10-Q 1 d587930d10q.htm FORM 10-Q Form 10-Q
Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

 

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

For the quarterly period ended September 30, 2013

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  x    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  x    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   x    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  x

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, 2013

Common Stock, $0.001 par value   1,014,442,318

 

 

 


Table of Contents

YAHOO! INC.

Table of Contents

 

PART I    FINANCIAL INFORMATION      3   
Item 1.    Condensed Consolidated Financial Statements (unaudited):   
   Condensed Consolidated Balance Sheets as of December 31, 2012 (unaudited) and September 30, 2013 (unaudited)      3   
  

Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2012 and 2013 (unaudited)

     4   
  

Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2012 and 2013 (unaudited)

     5   
  

Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2012 and 2013 (unaudited)

     6   
   Notes to Condensed Consolidated Financial Statements (unaudited)      7   
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      30   
Item 3.    Quantitative and Qualitative Disclosures About Market Risk      48   
Item 4.    Controls and Procedures      50   
PART II    OTHER INFORMATION      51   
Item 1.    Legal Proceedings      51   
Item 1A.    Risk Factors      51   
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds      63   
Item 3.    Defaults Upon Senior Securities      63   
Item 4.    Mine Safety Disclosures      63   
Item 5.    Other Information      63   
Item 6.    Exhibits      63   
   Signatures      64   

 

2


Table of Contents

PART I — FINANCIAL INFORMATION

 

Item 1. Condensed Consolidated Financial Statements (unaudited)

YAHOO! INC.

Condensed Consolidated Balance Sheets

 

     December 31,
2012
    September 30,
2013
 
     (Unaudited, in thousands
except par values)
 

ASSETS

    

Current assets:

    

Cash and cash equivalents

   $ 2,667,778      $ 842,428   

Short-term marketable securities

     1,516,175        987,870   

Accounts receivable, net

     1,008,448        844,118   

Prepaid expenses and other current assets

     460,312        891,807   
  

 

 

   

 

 

 

Total current assets

     5,652,713        3,566,223   

Long-term marketable securities

     1,838,425        1,384,638   

Alibaba Group Preference Shares

     816,261        —    

Property and equipment, net

     1,685,845        1,536,362   

Goodwill

     3,826,749        4,704,859   

Intangible assets, net

     153,973        427,351   

Other long-term assets

     289,130        165,866   

Investments in equity interests

     2,840,157        3,120,450   
  

 

 

   

 

 

 

Total assets

   $ 17,103,253      $ 14,905,749   
  

 

 

   

 

 

 

LIABILITIES AND EQUITY

    

Current liabilities:

    

Accounts payable

   $ 184,831      $ 123,042   

Accrued expenses and other current liabilities

     808,475        776,466   

Deferred revenue

     296,926        293,615   
  

 

 

   

 

 

 

Total current liabilities

     1,290,232        1,193,123   

Long-term deferred revenue

     407,560        295,970   

Capital lease and other long-term liabilities

     124,587        121,169   

Deferred and other long-term tax liabilities, net

     675,271        749,168   
  

 

 

   

 

 

 

Total liabilities

     2,497,650        2,359,430   

Commitments and contingencies (Note 11)

     —         —     

Yahoo! Inc. stockholders’ equity:

    

Common stock, $0.001 par value; 5,000,000 shares authorized; 1,189,816 shares issued and 1,115,233 shares outstanding as of December 31, 2012 and 1,210,154 shares issued and 1,013,059 shares outstanding as of September 30, 2013

     1,187        1,205   

Additional paid-in capital

     9,563,348        9,902,748   

Treasury stock at cost, 74,583 shares as of December 31, 2012 and 197,095 shares as of September 30, 2013

     (1,368,043     (4,481,162

Retained earnings

     5,792,459        6,810,550   

Accumulated other comprehensive income

     571,249        260,770   
  

 

 

   

 

 

 

Total Yahoo! Inc. stockholders’ equity

     14,560,200        12,494,111   

Noncontrolling interests

     45,403        52,208   
  

 

 

   

 

 

 

Total equity

     14,605,603        12,546,319   
  

 

 

   

 

 

 

Total liabilities and equity

   $ 17,103,253      $ 14,905,749   
  

 

 

   

 

 

 

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

 

3


Table of Contents

YAHOO! INC.

Condensed Consolidated Statements of Income

 

     Three Months Ended     Nine Months Ended  
     September 30,
2012
    September 30,
2013
    September 30,
2012
    September 30,
2013
 
     (Unaudited, in thousands except per share amounts)  

Revenue

   $ 1,201,732      $ 1,138,973      $ 3,640,759      $ 3,414,585   

Operating expenses:

        

Cost of revenue — traffic acquisition costs

     112,829        58,464        393,945        188,848   

Cost of revenue — other

     282,081        271,763        814,513        821,032   

Sales and marketing

     269,272        282,562        827,450        819,319   

Product development

     217,301        267,444        645,407        723,272   

General and administrative

     135,249        151,304        395,637        419,764   

Amortization of intangibles

     8,084        15,253        27,893        30,702   

Restructuring charges (reversals), net

     24,727        (576     159,536        (4,060
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     1,049,543        1,046,214        3,264,381        2,998,877   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     152,189        92,759        376,378        415,708   

Other income, net

     4,607,656        5,370        4,630,109        46,048   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes and earnings in equity interests

     4,759,845        98,129        5,006,487        461,756   

Provision for income taxes

     (1,774,094     (31,891     (1,857,036     (111,894

Earnings in equity interests

     175,265        232,756        527,499        675,034   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     3,161,016        298,994        3,676,950        1,024,896   

Net income attributable to noncontrolling interests

     (778     (2,338     (3,738     (6,805
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Yahoo! Inc.

   $ 3,160,238      $ 296,656      $ 3,673,212      $ 1,018,091   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 2.66      $ 0.29      $ 3.05      $ 0.96   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 2.64      $ 0.28      $ 3.02      $ 0.93   
  

 

 

   

 

 

   

 

 

   

 

 

 

Shares used in per share calculation — basic

     1,186,046        1,024,289        1,205,050        1,065,949   
  

 

 

   

 

 

   

 

 

   

 

 

 

Shares used in per share calculation — diluted

     1,195,085        1,041,698        1,214,430        1,081,495   
  

 

 

   

 

 

   

 

 

   

 

 

 

Stock-based compensation expense by function:

        

Cost of revenue — other

   $ 2,363      $ 2,608      $ 7,871      $ 9,215   

Sales and marketing

   $ 19,876      $ 29,175      $ 59,954      $ 68,995   

Product development

   $ 17,050      $ 28,702      $ 54,329      $ 57,502   

General and administrative

   $ 22,077      $ 20,241      $ 44,749      $ 57,755   

Restructuring expense reversals

   $ —       $ —       $ (3,429   $ —    

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

 

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Table of Contents

YAHOO! INC.

Condensed Consolidated Statements of Comprehensive Income

 

     Three Months Ended     Nine Months Ended  
     September 30,
2012
    September 30,
2013
    September 30,
2012
    September 30,
2013
 
     (Unaudited, in thousands)  

Net income

   $ 3,161,016      $ 298,994      $ 3,676,950      $ 1,024,896   
  

 

 

   

 

 

   

 

 

   

 

 

 

Available-for-sale securities:

        

Unrealized gains (losses) on available-for-sale securities, net of taxes of $(246) and $(2,390) for the three months ended September 30, 2012 and 2013, respectively, and $(41) and $598 for the nine months ended September 30, 2012 and 2013, respectively

     463        (2,072     6,143        2,046   

Reclassification adjustment for realized (gains) losses on available-for-sale securities included in net income, net of taxes of $57 and $187 for the three months ended September 30, 2012 and 2013, respectively, and $(5,298) and $390 for the nine months ended September 30, 2012 and 2013, respectively

     (98     (312     9,260        (651
  

 

 

   

 

 

   

 

 

   

 

 

 

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

     365        (2,384     15,403        1,395   
  

 

 

   

 

 

   

 

 

   

 

 

 

Foreign currency translation adjustments (“CTA”):

        

Foreign CTA gains (losses), net of tax

     28,009        (41,838     (193,128     (567,197

Net investment hedge CTA gains (losses), net of tax

     —         (15,165     —         254,572   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net foreign CTA gains (losses), net of tax

     28,009        (57,003     (193,128     (312,625
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash flow hedges:

        

Unrealized gains (losses) on cash flow hedges, net of taxes of nil and $249 for the three months ended September 30, 2012 and 2013, respectively, and nil and $(114) for the nine months ended September 30, 2012 and 2013, respectively

     —         856        —         867   

Reclassification adjustment for realized (gains) losses on cash flow hedges, net of taxes of nil and $(65) for the three months ended September 30, 2012 and 2013, respectively, and nil and $69 for the nine months ended September 30, 2012 and 2013, respectively

     —         (106     —         (83
  

 

 

   

 

 

   

 

 

   

 

 

 

Net change in unrealized gains (losses) on cash flow hedges, net of tax

     —         750        —         784   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss)

     28,374        (58,637     (177,725     (310,446
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

     3,189,390        240,357        3,499,225        714,450   

Less: comprehensive income attributable to noncontrolling interests

     (778     (2,338     (3,738     (6,805
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income attributable to Yahoo! Inc.

   $ 3,188,612      $ 238,019      $ 3,495,487      $ 707,645   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

 

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Table of Contents

YAHOO! INC.

Condensed Consolidated Statements of Cash Flows

 

     Nine Months Ended  
     September 30,
2012
    September 30,
2013
 
     (Unaudited, in thousands)  

CASH FLOWS FROM OPERATING ACTIVITIES:

    

Net income

   $ 3,676,950      $ 1,024,896   

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

    

Depreciation

     401,022        412,646   

Amortization of intangible assets

     84,087        68,365   

Stock-based compensation expense, net

     163,474        193,467   

Non-cash restructuring charges

     40,462        547   

Dividend income related to Alibaba Group Preference Shares

     —         (35,726

Dividends received from equity investees

     83,648        135,058   

Tax benefits (detriments) from stock-based awards

     (9,471     33,894   

Excess tax benefits from stock-based awards

     (30,751     (47,193

Deferred income taxes

     (891,288     (74,981

Earnings in equity interests

     (527,499     (675,034

Gain from sale of Alibaba Group Shares

     (4,603,322     —    

(Gain) loss from sales of investments, assets, and other, net

     (18,308     19,994   

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

    

Accounts receivable, net

     86,942        161,459   

Prepaid expenses and other

     41,059        (17,738

Accounts payable

     (22,457     (54,343

Accrued expenses and other liabilities

     2,628,962        (183,706

Deferred revenue

     514,811        (114,085
  

 

 

   

 

 

 

Net cash provided by operating activities

     1,618,321        847,520   
  

 

 

   

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

    

Acquisition of property and equipment, net

     (355,787     (229,310

Purchases of marketable securities

     (1,838,860     (2,247,302

Proceeds from sales of marketable securities

     684,979        2,642,548   

Proceeds from maturities of marketable securities

     250,653        557,565   

Proceeds related to sale of Alibaba Group Shares, net

     6,247,728        —    

Proceeds related to the redemption of Alibaba Group Preference Shares

     —         800,000   

Proceeds from the sale of investments

     26,132        —    

Acquisitions, net of cash acquired

     —         (1,187,229

Purchases of intangible assets

     (3,088     (2,290

Other investing activities, net

     (9,421     (11,045
  

 

 

   

 

 

 

Net cash provided by investing activities

     5,002,336        322,937   
  

 

 

   

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

    

Proceeds from issuance of common stock

     116,420        203,417   

Repurchases of common stock

     (716,379     (3,113,118

Excess tax benefits from stock-based awards

     30,751        47,193   

Tax withholdings related to net share settlements of restricted stock units

     (48,097     (106,177

Proceeds from credit facility borrowings

     —         150,000   

Repayment of credit facility borrowings

     —         (150,150

Other financing activities

     (3,519     (5,713
  

 

 

   

 

 

 

Net cash used in financing activities

     (620,824     (2,974,548
  

 

 

   

 

 

 

Effect of exchange rate changes on cash and cash equivalents

     (1,823     (21,259

Net change in cash and cash equivalents

     5,998,010        (1,825,350

Cash and cash equivalents at beginning of period

     1,562,390        2,667,778   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 7,560,400      $ 842,428   
  

 

 

   

 

 

 

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

 

6


Table of Contents

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 making the world’s daily habits inspiring and entertaining. By creating highly personalized experiences for its users, the Company keeps people connected to what matters most to them, across devices and around the world. The Company creates value for advertisers by connecting them with the audiences that build their businesses. Advertisers can build their businesses through advertising to targeted audiences on the Company’s online properties and services (“Yahoo Properties”), or through a distribution network of third-party entities (“Affiliates”) who 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.

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, 2012. 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, 2012 was derived from the Company’s audited financial statements for the year ended December 31, 2012, 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 INVESTMENTS AND FAIR VALUE MEASUREMENTS

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

 

     December 31, 2012  
     Gross
Amortized
Costs
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Estimated
Fair Value
 

Government and agency securities

   $ 1,312,876       $ 985       $ (45   $ 1,313,816   

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

     2,039,809         1,597         (622     2,040,784   

Corporate equity securities

     230         —          (33     197   

Alibaba Group Preference Shares

     816,261         —          —         816,261   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total investments in available-for-sale securities

   $ 4,169,176       $ 2,582       $ (700   $ 4,171,058   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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Table of Contents
     September 30, 2013  
     Gross
Amortized
Costs
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Estimated
Fair Value
 

Government and agency securities

   $ 294,644       $ 110       $ (180   $ 294,574   

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

     2,078,519         1,339         (1,924     2,077,934   

Corporate equity and other marketable securities

     230         141         —         371   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total investments in available-for-sale securities

   $ 2,373,393       $ 1,590       $ (2,104   $ 2,372,879   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

     December 31,
2012
     September 30,
2013
 

Reported as:

     

Short-term marketable securities

   $ 1,516,175       $ 987,870   

Long-term marketable securities

     1,838,425         1,384,638   

Alibaba Group Preference Shares

     816,261         —    

Other assets

     197         371   
  

 

 

    

 

 

 

Total

   $ 4,171,058       $ 2,372,879   
  

 

 

    

 

 

 

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 not material as of December 31, 2012 and September 30, 2013 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 three and nine months ended September 30, 2012 and 2013.

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

 

     December 31,
2012
     September 30,
2013
 

Due within one year

   $ 1,516,175       $ 987,870   

Due after one year through five years

     1,838,425         1,384,638   
  

 

 

    

 

 

 

Total available-for-sale marketable securities

   $ 3,354,600       $ 2,372,508   
  

 

 

    

 

 

 

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, 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

   $ 165,025       $ (45   $ —        $ —        $ 165,025       $ (45

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

       729,046         (622     —          —          729,046         (622

Corporate equity securities

     197         (33     —          —          197         (33
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Total investments in available-for-sale securities

   $ 894,268       $ (700   $ —        $ —        $ 894,268       $ (700
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 
     September 30, 2013  
     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

   $ 110,362       $ (180   $ —        $ —        $ 110,362       $ (180

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

       948,913         (1,924     —          —          948,913         (1,924
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Total investments in available-for-sale securities

   $ 1,059,275       $ (2,104   $ —        $ —        $ 1,059,275       $ (2,104
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

 

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The Company’s investment portfolio consists of liquid high-quality fixed income government, agency, and corporate debt securities, money market funds, and time deposits with financial institutions. Investments in fixed rate instruments carry a degree of interest rate risk. Fixed rate securities may have their fair value adversely impacted due to a rise in interest rates or by 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 the securities in an unrealized loss position. 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 was presented as an asset carried at estimated fair value on the Company’s condensed consolidated balance sheet as of December 31, 2012. As of December 31, 2012, the carrying value of the Alibaba Group Preference Shares approximated the fair value. As of December 31, 2012, the total fair value of the Alibaba Group Preferences Shares was $822 million, which included $6 million of accrued dividend income recorded within prepaid expenses and other current assets and $16 million of accrued dividend income recorded as part of the carrying value of the Alibaba Group Preference Shares. On May 16, 2013, Alibaba Group Holding Limited (“Alibaba Group”) exercised its right to redeem the Alibaba Group Preference Shares for $846 million in cash. The cash received represented the redemption value, which included the stated value of $800 million plus accrued dividends of $46 million.

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, 2012 (in thousands):

 

     Fair Value Measurements at Reporting Date Using  

Assets

   Level 1      Level 2     Level 3      Total  

Money market funds(1)

   $ 685,707       $ —       $ —        $ 685,707   

Available-for-sale securities:

          

Government and agency securities(1)

     —          2,464,227        —          2,464,227   

Commercial paper and bank certificates of deposit(1)

     —          892,769        —          892,769   

Corporate debt securities(1)

     —          1,298,123        —          1,298,123   

Time deposits

     —          84,555        —          84,555   

Alibaba Group Preference Shares

     —          —         816,261         816,261   

Corporate equity securities(2)

     197         —         —          197   

Foreign currency derivative contracts(3)

     —          5,007        —          5,007   
  

 

 

    

 

 

   

 

 

    

 

 

 

Financial assets at fair value

   $ 685,904       $ 4,744,681      $ 816,261       $ 6,246,846   

Liabilities

          

Foreign currency derivative contracts(3)

     —          (6,662     —          (6,662
  

 

 

    

 

 

   

 

 

    

 

 

 

Total financial assets and liabilities at fair value

   $ 685,904       $ 4,738,019      $ 816,261       $ 6,240,184   
  

 

 

    

 

 

   

 

 

    

 

 

 

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, 2013 (in thousands):

 

     Fair Value Measurements at Reporting Date Using  

Assets

   Level 1      Level 2     Total  

Money market funds(1)

   $ 76,782       $ —       $ 76,782   

Available-for-sale securities:

       

Government and agency securities(1)

     —          322,377        322,377   

Commercial paper and bank certificates of deposit(1)

     —          291,886        291,886   

Corporate debt securities(1)

     —          1,786,048        1,786,048   

Time deposits

     —          80,261        80,261   

Corporate equity and other marketable securities(2)

     371         —          371   

Foreign currency derivative contracts(3)

     —          418,044        418,044   
  

 

 

    

 

 

   

 

 

 

Financial assets at fair value

   $ 77,153       $ 2,898,616      $ 2,975,769   

Liabilities

       

Foreign currency derivative contracts(3)

     —          (10,865     (10,865
  

 

 

    

 

 

   

 

 

 

Total financial assets and liabilities at fair value

   $ 77,153       $ 2,887,751      $ 2,964,904   
  

 

 

    

 

 

   

 

 

 

 

(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 securities in the condensed consolidated balance sheets.

(2) 

The corporate equity securities are classified as part of the other long-term assets and other marketable securities are classified as investments in marketable securities 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 $3.4 billion, including contracts designated as net investment hedges of $3 billion, as of December 31, 2012, and $2.9 billion, including contracts designated as net investment hedges of $2.5 billion, as of September 30, 2013.

 

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The amount of cash and cash equivalents as of December 31, 2012 and September 30, 2013 included $597 million and $658 million, respectively, of cash deposits.

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 using quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets in markets that are not active; and inputs other than quoted prices, e.g., interest rates and yield curves. The Company utilizes a pricing service to assist in obtaining fair value pricing for the majority of the investment portfolio. The Company classified its investment in the Alibaba Group Preference Shares within Level 3 because it was valued using significant unobservable inputs. To estimate the fair value as of December 31, 2012, 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 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.

Activity between Levels of the Fair Value Hierarchy. During the year ended December 31, 2012, the Company did not make any transfers between Level 1, Level 2, or Level 3 assets or liabilities. During the nine months ended September 30, 2013, the Company did not make any transfers between Level 1 and Level 2 assets or liabilities.

Note 3 CONSOLIDATED FINANCIAL STATEMENT DETAILS

Accumulated Other Comprehensive Income

The components of accumulated other comprehensive income were as follows (in thousands):

 

     December 31,
2012
     September 30,
2013
 

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

   $ 9,121       $ 11,267   

Foreign currency translation, net of tax

     562,128         249,503   
  

 

 

    

 

 

 

Accumulated other comprehensive income

   $ 571,249       $ 260,770   
  

 

 

    

 

 

 

Noncontrolling Interests

Noncontrolling interests were as follows (in thousands):

 

     December 31,
2012
     September 30,
2013
 

Beginning noncontrolling interests

   $ 40,280       $   45,403   

Net income attributable to noncontrolling interests

     5,123         6,805   
  

 

 

    

 

 

 

Ending noncontrolling interests

   $ 45,403       $ 52,208   
  

 

 

    

 

 

 

Other Income, Net

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

 

     Three Months Ended      Nine Months Ended  
     September 30,
2012
    September 30,
2013
     September 30,
2012
     September 30,
2013
 

Interest, dividend, and investment income

   $ 6,402      $ 5,362       $ 15,682       $ 53,214   

Gain related to sale of Alibaba Group Shares

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

Other

     (2,068     8         11,105         (7,166
  

 

 

   

 

 

    

 

 

    

 

 

 

Total other income, net

   $ 4,607,656      $ 5,370       $ 4,630,109       $ 46,048   
  

 

 

   

 

 

    

 

 

    

 

 

 

Interest, dividend and investment income consists of income earned from cash in bank accounts, investments made in marketable securities and money market funds, and dividend income on the Alibaba Group Preference Shares.

The Company recorded a pre-tax gain of approximately $4.6 billion in the three and nine months ended September 30, 2012 related to the sale of Alibaba Group ordinary shares. See Note 8—“Investments in Equity Interests” for additional information.

 

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Other consists of gains and losses from sales or impairments of marketable 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 balance sheet hedges, and other non-operating items.

Reclassifications Out of Accumulated Other Comprehensive Income

Reclassifications out of accumulated other comprehensive income for the three months ended September 30, 2013 were as follows (in thousands):

 

     Amount
Reclassified from
Accumulated
Other
Comprehensive
Income
    Affected Line Item in the
Statement of Income
 

Realized gains on cash flow hedges, net of tax

   $ (106     Revenue   

Realized gains on available-for-sale securities, net of tax

     (312     Other income, net   
  

 

 

   

Total reclassifications for the period

   $ (418  
  

 

 

   

Reclassifications out of accumulated other comprehensive income for the nine months ended September 30, 2013 were as follows (in thousands):

 

     Amount
Reclassified from
Accumulated
Other
Comprehensive
Income
    Affected Line Item in the
Statement of Income
 

Realized gains on cash flow hedges, net of tax

   $ (83     Revenue   

Realized gains on available-for-sale securities, net of tax

     (651     Other income, net   
  

 

 

   

Total reclassifications for the period

   $ (734  
  

 

 

   

Note 4 ACQUISITIONS

Transactions completed in 2013

Tumblr. On June 19, 2013, the Company completed the acquisition of Tumblr, Inc. (“Tumblr”), a blog-hosting website that allows users to post their own content as well as follow or re-blog posts made by other users. The acquisition of Tumblr brings a community of new users to the Yahoo network.

The purchase price exceeded the fair value of the net tangible and identifiable intangible assets acquired from Tumblr and, as a result, the Company recorded goodwill in connection with this transaction. Under the terms of the agreement, the Company acquired all of the equity interests (including all outstanding vested options) in Tumblr. Tumblr stockholders and vested optionholders were paid in cash, outstanding Tumblr unvested options and restricted stock units were assumed and converted into equivalent awards covering Yahoo common stock and a portion of the Tumblr shares held by its founder were exchanged for Yahoo common stock.

The total purchase price of approximately $990 million consisted mainly of cash consideration. The preliminary allocation of the purchase price of the assets acquired and liabilities assumed based on their fair values was as follows (in thousands):

 

Cash and marketable securities acquired

   $ 16,587   

Other tangible assets acquired

     73,780   

Amortizable intangible assets:

  

Developed technology

     23,700   

Customer contracts and related relationships

     182,400   

Trade name

     56,500   

Goodwill

     751,114   
  

 

 

 

Total assets acquired

     1,104,081   

Liabilities assumed

     (113,870
  

 

 

 

Total

   $ 990,211   
  

 

 

 

In connection with the acquisition, the Company is recognizing stock-based compensation expense of $70 million over a period of up to 4 years. This amount is comprised of assumed unvested stock options and restricted stock units (which had an aggregate fair value of $29 million at the acquisition date), and Yahoo common stock issued to Tumblr’s founder (which had a fair value of $41 million at the acquisition date). The Yahoo common stock issued to Tumblr’s founder is subject to holdback and will be released over four years

 

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Table of Contents

provided he remains an employee of the Company. In addition, the transaction resulted in contingent cash consideration of $40 million to be paid to Tumblr’s founder over 4 years also provided that Tumblr’s founder remains an employee of the Company. Such cash payments are being recognized as compensation expense over the 4-year service period.

The amortizable intangible assets have useful lives not exceeding 6 years and a weighted average useful life of 6 years. No amounts have been allocated to in-process research and development and $751 million has been allocated to goodwill. Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired and is not deductible for tax purposes. This acquisition brings a community of new users to the Yahoo network by deploying Yahoo’s personalization technology and search infrastructure to deliver relevant content to the Tumblr user base. Operating results from the date of acquisition were not significant to the Company’s consolidated results of operations for the three and nine months ended September 30, 2013.

Other Acquisitions — Business Combinations. During the nine months ended September 30, 2013, the Company acquired seventeen other companies, which were accounted for as business combinations. The total aggregate purchase price for these other acquisitions was $218 million. The total cash consideration of $218 million less cash acquired of $2 million resulted in a net cash outlay of $216 million. The preliminary allocation of the purchase price of the assets and liabilities assumed based on their estimated fair values was $77 million to amortizable intangible assets, $2 million to cash acquired, $23 million to other tangible assets, $32 million to assumed liabilities, and the remainder of $148 million to goodwill.

The Company’s business combinations completed during the nine months ended September 30, 2013 did not have a material impact on the Company’s condensed consolidated financial statements, and therefore pro forma disclosures have not been presented.

Transactions completed in 2012

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

Note 5 GOODWILL

The Company’s goodwill balance was $3.8 billion as of December 31, 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 $0.3 billion in the Asia Pacific segment. As of September 30, 2013, the Company’s goodwill balance was $4.7 billion, of which $3.8 billion was recorded in the Americas segment, $0.6 billion in the EMEA segment, and $0.3 billion in the Asia Pacific segment. Goodwill related to the Tumblr acquisition, which was completed during June 2013, is included as part of the Americas segment. The increase in the carrying amount of goodwill of $878 million reflected on the Company’s condensed consolidated balance sheets during the nine months ended September 30, 2013 was primarily due to additions to goodwill of $899 million related to acquisitions made during the nine months ended September 30, 2013 offset by net foreign currency translation losses of $21 million.

Note 6 INTANGIBLE ASSETS, NET

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

 

     December 31, 2012      September 30, 2013  
     Net      Gross Carrying
Amount
     Accumulated
Amortization(*)
    Net  

Customer, affiliate, and advertiser related relationships

   $ 62,393       $ 298,212       $ (80,605   $ 217,607   

Developed technology and patents

     71,634         269,920         (133,593     136,327   

Trade names, trademarks, and domain names

     19,946         107,382         (33,965     73,417   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total intangible assets, net

   $ 153,973       $ 675,514       $ (248,163   $ 427,351   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(*) 

Cumulative foreign currency translation adjustments, reflecting movement in the currencies of the underlying entities increased total intangible assets by approximately $18 million as of September 30, 2013.

For the three months ended September 30, 2012 and 2013, the Company recognized amortization expense for intangible assets of $24 million and $31 million, respectively, including $16 million in cost of revenue—other for both the three months ended September 30, 2012 and 2013. For the nine months ended September 30, 2012 and 2013, the Company recognized amortization expense for intangible assets of $84 million and $68 million, respectively, including $56 million and $38 million in cost of revenue—other for the nine months ended September 30, 2012 and 2013, respectively. Based on the current amount of intangibles subject to amortization, the estimated amortization expense for the remainder of 2013 and each of the succeeding years is as follows: three months ending December 31, 2013: $27 million; 2014: $101 million; 2015: $80 million; 2016: $55 million; and thereafter $148 million.

 

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Table of Contents

Note 7 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 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.

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 4 million and 12 million shares of common stock for the three and nine months ended September 30, 2013, respectively, 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,
2012
    September 30,
2013
    September 30,
2012
    September 30,
2013
 

Basic:

        

Numerator:

        

Net income attributable to Yahoo! Inc.

   $ 3,160,238      $ 296,656      $ 3,673,212      $ 1,018,091   

Less: Net income allocated to participating securities

     (35     (6     (47     (24
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 3,160,203      $ 296,650      $ 3,673,165      $ 1,018,067   
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator:

        

Weighted average common shares

     1,186,046        1,024,289        1,205,050        1,065,949   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 2.66      $ 0.29      $ 3.05      $ 0.96   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted:

        

Numerator:

        

Net income attributable to Yahoo! Inc.

   $ 3,160,238      $ 296,656      $ 3,673,212      $ 1,018,091   

Less: Net income allocated to participating securities

     (34     (6     (46     (24

Less: Effect of dilutive securities issued by equity investees

     (1,334     (5,040     (3,846     (10,778
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 3,158,870      $ 291,610      $ 3,669,320      $ 1,007,289   
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator:

        

Denominator for basic calculation

     1,186,046        1,024,289        1,205,050        1,065,949   

Weighted average effect of Yahoo! Inc. dilutive securities:

        

Restricted stock and restricted stock units

     7,587        12,689        7,776        12,085   

Stock options and employee stock purchase plan

     1,452        4,720        1,604        3,461   
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator for diluted calculation

     1,195,085        1,041,698        1,214,430        1,081,495   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ 2.64      $ 0.28      $ 3.02      $ 0.93   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

Note 8 INVESTMENTS IN EQUITY INTERESTS

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

 

      December 31,
2012
     Percent
Ownership
    September 30,
2013
     Percent
Ownership
 

Alibaba Group

   $ 276,389         24   $ 807,736         24

Yahoo Japan

     2,555,717         35     2,300,854         35

Other

     8,051         24     11,860         20
  

 

 

      

 

 

    

Total

   $ 2,840,157         $ 3,120,450      
  

 

 

      

 

 

    

Equity Investment in Alibaba Group. The investment in 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 and related tax impact, one quarter in arrears within earnings in equity interests in the condensed consolidated statements of income. As of September 30, 2013, the excess of carrying value of the Company’s investment in Alibaba Group and the Company’s proportionate share of the net assets of Alibaba Group is largely attributable to goodwill.

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 (the “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 and October 14, 2013, the “Repurchase Agreement”). Yahoo received $13.54 per Share, or approximately $7.1 billion in total consideration, for 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, which Alibaba Group redeemed on May 16, 2013. The Initial Repurchase resulted in a pre-tax gain of approximately $4.6 billion for the year ended December 31, 2012.

The Alibaba Group Preference Shares yielded 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 increasing the liquidation preference. The Alibaba Group Preference Shares were callable by Alibaba Group at the redemption value (including accrued dividends). On May 16, 2013, the Company received $846 million in cash from Alibaba Group to redeem the Alibaba Group Preference Shares. The cash received represented the redemption value, which included the stated value of $800 million plus accrued dividends of $46 million.

The Repurchase Agreement provided that at the time Alibaba Group completes an initial public offering meeting certain specified criteria (a “Qualified IPO”), Yahoo and YHK would 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. This amount was subsequently reduced to 208.0 million by an amendment to the Repurchase Agreement dated as of October 14, 2013. 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 17 — “Subsequent Events” for additional information.

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 an initial 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 of the TIPLA. For the three months ended September 30, 2012, the Company recognized approximately $5 million in revenue related to the initial payment. For the three and nine months ended September 30, 2013, the Company recognized approximately $34 million and $103 million, respectively, in revenue related to the initial payment. 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. The Company recognized revenue relating to the continuing royalty payments under the TIPLA of approximately $19 million and $27 million for the three months ended September 30, 2012 and 2013, respectively, and approximately $51 million and $83 million for the nine months ended September 30, 2012 and 2013, respectively.

 

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The following table presents Alibaba Group’s U.S. GAAP financial information, as derived from the Alibaba Group financial statements (in thousands):

 

     Three Months Ended      Nine Months Ended  
      June 30,
2012
     June 30,
2013
     June 30,
2012
     June 30,
2013
 

Operating data:

           

Revenue

   $ 1,077,045       $ 1,737,180       $ 2,905,752       $ 4,959,274   

Gross profit

   $ 739,914       $ 1,287,807       $ 1,967,290       $ 3,653,739   

Income from operations

   $ 371,854       $ 855,791       $ 861,775       $ 2,317,273   

Net income

   $ 292,928       $ 716,991       $ 781,701       $ 2,046,505   

Net income attributable to Alibaba Group

   $ 273,043       $ 706,708       $ 730,438       $ 2,017,557   

 

      September 30,
2012
     June 30,
2013
 

Balance sheet data:

     

Current assets

   $ 4,062,823       $ 6,841,126   

Long-term assets

   $ 3,204,144       $ 5,284,556   

Current liabilities

   $ 2,624,656       $ 4,078,438   

Long-term liabilities

   $ 4,705,347       $ 5,269,175   

Convertible preferred shares

   $ 1,317,526       $ 1,695,269   

Noncontrolling interests

   $ 65,907       $ 87,613   

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.

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

The fair value of the Company’s ownership interest in the common stock of Yahoo Japan, based on the quoted stock price, was approximately $11.4 billion as of September 30, 2013.

During the nine months ended September 30, 2012 and 2013, the Company received cash dividends from Yahoo Japan in the amount of $84 million and $77 million, net of withholding 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, which are prepared on the basis of Japanese GAAP. 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,
2012
     June 30,
2013
     June 30,
2012
     June 30,
2013
 
     (in thousands)  

Operating data:

           

Revenue

   $ 1,036,650       $ 992,340       $ 3,175,951       $ 3,270,983   

Gross profit

   $ 877,116       $ 818,441       $ 2,693,956       $ 2,733,506   

Income from operations

   $ 512,994       $ 489,890       $ 1,640,935       $ 1,655,870   

Net income

   $ 315,949       $ 364,612       $ 966,646       $ 1,056,323   

Net income attributable to Yahoo Japan

   $ 314,726       $ 362,180       $ 962,818       $ 1,048,893   

 

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      September 30,
2012
     June 30,
2013
 
     (In thousands)  

Balance sheet data:

     

Current assets

   $ 5,752,826       $ 5,799,398   

Long-term assets

   $ 1,837,829       $ 1,729,000   

Current liabilities

   $ 1,167,772       $ 1,758,926   

Long-term liabilities

   $ 49,461       $ 57,251   

Noncontrolling interests

   $ 31,034       $ 58,247   

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 $75 million and $65 million for the three months ended September 30, 2012 and 2013, respectively, and approximately $211 million and $199 million for the nine months ended September 30, 2012 and 2013, respectively. As of December 31, 2012 and September 30, 2013, the Company had net receivable balances from Yahoo Japan of approximately $43 million and $42 million, respectively.

Note 9 DERIVATIVE FINANCIAL INSTRUMENTS

The Company uses derivative financial instruments, primarily forward contracts, to mitigate risk associated with adverse movements in foreign currency exchange rates.

The Company generally enters into master netting arrangements, which are designed to reduce credit risk by permitting net settlement of transactions with the same counterparty. The Company presents its derivative assets and liabilities at their gross fair values on the condensed consolidated balance sheets. The Company is not required to pledge, and is not entitled to receive, cash collateral related to these derivative transactions.

Net Investment Hedges. In December 2012, the Company began hedging, on an after-tax basis, its net investment in Yahoo Japan with forward contracts to reduce the risk that its investment in Yahoo Japan will be adversely affected by foreign currency exchange rate fluctuations. At inception, the forward contracts had maturities ranging from 9 to 15 months. The Company applies hedge accounting on its forward contracts for the net investment hedge of Yahoo Japan. The total balance of the after-tax net investment hedge was less than the Yahoo Japan investment balance as of both December 31, 2012 and September 30, 2013. As such, the net investment hedge was considered to be effective, and, as a result, the changes in the fair value were recorded within accumulated other comprehensive income on the Company’s condensed consolidated balance sheets. The Company recognizes net investment derivative instruments as either an asset or a liability on the Company’s condensed consolidated balance sheets at fair value. The notional amounts of the foreign currency forward contracts were $3 billion and $2.5 billion as of December 31, 2012 and September 30, 2013, respectively. See Note 17 — “Subsequent Events” for additional information. The fair value of the foreign currency forward contract assets was $3 million as of December 31, 2012, and was included in prepaid expenses and other current assets on the Company’s condensed consolidated balance sheets. The fair values of the foreign currency forward contracts were a $416 million asset and a $4 million liability as of September 30, 2013, and were included in prepaid expenses and other current assets and accrued expenses and other current liabilities, respectively, on the Company’s condensed consolidated balance sheets. Pre-tax net gains of $3 million and $412 million were recorded as of December 31, 2012 and September 30, 2013, respectively, and were included in accumulated other comprehensive income on the Company’s condensed consolidated balance sheets.

Cash Flow Hedges. In May 2013, the Company began hedging a portion of its forecasted revenue from Yahoo Japan with forward contracts to reduce the risk that its expected future cash flows from Yahoo Japan will be adversely affected by foreign currency exchange rate fluctuations. The Company entered into foreign currency forward contracts designated as cash flow hedges of varying maturities through January 31, 2014. For derivatives designated as cash flow hedges, the effective portion of the unrealized gains or losses on these forward contracts is recorded in accumulated other comprehensive income on the Company’s condensed consolidated balance sheets and reclassified into revenue on the condensed consolidated statements of income when the underlying hedged revenue is recognized. If the cash flow hedges were to become ineffective, the ineffective portion would be immediately recorded in other income, net on the Company’s condensed consolidated statements of income. The cash flow hedges were considered to be effective as of September 30, 2013. The total notional amount of the foreign currency forward contracts was $82 million as of September 30, 2013. The fair value of the foreign currency forward contracts was a less than $1 million net asset as of September 30, 2013; the contracts’ fair value was included in prepaid expenses and other current assets and accrued expenses and other current liabilities on the Company’s condensed consolidated balance sheets. A pre-tax net gain of less than $1 million was recorded as of September 30, 2013, which was included in accumulated other comprehensive income on the Company’s condensed consolidated balance sheets. For both the three and nine months ended September 30, 2013, the Company recorded gains of less than $1 million, net of tax, for cash flow hedges, which were recorded in revenue in the condensed consolidated statements of income. The Company expects all of the forward contracts designated as cash flow hedges to be reclassified to revenue within fiscal year 2013, as it expects to recognize the hedged anticipated revenue related to these contracts by December 31, 2013.

 

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Balance Sheet Hedges. The Company hedges its net recognized foreign currency assets and liabilities with foreign exchange forward contracts to reduce the risk that its earnings and cash flows will be adversely affected by changes in foreign currency exchange rates. These derivative instruments hedge assets and liabilities, including intercompany transactions, which are denominated in foreign currencies. The Company recognizes balance sheet derivative instruments as either assets or liabilities on the Company’s condensed consolidated balance sheets at fair value. Changes in the fair value of these derivatives are recorded in other income, net on the Company’s condensed consolidated statements of income. The notional amounts of the foreign currency forward contracts were $356 million and $398 million as of December 31, 2012 and September 30, 2013, respectively. As of December 31, 2012, the fair value of the foreign currency forward contracts was a $5 million liability which was included in accrued expenses and other current liabilities on the Company’s condensed consolidated balance sheet. As of September 30, 2013, the fair value of the foreign currency forward contracts was a $6 million net liability; the contracts’ fair value was included in prepaid expenses and other current assets and accrued expenses and other current liabilities on the Company’s condensed consolidated balance sheets. Gains of $13 million and losses of $11 million were recorded for the three months ended September 30, 2012 and 2013, respectively, and were included in other income, net on the Company’s condensed consolidated statements of income. Gains of $8 million and losses of $7 million were recorded for the nine months ended September 30, 2012 and 2013, respectively, and were included in other income, net on the Company’s condensed consolidated statements of income. The Company paid $6 million in cash for settlement of certain foreign currency forward contracts during the nine months ended September 30, 2013.

Foreign currency forward contracts activity for the nine months ended September 30, 2013 was as follows (in millions):

 

      Beginning
fair value
    Settlement      Gain (loss)
recorded in
other income,
net
    Gain (loss)
recorded in
other
comprehensive
income
    Gain
(loss)
recorded
in
revenue
     Ending fair
value
 

Derivatives designated as hedging instruments:

              

Net investment hedges

   $ 3        —        $ —       $ 409 (1)    $ —        $ 412   

Cash flow hedges

     —         —          —          1 (2)      —          1   

Derivatives not designated as hedging instruments:

              

Balance sheet hedges

     (5     6         (7     —         —          (6

 

(1) 

This amount does not reflect the tax impact of $154 million recorded during the nine months ended September 30, 2013. The $255 million after tax impact of the gain recorded under other comprehensive income was included in accumulated other comprehensive income on the Company’s condensed consolidated balance sheets.

(2) 

This amount does not reflect the tax impact of less than $1 million recorded during the nine months ended September 30, 2013. The less than $1 million after tax impact of the gain was included in accumulated other comprehensive income on the Company’s condensed consolidated balance sheets.

Note 10 CREDIT AGREEMENT

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 maturing October 18, 2013 and subject to an 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. 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. During the three and nine months ended September 30, 2013, the applicable margin for borrowings under the Credit Agreement was based upon the leverage ratio of the Company and ranged 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. See Note 17 — “Subsequent Events” for additional information.

During the three months ended September 30, 2013, the Company borrowed $150 million under the Credit Agreement and subsequently repaid the amount within the same period. As of September 30, 2013, the Company was in compliance with the financial covenants in the Credit Agreement and no amounts were outstanding.

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 12 years which expire between 2013 and 2025.

 

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In May 2013, the Company entered into a 12 year operating lease agreement for four floors of the former New York Times building in New York City with a total expected minimum lease commitment of $125 million. The Company has the option to renew the lease for an additional five years. The lease requires monthly payments of approximately $1 million starting in July 2015 through June 2025.

A summary of gross and net lease commitments as of September 30, 2013 was as follows (in millions):

 

      Gross Operating
Lease
Commitments
     Sublease
Income
    Net Operating
Lease
Commitments
 

Three months ending December 31, 2013

   $ 39       $ (3   $ 36   

Years ending December 31,

       

2014

     132         (11     121   

2015

     108         (7     101   

2016

     72         (1     71   

2017

     53         —         53   

2018

     36         —         36   

Due after 5 years

     108         —         108   
  

 

 

    

 

 

   

 

 

 

Total gross and net lease commitments

   $ 548       $ (22   $ 526   
  

 

 

    

 

 

   

 

 

 

 

      Capital Lease
Commitment
 

Three months ending December 31, 2013

   $ 4   

Years ending December 31,

  

2014

     15   

2015

     12   

2016

     9   

2017

     9   

2018

     9   

Due after 5 years

     4   
  

 

 

 

Gross lease commitment

   $ 62   

Less: interest

     (16
  

 

 

 

Net lease commitment included in capital lease and other long-term liabilities

   $ 46   
  

 

 

 

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, 2013, these commitments totaled $33 million, of which $22 million will be payable in the remainder of 2013, $9 million will be payable in 2014, $1 million will be payable in 2015, and $1 million will be payable in 2016.

Intellectual Property Rights. The Company is committed to make certain payments under various intellectual property arrangements of up to $29 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 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, 2013, 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. Accordingly, 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.

 

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See Note 16 — “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”).

Legal Contingencies

Intellectual Property and General Matters. From time to time, third parties assert patent infringement claims against the Company. 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.

Stockholder and Securities Matters. 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 of directors (“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 October 23, 2013, the California Court of Appeal affirmed the Superior Court’s judgment in favor of all defendants following dismissal of plaintiff’s third amended complaint without leave to amend.

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.com Co., Ltd. (“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. On September 13, 2013, the Company filed a motion to extend that stay pending resolution of the appeal filed by the plaintiffs in the related stockholder class actions.

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 of the Company 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 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.

On July 30, 2013, a stockholder derivative action captioned Zucker v. Loeb, et al. was filed in the Supreme Court of New York for the County of New York against current and former members of the Board, Third Point LLC, and entities related to Third Point LLC. The complaint filed by the plaintiff asserts claims for alleged breach of fiduciary duty, waste, and unjust enrichment in connection with the Company’s repurchase of 40 million shares of Company stock beneficially owned by Third Point LLC. The complaint seeks a judgment declaring that the defendants breached their fiduciary duties, an award of restitution, and corporate governance changes.

Mexico Matter. On November 16, 2011, plaintiffs Worldwide Directories, S.A. de C.V. (“WWD”), and Ideas Interactivas, S.A. de C.V. (“Ideas”) filed an action in the 49th Civil Court of Mexico against the Company, Yahoo! de Mexico, S.A. de C.V. (“Yahoo!

 

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Mexico”), Yahoo International Subsidiary Holdings, Inc., and Yahoo Hispanic Americas LLC. The complaint alleged claims of breach of contract, breach of promise, and lost profits in connection with various commercial contracts entered into among the parties between 2002 and 2004, relating to a business listings service, and alleged total damages of approximately $2.75 billion. On December 7, 2011, Yahoo! Mexico filed a counterclaim against WWD for payments of approximately $2.6 million owed to Yahoo! Mexico for services rendered. On April 10, 2012, plaintiffs withdrew their claim filed against Yahoo International Subsidiary Holdings, Inc. and Yahoo Hispanic Americas LLC.

On November 28, 2012, the 49th Civil Court of Mexico entered a non-final judgment against the Company and Yahoo! Mexico in the amount of USD $2.75 billion and a non-final judgment in favor of Yahoo! Mexico on its counterclaim against WWD in the amount of $2.6 million. The judgment against the Company and Yahoo! Mexico purported to leave open for determination in future proceedings certain other alleged damages that were not quantified in the judgment. The judgment was issued by a law clerk to the trial court judge who presided over the entire case during the trial court proceedings but stepped down from his position shortly before the judgment was entered.

On December 12, 2012 and December 13, 2012, respectively, Yahoo! Mexico and the Company appealed the judgment to a three-magistrate panel of the Superior Court of Justice for the Federal District (the “Superior Court”). On May 15, 2013, the Superior Court reversed the judgment, overturned all monetary awards against the Company and reduced the monetary award against Yahoo! Mexico to $172,500. The Superior Court affirmed the award of $2.6 million in favor of Yahoo! Mexico on its counterclaim.

Plaintiffs have appealed the Superior Court’s decision to the Mexican Federal Civil Collegiate Court for the First Circuit (“Civil Collegiate Court”). The Company has appealed the Superior Court’s decision not to award it statutory costs in the underlying proceeding. Yahoo! Mexico has appealed the Superior Court’s award of $172,500, the Superior Court’s decision not to award it additional moneys beyond the $2.6 million award on its counterclaims, and the Superior Court’s decision not to award it statutory costs. These appeals are all pending before the Civil Collegiate Court, where review is limited to whether the Superior Court’s decision is unconstitutional, unlawful, or both.

The Company believes the plaintiffs’ claims are without legal or factual merit. First, the plaintiffs’ claims are based on agreements that were either terminated by agreement with releases or had expired or terminated in accordance with their terms, a non-binding letter of intent pursuant to which no definitive agreements were ever entered into by the parties, and correspondence that did not constitute agreements. Second, the loss of profits of the type claimed by plaintiffs are not awardable under Mexico law because they were not a direct and immediate consequence of a breach of contract. Of the $2.75 billion in total damages alleged by plaintiffs, more than $2.4 billion were for loss of profits. Third, the plaintiffs’ alleged damages and loss of profits were further precluded by the agreements at issue through, among other things, contractual and legal limitations of liability. Fourth, the plaintiffs’ pleadings in the complaint, as well as documentary evidence filed by the plaintiffs in support of their allegations, were generally deficient to support or establish plaintiffs’ claims. Fifth, the decision failed to consider substantially all of the defenses asserted by the Company and Yahoo! Mexico. Finally, the Company believes that the law clerk who entered the judgment lacked the requisite authority to issue the judgment.

The Company has not recorded an accrual for the judgment, which was reversed, as explained above. The Company cannot assure the ultimate outcome of the pending or further appeals.

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 described above. The Company has also determined, based on current knowledge, that the aggregate amount or range of losses that are estimable with respect to the Company’s legal proceedings, including the matters described above other than the Mexico matter, 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, 2012 and September 30, 2013 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, 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 STOCKHOLDERS’ EQUITY AND EMPLOYEE BENEFITS

Employee Stock Purchase Plan. As of September 30, 2013, there was $5 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 0.6 years.

 

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Stock Options. The Company’s 1995 Stock Plan, the Directors’ Plan, stock-based awards assumed through acquisitions, and the Tumblr equity holdback are collectively referred to as the “Plans.” Stock option activity under the Company’s Plans for the nine months ended September 30, 2013 is summarized as follows (in thousands, except per share amounts):

 

      Shares     Weighted Average
Exercise Price Per
Share
 

Outstanding at December 31, 2012

     38,092      $ 21.42   

Options granted

     42      $ 26.93   

Options assumed

     1,121      $ 7.39   

Options exercised

     (8,169   $ 17.66   

Options expired

     (3,250   $ 29.73   

Options cancelled/forfeited

     (1,013   $ 15.20   
  

 

 

   

Outstanding at September 30, 2013

     26,823      $ 21.24   
  

 

 

   

As of September 30, 2013, there was $22 million of unamortized stock-based compensation expense related to unvested stock options, which is expected to be recognized over a weighted average period of 1.5 years.

The fair value of option grants is determined using the Black-Scholes option pricing model with the following weighted average assumptions:

 

     Stock Options     Purchase Plan (1)  
     Three Months Ended     Three Months Ended  
      September 30,
2012
    September 30,
2013
    September 30,
2012
    September 30,
2013
 

Expected dividend yield

     0.0     0.0     0.0     0.0

Risk-free interest rate(2)

     0.6     0.8     0.8     0.1

Expected volatility

     31.2     34.8     31.2     32.0

Expected life (in years)(2)

     4.00        3.17        1.86        0.25   
      Stock Options     Purchase Plan (1)  
     Nine Months Ended     Nine Months Ended  
      September 30,
2012
    September 30,
2013
    September 30,
2012
    September 30,
2013
 

Expected dividend yield

     0.0     0.0     0.0     0.0

Risk-free interest rate(2)

     0.7     0.6     1.1     0.1

Expected volatility

     31.9     32.4     33.1     30.3

Expected life (in years)(2)

     4.03        3.47        1.46        0.25   

 

(1) 

Assumptions for the Employee Stock Purchase Plan relate to the annual average of the enrollment periods. During the year ended December 31, 2012, enrollment was permitted in May and November of each year. Beginning in 2013, enrollment is permitted in February, May, August, and November of each year.

(2) 

Beginning in November 2012, the Employee Stock Purchase Plan was modified to consist of three-month offering periods.

Restricted Stock and Restricted Stock Units. Restricted stock and restricted stock unit activity under the Plans for the nine months ended September 30, 2013 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, 2012(*)

     33,801      $ 17.63   

Granted(*)

     28,140      $ 23.34   

Assumed

     2,364      $ 26.24   

Vested

     (11,759   $ 15.05   

Forfeited

     (5,805   $ 17.33   
  

 

 

   

Awarded and unvested at September 30, 2013(*)

     46,741      $ 22.19   
  

 

 

   

 

(*) 

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

As of September 30, 2013, there was $542 million of unamortized stock-based compensation expense related to unvested restricted stock and restricted stock units, which is expected to be recognized over a weighted average period of 2.4 years.

 

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During the nine months ended September 30, 2012 and 2013, 8.8 million shares and 11.8 million shares, respectively, that were subject to previously granted restricted stock units vested. These vested restricted stock units were net share settled. During the nine months ended September 30, 2012 and 2013, the Company withheld 3.2 million shares and 4.3 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 $48 million and $106 million, respectively, for the nine months ended September 30, 2012 and 2013 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. 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.

Performance-Based Executive Incentive Equity Awards. The financial performance stock options awarded by the Company in November 2012 include multiple performance periods. In January 2013, the Compensation and Leadership Development Committee of the Board (the “Compensation Committee”) established performance goals under these stock options for the first performance period (the six months ended June 30, 2013) and the second performance period (the full year ending December 31, 2013). These options are held by Ms. Mayer, Mr. de Castro and Mr. Goldman (the first performance period for Mr. Goldman is the full year ending December 31, 2013). The number of stock options that ultimately vest for each performance period will range from 0 percent to 100 percent of the target amount for such period stated in each executive’s award agreement based on the Company’s performance. The financial performance metrics (and their weightings) under the performance options are revenue ex-TAC (50 percent), operating income (30 percent) and free cash flow (20 percent). The financial performance goals for each metric are established at the beginning of each performance period and, accordingly, the portion (or “tranche”) of the award related to each performance period is treated as a separate grant for accounting purposes. The grant date fair values of the first and second tranches of the November 2012 financial performance stock options were $12 million and $14 million, respectively, and are being recognized over six and twelve month service periods, respectively. The Company began recording stock-based compensation expense for these tranches in January 2013, when the financial performance goals were established and approved.

In February 2013, the Compensation Committee approved additional long-term performance-based incentive equity awards to Ms. Mayer and other senior officers. These restricted stock units generally will be eligible to vest in equal annual tranches over four years (three years for Ms. Mayer) based on the Company’s attainment of annual financial performance goals as well as the executive’s continued employment through the vesting date. The number of restricted stock units that ultimately vest each year will range from 0 percent to 200 percent of the annual target amount stated in each executive’s award agreement based on the Company’s performance. The annual financial performance metrics and goals are established at the beginning of each fiscal year and, accordingly, the tranche of the award related to each annual performance period goal is treated as a separate annual grant for accounting purposes. In February 2013, financial performance metrics and goals were established for the first performance period (the fiscal year ending December 31, 2013). The financial performance metrics (and their weightings) for fiscal year 2013 are revenue ex-TAC (60 percent), operating income (20 percent) and free cash flow (20 percent). The grant date fair value of the first tranche of the February 2013 annual financial performance restricted stock unit grants was $9 million and is being recognized over a one-year service period.

Stock Repurchases. In May 2012, the Board authorized a stock repurchase program allowing the Company to repurchase up to $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. The aggregate amount remaining available under the May 2012 repurchase program was approximately $324 million at September 30, 2013. Repurchases under the repurchase program may take place in the open market or in privately negotiated transactions, including structured and derivative transactions such as accelerated share repurchase transactions, and may be made under a Rule 10b5-1 plan. During the nine months ended September 30, 2013, the Company repurchased approximately 123 million shares of its common stock under this stock repurchase program at an average price of $25.41 per share for a total of $3.1 billion. These repurchases included the Company’s repurchase of 40 million shares of its common stock beneficially owned by Third Point LLC on July 25, 2013. These shares were repurchased pursuant to a Purchase Agreement entered into on July 22, 2013, prior to the market opening for trading in Yahoo stock, at $29.11 per share, which was the closing price of the Company’s common stock on July 19, 2013. The total purchase price for these shares was $1.164 billion. The repurchase transaction was funded primarily with cash as well as borrowings of $150 million under the Company’s unsecured revolving credit facility.

 

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Note 13 RESTRUCTURING CHARGES (REVERSALS), NET

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

 

     Three Months Ended September 30, 2012     Nine Months Ended September 30, 2012  
      Restructuring
Plans Prior
to
2012
    Q2’12
Restructuring
Plan
    Q4’12
Korea
Business
Closure
     Total     Restructuring
Plans Prior
to
2012
    Q2’12
Restructuring
Plan
    Q4’12
Korea
Business
Closure
    Total  

Employee severance pay and related costs

   $ (44   $ 11,511      $ —        $ 11,467      $ 3,617      $ 102,577      $ —       $ 106,194   

Non-cancelable lease, contract terminations, and other charges

     2,104        9,332        —          11,436        6,360        9,949        —         16,309   

Other non-cash charges

     —         1,824        —          1,824        —         40,462        —         40,462   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Sub-total before reversal of stock-based compensation expense

     2,060        22,667        —          24,727        9,977        152,988        —         162,965   

Reversal of stock-based compensation expense for forfeitures

     —         —         —          —         —         (3,429     —         (3,429
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Restructuring charges, net

   $ 2,060      $ 22,667      $ —        $ 24,727      $ 9,977      $ 149,559      $ —       $ 159,536   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
     Three Months Ended September 30, 2013     Nine Months Ended September 30, 2013  
      Restructuring
Plans Prior
to
2012
    Q2’12
Restructuring
Plan
    Q4’12
Korea
Business
Closure
     Total     Restructuring
Plans Prior
to
2012
    Q2’12
Restructuring
Plan
    Q4’12
Korea
Business
Closure
    Total  

Employee severance pay and related costs

   $ (20   $ (2,807   $ —        $ (2,827   $ (459   $ (15,784   $ (103   $ (16,346

Non-cancelable lease, contract terminations, and other charges

     2,217        33        1         2,251        11,652        131        (44     11,739   

Other non-cash charges

     —         —         —          —         —         —         547        547   
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Restructuring charges (reversals), net

   $ 2,197      $ (2,774   $ 1       $ (576   $ 11,193      $ (15,653   $ 400      $ (4,060
  

 

 

   

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

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

Restructuring Plans Prior to 2012. Prior to 2012, 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 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 under these restructuring plans, the majority of which related to the Americas segment.

During the three and nine months ended September 30, 2013, the Company incurred total pre-tax cash charges of $2 million and $11 million, respectively, in severance, facility, and other related costs under these restructuring plans. The $2 million recorded for the three months ended September 30, 2013 was primarily related to the Americas segment. Of the $11 million recorded for the nine months ended September 30, 2013, $7 million related to the Americas segment and $4 million related to the EMEA segment.

Q2’12 Restructuring Plan. During the second quarter of 2012, the Company began implementing the Q2’12 Restructuring Plan to reduce its worldwide workforce by approximately 2,000 employees and to consolidate certain real estate and data center facilities. 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

 

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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 under this restructuring plan. 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.

During the three months ended September 30, 2013, the Company recorded a net reversal of $3 million for severance-related cost reversals due to changes to original estimates and redeployments and voluntary resignations of employees prior to their planned severance dates. During the nine months ended September 30, 2013, the Company recorded $6 million in severance- and facility-related costs which were offset by a credit of $22 million for severance-related reversals due to adjustments to original estimates as a result of redeployments and voluntary resignations of employees prior to their planned severance dates. Of the $3 million credit in restructuring charges, net, recorded in the three months ended September 30, 2013, $2 million related to the EMEA segment and $1 million related to the Asia Pacific segment. Of the $16 million credit in restructuring charges, net, recorded in the nine months ended September 30, 2013, $8 million related to the Americas segment, $7 million related to the EMEA segment, and $1 million related to the Asia Pacific segment.

Q4’12 Korea Business Closure. During the fourth quarter of 2012, the Company decided to close its Korea business by the end of 2012 to streamline its operations and focus its resources. During both the three and nine months ended September 30, 2013, the Company recorded net pre-tax charges of less than $1 million in severance, facility and contract termination costs related to the Asia Pacific segment.

Restructuring Accruals. The $30 million restructuring liability as of September 30, 2013 consisted of $2 million for employee severance pay expenses, which the Company expects to pay out by the end of the fourth quarter of 2013, and $28 million relating to non-cancelable lease and contract termination costs, which 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, 2013 is summarized as follows (in thousands):

 

      Restructuring
Plans Prior to
2012
    Q2’12
Restructuring
Plan
    Q4’12
Korea Business
Closure
    Total  

Balance as of January 1, 2013

   $ 27,716      $ 35,049      $ 10,102      $ 72,867   
  

 

 

   

 

 

   

 

 

   

 

 

 

Employee severance pay and related costs

     28        6,271        443        6,742   

Non-cancelable lease, contract termination, and other charges

     12,127        131        1,227        13,485   

Other non-cash charges

     —         —         547        547   

Changes in estimates and reversals of previous charges

     (962     (22,055     (1,817     (24,834
  

 

 

   

 

 

   

 

 

   

 

 

 

Restructuring charges (reversals), net for the nine months ended September 30, 2013

   $ 11,193      $ (15,653   $ 400      $ (4,060

Cash paid

     (13,424     (15,358     (9,045     (37,827

Other non-cash charges

     —         —         (547     (547

Foreign currency

     142        (250     (171     (279
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance as of September 30, 2013

   $ 25,627      $ 3,788      $ 739      $ 30,154   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

 

      December 31,
2012
     September 30,
2013
 

Americas

   $ 42,689       $ 20,190   

EMEA

     18,144         8,851   

Asia Pacific

     12,034         1,113   
  

 

 

    

 

 

 

Total restructuring accruals

   $ 72,867       $ 30,154   
  

 

 

    

 

 

 

Note 14 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, 2013 was 32 percent compared to 37 percent for the same period in 2012. The effective tax rate reported for the nine months ended September 30, 2013 was 24 percent compared to 37 percent for the same period in 2012. The effective tax rates for the three and nine months ended September 30, 2012 were higher than for the corresponding periods in 2013, because they included the tax expense associated with the Company’s taxable gain from the sale of Alibaba Group Shares in September 2012. The lower effective tax rates for the three and nine months ended September 30, 2013 were also related to a reduction of tax reserves that were recorded as tax audits were favorably settled and a tax benefit from the resolution of certain tax matters associated with a one-time foreign earnings distribution made in 2012 as described below.

The conclusion of the 2005 and 2006 IRS tax audit and certain foreign tax audits had the effect of increasing the foreign tax credits available to offset the tax from the distribution of foreign earnings made during the three months ended September 30, 2012 as described below. The increased foreign tax credits and the tax benefit relating to the resolution of certain tax matters associated with a one-time foreign earnings distribution made during the quarter ended September 30, 2012 mentioned above, resulted in a tax benefit during the nine months ended September 30, 2013 of approximately $31 million.

The federal research and development credit expired on December 31, 2011. On January 2, 2013, the American Taxpayer Relief Act of 2012 was signed into law. Under this act, the federal research and development credit was retroactively extended for amounts paid or incurred after December 31, 2011 and before January 1, 2014. This change resulted in a 2012 tax benefit of approximately $11 million, which was recognized over the nine months ended September 30, 2013.

The U.S. Department of the Treasury issued final regulations on the deduction and capitalization of expenditures related to tangible property for income tax purposes. These regulations apply to the Company’s tax year beginning on January 1, 2014. The Company is currently assessing the financial statement impact of these regulations.

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, capital expenditures and stock repurchases, the Company made a one-time repatriation of cash from certain of its consolidated foreign subsidiaries in 2012. The remaining undistributed foreign earnings of approximately $2 billion plus all subsequent earnings will continue to be indefinitely reinvested going forward. As of September 30, 2013, those earnings are approximately $2.5 billion in total and are principally related to Yahoo Japan.

During the nine months ended September 30, 2013, the Company settled the income tax examination for the 2005 and 2006 returns with the IRS Appeals Division. That settlement resulted in a reduction of tax reserves. The income tax examination for the 2007 and 2008 returns is currently under protest with the IRS Appeals Division relating to certain proposed adjustments to the Company’s intercompany transfer pricing methodology. The Company’s 2009 and 2010 returns are currently under IRS examination.

As of September 30, 2013, the Company’s 2005 through 2008 tax returns are also under various stages of audit by the California Franchise Tax Board. While the California Franchise Tax Board has not reached any conclusions on the 2007 and 2008 returns, the Company has protested the proposed California Franchise Tax Board’s adjustments to the 2005 and 2006 returns. The Company is also in various stages of examination and appeal in connection with its taxes in foreign jurisdictions, which generally span tax years 2005 through 2011.

The Company’s gross amount of unrecognized tax benefits as of September 30, 2013 was $703 million, of which $621 million is recorded on the condensed consolidated balance sheets. The gross unrecognized tax benefits as of September 30, 2013 decreased by $24 million from the recorded balance as of December 31, 2012. It is difficult to determine when the examinations will be settled or their final outcomes; however, 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 $24 million in the next twelve months. 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 the Company’s consolidated financial position, results of operations, or cash flows.

The Company may have additional tax liabilities in China related to the sale to Alibaba Group of 523 million Alibaba Group Shares that took place during the year ended December 31, 2012. Any taxes assessed and paid in China are expected to be ultimately offset and recovered in the U.S.

During the year ended December 31, 2012, tax authorities from the Brazilian State of Sao Paulo assessed certain indirect taxes against the Company’s Brazilian subsidiary, Yahoo! do Brasil Internet Ltda., related to online advertising services. The assessment totaling approximately $85 million is for calendar years 2008 and 2009. The Company currently believes the assessment is without merit. The Company does not believe that it is probable the assessment will be sustained upon appeal and, accordingly, has not recorded an accrual for the assessment.

Note 15 SEGMENTS

The Company continues to manage its business geographically. The primary areas of measurement and decision-making are currently Americas, EMEA (Europe, Middle East, and Africa), and Asia Pacific. Management relies on an internal reporting process that

 

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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. Tumblr, which the Company acquired during June 2013, is included as part of the Americas for segment reporting purposes.

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

 

     Three Months Ended     Nine Months Ended  
     September 30,
2012
     September 30,
2013
    September 30,
2012
     September 30,
2013
 

Revenue by segment:

          

Americas

   $ 843,731       $ 850,935      $ 2,501,515       $ 2,521,667   

EMEA

     96,473         89,156        358,534         281,367   

Asia Pacific

     261,528         198,882        780,710         611,551   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total Revenue

   $ 1,201,732       $ 1,138,973      $ 3,640,759       $ 3,414,585   
  

 

 

    

 

 

   

 

 

    

 

 

 

TAC by segment:

          

Americas

   $ 41,289       $ 36,435      $ 130,154       $ 111,077   

EMEA

     17,399         9,929        97,248         32,837   

Asia Pacific

     54,141         12,100        166,543         44,934   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total TAC

   $ 112,829       $ 58,464      $ 393,945       $ 188,848   
  

 

 

    

 

 

   

 

 

    

 

 

 

Revenue ex-TAC by segment:

          

Americas

   $ 802,442       $ 814,500      $ 2,371,361       $ 2,410,590   

EMEA

     79,074         79,227        261,286         248,530   

Asia Pacific

     207,387         186,782        614,167         566,617   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total Revenue ex-TAC

   $ 1,088,903       $ 1,080,509      $ 3,246,814       $ 3,225,737   
  

 

 

    

 

 

   

 

 

    

 

 

 

Direct costs by segment(1):

          

Americas

     189,345         171,285        550,080         513,677   

EMEA

     39,167         39,922        120,665         119,766   

Asia Pacific

     56,329         47,583        164,068         152,264   

Global operating costs(2)(3)

     396,269         490,594        1,228,686         1,354,118   

Depreciation and amortization

     169,511         158,216        480,498         480,797   

Stock-based compensation expense

     61,366         80,726        166,903         193,467   

Restructuring charges (reversals), net

     24,727         (576     159,536         (4,060
  

 

 

    

 

 

   

 

 

    

 

 

 

Income from operations

   $ 152,189       $ 92,759      $ 376,378       $ 415,708   
  

 

 

    

 

 

   

 

 

    

 

 

 

 

(1) 

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

(2) 

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

(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,
2012
     September 30,
2013
     September 30,
2012
     September 30,
2013
 

Capital expenditures, net:

           

Americas

   $ 122,812       $ 70,044       $ 302,139       $ 210,521   

EMEA

     9,238         2,817         22,599         8,481   

Asia Pacific

     7,815         4,792         31,049         10,308   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total capital expenditures, net

   $ 139,865       $ 77,653       $ 355,787       $ 229,310   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents
     December 31,
2012
     September 30,
2013
 

Property and equipment, net:

     

Americas:

     

U.S

   $ 1,483,225       $ 1,383,769   

Other

     1,869         1,428   
  

 

 

    

 

 

 

Total Americas

   $ 1,485,094       $ 1,385,197   
  

 

 

    

 

 

 

EMEA

     59,416         48,183   

Asia Pacific

     141,335         102,982   
  

 

 

    

 

 

 

Total property and equipment, net

   $ 1,685,845       $ 1,536,362   
  

 

 

    

 

 

 

See Note 13 —“Restructuring Charges (Reversals), 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,
2012
     September 30,
2013
     September 30,
2012
     September 30,
2013
 

Display

   $ 506,002       $ 469,932       $ 1,552,191       $ 1,396,745   

Search

     472,537         435,192         1,403,903         1,278,081   

Other

     223,193         233,849         684,665         739,759   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

   $ 1,201,732       $ 1,138,973       $ 3,640,759       $ 3,414,585   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

     Three Months Ended      Nine Months Ended  
     September 30,
2012
     September 30,
2013
     September 30,
2012
     September 30,
2013
 

Revenue:

           

U.S.

   $ 800,984       $ 812,048       $ 2,379,955       $ 2,401,527   

International

     400,748         326,925         1,260,804         1,013,058   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

   $ 1,201,732       $ 1,138,973       $ 3,640,759       $ 3,414,585   
  

 

 

    

 

 

    

 

 

    

 

 

 

Revenue is attributed to individual countries according to the online property that generated the revenue. No single foreign country was material to revenue for the three or nine months ended September 30, 2012 and 2013.

Note 16 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 has the ability to integrate this technology into its existing Web search platforms. On February 18, 2010, the Company received regulatory clearance from both the U.S. Department of Justice and the European Commission and on February 23, 2010 the Company commenced implementation of the Search Agreement on a market-by-market basis. Under the Search Agreement, the Company is 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 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. Approximately 27 percent and 24 percent of the Company’s revenue for the three and nine months ended September 30, 2012, respectively, was attributable to the Search Agreement, and approximately 31 percent and 30 percent of the Company’s revenue for the three and nine months ended September 30, 2013, respectively, was attributable to 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. For new Affiliates during the term of the Search Agreement, and for all Affiliates after the first five years of such term, the Company will receive 88 percent of the revenue generated from Microsoft’s services on Affiliate sites after the Affiliate’s share of revenue and certain Microsoft costs are deducted. On February 23, 2015 (the fifth anniversary of the date that implementation of the

 

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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, 2012 and September 30, 2013, the Company had collected total amounts of nil and $24 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 88 percent share in connection with the Search Agreement, which is included in accounts receivable, net, was $258 million and $251 million as of December 31, 2012 and September 30, 2013, respectively.

Under the Search Agreement, for each market, Microsoft generally guarantees Yahoo’s revenue per search (“RPS Guarantee”) on Yahoo Properties only for 18 months after the transition of paid search services to Microsoft’s platform in that market based on the difference in revenue per search 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 is typically the quarter in which the associated shortfall in revenue per search occurred. In the fourth quarter of 2011, Microsoft agreed to extend the RPS Guarantee in the U.S. and Canada through March 2013, and in the second quarter of 2013, Microsoft extended the RPS Guarantee in the U.S. through March 2014. In June 2013, Microsoft and Yahoo agreed upon the RPS Guarantee payment amounts to be paid to the Company for the quarters ended December 31, 2012, March 31, 2013 and June 30, 2013. The Company also agreed to fixed quarterly payments in lieu of the RPS Guarantee in the U.S. for the quarters ending September 30, 2013, December 31, 2013 and March 31, 2014. In addition, the Company agreed to waive its right to receive any future RPS Guarantee payments in all other markets except Taiwan and Hong Kong.

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 2012, the Company completed the transition of paid search in most of the EMEA markets as well as six markets in Latin America. In the second quarter of 2013, the Company completed the transition of paid search in Brazil. In the third quarter of 2013, the Company completed the transition of paid search in six markets in Southeast Asia. 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.

In September 2013, the Company advised Microsoft that we were delaying the transition of paid search in Taiwan and Hong Kong. Microsoft disagreed with the delay and initiated an emergency arbitration under the Search Agreement. The arbitrator enjoined the Company from continuing the delay and directed the Company to complete the transition of Taiwan and Hong Kong in October and November, respectively. The Company sought to vacate the arbitrator’s award in the United States District Court for the Southern District of New York, but the District Court issued an order denying the Company’s petition to vacate. The Company then filed a notice of appeal to the United States Court of Appeals for the Second Circuit, together with a motion to stay enforcement of the District Court’s order pending the appeal. The Second Circuit granted a temporary stay of enforcement of the District Court’s order, but on November 7, 2013, denied the continuation of the stay pending appeal. The Company is working with Microsoft on a transition schedule.

From February 23, 2010 until the applicable services are fully transitioned to Microsoft in all markets, Microsoft is required under the Search Agreement to 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 $17 million and $51 million for the three and nine months ended September 30, 2012, respectively, and $11 million and $42 million for the three and nine months ended September 30, 2013, 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.

Reimbursement receivables are recorded as the reimbursable costs are incurred and are applied against the operating expense categories in which the costs were incurred. Of the total amounts incurred during the year ended December 31, 2012 and the nine months ended September 30, 2013, the total reimbursements not yet received from Microsoft of $5 million and $8 million, respectively, were classified as part of prepaid expenses and other current assets on the Company’s condensed consolidated balance sheets as of December 31, 2012 and September 30, 2013, respectively.

 

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Note 17 SUBSEQUENT EVENTS

Stock Repurchase Transactions. From October 1, 2013 through November 12, 2013, the Company repurchased approximately 1.2 million shares of its common stock at an average price of $33.37 per share, for a total of $41 million.

Net Investment Hedge. In October 2013, the Company received $158 million in cash for the settlement of certain foreign exchange forward contracts designated as net investment hedges reducing the outstanding notional amount to $2.3 billion.

Amendment to Share Repurchase and Preference Share Sale Agreement with Alibaba Group. The Company, Yahoo! Hong Kong Holdings Limited (“YHK”) and Alibaba Group entered into a Second Amendment to the Share Repurchase and Preference Share Sale Agreement, dated as of October 14, 2013. The amendment reduced the maximum number of Shares of Alibaba Group that Yahoo is required to sell in connection with a Qualified IPO of Alibaba Group from 261.5 million Shares to 208.0 million Shares.

Amendment No. 1 to Credit Agreement. On October 10, 2013, the Company entered into Amendment No. 1 to its Credit Agreement. Amendment No. 1 extends the termination date of the Credit Agreement from October 18, 2013 to October 9, 2014. The Credit Agreement, as amended, continues to provide for a $750 million unsecured revolving credit facility, subject to increase by up to $250 million in accordance with its terms. There are no borrowings currently outstanding under the Credit Agreement.

Patent Sale Agreement. Subsequent to September 30, 2013, the Company entered into a patent sale agreement pursuant to which the Company sold certain patents for an aggregate consideration of $70 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 changes in our earnings in equity interests;

 

   

expectations about operating expenses;

 

   

anticipated capital expenditures;

 

   

expectations about our share repurchase activity;

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

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

Overview

Yahoo! Inc., together with its consolidated subsidiaries (“Yahoo,” the “Company,” “we,” or “us”), is focused on making the world’s daily habits inspiring and entertaining. By creating highly personalized experiences for our users, we keep people connected to what matters most to them, across devices and around the world. In turn, we create value for advertisers by connecting them with the audiences that build their businesses. Advertisers can build their businesses through advertising to targeted audiences on our online properties and services (“Yahoo Properties”), or through our distribution network of third-party entities (“Affiliates”) who integrate our advertising offerings into their Websites or other offerings (those Websites and other offerings, “Affiliate sites”).

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

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

 

 

Key Financial Metrics;

 

 

Non-GAAP Financial Measures;

 

 

Significant Transactions;

 

 

Results of Operations;

 

 

Liquidity and Capital Resources; and

 

 

Critical Accounting Policies and Estimates.

 

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Key Financial Metrics

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

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2012      2013     2012      2013  
     (dollars in thousands)  

Revenue

   $ 1,201,732       $ 1,138,973      $ 3,640,759       $ 3,414,585   

Revenue ex-TAC

   $ 1,088,903       $ 1,080,509      $ 3,246,814       $ 3,225,737   

Income from operations(*)

   $ 152,189       $ 92,759      $ 376,378       $ 415,708   

Adjusted EBITDA

   $ 407,793       $ 331,125      $ 1,189,815       $ 1,085,912   

Net income attributable to Yahoo! Inc.

   $ 3,160,238       $ 296,656      $ 3,673,212       $ 1,018,091   

Net cash provided by operating activities

   $ 1,046,308       $ 298,010      $ 1,618,321       $ 847,520   

Free cash flow

   $ 920,424       $ 249,037      $ 1,209,637       $ 530,345   

(*)    Includes:

     

Stock-based compensation expense

   $ 61,366       $ 80,726      $ 166,903       $ 193,467   

Restructuring charges (reversals), net

   $ 24,727       $ (576   $ 159,536       $ (4,060

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

 

     Three Months Ended September 30,      Percent
Change
    Nine Months Ended September 30,      Percent
Change
 
   2012      2013            2012      2013         
     (dollars in thousands)  

Revenue

   $ 1,201,732       $ 1,138,973         (5 )%    $ 3,640,759       $ 3,414,585         (6 )% 

Less: TAC

     112,829         58,464         (48 )%      393,945         188,848         (52 )% 
  

 

 

    

 

 

      

 

 

    

 

 

    

Revenue ex-TAC

   $ 1,088,903       $ 1,080,509         (1 )%    $ 3,246,814       $ 3,225,737         (1 )% 
  

 

 

    

 

 

      

 

 

    

 

 

    

For the three and nine months ended September 30, 2013, revenue ex-TAC decreased 1 percent compared to the same periods of 2012, due to a decline in display revenue ex-TAC partially offset by an increase in search and other revenue ex-TAC.

Adjusted EBITDA (a Non-GAAP Financial Measure)

 

     Three Months Ended September 30,     Percent
Change
     Nine Months Ended September 30,     Percent
Change
 
   2012     2013            2012     2013        
     (dollars in thousands)  

Net income attributable to Yahoo! Inc.

   $ 3,160,238      $ 296,656        (91)%       $ 3,673,212      $ 1,018,091        (72)%   

Depreciation and amortization

     169,511        158,216        (7)%         480,498        480,797        —     

Stock-based compensation expense

     61,366        80,726        32 %         166,903        193,467        16 %   

Restructuring charges (reversals), net

     24,727        (576)        (102)%         159,536        (4,060)        (103)%   

Other income, net

     (4,607,656)        (5,370)        (100)%         (4,630,109)        (46,048)        (99)%   

Provision for income taxes

     1,774,094        31,891        (98)%         1,857,036        111,894        (94)%   

Earnings in equity interests

     (175,265)        (232,756)        33 %         (527,499)        (675,034)        28 %   

Net income attributable to noncontrolling interests

     778        2,338        201 %         3,738        6,805        82 %   

Deal costs related to the sale of Alibaba Group shares

     —         —         —           6,500        —         (100)%   
  

 

 

   

 

 

      

 

 

   

 

 

   

Adjusted EBITDA

   $ 407,793      $ 331,125        (19)%       $ 1,189,815      $ 1,085,912        (9)%   
  

 

 

   

 

 

      

 

 

   

 

 

   

Percentage of revenue ex-TAC(1)(2)

     37     31        37     34  
  

 

 

   

 

 

      

 

 

   

 

 

   

 

(1) 

Revenue ex-TAC is calculated as GAAP revenue less TAC.

 

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(2) 

Net income attributable to Yahoo! Inc. as a percentage of GAAP revenue for the three and nine months ended September 30, 2013 was 26 percent and 30 percent, respectively. Net income attributable to Yahoo! Inc. as a percentage of GAAP revenue for the three and nine months ended September 30, 2012 was 263 percent and 101 percent, respectively.

For the three and nine months ended September 30, 2013, adjusted EBITDA decreased 19 percent and 9 percent, respectively, compared to the same periods of 2012, mainly due to a decline in revenue ex-TAC and an increase in global operating costs, which was partially offset by a decline in direct costs in the Americas and Asia Pacific regions.

Free Cash Flow (a Non-GAAP Financial Measure)

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2012     2013     2012     2013  
     (dollars in thousands)  

Net cash provided by operating activities

   $ 1,046,308      $ 298,010      $ 1,618,321      $ 847,520   

Acquisition of property and equipment, net

     (139,865     (77,653     (355,787     (229,310

Dividends received from equity investees

     —         —         (83,648     (135,058

Excess tax benefits from stock-based awards

     13,981        28,680        30,751        47,193   
  

 

 

   

 

 

   

 

 

   

 

 

 

Free cash flow

   $ 920,424      $ 249,037      $ 1,209,637      $ 530,345   
  

 

 

   

 

 

   

 

 

   

 

 

 

For the three and nine months ended September 30, 2013, free cash flow decreased $671 million, or 73 percent, and $679 million, or 56 percent, respectively, compared to the same periods of 2012. The decrease for both periods was primarily attributable to a decline in cash provided by operating activities due to a payment of $550 million from Alibaba Group Holding Limited (“Alibaba Group”) related to a technology and intellectual property license, which was included in 2012, for which no similar transactions occurred in 2013. This was partially offset by a decline in capital expenditures in both the three and nine months ended September 30, 2013, as compared to the same periods of 2012.

Non-GAAP Financial Measures

Revenue ex-TAC

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

Adjusted EBITDA

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

Free Cash Flow

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

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

 

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Significant Transactions

Acquisition of Tumblr

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

Initial Repurchase of Alibaba Group Holding Limited Ordinary Shares

See Note 8—“Investments in Equity Interests” in the Notes to our condensed consolidated financial statements for information regarding the repurchase by Alibaba Group of 523 million of the 1,047 million ordinary shares of Alibaba Group (the “Shares”) owned by us (the “Initial Repurchase”) pursuant to the terms of a Share Repurchase and Preference Share Sale Agreement (as amended on September 11, 2012 and October 14, 2013, the “Repurchase Agreement”).

In September 2012, we received net cash proceeds after the payment of taxes and fees from the Initial Repurchase and the $550 million TIPLA payment of approximately $4.3 billion. We committed to return $3.65 billion of these after-tax proceeds to shareholders and have now completed this commitment.

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

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

Search Agreement with Microsoft Corporation

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

During the first five years of the Search Agreement, in transitioned markets, we are entitled to receive 88 percent of the revenue generated from Microsoft’s services on Yahoo Properties. We are also entitled to receive 88 percent of the revenue generated from Microsoft’s services on Affiliate sites after the Affiliate’s share of revenue. In the transitioned markets, for search revenue generated from Microsoft’s services on Yahoo Properties and Affiliate sites, we report as revenue the 88 percent revenue share, as we are not the primary obligor in the arrangement with the advertisers and publishers. The underlying search advertising services are provided by Microsoft. For new Affiliates during the term of the Search Agreement, and for all Affiliates after the first five years of such term, we will receive 88 percent of the revenue generated from Microsoft’s services on Affiliate sites after the Affiliate’s share of revenue and certain Microsoft costs are deducted. On February 23, 2015 (the fifth anniversary of the date that implementation of the Search Agreement commenced), Microsoft will have the option to terminate our sales exclusivity for premium search advertisers. If Microsoft exercises its option, the revenue share rate will increase to 93 percent for the remainder of the term of the Search Agreement, unless we exercise our option to retain our sales exclusivity, in which case the revenue share rate would be reduced to 83 percent for the remainder of the term. If Microsoft does not exercise such option, the revenue share rate will be 90 percent for the remainder of the term of the Search Agreement. The term of the Search Agreement is 10 years from February 23, 2010, subject to earlier termination as provided in the Search Agreement.

Under the Search Agreement, for each market, Microsoft generally guarantees Yahoo’s revenue per search (“RPS Guarantee”) on Yahoo Properties only for 18 months after the transition of paid search services to Microsoft’s platform in that market based on the difference in revenue per search between the pre-transition and post-transition periods and certain other factors. We record the RPS Guarantee as search revenue in the quarter the amount becomes fixed, which is typically the quarter in which the associated shortfall in revenue per search occurred. In the fourth quarter of 2011, Microsoft agreed to extend the RPS Guarantee in the U.S. and Canada through March 2013, and in the second quarter of 2013, Microsoft extended the RPS Guarantee in the U.S. through March 2014. In June 2013, Microsoft and we agreed upon the RPS Guarantee payment amounts to be paid to us for the quarters ended December 31, 2012, March 31, 2013 and June 30, 2013. We also agreed to fixed quarterly payments in lieu of the RPS Guarantee in the U.S. for the quarters ending September 30, 2013, December 31, 2013 and March 31, 2014. In addition, we agreed to waive our right to receive any future RPS Guarantee payments in all other markets except Taiwan and Hong Kong. We do not expect the remaining quarterly payments from Microsoft and any RPS Guarantee payments for Taiwan and Hong Kong to have a material impact on our expected future revenue.

 

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We completed the transition of our algorithmic and paid search platforms to the Microsoft platform in the U.S. and Canada in the fourth quarter of 2010. In 2011, we completed the transition of algorithmic search in all other markets and the transition of paid search in India. In 2012, we completed the transition of paid search in most of the EMEA markets as well as six markets in Latin America. In the second quarter of 2013, we completed the transition of paid search in Brazil. In the third quarter of 2013, we completed the transition of paid search in six markets in Southeast Asia. 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.

In September 2013, the Company advised Microsoft that we were delaying the transition of paid search in Taiwan and Hong Kong. Microsoft disagreed with the delay and initiated an emergency arbitration under the Search Agreement. The arbitrator enjoined the Company from continuing the delay and directed the Company to complete the transition of Taiwan and Hong Kong in October and November, respectively. The Company sought to vacate the arbitrator’s award in the United States District Court for the Southern District of New York, but the District Court issued an order denying the Company’s petition to vacate. The Company then filed a notice of appeal to the United States Court of Appeals for the Second Circuit, together with a motion to stay enforcement of the District Court’s order pending the appeal. The Second Circuit granted a temporary stay of enforcement of the District Court’s order, but on November 7, 2013, denied the continuation of the stay pending appeal. The Company is working with Microsoft on a transition schedule.

From February 23, 2010 until the applicable services are fully transitioned to Microsoft in all markets, Microsoft is required under the Search Agreement to reimburse us for the costs of operating algorithmic and paid search services subject to specified exclusions and limitations. Our results reflect search operating cost reimbursements from Microsoft under the Search Agreement of $17 million and $51 million for the three and nine months ended September 30, 2012, respectively, and $11 million and $42 million for the three and nine months ended September 30, 2013, respectively. Search operating cost reimbursements are expected to decline as we fully transition all markets and, in the long term, the underlying expenses are not expected to be incurred under our cost structure.

We record receivables for the reimbursements as costs are incurred and apply them against the operating expense categories in which the costs were incurred. Of the total amounts incurred during the year ended December 31, 2012 and the nine months ended September 30, 2013, the total reimbursements not yet received from Microsoft of $5 million and $8 million, were classified as part of prepaid expenses and other current assets on our condensed consolidated balance sheets as of December 31, 2012 and September 30, 2013, respectively.

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

 

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Results of Operations

 

     Three Months Ended September 30,     Percent
Change
     Nine Months Ended September 30,     Percent
Change
 
   2012      2013            2012      2013        
     (dollars in thousands)  

Revenue for groups of similar services:

               

Display

               

Yahoo Properties

   $ 446,669       $ 421,378        (6)%       $ 1,417,004       $ 1,251,781        (12)%   

Affiliate Sites

     59,333         48,554        (18)%         135,187         144,964        7%   
  

 

 

    

 

 

      

 

 

    

 

 

   

Total Display revenue

   $ 506,002       $ 469,932        (7)%       $ 1,552,191       $ 1,396,745        (10)%   
  

 

 

    

 

 

      

 

 

    

 

 

   

Search

               

Yahoo Properties

   $ 311,060       $ 345,428        11 %       $ 881,435       $ 994,974        13 %   

Affiliate Sites

     161,477         89,764        (44)%         522,468         283,107        (46)%   
  

 

 

    

 

 

      

 

 

    

 

 

   

Total Search revenue

   $ 472,537       $ 435,192        (8)%       $ 1,403,903       $ 1,278,081        (9)%   
  

 

 

    

 

 

      

 

 

    

 

 

   

Other

   $ 223,193       $ 233,849        5 %       $ 684,665       $ 739,759        8 %   
  

 

 

    

 

 

      

 

 

    

 

 

   

Total revenue

   $ 1,201,732       $ 1,138,973        (5)%       $ 3,640,759       $ 3,414,585        (6)%   
  

 

 

    

 

 

      

 

 

    

 

 

   

Cost of revenue — traffic acquisition costs

     112,829         58,464        (48)%         393,945         188,848        (52)%   

Cost of revenue — other

     282,081         271,763        (4)%         814,513         821,032        1 %   

Sales and marketing

     269,272         282,562        5 %         827,450         819,319        (1)%   

Product development

     217,301         267,444        23 %         645,407         723,272        12 %   

General and administrative

     135,249         151,304        12 %         395,637         419,764        6 %   

Amortization of intangibles

     8,084         15,253        89 %         27,893         30,702        10%   

Restructuring charges (reversals), net

     24,727         (576     (102)%         159,536         (4,060     (103)%   
  

 

 

    

 

 

      

 

 

    

 

 

   

Total operating expenses

   $ 1,049,543       $ 1,046,214        —          $ 3,264,381       $ 2,998,877        (8)%   
  

 

 

    

 

 

      

 

 

    

 

 

   

Income from operations

   $ 152,189       $ 92,759        (39)%       $ 376,378       $ 415,708        10 %   
  

 

 

    

 

 

      

 

 

    

 

 

   

Includes:

               

Stock-based compensation expense

   $ 61,366       $ 80,726        32 %       $ 166,903       $ 193,467        16 %   

 

 

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Table of Contents

The following table sets forth selected information concerning our results of operations as a percentage of revenue for the period indicated:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
   2012     2013     2012     2013  

Revenue for groups of similar services:

        

Display

        

Yahoo Properties

     37     37     39     37

Affiliate Sites

     5     4     4     4
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Display revenue

     42     41     43     41
  

 

 

   

 

 

   

 

 

   

 

 

 

Search

        

Yahoo Properties

     26     30     24     29

Affiliate Sites

     13     8     14     8
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Search revenue

     39     38     38     37
  

 

 

   

 

 

   

 

 

   

 

 

 

Other

     19     21     19     22
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     100     100     100     100
  

 

 

   

 

 

   

 

 

   

 

 

 

Cost of revenue — traffic acquisition costs

     9     5     11     6

Cost of revenue — other

     24     24     22     24

Sales and marketing

     22     25     23     24

Product development

     18     24     18     21

General and administrative

     11     13     11     12

Amortization of intangibles

     1     1     1     1

Restructuring charges (reversals), net

     2     —           4     —      
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     87     92     90     88
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     13     8     10     12
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

Management Reporting

We continue to manage our business geographically. The primary areas of measurement and decision-making are currently the Americas, EMEA, and Asia Pacific. Management relies on an internal reporting process that provides revenue ex-TAC, direct costs excluding TAC by segment, and consolidated income from operations for making decisions related to the evaluation of the financial performance of, and allocating resources to, our segments. Tumblr, which we acquired during June 2013, is included as part of the Americas for segment reporting purposes.

 

     Three Months Ended     Percent
Change
    Nine Months Ended     Percent
Change
 
     September 30,
2012
     September 30,
2013
          September 30,
2012
     September 30,
2013
       
     (dollars in thousands)  

Revenue by segment:

              

Americas

   $ 843,731       $ 850,935          $ 2,501,515       $ 2,521,667        1  % 

EMEA

     96,473         89,156        (8 )%      358,534         281,367        (22 )% 

Asia Pacific

     261,528         198,882        (24 )%      780,710         611,551        (22 )% 
  

 

 

    

 

 

     

 

 

    

 

 

   

Total revenue

   $ 1,201,732       $ 1,138,973        (5 )%    $ 3,640,759       $ 3,414,585        (6 )% 
  

 

 

    

 

 

     

 

 

    

 

 

   

TAC by segment:

              

Americas

   $ 41,289       $ 36,435        (12 )%    $ 130,154       $ 111,077        (15 )% 

EMEA

     17,399         9,929        (43 )%      97,248         32,837        (66 )% 

Asia Pacific

     54,141         12,100        (78 )%      166,543         44,934        (73 )% 
  

 

 

    

 

 

     

 

 

    

 

 

   

Total TAC

   $ 112,829       $ 58,464        (48 )%    $ 393,945       $ 188,848        (52 )% 
  

 

 

    

 

 

     

 

 

    

 

 

   

Revenue ex-TAC by segment:

              

Americas

   $ 802,442       $ 814,500        2  %    $ 2,371,361       $ 2,410,590        2  % 

EMEA

     79,074         79,227               261,286         248,530        (5 )% 

Asia Pacific

     207,387         186,782        (10 )%      614,167         566,617        (8 )% 
  

 

 

    

 

 

     

 

 

    

 

 

   

Total revenue ex-TAC

   $ 1,088,903       $ 1,080,509        (1 )%    $ 3,246,814       $ 3,225,737        (1 )% 
  

 

 

    

 

 

     

 

 

    

 

 

   

Direct costs by segment(1):

              

Americas

     189,345         171,285        (10 )%      550,080         513,677        (7 )% 

EMEA

     39,167         39,922        2  %      120,665         119,766        (1 )% 

Asia Pacific

     56,329         47,583        (16 )%      164,068         152,264        (7 )% 

Global operating costs(2)(3)

     396,269         490,594        24  %      1,228,686         1,354,118        10  %