and liabilities. The gains and losses on the forward contracts may not offset any or more than a portion of the transaction gains and losses on certain foreign currency receivables, investments and payables recognized in earnings. Transaction gains and losses on these foreign exchange contracts are recognized each period in other income, net included on the condensed consolidated statements of income. We had a net realized and unrealized foreign currency transaction loss of $1 million for the three months ended September 30, 2012 and a gain of $3 million for the nine months ended September 30, 2012. Our net realized and unrealized foreign currency transaction gains were $2 million and $3 million for the three and nine months ended September 30, 2011. As of September 30, 2012, we had two outstanding forward contracts with notional value equivalents of approximately $76 million and $400 million, respectively, which will mature on October 31, 2012 and March 28, 2013, respectively. On October 31, 2012, we entered into a new forward contract with a notional value equivalent to approximately $70 million, which will mature on January 31, 2013.

Translation Exposure. We are also exposed to foreign exchange rate fluctuations as we convert the financial statements of our foreign subsidiaries and our investments in equity interests into U.S. dollars in consolidation. If there is a change in foreign currency exchange rates, the conversion of the foreign subsidiaries’ financial statements into U.S. dollars results in a gain or loss which is recorded as a component of accumulated other comprehensive income which is part of stockholders’ equity.

Revenue ex-TAC and related expenses generated from our international subsidiaries are generally denominated in the currencies of the local countries. Primary currencies include Australian dollars, British pounds, Euros, Japanese yen, Korean won, and Taiwan dollars. The statements of income of our international operations are translated into U.S. dollars at exchange rates indicative of market rates during each applicable period. To the extent the U.S. dollar strengthens against foreign currencies, the translation of these foreign currency-denominated transactions results in reduced consolidated revenue and operating expenses. Conversely, our consolidated revenue and operating expenses will increase if the U.S. dollar weakens against foreign currencies. Using the foreign currency exchange rates from the three and nine months ended September 30, 2011, revenue ex-TAC for the Americas segment for the three and nine months ended September 30, 2012 would have been higher than we reported by $4 million and $8 million, respectively; revenue ex-TAC for the EMEA segment would have been higher than we reported by $7 million and $15 million, respectively; and revenue ex-TAC for the Asia Pacific segment would have been higher than we reported by $7 million and $8 million, respectively. Using the foreign currency exchange rates from the three and nine months ended September 30, 2011, direct costs for the Americas segment for the three and nine months ended September 30, 2012 would have been higher than we reported by $2 million and $4 million, respectively; direct costs for the EMEA segment would have been higher than we reported by $4 million and $7 million, respectively; and direct costs for the Asia Pacific segment would have been higher than we reported by $2 million and $3 million respectively.

Investment Exposure

We are exposed to investment risk as it relates to changes in the market value of our investments. We have investments in marketable debt securities and equity instruments of public and private companies.

Our cash and marketable debt securities investment policy and strategy attempts primarily to preserve capital and meet liquidity requirements. A large portion of our cash is managed by external managers within the guidelines of our investment policy. We protect and preserve invested funds by limiting default, market, and reinvestment risk. To achieve this objective, we maintain our portfolio of cash and cash equivalents and short-term and long-term investments in a variety of liquid fixed income securities, including both government and corporate obligations and money market funds. As of September 30, 2011 and 2012, net unrealized gains and losses on these investments were not material.

Alibaba Group Preference Shares Exposure. To estimate the fair value, we performed benchmarking by comparing the terms and conditions of the Alibaba Group Preference Shares to dividend rates, subordination terms, and credit ratings of those of similar type instruments. The credit rating of Alibaba Group, general business conditions, and market rates could materially affect the fair value of the Alibaba Group Preference Shares.

 

Item 4. Controls and Procedures

Disclosure Controls and Procedures. The Company’s management, with the participation of the Company’s principal executive officer and principal financial officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this Report. Based on such evaluation, the Company’s principal executive officer and principal financial officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures were effective.

Internal Control Over Financial Reporting. There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II — OTHER INFORMATION

 

Item 1. Legal Proceedings

For a description of our material legal proceedings, see the section captioned “Contingencies” included in Note 11 — “Commitments and Contingencies” in the Notes to the condensed consolidated financial statements, which is incorporated by reference herein.

 

Item 1A. Risk Factors

We have updated the risk factors previously disclosed in Part I, Item 1A. of our Annual Report on Form 10-K for the year ended December 31, 2011, which was filed with the Securities and Exchange Commission on February 29, 2012, as set forth below. We do not believe any of the changes constitute material changes from the risk factors previously disclosed in the Annual Report on Form 10-K for the year ended December 31, 2011, as updated in our subsequent Quarterly Reports on Form 10-Q.

We face significant competition for users, advertisers, publishers, developers, and distributors.

We face significant competition from integrated online media companies as well as from social networking sites, traditional print and broadcast media, general purpose and vertical search engines and various e-commerce sites. In a number of international markets, especially those in Asia, Europe, the Middle East and Latin America, we face substantial competition from local Internet service providers and other portals that offer search, communications, and other commercial services.

Several of our competitors offer an integrated variety of Internet products, advertising services, technologies, online services and content in a manner similar to Yahoo!. We compete against these and other companies to attract and retain users, advertisers, developers, and third-party Website publishers as participants in our Affiliate network, and to obtain agreements with third parties to promote or distribute our services. We also compete with social media and networking sites which are attracting a substantial and increasing share of users and users’ online time, and may continue to attract an increasing share of online advertising dollars.

In addition, several competitors offer products and services that directly compete for users with our offerings, including consumer e-mail, local search, instant messaging, daily deals, photos, maps, video sharing, content channels, mobile applications, and shopping. Similarly, the advertising networks operated by our competitors or by other participants in the display marketplace offer services that directly compete with our offerings for advertisers, including advertising exchanges, ad networks, demand side platforms, ad serving technologies and sponsored search offerings. We also compete with traditional print and broadcast media companies to attract domestic and international advertising spending. Some of our existing competitors and possible entrants may have greater brand recognition for certain products and services, more expertise in a particular segment of the market, and greater operational, strategic, technological, financial, personnel, or other resources than we do. Many of our competitors have access to considerable financial and technical resources with which to compete aggressively, including by funding future growth and expansion and investing in acquisitions, technologies, and research and development. Further, emerging start-ups may be able to innovate and provide new products and services faster than we can. In addition, competitors may consolidate with each other or collaborate, and new competitors may enter the market. Some of our competitors in international markets have a substantial competitive advantage over us because they have dominant market share in their territories, are owned by local telecommunications providers, have greater brand recognition, are focused on a single market, are more familiar with local tastes and preferences, or have greater regulatory and operational flexibility due to the fact that we may be subject to both U.S. and foreign regulatory requirements.

If our competitors are more successful than we are in developing and deploying compelling products or in attracting and retaining users, advertisers, publishers, developers, or distributors, our revenue and growth rates could decline.

The majority of our revenue is derived from display and search advertising, and the reduction in spending by or loss of current or potential advertisers would cause our revenue and operating results to decline.

For the three months ended September 30, 2012, 81 percent of our total revenue came from display and search advertising. Our ability to continue to retain and grow display and search revenue depends upon:

 

   

maintaining and growing our user base;

 

   

maintaining and growing our popularity as an Internet destination site;

 

   

maintaining and expanding our advertiser base on PCs and mobile devices;

 

   

broadening our relationships with advertisers to small- and medium-sized businesses;

 

   

successfully implementing changes and improvements to our advertising management platforms and obtaining the acceptance of our advertising management platforms by advertisers, Website publishers, and online advertising networks;

 

   

successfully acquiring, investing in, and implementing new technologies and strategic partnerships;

 

   

successfully implementing changes in our sales force, sales development teams, and sales strategy;

 

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continuing to innovate and improve the monetization capabilities of our display advertising products;

 

   

effectively monetizing search queries;

 

   

continuing to innovate and improve users’ search experiences;

 

   

maintaining and expanding our Affiliate program for search and display advertising services; and

 

   

deriving better demographic and other information about our users to enable us to offer better experiences to both our users and advertisers.

In most cases, our agreements with advertisers have a term of one year or less, and may be terminated at any time by the advertiser or by us. Search marketing agreements often have payments dependent upon usage or click-through levels. Accordingly, it is difficult to forecast display and search revenue accurately. In addition, our expense levels are based in part on expectations of future revenue, including occasional guaranteed minimum payments to our Affiliates in connection with search and/or display advertising, and are fixed over the short-term in some categories. The state of the global economy and availability of capital has impacted and could further impact the advertising spending patterns of existing and potential advertisers. Any reduction in spending by, or loss of, existing or potential advertisers would negatively impact our revenue and operating results. Further, we may be unable to adjust our expenses and capital expenditures quickly enough to compensate for any unexpected revenue shortfall.

Adverse general economic conditions have caused and could cause decreases or delays in spending by our advertisers and could harm our ability to generate revenue and our results of operations.

Advertising expenditures tend to be cyclical, reflecting overall economic conditions and budgeting and buying patterns. Since we derive most of our revenue from advertising, adverse economic conditions have caused, and a continuation of adverse economic conditions could cause, additional decreases or delays in advertising spending, a reduction in our advertising revenue and a negative impact on our short-term ability to grow our revenue. Further, any decreased collectability of accounts receivable or early termination of agreements, whether resulting from customer bankruptcies or otherwise due to the current economic conditions, could negatively impact our results of operations.

If we do not manage our operating expenses effectively, our profitability could decline.

We have implemented cost reduction initiatives to better align our operating expenses with our revenue, including reducing our headcount, outsourcing some administrative functions, consolidating space and terminating leases or entering into subleases. We plan to continue to manage costs to better and more efficiently manage our business. However, our operating expenses might also increase from their reduced levels as we expand our operations in areas of desired growth, continue to develop and extend the Yahoo! brand, fund product development, build data centers or acquire real property, and acquire and integrate complementary businesses and technologies. Our operating costs might also increase if we do not effectively manage costs as we transition markets under the Search Agreement and reimbursements from Microsoft under the Search Agreement decline or cease. In addition, weak economic conditions or other factors could cause our business to contract, requiring us to implement additional cost cutting measures. If our expenses increase at a greater pace than our revenue, or if we fail to implement additional cost cutting if required in a timely manner, our profitability will decline.