S-1/A 1 ds1a.htm AMENDMENT NO 2 TO THE REGISTRATION STATEMENT ON FORM S-1/A Amendment No 2 To The Registration Statement On Form S-1/A

As filed with the Securities and Exchange Commission on March 4, 2011

Registration No. 333-168646

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

AMENDMENT NO. 2

TO

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

Skype S.à r.l.

(to be converted into Skype S.A.)

(Exact name of Registrant as specified in its charter)

 

 

 

Luxembourg   7372   Not applicable

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(IRS Employer

Identification Number)

23-29 Rives de Clausen,

L-2165 Luxembourg

+352 274 787 11

(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)

 

 

Skype Inc.

160 Greentree Drive

Suite 101, Dover

DE 19904

(302) 674-4089

 

(Name, address, including zip code, and telephone number, including area code, of agent for service)

Copies to:

 

Richard C. Morrissey

David B. Rockwell

Sullivan & Cromwell LLP

1 New Fetter Lane

London England EC4A 1AN

+44 207 959-8900

 

Neal D. Goldman

Chief Legal and Regulatory Officer

Skype Global S.à r.l.

23-29 Rives de Clausen,

L-2165 Luxembourg

+352 274 787 11

 

Kevin P. Kennedy

Simpson Thacher & Bartlett LLP

2550 Hanover Street

Palo Alto, California 94304

(650) 251-5000

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of the Registration Statement.

 

 

If any of the securities being registered on this Form are being offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration number of the earlier effective registration statement for the same offering.  ¨

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. (Check one):

 

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

 

 

The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until this registration statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


The information in this prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state or other jurisdiction where the offer or sale is not permitted.

 

Subject to Completion

Preliminary Prospectus dated March 4, 2011

PROSPECTUS

American Depositary Shares

representing             Ordinary Shares

LOGO

Skype S.A.

 

 

This is the initial public offering of                 American depositary shares, or ADSs, each representing ordinary shares of Skype S.A., a joint stock company (société anonyme) existing under the laws of the Grand Duchy of Luxembourg. We are offering              ADSs to be sold in this offering, and the selling shareholders identified in this prospectus are offering an additional              ADSs. We will not receive any proceeds from the sale of the ADSs to be offered by the selling shareholders.

Prior to this offering, there has been no public market for our ADSs or our ordinary shares. It is currently estimated that the initial public offering price per ADS will be between $             and $            . We have filed an application to list our ADSs on The Nasdaq Global Select Market under the symbol                     .

When this offering is completed, our principal shareholders (Silver Lake, eBay, Canada Pension Plan Investment Board, Joltid Limited and Andreessen Horowitz) will collectively beneficially own at least         % of our outstanding ordinary shares. As a result, we have elected to be treated as a “controlled company” within the meaning of the corporate governance standards of the Nasdaq Stock Exchange. See “Management—Composition of our Board of Directors.”

Investing in our ADSs involves a high degree of risk. See “Risk Factors” beginning on page 24 of this prospectus.

 

 

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities nor passed upon the accuracy or adequacy of the disclosures in the prospectus. Any representation to the contrary is a criminal offense.

 

     Per ADS      Total  

Initial public offering price

   $                    $                

Underwriting discounts and commissions

   $                    $                

Proceeds, before expenses, to Skype S.A.

   $                    $                

Proceeds, before expenses, to the selling shareholders

   $                    $                

 

 

To the extent that the underwriters sell more than              ADSs, the underwriters have an option for              days to purchase up to an additional              ADSs from the selling shareholders at the initial public offering price, less underwriting discounts and commissions.

The underwriters expect to deliver the ADSs against payment in New York, New York on             , 2011.

 

 

 

Goldman, Sachs & Co.

   J.P. Morgan    Morgan Stanley

 

BofA Merrill Lynch    Barclays Capital    Citi    Credit Suisse    Deutsche Bank Securities

 

Lazard Capital Markets    RBC Capital Markets    UBS Investment Bank
Allen & Company LLC    Evercore Partners

Prospectus dated                      , 2011


LOGO


LOGO


LOGO

 

 


TABLE OF CONTENTS

 

     Page  

Prospectus Summary

     1   

Risk Factors

     24   

Forward-Looking Statements

     67   

Market Data

     68   

Use of Proceeds

     69   

Corporate Reorganization

     70   

Dividend Policy

     73   

Capitalization

     74   

Dilution

     76   

Selected Financial Data

     78   

Unaudited Pro Forma Condensed Consolidated Financial Information

     84   

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

     86   

Business

     132   

Management

     169   

Executive Compensation

     178   

Certain Relationships and Related Party Transactions

     214   

Principal and Selling Shareholders

     226   

Description of Share Capital

     229   

Description of American Depositary Shares

     237   

Comparison of Shareholder Rights

     245   

Shares Eligible for Future Sale

     259   

United States and Luxembourg Income Tax Considerations

     261   

Underwriting

     269   

Validity of Securities

     273   

Change in Accountants

     273   

Experts

     273   

Where You Can Find More Information

     274   

Index to Consolidated Financial Statements

     F-1   

Neither we, the selling shareholders nor the underwriters have authorized anyone to provide you with information that is different from that contained in this prospectus or with any other information, and neither we, the selling shareholders nor the underwriters can assure you that information extrinsic to this prospectus (and any free writing prospectus prepared by us in connection with this offering) is reliable. We are offering to sell, and seeking offers to buy, our ADSs only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date on the front cover of this prospectus, or other date stated in this prospectus, regardless of the time of delivery of this prospectus or of any sale of our ADSs.

Until                      (25 days after commencement of this offering), all dealers that buy, sell, or trade our ordinary shares, whether or not participating in this offering, may be required to deliver a prospectus. This delivery requirement is in addition to the obligation of dealers to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

No action has been or will be taken in any jurisdiction by us, the selling shareholders or any underwriter that would permit a public offering of our ADSs or the possession or distribution of this prospectus or any free writing prospectus prepared by us in connection with this offering in any jurisdiction where action for that purpose is required, other than the United States. Persons outside the United States who come into possession of this prospectus or any such free writing prospectus must inform themselves about and observe any restrictions relating to the offering and sale of our ADSs and the distribution of this prospectus and any such free writing prospectus outside the United States. Unless otherwise expressly stated or the context otherwise requires,

 

i


references in this prospectus and any such free writing prospectus to “dollars” and “$” are to United States dollars and to “€” are to euro.

This prospectus has been prepared on the basis that all offers of ADSs will be made pursuant to an exemption under the Prospectus Directive, as implemented in Member States of the European Economic Area, from the requirement to produce a prospectus. Accordingly, any person making or intending to make any offer within the European Economic Area of ADSs which are the subject of the placement contemplated in this prospectus should only do so in circumstances in which no obligation arises for us or any of the underwriters to produce a prospectus for such offer. Neither the Company nor the underwriters have authorized, nor do they authorize, the making of any offer of ADSs through any financial intermediary, other than offers made by the underwriters which constitute the final placement of ADSs contemplated in this prospectus.

In the United Kingdom, this prospectus is directed only at persons (“Relevant Persons”) who (i) fall within Article 19(5) (investment professionals) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, (ii) fall within Article 49(2)(a) to (d) (high net worth companies, unincorporated associations etc.) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, or (iii) are persons to whom an invitation or inducement to engage in investment activity (within the meaning of section 21 of the Financial Services and Markets Act 2000) in connection with the issue or sale of any ADSs may otherwise lawfully be communicated or caused to be communicated. This prospectus must not be acted on or relied on by persons who are not Relevant Persons. Any investment or investment activity to which this prospectus relates is available only to Relevant Persons and will be engaged in only with Relevant Persons. Recipients of this prospectus are not permitted to transmit it to any other person. The ADSs are not being offered to the public in the United Kingdom.

ENFORCEMENT OF CIVIL LIABILITIES

We are a company organized under the laws of the Grand Duchy of Luxembourg. A substantial majority of our assets are located outside the United States. Furthermore, some of our directors and officers named in this prospectus reside outside the United States and all or most of the assets of those officers and directors may be located outside the United States. As a result, investors may find it difficult to effect service of process within the United States upon us or these persons or to enforce outside the United States judgments obtained against us or these persons in U.S. courts, including judgments in actions predicated upon the civil liability provisions of the U.S. federal securities laws. Likewise, it may also be difficult for an investor to enforce in U.S. courts judgments obtained against us or these persons in courts located in jurisdictions outside the United States. It may also be difficult for an investor to bring an original action in a Luxembourg or other foreign court predicated upon the civil liability provisions of the U.S. federal securities laws against us or these persons.

In particular, there is doubt as to the enforceability of original actions in Luxembourg courts of civil liabilities predicated solely upon U.S. federal securities laws, and the enforceability in Luxembourg courts of judgments entered by U.S. courts predicated upon the civil liability provisions of U.S. federal securities laws will be subject to compliance with procedural and other requirements under Luxembourg law, including the condition that the judgment does not violate Luxembourg public policy.

 

ii


PROSPECTUS SUMMARY

This summary highlights information contained elsewhere in this prospectus and does not contain all of the information you should consider in making your investment decision. You should read this summary together with the more detailed information, including our historical combined and consolidated financial statements and the related notes, included elsewhere in this prospectus. You should carefully consider, among other things, the matters discussed in “Risk Factors.” As used in this prospectus, “Skype Global” refers to Skype Global S.à r.l. (formerly Springboard Group S.à r.l. and formerly SLP III Cayman DS IV Holdings S.à r.l.). Furthermore, as used in this prospectus, “Skype,” “Company,” “we,” “our,” “us” or “Successor” refer to Skype Global and its subsidiaries on a consolidated basis prior to the completion of our corporate reorganization and to Skype S.A. and its subsidiaries on a consolidated basis as of the completion of our corporate reorganization and thereafter. As used in this prospectus, “Predecessor” refers to the communications business segment of eBay Inc. (“eBay,” which term, as used herein, includes, unless otherwise expressly stated or the context otherwise requires, its consolidated subsidiaries), which consisted of the assets and liabilities of Skype Luxembourg Holdings S.à r.l. (“Skype Holdings”) and its affiliates, Sonorit Holdings A.S. (“Sonorit”) and Skype Inc. (collectively, the “Skype Companies”). On November 19, 2009, Skype Global acquired the Skype Companies from eBay (the “Skype Acquisition”).

In this summary and elsewhere in this prospectus, we sometimes refer to our pro forma results of operations for the year ended December 31, 2009. Unless otherwise expressly stated or the context otherwise requires, this pro forma data has been prepared on the basis described under “Unaudited Pro Forma Condensed Consolidated Financial Information” and is subject to the assumptions and uncertainties described in that section. We also sometimes refer to Adjusted EBITDA, which is a non-GAAP measure, in this summary and this prospectus. For a description of Adjusted EBITDA and a reconciliation of Adjusted EBITDA to net income, refer to “—Adjusted EBITDA” in this summary.

Our Company

Skype is a global technology leader that enables real-time communications over the Internet. Our software-based communications platform offers high-quality, easy-to-use tools for consumers and businesses to communicate and collaborate globally through voice, video and text conversations. During 2010, our users made 207 billion minutes of voice and video calls using Skype. In the fourth quarter of 2010, video calls accounted for approximately 42% of all Skype-to-Skype minutes, and in 2010, our users sent over 176 million SMS text messages through Skype.

Skype has grown rapidly to achieve significant global scale since we were founded in 2003. We believe our connected user base is one of the largest and most engaged Internet user bases. From December 31, 2009 to December 31, 2010, we grew our registered users from 474 million to 663 million. From the three months ended December 31, 2009 to the three months ended December 31, 2010, we grew our average monthly connected users from 105 million to 145 million and our average monthly paying users from 7.3 million to 8.8 million. See “Selected Financial Data—Key Metrics” for definitions of these metrics and their limitations. Although we have achieved significant global scale and user growth to date, the penetration of our connected and paying users is low relative to our addressable market. We continue to invest in innovation with the goal of promoting growth in our user base and increasing user engagement. We believe that we can generate revenue from our users and their engagement in multiple ways over time.

We believe the scale, global distribution and growth of our user base provide us with powerful network effects, whereby Skype becomes more valuable as more people use it, thereby creating an incentive for existing users to encourage new users to join. We believe that these network effects help us to attract new users and provide significant competitive advantages, such as strengthening our brand and enabling us to benefit from

 

 

1


“viral” marketing, which provides us with a cost advantage by keeping our user acquisition costs low. In addition, our scale and network effects encourage other companies to form strategic relationships with Skype, creating more value for our users and increasing user engagement. For example, we have strategic relationships with leading mobile operators such as Verizon Wireless in the United States and KDDI in Japan and with television and Blu-ray player manufacturers (LG, Panasonic, Samsung, Sony and Vizio) that embed Skype software on their applications and devices. In addition, in October 2010, we partnered with Facebook to integrate the Facebook channel, including Facebook news feed and Facebook phonebook, into our Skype software client for Windows. Furthermore, in September 2010, we entered into an agreement with Avaya for the promotion and support of Skype Connect and to cooperate with the objective of launching, in a second phase, integrated communications and collaboration solutions for businesses, in each case in the United States. Strategic relationships like these help us make Skype present in more communications devices and platforms in both the consumer and enterprise markets, which increases the accessibility and usage of Skype by our large and growing user base.

We believe our highly scalable peer-to-peer software architecture gives us a significant cost advantage compared to conventional communications networks because it utilizes our users’ existing Internet connections and does not require us to build or maintain a physical communications network. As a result, we can add new users and provide them with a wide range of communications tools at minimal incremental cost to us, allowing us to offer many of our products for free. We believe our low cost and highly scalable peer-to-peer software architecture positions us to grow in new regions faster and address opportunities more quickly than many other competitive offerings.

In 2010, we generated $860 million of net revenues, and our Adjusted EBITDA was $264 million, while our net loss amounted to $7 million. While Skype-to-Skype voice, one-to-one video and text conversations are free, our primary source of revenue, to date, has been from the purchase of credit (on a pay-as-you-go or subscription basis) for our SkypeOut product, which provides low-priced calling to landlines and mobile devices. We have successfully increased the number of our paying users who sign up for subscriptions, and the percentage of our users with subscriptions has increased over time. Going forward, we plan to continue growing and diversifying our sources of revenue in four specific areas:

 

   

First, we believe that there is a significant opportunity to grow our user base given that our connected and paying users remain at relatively low levels of penetration relative to our addressable market and that fixed and mobile broadband access continues to increase around the world.

 

   

Second, we believe that we can generate more communications revenue from our users by improving awareness and adoption of our paid products and introducing premium products such as group video calling.

 

   

Third, we will continue to develop new monetization models for our large connected user base. We currently generate a small portion of our net revenues through marketing services (such as advertising) and licensing, which we expect will grow as a percentage of our net revenues over time.

 

   

Fourth, we intend to broaden our user base to include more enterprise users.

Recent Developments

In November 2009, we were acquired from eBay by an investor group, led by Silver Lake and including the Canada Pension Plan Investment Board (CPPIB) and Andreessen Horowitz. In connection with the Skype Acquisition, eBay received a significant ownership stake in the Company, and Joltid also made an equity investment in the Company. We believe that our investor group includes a unique combination of investors and operators with specific domain expertise and skill sets, including Silver Lake, a leading large-scale global technology investor with extensive operating experience; CPPIB, an institutional investor with deep sector

 

 

2


expertise; and Andreessen Horowitz, an Internet-focused venture capital specialist, together with the Internet experience of eBay and the Skype-specific and consumer-facing Internet knowledge of Skype’s founders.

Since the Skype Acquisition, we have continued to pursue our mission to be the worldwide communications platform of choice and have made significant improvements in our business. In particular, we have made significant investments in people, infrastructure and the acquisition of Qik Inc., and we have continued to grow our user base and net revenues while adding new products and partnerships and further strengthening our capital structure.

Examples of our recent progress include:

Acquisition of Intellectual Property

 

   

In November 2009, we acquired from Joltid the intellectual property rights to technology that facilitates communications in the peer-to-peer network of Skype users. We acquired this technology as part of a settlement that we and eBay reached with Joltid regarding our use of this peer-to-peer communication technology, in which all outstanding litigation between the parties was resolved. Joltid also made an investment of $80 million in us. We refer to these matters collectively as the “Joltid Transaction.”

Increased Investment

 

   

People. We have recruited several new executives to strengthen our senior management team, including, among others, a new Chief Executive Officer, Chief Financial Officer, Chief Marketing Officer, Chief Legal Officer and a new General Manager of Skype Enterprise, and grew our number of employees and long-term contractors from 733 as of December 31, 2009 to 911 as of December 31, 2010.

 

   

Infrastructure. We invested $32 million in capital expenditures in 2010, a substantial increase from $14 million in 2009. We have invested large amounts in a new SAP ERP system, for financial reporting and other control processes, and in Human Resources systems to help us systematically attract, develop and manage our workforce. We are also investing to provide new office infrastructure across multiple geographies to support our growth.

 

   

Acquisitions. In January 2011, we acquired Qik Inc., a provider of mobile video software, for approximately $121 million of initial cash consideration and additional contingent payments of approximately $29 million. The acquisition allows us to accelerate the development of new premium subscription revenue models, provides access to key engineering talent, and extends our carrier and OEM partnerships. As part of the acquisition, we added 63 employees from Qik in January 2011.

Sustained Growth

 

   

Users and financial performance. We have significantly increased both our free and paying users, growing our average monthly connected users by 38% and average monthly paying users by 19%, from the three months ended December 31, 2009 to the three months ended December 31, 2010. Net revenues increased by 20% from $719 million in pro forma 2009 to $860 million in 2010, and Adjusted EBITDA increased by 43% from $185 million in pro forma 2009 to $264 million in 2010. Our net loss in 2010 was $7 million, compared to a net loss of $418 million on a pro forma basis in 2009 (which includes a $344 million charge incurred by us in connection with the settlement in the Joltid Transaction).

 

   

Strategic relationships. We have launched several important commercial strategic relationships, including relationships in the mobile market with Verizon Wireless in the United States and KDDI in Japan and others in the consumer electronics market, such as arrangements with LG, Panasonic, Samsung, Sony and Vizio to embed Skype in certain HD televisions and Blu-ray players. More

 

 

3


 

broadly, in July 2010, we released SkypeKit, a software development tool designed to meet demand from independent software developers and consumer electronics manufacturers to incorporate Skype functionality within their own applications and devices. In addition, in October 2010, we partnered with Facebook to integrate the Facebook channel, including Facebook news feed and Facebook phonebook, into our Skype software client for Windows. Furthermore, in September 2010, we entered into an agreement with Avaya for the promotion and support of Skype Connect and to cooperate with the objective of launching, in a second phase, integrated communications and collaboration solutions for businesses, in each case in the United States. Through our acquisition of Qik in January 2011, we have also added Qik’s existing strategic partners including Sprint and T-Mobile in the United States.

 

   

Products and features. We have released a significant number of new products and features, including:

 

   

Mobile. We have released Skype products on multiple platforms including iOS (iPhone), Blackberry, Linux, Android and Symbian.

 

   

Integrated features. In October 2010, we integrated the Facebook channel, including Facebook news feed and Facebook phonebook, into our Skype software client for Windows. Skype users can now interact with their Facebook news feed directly from Skype. They can also place low cost SkypeOut calls to their Facebook friends that have posted mobile and/or landline phone numbers on Facebook and free Skype-to-Skype calls to their Facebook friends that are also Skype users.

 

   

Premium products. With our Skype 5.1 client for Windows and our Skype 5.0 client for Mac, we officially launched group video calling in January 2011 as part of our “Skype Premium” product, which also includes live chat customer support and a discount on HD webcams.

 

   

Marketing services, including advertising. We have launched products that allow businesses to market their products or services selectively to our user base, including Click & Call, which enables users to initiate a Skype call from a website to participating businesses. We have also enhanced the functionality on our Skype 5.1 client for Windows and Skype 5.0 client for Mac to enable them to feature display advertising.

 

   

Skype Enterprise. We have launched our Skype Enterprise product offerings: Skype Manager, which allows businesses to manage Skype accounts for their employees, and Skype Connect, which allows businesses to connect their private telephone branch exchange (PBX) over the Internet to the peer-to-peer network of Skype users to achieve low-cost calling.

Capital Structure

 

   

Financing. We raised $825 million face amount of debt to help finance the Skype Acquisition, consisting of $700 million face amount of senior debt and a payment-in-kind loan of $125 million from eBay. We refinanced our debt in February 2010. As part of this refinancing, we reduced our total debt and significantly lowered our cost of debt by increasing our senior debt to a U.S. dollar equivalent $775 million face amount while repaying the eBay payment-in-kind note in full. We also have a $30 million revolving credit facility, of which $25 million was drawn in connection with the Qik Acquisition in January 2011.

Our Platform

The large and growing global market for communications and collaboration solutions is being transformed by the Internet. We believe that underlying market forces increasingly challenge the ways that communications have traditionally been provided and offer opportunities for innovative and disruptive solutions such as ours to help accelerate the transformation of the global communications industry. These market forces include a growing desire to communicate globally, increasing Internet penetration, expansion and diversification of the ways people communicate, and proliferation of Internet-connected devices. Furthermore, as the Internet transforms the ways

 

 

4


people communicate, new markets and business models are being developed, including social networking, advertising, social gaming and virtual goods. We believe that our large and engaged user base, combined with our easy-to-use, high-quality platform, position us well to compete in these evolving markets.

We have developed an innovative software-based communications platform that offers a simple and convenient way for our users to stay in touch virtually anywhere in the world. This platform allows us to bring an Internet-based model to the communications industry. Skype users can have free voice, video and text conversations with other Skype users, or can call anyone with a landline or mobile phone number at a low cost. We believe that our platform is well-positioned to capitalize on the market forces that are transforming the global communications industry:

 

   

We facilitate global communication and collaboration. Our software platform is currently available in 32 languages, and we have an extremely broad reach in countries throughout the world.

 

   

We leverage existing fixed and wireless Internet infrastructure. Our software platform only requires an Internet-connected device to connect instantly with our global network of 145 million average monthly connected users (for the three months ended December 31, 2010) for free, or with hundreds of millions of mobile handsets and landlines around the world at a low price.

 

   

We offer numerous communication tools and ways to communicate and collaborate. In addition to voice and video calling, our software platform also offers a variety of other communication and collaboration methods, such as instant messaging, paid SMS messaging, screen sharing and file transferring. Features are seamlessly tied together on the Skype platform, allowing our users to switch easily between various ways of communicating and collaborating. In addition to one-to-one communications, users can communicate with groups using Skype through group instant messages and group voice or video calls. With the acquisition of Qik in January 2011, we further expanded our product offering to include video broadcast, video recording, social video sharing and video messaging.

 

   

Skype is available on diverse Internet-connected devices. As Skype is software-based, users can access their Skype account and use our software platform’s functionality from virtually any Internet-connected device. Skype is currently available, either pre-installed or through user download, on desktops and laptops, as well as selected mobile phones, netbooks, tablets, televisions, Blu-ray players and video game consoles, and our Qik applications are pre-loaded or available to download on a wide range of mobile smartphones.

Our Competitive Strengths

We believe our products, technology and business model distinguish us from alternative providers and bring us a number of differentiated competitive strengths:

 

   

Large, highly engaged, growing and diverse global user base. Our user base is large and continues to grow rapidly and is geographically and demographically diverse, as our software is used by people in countries throughout the world. Our software has broad global appeal and is actively used by people across gender, age and income groups, helping everyone from business executives to grandparents to schoolchildren stay connected. We believe our users are also highly engaged in using our product and this engagement has increased over time.

 

   

Strong network effects. We and our users benefit from network effects. Skype becomes more valuable as more people use Skype, thereby creating an incentive for existing users to encourage new users to join. This results in viral marketing and lower marketing expense for Skype.

 

   

Strong communications brand. Despite low levels of marketing spending by us to date, we believe that Skype is among the most recognized brands in Internet communications, appealing to a broad range of people across diverse demographic groups and geographies.

 

 

5


   

Low cost and highly scalable peer-to-peer architecture. Our peer-to-peer software architecture connects our users by utilizing their existing network and computing resources. This provides us with a significant cost advantage because we are not required to build or maintain a physical communications network, such as a wire or fiber optic network or cellular infrastructure.

 

   

High-quality, multi-feature voice and video product suite. We offer a wide range of tools for our users to communicate and collaborate, including voice and video calling, instant messaging, screen sharing and file transferring. For example, we recently introduced group video calling, which allows our users to communicate with up to nine other users in a simultaneous video conversation. During the fourth quarter of 2010, approximately 42% of our Skype-to-Skype minutes were video calls, which we believe demonstrates the high quality and utility of our video products. We also officially launched our Skype 5.0 client for Windows in October 2010 and our Skype 5.0 client for Mac in January 2011, which we believe offers a simplified user interface and an easy-to-navigate voice and video communications experience.

 

   

Payment infrastructure. Because of our size and experience we have the ability to collect small payments in many countries around the world. We currently accept payments in 15 currencies. We are able to accept multiple forms of payment, including PayPal, credit cards, debit cards, cash payments for a voucher and bank transfers. Additionally, we have substantial experience addressing fraudulent payment activity and have developed sophisticated anti-fraud practices and systems.

 

   

Software platform that is device and network agnostic. Unlike some competitive offerings, our platform is software-based and is available across multiple devices and networks. Our software runs on virtually all major computer and mobile operating systems and on multiple hardware platforms, including televisions, Blue-ray players and mobile phones, and across Internet and mobile telecommunications networks.

 

   

Attractive financial structure. We believe that our business benefits from an attractive financial structure. For example, our cash flow and working capital are enhanced by the fact that users of our paid communications services products, including SkypeOut, pay us in advance of their use of our products; and the growing popularity of our subscription-based products provides us with higher predictability regarding our future revenues. We believe our business is also characterized by low operating and capital expenditures as a result of the strong network effects that help us grow our user base, our strong communications brand, which we have built despite low levels of marketing spending, and the low-cost peer-to-peer architecture that does not require us to build or maintain a network. We also have relatively low cash tax expense, expressed as a percentage of our income or loss before income taxes. This financial structure provides us the opportunity to invest cash generated from our operating activities in the continued development of innovative products and technologies.

 

 

6


Our Users

We believe that the growth and loyalty of our user base validate our competitive strengths. Our registered, connected and paying users have grown over time, which we believe is primarily attributable to the network effects of our users, our strong global brand and our differentiated technology and product offering. For a description of how we calculate each of our metrics, see “Selected Financial Data—Key Metrics.” The chart below highlights the growth in our users since 2007:

LOGO

 

(1)

Our registered user metric is difficult for us to verify and is subject to a degree of overstatement. For more information, see “Risk Factors—The number of our registered users overstates the number of unique individuals who register to use our products.” Our registered user number includes users who registered through their MySpace account and excludes users that have registered on Skype through our investment to address the Chinese market, Tel-Online Limited. For more information, see “Selected Financial Data—Key Metrics.”

(2)

Our connected and paying user metrics are subject to uncertainties and inaccuracies and may be overstated or understated. For more information, see “Risk Factors—Our connected users metric is subject to uncertainties and may overstate the number of users who actively use our products” and “—Our paying user and communications services billing minutes metrics are subject to a degree of inaccuracy due to fraudulent transactions and our method of calculating these metrics.” Our average monthly connected and paying user numbers include users who registered through their MySpace account and exclude users that have connected to Skype through our investment to address the Chinese market, Tel-Online Limited. For more information, see “Selected Financial Data—Key Metrics.”

Since 2008, our connected users have increased rapidly due to the increasing popularity of our free products, including video calling, which represented approximately 42% of all Skype-to-Skype minutes for the fourth quarter of 2010. We view the growth in our connected user base as an opportunity to convert more of these connected users into future paying users. In addition, our paying users exhibit strong long-term loyalty as well as relatively stable spending patterns over time, as demonstrated by our monthly SkypeOut billings data trends.

Skype appeals to a geographically and demographically diverse range of users. People use Skype in a variety of different ways, from friends or relatives calling each other in different cities or countries, to grandparents video-calling their grandchildren, to teachers conducting classes remotely, to students text messaging each other or to business associates transferring files or screen-sharing. Our appeal is global, and our users correspondingly vary in age, gender and professional background. For example, for the three months ended December 31, 2010, connected users registered in the United States represented approximately 17% of our global average monthly connected users, while no other single country represented more than 8% of our average monthly connected users.

 

 

7


Our Strategy

Our mission is to be the communications platform of choice for consumers and businesses around the world. We believe we have a significant opportunity to grow our users, revenue and profitability by increasing the penetration of our user base within our addressable market, expanding the use and engagement of our free and paid products, and by developing new products and monetization models as the industry continues to evolve. We believe we can generate revenue from our users and their engagement in multiple ways over time and believe that our large, growing and engaged user base is very attractive to advertisers. Our strategy has four key components:

 

1. Continue to grow our connected and paying user base. In the three months ended December 31, 2010, we had 145 million average monthly connected users and 8.8 million average monthly paying users. We aim to grow our user base and increase the portion of our users who use paid products by supplementing our viral marketing with new marketing initiatives and strategic relationships.

 

2. Increase usage and engagement of our free and paid products and extend our relationship with our users. As our users continue to use Skype more often, they begin to recognize the full benefits of using our products and many migrate to using Skype as their preferred communications tool across a variety of connected devices. We seek to capitalize on this migration path and to grow usage of our free and paid products through multiple initiatives, including improving our suite of free products, adding new features and paid products, increasing our users’ awareness of our paid products and making it easier for users to pay. We also intend to promote our subscription products and to continue developing Skype software for multiple platforms to increase the accessibility of Skype to our user base around the world.

 

3. Develop new monetization models, including advertising. Our users made 194 billion minutes of Skype-to-Skype calls in 2010. We believe this represents a meaningful opportunity to increase our revenue from alternative monetization models, including advertising, gaming and virtual goods.

 

4. Broaden our user base to include more enterprise users. We believe the business communications market represents a large opportunity for Skype. Approximately 37% of over 40,000 of our connected users surveyed in the first quarter of 2010 told us that they use our product platform occasionally or often for business-related purposes. We believe there is a significant opportunity to better serve the communications needs of the small and medium enterprise segment, as well as larger enterprise customers, by focusing on user needs in this market and developing additional products specifically tailored to enterprise users.

Risks Affecting Our Business

You should carefully consider the risks described under “Risk Factors” and elsewhere in this prospectus. These risks could harm our business, results of operations and financial condition materially and could cause the market price of the American Depositary Shares, or ADSs, representing our ordinary shares to decline and could result in a partial or total loss of your investment.

Corporate Reorganization

We currently conduct our business through Skype Global S.à r.l., a Luxembourg limited liability company (société à responsabilité limitée), and its subsidiaries. The registrant, Skype S.à r.l., is a Luxembourg limited liability company (société à responsabilité limitée) formed in July 2010 for the purpose of making this offering. Skype S.à r.l., currently a wholly-owned subsidiary of Skype Global S.à r.l., does not engage in any operations and has only nominal assets, including a 100% interest in Skype Global Holdco S.à r.l., a Luxembourg limited liability company (société à responsabilité limitée), which itself does not engage in any operations and holds no material assets. The corporate reorganization, which is expected to occur prior to the effectiveness of the registration statement of which this prospectus forms a part, will involve, among other steps, the conversion of Skype S.à r.l. into a Luxembourg joint stock company (société anonyme), Skype S.A., and the acquisition of the

 

 

8


shares of Skype Global S.à r.l. by Skype S.A., as further described in “Corporate Reorganization.” As a result, Skype S.A. will become our new parent company. Investors in this offering will only receive, and this prospectus only describes the offering of, ADSs representing the ordinary shares of Skype S.A.

Principal Shareholders

In November 2009, we were acquired by an investor group, led by Silver Lake and including the Canada Pension Plan Investment Board (CPPIB) and Andreessen Horowitz. In connection with the Skype Acquisition, eBay received a significant ownership stake in the Company, and Joltid, which was founded by the original founders of Skype, also invested in the Company.

The following table shows the percentage of our ordinary shares beneficially owned by each of our principal shareholders upon effectiveness of the corporate reorganization and prior to the consummation of this offering, as well as upon consummation of this offering. The table also shows the estimated amount of net proceeds that each of our principal shareholders will receive from the sale of shares in this offering based on an assumed initial public offering price of $             per share, which is the mid-point of the range specified on the cover of this prospectus:

 

Principal Shareholder

  Percentage shareholding interest
upon effectiveness of corporate
reorganization and prior to
this offering(1)
  Percentage shareholding
interest upon consummation of
this offering(1)
  Estimated amount of
net proceeds
upon consummation of
this offering(2)

Silver Lake

      %       %   $

eBay International AG

     

Joltid

     

Canada Pension Plan Investment Board (CPPIB)

     

Andreessen Horowitz

     
           

Total

      %       %   $
           

 

(1)

Based on ordinary shares outstanding as of December 31, 2010.

(2)

Net proceeds are shown net of underwriting discounts and commissions.

For further information on our principal shareholders and how these percentages were calculated, see “Principal and Selling Shareholders.”

In connection with the closing of the Skype Acquisition in November 2009, we entered into a shareholders agreement with our shareholders. We expect that pursuant to the terms of our shareholders agreement, which is anticipated to be amended and restated prior to this offering, certain Silver Lake Funds, eBay, CPPIB, Joltid and Andreessen Horowitz will be able to elect their respective designees to serve as members of our board of directors. These shareholders’ designees are expected to represent          of the          members of our board of directors immediately after this offering. See “Management” elsewhere in this prospectus. These shareholders will have a continuing ability to control our board of directors and to exercise a significant influence over our affairs for the foreseeable future.

In connection with the Skype Acquisition, we also entered into management services agreements with our principal shareholders and their affiliates, pursuant to which we have agreed to pay them periodic monitoring fees for management, financial, consulting and other advisory services. Our management services agreements provide that, on the date of the consummation of any initial public offering, such as this offering, all payments we owe under these agreements will be accelerated and paid at their net present value, and the agreements will be terminated. We estimate that we will have to pay an aggregate amount of approximately $         million in connection with the termination of our management services agreements.

 

 

9


Principal Executive Offices, Operations and Trademarks

Skype S.à r.l. was incorporated as a limited liability company (a société à responsabilité limitée) under the laws of the Grand Duchy of Luxembourg in July 2010 and will be transformed into a Luxembourg joint stock company (a société anonyme) becoming Skype S.A. as part of the corporate reorganization described under “Corporate Reorganization.” Skype Global S.à r.l., a Luxembourg limited liability company (a société à responsabilité limitée or “S.à r.l.”), was organized under the laws of the Grand Duchy of Luxembourg in September 2008. Our principal executive office is located at 23-29 Rives de Clausen, L-2165 Luxembourg, and our telephone number at this address is +352 274 787 11. Our website is www.skype.com. Information on, or accessible through, our website is not a part of, and is not incorporated into, this prospectus.

All of our activities are conducted through various subsidiaries, which are organized and operated according to the laws of their country of incorporation.

Skype, associated trademarks and logos (including SkypeIn, SkypeOut, Skype To Go, Skype Access, Skype Certified and SILK) and the “S” symbol are our trademarks. This prospectus also may refer to brand names, trademarks, service marks and trade names of other companies and organizations, and those brand names, trademarks, service marks and trade names are the property of their respective owners.

 

 

10


The Offering

 

ADSs offered by us

            ADSs

 

ADSs offered by the selling shareholders

            ADSs (or                     ADSs if the underwriters exercise their option to purchase additional ADSs in full)

 

Ordinary shares outstanding immediately after this offering

            ordinary shares (including ordinary shares represented by ADSs)

 

Use of proceeds

We estimate that we will receive net proceeds of approximately $            million from the sale by us of ADSs offered in this offering, after deducting the underwriting discount and estimated offering expenses payable by us. We intend to use the net proceeds received by us in connection with this offering for general corporate purposes. While we currently have no specific plans for the application of the net proceeds to us from this offering, these corporate purposes may include, without limitation, investing in the development and marketing of new products, investing in our infrastructure or repaying a portion of our debt outstanding under our Amended Five Year Credit Agreement. As discussed further under “Management’s Discussion and Analysis of Financial Condition and Results of Operation—Liquidity and Capital Resources—Indebtedness—Five Year Credit Agreement,” on November 19, 2009, we incurred $806.7 million of indebtedness to finance the Skype Acquisition, of which $681.7 million was attributable to our Five Year Credit Agreement. After the amendment thereof, as of December 31, 2010, $724.9 million was outstanding under our Amended Five Year Credit Agreement. The variable interest rate under this facility is calculated on the basis of LIBOR for the appropriate currency, subject to a 2% floor, plus 5% or 5.5% for the U.S. dollar and Euro tranches, respectively. The Amended Five Year Credit Agreement matures on February 23, 2015.

 

  Furthermore, in connection with the termination of the management services agreements we have entered into with certain of our shareholders and their affiliates, we will pay approximately $            million to such counterparties, on the date of the consummation of this offering, using a portion of the proceeds of this offering. See “Certain Relationships and Related Party Transactions—Management Services Agreements.”

 

  We will not receive any proceeds from the sale of approximately $             million of ADSs to be offered by the selling shareholders. See “Principal and Selling Shareholders.”

 

Dividend policy

We do not anticipate paying any cash dividends on our ordinary shares in the foreseeable future. We anticipate that we will retain all of our available funds for use in the operation and development of our business. See “Dividend Policy.”

 

 

11


Proposed Nasdaq Global Select Market symbol for the ADSs

 

The ADSs

Each ADS represents             ordinary shares. The ADSs may be evidenced by American depositary receipts, or ADRs.

 

  The depositary will be the holder of the ordinary shares underlying the ADSs and you will have the rights of an ADS holder as set forth in the deposit agreement among us, the depositary and holders and beneficial owners of ADSs from time to time.

 

  You may surrender your ADSs to the depositary to withdraw the ordinary shares underlying your ADSs. The depositary will charge you a fee for that surrender.

 

  We may amend or terminate the deposit agreement for any reason without your consent. If an amendment becomes effective, you will be bound by the deposit agreement, as amended, if you continue to hold your ADSs.

 

  See “Risk Factors—Risks Related to Our ADSs and this Offering” and “Description of the American Depositary Shares.”

 

Depositary

The Bank of New York Mellon

 

Tax considerations

See “United States and Luxembourg Income Tax Considerations.”

The number of ordinary shares that will be outstanding immediately after this offering is based on ordinary shares outstanding on December 31, 2010, plus the              ordinary shares to be sold by us in the form of ADSs in this offering, and excludes the following ordinary shares:

 

   

            ordinary shares issuable upon the exercise of stock options granted to our employees, directors, service providers and consultants outstanding at December 31, 2010 under the Skype Global S.à r.l. Equity Incentive Plan (the “Skype Equity Incentive Plan”) with exercise prices of between $            and $            per share (equivalent to a weighted average exercise price of $             per share);

 

   

            ordinary shares issuable upon the exercise of stock options granted to our employees, directors, service providers and consultants after December 31, 2010 under the Skype Equity Incentive Plan with exercise prices of between $            and $            per share (equivalent to a weighted average exercise price of $             per share);

 

   

            ordinary shares reserved for future issuance under the Skype Equity Incentive Plan; for a discussion of the Skype Equity Incentive Plan, see “Executive Compensation—Compensation Discussion & Analysis—Components of Executive Compensation—Long-Term Equity Incentives”; and

 

   

            ordinary shares into which warrants that were originally granted to Joltid Limited on November 19, 2009, which are now held by SEP Investments Pty Limited, may be exercised at an exercise price of $             per share (the warrants expire upon the earlier of November 19, 2019 and the occurrence of a reorganization event, as defined under the terms of the warrant). See “Capitalization—Warrants” for more information regarding the terms of the warrant.

 

 

12


Unless otherwise expressly stated or the context otherwise requires, the information in this prospectus assumes:

 

   

no exercise of the underwriters’ option to purchase up to              additional ADSs from the selling shareholders;

 

   

the completion of our corporate reorganization pursuant to which Skype Global S.à r.l. will become an indirect wholly-owned subsidiary of Skype S.A.; and

 

   

the adoption of our new articles of incorporation, which will occur prior to the closing of this offering.

 

 

13


Financial Overview

We believe the growth, scale and engagement of our user base are primary drivers of our business. Our user base has grown rapidly since we were founded in 2003. From the three months ended December 31, 2009 to the three months ended December 31, 2010, we grew our average monthly connected users by 38%, from 105 million to 145 million.

The growth in our user base has translated into revenue growth. Our net revenues have historically been driven by the increasing use of our SkypeOut product, which enables Skype users to make low-priced calls to landlines and mobile devices on a pay-per-minute or subscription basis. Users of our paid communications services products, including SkypeOut, pay us in advance of their use of our products, and the growing popularity of our subscription-based products is providing us with more predictability of our future revenues.

Our primary costs associated with our net revenues are costs incurred by us to have SkypeOut calls connected, or “terminated,” on a landline or wireless network. As we have grown our business and entered into agreements with more telecommunications carriers to connect SkypeOut calls, we have been able to negotiate lower termination costs. As a result, cost of net revenues relating to our SkypeOut product has been increasing at a slower rate than our net revenues from the product, enabling us to improve our gross margin.

We believe our business is also characterized by low operating expenditures. In particular, our business and user communities benefit from network effects, whereby Skype products become more valuable as more people use them, thereby creating an incentive for current users to encourage new users to join. As more users join and attract others, Skype creates more value for users, thereby increasing engagement. These positive network effects have helped us grow our user base and establish Skype as a well-recognized brand in Internet communication, without requiring us to make significant investments in sales and marketing activities.

Our relatively low capital expenditures are primarily due to the “peer-to-peer” architecture that enables our software platform and leverages the network resources of our users to connect them. This architecture provides us with a significant cost advantage because we are not required to build or maintain a physical communications network, such as a wire or fiber optic network or cellular infrastructure. As a result, we can add new users and provide them with a wide range of products at minimal incremental cost to us, allowing us to offer many of our products for free. Furthermore, we have relatively low cash tax expense, expressed as a percentage of our income or loss before income taxes.

Summary Financial Data

The following summary financial information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Unaudited Pro Forma Condensed Consolidated Financial Information,” our audited consolidated financial statements for the Predecessor year ended December 31, 2008, for the Predecessor period from January 1, 2009 to November 18, 2009, for the Successor period from November 19, 2009 to December 31, 2009, as of December 31, 2009 and as of and for the Successor year ended December 31, 2010 included elsewhere in this prospectus.

On November 19, 2009, Skype Global acquired the Communications business segment of eBay, which consisted of the assets and liabilities of the Skype Companies (which we refer to as the “Skype Acquisition”). As a result of the Skype Acquisition, the financial results for the year ended December 31, 2009 has been presented for the Predecessor for the period from January 1, 2009 to November 18, 2009, and for the Successor for the period from November 19, 2009 to December 31, 2009.

 

 

14


Our summary statement of operations data and cash flows data for the Predecessor year ended December 31, 2008, for the Predecessor period from January 1, 2009 to November 18, 2009, for the Successor period from November 19, 2009 to December 31, 2009 and for the Successor year ended December 31, 2010, as well as the summary balance sheet data as of December 31, 2010, have been derived from our audited consolidated financial statements which have been prepared in accordance with United States generally accepted accounting principles (U.S. GAAP) and are included in this prospectus. Our summary statement of operations data for the Predecessor year ended December 31, 2007 have been derived from audited consolidated financial statements that were prepared in accordance with U.S. GAAP and are not included in this prospectus. The summary statement of operations data for the Predecessor year ended December 31, 2006 have been derived from unaudited combined financial statements that were prepared in accordance with U.S. GAAP.

Certain reclassifications affecting cost of net revenues and operating expenses have been made to our consolidated statements of operations for years prior to 2010, in order to conform with the presentation for the year ended December 31, 2010.

The Skype Acquisition was accounted for as a business combination using the acquisition method and resulted in a new basis of accounting in the acquired Skype Companies. Accordingly, the purchase price was allocated to assets and liabilities based on their estimated fair value at the acquisition date on November 19, 2009. The excess of purchase price over the tangible assets, identifiable intangible assets and assumed liabilities was recorded as goodwill (see Note 3 to our audited consolidated financial statements included elsewhere in this prospectus for further information). The vertical lines separating the Successor and Predecessor financial data in this prospectus are included to highlight the lack of comparability between these accounts due to the period durations and new basis of accounting resulting from the Skype Acquisition.

For presentation purposes only, we refer in this prospectus to the Predecessor’s combined financial statements of the Skype Companies and the Successor’s consolidated financial statements collectively as our “consolidated financial statements.”

 

 

15


Summary Statement of Operations Data from 2006 to 2010

 

    Predecessor           Successor  
    Year ended
December 31,
2006
    Year ended
December 31,
2007
    Year ended
December 31,
2008
    January 1
to
November  18,
2009
          November 19
to
December  31,
2009
    Year ended
December 31,
2010
 
    (thousands of U.S. dollars, except share data)  

Summary Statement of Operations Data:

               

Net revenues:

  $ 193,696      $ 381,551      $ 551,364      $ 626,458          $ 92,445      $ 859,815   

Cost of net revenues(1)

    140,107        229,496        293,201        298,334            45,647 (2)      415,702 (2) 
                                                   

Gross profit

    53,589        152,055        258,163        328,124            46,798        444,113   
                                                   

Operating expenses:

               

Sales and marketing(1)

    59,787        64,304        83,222        104,279            16,710        131,939   

Product development(1)

    38,900        22,857        33,599        38,462            6,565        72,263   

General and administrative(1)(3)

    37,865        42,423        48,648        48,688            112,274 (4)      104,954 (5) 

Amortization of acquired intangible assets

    60,156        65,514        69,832        55,453            13,284 (2)      114,308   

Litigation settlement

    —          —          —          343,826 (6)          —          —     

Impairment of goodwill

    —          1,390,938 (7)      —          —              —          —     
                                                   

Total operating expenses

    196,708        1,586,036        235,301        590,708            148,833        423,464   
                                                   

(Loss)/income from operations

    (143,119     (1,433,981     22,862        (262,584         (102,035     20,649   

Realized loss on amended credit agreement(8)

    —          —          —          —              —          (13,513

Interest income and other (expense), net

    2,029        5,303        10,297        (2,549         5,492        4,817   

Interest expense

    —          —          —          —              (10,387 )(9)      (68,645 )(10) 
                                                   

(Loss)/income before income taxes

    (141,090     (1,428,678     33,159        (265,133         (106,930     (56,692

Income tax (benefit)/expense

    (22,044     (23,342     (8,447     3,950            (7,209     (49,787
                                                   

Net income (loss)

  $ (119,046   $ (1,405,336   $ 41,606      $ (269,083       $ (99,721   $ (6,905
                                                   

Basic and diluted net loss per share (Class A
through J):(11)

              $ (10.59   $ (0.73

Weighted number of shares, basic and diluted (Class A through J):(11)

                9,414,600        9,433,743   

 

 

16


 

(1)

Figures for the periods shown below include stock-based compensation expense as follows:

 

    Predecessor           Successor  
    Year ended
December 31,
2006
    Year ended
December 31,
2007
    Year ended
December 31,
2008
    January 1 to
November 18,
2009
          November 19 to
December 31,
2009
    Year ended
December 31,
2010
 
   

(thousands of U.S. dollars)

 

Cost of net revenues

  $ 2,141      $ 200      $ (145   $ 331          $ 6      $ 123   

Sales and marketing

    10,247        1,953        3,636        4,524            111        2,500   

Product development

    13,303        3,883        5,443        2,910            92        2,714   

General and administrative

    7,378        4,233        3,892        6,720            52        10,613   
                                                   

Total

  $ 33,069      $ 10,269      $ 12,826      $ 14,485          $ 261      $ 15,950   
                                                   

 

(2)

Cost of net revenues and amortization of acquired intangible assets for the Successor period from November 19, 2009 to December 31, 2009 include $4.2 million and $13.3 million of amortization costs, respectively, and for the year ended December 31, 2010 include $36.1 million and $114.3 million of amortization costs, respectively, in each case relating to the amortization of the intangible assets acquired in the Skype Acquisition. The increase from the Predecessor period is a result of the Skype Acquisition, whereby the gross carrying amount of intangible assets increased from $340.5 million as of December 31, 2008 to $805.6 million as of December 31, 2009 and December 31, 2010.

(3)

The consummation of this offering will trigger payments under management services agreements entered into in connection with the Skype Acquisition in aggregate amount of $            million. Upon the consummation of this offering, all payments we owe under these agreements will be accelerated and paid at their net present value, and these agreements will terminate. See “Certain Relationships and Related Party Transactions—Management Service Agreements.”

(4)

This amount includes $98.7 million of transaction fees and expenses incurred in connection with the Skype Acquisition.

(5)

During 2010, this amount includes $9.7 million of separation costs, including $5.8 million of share-based compensation incurred in connection with the separation agreement that we entered into with our former Chief Executive Officer. See “Executive Compensation—Compensation Discussion & Analysis—Employment Agreements; Severance and Change in Control Provisions—Payments and Benefits in Connection with Mr. Silverman’s Separation” and “—Summary Compensation Table—Potential Payments upon Termination or Change in Control—Chief Executive Officer Separation.”

(6)

This amount represents the net charge incurred by us in connection with the settlement that we and eBay reached with Joltid regarding our use of the “Global Index” technology that facilitates communications in the peer-to-peer network of Skype users. For more information regarding this settlement and the Joltid Transaction generally, please refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Factors Affecting Results of Operations,” “Certain Relationships and Related Party Transactions—Acquisition-Related Matters—The Joltid Transaction” and Note 14 to our audited consolidated financial statements included elsewhere in this prospectus.

(7)

This amount represents the impairment in 2007 of the goodwill recorded in connection with our acquisition by eBay in 2005 (the “eBay Acquisition”). As a result of the assessment in 2007 that the carrying value of that goodwill exceeded its fair value, an impairment charge of $1.4 billion was recorded. For more information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations—Impairment of Goodwill” and Note 4 to our audited consolidated financial statements included elsewhere in this prospectus.

(8)

This amount represents the expense incurred in connection with the amendment of our Amended Five Year Credit Agreement in February 2010, described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Indebtedness.”

(9)

This amount represents the net interest expense, including amortization of original issuance discount and deferred financing cost, incurred for the Successor period from November 19, 2009 to December 31, 2009 in connection with the indebtedness incurred to finance the Skype Acquisition, as described further under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Indebtedness.”

(10)

This amount represents the net interest expense, including amortization of original issuance discount and deferred financing cost, incurred for the year ended December 31, 2010 in connection with the outstanding indebtedness incurred to finance the Skype Acquisition, described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Indebtedness.”

(11)

Per share information is not provided for the Predecessor periods from the year ended December 31, 2006 to the period ended November 18, 2009 because the Predecessor financial statements have been prepared on a combined basis and have an equity structure reflecting eBay’s net investment in the Skype Companies.

 

 

17


Summary Balance Sheet Data

Our consolidated balance sheet data as of December 31, 2010 is presented:

 

   

on an actual basis; and

 

   

on an as adjusted basis to give effect to our corporate reorganization and to reflect our receipt of the estimated net proceeds from this offering, based on at an assumed initial public offering price of $             per ADS (the mid-point of the price range set forth on the cover page of this prospectus) and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us, the payment of approximately $             million to certain of our shareholders upon the consummation of this offering in connection with the termination of our management service agreements with them, and the application of such net proceeds as described under “Use of Proceeds.”

 

     As of December 31, 2010  
     Actual            As  adjusted(1)  
     (thousands of U.S. dollars)  

Summary Balance Sheet Data:

       

Cash and cash equivalents

   $ 142,465        

Total current assets

     243,387        

Property and equipment, net

     36,523        

Goodwill

     2,372,779 (2)      

Intangible assets, net

     637,688 (3)      

Total assets

     3,317,855        
 

Accrued expenses and other current liabilities

     121,100        

Deferred revenue and user advances

     176,681        

Total current liabilities

     353,726        

Long term debt

     686,348 (4)      

Total liabilities

     1,071,165        

Total shareholders’ equity

     2,246,690        

Total liabilities and shareholders’ equity

   $ 3,317,855        

 

(1)

A $1.00 increase (decrease) in the assumed initial public offering price of $            per ADS in this offering, which is, the midpoint of the range set forth on the cover of this prospectus, would increase (decrease) each of cash equivalents, total current assets, total assets, total shareholders’ equity and total liabilities and shareholders’ equity by approximately $             million, assuming the number of ADSs offered by us, as set forth on the cover of this prospectus, remains the same, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

(2)

This amount represents the excess of purchase price over the tangible assets, identifiable intangible assets and assumed liabilities in the Skype Acquisition, which has been recorded as goodwill.

(3)

This amount represents the identifiable intangible assets acquired in connection with the Skype Acquisition and the Joltid Transaction. As a result of the Skype Acquisition, the gross carrying amount of intangible assets increased from $340.5 million as of December 31, 2008 to $805.6 million as of December 31, 2009 and 2010.

(4)

This amount represents the outstanding amount as of December 31, 2010 of long-term debt incurred to finance the Skype Acquisition, as described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Indebtedness.”

 

 

18


Summary Cash Flow Data

 

    Predecessor           Successor  
    Year ended
December 31,
2008
    January 1 to
November 18,
2009
          November 19 to
December 31,
2009
    Year ended
December  31,

2010
 
    (thousands of U.S. dollars)  

Summary Cash Flow Data:

           

Net cash provided by (used in) operating activities:

  $ 148,801      $ 128,049          $ (150,913 )(1)    $ 156,848   

Net cash used in investing activities:

    (4,964     (11,733         (1,958,981 )(2)      (35,024

Net cash provided by (used in) financing activities:

    13,305        (263,302         2,082,013 (3)      (86,862 )(4) 

 

(1)

This amount was impacted by outgoing cash payments of $94.4 million in connection with the Joltid litigation settlement as part of the Joltid Transaction. For more information see “Certain Relationships and Related Party Transactions—Acquisition-Related Matters—The Joltid Transaction” and Note 14 to our audited consolidated financial statements included elsewhere in this prospectus. In addition, net cash of $98.7 million was also paid as fees and expenses in connection with the Skype Acquisition.

(2)

This amount includes $1.9 billion in cash paid to eBay as a portion of the consideration in the Skype Acquisition. In addition, $34.6 million was paid to acquire intangible assets as part of the Joltid Transaction we entered into prior to the Skype Acquisition.

(3)

This amount includes $681.7 million net proceeds from indebtedness incurred in connection with the Skype Acquisition and $1.4 billion in net cash proceeds from the issuance of common stock in the Skype Acquisition.

(4)

This amount primarily reflects the refinancing of our Amended Five Year Credit Agreement and the contemporaneous repayment of the entire $125.0 million outstanding payment-in-kind loan agreement with eBay.

Key Metrics

We monitor certain key operating metrics that we believe drive our financial performance, including net revenues, and that we use to measure usage during different periods of the year to manage our business and to help identify potential fraudulent activities. These metrics are derived from our operational systems, as opposed to our financial reporting systems. As our business evolves and we continue to gain further insight into our growing business, we may change the method of calculating our key operating metrics, enhance our operational systems to address uncertainties in these metrics or add new key operating metrics to reflect the changes in our business.

Our registered user metric is subject to a degree of overstatement. Other metrics are subject to uncertainties and inaccuracies and may be overstated or understated. For more information, see “Risk Factors—The number of our registered users overstates the number of unique individuals who register to use our products,” “—Our connected users metric is subject to uncertainties and may overstate the number of users who actively use our products” and “—Our paying user and communications services billing minutes metrics are subject to a degree of inaccuracy due to fraudulent transactions and our method of calculating these metrics.”

For details of how we calculate each of these metrics, as well as certain key assumptions relating to these metrics, see “Selected Financial Data—Key Metrics.”

 

 

19


The table below shows our registered users as of the relevant dates specified below as well as the average monthly connected users and average monthly paying users for the three months ended on the relevant dates specified below:

 

     As of or for the three months ended
December 31,
 
     2008      2009            2010  
     (millions)  

Registered users(1)

     325         474           663   

Average monthly connected users(2)

     75         105           145   

Average monthly paying users

     5.8         7.3           8.8   

 

(1)

Our registered users number as of December 31, 2008, 2009 and 2010 includes 17 million, 20 million, and 21 million users, respectively, who registered through their MySpace account. We believe that MySpace registered users are infrequent users of Skype products. The agreement with MySpace, through which users were able to register through MySpace, expired on November 27, 2010 and was not renewed by us. The registered users number in the table above excludes users that have registered on Skype through our investment to address the Chinese market, Tel-Online Limited; the number of users that registered through Tel-Online Limited amounted to 80 million, 86 million and 91 million as of December 31, 2008, 2009 and 2010, respectively.

(2)

Our average monthly connected users number for the three months ended December 31, 2008, 2009 and 2010 includes 4 million, 2 million and 0.2 million users, respectively, who registered through their MySpace account. We believe that MySpace connected users are infrequent users of Skype products. The agreement with MySpace, through which users were able to register through MySpace, expired on November 27, 2010 and was not renewed by us. The average monthly connected users number in the table above excludes users that have connected to Skype through our investment to address the Chinese market, Tel-Online Limited; the average monthly connected users that connected through Tel-Online Limited amounted to 3 million, 2 million and 3 million for the three months ended December 31, 2008, 2009 and 2010, respectively.

The table below shows average communications services revenue per paying user, which represents our net revenues derived from our communications services products for the relevant period divided by the average paying users for such period:

 

     For the year ended December 31,  
         2008              2009              2010      
    

(U.S. dollars)

 

Average communications services revenue per paying user

   $ 102       $ 98       $ 97   

The table below shows our communications services billing minutes and Skype-to-Skype minutes for each of the periods presented:

 

     For the year ended December 31,  
         2008              2009              2010      
     (billions)  

Communications services billing minutes

     6.9         10.7         12.8   

Skype-to-Skype minutes

     65.5         113.0         194.3   

 

 

20


Adjusted EBITDA

To supplement our consolidated financial statements which are presented in accordance with U.S. GAAP, we use Adjusted EBITDA as a non-GAAP performance measure. We present Adjusted EBITDA because it is used by our board of directors and management to evaluate our operating performance, and we consider it an important supplemental measure of our performance. Adjusted EBITDA, as we present it, represents net income before income tax (benefit)/expense, interest expense, interest income and other (expense), net, depreciation and amortization, further adjusted for the following additional items:

 

   

Stock-based compensation expense;

 

   

Realized loss upon amendment of our Five Year Credit Agreement;

 

   

Costs we incurred as a result of the Skype Acquisition and the Qik Acquisition, such as external transaction costs, payments under management services agreements with shareholders of Skype, transition services agreement costs payable to eBay and cash bonuses to certain Skype employees;

 

   

Litigation settlement costs;

 

   

Separation costs incurred subsequent to the Skype Acquisition and severance and bonus costs relating to the change in our CEO;

 

   

Foreign exchange gains and losses prior to invoice receipt and related to hedging instruments;

 

   

Costs incurred as a result of a dispute with a payment service provider; and

 

   

Non-capitalizable expenses attributable to this offering of securities.

Adjusted EBITDA is not in accordance with, or an alternative to, measures prepared in accordance with U.S. GAAP. In addition, this non-GAAP measure is not based on any comprehensive set of accounting rules or principles. As a non-GAAP measure, Adjusted EBITDA has limitations in that it does not reflect all of the amounts associated with our results of operations as determined in accordance with U.S. GAAP. In particular:

 

   

Unless reconciled to our pro forma net income, Adjusted EBITDA is not a pro forma measure, nor does it purport to represent what our consolidated results of operations would have been had the Skype Acquisition not occurred or occurred on a different date;

 

   

Adjusted EBITDA is not indicative of our future consolidated results of operations;

 

   

Adjusted EBITDA does not reflect our cash expenditures, or future requirements for capital expenditures;

 

   

Adjusted EBITDA does not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments, on our debt;

 

   

Adjusted EBITDA does not reflect our tax expense; and

 

   

Others may calculate Adjusted EBITDA differently than we do, and these calculations may not be comparable to our Adjusted EBITDA metric.

 

 

21


The following table reconciles our Adjusted EBITDA for the Predecessor year 2008, the Predecessor period from January 1, 2009 to November 18, 2009, the Successor period from November 19, 2009 to December 31, 2009, the pro forma year 2009, and the Successor year 2010 to the nearest U.S. GAAP performance measure, which is net income (loss):

 

    Predecessor
Year ended
December 31,
2008
    Predecessor
January 1 –
November 18,
2009
          Successor
November 19 –
December 31,
2009
          Pro forma
Year ended
December 31,
2009(1)
          Successor
Year ended
December 31,
2010
 
    (thousands of U.S. dollars)  

Net (loss)/income

    41,606        (269,083         (99,721         (417,547         (6,905

Income tax (benefit)/ expense

    (8,447     3,950            (7,209         (21,398         (49,787

Interest expense

    —          —              10,387            89,644            68,645   

Interest (income) and other expense, net

    (10,297     2,549            (5,492         (2,943         (4,817

Depreciation and amortization

    75,534        60,649            18,400            156,543            161,297   

Stock-based compensation

    12,826        14,485            261            14,746            15,950   

Realized loss on credit agreement(2)

    —          —              —              —              13,513   

Management Services Agreements with shareholders(3)

    —          —              1,685            14,177            14,835   

Acquisition transaction fees(4)

    —          —              98,715            —              1,229   

Skype Acquisition transaction bonuses(5)

    —          3,647            —              —              —     

Transition Services Agreement(6)

    —          —              1,118            1,118            2,463   

Excluded bonus and severance(7)

    —          144            1,611            1,755            15,315   

Joltid litigation settlement(8)

    —          343,826            —              343,826            —     

Other litigation settlements(9)

    (410     2,928            —              2,928            (784

Separation costs(10)

    —          873            1,181            2,054            11,312   

Foreign exchange gains and losses prior to invoice receipt and related to hedging instruments(11)

    (334     (1,140         1,132            (8         12,165   

Dispute with payment service provider(12)

    —          —              —              —              9,247   

Non-capitalizable expenses attributable to this offering of securities(13)

    —          —              —              —              669   
                                                       

Adjusted EBITDA

    110,478        162,828            22,068            184,895            264,347   
                                                       

 

(1)

See “Unaudited Pro Forma Condensed Consolidated Financial Information” and the notes thereto included elsewhere in this prospectus to understand how pro forma net income was computed.

(2)

This amount represents the expense incurred in connection with the amendment of our Amended Five Year Credit Agreement in February 2010, described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Indebtedness.”

(3)

In connection with the Skype Acquisition, we entered into management service agreements with certain of our shareholders and their affiliates, which provide for the payment of periodic monitoring fees for management, financial, consulting and other advisory services provided by them to us after completion of the Skype Acquisition. Upon the consummation of this offering, all payments we owe under these agreements will be accelerated and paid at their net present value, and these agreements will terminate. See “Certain Relationships and Related Party Transactions—Management Services Agreements.”

(4)

This amount represents the external transaction fees and expenses incurred in connection with the Skype Acquisition in 2009 and the transaction fees incurred in 2010 in connection with the acquisition of Qik, which closed in 2011.

(5)

This amount represents cash bonus payments to certain Skype executives that vested upon the completion of the Skype Acquisition.

(6)

Our indirect subsidiary, Skype Technologies S.A., entered into a transition services agreement with eBay pursuant to which eBay agreed to provide us certain transition services in connection with the conduct of our business. The initial term was one year from the date of the Skype Acquisition, except for customer service applications support, the term for which was six months. See “Certain Relationships and Related Party Transactions—Acquisition-Related Matters—The Skype Acquisition and Ancillary Agreements—Transition Services Agreement.”

(7)

In conjunction with the Skype Acquisition, a special cash pool was funded to reward eligible Skype employees. Employees were eligible to receive a bonus based on continued employment that vested on the one-year anniversary of the Skype Acquisition. The total value of awards recognized as employee compensation expense was $7.5 million during the year ended December 31, 2010. See “Certain Relationships and Related Party Transactions—Acquisition-Related Matters—The Skype Acquisition and Ancillary Agreements—Cash Pool.” Furthermore, certain employees were eligible for additional bonus payments totaling $2.9 million during the year ended December 31, 2010 based on the successful achievement of certain strategic initiatives outlined by the Company in conjunction with our separation from eBay. In addition, we incurred severance of $3.9 million paid to our former CEO and a sign-on bonus of $1.0 million paid to our current CEO, who joined during the fourth quarter of 2010. These amounts exclude payroll taxes.

(8)

This amount represents the net charge incurred by us in connection with the settlement by us and eBay of a dispute with Joltid over our use of peer-to-peer communication technology. For more information about the Joltid Transaction, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Factors Affecting Results of Operations” and “Certain Relationships and Related Party Transactions—Acquisition-Related Matters—The Joltid Transaction” included elsewhere in this prospectus.

(9)

Reflects additional losses or (gains) we recorded related to litigation settlements other than the Joltid Transaction discussed above. See “Business—Legal Proceedings” for a discussion of other legal and regulatory proceedings, disputes and regulatory inquiries related to our business.

 

 

22


(10)

Separation costs primarily relate to external service provider fees for strategic projects aimed at building processes for scaling the Company subsequent to the Skype Acquisition, establishing new employee benefit structures and compensation programs and planning for the implementation of our stand-alone IT infrastructure, as well as tax, legal and other consulting fees related to our separation from eBay.

(11)

Under U.S. GAAP, foreign currency gains and losses arising from the re-measurement of monetary assets and liabilities into our functional currencies (“foreign currency gains and losses”) are recorded in our statements of operations as a component of interest income and other (expense), net. As indicated above, we remove the total amount of interest income and other (expense), net from our calculation of Adjusted EBITDA. However, we do include in Adjusted EBITDA the foreign currency gains and losses arising between the date of initial expense recognition and the date of invoice receipt, at which point we believe management has less control over foreign currency gains and losses. Additionally, we exclude from Adjusted EBITDA gains and losses arising from our foreign exchange forward contracts. During the year ended December 31, 2010, we recognized a loss of $3.4 million in revenue relating to our foreign exchange forward contracts. We did not enter into such contracts prior to 2010.

(12)

In December 2010, we recorded a bad debt expense of $9.2 million related to a receivable from a payment processing vendor, who collected amounts due to us from our paying users in one jurisdiction.

(13)

Represents amounts paid to external advisors for certain services relating to this offering that we record as expense, as we incur them.

 

 

23


RISK FACTORS

An investment in our ordinary shares or ADSs involves a high degree of risk. Before making an investment in our ordinary shares or ADSs, you should carefully consider the following risks, as well as the other information contained in this prospectus. Any of the risks described below and elsewhere in this prospectus could materially harm our business, prospects, financial condition and results of operations. The risks described below include risks we consider material of which we are currently aware. As a result, the trading price of our ordinary shares or ADSs could decline, and you may lose part or all of your investment.

Risks Related to Our Business

We may not maintain recent rates of net revenue growth.

Although our net revenues have increased substantially over the last few years, we may not be able to maintain historical rates of net revenue growth. We believe that our continued growth will depend, among other factors, on our ability to:

 

   

attract new users, convert connected users into paying users, keep existing paying users actively using our paid products, and increase purchases of our paid products by our paying users;

 

   

develop new sources of revenue from our users and other customers, such as enterprise users;

 

   

react to changes in consumer access to and use of the Internet;

 

   

expand into new market segments and integrate new devices, platforms and operating systems;

 

   

increase the awareness of our brand across geographies;

 

   

provide our customers with a superior user experience, customer support and payment experiences; and

 

   

maintain effective and integrated payment processing capabilities.

However, we cannot assure you that we will successfully implement any of these steps.

We have recorded losses in 2009 and 2010 and we may not achieve profitability in the coming years.

We reported a net loss of $6.9 million for the year ended December 31, 2010, a net loss of $99.7 million in the period from November 19, 2009 to December 31, 2009, a net loss of $269.1 million in the period from January 1, 2009 to November 18, 2009, a pro forma net loss of $417.5 million during the year ended December 31, 2009 (including litigation settlement expenses in the net amount of $343.8 million incurred in connection with the Joltid Transaction and excluding expenses of $98.7 million related to the Skype Acquisition) and net income of $41.6 million in 2008. We reported an accumulated deficit of $106.6 million as of December 31, 2010. We may continue to incur net losses and cannot assure you that we will be profitable in the future or that, if we are, we will be able to sustain profitability. We believe that our profitability will depend, among other factors, on our ability to:

 

   

increase or maintain our net revenues (see “—We may not maintain recent rates of net revenue growth.”);

 

   

manage the costs of our business, including the costs associated with maintaining and developing our software and products and expanding our products to enterprise users, termination costs, integrating newly acquired businesses, customer support and product expansion into new jurisdictions;

 

   

manage the costs associated with regulatory compliance;

 

   

meet the challenge imposed by the intensely competitive nature of our business, including competition from large, well-established Internet companies, telecommunications companies and hardware-based voice over Internet protocol providers and, as we enter into new business areas, small and medium-size enterprise telecommunications services providers; and

 

   

maintain our current tax position.

 

24


The rate at which we add registered, connected and paying users may decline. In addition, we may fail to successfully convert connected users into paying users. As a result, our net revenues may fail to grow as we expect.

In 2010, 189 million new users registered a Skype username, and we grew our average monthly connected users by 40 million users for the three months ended December 31, 2010 compared to the same period in 2009. See, however, “—The number of our registered users overstates the number of unique individuals who register to use our products” and “—Our connected user metric is subject to uncertainties and may overstate the number of users who actively use our products.” We may fail to attract new registered users at an equivalent rate in the future. Furthermore, we lose connected users in the ordinary course of business. As a result, we need to acquire new connected users on an ongoing basis just to maintain our existing level of connected users. We must also convert connected users into paying users. If we are unable to attract new registered users, retain them as connected users and convert non-paying users into paying users, our net revenues may fail to grow as we expect and our business, results of operations and financial position will suffer.

Our operating results may fluctuate. As a result, we may have difficulty forecasting net revenues and planning expenditures to support development of our operations. Fluctuations in our operating results may cause us to fail to meet or exceed the expectations of securities analysts or investors, which could cause the market price of our ADSs to decline.

Our operating results have varied on a quarterly basis during our operating history. Our operating results may fluctuate significantly as a result of a variety of factors, many of which are outside our control, including:

 

   

Currency fluctuations: Because we have substantial global operations, we transact in a number of currencies but report our financial results in U.S. dollars. As exchange rates may fluctuate significantly between reporting periods, our net revenues, expenses and operating results, when translated into U.S. dollars, may experience significant fluctuations between periods for reasons unrelated to our operating performance. We therefore face exposure to adverse movements in currency exchange rates. To the extent the U.S. dollar weakens against foreign currencies, our net revenues and expenses from foreign-currency-denominated operations, when reported in U.S. dollars, will increase. Similarly, our net revenues and operating expenses from foreign-currency-denominated operations will be lower to the extent the U.S. dollar strengthens against foreign currencies. In particular, to the extent the U.S. dollar strengthens against the euro and the British pound, our foreign net revenues will be reduced when reported in U.S. dollars. In addition, the currencies in which we incur cost of net revenues and operating expenses may not be the same as the currencies in which we sell products to our users and customers and generate net revenues. We also may receive payments in a different currency than the one in which we sell our products to our users or customers. Beginning in 2010, we regularly seek to hedge our near-term net foreign currency positions in order to attempt to neutralize imbalances between foreign currency revenues and costs, but there is no assurance we will be able to successfully do so in practice.

 

   

Timing of product launches: Because we are a growing company and are seeking to develop and introduce new products, our net revenues may fluctuate due to our customers responding quickly to our new product offerings. Similarly, our costs fluctuate based on the level of investment in developing, marketing and/or launching products during a given quarter. For example, during any particular period, we may increase the number of employees or contractors to develop new products or launch marketing campaigns, which can increase costs significantly during that period.

 

   

Changes in our gross margin: Our gross margin (which we define as gross profit, or net revenues less cost of net revenues, divided by net revenues) can fluctuate in any given period due to a number of factors, including, without limitation, changes in product mix, user usage patterns and pricing, changes in termination costs for our SkypeOut product, and entry into or termination of commercial contracts. With respect to product mix, our subscription-based payment option has historically carried a lower

 

25


 

margin than our pay-as-you-go payment option. As a result, changes in user behavior, including in how they prefer to pay for our products, has affected and could in the future affect our product mix, which could have a negative effect on our gross margin. We change our pricing from time to time, and we may need to decrease the price of our paid products for a number of reasons, including competitive pressures. In addition, we incur termination costs in connection with our SkypeOut products. Under the contractual arrangements we have with our partners, our termination costs vary from time to time and, therefore, may increase while the net revenues corresponding to those costs may remain the same, resulting in a decreased gross margin. Moreover, in any given period we may enter into commercial contracts, such as product licensing agreements, or these agreements can be terminated, which can cause our net revenues to fluctuate and affect our gross margin.

 

   

Seasonality: Our business exhibits seasonality because many of our users reduce their use of our products with the onset of good weather during the Northern Hemisphere’s summer months and our users tend to use our products more in the fourth quarter during the holiday season resulting in weaker net revenue growth during the second and third quarter of the year. Furthermore, we experience significant spikes in the use of our products during significant holidays or world events, such as Christmas, the Chinese New Year or the 2010 volcanic eruption in Iceland.

 

   

Litigation: We have incurred, and may in the future incur, significant and unpredictable expenses in connection with litigation. In 2009, our results of operations were adversely affected by litigation settlement expenses in the net amount of $343.8 million incurred in connection with the settlement that we and eBay reached with Joltid regarding our use of the “Global Index” technology that facilitates communications in the peer-to-peer network of Skype users, which we acquired as part of the Joltid Transaction. For more information, see “Certain Relationships and Related Party Transactions—Acquisition-Related Matters—The Joltid Transaction.”

Furthermore, it is difficult for us to forecast the level of our net revenues and gross margin. In view of the rapidly evolving nature of our business and our limited operating history, we believe that period-to-period comparisons of our operating results may not be meaningful, and you should not rely upon them as an indication of future performance. Due to, among other things, our short operating history and the inherent difficulty in forecasting net revenues, it is also difficult to forecast expenses as a percentage of net revenues. Quarterly and annual expenses as a percentage of net revenues may be significantly different from historical or projected rates. In addition, our gross margin is difficult to predict due to changes in usage patterns, potential future sources of additional net revenues and future arrangements with third parties, which may include revenue sharing or other alternative pricing models.

In part as a result of the fluctuation in our results and uncertainty of our forecasts, our operating results in one or more future quarters may fall below the expectations of securities analysts and investors. In that event, the trading price of our ADSs would almost certainly decline. In addition, fluctuations in our operating results may also make it more difficult for securities analysts and investors to assess the longer-term prospects and strength of our business at any particular point, which could lead to increased volatility in the price of our ADSs. Increased volatility could cause the price of our ADSs to suffer in comparison to less volatile investments.

We generate net revenues almost entirely from the use of our paid communications services products, in particular SkypeOut, which are purchased by a small minority of our users, and may face challenges as we seek to expand our sources of revenue.

Many of our products are free. As a result, we have generated nearly all of our historical revenues from our paid communications services products, which are purchased by a small minority of our users. During the three months ended December 31, 2010, we generated on average net revenues from calls made by approximately 8.8 million paying users to landline or mobile phones. These paying users represented approximately 6% of our average connected users during this period. If even a small percentage of our paying users cease paying for our products, this could have a significant impact on our net revenues.

 

26


In addition, we have historically derived a substantial portion of our net revenues from a single product—SkypeOut. For the pro forma year ended December 31, 2009 and the year ended December 31, 2010, 86% and 86% of our pro forma net revenues and net revenues, respectively, were derived from the use of SkypeOut. Due to this dependence on SkypeOut as our primary source of net revenues, we are subject to an elevated risk of reduced demand for our SkypeOut product.

Our other sources of net revenues, including our Skype Enterprise products and marketing services and licensing, are currently limited. We may face challenges as we seek to expand our sources of revenue. For example, we have only recently enabled the Skype software client to feature industry standard-sized display advertising, and it is still uncertain what level of revenues can be generated through advertising. Furthermore, we may face difficulty in successfully implementing advertising on certain platforms, such as mobile devices. Finally, our users may respond negatively to receiving advertisements through their Skype software client, which could negatively and materially affect user engagement, our Skype brand and our results of operations.

We have a short operating history and a relatively new business in an emerging and rapidly evolving market. This makes it difficult to evaluate our future prospects, may increase the risk that we will not continue to be successful and increases the risk of your investment.

We have a short operating history with our communications services products, which were developed in connection with our launch in 2003. As a result, we have very little operating history for you to evaluate in assessing our future prospects. Also, we derive nearly all of our net revenues from Internet communications, which is a new industry that has undergone rapid and dramatic changes in its short history and is subject to significant challenges. We have expanded our headcount, facilities and infrastructure, including since the Skype Acquisition, and we anticipate that further expansion in certain areas will be required for us to operate as an independent public company and for the development of some of our businesses. For example, our number of employees and long-term contractors increased from 733 people as of December 31, 2009 to 911 people as of December 31, 2010, and we added 63 employees from Qik as part of our acquisition of Qik in January 2011. This expansion has placed, and we expect it will continue to place, a significant strain on our management, operational and financial resources. You must consider our business and prospects in light of the risks and difficulties we will encounter as an early-stage company in a new and rapidly evolving market. We may not be able to address successfully these risks and difficulties, which could materially harm our business and operating results and reduce the price of our ADSs.

Goodwill and intangible asset impairment analysis may result in charges, which may be significant.

U.S. GAAP requires us to conduct an impairment analysis of our goodwill annually and at such other times when an event or change in circumstances occurs that would indicate potential impairment. We are also required to evaluate finite-lived intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of these intangible assets may not be recoverable. Our limited operating history increases the risk of differences between projected and actual performance, which could substantially impact our future estimates of recoverability and fair value. In 2007, our results of operations were adversely affected by a charge of $1.4 billion for the impairment of goodwill. The impairment charge was determined by comparing the carrying value of goodwill in eBay’s Communications reporting unit with the implied fair value of the goodwill. Following the Skype Acquisition in 2009, we recorded the excess of the purchase price over tangible assets, identifiable intangible assets and assumed liabilities in the amount of $2.4 billion as goodwill, which is substantially higher than the goodwill in our Predecessor period financial statements. We may be required to write down the carrying value of goodwill based on the value of our business in the future. If we conclude that there is significant impairment of our goodwill as a result of any impairment analysis, we would be required to record corresponding non-cash impairment charges, which could negatively and materially affect our operating results and the market price of our ADSs.

 

27


The number of our registered users overstates the number of unique individuals who register to use our products.

We calculate registered users as the cumulative number of user accounts at the end of the relevant period. The actual number of registered users however is likely to be lower, potentially significantly, for two primary reasons. First, some legitimate users may register more than once and therefore have more than one account. For example, a user who has lost his or her original Skype Name or password may simply register again and create an additional account, or a user may create separate accounts for business and personal use. Second, we experience irregular registration activities, some of which we believe are the result of fraudulent activities that involve the creation of a significant number of spurious user accounts. See “—Failure to deal effectively with fraudulent transactions would increase our loss rate and could increase our expenses, make us liable to credit card issuing banks or result in the loss of our ability to accept certain credit cards.” The actual number of registered users includes users who we actively block from using our services due to our concerns of those users engaging in fraudulent activities. We do not validate information provided during the registration process and thus registration is not prohibited, even when we have indication that such user may engage in fraudulent activity. Instead, we limit the connection to our services of such registered users.

In addition, as of December 31, 2010, the number of registered users includes 21 million users who initially registered through their MySpace account. Such registration occurred automatically as part of the MySpace registration process, and as a result, the number of our registered users may overstate the number of users who actively decided to create a Skype account. We believe that users that have registered through MySpace are infrequent users of Skype products.

Our connected users metric is subject to uncertainties and may overstate the number of users who actively use our products.

We calculate connected users as the number of user accounts, averaged over a three month period, that log in to the Skype software client, either manually or automatically, in a given calendar month. We also include in connected users the number of users, averaged over a three month period, who have a valid Skype software certificate (for example, a mobile phone with the Skype software client installed) that is checked and has been validated during the past thirty days.

The number of connected users is subject to uncertainties and in some ways may overstate the number of users actively using our products during a given period. For example, for a number of our users, once a user has downloaded our software onto their device, the software will automatically be logged into when the device is turned on, even if the customer takes no steps to affirmatively engage our software client after initial registration. In addition, the number of connected users also includes, for the three months ended December 31, 2010, 0.2 million users who connected during such period primarily as a result of signing into their MySpace account and who we believe are infrequent users of Skype products. Our contractual arrangement with MySpace, through which users were able to register through MySpace expired on November 27, 2010 and we did not renew it. Based on recent trends, we believe that the number of users that connected to Skype through MySpace will become insignificant in the short-term and will remain insignificant.

Furthermore, a number of connected users in a given period includes the creation and use of spurious user accounts, because we count a new registered user as a connected user in the month of registration. While we have taken and will seek to continue to take steps, such as by requiring additional authentication steps, to reduce the ability of fictitious users to connect to the different versions of the Skype software client, and to prevent users from connecting to our system more than once, we cannot assure you that these measures will be effective in reducing the number of fictitious users or users who have connected more than once.

Our connected user metric is also subject to uncertainties because, in some cases, it can underestimate the number of users actively using our products during a given period. For example, users accessing Skype from behind a firewall may not be captured in our systems as connected users.

 

28


As a result, there is a degree of uncertainty in this metric because it can be influenced by different factors in the same period, sometimes with opposite effects.

Our paying user and communications services products billing minutes metrics are subject to a degree of inaccuracy due to fraudulent transactions and our method of calculating these metrics.

We calculate paying users as the number of unique user accounts, averaged over a three month period, who make a successful SkypeOut call using Skype credit on a pay-as-you-go basis in a given calendar month or who had an active subscription at any time during such calendar month. We calculate communications services billing minutes as the cumulative number of minutes that Skype users were connected to our communications services products, which mainly comprise billing minutes related to SkypeOut calls to traditional fixed-line or mobile telephones during a relevant period. A user need not be logged into the Skype software client to be considered as having made a successful SkypeOut call or to register a billing minute; for example, the user may make a Skype-to-Go call or use Call Forwarding, which do not require users to log into the Skype software client themselves.

With respect to both the number of paying users and the number of communications services billing minutes, these metrics include users paying for our products and the billing minutes generated through fraudulent activities, such as stolen credit cards. Therefore, for any given month, in particular if we have been subject to a particular spike in fraudulent activity during that period, our paying user and communications services billing minutes may not accurately reflect the genuine number of paying users and communications services billing minutes during that period. See “—Failure to deal effectively with fraudulent transactions would increase our loss rate and could increase our expenses, make us liable to credit card issuing banks or result in the loss of our ability to accept certain credit cards.”

These metrics are also subject to a degree of inaccuracy for other reasons. These metrics are derived from our operational systems, not our financial systems, and we have identified certain instances in the past whereby these systems have not always accurately captured the number of paying users and communications services billing minutes. With respect to paying users, we seek to eliminate from our number of paying users any users who only made SkypeOut calls utilizing promotional, free Skype credit or promotional subscriptions services. With respect to communications services billing minutes, we seek to eliminate from this number minutes attributable to SkypeOut calls made utilizing promotional, free Skype credit or promotional subscriptions services, or other free calls. In both cases, our operational systems may fail to classify properly these users and minutes, and accordingly these metrics are subject to potential inaccuracies.

The peer-to-peer nature of our software architecture makes it difficult to determine certain operational metrics, which may lead us to take inappropriate decisions for our business and operations or allocate our resources in an inefficient way.

Because our software operates through a peer-to-peer architecture, it is difficult for us to determine with accuracy certain operational metrics with respect to non-paid products, such as free calling minutes or the percentage of calls including certain features like video. As a result, these metrics are intended as estimates only and may not be accurate. Due to the uncertainty surrounding these operational metrics, we may not take the most appropriate decisions for our business and operations or allocate our financial resources in an optimal manner.

Our industry is intensely competitive and if we do not compete successfully, we could lose market share, experience reduced revenues or suffer losses.

The market for our products is intensely competitive and characterized by rapid technological change, and we expect competition to intensify significantly in the future. In particular, some of our competitors have taken steps or may decide to more aggressively compete against us.

 

29


Our competitors include a variety of communication service and product providers, including Internet product and software companies, telecommunications companies and hardware-based voice over Internet protocol providers and, potentially, small and medium-size enterprise telecommunications services providers. Many of our competitors are substantially larger than we are and have substantially longer operating histories and substantially greater product development and marketing budgets and financial, human and other resources than we do. Some also have greater name and brand recognition and a larger base of customers or users than we have. They may be able to devote greater resources to develop, promote, and sell their products and to respond quickly to new technologies and changing consumer behavior. We may also face a disadvantage because we do not currently offer email, a product that is offered by many of our competitors. Our ability to compete successfully depends on our ability to achieve continual technological innovation and adapt to the evolving needs of our customers, but we cannot assure you that we will be successful in this regard.

Our primary competitors include:

 

   

Internet and software companies. We compete with divisions of large Internet and software companies, including Google, Microsoft, Apple and Yahoo!, which offer a selection of instant messaging, voice and video communications products to their users. Some of these competitors charge less than we do for voice calls and SMS text messages to landline and mobile devices to or from certain countries, and most have also historically offered free calling between their users. The leading Internet companies have very large networks of users, strong brands and significant resources and have launched, and continue to launch, initiatives to compete with us. In addition, new Internet companies may choose to enter our market and integrate these products with their existing products. Initiatives by Internet companies, particularly the large Internet companies with well-known brands and large user bases, to focus more of their resources on their communications products or otherwise enhance those products, or adoption by their users of those products instead of ours, could, among other things, reduce the market for our products, increase competition for users and price competition or make our products obsolete, which could decrease our ability to attract new users or cause our current users to migrate to communications products offered by Internet companies. For example, Google has recently acquired Global IP Solutions, which has developed a real-time audio and video-over-Internet technology similar to ours. Google may use this technology to compete against us. Google has also recently expanded its internet communication services by enabling U.S. and Canadian users of its “Gmail” email service to call landlines and mobile phones from their e-mail inbox.

 

   

Telecommunications companies and hardware-based Voice over Internet Protocol (VoIP) providers. Although we are not a replacement for traditional telephone services, we compete with certain products and services offered by regulated telecommunications companies that provide landline, cable or wireless telecommunications products and hardware-based VoIP telecommunications providers that have recently begun to challenge incumbent telecommunications companies with respect to certain products in their regional markets. The telephone companies have historically dominated their regional markets due to their incumbent status and ability to offer features that we do not provide, such as emergency calling services and “bundled” services. We also compete with certain products offered by cable and satellite broadcast companies. All of these companies have the ability to offer bundled services to their large existing customer bases. For example, they can provide Internet access, television and landline and/or wireless voice communication at a price that would be lower than if the customer purchased those services separately. If the telecommunications companies with which we compete successfully introduce new products, offer bundled services at attractive prices or enhance their existing products, this could reduce the market for our products, increase competition for users and price competition, or make our products obsolete, which could impair our ability to attract new users or cause our current users to migrate to a telecommunications company. In addition, customers may be reluctant to use Internet-based communications instead of traditional telephony services because they may experience lower call quality, including static, echoes and delays in transmissions, as well as a higher rate of dropped calls. We also compete with wireless carriers, many of which have a strong retail presence and significant financial resources. Some consumers use wireless services to

 

30


 

replace landline services. Domestic and international telecommunications prices have decreased significantly over the last few years, and we anticipate that prices will continue to decrease. Users who select our products to take advantage of our prices may switch to another provider as the difference between prices diminishes or disappears, and we may be unable to use our price as a distinguishing feature to attract new customers in the future. In addition, we compete with hardware-based voice over Internet protocol providers, which have recently begun to challenge incumbent telecommunications companies in their regional markets through lower cost features and enhanced functionality. If these regional voice over Internet protocol providers are able to replace traditional telecommunications services in their region and offer products similar to ours, this could reduce the market for our products or increase price competition, which could decrease our ability to attract new users or cause our current users to migrate to those providers.

 

   

Small and medium-size enterprise telecommunications services providers. As we develop and build out our enterprise offering, we expect to compete increasingly with small and medium-size enterprise telecommunications services providers. Many of these services providers have a broad set of products and offer features we do not offer, such as email. In addition, a number of these services providers have some of the most recognized brands in the enterprise marketplace and incumbent status, including, in certain cases, long-term customer contracts. As a result, it may be difficult for us to compete with them.

One particular risk we face is that some of our competitors, particularly large incumbent telephone companies with significant financial resources, may attempt to gain significant market share from us by offering their communications products for free or at prices at or below the prices we charge, which would have a material adverse effect on our business. These and other competitors may elect to commence or intensify these forms of price competition at any time, including shortly after we complete this offering and, because many of these competitors have alternative sources of revenue, they may be able to sustain this price competition indefinitely. In addition, we expect our various communications competitors to continue to improve the performance of their current products and introduce new communications products, software, services and technologies. Some of our competitors have the ability to restrict or increase the price of access to our products and have done so. For example, in Germany, T-Mobile announced in April 2009 that it was blocking VoIP communications over its mobile network, and in June 2009 it introduced a fixed monthly fee for the option of using VoIP on its network. Many of our competitors offer email as part of their communications solution. We do not offer email, which may harm our ability to compete. If we are unable to compete effectively, our growth and ability to sell products at profitable margins could be materially and adversely affected. Going forward, as we enhance our communications product offerings, we may enter new markets and face competition from other companies.

In certain countries, companies with which we compete may be government owned, sponsored or supported, which may place us at a competitive disadvantage. For example, governments in these countries may require us to be regulated or may determine not to provide us with a necessary license. In addition, government owned, sponsored or supported companies may be able to obtain financing on terms more favorable than terms available to private companies such as us.

System failure, interruptions and downtime can attract adverse publicity for our products and result in net revenue losses and a decrease in users of Skype products.

Although we seek to reduce the possibility of disruptions or other outages, our service may be disrupted by problems with our technology and systems, such as malfunctions in our software or other facilities and overloading of the peer-to-peer network of Skype users. We have experienced system failures from time to time, including a recent outage in December 2010, and any interruption in the ability of users to use our products would reduce our current net revenues, could harm our future net revenues, could subject us to regulatory scrutiny and could lead to users seeking alternative forms of communication and ceasing to use Skype as a communications method. System failures can result from errors in our software.

 

31


On December 22, 2010 a software error in one version of our Windows client caused approximately 40% of those clients to fail. Although this error only affected approximately 20% of our global users, it resulted in 25% to 30% fewer “super-nodes” than normal being available to the network of Skype users. Super-nodes allow users’ computing and mobile devices to find other connected users. The increased load on the remaining “super-nodes”, originally unaffected by the software error, resulted in a cascading effect that led to near complete failure of the network of Skype users within a few hours of the initial event, and a loss of Skype functionality for a large percentage of Skype users for a total period of approximately 24 hours during a December holiday period where we normally experience peaks in Skype usage. Similarly, in August 2007, we experienced an interruption with the peer-to-peer network of our users as a result of an unanticipated feature of our software during which the majority of our users were unable to use our products for approximately two days. While we have taken and will continue to take remedial action to prevent such outages from occurring, there is no certainty that these failures will not occur again in the future. With respect to both outages, we experienced significant adverse publicity and lost net revenues, and any similar outage in the future would likely harm our business. As we increasingly introduce products particularly targeted at enterprise customers, for whom system stability is a critical factor, any system failures could have a significant impact on our ability to attract or maintain our relationships with enterprise customers.

As a result of disruptions, in addition to the revenues we lose during an outage, we may choose to provide our users with remedial compensation as a gesture of goodwill such as extending subscription periods by a number of days or applying credits to our paying customers’ accounts. Depending on the severity of an outage and the terms of these actions, we may incur costs as a result of these measures that could have an adverse effect on our results of operations.

In addition, the servers that process user payments experience some downtime on a regular basis and during these times our customers cannot make SkypeOut calls, which may result in lost revenues and may negatively impact our brand and customer perception of the reliability of our products. Any scheduled or unscheduled interruption in the ability of customers to use our products could result in an immediate, and possibly substantial, loss of revenues.

Our systems may be vulnerable to damage or interruption from telecommunications failures, computer denial-of-service attacks, power loss, computer viruses, earthquakes, floods, fires, terrorist attacks and similar events. Some of our systems are not fully redundant, and our disaster recovery planning is not sufficient for all eventualities. Our systems are also subject to break-ins, sabotage, and acts of vandalism. Despite any precautions we may take, the occurrence of a natural disaster, a decision by any of our third-party hosting providers or telecommunications reseller partners to close a facility we use without adequate notice for financial or other reasons, or other unanticipated problems at our hosting facilities could result in lengthy interruptions in the availability of our products. We do not carry business interruption insurance sufficient to compensate us for losses that may result from interruptions in the availability of our products as a result of system failures.

Our customers (particularly those who use our products for business, which is an area where we are seeking to increase our penetration) may use our products for critical transactions and communications. As a result, any system failures could result in damage to our customers’ businesses. These customers could seek significant compensation from us for their losses. Even if unsuccessful, this type of claim likely would be time consuming and costly for us to address.

We are subject to proceedings that may prevent us from protecting our Skype brand, which could impair our ability to market our products.

We regard our brand as one of our most valuable assets. The unlicensed use of our brand by third parties could harm our reputation, cause confusion among our users, and severely undermine the value of our brand in the marketplace. In that regard, we have registered and are in the process of applying to register the “Skype” name

 

32


and other related marks as trademarks and service marks in various jurisdictions. In the European Union and several other countries, some of our applications have received objections from the applicable trademark agency or have been opposed by third parties.

In particular, in the European Union, India and Brazil, our applications in respect of the Skype name are being opposed by BSkyB plc., a British satellite broadcaster, Internet service and telephony service provider, or by one of its affiliates. These oppositions are based on BSkyB’s claimed rights with respect to the mark “SKY.” To date, we have successfully defended these oppositions in Switzerland and Turkey and have received a positive decision in Brazil. However, in the second half of 2010, we received negative first instance decisions from the Trade Marks and Designs Registration Office of the European Union (OHIM) on BSkyB’s opposition proceeding against certain Skype trademark applications, including with respect to the Skype bubble logo, the word “Skype”, the device mark “Skype, The whole world can talk for free” and “Skypephone” marks. We are at various stages of appeal to the OHIM Board of Appeal in respect of these decisions, and intend to further appeal any OHIM decisions, if necessary, to the General Court and the Court of Justice of the European Community. If the oppositions to our applications for trademark registration are ultimately successful, it will be more difficult for us to prevent third parties from using the Skype brand without our permission in some jurisdictions, which may have a material adverse effect on our business. Moreover, a successful opposition to our application in one or more countries might encourage BSkyB or other third parties to make additional oppositions or commence trademark infringement proceedings.

In addition, if BSkyB or other third parties were to pursue litigation to prevent our use of the Skype name or logo, defending against that litigation could be costly and time consuming even if we were ultimately to prevail. If we were not ultimately to prevail in any such litigation, we could be precluded from using the Skype name or logo in one or more jurisdictions without obtaining a license from BSkyB or such other third parties, which license may not be available on commercially reasonable terms or at all, which could be costly and have a material adverse effect on our results of operations and financial condition.

In certain countries, such as China, Russia, Brazil and Indonesia, certain third parties have applied for and in some cases have been granted trademarks that are identical or similar to ours and, in certain instances, like in China, our trademark applications have faced preliminary refusals because there has been a third-party trademark application submitted prior to our application. In most cases, we are requesting a review of these preliminary refusals and are opposing and pursuing cancellation actions against those third-party trademarks and trademark applications. The loss, limitation or refusal of trademark protection for our brand in any jurisdiction could, however, have a material adverse effect on our business.

We are subject to patent and other intellectual property litigation, which is inherently time consuming and costly to manage and resolve, could divert management and financial resources away from our daily business or could require changes in our methods of doing business or our products. We expect that we will increasingly be subject to intellectual property claims as our business expands.

Our business is heavily reliant upon the quality of our products, which in turn are dependent on the underlying software and related technology, including communications technology. By its nature, software and related technology are heavily reliant on intellectual property including patents and trade secrets. Third parties have from time to time claimed, and it is likely that others will claim in the future, that we and/or our distributors or commercial partners have infringed their patents or other intellectual property rights. The application of patent law to the software industry is particularly uncertain because the time it takes for a software-related patent to issue is typically lengthy, which increases the likelihood of pending patent applications claiming inventions whose priority dates may pre-date development of our own proprietary software. We are subject to patent disputes, and expect that we will increasingly be subject to patent infringement claims as our products and distribution model expand in market share, scope and complexity.

Intellectual property claims against us, whether meritorious or not, are time consuming and costly to resolve, could divert management attention and financial resources away from our daily business, could require changes in our methods of doing business or our products, could require us to enter into costly royalty or

 

33


licensing agreements or to make substantial payments to settle claims or satisfy judgments, and could require us to cease conducting certain operations or offering certain products in certain areas or generally. We do not conduct comprehensive patent searches to determine whether the technologies used in our products infringe upon patents held by others. In addition, product development is inherently uncertain in a rapidly evolving technological environment in which there may be numerous patent applications pending, many of which are confidential when filed, with regard to similar technologies. While we believe that our products do not infringe in any material respect upon intellectual property rights of third parties, we cannot be certain that this is the case. In addition, in any potential dispute involving our patents or other intellectual property, our customers and distributors could also become the target of litigation. We have certain contractual obligations to indemnify our customers, distributors and commercial partners for liability that they may incur based on third party claims of intellectual property infringement for the use of our products or technology. For example, we distribute the Skype software client to makers of mobile and computer devices who pre-load the Skype software client with their products. In the event that any customer or distributor were subject to a claim that its use or distribution of our products infringed third party intellectual property rights, we may be responsible for the defense and costs of such claim, which could result in substantial expenses to us or could require us to modify or cease offering certain products in certain areas or generally. In addition, as a result of such claim, any such customer or distributor may decide not to use our products in the future, which could harm our results of operations and financial condition.

In 2009, we incurred a charge of $343.8 million in our results of operations resulting from the settlement that we and eBay reached with Joltid regarding our use of the “Global Index” technology that facilitates communications in the peer-to-peer network of Skype users, which we acquired as part of the Joltid Transaction. For more information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Factors Affecting Results of Operations” and “Certain Relationships and Related Party Transactions—Acquisition-Related Matters—The Joltid Transaction.”

To the extent we are subject to litigation, there is a possibility that we may be adversely affected. If we are required to make substantial payments to settle legal proceedings or to satisfy any damages that might be awarded by a court, or if a court were to enter an injunction against us, any such requirement could have a material adverse effect on our consolidated financial position and results of operations or cash flows.

We may also face infringement claims from the employees, consultants, agents and outside organizations we have engaged to develop our technology. While we have sought to protect ourselves against such claims through contractual means, there can be no assurance that such contractual provisions are adequate, and any of these parties might claim full or partial ownership of the intellectual property in the technology that they were engaged to develop for us.

The loss of licenses we currently have for a number of components of our products may require us to transition to proprietary or open source alternatives, where available, which may be lengthy and costly and could result in a degradation of the quality of our products. In addition, our products and services may be covered by patent rights held by third parties, and we may have to pay substantial royalties to secure such patent rights.

We license technology for certain components of our products from third parties we do not control, such as certain codec licenses used for encoding and/or decoding digital data streams and messaging “middleware” licences (used to pass information between servers). Although we have contracts in place with our third party technology providers, there can be no assurance that the technology we license will continue to be available on commercially reasonable terms, or at all, in the future. While proprietary or open source alternatives may be available in some cases, transitioning to such alternatives may take time and be costly. The loss of existing licenses or the unavailability of such alternative technology could result in a decrease in the quality of our products or loss of the ability to provide our products until equivalent technology or suitable alternatives can be developed, identified, licensed and integrated. For example, we have certain in-bound licenses for video

 

34


compression codecs and audio compression codecs, on which our products rely. Some of these in-licenses have a fixed term and may or not be renewed by the applicable licensor. If we were required to obtain or develop suitable alternatives, the costs associated with licensing or developing such alternatives could be high and the technical challenge of assuring “backward compatibility” with older versions of our technology may be difficult to overcome and could materially harm our business.

Our products and services rely on certain technical standards, among other things, for interoperability of communication of voice and video, including standards relating to audio and video compression standards, such as H.264 and G.729. These standards may be covered by patent rights held by third parties. The combined costs of identifying and obtaining licenses from all holders of patent rights essential to such standards could be high and could reduce our profitability or increase our losses. The cost of not obtaining such licenses could also be high if a holder of such patent rights brings a claim for patent infringement. While some such patent holders, based on their involvement with the standard setting organizations, may license relevant technology to us under reasonable and non-discriminatory terms, there can be no assurance that all necessary patent rights can be secured under such terms, and we may have to pay substantial royalties, which may include royalties for past activities, to secure such patent rights.

We may not be able to protect or enforce our intellectual property rights adequately for a number of reasons. As a result, we may not be able to prevent misappropriation or deter independent development of similar technologies by others.

We regard the protection of our trademarks, service marks, copyrights, patents, domain names, trade dress, and trade secrets as critical to our success. We seek to protect our intellectual property rights by relying on national, supranational, state and common law rights, as well as a variety of administrative procedures. We also rely on confidentiality agreements and other contractual restrictions to protect our proprietary rights and intellectual property. These contractual arrangements and the other steps we have taken to protect our intellectual property, however, may not prevent misappropriation of our technology or deter independent development of similar technologies by others. For example, we rely on contractual and license agreements with our customers, distributors and users of our application programming interfaces in connection with their use of our products and technology, including “click-wrap” and “shrink-wrap” licenses with our end user customers, which are not negotiated or signed by individual licensees and therefore may be more difficult to enforce or may even be unenforceable in some jurisdictions. We cannot assure you that our contractual restrictions will not be breached, that we will be able to effectively enforce these agreements, that we will have adequate remedies for any breach, or that our trade secrets and other proprietary information will not be disclosed or will otherwise be protected.

We continue to pursue the registration of certain of our trademarks, service marks, patents, and domain names in the European Union, the United States and in certain other jurisdictions. Effective trademark, copyright, patent, domain name, trade dress, and trade secret protection may not be available in every country or jurisdiction in which our products may be made available, which may cause our business and operating results to suffer. Where effective protection is available, it may be very expensive to maintain and may require litigation, and even then it may not be successful in preventing the misappropriation of our intellectual property or the development of similar technologies by others.

We aim to protect our trademarks from infringement by third parties. However, we evaluate each case independently and we may decide to take less stringent enforcement action, or in some cases, no action at all, based on the circumstances. This may dilute our trademark rights, and subject them to challenge or invalidation, which could harm our reputation, cause confusion among our users, and undermine the value of our trademarks in the marketplace. In the extreme case, this may result in abandonment of our trademarks in jurisdictions where we have not enforced our trademarks diligently.

Internet search engine keywords purchased and domain names registered by third parties could cause confusion to our users, divert online customers away from our products or harm our reputation.

Competitors and other third parties may purchase our trademarks and confusingly similar terms as keywords in Internet search engine advertising programs and in the header and text of the resulting sponsored link

 

35


advertisements in order to divert potential customers to their websites. Preventing such unauthorized use is inherently difficult. If we are unable to protect our trademarks and confusingly similar terms from such unauthorized use, competitors and other third parties may continue to drive potential online customers away from our websites to competing websites, which could harm our reputation and cause us to lose revenue.

Third parties have registered domain names that contain the Skype trademark without our consent, and a small proportion of the Skype domain names are registered in the names of our former employees rather than in our name. While we are seeking to have these domain names transferred to us, we may not be successful and to the extent that Skype domain names are not under our control in certain countries, it could hinder our marketing efforts, cause confusion to our users and may harm our reputation in those countries if those domain names are used in ways unrelated to our business or in ways with which we would not agree.

As our patents may expire and not be extended, our patent applications may not be granted and our patent rights may be contested, circumvented, invalidated or limited in scope, our patent rights may not protect us effectively. In particular, we may not be able to prevent others from developing or exploiting competing technologies.

A number of our patents expire between 2021 to 2026. If we are unable to obtain continuations of such patents upon their expiration, we will lose the benefit of exclusive use of the technology covered by these patents. In addition, we have patent applications pending in various jurisdictions, and we cannot assure you that our pending applications will be granted. Even if patents are issued from our patent applications, which is not certain, they may be contested, circumvented or invalidated in the future. The rights granted under any issued patents may not provide us with proprietary protection or competitive advantages. Further, the claims under any patents that issue from our applications may not be broad enough to prevent others from developing technologies that are similar or that achieve similar results to ours. It is also possible that the intellectual property rights of others will bar us from licensing and from exploiting any patents that issue from our pending applications. Numerous U.S. and foreign issued patents and pending patent applications owned by others exist in the fields in which we have developed and are developing our technology. These patents and patent applications might have priority over our patent applications and could subject our patent applications to invalidation. Finally, in addition to those who may claim priority, any of our existing patents or patents that issue from our applications may also be challenged by our competitors or others on the basis that they are otherwise invalid or unenforceable.

We may be unable to protect, or enforce our intellectual property rights in, our source code adequately.

Protection of our source code is very important to us. We protect our source code as a trade secret and as a copyrighted work. We distribute our products in object code, which is a form of computer software that is executed by computers and does not reveal the structure or logic of the programming performed by humans. Our agreements with our customers prohibit reverse engineering of the object code to get access to the source code. Nevertheless, a third party might try to reverse engineer or otherwise obtain and use our source code without our permission. The steps taken by us to protect our source code may not be adequate to prevent misappropriation. In addition, the laws of some countries in which we sell our product may not protect software and intellectual property rights to the same extent as the laws of the United States. Unauthorized copying, use or reverse engineering of our products could have a material adverse effect on our business, financial condition and results of operations.

We may be required to freely provide source code for our products to the extent that such code is a derivative work of open source code that is included in our Skype software for ancillary capabilities.

Some of our Skype software client includes open source code for ancillary capabilities. While we believe that there is no obligation to make available or redistribute other components of the Skype software as a result of the inclusion of such open source code, in the event that our software includes open source code which does in fact introduce such obligations, we may be required to freely provide source code for our products to the extent that such code is a derivative work of the open source code for others to use, modify and redistribute according to the open

 

36


source code license. The terms of many open source licenses have not been interpreted by U.S. and other courts, and there is a risk that these licenses could be construed in a manner that could impose unanticipated conditions or restrictions on our ability to commercialize our products. If we were found to have violated an open source license, the copyright holder for the corresponding open source software may be able to obtain injunctive relief and/or monetary damages against us. In addition, open source licenses generally do not provide warranties or other contractual protections regarding infringement claims or the quality of the code. Thus, we may have little or no recourse if we become subject to infringement claims relating to the open source software that we might use or if such open source software is defective in any manner.

If our business were deemed to be a regulated telecommunications business in one or more jurisdictions, it would significantly increase our expenses and may require us to change our products and other aspects of our business in potentially detrimental ways.

We operate as a software company and not as a regulated telecommunications company. We are subject to the risk that, due to changes in communications, e-commerce and other similar laws and regulations or in the application, interpretation or enforcement of both existing and future communications, e-commerce and other similar laws and regulations, we may be required to comply with these laws and regulations in one or more jurisdictions. In addition, we are continually seeking ways to improve our products and offer them across multiple communication platforms, which may involve from time to time upgrades or changes in the technological infrastructure on which our products are based and which could result in subjecting our activities to greater regulation in multiple jurisdictions. For example, the rolling out of our Skype Enterprise suite of products in the United States may subject us to a greater risk of regulatory oversight in this country. If we are required to comply with communications, e-commerce and other similar laws and regulations, we would need to meet a number of obligations, which could vary from jurisdiction to jurisdiction, including new or enhanced compliance in the following areas:

 

   

licensing and notification requirements;

 

   

emergency calling requirements, including enhanced emergency calling through multi-line telephone systems;

 

   

universal service fund contribution requirements;

 

   

lawful interception or wiretapping requirements;

 

   

privacy and data retention and disclosure requirements;

 

   

limitations on our ability to use encryption technology;

 

   

disability access requirements;

 

   

consumer protection requirements and local dispute resolution requirements;

 

   

requirements related to customer support;

 

   

quality of service requirements;

 

   

provision of numbering directories;

 

   

numbering rules, including portability requirements;

 

   

directory and operator services; and

 

   

access and interconnection obligations.

If we are required to comply with communications, e-commerce and other similar laws and regulations in one or more jurisdictions, it could have the following effects, among others:

 

   

the cost and general impact of compliance would be substantial, may require significant investments and organizational changes and may erode or eliminate our pricing advantage over competing forms of communication and, potentially, our ability to compete effectively;

 

37


   

the cost of compliance may adversely affect our operating margins or profitability or result in net losses;

 

   

compliance may require us to make certain fundamental and potentially detrimental changes to the products we offer and the way we conduct business in certain states, countries or other regions, including withdrawing products and withdrawing from markets;

 

   

compliance may be technically difficult or impossible;

 

   

we may need to change our distribution, marketing and sales activities;

 

   

we may need to terminate or restructure partnerships and other commercial agreements;

 

   

we may need to establish a local presence in any given jurisdiction, sell our products through a local entity and be required to pay new or increased taxes in that jurisdiction;

 

   

we may become subject to additional local laws and regulations by virtue of being subject to communication and other similar laws and regulations, and compliance with those additional laws and regulations may be costly and adversely affect our business; and

 

   

we would need to increase our headcount.

The regulation of Internet communications products is currently uncertain, which poses risks for our business from changes in laws, regulations, interpretation or enforcement of existing laws or regulations.

The current regulatory environment for Internet communications products is uncertain. Many laws and regulations were adopted prior to the advent of the Internet and related technologies and, as a result, do not contemplate or address the specific issues associated with the Internet and related technologies. Laws that do reference the Internet are being interpreted by the courts and regulatory agencies, but their applicability and scope remain largely uncertain and are subject to statutory or interpretive change. We cannot be certain that we, our partners or our users are currently in compliance with regulatory or other legal requirements in the numerous countries in which Skype is used. Our failure, or the failure of those with whom we transact business or to whom we license our software, to comply with existing or future regulatory or other legal requirements may subject us to a variety of penalties and force us to alter our products, operations, organization and infrastructure. Regulators disagree or may disagree with our interpretations of existing laws or regulations or the applicability of such laws or regulations to our business, or they may alter their view of the products we provide, due to a change in laws, regulations or interpretation of existing laws or regulations or otherwise. Due to the uncertainty of the regulatory status of Internet communications products in many jurisdictions worldwide, we frequently must respond to inquiries and requests from regulators about our regulatory status, which may mobilize internal resources and be time-consuming and costly.

For example, authorities in Sweden ruled in 2009 and confirmed in 2010 that we were a provider of electronic communications services in Sweden and, therefore, subject to a local notification obligation. While we disagree with the ruling of the Swedish authorities, we have however made a number of changes as to how we offer our products to Swedish users in response to the Swedish ruling. In addition, the telecommunications regulatory authority in Austria formally ruled in 2007 and again in 2008, that provision of the SkypeOut product should be suspended in Austria until we register as an electronic communications services provider and comply with local electronic communications regulations. We do not agree with the ruling of the Austrian authorities. We have not changed how SkypeOut is offered in response to this ruling and do not believe that any attempt has been made to enforce this ruling.

There can be no assurance of the views of regulators on the applicability of legal and regulatory requirements to our products in the future or of the views of regulators of any actions we have taken or may take in the future in any jurisdiction. If we are ultimately required to comply with these requirements, we may need to make changes to our products, processes, organization and infrastructure, which could be costly and difficult.

 

38


Because our products are used worldwide, we may be deemed to be subject to regulations in multiple jurisdictions, which would be complicated and costly and may require us to change our business practices or organization or limit the products we offer.

We are incorporated in Luxembourg and generally operate under Luxembourg law. For the purposes of Skype Enterprise sales to U.S.-based enterprise customers, we have also recently started to offer our products through Skype Inc., a Delaware corporation. However, because our products are used worldwide, and facilitate communications among users worldwide, one or more jurisdictions (including the state jurisdictions in the United States) may claim that we or our users are required to comply with their laws based on the location of our various offices, staff, commercial partners, commercial operations, equipment or one or more of our users. Compliance with telecommunications, data retention, privacy, consumer protection and other applicable laws and regulations in multiple jurisdictions and states may be complicated or costly or may require us to change our business practices or organization or limit the products we offer, and the imposition of any laws and regulations on our users may harm our business. In addition, we may be subject to overlapping legal or regulatory regimes that impose conflicting requirements on us. As our business grows and evolves and our products are used in a greater number of countries, and as the group of countries in which we employ staff grows, more jurisdictions and states are likely to claim that we are subject to their telecommunications, data retention, privacy, consumer protection, financial and other applicable laws and regulations. Any failure to comply with local laws and regulations could subject us to penalties ranging from criminal prosecution to significant fines to bans on our products.

As a precautionary response to the regulatory framework in certain countries, we have limited the manner in which we market and sell our paid products. In the future, we may decide to alter our business or the products we offer in ways that would make our activities more likely to be subject to telecommunications, consumer protection and other local laws and regulations.

As a precautionary response to the regulatory framework in certain countries, we have limited localized and offline marketing and sales activities for our paid products, such as bill boards or television advertisements. These limits on our marketing and sales activities may make it more difficult to attract or retain users or to maintain our brand, which may harm our business prospects. In the future, we may decide to change our business model or offer products and services in ways that would make our activities more likely to be subject to telecommunications, data retention, privacy, consumer protection and other local laws and regulations in multiple jurisdictions and the additional associated costs of compliance and the risks of non-compliance. We may choose to do this in one or more selected jurisdictions or generally. The benefits obtained from increased sales and marketing may be outweighed by the costs associated with regulatory compliance discussed in “—If our business were deemed to be a regulated telecommunications business in one or more jurisdictions, it would significantly increase our expenses and may require us to change our products and other aspects of our business in potentially detrimental ways.”

If our local partners do not comply with local law and other applicable laws and regulations, we may face additional regulation, liabilities or penalties or other governmental action, and our brand and reputation may be harmed.

In certain countries, such as Brazil, China, South Korea and Taiwan, we rely on our local partner for regulatory compliance, including compliance with local telecommunications laws and other applicable laws and regulations. For example, our local partner in South Korea (which is a subsidiary of eBay) and our local partner in Taiwan hold the governmental license necessary for them to offer our paid products in that country. To address the Chinese market, we have a 49% interest in an entity, Tel-Online Limited, and our majority partner, Tom Online, in practice handles relationships with local regulatory and law enforcement authorities. If our local partners do not ensure that their operations and our products comply with local law and other applicable laws and regulations, we may face additional regulation, liability or penalties or other governmental action for failure to comply with these laws and regulations, and our brand and reputation may be harmed as a result of negative

 

39


publicity resulting from any such failure. Our reliance on our local partners to comply with local laws and other applicable laws and regulations could cause also us harm, reputational or otherwise. See “—User concerns about our use and protection of personal data and the privacy of their communications and data protection breaches could harm our brand, reduce demand for our products and expose us to government proceedings and actions. Failure or perceived failure by us to comply with our privacy policy or legal or regulatory requirements in one or multiple jurisdictions could result in proceedings, actions or penalties against us. ”

We develop and provide new products and features that may be deemed to be subject to telecommunications and other laws and regulations in various jurisdictions.

We are developing and have developed new products and features, such as Skype Connect and Skype Manager, that involve from time to time upgrades or changes in the technological infrastructure on which they are based and in the way they operate and are offered, which could be deemed to be subject to telecommunications and other laws and regulations in different jurisdictions. If such new products and features were deemed to be subject to, and we were required to comply with, telecommunications, data retention, privacy, consumer protection and other local laws and regulations in one or more jurisdictions, we would need to meet a number of obligations, which could vary from jurisdiction to jurisdiction. See “—If our business were deemed to be a regulated telecommunications business in one or more jurisdictions, it could significantly increase our expenses and may require us to change our products and other aspects of our business in potentially detrimental ways.”

Established businesses and their trade associations may employ their resources in an effort to shape legal and regulatory regimes in ways intended to reduce the competitiveness of our business.

Some third parties, including our competitors, have raised, and may raise in the future, concerns with policymakers and regulators in various parts of the world about the application of local laws and regulations to our business. We believe that some of these established businesses (which may include incumbent telecommunications companies) and their trade association groups employ significant resources in their efforts to shape legal and regulatory regimes and may employ these resources to change legal and regulatory regimes in ways intended to reduce the competitiveness of our business. Most incumbent telecommunications companies, landline and wireless, have substantial budgets devoted to lobbying and governmental relations and long-standing relationships with regulators and legislators that we, as a newer entrant in the Internet communications market, do not have. Some of these incumbent businesses have raised concerns relating to allowing consumers open access to the Internet, the lack of regulatory controls and obligations placed on Internet communications products, and the cost advantage this brings to providers of such products. Continuing actions by these competitors or trade groups may result in additional jurisdictions requiring us to comply with the local telecommunications and other laws and regulations.

We may be required to comply with emergency calling regulations in certain jurisdictions. Compliance with emergency calling regulations may be costly and technically difficult.

In many jurisdictions, traditional and replacement telephony service providers and some other forms of communications service providers are required to provide customers with emergency calling services (such as dialing 911 in the United States or 112 in the European Union) that route calls directly to an emergency services dispatcher in the caller’s area. In some jurisdictions, for example, the United States, these emergency calling services obligations also include a requirement that the telecommunications provider provide the location of the person making the emergency call. Our products generally do not offer emergency calling services.

At the end of 2009, for example, the European Parliament adopted amendments to the E.U. telecommunications regulatory framework that will require changes to be made to communications laws of the 27 E.U. Member States by May 2011. Under the E.U. directive, home country legislation must provide that any

 

40


electronic communications service designed for originating calls must provide “reliable and accurate” access to emergency services through emergency numbers. Although it is currently uncertain how each Member State will implement these amendments, whether some Member States may not have completed their amendment process by May 2011 resulting in delayed implementation and whether these amendments will apply to our operations, we may be required to comply as and when implementing legislation is introduced in the E.U. Member States. We have voluntarily begun to provide a basic level of emergency calling functionality without location information in the United Kingdom and Australia. In 2011, we intend to implement a similar voluntary basic level of emergency calling functionality in certain Nordic countries, the Netherlands and Ireland and we may voluntarily offer certain emergency calling services in other jurisdictions in the future.

Unlike landline phones, where the telephone is located at a fixed address, or mobile phones, which can be located using triangulation of cell towers or GPS technology in the handset, we are unable to determine the exact location of a caller who uses our products to make a call over the Internet. Our customers have the ability to use our products nomadically, meaning that they can log in and use our products from virtually any Internet connection worldwide. They can also log in on up to five devices simultaneously at a variety of locations. Although we have the limited ability to identify the registered user using our products to make a call (based on information voluntarily provided to us when the user first registered with us), we cannot determine the actual location from which a call is originated. Additionally, due to the inherent nature of transmission via the Internet, we are unable to guarantee completion of any call, including a call to emergency services. Regulators and other authorities are evaluating whether and how software products such as Skype might supply location data to first responders and interoperate with a next-generation emergency calling network. The E.U. telecommunications framework amendments also include a provision that, once internationally recognized standards ensuring accurate and reliable routing and connection to the emergency services are in place, “network-independent” providers, such as Skype, should also fulfill the obligations related to caller location information at a level comparable to that required of other providers. To date, in places where we have enabled and will enable this functionality, we are still unable to identify reliably the geographic location of the user beyond the country level or to provide detailed caller information, and the user location information is not being provided to our carrier partners or emergency call centers in connection with the call.

If we were required to comply fully with all emergency calling service requirements, which vary from jurisdiction to jurisdiction, it would be costly and technically and administratively difficult or impossible. Compliance with these regulations may require us to alter or limit our products in certain jurisdictions or otherwise change the way we do business in those jurisdictions.

If we were required to contribute directly to universal service funds, the cost of providing our products would increase, and if we were to seek to recover the increased cost from our customers, the cost advantage of using our products would be reduced.

Certain countries, including the United States, France, Spain, Canada, Australia, India, Japan, Hong Kong, South Korea and Taiwan, as well as several states within the United States, have adopted laws that allow regulatory authorities to require telecommunications providers to contribute to a universal service fund, or USF, that is imposed by law and applied through regulation to facilitate access to telecommunications services by all potential users. For example, in the United States, the U.S. Federal Communications Commission (the “FCC”) requires certain telecommunications carriers or interconnected voice over Internet protocol providers to contribute a percentage of their interstate revenues to the federal universal service fund. The percentage is adjusted periodically and was 15.5% of interstate revenue as of January 1, 2011. Currently, we rely on our carrier partners, which are telecommunications providers, to make any federal universal service fund payment applicable to our paid products. From time to time we have received, and may continue to receive, inquiries from regulators relating to the applicability of the universal service fund to our paid products. We respond to these inquiries in the ordinary course, stating that direct universal service payment requirements are not applicable to our products. In the United States, for example, the federal universal service fund only applies to telecommunications services and interconnected voice over the Internet protocol services, a category of services we believe would not include our paid products. If

 

41


we were required to contribute directly to any universal service funds, including due to a change in laws or regulations or a change in interpretation of current laws or regulations, the cost of providing our products would increase. If we became subject to any such laws or regulations, we might seek to collect universal service fund contributions from our customers or alternatively recover increased costs through rates we charge for calls; however, that would increase the cost of our products to our customers and could reduce demand for our products. In addition, if we were required to make universal service fund contributions based upon a change in interpretation of a current regulation, the requirements for the contribution might be imposed on us retroactively, in which case we would be unable to recover costs relating to past calls from our customers. Retroactive application of these laws could also require us to make significant payments, which could harm our results of operations or financial condition.

Compliance with requests from law enforcement agencies and compliance with data disclosure and lawful interception laws is costly and difficult and might subject us to conflicting obligations and result in improper interpretation and application of complex laws.

Communications companies are subject to various regulations that require them to assist law enforcement and intelligence agencies with access to personal and traffic data and lawful interception of certain of their services and products. The scope of applicability and level of sophistication of such regulations vary greatly from country to country. We have been and may in the future be asked to disclose historic personal and traffic data to various law enforcement agencies. In addition, various authorities could consider that we are subject to lawful interception laws, and we have been contacted from time to time by a number of authorities in relation to our ability to intercept, trace or identify our users’ communications. Furthermore, we monitor regulatory developments in countries such as India where regulators have expressed a desire for greater access to highly encrypted internet communication data like that used in some of our products. To the extent that our products and operations are or were found to be or would become subject to lawful interception laws in any jurisdiction, we would need to adapt our systems and processes to comply with a variety of requirements on a jurisdiction-by-jurisdiction basis, which can be very costly and technically difficult. Furthermore, such requests by law enforcement and other authorities can make us subject to potentially conflicting obligations across jurisdictions. In addition, determining whether compliance is legally appropriate in any particular case could require us to exercise judgment and result in improper interpretation and application of complex laws. Compliance with data disclosure and legal interception orders may also conflict with certain local laws, including laws governing privacy.

As data retention laws vary from jurisdiction to jurisdiction and may overlap, compliance may be difficult and costly from a legal, operational and technical perspective.

Many countries, such as the E.U. Member States via the 2006 E.U. Data Retention Directive, are introducing, or have already introduced, into local law some form of traffic and user data retention requirements, which are generally applicable to providers of electronic communications services. Retention periods and data types vary from country to country, and the various local data protection and other authorities may determine their jurisdiction with respect to certain data in different and potentially overlapping manners. We may be subject to data retention obligations in one or more jurisdictions, and we could become further subject to these obligations through changes to our product offerings or as result of modifications to our products or changes to the technological infrastructure on which our products are based or otherwise. Compliance with those laws can be difficult and costly to our activities from a legal, operational and technical perspective.

Telecommunications numbering rules could require us to change the manner in which we use or contract for numbers, or require that we suspend, withdraw or otherwise limit number-based products, potentially resulting in customer claims and loss of customers, regulatory disputes and limitations on future local operations.

In the jurisdictions where we enable the provision of numbers for our SkypeIn or Skype to Go products, changes in the numbering rules or changes in their interpretation or enforcement could require us to change the

 

42


manner in which we use or contract for numbers, or require that we authorize transfers (or provide portability), suspend, withdraw or otherwise limit number-based products in affected markets, potentially resulting in customer claims and loss of customers, regulatory disputes and limitations on future local operations, including limitations on the usage of numbers and access to carrier partners, negatively impacting the Skype brand, products, carrier and other partnerships, operations and regulatory positioning in the relevant jurisdictions. See “Business—Regulation.”

If we are required to obtain, maintain or update import, export and distribution authorizations and licenses for highly encrypted technologies and fail to comply with such requirements, the availability and use of our products and our partners’ products may be negatively affected.

In some countries, the export, import and distribution (online and offline) of highly encrypted technologies, such as our software application, are subject to licenses, authorizations or permissions by relevant local authorities. In 2005, the Luxembourg competent authority (the “Office des licences”) confirmed that the Skype software benefits from an exemption from export authorization. In 2006, we obtained an authorization from the U.S. Department of Commerce for the export of Skype software. If we are not able to obtain, maintain or update import, export and distribution authorizations and licenses in countries that require them, it may negatively impact the distribution, availability and use of our products and our partners’ products in such countries and subject us to penalties ranging from criminal prosecution to fines or bans on the distribution of our products.

Compliance with disabilities access regulations could be technically difficult and could impose significant additional costs on our operations.

In some jurisdictions, telecommunications services, website and software providers are subject to various rules to ensure that their sites and products are sufficiently accessible to people with disabilities, such as visual impairment. These rules are designed generally to ensure that people with disabilities can access the features of websites or software in a functionally equivalent manner as compared to people without disabilities. For example, in October 2010, the 21st Century Communications and Video Accessibility Act was signed into law in the United States, which outlines several steps to ensure that persons with vision and hearing disabilities have full access to a range of communications mediums. Although we believe the law will apply to certain Skype products and the FCC has moved to implement the law, the implementation process is at an early stage, and there is considerable uncertainty about how the law will ultimately impact our products and business more generally. Similarly, the European Commission is becoming more active in this area, and requirements for functional equivalence were adopted in the review of the E.U. electronic communications regulatory framework agreed at the end of 2009. These requirements may impact the way we develop, and the usability of, our software. Depending on how the requirements are adopted, requirements to implement disabilities access requirements on part or all of our website and one or more of our products could be technically difficult to comply with and could impose significant additional costs on our operations.

If our online credits were regulated as a currency or if we were regulated as an electronic money lending institution or similar entity, we would face additional compliance costs.

Our customers purchase online prepaid credits to buy and use our paid products, which we refer to as Skype Credit. If existing laws and regulations that apply to currencies, currency issuing activities or electronic money (e-money) were interpreted by regulators to apply to Skype Credit or us, or if new laws or regulations were adopted that would cause Skype Credit to be regulated as a currency, e-money or financial service generally or if we were regulated as an electronic money lending institution, we could be required to comply with those laws and regulations and any such compliance may be costly. For example, if Skype Credit were regulated as a currency or as e-money or if we were regulated as an electronic money lending institution or credit issuer, we may be required to seek licenses, authorizations or approvals from relevant regulators, the granting of which may be dependent on us meeting certain capital and other prudential requirements; we may be subject to additional oversight of our business; and we may be required to comply with conduct of business rules, including disclosure requirements and anti-money laundering and know-your-customer rules, all of which could significantly increase our operating costs.

 

43


For example, in 2009, the Japanese Financial Services Act was amended establishing new conditions requiring companies that offer pre-paid credit to register as an issuer of credit and post a bond, for example by establishing a trust fund, amounting to a minimum of 50% of the total of the value of the outstanding amount of credit. While we believe that we do not conduct operations in Japan, if we were ultimately required to comply with the new provisions of the Japanese Financial Services Act, compliance could be costly and difficult.

Certain countries are reported to have prohibited or blocked the use of our products; however, consumers in those countries may continue to use our products, which may cause these countries to impose penalties on us or take other governmental action against us.

Certain countries have made the use of one or more of our products illegal or are reported to have prohibited or blocked access to our website. For example, the United Arab Emirates is reported to have banned the use of our products and the accessibility of our website in its territory. In January 2011, however, the U.A.E. regulator is reported as having revised its position and shifted the burden for allowing, or not allowing, the use of Skype to the country’s two incumbent operators. In addition, in March 2010, the Egyptian National Telecommunication Regulatory Authority (“NTRA”) announced that it was banning Skype when accessed on mobile devices, citing an Egyptian law that international calls must pass through an international long distance gateway controlled by a license holding Egyptian company. However, we believe, following clarification from the Communications Ministry, that Skype products are authorized to be accessed through fixed broadband and fixed and mobile WiFi Internet connections in Egypt. More recently, in connection with recent political developments in Egypt, the use of Skype products in Egypt was disrupted when access to the Internet was suspended temporarily by the Egyptian government. If governments in other countries similarly respond to civil unrest or political instability by suspending the use of the Internet in their countries for extended periods of time, our business in those countries and our results of operations may be adversely affected.

Even where our products are reportedly illegal or become illegal and access to our website is impaired, users in those countries who continue to have access to our software may be able to continue to use our products in those countries notwithstanding the illegality of doing so. We may be subject to penalties or governmental action if consumers continue to use our products in countries where it is illegal to do so, and any such penalties or governmental action may be costly and may harm our business.

Because we are not a regulated telecommunications provider, we do not benefit from certain liability exemptions regarding emergency calling services from which regulated providers may benefit, which may expose us to significant liability in jurisdictions where we offer limited emergency calling services.

In a number of jurisdictions, “interconnected VoIP” companies are exempt from liability for failure of emergency calling services. In the United Kingdom and Australia, we voluntarily offer certain limited emergency calling services and intend to voluntarily offer certain emergency calling services in other selected jurisdictions in the future. In jurisdictions where we offer emergency calling services, we may be responsible for potential limitations and failures in the provisions of such services, and we may not have the benefit of any exemptions from liability that may be provided to regulated telecommunications providers. The unavailability of this exemption may expose us to liability from customers who suffer personal injury or other damages as a result of using our emergency calling services. Any such liability could be significant.

Our business depends on our users having continued and unimpeded access to the Internet. Companies providing access to the Internet may be able to block or degrade our calls, or block access to our website or charge us or our users additional fees for our products.

Most of our users rely on open, unrestricted access to the Internet to use our products. In many cases that access is provided by companies that compete with at least some of our products, including incumbent landline telephone companies, cable television system operators, mobile wireless communications companies, and large Internet service providers. Some of these providers in the United States, Canada, the European Union and other jurisdictions have stated that they may take measures that could block, degrade or otherwise disrupt our calls, or

 

44


increase the cost of customers’ use of our products by restricting or prohibiting the use of their lines or access points to the Internet for our products, by filtering, blocking, delaying, or degrading the packets of data used to transmit our communications, and by charging increased fees to our users for access to our products. For example, in June 2010 AT&T in the United States and certain carriers in the United Kingdom introduced tiered priced data plans for the iPhone setting monthly data usage limits, with iPhone users incurring overcharges above those quotas. In South Korea, SK Telecom and Korea Telecom have introduced data plans limiting the amount of VoIP usage within any particular plan. These plans may diminish the attractiveness of our products on the iPhone and similar high-end mobile devices as users increase their data use and find their usage restricted by their plans. In addition, Internet access providers may limit the ability of our existing or prospective users to gain access to our website to download our software or purchase Skype Credit.

Some Internet access providers have additionally, or alternatively, contractually restricted their customers’ access to Internet communications products (which would include Skype) through their terms of service. For example, France Telecom, SFR and Bouygues in France and Telenor and Telia in Sweden restrict access to voice over the Internet protocol services to only their most expensive mobile calling plans. Among others, T-Mobile in Germany and Vodafone in Italy, Germany and the United Kingdom have established special additional tariffs for voice over the Internet protocol. Customers of these and other Internet access providers may not be aware that technical disruptions or additional tariffs are the act of other parties, which could harm our brand. Even if customers understand that we are not the source of such disruptions, they may be less likely to use our products as a result.

Our products may also be blocked or degraded by firewalls or other measures implemented to protect private networks maintained by enterprises, governmental bodies or others, and certain of these entities may take steps to prevent their employees and other users of their networks from using Skype products. Interference with our products or higher charges for access to our products, whether paid by us or by our customers, could cause us to lose existing customers, impair our ability to attract new customers, and harm our revenues and growth.

In the United States, the European Union and other jurisdictions, regulatory authorities are in the process of examining the adoption of “network neutrality” policies, which aim to treat all Internet traffic equally, and developing or considering laws and regulations to codify acceptable behaviors on the part of network operators and access providers when providing consumers and businesses with access to the Internet. In December 2010, the FCC approved rules promoting “network neutrality”; however, the rules are subject to legal challenges in the United States courts and may not be enforced by the FCC or be overturned by the federal legislature. Different regulatory authorities have different approaches to this policy area both from a substantive and procedural perspective. Any failure on the part of regulatory authorities to protect the accessibility of the Internet to all, or any particular category of, Internet subscribers, or their failure to protect the delivery on a non-discriminatory basis of user communications over the Internet, regardless of type or service, could harm our results of operations and prospects.

Our future performance depends on key personnel, and we may not be successful in attracting and retaining senior management and highly skilled engineering, technical, managerial, marketing and customer support personnel to meet our managerial and technical needs in an intensely competitive environment.

Our future performance depends substantially on the continued services of our senior management and other key personnel, including our engineers, and our ability to retain and motivate them. We do not have long-term employment agreements with any of our key personnel and we do not maintain any “key person” life insurance policies. The loss of the services of any of our executive officers or other key employees could harm our business, as could the loss of certain groups of engineers. Our business depends on attracting and retaining key personnel. Our future success also will depend on our ability to attract, train, retain and motivate highly skilled engineering, technical, managerial, marketing and customer support personnel. Competition for this personnel is intense, and we may be unable to successfully attract, integrate, or retain sufficiently qualified personnel. In making employment decisions, particularly in the Internet and high-technology industries, job candidates often consider the value of the equity awards they would receive in connection with their employment. If our

 

45


employees have substantial in-the-money, vested options or other equity awards it may be difficult to motivate and retain those employees. Conversely, if options granted to our employees have exercise prices that are substantially “under water,” meaning that the option exercise price is substantially above our then-current ordinary share price or ADS price, it may be difficult to motivate and retain those employees. Likewise, if the market price of our ordinary shares or ADSs does not increase or declines, it may limit our ability to attract new employees with equity incentives.

Our senior management has limited experience working together as a group and may not be able to manage our business effectively.

Many of the members of our senior management, including our Chief Executive Officer, Chief Financial Officer, Chief Marketing Officer and Chief Legal Officer, have been hired since March 2010. As a result, our senior management has limited experience working together as a group. This lack of shared experience could harm our senior management’s ability to quickly and efficiently respond to problems and effectively manage our business. If our senior management is not able to effectively work together as a group, our results of operations may suffer and our business may be harmed.

Rapidly evolving technologies could cause demand for our products to decline or could cause our products to become obsolete.

Current or future competitors may develop technological or product innovations that address Internet communications in a manner that is, or is perceived to be, equivalent or superior to our products. In the technology market in particular, innovative products have been introduced which have the effect of revolutionizing a product category and rendering many existing products obsolete. If competitors introduce new products or services that compete with or surpass the quality or the price/performance of our products, we may be unable to attract and retain users or to maintain or increase revenues from our users. We may not anticipate such developments and may be unable to adequately compete with these potential solutions. As a result of these or similar potential developments, in the future it is possible that competitive dynamics in our market may require us to reduce prices for our paid products, which could harm our net revenues, gross margin and operating results or cause us to incur losses.

Errors in our products may cause us to lose users, damage our reputation and brand name and materially and adversely affect our operations.

Our software, products and website could contain undetected errors or “bugs” that could adversely affect their performance. We regularly update and enhance our software and website and introduce new versions of our software, which often results in errors. The prevalence of software bugs is typically higher in the context of releases of new generations of software than in the releases of more modest version upgrades. The occurrence of errors in our software, products or website may cause us to lose users, damage our reputation and brand name, and materially and adversely affect our business. In addition, as our users increase their use of our paid products, they may have higher expectations for these products than for free products. Also, as we increasingly introduce products particularly targeted at business users, we may find that business users have more demanding expectations than individual users, and even minor errors in our software could deter business users.

Disruptions and other failures in Internet infrastructure could cause current or potential users to believe that our systems are unreliable, lead them to switch to our competitors or to avoid our products, and could permanently harm our reputation and brands.

Unlike traditional communications products, our users rely on the Internet to communicate via Skype. Increasing numbers of users and increasing bandwidth requirements may harm the performance of the Internet. In addition, if Internet service providers and other third parties providing Internet services have outages or deteriorations in their quality of service, our customers will not have access to our products or may experience a

 

46


decrease in the quality of our products. Furthermore, as the rate of adoption of new technology increases, the networks on which our products rely in certain countries in particular with respect to our mobile video-based products may not be able to sufficiently adapt to the increased demand for their products and services. Frequent or persistent interruptions could cause current or potential users to believe that our systems are unreliable, leading them to switch to our competitors or to avoid our products, and could permanently harm our reputation and brands.

We may be subject to allegations of civil or criminal liability for unlawful activities carried out by users through the use of our products, which may be costly and damage our reputation.

We may be unable to prevent our users from using our products in an unlawful manner, and we may be subject to allegations of civil or criminal liability for unlawful activities carried out by users through the use of our products. We may be obligated to expend resources to attempt to prevent illegal activities. In a number of circumstances, third parties have alleged that our products facilitate and enable certain violations of certain laws, such as anti-spamming (i.e., the sending of spam through instant messages), promulgation of unlawful or illegal content and other criminal and terrorist activities. Our products may be used for criminal or terrorist purposes, and any high-profile criminal or terrorist action organized through the use of our products could result in adverse media attention that could damage our reputation or cause governments to obligate us to enable communications via our products to be intercepted and decrypted, which would be costly and technically difficult. In addition, users may register with a Skype Name that a third party believes infringe its intellectual property rights (e.g., cybersquatting). If any of these third parties were to seek to hold us responsible for any alleged direct, contributory or indirect intellectual property infringements, defending against such claims could be costly and time consuming. Any costs incurred as a result of potential liability relating to unlawful activities conducted through the use of our products could harm our business. In addition, negative publicity relating to such unlawful activities could damage our reputation, diminish the value of our brand and make users less likely to use our products.

We have experienced and may in the future experience further security breaches, which may result in fraud, disrupt our operations, damage our users’ computers, discourage use of our website or otherwise damage our reputation and operations.

To succeed, providers of online products must provide a secure transmission of confidential information over public networks. Our security measures may not detect or prevent security breaches that could harm our business. Currently, a significant number of our users authorize us to bill their credit card accounts directly. We rely on encryption and authentication technology licensed from third parties to provide the security and authentication designed to secure transmission of confidential information, including customer credit card numbers. Advances in computer capabilities, new discoveries in the field of cryptography or other developments may result in a compromise or breach of the technology used by us to protect transaction data. In addition, any party who is able to illicitly obtain a user’s password could access the user’s Skype account, including any personal data contained in the account, and misappropriate payment data to make payments and funding calls. An increasing number of websites have reported breaches of their security. Any compromise of our security could harm our reputation and, therefore, our business, and could result in a violation of applicable privacy and other laws. In addition, a party that is able to circumvent our security measures could misappropriate proprietary information, cause interruption in our operations, damage our users’ computers, or otherwise damage our reputation and business.

Our users, as well as those of other Internet companies, have been and will continue to be targeted by parties using fraudulent “spoof” and “phishing” emails to misappropriate passwords, credit card numbers, or other personal information or to introduce viruses through “trojan horse” programs to our users’ computers. These emails appear to be legitimate e-mails sent by us, but direct recipients to fake websites operated by the sender of the email or request that the recipient send a password or other confidential information via email or download a program. In addition, “spam” e-mails, unwanted and unsolicited communications from one user to another, have

 

47


been sent abusively via our network, recently from a group of individuals acting in concert. Spam e-mails are generally phishing emails or seek to sell products or services. Spoof, phishing and spam may damage our brand, discourage use of our website, and increase our costs.

Certain third parties have established websites to attempt to fraudulently charge consumers for our free software. While we are attempting to prevent the operation of these fraudulent websites, we may not be successful. These fraudulent websites may damage our brand and may increase our expenses as we monitor and take steps with respect to these sites as appropriate.

Our or third party servers are also vulnerable to computer viruses, physical or electronic break-ins, and similar disruptions, and we have experienced “denial-of-service” type attacks on our system that have attempted to make all or portions of our websites unavailable for periods of time. We may need to expend significant resources to protect against security breaches or to address problems caused by breaches. Security breaches, including any breach by us or by parties with which we have commercial relationships that result in the unauthorized release of our users’ personal information, could damage our reputation and expose us to a risk of loss or litigation and possible liability. Insurance policies covering our business, when they are available, may not adequately reimburse us for losses caused by security breaches.

For example, in mid-2010, an individual was able to reverse engineer parts of our protocol, emulate our Skype software client on the peer-to-peer network of our users and perform such functions as log-on, search, instant messaging or sending contact requests. We believe that the privacy of our users’ communications, which are encrypted, has not been compromised, and that the components of our Skype software client relating to voice or video calls have not been reverse engineered. However, we have observed that this reverse engineering activity has been used to send spam via instant messaging on the peer-to-peer network of our users. In addition, we are aware that the results of this reverse engineering has been leaked, both inadvertently and deliberately, increasing the likelihood that others will attempt to interact with the network of our users emulating legitimate clients, including for malicious purposes such as spamming.

The peer-to-peer architecture of our software may create, or may be perceived as creating, additional security risks and system constraints, which may discourage use of our products.

Due to the peer-to-peer architecture of our software, our software utilizes small amounts of the processor and Internet bandwidth of users’ computers (or other applicable devices), making them “relay nodes” or “super-nodes” in the peer-to-peer network. Super-nodes allow users’ computing and mobile devices to find other connected users. Relay nodes relay communications between other Skype users when direct, peer-to-peer communication is not possible. In most cases, users must allow their computing devices’ resources to be used in order to use our software. Users may discontinue using our products based on concerns about a portion of the resources of their computing power and their Internet bandwidth being used by our products or privacy or security concerns relating to being connected to other users through the peer-to-peer community. Managers of some large networks in businesses and large institutions may refuse to allow the use of our products due to concerns over security or bandwidth usage or for other reasons. The perception that our software is unsafe could hamper its adoption, and any actual security breach could damage our reputation and expose us to a risk of loss or litigation and possible liability.

Failure to deal effectively with fraudulent transactions would increase our loss rate and could increase our expenses, make us liable to credit card issuing banks or result in the loss of our ability to accept certain credit cards.

We must remit payments to credit card companies for transactions due to fraud or other reasons, a process to which we refer as “chargeback.” In that regard, we estimate that for the pro forma year ended December 31, 2009 and the year ended December 31, 2010, our losses resulting from chargebacks were $5.8 million and $3.3 million, respectively. Identity thieves and those committing fraud using stolen credit card or bank account

 

48


numbers can potentially steal large amounts of money using our products. We have become aware of certain fraudulent activities involving the creation of a significant number of spurious user accounts. These criminals create new accounts, purchase Skype’s prepaid calling credit, or Skype Credit, for each new account using a stolen credit card number or bank account information, and then establish their own 900 numbers to charge amounts from these stolen credit cards or sell the Skype Credits to other users who use them to make SkypeOut calls. We pay a fee for SkypeOut calls to enable these calls to be made to a landline or mobile phone, which we refer to as a “termination fee.” Termination fees are usually charged based on the duration of the call. When fraudulent Skype Credits are used to make SkypeOut calls, we are required to pay these termination fees while credit card holders may dispute payments made to us and cause credit card companies to require us to return these payments, which adversely affects our results of operations. Credit card companies also charge us a processing fee for all chargebacks, which adversely affects our results of operations. In addition, it often takes several payment cycles for credit card companies to detect fraudulent activity, which can further increase chargebacks and related processing fees.

Our subscription plans may also be the subject of fraudulent activity. While the subscription plans that we offer are subject to fair use policies that require that the plan be used only by the individual user, we are aware that users have violated these policies by allowing multiple people to use the same plan. Because our software allows users to log on to up to five devices simultaneously, it is difficult for us to detect and prevent this type of fraudulent activity.

Fraudulent schemes are constantly evolving which makes it difficult for us to detect and prevent them. We expect that technically knowledgeable criminals will continue to attempt to circumvent our anti-fraud systems using increasingly sophisticated methods. Measures we take to deter or prevent fraud (such as limiting the use of Skype products to call 900 numbers or limiting the amount of Skype Credit that a user can purchase to a small amount, like $10) may reduce the convenience or simplicity of our products or make it more difficult to purchase and use Skype Credit, which may make our products less attractive to customers.

In addition to the direct costs of losses from credit card chargebacks, if these chargebacks become excessive, we would face higher credit card processing fees and could potentially lose the right to accept credit cards for payment. Under credit card rules and our contracts with our card processors, if there is a breach of credit card information that we store or if we fail to maintain compliance with the Payment Card Industry data security standard, even if there is no actual compromise of customer information, we could be liable to the credit card issuing banks for their cost of issuing new cards and related expenses and could lose the right to accept credit cards for payment.

When we involve local partners for local activities, we and/or our partners may be required to comply with local registration, license and other requirements. As a result of these requirements, we might have to suspend or withdraw our products or could be subject to penalties in certain jurisdictions. In addition, we are subject to risks of doing business worldwide.

Our products are available in almost every country where the public Internet is accessible. In certain cases, our partners localize our products to take account of local language, culture, standards, and policies. In addition, we may choose to partner with a third party in certain countries, which could result in an increase in distribution expenses payable or sharing of revenue with these partners. In certain countries, we or our local partner may be required to obtain relevant licenses or registrations to offer communication products in such country, and without such licenses or registrations we or our partner may be unable to offer certain of our products in those countries. As a consequence, we might have to suspend or withdraw products or operations that relate to such country or could be subject to penalties, which could harm our business.

In many countries, we compete with local companies that understand the local market better than we do and have greater local political and economic power. We may not be successful in achieving consumer acceptance of our products in particular international markets or in generating net revenues from those markets.

 

49


In emerging markets, there may be constraints on the abilities of local users to purchase Skype Credit. In these markets, we may need to partner with local payment providers to permit local users to purchase Skype Credit. These arrangements may be difficult to establish due to potentially conflicting sales and value added tax rules, potential requirements for telecommunications licenses and other local laws and requirements. We also face additional costs in these markets as we localize our products, including enabling payment for our products in the local currency.

In addition to the risks discussed elsewhere in this section, we are subject to risks of doing business worldwide, including the following:

 

   

greater liability or legal uncertainty as a result of legal systems that are less developed with respect to the Internet and Internet communications, unique local laws, conflicting court decisions and lack of clear precedent or applicable law;

 

   

cultural ambivalence towards, or non-acceptance of, our products;

 

   

laws that limit or prohibit foreign ownership of certain businesses;

 

   

inconsistency among laws of various jurisdictions;

 

   

different employee/employer relationships and the existence of workers’ councils;

 

   

the need to comply with anti-bribery and anti-corruption laws and regulations;

 

   

the need to comply with applicable sanctions laws and regulations worldwide;

 

   

difficulties in staffing and managing foreign subsidiary offices;

 

   

different accounting practices and greater problems in collecting accounts receivable;

 

   

restrictions or taxes on the repatriation of capital, withholding taxes and foreign currency exchange restrictions;

 

   

volatility in a specific country’s or region’s political, economic or military conditions; and

 

   

lack of transparency or rule of law.

User concerns about our use and protection of personal data and the privacy of their communications and data protection breaches could harm our brand, reduce demand for our products and expose us to government proceedings and actions. Failure or perceived failure by us to comply with our privacy policy or legal or regulatory requirements in one or multiple jurisdictions could result in proceedings, actions or penalties against us.

Certain of our users, particularly those in the United States and Europe, have strong expectations about the confidentiality of their personal data and the content of their communications. Negative publicity regarding actual or perceived intrusions on our users’ privacy could harm our brand and reduce demand for our products. For example, in China, Tom Online, the majority investor in Tel-Online Limited in which we hold a 49% interest, has added filtering technology to the localized version of our product that allows instant messages to be filtered and stored along with related data based on content. We understand that Tel-Online Limited is obligated by the government to provide this filtering and storage. We received significant negative media attention as a result of these practices, as well as a security failure relating to the storage of these instant messages. Further news reports concerning content filtering and the apparent lack of privacy of communications in China and other countries are attracting political attention in the United States and Europe. Such attention could develop into legislative action resulting in additional legal requirements being imposed on us.

We make available on our website our privacy policy, which describes how we use, store and disclose our users’ personal and traffic data. In addition, details of how we use our users’ personal data are maintained on a public register in Luxembourg. We have made various international data transfers to our partners and suppliers

 

50


located outside the European Union. International transfers of data may require prior approval from regulatory authorities in Luxembourg and other administrative or contractual measures to be put in place. Increased operations worldwide or changes to the location of our suppliers may result in an increased administrative burden in dealing with international data transfers. Data protection and related laws and regulations that apply or may apply to an Internet communications company like Skype with users and partners in multiple jurisdictions can be unclear and overlapping, requiring interpretation where precedents are not available and creating uncertainty and potential conflicts of law. Moreover, changes or upgrades to our products or technological infrastructure on which our products, or the introduction of new products, are based could result in our activities being subject to data protection, data retention and related laws and regulations in multiple jurisdictions, increasing uncertainty as well as potential overlap and conflicts of law. In addition, certain jurisdictions, such as the European Union and the United States, have new or pending privacy legislation that would require notification of consumer data breaches and other privacy protections. Any failure, or perceived failure, by us to comply with our posted privacy policy or with any legal or regulatory requirements relating to privacy in one or multiple jurisdictions could result in proceedings or actions against us by governmental entities or others and subject us to significant penalties and negative publicity.

In addition, communications companies are subject to various additional data security, privacy, data retention and disclosure laws and regulations locally, some of which conflict across jurisdictions. If communications laws and regulations were found to be applicable to us, it would be difficult for us to comply with them.

While some of these privacy requirements apply to our business in Luxembourg and in the United States (with respect to United States based users of Skype Enterprise), complying with all of these various requirements on a jurisdiction-by-jurisdiction basis would impose additional costs on our operations and would be difficult and costly.

If OFAC were to determine that our activities involving terminating calls in Iran constituted violations of U.S. sanctions regulations in some manner, civil penalties, including fines, could be assessed against us.

On July 30, 2010, an administrative subpoena from the U.S. Treasury Department’s Office of Foreign Assets Control (“OFAC”) was received by one of our shareholders, Silver Lake, requesting information regarding transactions that Skype has conducted involving Iran since August 1, 2005, including a certain number of identified transactions relating to call termination fees to an Iranian telecommunications provider. Upon Silver Lake’s receipt of this subpoena, we initiated an internal review of our transactions involving Iran and on August 26, 2010, we submitted our response to the subpoena. To date we have not received any additional requests from OFAC with respect to this inquiry. We intend to continue to cooperate fully with OFAC in responding to any additional requests. While we cannot at present predict the ultimate outcome of OFAC review, should OFAC determine that our activities involving terminating calls in Iran constituted violations of U.S. sanctions regulations in some manner, civil penalties, including fines, could be assessed against us. In exceptional circumstances, if OFAC determined that violations of U.S. sanctions occurred, it could also seek to pursue criminal penalties, although we believe the risk of this occurring to be highly remote in this case.

Acquisitions and other strategic transactions could result in operating difficulties, dilution, and other harmful consequences.

We periodically evaluate and consider a wide range of potential strategic transactions, including business combinations and acquisitions of businesses, technologies, services, products and other assets. Any of these transactions could be material to our financial condition and results of operations. We may not realize the anticipated benefits of any of these transactions, or may not realize them in the time frame expected. We may also experience unforeseen difficulties and expenditures in integrating the operations, technologies and employees of any acquired businesses and in retaining and motivating key personnel from these businesses. Other areas where we may face risks include: unanticipated or unknown liabilities relating to acquired

 

51


businesses, the quality of the assets we sought to acquire, the validity of any acquired patents and the protection of the intellectual property rights of the acquired technologies. Any of these transactions may divert management’s attention, disrupt our ongoing operations, increase our expenses and adversely impact our business and results of operations. In addition, acquisitions of foreign operations involve additional risks, including the need to integrate operations across different cultures and languages and to address the particular economic, currency, political, and regulatory risks associated with specific countries. Any acquisitions or strategic transactions may require us to issue additional equity securities, which could be dilutive to our shareholders, spend our cash, or incur debt, liabilities, amortization expenses related to intangible assets or write-offs of assets or goodwill, any of which could adversely affect our results of operations and harm our business.

We do not have operational control over entities and strategic alliances in which we hold a minority interest and the conduct of the controlling partner in such arrangements may harm our reputation or adversely affect the value of our investment and may limit our ability to offer our products in certain markets directly or through other third parties.

We have and may in the future acquire minority equity interests in entities and enter into strategic alliances, in which we lack management and operational control. For example, to address the Chinese market we have a 49% equity interest in an entity in which Tom Online has a majority stake. Minority investments involve risks. The controlling partner in such entities and alliances may have business interests, strategies or goals that are inconsistent with ours, including with respect to customer relations, investments, marketing and other business initiatives, interactions with local governments and competitors, and business decisions. Actions or omissions of the controlling partner or the entity in which we have an interest may result in harm to our reputation or adversely affect the value of our investment. Our partners may go bankrupt, which may as a practical matter subject us to such partners’ liabilities in connection with the entity in which we have an interest. In addition, arrangements governing entities in which we hold a minority interest or other strategic relationships may be exclusive in certain countries or regions, which may limit our ability to offer our products directly or through another third party in that geography.

Our SkypeIn and Skype To Go businesses are highly dependent on partners in different jurisdictions, and the conduct, business practices and financial health of those partners expose us to potential risks that could harm our reputation and adversely affect our products in those jurisdictions.

The offer of number-based products by Skype is highly dependent on our operator partners providing us the numbers in different jurisdictions. The SkypeIn product, which assigns a number to a user who can then receive calls on his or her computer or other Internet-connected device from a landline or mobile phone, and the Skype To Go business, which uses numbers to allow users to access the Skype calling functionality from any phone, are our two key products using numbers. Numbers are contracted under commercial arrangements with third party telecommunications operators, who generally have obtained the numbers directly from the relevant numbering authorities. In most of the countries in which we offer SkypeIn or Skype To Go products, we rely on one partner for the provision of numbers. In certain markets, the SkypeIn or Skype To Go numbers are provided directly by such partners to end users, who contract with the end users for such numbers. Moreover, although our commercial agreements with our numbering partners usually include provisions requiring the transfer of numbers to a third party appointed by Skype upon termination of our agreement, such transfers may be legally, commercially, technically or practically difficult or impossible to carry out. As a result of these dependencies, the success of our SkypeIn and Skype To Go businesses is highly dependent on the ongoing conduct, business practices and financial health of our numbering partners, and the partner relationships we have with them. For example, if our local number partner terminated the agreement with Skype, encountered financial difficulty or became subject to bankruptcy or other insolvency proceedings, we might have to terminate or suspend the usage of existing SkypeIn and Skype To Go products and/or change the numbers in use by SkypeIn and Skype To Go end users in the affected country, disrupting the usage of the product by our end users.

Moreover, if local numbering rules or regulations or the interpretation or enforcement of such rules or regulations by local authorities or our partners change, we or our partners might have to terminate the provision

 

52


of the affected products or implement relevant compliance measures, which could be difficult and costly, complicate the subscription process or restrict the usage of numbers to certain user categories or usage types. In addition, our partners may change their business practices in response to local or international factors (e.g., governmental regulation, competition, change in management or otherwise), and depending on the nature of such changes, they may impact our partners’ ability or willingness to provide SkypeIn or Skype To Go numbers or to provide them in the manner that we would prefer, or result in increased costs or new compliance requirements impacting our products.

Any of these changes and events could have an adverse impact on our SkypeIn and Skype To Go products, our business, results of operations, brand, reputation and regulatory status in the country in question and beyond.

Use or delivery of our products may become subject to new or increased regulatory requirements, taxes or fees.

The increasing growth and popularity of Internet communications heighten the risk that governments will seek to regulate or impose new or increased fees or taxes on Internet communications products. To the extent that the use of our products grows, regulators may be more likely to seek to regulate or impose taxes on the distribution of our products. Similarly, advances in technology that are within or outside our control, such as improvements in locating the geographic origin of Internet communications, could cause our products to become subject to additional regulations, fees or taxes or could require us to invest in or develop new technologies, which may be costly. In addition, as we continue to expand our user base and offer more products, we may become subject to new regulations, fees or taxes. For example, provision of our Skype Enterprise suite of products in the United States may result in greater regulatory oversight and increased exposure to income, sales and utility taxes and telecommunications fees in the United States. Increased fees could include access and other charges payable to local telephone companies that allow calls from Skype users to be made to traditional landline and mobile phones, contributions to federal or state universal service funds in the United States and similar funds elsewhere, and other charges. Increased regulatory requirements, taxes or fees on Internet communications products, which could be assessed by governments retroactively or prospectively, would substantially increase our costs, and, as a result, our business would suffer.

We may become subject to additional income tax expense, which would adversely affect our results of operations and the value of our ADSs.

Skype’s favorable geographic mix of income contributes to lowering our overall tax expense. In particular, while our income is generated predominantly by our Luxembourg operating company, our tax expense is significantly lower than the amount computed by applying the Luxembourg statutory tax rate to pre-tax U.S. GAAP income because our taxable income is reduced as a consequence of, among other items, our intercompany licenses of intellectual property and historic net operating losses in Luxembourg. However, the determination of taxable income in any jurisdiction is dependent upon, among other factors, the acceptance of our operational and intercompany transfer pricing practices by taxing authorities as being on an arm’s length basis. Because the arm’s length standard is inconsistently applied among tax authorities and because double tax treaty relief may not be available, successful transfer pricing challenges could materially increase our reported income tax expense. Furthermore, it is possible that one or more jurisdictions will change its tax laws or its interpretation of existing tax laws (possibly on a retroactive basis) in a manner that would subject us to additional tax. If any of these things were to happen, our results of operations and growth prospects, and the value of our ADSs, could be materially adversely affected.

We or certain of our subsidiaries may become subject to net income taxation in additional jurisdictions which would adversely affect our financial condition and the value of our ADSs.

We or one or more of our subsidiaries (including Skype Communications, through which we market and sell our products) may become treated as resident or as otherwise being engaged in a trade or business or having a permanent establishment in one or more jurisdictions in which we currently believe we or the relevant subsidiary

 

53


is not so treated. If that were to happen, we or the relevant subsidiary would be subject to net income taxation in that jurisdiction on some or all of our or the relevant subsidiary’s income (depending on the jurisdiction and the circumstances). There could be many possible causes for such treatment, including activities indicating that management and control of our company or of the relevant subsidiaries are exercised in that jurisdiction, the nature of our activities and operations in that jurisdiction, or the location of our assets or use of our products in that jurisdiction. No assurance can be given that we will not be subject to such taxes retroactively or prospectively or that such taxes will not be substantial. The imposition of such taxes could have a material adverse effect on our results of operations and accordingly on the value of our ADSs.

We may be subject to indirect taxes (such as value-added tax or sales tax) in jurisdictions in which we currently do not collect or pay such tax.

In the European Union, under the 6th value-added tax, or VAT, directive, the place of supply for most of our electronically delivered products is Luxembourg, and therefore a 15% VAT rate applies, which is among the lowest in the European Union. This rule will be in effect until December 31, 2014, when the place of supply will shift to the place where the customer resides. This change may increase the ultimate cost of our products to E.U. resident customers and could decrease demand for our products. Moreover, such change will require to us to invest significant amounts in developing and modifying our technological and administrative systems to enable us to collect and remit VAT in multiple E.U. jurisdictions.

In countries outside of the European Union, we generally do not collect or remit VAT. Some countries outside of the European Union may, however, require us to collect and remit VAT, which could be burdensome or expensive for us to administer and increase the costs of our products or reduce our profitability or result in losses. For example, tax authorities in Switzerland have notified us that we should collect and remit VAT from our users with a Swiss billing address. At present, we remit VAT to Switzerland, but we do not collect the VAT from our Swiss users and, as a result, we absorb the cost of VAT, which adversely affects our results of operations.

In the United States, the subsidiary through which we market and sell most of our products, Skype Communications, does not at present collect or remit U.S. state or municipal taxes (such as sales, excise, utility, use or ad valorem taxes), fees or surcharges in respect of sales to our U.S. customers. However, we have occasionally received inquiries from a small number of state and municipal taxing authorities seeking payment of taxes, fees or surcharges that are traditionally applied to, or collected from, customers of providers of traditional public switched telephone network services. In addition, U.S. federal regulators have inquired into whether Skype properly remits payments to the federal universal service fund.

With respect to a U.S. state’s ability to impose obligations to collect taxes, fees or surcharges with respect to sales made over the Internet, the U.S. Supreme Court’s decision in Quill Corporation v. North Dakota currently requires that a taxpayer have physical presence within the state before the state can collect such taxes. However, the U.S. Supreme Court has provided little guidance as to what levels of contacts constitute physical presence, and no assurance can be given that we will not be found to have a physical presence in certain U.S. states based on, for example, our affiliations with other businesses that have a physical presence in the state.

Furthermore, a number of states, as well as the U.S. Congress, have been considering or have adopted initiatives that could limit the Supreme Court’s position regarding sales and use taxes on Internet sales. If these initiatives are successful, we could be required to collect sales and use taxes in a number of states or change our business practices. The imposition by state and local governments of various taxes, fees and surcharges upon Internet commerce could result in administrative burden, put us at a competitive disadvantage if similar obligations are not imposed on all or substantially all of our online competitors and affect negatively our future sales.

In addition, several proposals have been made at the U.S. federal, state and local levels that would impose additional taxes on communications through the Internet. These proposals, if adopted, could substantially impair

 

54


our growth and substantially increase the costs of our products. In particular, the tax status of our products could subject us to conflicting taxation requirements and complexity with regard to the collection and remittance of VAT, sales or use taxes. Furthermore, given the international nature of our business, we may incur significant costs in developing and modifying our technological and administrative systems to enable us to collect and remit taxes in such a manner that applies only to the relevant taxable activity.

Any of these developments could adversely affect our results of operations and the value of our ADSs.

Governments may levy new taxes on us which could adversely affect our financial condition and the value of our shares.

The current economic downturn has created or exacerbated budget deficits for many governments. Governments may seek to address these budget issues in part by imposing new taxes on businesses, including ours. Any such additional taxes could harm our results of operations.

We may be unable to use some or all of our net operating loss carryforwards, which could adversely affect our reported financial condition and results of operations and therefore the value of our ADSs.

As of December 31, 2010, we had net operating loss carryforwards of $2.1 billion, which primarily consisted of $1.9 billion net operating loss carryforwards recognized in Luxembourg and $0.2 billion net operating losses recognized in Ireland (which we currently do not expect to utilize as our Irish subsidiary does not generate taxable income). Our ability to utilize net operating loss carryforwards may be limited for a number of reasons, including insufficient future taxable income at the relevant entity. For this reason, we periodically establish valuation allowances in respect of our net operating loss carryforwards. However, the recognition of valuation allowances requires significant judgment, and the valuation allowances we have recognized may be insufficient in the event we are able to use less net operating losses than previously estimated.

We may incur additional tax assessments.

We are subject to income taxes in Luxembourg, the United States and various other jurisdictions. The determination of our worldwide provision for income taxes and other tax liabilities requires estimation and significant judgment and there are many transactions and calculations where the ultimate tax determination is uncertain. Furthermore, our determination of our tax liability is always subject to audit and review by applicable domestic and foreign tax authorities, and we currently have “open” tax years that could become subject to audits, investigations and reviews by taxing authorities throughout the world. Any adverse outcome of any such audit or review could have a negative effect on our business, operating results and financial condition, and the ultimate tax outcome may differ from the amounts recorded in our financial statements and may materially adversely affect our reported financial results in the period or periods for which such determination is made.

If telecommunications providers with whom we transact to offer our SkypeOut and SkypeIn products fail to deliver satisfactory services or increase their prices, our reputation and results of operations may be harmed.

A number of parties, many of whom compete with us, provide services to us or to our users that we rely on to offer our products. We have agreements with a number of telecommunications providers in order for us to provide many of our paid products, including our SkypeOut and SkypeIn products. The quality of calls made by our users to and received by our users from landline and mobile phones depends in large part of the call quality of the relevant landline or mobile network. As a result, if these third parties do not provide sufficiently high quality services, our call quality may be negatively affected which may in turn adversely impact our brand, reputation and consumer acceptance of our products. In addition, price increases by companies that provide services to us or our users could harm our results of operations.

 

55


If third party providers to which we have outsourced certain functions do not perform satisfactorily or cease operations or are otherwise unable to provide their services, our operations could be disrupted, and we may only be able to replace these providers on terms that are less favorable to us.

We have outsourced elements of certain functions to third-party providers, including payment processing, the support of certain mobile operations and a portion of our billing and collection processes with respect to Skype Enterprise. If these third-party service providers do not perform satisfactorily or cease operations or are otherwise unable to provide these services, our operations could be disrupted, which could adversely affect our business and results of operations. For example, in December 2010, we recorded a bad debt expense of $9.2 million as a result of a dispute with a payment processing vendor whereby amounts they had collected from our users were not remitted to us. Furthermore, we rely on third parties to provide all of the credit card payment processing for our paid products with Bibit BV, an affiliate of Royal Bank of Scotland, and PayPal, an eBay subsidiary, handling an aggregate of approximately 75% of the processing of our net revenues in 2010. We have also outsourced a portion of our billing and collections processes with respect to Skype Enterprise to a third-party provider. If a third party payment processor ceased to provide these services to us, we would need to transition to an alternate provider which would require us to integrate our IT systems with the IT systems of the replacement provider. In addition, we would need to negotiate a new contract within a very short timeframe which could result in terms that are less favorable to us.

We started in 2010 to license our application programming interfaces and software to third parties, and actions these third parties take may harm our regulatory positioning, product security, user experience and brand image, and breach laws and intellectual property or other third party rights.

In July 2010, we released SkypeKit, a software development kit that allows independent software developers and consumer electronics manufacturers to incorporate Skype capabilities with their own applications and devices. Such third party developers and manufacturers may make available software, hardware, services, features, systems and solutions that operate with our Internet communications products in breach of our licensing agreements and/or applicable laws or regulations. Such third party products may further be used to offer our products to users in ways that may adversely affect our regulatory positioning, product security, user experience and brand image, and breach laws such as consumer protection, user privacy and data protection laws and intellectual property or other third party rights.

Our business may be adversely affected by factors that cause our users to spend less time using our products, including seasonal factors, worker migration patterns, national events and increased usage of other websites.

Anything that diverts our users from their customary level of usage of our products could adversely affect our business. Our results of operations historically have been seasonal because many of our users reduce their use of our products with the onset of good weather during the summer months and our users tend to use our products more in the fourth quarter during the holiday season. Our rapid growth may have overshadowed whatever seasonal factors might have influenced our business to date. In addition, if worker migration patterns change, our business may be affected. For example, if fewer workers seek work outside their home country due to the current difficult economic environment or otherwise, the volume of international calling may decline. In addition, increased usage of social networking websites may decrease the amount of time users spend using our communications products, which could adversely affect our financial results.

Part of our strategy is to expand our products for business customers, expand our mobile products, and attract third-party developers and other companies to extend the functionality of our products. If these initiatives are not successful, our business may suffer.

Our strategy contemplates expanded products for the enterprise market, which is a more difficult market for us to penetrate. Enterprise customers have different needs and often have more demanding expectations than consumers, and we will likely need to add product features and provide more consistent quality, among other things, in order to attract enterprise customers. For example, we have historically not offered robust customer service. Although we have recently enhanced our capabilities in this area, these enhancements may not be sufficient to meet

 

56


enterprise customer expectations. Initiatives to attract enterprise customers may be costly, and we may not be able to recover the costs incurred. In addition, many enterprise vendors offer unified communication systems that include products we do not offer, such as email. These vendors also are recognized brands in the enterprise marketplace and have incumbent status, including, in certain cases, long-term customer contracts, and as a result, it may be difficult for us to replace them. In addition, in-house information technology staff may be more familiar with the products of enterprise vendors, which also may make it more difficult to displace them. If we are unable to successfully develop and market products to enterprise customers, our results of operations and financial condition may suffer.

Our strategy depends on our ability to continue to offer our products on a mobile platform, and mobile network operators may be reluctant to partner with us. Our business strategy depends on our ability to continue to offer our products on a mobile platform. Mobile network operators may be reluctant to partner with us or allow our products to be used on their devices due to concerns about cannibalizing their business. We have already faced such reluctance by mobile network operators, particularly in European markets, in relation to VoIP and peer-to-peer applications generally.

Similarly, mobile hardware manufacturers and applications store providers may be reluctant to sell Skype mobile products in their application stores due to a concern of jeopardizing established relationships with their major hardware customers and mobile network operators. Application store owners have ultimate control over the products and services made available through their channels and may choose to remove Skype from their stores or restrict functionality based on perceived competitive threat or cannibalization of their own products.

Third party developers and other companies may not develop applications to extend our platform. Our strategy contemplates attracting third party developers and other companies to use our application programming interfaces to extend our platform; however, this is a recent initiative for us and we may not be able to attract developers and other companies interested in developing applications for our platform.

Our costs will increase significantly as a result of operating as a public company, and our management will be required to devote substantial time to complying with public company regulations.

Skype was acquired by eBay on October 14, 2005 and operated as an indirect, wholly-owned subsidiary of eBay until the effective date of the Skype Acquisition on November 19, 2009. We have operated as a privately held company since the effective date of the Skype Acquisition. After this offering, we will become obligated to file with the Securities and Exchange Commission (the “SEC”) annual and other reports pursuant to the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We will also be required to ensure that we have the ability to prepare financial statements that are fully compliant with all applicable reporting requirements on a timely basis. In addition, we will also become subject to other reporting and corporate governance requirements, including certain requirements of the Nasdaq Stock Market, and certain provisions of the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) and the regulations promulgated under Sarbanes-Oxley, which will impose significant compliance obligations upon us.

Sarbanes-Oxley, as well as rules subsequently implemented by the SEC and the Nasdaq Stock Market, have imposed increased regulation and disclosure and required enhanced corporate governance practices of public companies. Our efforts to comply with evolving laws, regulations and standards in this regard are likely to result in increased expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities. These changes will require a significant commitment of additional resources. We may not be successful in implementing these requirements and implementing them could materially adversely affect our business, results of operations and financial condition. In addition, if we fail to implement the requirements with respect to our internal accounting and audit functions, our ability to report our operating results on a timely and accurate basis could be impaired. If we do not implement such requirements in a timely manner or with adequate compliance, we might be subject to sanctions or investigation by regulatory authorities, such as the SEC or the Nasdaq Stock Market. Any such action could harm our reputation and the confidence of investors and users in our company and could materially adversely affect our business and cause the market price of our ADSs to fall.

 

57


In addition, changing laws, regulations and standards relating to corporate governance and public disclosure are creating uncertainty for public companies, increasing legal and financial compliance costs and making some activities more time consuming. These laws, regulations and standards are subject to varying interpretations, in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. If our efforts to comply with new laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to practice, regulatory authorities may initiate legal proceedings against us and our business may be harmed.

We also expect that being a public company and these new rules and regulations will make it more expensive for us to obtain director and officer liability insurance, and we may be required to incur substantially higher costs to obtain coverage. These factors could also make it more difficult for us to attract and retain qualified members of our board of directors, particularly to serve on our audit committee and compensation committee, and qualified executive officers.

Failure to achieve and maintain effective internal controls in accordance with Section 404 of Sarbanes-Oxley could have a material adverse effect on our business and the market price of our ADSs.

As a public company, we will be required to document and test our internal control over financial reporting in order to satisfy the requirements of Section 404 of Sarbanes-Oxley, which will require annual management assessments of the effectiveness of our internal control over financial reporting and, beginning with our annual report on Form 10-K for the year ended December 31, 2012, a report by our independent registered public accounting firm that addresses the effectiveness of internal control over financial reporting. During the course of our testing, we may identify deficiencies which we may not be able to remediate in time to meet our deadline for compliance with Section 404 or that may require a restatement or other revision to our financial statements. Testing and maintaining internal control can divert our management’s attention from other matters that are important to the operation of our business. We also expect that the imposition of these regulations will increase our legal and financial compliance costs, make it more difficult to attract and retain qualified officers and members of our board of directors, particularly to serve on our audit committee, and make some activities more difficult, time consuming and costly. We may not be able to conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404 or our independent registered public accounting firm may not be able or willing to issue an unqualified report on the effectiveness of our internal control over financial reporting. If we conclude that our internal control over financial reporting is not effective, we cannot be certain that our financial statements are accurate. If either we are unable to conclude that we have effective internal control over financial reporting or our independent registered public accounting firm is unable to provide us with an unqualified report as required by Section 404, then investors could lose confidence in our reported financial information, which would likely have a negative effect on the trading price of our ADSs. In addition, if we do not maintain effective internal controls, we may not be able to accurately report our financial information on a timely basis, which could harm the trading price of our ADSs, impair our ability to raise additional capital, or jeopardize our continued listing on Nasdaq Stock Market or any other stock exchange on which our ADSs may be listed.

Our substantial indebtedness could adversely affect our financial health and our ability to raise additional capital, limit our ability to react to changes in the economy or our industry, expose us to interest rate risk to the extent of our variable rate indebtedness and prevent us from fulfilling our obligations under our indebtedness.

As of December 31, 2010, we had $724.9 million of debt outstanding under our Amended Five Year Credit Agreement. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Indebtedness.” Subject to restrictions in our Amended Five Year Credit Agreement, we may incur additional indebtedness.

 

58


Our substantial indebtedness could have important consequences, including:

 

   

increasing our vulnerability to adverse general economic and industry conditions;

 

   

requiring us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, research and development efforts, execution of our business strategy and other general corporate purposes;

 

   

limiting our flexibility in planning for, or reacting to, changes in the economy and technologies;

 

   

placing us at a competitive disadvantage compared to our competitors with less indebtedness;

 

   

exposing us to interest rate and foreign currency risks;

 

   

limiting our ability to, or increasing the costs to, refinance indebtedness; and

 

   

making it more difficult to borrow additional funds in the future to fund working capital, capital expenditures and other purposes.

Any of the foregoing could materially and adversely affect our business, financial conditions and results of operations.

Our credit agreement imposes significant restrictions on our business and the lenders are entitled to take possession of and sell the assets we have pledged as collateral if there is a default under the credit agreement.

Our Amended Five Year Credit Agreement contains a number of covenants imposing significant restrictions on our business. These restrictions may affect our ability to operate our business and may limit our ability to take advantage of potential business opportunities as they arise. The restrictions placed on us include limitations, among other things, on our ability and the ability of our subsidiaries to:

 

   

incur additional indebtedness and incur or create liens;

 

   

consolidate, merge, liquidate or dissolve;

 

   

make investments, acquisitions, loans or advances;

 

   

transfer and sell assets;

 

   

engage in sale and lease back transactions;

 

   

enter into swap, forward, future or derivative transactions;

 

   

pay dividends or make other distributions on, redeem or repurchase equity interests, including our ADSs or ordinary shares, or make payments on junior financing; and

 

   

engage in transactions with affiliates.

Our Amended Five Year Credit Agreement also requires us to meet an interest expense coverage ratio test and a leverage ratio test. Our ability to meet these ratios may be affected by events beyond our control, and we cannot assure you that we will be able to maintain these ratios at all relevant times.

In addition, under our Amended Five Year Credit Agreement, we may be required to prepay outstanding term loans in a number of circumstances, including if we receive net proceeds arising from the sale or transfer of assets and properties (such sale and transfer would not, however, include this offering) or the incurrence of additional indebtedness. In addition, after the end of each fiscal year, commencing with the fiscal year ending December 31, 2010, we will be required to prepay outstanding term loans with a percentage of our “excess cash flow,” calculated as set forth in our Amended Five Year Credit Agreement, if our leverage ratio exceeds pre-defined levels. If, as of the end of the fiscal year, our leverage ratio is greater than or equal to 3:1, we will be required to prepay outstanding term loans in the aggregate amount of 50% of our excess cash flow. If, as of the end of the fiscal year, our leverage ratio is greater than or equal to 2.25:1 but less than 3:1, we will be required to

 

59


prepay outstanding term loans in the aggregate amount of 25% of our excess cash flow. If our leverage ratio is less than 2.25:1 as of the end of the fiscal year, we will not be required to prepay outstanding term loans with excess cash flow for that year.

The foregoing restrictions could limit our ability to plan for, or react to, changes in market conditions or our capital needs. If for any reason we are unable to meet these requirements, we may not be granted waivers under, or amendments to, our Amended Five Year Credit Agreement or we may not be able to refinance our indebtedness on terms acceptable to us, or at all. The breach of any of these restrictions, covenants or prepayment requirements could result in a default under our Amended Five Year Credit Agreement, which would have a material adverse effect on our business, financial condition and results of operations. Our obligations under the Amended Five Year Credit Agreement are secured by pledges of all share capital held by Skype Global and certain of our subsidiaries, and by security interests in substantially all of our tangible and intangible assets (with certain exceptions, including deposit accounts, other bank or securities accounts and other assets already subject to security interests). On occurrence of an event of default, the loans may be accelerated and declared due and payable immediately and the lenders would be entitled to take possession of and sell the assets we have pledged as collateral and to apply the proceeds from those sales to repay loans and other amounts due under the Amended Five Year Credit Agreement. For more information on our outstanding indebtedness, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Indebtedness” elsewhere in this prospectus.

A significant part of our historical financial results is unlikely to be representative of our results as a stand-alone company.

Skype was acquired by eBay on October 14, 2005 and operated as part of the eBay group until the effective date of the Skype Acquisition on November 19, 2009. Our financial results from October 14, 2005 to November 18, 2009 have been prepared from the accounting records of eBay using the historical basis of assets and liabilities of the Skype Companies. As part of the eBay group, Skype received various services and support provided by eBay, including finance, legal, information technology systems, shared facilities and human resources. Until November 2010, eBay provided us with similar services pursuant to a transition services agreement. We have now completed our transition to, and operate as, a stand-alone company, which involves greater costs associated with developing and implementing these services on a stand-alone basis.

Our financial statements for the periods subsequent to October 14, 2005 and prior to November 19, 2009 include estimated allocations of certain eBay expenses including centralized legal, tax, treasury, information technology, employee costs, corporate services and other infrastructure costs, collectively referred to as “corporate allocations.” Although the corporate allocations have been determined on a basis that we considered to be reasonable reflections of the utilization of services provided or the benefit received by us, our actual expenses might have been higher, perhaps substantially, than those allocations had we operated as a stand-alone company for the periods presented. Accordingly, our financial statements for the periods subsequent to October 14, 2005 and prior to November 19, 2009 do not purport to reflect what our results of operations or financial position would have been had we operated as a stand-alone company during the periods presented nor do they purport to indicate what our results of operations or financial position will be as of any future date or for any future period.

In particular, we are a smaller and less diversified company than eBay, and we do not have access to financial and other resources comparable to those of eBay. As a separate, stand-alone company, we may be unable to obtain goods, technology and services at prices and on terms as favorable as those available prior to the Skype Acquisition.

We have entered into a tax cooperation agreement with eBay pursuant to which we may be required to pay eBay an indemnity if we engage in certain changes to our operations without eBay’s consent.

In connection with the Skype Acquisition, we entered into a tax cooperation agreement with eBay pursuant to which we have agreed to notify and collaborate with eBay if we propose material changes to our operations,

 

60


including new business initiatives, changes to existing business models, mergers, acquisitions, disposition of stock or assets or material changes in the source or character of income. If in eBay’s reasonable judgment, such material changes will result in an increase in certain types of so-called Subpart F Income that eBay may be required to recognize in accordance with the U.S. Internal Revenue Code of 1986, as amended, and if we implement such material change without eBay’s consent, we would need to pay eBay an indemnity equal to its tax liability arising from its pro rata share of such increase in these types of Subpart F Income for each taxable year in which eBay holds (directly, indirectly or constructively) 10% or more of our voting power and in which U.S. persons holding (directly, indirectly or constructively) 10% or more of our voting power hold (directly, indirectly or constructively) in the aggregate more than 50% of our shares by vote or value. Such indemnity may negatively affect our results of operation and we may forego certain restructurings or new business opportunities or might choose to structure new business opportunities in a more expensive way in order to avoid paying such indemnity.

Risks Related to Investment in a Luxembourg Company

We will become a Luxembourg joint stock company (“société anonyme”) upon our corporate reorganization and it may be difficult for you to obtain or enforce judgments against us or our executive officers and directors in the United States.

We are organized under the laws of the Grand Duchy of Luxembourg. Most of our assets are located outside the United States. Furthermore, some of our directors and officers named in this prospectus reside outside the United States and most of their assets are located outside the United States. As a result, investors may find it difficult to effect service of process within the United States upon us or these persons or to enforce outside the United States judgments obtained against us or these persons in U.S. courts, including judgments in actions predicated upon the civil liability provisions of the U.S. federal securities laws. Likewise, it may also be difficult for an investor to enforce in U.S. courts judgments obtained against us or these persons in courts located in jurisdictions outside the United States, including actions predicated upon the civil liability provisions of the U.S. federal securities laws. It may also be difficult for an investor to bring an original action in a Luxembourg court predicated upon the civil liability provisions of the U.S. federal securities laws against us or these persons. Luxembourg law, furthermore, does not recognize a shareholder’s right to bring a derivative action on behalf of the company.

As there is no treaty in force on the reciprocal recognition and enforcement of judgments in civil and commercial matters between the United States and the Grand Duchy of Luxembourg, courts in Luxembourg will not automatically recognize and enforce a final judgment rendered by a U.S. court. The enforceability in Luxembourg courts of judgments entered by U.S. courts will depend upon the conditions set forth in the Luxembourg procedural code, which may include the following:

 

   

the judgment of the U.S. court is enforceable (exécutoire) in the United States;

 

   

the U.S. court had jurisdiction over the subject matter leading to the judgment (that is, its jurisdiction was in compliance both with Luxembourg private international law rules and with the applicable domestic U.S. federal or state jurisdictional rules);

 

   

the U.S. court has applied to the dispute the substantive law which would have been applied by Luxembourg courts;

 

   

the judgment was granted following proceedings where the counterparty had the opportunity to appear, and if it appeared, to present a defense;

 

   

the U.S. court has acted in accordance with its own procedural laws; and

 

   

the judgment of the U.S. court does not contravene Luxembourg international public policy.

 

61


Under our articles of incorporation, we indemnify and hold our directors harmless against all claims and suits brought against them, subject to limited exceptions.

Our shareholders may have more difficulty protecting their interests than they would as shareholders of a U.S. corporation.

Our corporate affairs are governed by our articles of incorporation and by the laws governing joint stock companies organized under the laws of the Grand Duchy of Luxembourg. The rights of our shareholders and the responsibilities of our directors and officers under Luxembourg law are different from those applicable to a corporation incorporated in the United States. Luxembourg law and regulations in respect of corporate governance matters might not be as protective of minority shareholders as state corporation laws in the United States. Therefore, our shareholders may have more difficulty in protecting their interests in connection with actions taken by our directors and officers or our principal shareholders than they would as shareholders of a corporation incorporated in the United States. Please see “Description of Share Capital” for a discussion of differences between Luxembourg and Delaware corporate law.

You may not be able to participate in equity offerings, and you may not receive any value for rights that we may grant.

Pursuant to Luxembourg corporate law, existing shareholders are generally entitled to preemptive subscription rights in the event of capital increases and issues of shares against cash contributions. However, under our articles of incorporation, our board of directors has been authorized to waive, limit or suppress such pre-emptive subscription rights until              and the general meeting of our shareholders may renew, expand or amend such authorization. In addition, under the deposit agreement for the ADSs and applicable law, the depositary will not offer these rights to ADS holders unless both the rights and the underlying securities to be distributed to ADS holders are either registered or exempt from registration under the Securities Act of 1933, as amended (the “Securities Act”), with respect to all holders of ADSs. We are under no obligation to file a registration statement with respect to any such rights or underlying securities or to endeavor to cause such a registration statement to be declared effective. Furthermore, we may not be able to take advantage of any exemptions from registration under the Securities Act. Accordingly, holders of our ADSs and ordinary shares may be unable to participate in our rights offerings and issue of shares and may experience dilution of their holdings as a result. If the depositary is unable to sell preemptive subscription rights corresponding to ordinary shares represented by ADSs that are not exercised by, or distributed to, ADS holders, or if the sale of these rights is not lawful or reasonably practicable, the depositary will allow the rights to lapse, in which case ADS holders will receive no value for these rights.

Risks Related to Our ADSs and this Offering

Control by principal shareholders could adversely affect our other shareholders.

When this offering is completed, our greater than 5% shareholders (Silver Lake Funds, eBay, CPPIB, Joltid and Andreessen Horowitz) collectively, will beneficially own at least             % of ordinary shares (including ordinary shares represented by ADSs) (based on the number of ordinary shares outstanding as of                          2010 and excluding ordinary shares issuable upon exercise of outstanding options), assuming no exercise of the underwriters’ option to purchase additional ADSs. On the same basis, our executive officers and directors, will beneficially own approximately             % of ordinary shares.

In addition, we expect that, pursuant to the terms of the Shareholders Agreement that we expect to be amended and restated prior to this offering, certain Silver Lake funds, eBay, CPPIB, Joltid and Andreessen Horowitz will be able to elect their respective designees to serve as members of our board of directors. These shareholders’ designees are expected to represent              of the              members of our board of directors immediately after this offering. These shareholders will have a continuing ability to control our board of directors and to exercise significant influence over our affairs for the foreseeable future, including controlling the election of directors and significant corporate transactions, such as a merger or other sale of our company or our assets.

 

62


Furthermore, because Silver Lake Funds, eBay, CPPIB, Joltid and Andreessen Horowitz will be considered to form a “group” that owns more than 50% of our outstanding voting securities, we are a “controlled company” within the meaning of the Nasdaq Stock Market rules. Following the consummation of this offering, we intend to rely upon the “controlled company” exception to the independence requirements of the Nasdaq Stock Market, which means we will be exempt from the rules of the Nasdaq Stock Market that require that our board of directors be comprised of a majority of independent directors, that we have a compensation committee comprised solely of independent directors and that we have a nominating and governance committee comprised solely of independent directors. This concentrated control will limit the ability of other shareholders to influence corporate matters and, as a result, we may take actions that our other shareholders do not view as beneficial. For example, this concentration of ownership could have the effect of delaying or preventing a change in control or otherwise discouraging a potential acquirer from attempting to obtain control of us, which in turn could cause the market price of our ADSs to decline or prevent our shareholders from realizing a premium over the market price for their ADSs.

The market price of our ADSs may be volatile and may decline.

Prior to this offering, our ordinary shares or ADSs have not been traded in the public markets. We cannot predict the extent to which a trading market for our ADSs will develop or how liquid that market might become. An active trading market for our ADSs may never develop or may not be sustained, which could adversely affect your ability to sell your ADSs and the market price of your ADSs. The initial public offering price for the ADSs was determined by negotiations between us, the selling shareholder and the underwriters and does not purport to be indicative of prices at which our ADSs will trade upon completion of this offering.

The stock market in general, and the market for equities of some technology companies, early stage companies and Internet companies in particular, have been highly volatile. As a result, the market price of our ADSs is likely to be similarly volatile, and investors in our ADSs may experience a decrease, which could be substantial, in the value of their ADSs, including decreases unrelated to our operating performance or prospects, or a complete loss of their investment. The price of our ADSs could be subject to wide fluctuations in response to a number of factors, including those listed elsewhere in this “Risk Factors” section and others such as:

 

   

variations in our operating performance and the performance of our competitors;

 

   

actual or anticipated fluctuations in our quarterly or annual operating results;

 

   

changes in our revenues or earnings estimates or recommendations by securities analysts;

 

   

publication of research reports by securities analysts about us or our competitors or our industry;

 

   

our failure or the failure of our competitors to meet analysts’ projections or guidance that we or our competitors may give to the market;

 

   

additions or departures of key personnel;

 

   

strategic decisions by us or our competitors, such as acquisitions, divestitures, spin-offs, joint ventures, strategic investments or changes in business strategy;

 

   

announcement of technological innovations by us or our competitors;

 

   

the passage of legislation, change in interpretations of laws or other regulatory events or developments affecting us;

 

   

speculation in the press or investment community;

 

   

changes in accounting principles;

 

   

the expiration of contractual lock-up arrangements with our executive officers, directors and shareholders;

 

   

terrorist acts, acts of war or periods of widespread civil unrest; and

 

   

changes in general market and economic conditions.

 

63


In the past, securities class action litigation has often been initiated against companies following periods of volatility in their stock price. This type of litigation could result in substantial costs and divert our management’s attention and resources, and could also require us to make substantial payments to satisfy judgments or to settle or defend litigation.

A total of         or         % of our total outstanding ordinary shares (including ordinary shares represented by ADSs) after the offering are restricted from immediate resale, but may be sold on a stock exchange in the near future. The large number of ordinary shares or ADSs eligible for public sale or subject to rights requiring us to register them for public sale could depress the market price of our ADSs.

The market price of our ADSs could decline as a result of sales of a large number of shares of our ordinary shares or ADSs in the market after this offering, and the perception that these sales could occur may also depress the market price of our ADSs. We will have         ordinary shares outstanding (including ordinary shares represented by ADSs) after this offering, assuming no exercise of our outstanding options or warrants. Of these shares,         ordinary shares represented by ADSs sold in this offering will be freely tradable in the United States, except for any ordinary shares purchased by our “affiliates” as defined in Rule 144 under the Securities Act of 1933.

The holders of         shares of outstanding ordinary shares or ADSs have agreed with the underwriters, subject to a number of exceptions, not to dispose of or hedge any of their ordinary shares during the 180-day period beginning on the date of this prospectus, except with the prior written consent of the representatives of the underwriters in this offering. After the expiration of the 180-day restricted period, these shares and ADS, may be sold in the public market in the United States, subject to prior registration in the United States, if required, or reliance upon an exemption from U.S. registration, including, in the case of ordinary shares or ADSs held by affiliates, compliance with the volume restrictions of Rule 144. We expect         ordinary shares to be subject to contractual transfer restrictions pursuant to the Shareholders Agreement, which we expect to be amended prior to this offering (see “Certain Relationships and Related Party Transactions—Amended and Restated Shareholders Agreement”).

 

Number of Shares and %
of Total Outstanding

  

Date Available for Sale into Public Markets

                    , or     %

   Immediately after this offering.

                    , or     %

   180 days after the date of this prospectus due to contractual obligations and lock-up agreements between the holders of these shares and the underwriters. However, the representatives of the underwriters can waive the provisions of these lock-up agreements and allow these shareholders to sell their shares or ADSs at any time, provided applicable holding period under Rule 144 have expired.

Upon completion of this offering, the holders of              ordinary shares, or     % of our outstanding ordinary shares as of              December 31, 2010, will be entitled, under contracts providing for registration rights, to require us to register our ordinary shares or ADSs owned by them with the SEC. Upon effectiveness of any registration statement, subject to lock-up agreements with the representatives of the underwriters, those ordinary shares or ADSs will be available for immediate resale in the United States in the open market.

Sales of our ordinary shares and ADSs as restrictions end or pursuant to registration rights may make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate. These sales, or the perception that such sales could occur also could cause the market price for our ADSs to fall and make it more difficult for you to sell our ADSs.

Purchasers in this offering will immediately experience substantial dilution in net tangible book value of their ADSs, and the exercise of the existing warrants and stock options will result in further dilution.

The initial public offering price of our ADSs in this offering is considerably more than the net tangible book value per ADS. Purchasers in this offering will suffer immediate dilution of $             per ADS pro forma net

 

64


tangible book value, based on the sale of ADSs to be sold in this offering at an assumed initial public offering price of $             per ADS (the mid-point of the price range set forth on the cover of this preliminary prospectus). See “Dilution.”

Following the closing of this offering, the holder of our outstanding warrants will be entitled to purchase              ordinary shares of Skype S.A. at an exercise price of $            per ordinary share. See “Capitalization—Warrants.” In addition, as of the date of this prospectus, there are                  outstanding stock options over our ordinary shares (with a weighted average exercise price of $             per ordinary share). The exercise of the existing warrants and stock options will result in further dilution.

After the completion of this offering, we do not expect to declare any dividends in the foreseeable future. Accordingly, investors may only realize future gains on their investments if the price of their ADSs increases, which may never occur.

After the completion of this offering, we do not anticipate making any cash or other distributions on our ordinary shares in the foreseeable future. The payment of cash distributions on ordinary shares is restricted under the terms of our Amended Five Year Credit Agreement. In addition, because we are a holding company, our ability to make any distributions on ordinary shares may be limited by restrictions on our ability to obtain sufficient funds from subsidiaries, including restrictions under the terms of our Amended Five Year Credit Agreement. Furthermore, under the laws of Luxembourg, we are able to make distributions only to the extent that we receive distributions from our subsidiaries, recognize gains from the sale of our assets or have available share premium. We anticipate that we will retain all of our available funds for use in the operation and development of our business. Accordingly, investors may only realize future gains on their investments if the price of their ADSs increases, which may never occur. Investors seeking cash or other distributions should not purchase our ADSs. See “Distribution Policy.”

If securities or industry analysts do not publish research or reports about our business, if they adversely change their recommendations regarding our ADSs or if our operating results do not meet their expectations, the price of our ADSs could decline.

The market price of our ADSs will be influenced by the research and reports that industry or securities analysts publish about us or our business. If one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, we could lose visibility in the financial markets, which in turn could cause the market price of our ADSs or its trading volume to decline. Moreover, if one or more of the analysts who cover our company downgrade our ADSs or if our operating results or prospects do not meet their expectations, the market price of our ADSs could decline.

Future equity issuances may dilute the holdings of current ordinary shareholders or ADS holders and could materially affect the market price of our ADSs.

We may in the future decide to offer additional equity to raise capital or for other purposes. Any such additional offering could reduce the proportionate ownership and voting interests of holders of our ordinary shares and ADSs, as well as our earnings per ordinary share or ADS and net asset value per ordinary share or ADS.

As a holder of our ADSs, you will be required to pay certain fees and expenses.

Holders of ADSs will be required to pay an annual fee for services performed by the depositary in administering our ADS program, a fee for any distributions made to ADS holders, a fee for exchanging ADSs for ordinary shares or ordinary shares for ADSs, and other specified fees and expenses. We may agree with the depositary to amend the depositary agreement without your consent for any reason.

You may be subject to limitations on transfer of your ADSs.

Your ADSs are transferable on the books of the depositary. However, the depositary may refuse to deliver, transfer or register transfers of ADSs generally when its books are closed or when any such action is deemed necessary or advisable by the depositary or by us or because of any requirement of law or of any governmental

 

65


body or commission. Moreover, the surrender of ADSs and withdrawal of our ordinary shares may be suspended pending the payment of fees, taxes and similar charges or if we direct the depositary at any time to cease new issuances and withdrawals of our shares during periods specified by us in connection with shareholders’ meetings, the payment of dividends or as otherwise reasonably necessary for compliance with any applicable laws or government regulations.

Our management will have considerable discretion as to the use of the net proceeds to be received by us from this offering.

Our allocation of the net proceeds to be received by us in this offering is based on current plans and business conditions. The amounts and timing of any expenditure will vary depending on the amount of cash generated by our operations and competitive and market developments, among other factors. Accordingly, our management will have considerable discretion in the application of the net proceeds received by us. The net proceeds may be used for corporate purposes that do not improve our profitability or increase the price of our ADSs. Net proceeds from this offering, pending allocation to operating assets, may be placed in investments that do not produce income or that lose value.

If you directly or indirectly acquire more than 10% of our outstanding shares, including in the form of ADSs, CFC rules may apply to you.

We expect that we and certain of our non-U.S. subsidiaries are, and will continue to be following the offering, controlled foreign corporations (“CFCs”) for U.S. federal income tax purposes. Each “U.S. shareholder” of a CFC that directly or indirectly owns shares in the CFC on the last day of the taxable year on which the corporation is a CFC must generally include in its gross income for U.S. federal income tax purposes its pro rata share of the CFC’s “Subpart F income,” even if the Subpart F income is not distributed. For these purposes, any U.S. person who owns, directly, indirectly through foreign persons, or constructively (under applicable constructive ownership rules of the U.S. Internal Revenue Code of 1986, as amended) 10% or more of the total combined voting power of all classes of shares of a foreign corporation will be considered to be a “U.S. shareholder” of the corporation. See “United States and Luxembourg Income Tax Considerations—United States Federal Income Tax Considerations—Controlled Foreign Corporation Rules.”

 

66


FORWARD-LOOKING STATEMENTS

This prospectus includes forward-looking statements, including statements that involve expectations, plans or intentions (such as those relating to future business or financial results, new features or products, or management strategies). You can identify these forward-looking statements by words such as “may,” “will,” “would,” “should,” “could,” “expect,” “anticipate,” “believe,” “estimate,” “intend,” “plan” and other similar expressions. These forward-looking statements involve risks and uncertainties that could cause our actual results to differ materially from those expressed or implied in these forward-looking statements. These risks and uncertainties include, among others, those described under “Risk Factors” and elsewhere in this prospectus, including in our financial statements and related notes appearing in this prospectus, and the following:

 

   

our ability to maintain or improve our operating and financial performance, and fluctuations in our financial performance;

 

   

uncertainties and limitations of our user metrics;

 

   

intense competition from companies in a number of industries, including Internet product and software companies, telecommunications companies and hardware-based VoIP providers and, potentially, small and medium-sized enterprise telecommunications services providers;

 

   

product errors, system failures and the reliability of Internet infrastructure;

 

   

intellectual property litigation and our ability to protect our intellectual property, technology and brand;

 

   

regulation of our current or future products and services and the risk that compliance with regulatory requirements may be costly and may require that we change the products we offer or the way we do business in particular states, countries or other regions, or that we may be unable to comply with regulatory requirements;

 

   

challenges managing a global business and our reliance on local partners and third-party vendors;

 

   

the growth and availability of broadband Internet access and the risk that some countries may block use of our products;

 

   

our dependence on key personnel and our management team’s limited experience working as a group;

 

   

the impact of new technologies on demand for our products;

 

   

fraudulent activities, use of our products for illegal purposes, and real or perceived security or privacy risks;

 

   

risks associated with acquisitions, minority investments and other strategic transactions;

 

   

increased taxation of our products or increased income tax expense, and our ability to use our net operating losses;

 

   

our ability to expand our products;

 

   

the costs associated with being an independent public company and our ability to comply with the internal control and reporting obligations of public companies; and

 

   

our substantial indebtedness and the restrictions our credit agreement imposes on our business.

We do not intend, and undertake no obligation, to update any of our forward-looking statements to reflect actual results, changes in circumstances, assumptions or beliefs, or future events or circumstances. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

 

67


MARKET DATA

Unless otherwise expressly stated or the context otherwise requires, industry, market and demographic data appearing in this prospectus, including information relating to the telecommunications industry, are derived principally from publicly available information, industry publications, data from market research firms and other third-party sources and estimates by our management, and management estimates are based upon information from the foregoing sources, data from our internal research and assumptions made by us based on such data and our knowledge of our industry and markets. The industry in which we operate is subject to a high degree of uncertainty and risk due to a variety of factors, including those described in “Risk Factors.” These and other factors could cause results to differ materially from those expressed in the estimates made by third parties and by us. If any one or more of these assumptions turn out to be incorrect, actual market results may differ from those predicted. While we do not know what impact any such differences may have on our business, if there are such differences, they could have a material adverse effect on our future results of operations and financial condition, and the trading price of our ADSs.

 

68


USE OF PROCEEDS

We estimate that we will receive net proceeds of approximately $             million from the sale by us of ADSs offered in this offering, after deducting the underwriting discount and estimated offering expenses payable by us. We intend to use the net proceeds received by us in connection with this offering for general corporate purposes. While we currently have no specific plans for the application of the net proceeds to us from this offering, these corporate purposes may include, without limitation, investing in the development and marketing of new products, investing in our infrastructure or repaying a portion of our debt outstanding under our Amended Five Year Credit Agreement. As further discussed under “Management’s Discussion and Analysis of Financial Condition and Results of Operation—Liquidity and Capital Resources—Indebtedness—Five Year Credit Agreement,” on November 19, 2009, we incurred $806.7 million of indebtedness to finance the Skype Acquisition, of which $681.7 million was attributable to our Five Year Credit Agreement. After the amendment thereof, as of December 31, 2010, $724.9 million was outstanding under our Amended Five Year Credit Agreement. The variable interest rate under this facility is calculated on the basis of LIBOR for the appropriate currency, subject to a 2% floor, plus 5% or 5.5% for the U.S. dollar and Euro tranches, respectively. The Amended Five Year Credit Agreement matures on February 23, 2015.

In connection with the termination of the management services agreements we have entered into with certain of our shareholders and their affiliates, we will pay approximately $            million to such counterparties, on the date of the consummation of this offering, using a portion of the proceeds of this offering. See “Certain Relationships and Related Party Transactions—Management Services Agreements.”

We will not receive any proceeds from the sale of approximately $             million of ADSs to be offered by the selling shareholders. See “Principal and Selling Shareholders.”

 

69


CORPORATE REORGANIZATION

We currently conduct our business through Skype Global S.à r.l., a Luxembourg limited liability company (société à responsabilité limitée), and its subsidiaries. Skype S.à r.l., the registrant, is a Luxembourg limited liability company (société à responsabilité limitée), formed in July 2010 for the purpose of making this offering. Skype S.à r.l., currently a wholly-owned subsidiary of Skype Global S.à r.l., does not engage in any operations and has only nominal assets, including a 100% interest of Skype Global Holdco S.à r.l., a Luxembourg limited liability company (société à responsabilité limitée), which itself does not engage in any operations and holds no material assets. The corporate reorganization, which is expected to occur prior to the effectiveness of the registration statement of which this prospectus forms a part, will consist of the following principal steps:

 

   

Skype S.à r.l., formed as a Luxembourg limited liability company (société à responsabilité limitée) subsidiary of Skype Global S.à r.l., and holding the entire capital of Skype Global Holdco S.à r.l., will change its form and convert into a Luxembourg joint stock company (société anonyme), Skype S.A.

 

   

After the conversion, all shareholders of Skype Global S.à r.l. will contribute in kind and exchange their shares in Skype Global S.à r.l. against newly issued shares in Skype S.A. Skype S.A. shares held by Skype Global S.à r.l. will be cancelled.

 

   

Upon completion of such contribution in kind, the articles of incorporation of Skype S.A. will be amended and restated, the re-composition of our board will be approved and Skype S.A. will enter into an amended and restated shareholders agreement with its shareholders.

 

   

Skype S.A. then will in turn contribute all shares of Skype Global S.à r.l. to Skype Global Holdco S.à r.l. against the issue by Skype Global Holdco S.à r.l. of shares of two different classes, namely class A and class B.

 

   

Once Skype Global S.à r.l. is the wholly owned subsidiary of Skype Global Holdco S.à r.l., the articles of incorporation of Skype Global S.à r.l. will be amended and restated.

Immediately following the corporate reorganization, our shareholders will have the same proportionate ownership interest in Skype S.A. as they had in Skype Global S.à r.l. prior to the corporate reorganization. See “Principal and Selling Shareholders” for more information on the ordinary shares held by our directors, named executive officers, more than 5% shareholders and selling shareholders. Investors in this offering will only receive, and this prospectus only describes the offering of, ADSs representing ordinary shares of Skype S.A. See “Description of Share Capital” for additional information regarding the terms of our articles of incorporation and the rights attached to our ordinary shares.

In connection with the corporate reorganization, each outstanding stock option granted by Skype Global S.à r.l. to our employees, directors, service providers and consultants under the Skype Equity Incentive Plan will be assumed by Skype S.A. and converted into an equivalent stock option to purchase ordinary shares of Skype S.A. The Skype Equity Incentive Plan will also be assumed by Skype S.A. From and after the completion of this offering, each stock option will be deemed to constitute a stock option to acquire, on the same terms and conditions as were applicable under the Skype Equity Incentive Plan, a number of Skype S.A. ordinary shares equal to the product of (1) the number of shares of Skype Global ordinary shares otherwise purchasable pursuant to such stock option and (2)                             , rounded down, if necessary, to the nearest whole share; and such stock option to acquire Skype S.A. ordinary shares will have an exercise price per share equal to (1) the exercise price per share of the Skype Global stock option, divided by (2)            , rounded up to the nearest cent. After the completion of this offering, any employee, director, service provider or consultant acquiring ordinary shares of Skype S.A. pursuant to the exercise of a stock option will hold such shares directly and not through Skype Management L.P. as was required prior to the completion of this offering.

 

70


Our corporate reorganization will not affect our operations, which we will continue to conduct through our operating subsidiaries. The following chart reflects our corporate structure after consummation of this offering, after giving effect to the corporate reorganization:

LOGO

 

(1)

Includes Silver Lake, CPPIB, Andreessen Horowitz, eBay, Joltid, Charleston Investment Holdings Limited and certain of their affiliates. See “Principal and Selling Shareholders.”

 

71


(2)

Prior to this offering, employees, directors and consultants who invested in Skype Global or who acquired ordinary shares pursuant to the exercise of any stock option granted under the Skype Equity Incentive Plan held their equity interest in Skype Global through Skype Management, L.P. (“Skype Management”), an exempted limited partnership organized under the laws of the Cayman Islands, which is a shareholder in Skype Global, primarily to enable Skype Global to comply with the limitation on the number of record holders of its ordinary shares under applicable law. Skype Management received such acquired shares on behalf of the employees, directors and consultants and issued a corresponding number of partnership units to the employees, directors and consultants. In connection with this offering, the partnership will terminate and be wound up and Skype Management’s ordinary shares in Skype Global will be distributed to the employees, directors and consultants according to their respective numbers of partnership units.

 

72


DIVIDEND POLICY

We do not anticipate making any dividends or other distributions on our ordinary shares in the foreseeable future. We anticipate that we will retain all of our available funds for use in the operation and development of our business. Any future determination to make dividends or other distributions will be at the discretion of the general meeting of our shareholders or, with respect to interim dividends or distributions, our board of directors, and will depend on, among other things, our financial condition, results of operations, cash needs, plans for expansion, tax considerations, available net profits and reserves, limitations under Luxembourg law and other factors that our board of directors considers to be relevant. In addition, covenants in instruments and agreements, including the Amended Five Year Credit Agreement, may restrict our ability to make dividends or other distributions on our ordinary shares.

 

73


CAPITALIZATION

The following table sets forth our cash and cash equivalents and capitalization as of December 31, 2010:

 

   

on an actual basis; and

 

   

on an as adjusted basis to give effect to our corporate reorganization and to reflect our receipt of the estimated net proceeds from this offering, based on an assumed initial public offering price of $             per ADS (the mid-point of the price range set forth on the cover page of this prospectus) and after deducting the estimated underwriting discount and estimated offering expenses payable by us, the payment of approximately $             million to certain of our shareholders upon the consummation of this offering in connection with the termination of our management service agreements with them, and the application of such net proceeds as described under “Use of Proceeds.”

You should read the information in the following table together with “Corporate Reorganization,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes appearing elsewhere in this prospectus.

 

     As of December 31, 2010  
     Actual     As  Adjusted(1)  
     (thousands of U.S. dollars)  

Cash and cash equivalents

   $ 142,465      $                
                

Total outstanding debt(2)

   $ 724,860      $     
                

Shareholder’s equity:

    

Common stock classes A,B,C,D,E,F,G,H,I,J, $0.01 par value, 943,673 shares of each of the 10 classes authorize, issued and outstanding as of December 31, 2010 (actual); ordinary shares, $0.01 par value,              shares authorized,              shares issued and outstanding (as adjusted)(3)

     94     

Additional paid-in capital

     2,337,680     

Warrants

     17,214     

Accumulated deficit

     (106,626  

Accumulated other comprehensive income/(loss)

     (1,672  
                

Total shareholders’ equity

     2,246,690     
                

Total capitalization

   $ 3,317,855      $     
                

 

(1)

A $1.00 increase (decrease) in the assumed initial public offering price of $             per ADS in this offering, which is the midpoint of the range set forth on the cover of this prospectus, would increase (decrease) each of cash and cash equivalents, additional paid-in capital, total shareholders’ equity and total capitalization by $             million, assuming the number of ADSs offered by us, as set forth on the cover of this prospectus, remains the same, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

(2)

Consists of outstanding term loan under our Amended Five Year Credit Agreement.

(3)

The number of ordinary shares issued and outstanding, as adjusted to give effect to our corporate reorganization and this offering, does not include:

 

   

         ordinary shares issuable upon the exercise of stock options granted to our employees, directors, service providers and consultants outstanding at December 31, 2010 under the Skype Equity Incentive Plan with exercise prices of between $             and $             per share (equivalent to a weighted average exercise price of $             per share);

 

   

         ordinary shares issuable upon the exercise of stock options granted to our employees, directors, service providers and consultants after December 31, 2010 under the Skype Equity Incentive Plan with exercise prices of between $             and $             per share (equivalent to a weighted average exercise price of $             per share);

 

74


   

         ordinary shares reserved for future issuance under the Skype Equity Incentive Plan; for a discussion of the Skype Equity Incentive Plan, see “Executive Compensation—Compensation Discussion & Analysis—Components of Executive Compensation—Long-Term Equity Incentives”; and

 

   

         ordinary shares into which warrants that were originally granted to Joltid Limited on November 19, 2009, which are now held by SEP Investments Pty Limited, may be exercised at an exercise price of $             per share (the warrants expire upon the earlier of November 19, 2019 and the occurrence of a reorganization event, as defined under the terms of the warrant). See below for more information regarding the terms of the warrant.

Warrants

In connection with the Joltid Transaction, Joltid received warrants to purchase an additional 98,680 Skype Global shares, equivalent to a 1% equity stake at such time, exercisable until the earlier of November 19, 2019 or the closing of a reorganization event, as defined in the warrant agreement. On April 15, 2010, the warrants were transferred to SEP Investments Pty Limited, an entity unaffiliated with Joltid.

The exercise price of the warrants upon completion of this offering will be $            per ordinary share, and the holder of the warrants will be entitled to purchase              ordinary shares of Skype S.A. following the closing of the offering. A reorganization event includes any transaction pursuant to which all or substantially all of Skype Global’s outstanding shares are sold, exchanged or converted into cash, securities or other consideration. A reorganization event, however, excludes transactions with affiliates of Skype Global and transactions where Skype Global’s shareholders prior to the reorganization event retain majority control of the surviving entity following such event. Upon the occurrence of a reorganization event, the warrant holder will receive such consideration with a fair market value equal to the difference between the amount the holder would have received in the reorganization event had it exercised all of its warrants immediately prior to such event, less the amount it would have had to pay to exercise the warrants. The corporate reorganization described elsewhere in this prospectus is not a reorganization event under the warrant agreement, but instead Skype S.A. will assume the warrants and the warrant holder will have a right thereunder to a number of Skype S.A. shares equal to the number of shares that the holder would have received had it exercised the warrants immediately prior to the corporate reorganization.

 

75


DILUTION

If you invest in our ADSs, your ownership interest will be diluted to the extent of the difference between the initial public offering price per ADS and the net tangible book value per ADS upon the completion of this offering. Net tangible book value represents our total tangible assets (total assets less intangible assets) less total liabilities.

Our net tangible book value at December 31, 2010, after giving effect to the sale of              ADSs at an assumed initial public offering price of $             per ADS (the midpoint of the estimated initial public offering price range set forth on the cover page of this prospectus) and after deducting the underwriting discount and estimated offering expenses payable by us or “as adjusted net tangible book value”, would have been $            , or $             per ordinary share or $             per ADS. This represents an immediate increase in net tangible book value of $             per ordinary share or $             per ADS to existing shareholders and an immediate dilution of $             per ordinary share or $             per ADS to new investors, or         % of the assumed initial public offering price of $             per ordinary share or $             per ADS. The following table illustrates this dilution for investors in ADSs in this offering:

 

Assumed initial public offering price per ADS

      $                

Net tangible book value per ADS as of December 31, 2010, before giving effect to this offering

   $        

Increase in net tangible book value per ADS attributable to this offering

   $        
           

As adjusted net tangible book value per ADS

      $     
           

Dilution in as adjusted net tangible book value per ADS to investors in this offering

      $     
           

A $1.00 increase (decrease) in the assumed initial public offering price of $             per ADS would increase (decrease) our as adjusted net tangible book value by $            , the as adjusted net tangible book value per ADS by $             and the dilution in as adjusted net tangible book value per ADS to investors in this offering by $            , assuming that the number of ADSs offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discount and estimated offering expenses payable by us.

The following table summarizes, as of December 31, 2010, the number of ordinary shares (in the form of ordinary shares or ADSs) purchased from us since inception, the total consideration paid to us and the average price per ordinary share and per ADS paid by existing shareholders and by new investors purchasing in this offering at an assumed initial public offering price of $             per ADS (the midpoint of the estimated initial public offering price range set forth on the front cover page of this prospectus), before deducting underwriting discount and estimated offering expenses payable by us.

 

     Shares Purchased     Total
Consideration
    Average
Price
 
      Number      Percent     Amount      Percent     Per
Share
     Per
ADS
 

Existing shareholders

        %      $           %      $         $     

New investors

               
                                       

Total

        100   $           100     
                                       

A $1.00 increase or decrease in the assumed initial public offering price per ADS would increase or decrease, respectively, the total consideration paid by new investors by $            .

 

76


If the underwriters exercise their option to purchase an additional              ADSs in this offering, the number of ordinary shares represented by ADSs held by new investors will increase to approximately              ordinary shares, or approximately             % of the total number of our then outstanding ordinary shares (including ordinary shares represented by ADSs), and the total consideration paid by new investors will increase to approximately $            , or approximately             % of the total consideration paid for our outstanding ordinary shares (in the form of ordinary shares or ADSs), assuming an initial public offering price of $             per ADS (the mid-point of the estimated price range set forth on the cover page of this prospectus).

The foregoing discussion and tables assume the completion, prior to the effectiveness of the registration statement of which this prospectus forms a part, of our corporate reorganization and that the number of ordinary shares that will be outstanding immediately after this offering is based on              ordinary shares outstanding on December 31, 2010, plus the              ordinary shares to be sold by us in the form of ADSs in this offering, and excludes the following ordinary shares:

 

   

             ordinary shares issuable upon the exercise of stock options granted to our employees, directors, service providers and consultants outstanding at December 31, 2010 under the Skype Equity Incentive Plan with exercise prices of between $             and $             per share (equivalent to a weighted average exercise price of $             per share);

 

   

             ordinary shares issuable upon the exercise of stock options granted to our employees, directors, service providers and consultants after December 31, 2010 under the Skype Equity Incentive Plan with exercise prices of between $             and $             per share (equivalent to a weighted average exercise price of $             per share);

 

   

             ordinary shares reserved for future issuance under the Skype Equity Incentive Plan; for a discussion of the Skype Equity Incentive Plan, see “Executive Compensation—Compensation Discussion & Analysis—Components of Executive Compensation—Long-Term Equity Incentives”; and

 

   

             ordinary shares into which warrants that were originally granted to Joltid Limited on November 19, 2009, which are now held by SEP Investments Pty Limited, may be exercised at an exercise price of $             per share (the warrants expire upon the earlier of November 19, 2019 and the occurrence of a reorganization event, as defined under the terms of the warrant). See “Capitalization—Warrants” for more information regarding the terms of the warrant.

To the extent that any of the foregoing warrants and options are exercised, there may be further dilution to investors in this offering.

 

77


SELECTED FINANCIAL DATA

The following selected financial information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Unaudited Pro Forma Condensed Consolidated Financial Information,” our audited consolidated financial statements for the Predecessor year ended December 31, 2008, for the Predecessor period from January 1, 2009 to November 18, 2009, for the Successor period from November 19, 2009 to December 31, 2009, as of December 31, 2009 and as of and for the Successor year ended December 31, 2010 included elsewhere in this prospectus.

On November 19, 2009, Skype Global acquired the Communications business segment of eBay, which consisted of the assets and liabilities of the Skype Companies (which we refer to as the “Skype Acquisition”). As a result of the Skype Acquisition, the financial results for the year ended December 31, 2009 have been presented for the Predecessor for the period from January 1, 2009 to November 18, 2009, and for the Successor for the period from November 19, 2009 to December 31, 2009.

Our selected statement of operations data and cash flows data for the Predecessor year ended December 31, 2008, for the Predecessor period from January 1, 2009 to November 18, 2009, for the Successor period from November 19, 2009 to December 31, 2009 and for the Successor year ended December 31, 2010, as well as the selected Successor balance sheet data as of December 31, 2009 and December 31, 2010, have been derived from our audited consolidated financial statements which have been prepared in accordance with United States generally accepted accounting principles (U.S. GAAP) and are included in this prospectus. Our selected statement of operations data for the Predecessor year ended December 31, 2007 and the Predecessor balance sheet data as of December 31, 2008 have been derived from audited consolidated financial statements that were prepared in accordance with U.S. GAAP and are not included in this prospectus. The selected statement of operations data for the Predecessor year ended December 31, 2006, as well as the Predecessor combined balance sheet data below as of December 31, 2006 and 2007, have been derived from unaudited combined financial statements that were prepared in accordance with U.S. GAAP.

Certain reclassifications affecting cost of net revenues and operating expenses have been made to our consolidated statements of operations for years prior to 2010, in order to conform with the presentation for the year ended December 31, 2010.

The Skype Acquisition was accounted for as a business combination using the acquisition method and resulted in a new basis of accounting in the acquired Skype Companies. Accordingly, the purchase price was allocated to assets and liabilities based on their estimated fair value at the acquisition date on November 19, 2009. The excess of purchase price over the tangible assets, identifiable intangible assets and assumed liabilities was recorded as goodwill (see Note 3 to our audited consolidated financial statements included elsewhere in this prospectus for further information). The vertical lines separating the Successor and Predecessor financial data in this prospectus are included to highlight the lack of comparability between these accounts due to the period durations and new basis of accounting resulting from the Skype Acquisition.

The Predecessor financial statements include 100% of the assets and liabilities of the Skype Companies and have been presented on a combined basis. The Predecessor financial statements include allocations of certain eBay expenses including centralized legal, tax, treasury, information technology, employee costs, corporate services and other infrastructure costs, collectively referred to as “corporate allocations.” The corporate allocations have been determined on a basis that we considered to be reasonable reflections of the utilization of services provided to us or the benefit received by us. Additionally, certain other expenses incurred by eBay for the direct benefit of the Predecessor have been included in the Predecessor financial statements. See “Certain Relationships and Related Party Transactions” and Note 14 to our audited consolidated financial statements included elsewhere in this prospectus. We believe that the estimates, assumptions, and methodology underlying the allocation of these expenses as reflected in the Predecessor financial statements are reasonable; however, actual expenses may have differed materially from these allocations had the Predecessor operated independently of eBay for the periods presented. The Predecessor financial statements and selected financial data do not purport

 

78


to reflect what the results of operations, financial position or cash flows would have been had the Predecessor operated as an independent company during the periods presented nor do they purport to indicate what the Successor results of operations, cash flows or financial position will be as of any future date or for any future period.

For presentation purposes only, we refer in this prospectus to the Predecessor’s combined financial statements of the Skype Companies and the Successor’s consolidated financial statements collectively as our “consolidated financial statements.”

Selected Statement of Operations Data from 2006 to 2010

 

    Predecessor           Successor  
    Year ended
December 31,
2006
    Year ended
December 31,
2007
    Year ended
December 31,
2008
    January 1 to
November 18,
2009
          November 19 to
December 31,
2009
    Year ended
December 31,
2010
 
    (thousands of U.S. dollars, except share data)  

Selected Statement of Operations Data:

               

Net revenues:

  $ 193,696      $ 381,551      $ 551,364      $ 626,458          $ 92,445      $ 859,815   

Cost of net revenues(1)

    140,107        229,496        293,201        298,334            45,647 (2)      415,702 (2) 
                                                   

Gross profit

    53,589        152,055        258,163        328,124            46,798        444,113   
                                                   

Operating expenses:

               

Sales and marketing(1)

    59,787        64,304        83,222        104,279            16,710        131,939   

Product development(1)

    38,900        22,857        33,599        38,462            6,565        72,263   

General and administrative(1)(3)

    37,865        42,423        48,648        48,688            112,274 (4)      104,954 (5) 

Amortization of acquired intangible assets

    60,156        65,514        69,832        55,453            13,284 (2)      114,308   

Litigation settlement

    —          —          —          343,826 (6)          —          —     

Impairment of goodwill

    —          1,390,938 (7)      —          —              —          —     
                                                   

Total operating expenses

    196,708        1,586,036        235,301        590,708            148,833        423,464   
                                                   

(Loss)/income from operations

    (143,119     (1,433,981     22,862        (262,584         (102,035     20,649   

Realized loss on amended credit agreement(8)

    —          —          —          —              —          (13,513

Interest income and other (expense), net

    2,029        5,303        10,297        (2,549         5,492        4,817   

Interest expense

    —          —          —          —              (10,387 )(9)      (68,645 )(10) 
                                                   

(Loss)/income before income taxes

    (141,090     (1,428,678     33,159        (265,133         (106,930     (56,692

Income tax (benefit)/expense

    (22,044     (23,342     (8,447     3,950            (7,209     (49,787
                                                   

Net income (loss)

  $ (119,046   $ (1,405,336   $ 41,606      $ (269,083       $ (99,721   $     
                                                   

Basic and diluted net loss per share (Class A through J):(11)

              $ (10.59   $     

Weighted number of shares, basic and diluted (Class A through J):(11)

                9,414,600        9,433,743   

 

(1)

Figures for the periods shown below include stock-based compensation expense as follows:

    Predecessor           Successor  
    Year ended
December 31,
2006
    Year ended
December 31,
2007
    Year ended
December 31,
2008
    January 1 to
November 18,
2009
          November 19 to
December 31,
2009
    Year ended
December 31,
2010
 
    (thousands of U.S. dollars)  

Cost of net revenues

  $ 2,141      $ 200      $ (145   $ 331          $ 6      $ 123   

Sales and marketing

    10,247        1,953        3,636        4,524            111        2,500   

Product development

    13,303        3,883        5,443        2,910            92        2,714   

General and administrative

    7,378        4,233        3,892        6,720            52        10,613   
                                                   

Total

  $ 33,069      $ 10,269      $ 12,826      $ 14,485          $ 261      $ 15,950   
                                                   
(2)

Cost of net revenues and amortization of acquired intangible assets for the Successor period from November 19, 2009 to December 31, 2009 include $4.2 million and $13.3 million of amortization costs, respectively, and for the year ended December 31, 2010 include $36.1 million and $114.3 million of amortization costs, respectively, in each case relating to the amortization of the intangible assets acquired in the Skype Acquisition. The increase from the Predecessor period is a result of the Skype Acquisition, whereby the gross carrying amount of intangible assets increased from $340.5 million as of December 31, 2008 to $805.6 million as of December 31, 2009 and December 31, 2010.

(3)

The consummation of this offering will trigger payments under management services agreements entered into in connection with the Skype Acquisition in aggregate amount of $             million. Upon the consummation of this offering, all payments we owe under these agreements will be accelerated and paid at their net present value, and these agreements will terminate. See “Certain Relationships and Related Party Transactions—Management Service Agreements.”

(4)

This amount includes $98.7 million of transaction fees and expenses incurred in connection with the Skype Acquisition.

 

79


(5)

During 2010, this amount includes $9.7 million of separation costs, including $5.8 million of share-based compensation incurred in connection with the separation agreement that we entered into with our former Chief Executive Officer. See “Executive Compensation—Compensation Discussion & Analysis—Employment Agreements; Severance and Change in Control Provisions—Payments and Benefits in Connection with Mr. Silverman’s Separation” and “—Summary Compensation Table—Potential Payments upon Termination or Change in Control—Chief Executive Officer Separation.”

(6)

This amount represents the net charge incurred by us in connection with the settlement that we and eBay reached with Joltid regarding our use of the “Global Index” technology that facilitates communications in the peer-to-peer network of Skype users. For more information regarding this settlement and the Joltid Transaction generally, please refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Factors Affecting Results of Operations,” “Certain Relationships and Related Party Transactions—Acquisition-Related Matters—The Joltid Transaction” and Note 14 to our audited consolidated financial statements included elsewhere in this prospectus.

(7)

This amount represents the impairment in 2007 of the goodwill recorded in connection with our acquisition by eBay in 2005. As a result of the assessment in 2007 that the carrying value of that goodwill exceeded its fair value, an impairment charge of $1.4 billion was recorded. For more information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations—Impairment of Goodwill” and Note 4 to our audited consolidated financial statements included elsewhere in this prospectus.

(8)

This amount represents the expense incurred in connection with the amendment of our Amended Five Year Credit Agreement in February 2010, described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Indebtedness.”

(9)

This amount represents the net interest expense, including amortization of original issuance discount and deferred financing cost, incurred for the Successor period from November 19, 2009 to December 31, 2009 in connection with the indebtedness incurred to finance the Skype Acquisition, as described further under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Indebtedness.”

(10)

This amount represents the net interest expense, including amortization of original issuance discount and deferred financing cost, incurred for the year ended December 31, 2010 in connection with the outstanding indebtedness incurred to finance the Skype Acquisition, described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Indebtedness.”

(11)

Per share information is not provided for the Predecessor periods from the year ended December 31, 2006 to the period ended November 18, 2009 because the Predecessor financial statements have been prepared on a combined basis and have an equity structure reflecting eBay’s net investment in the Skype Companies.

Selected Balance Sheet Data

 

    Predecessor           Successor  
    As of December 31,           As of December 31,  
    2006     2007     2008           2009           2010  
    (thousands of U.S. dollars)  

Selected Balance Sheet Data:

               

Cash and cash equivalents

  $ 92,837      $ 115,884      $ 260,187          $ 114,077 (1)      $ 142,465   

Total current assets

    121,953        154,234        319,804            202,445          243,387   

Property and equipment, net

    7,123        9,075        6,040            13,238          36,523   

Goodwill

    2,575,931        1,919,341        1,836,562            2,372,779 (2)        2,372,779   

Intangible assets, net

    235,711        188,204        112,934            788,118 (3)        637,688 (3) 

Total assets

    2,944,758        2,275,410        2,282,535            3,409,704          3,317,855   
 

Accrued expenses and other current liabilities

    39,658        46,359        65,159            90,852          121,100   

Deferred revenue and user advances

    56,219        89,419        108,012            142,600          176,681   

Total current liabilities

    111,740        170,463        219,893            302,246          353,726   

Long term debt(4)

    —          —          —              772,220          686,348   

Total liabilities

    150,730        186,007        222,493            1,172,131          1,071,165   

Total invested / shareholders’ equity

    2,794,028        2,089,403        2,060,042            2,237,573          2,246,690   

Total liabilities and invested / shareholders’ equity

  $ 2,944,758      $ 2,275,410      $ 2,282,535          $ 3,409,704        $ 3,317,855   

 

(1)

Cash and cash equivalents decreased as of December 31, 2009 compared to December 31, 2008 primarily as a result of the repayment to eBay of a portion of its investment in the Skype Companies in the amount of $271.8 million immediately prior to the completion of the Skype Acquisition, as described in Note 2 to our audited consolidated financial statements included elsewhere in this prospectus.

 

80


(2)

This amount represents the excess of purchase price over the tangible assets, identifiable intangible assets and assumed liabilities in the Skype Acquisition, which has been recorded as goodwill.

(3)

This amount represents the identifiable intangible assets acquired in connection with the Skype Acquisition and the Joltid Transaction. As a result of the Skype Acquisition, the gross carrying amount of intangible assets increased from $340.5 million as of December 31, 2008 to $805.6 million as of December 31, 2009 and 2010.

(4)

These amounts represent the outstanding amount as of December 31, 2009 and 2010 of long-term debt incurred to finance the Skype Acquisition, as described under “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Indebtedness.”

Selected Cash Flow Data

 

    Predecessor           Successor  
    Year ended
December 31,
2008
    January 1 to
November 18,
2009
          November 19 to
December 31,
2009
          Year ended
December 31,
2010
 
    (thousands of U.S. dollars)  

Selected Cash Flow Data:

             

Net cash provided by (used in) operating activities:

  $ 148,801      $ 128,049          $ (150,913 )(1)      $ 156,848   

Net cash used in investing activities:

    (4,964     (11,733         (1,958,981 )(2)        (35,024

Net cash provided by (used in) financing activities:

    13,305        (263,302         2,082,013 (3)        (86,862 )(4) 

 

(1)

This amount was impacted by outgoing cash payments of $94.4 million in connection with the Joltid litigation settlement as part of the overall Joltid Transaction. For more information see “Certain Relationships and Related Party Transactions—Acquisition-Related Matters—The Joltid Transaction” and Note 14 to our audited consolidated financial statements included elsewhere in this prospectus. In addition, net cash of $98.7 million was also paid as fees and expenses in connection with the Skype Acquisition.

(2)

This amount includes $1.9 billion in cash paid to eBay as a portion of the consideration in the Skype Acquisition. In addition, $34.6 million was paid to acquire intangible assets as part of the Joltid Transaction we entered into prior to the Skype Acquisition.

(3)

This amount includes $681.7 million net proceeds from indebtedness incurred in connection with the Skype Acquisition and $1.4 billion in net cash proceeds from the issuance of common stock in the Skype Acquisition.

(4)

This amount primarily reflects the refinancing of our Amended Five Year Credit Agreement and the contemporaneous repayment of the entire $125.0 million outstanding payment-in-kind loan agreement with eBay.

Key Metrics

We monitor certain key operating metrics that we believe drive our financial performance, including net revenues, and that we use to measure usage during different periods of the year to manage our business and to help identify potential fraudulent activities. These metrics are derived from our operational systems, as opposed to our financial reporting systems. As our business evolves and we continue to gain further insight into our growing business, we may change the method of calculating our key operating metrics, enhance our operational systems to address uncertainties in these metrics or add new key operating metrics to reflect the changes in our business.

Our registered user metric is subject to a degree of overstatement. Other metrics are subject to uncertainties and inaccuracies and may be overstated or understated. For more information, see “Risk Factors—The number of our registered users overstates the number of unique individuals who register to use our products,” “—Our connected users metric is subject to uncertainties and may overstate the number of users who actively use our products,” “—Our paying user and communications services billing minutes metrics are subject to a degree of inaccuracy due to fraudulent transactions and our method of calculating these metrics.” and “—The peer-to-peer nature of our software architecture makes it difficult to determine certain operational metrics.”

We describe below how we calculate each of these metrics, as well as certain key assumptions relating to these metrics. We exclude from our registered, connected and paying user metrics those users that have become users through non-controlled entities in which we hold a minority interest because they do not contribute to net revenues in our statement of operations. As we present average revenue per paying user as a related metric, we believe it would not be appropriate to include paying users of such entities in this metric. Accordingly, we

 

81


exclude registered, connected and paying users of our only non-controlled entity, Tel-Online Limited, which is our Chinese investment in which we hold a 49% interest and our partner, Tom Online, holds a majority interest. We also exclude from our communications services billing minutes metric minutes of Skype users through Tel-Online Limited.

Registered users. We calculate registered users as the cumulative number of user accounts at the end of the relevant period. The registered user figure overstates the number of unique users because, among other things, users may register more than once and, as a result, may have more than one account and some users engage in fraudulent activities that result in the creation of spurious user accounts.

Connected users. We calculate connected users as the number of user accounts, averaged over a three month period, that log in to the Skype software client, either manually or automatically, in a given calendar month. We also include in connected users the number of users, averaged over a three month period, who have a valid Skype software certificate (for example, a mobile phone with the Skype software client installed) that is checked and has been validated during the past thirty days.

The number of connected users is subject to uncertainties and may not be indicative of users actively using our products during a given period. For example, for a number of our users, once a user has downloaded our software onto their device, the software will automatically be logged in to when the device is turned on even if the customer takes no steps to affirmatively engage our software client after initial registration. In addition, a number of connected users in a given period includes the creation and use of spurious user accounts. By contrast, users accessing Skype from behind a firewall may not be captured in our systems as connected users.

Paying users. We calculate paying users as the number of unique user accounts, averaged over a three month period, who make a successful SkypeOut call using Skype credit on a pay-as-you-go basis in a given calendar month or that had an active subscription at any time during such calendar month. A user need not be logged in to the Skype software client to be considered as having made a successful SkypeOut call; for example, the user may utilize our Skype-to-Go or Call Forwarding paid products, which do not require users to log in to the Skype software client. Thus, there may be user accounts in a particular period that are counted as paying users but are not counted as connected users. We strive to eliminate from our number of paying users any users who only made SkypeOut calls utilizing promotional, free Skype credit or promotional subscriptions services. Our operational systems may fail to classify properly these users, and accordingly this metric is subject to potential inaccuracies.

Communications services billing minutes. We calculate communications services billing minutes as the cumulative number of minutes that Skype users were connected to our communications services products, which mainly comprise billing minutes related to SkypeOut calls to traditional fixed-line or mobile telephones during a relevant period. A user does not need to be logged in to the Skype software client to register a billing minute; for example, the user may make a Skype-to-Go call or use Call Forwarding, which do not require users to log in to the Skype software client. Due to the rounding up of our billing system, this number will exceed the aggregate number of minutes of such calls our users made. We strive to eliminate from this number minutes attributable to SkypeOut calls made utilizing promotional, free Skype credit or promotional subscriptions services, or other free calls. Our operational systems may fail to classify properly these minutes, and accordingly this metric is subject to potential inaccuracies.

Skype-to-Skype minutes. We define Skype-to-Skype minutes as an estimate of the number of minutes in which a Skype user is simultaneously connected via a free Skype call with another Skype user. We derive this by collecting reports at regular intervals from selected points in the Skype user network and aggregating them in order to quantify the number of parallel calls. The estimated activity is designed to count one Skype-to-Skype minute per minute of conversation between two simultaneous users on a call, and 0.5 Skype-to-Skype minutes per minute of conversation for each additional user on a multi-party call involving three or more users.

 

82


The table below shows our registered users as of the relevant dates specified below as well as the average monthly connected users and average monthly paying users for the three months ended on the relevant dates specified below. Unless otherwise specified, the terms “average monthly connected user” and “average monthly paying user” as used below and in this prospectus represent a three month average of the relevant user metrics for each month within the period. Therefore, our average monthly connected users and our average monthly paying users are shown for the three months ending each period, which represents the sum of the monthly connected user and monthly paying user figures, respectively, for each individual month, divided by three.

 

     As of or for the three months ended, as
applicable,
 
     December 31,
2008
     December 31,
2009
     December 31,
2010
 
     (millions)  

Registered users(1)

     325         474         663   

Average monthly connected users(2)

     75         105         145   

Average monthly paying users

     5.8         7.3         8.8   

 

(1)

Our registered users number as of December 31, 2008, 2009 and 2010 includes 17 million, 20 million, and 21 million users, respectively, who registered through their MySpace account. We believe that MySpace registered users are infrequent users of Skype products. The agreement with MySpace, through which users were able to register through MySpace, expired on November 27, 2010 and was not renewed by us. The registered users number in the table above excludes users that have registered on Skype through our investment to address the Chinese market, Tel-Online Limited; the number of users that registered through Tel-Online Limited amounted to 80 million, 86 million and 91 million as of December 31, 2008, 2009 and 2010, respectively.

(2)

Our average monthly connected users number for the three months ended December 31, 2008, 2009 and 2010 includes 4 million, 2 million and 0.2 million users, respectively, who registered through their MySpace account. We believe that MySpace connected users are infrequent users of Skype products. The agreement with MySpace, through which users were able to register through MySpace, expired on November 27, 2010 and was not renewed by us. The average monthly connected users number in the table above excludes users that have connected to Skype through our investment to address the Chinese market, Tel-Online Limited; the average monthly connected users that connected through Tel-Online Limited amounted to 3 million, 2 million and 3 million for the three months ended December 31, 2008, 2009 and 2010, respectively.

The table below shows average communications services revenue per paying user for each of the periods presented. Average communications services revenue per paying user for a given fiscal year represents our net revenues derived from our communications services for such year divided by the average paying users for such year. For these purposes, “paying users” represent the average of the average monthly paying users for each of the four quarters in the relevant fiscal year.

 

     For the year ended
December 31,
 
     2008      2009      2010  
     (U.S. dollars)  

Average communications services revenue per paying user

   $ 102       $ 98         $97   

 

The table below shows our communications services billing minutes and Skype-to-Skype minutes for each of the periods presented:

 

   

     For the year ended
December 31,
 
     2008      2009      2010  
     (billions)  

Communications services billing minutes

     6.9         10.7         12.8   

Skype-to-Skype minutes

     65.5         113.0         194.3   

 

83


UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL INFORMATION

The following unaudited pro forma condensed consolidated financial information for the year ended December 31, 2009 has been developed by applying pro forma adjustments to our historical consolidated financial statements for the Predecessor period from January 1, 2009 to November 18, 2009 and the Successor period from November 19, 2009 to December 31, 2009 appearing elsewhere in this prospectus. For presentation purposes only, we refer in this prospectus to the Predecessor’s combined financial statements of the Skype Companies and the Successor’s consolidated financial statements collectively as our “consolidated financial statements.”

The unaudited pro forma condensed consolidated financial information for the year ended December 31, 2009 gives effect to the Skype Acquisition as if it had occurred on January 1, 2009 and excludes certain non-recurring charges associated with the Skype Acquisition. The unaudited pro forma adjustments are based upon available information and certain assumptions that we believe are reasonable. The unaudited pro forma condensed consolidated financial information is presented for informational purposes only. The unaudited pro forma condensed consolidated financial information, which has been prepared and presented in accordance with Article 11 of Regulation S-X, does not purport to represent what our actual consolidated results of operations would have been had the Skype Acquisition actually occurred on the date indicated, nor is it necessarily indicative of future consolidated results of operations. The unaudited pro forma condensed consolidated financial information should be read in conjunction with the information contained in “Selected Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the historical consolidated financial statements and the related notes thereto appearing elsewhere in this prospectus. All pro forma adjustments and their underlying assumptions are described more fully in the notes to our unaudited pro forma condensed consolidated financial information.

 

84


Unaudited Pro Forma Condensed Consolidated Statement of Operations for the Year Ended December 31, 2009

 

     Predecessor            Successor     Pro forma
adjustments
    Pro forma  
     Period from
January 1 to
November 18,
2009
           Period from
November 19 to
December 31,
2009
      Year ended
December 31,
2009
 
     (thousands of U.S. dollars, except per share information)  

Net revenues

   $ 626,458           $ 92,445      $ —        $ 718,903   

Cost of net revenues

     298,334             45,647        31,926 (1)      375,907   
                                     

Gross profit

     328,124             46,798        (31,926     342,996   
                                     

Operating expenses:

             

Sales and marketing

     104,279             16,710        (1,557 )(2)      119,432   

Product development

     38,462             6,565        —          45,027   

General and administrative

     48,688             112,274        (88,314 )(3)      72,648   

Amortization of acquired intangible assets

     55,453             13,284        45,570 (4)      114,307   

Litigation settlement

     343,826             —          —          343,826   
                                     

Total operating expenses

     590,708             148,833        (44,301     695,240   
                                     

(Loss)/income from operations

     (262,584          (102,035     12,375        (352,244

Interest income and other (expense), net

     (2,549          5,492        —          2,943   

Interest expense

     —               (10,387     (79,257 )(5)      (89,644
                                     

Loss before income taxes

     (265,133          (106,930     (66,882     (438,945

Income tax expense / (benefit)

     3,950             (7,209     (18,139 )(6)      (21,398
                                     

Net loss

   $ (269,083        $ (99,721   $ (48,743   $ (417,547
 

Basic and diluted net loss per share (Class A through J):(7)

          $ (10.59     $ (44.35

Weighted number of shares, basic and diluted (Class A through J):(7)

            9,414,600          9,414,600   

 

(1)

Reflects a net increase in cost of net revenues relating to the amortization of developed technology intangible assets acquired in connection with the Skype Acquisition. Acquired existing technologies have useful lives ranging from three to seven years and are amortized on a straight-line basis.

(2)

Reflects a decrease in sales and marketing expenses of $1.6 million relating to the elimination of cash bonus payments to certain Skype executives that vested upon the completion of the Skype Acquisition.

(3)

Reflects a net decrease in general and administrative expenses of $87.7 million relating to the elimination of transaction fees of $98.7 million directly relating to the Skype Acquisition, the elimination of $2.1 million in cash bonus payments to certain Skype executives that vested upon the completion of the Skype Acquisition, and the addition of $12.5 million relating to monitoring fees that are payable under management service agreements entered into with certain shareholders of Skype in connection with the Skype Acquisition. See “Certain Relationships and Related Party Transactions—Management Service Agreements.”

(4)

Reflects a net increase in the amortization of acquired intangible assets expenses including customer lists and user base (two to three year useful life), trademarks and trade names (ten year useful life) and other intangible assets acquired in connection with the Skype Acquisition. Each of these intangible assets is amortized over its estimated useful life on a straight-line basis.

(5)

Reflects an increase in interest expense of $79.3 million consisting of additional interest expense of $69.4 million on the Five Year Credit Agreement and the payment-in-kind loan agreement with eBay entered into in connection with the Skype Acquisition, and $9.9 million relating to amortization of the original issuance discount and deferred financing costs associated with the Five Year Credit Agreement.

(6)

Reflects the income tax effect of the pro forma adjustments at the statutory tax rate in effect in the jurisdiction to which the underlying pro forma adjustment related.

(7)

Per share information is not provided for the Predecessor period because the Predecessor financial statements have been prepared on a combined basis and have an equity structure reflecting eBay’s net investment in the Skype Companies.

 

85


MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This management’s discussion and analysis of financial condition and results of operations should be read together with the consolidated financial statements and related notes that are included elsewhere in this prospectus. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” or elsewhere in this prospectus. See “Risk Factors” and “Forward-Looking Statements” for a discussion of some of the uncertainties, risks and assumptions associated with those forward-looking statements.

Overview

Skype is a global technology leader that enables real-time communications over the Internet. Our software-based communications platform offers high quality, easy-to-use tools for Skype consumers and businesses to communicate and collaborate globally through voice, video and text conversations.

We believe the growth, scale and engagement of our user base are primary drivers of our business. Our user base has grown rapidly since we were founded in 2003. From the three months ended December 31, 2009 to the three months ended December 31, 2010, we grew our average monthly connected users by 38% from 105 million to 145 million. Our user base is geographically and demographically diverse, and our software is used by people throughout the world. For example, for the fourth quarter of 2010, users registered in the United States represented approximately 17% of our total connected users; no other single country represented more than 8% of our connected users. We believe that our software has broad appeal and is actively used by people across gender, age and income groups. We believe our users are also highly engaged in using our product and this engagement has increased over time: in the fourth quarter of 2010, our connected users spent an average of 140 minutes per month using Skype for voice and video communication compared to 122 minutes per month in the fourth quarter of 2009.

The growth in our user base has translated into revenue growth. Our net revenues have historically been driven by the increasing use of our SkypeOut product, which enables Skype users to make low-priced calls to landlines and mobile devices on a pay-per-minute or subscription basis. Users of our paid communications services products, including SkypeOut, pay us in advance of their use of our products, and the growing popularity of our subscription-based products is providing us with more predictability of our future revenues.

Our primary costs associated with our net revenues are costs incurred by us to have SkypeOut calls connected, or “terminated,” on a landline or wireless network. As we have grown our business and entered into agreements with more telecommunications carriers to connect SkypeOut calls, we have been able to negotiate lower termination costs. As a result, cost of net revenues relating to our SkypeOut product has been increasing at a slower rate than our net revenues from the product, enabling us to improve our gross margin.

We believe our business is also characterized by low operating expenditures. In particular, our business and user communities benefit from network effects, whereby Skype products become more valuable as more people use them, thereby creating an incentive for current users to encourage new users to join. As more users join and attract others, Skype creates more value for users, thereby increasing engagement. These positive network effects have helped us grow our user base and establish Skype as a well-recognized brand in Internet communication, without requiring us to make significant investments in sales and marketing activities.

Our relatively low capital expenditures are primarily due to the “peer-to-peer” architecture that enables our software platform and leverages the network resources of our users to connect them. This architecture provides us with a significant cost advantage because we are not required to build or maintain a physical communications network, such as a wire or fiber optic network or cellular infrastructure. As a result, we can add new users and

 

86


provide them with a wide range of products at minimal incremental cost to us, allowing us to offer many of our products for free. Furthermore, we have relatively low cash tax expense, expressed as a percentage of our income or loss before income taxes.

Our financial structure has allowed us to generate cash from operating activities that we are reinvesting in our business. We are continuing to invest in our core products, such as SkypeOut, because we believe that there is significant growth potential for these businesses. For example, we estimate that average monthly paying users of our communications services products represented approximately 6% of our average monthly connected users for the three months ended December 31, 2010, indicating that we have potential to continue to grow our paying user base substantially and attract new users of our existing products. Further, we believe that our connected users represent less than 9% of global Internet users as of June 30, 2010. In addition, we have invested and are continuing to invest in improving and diversifying our portfolio of products in particular our Skype Enterprise products as well as advertising-based products, and across multiple communications platforms and devices. As described in more detail in “Business,” our current major initiatives to broaden and diversify our revenue streams include continuing to grow our user base, increasing Skype free and paid usage, extending our relationship with our users, developing new monetization models, and growing our user base through Skype Enterprise.

We are also continually focused on addressing the main challenges and risks to our business. As the growth and scale of our user base and specifically the number of paid users are primary drivers of our business, we believe that the key challenges that we face in our highly competitive market are continuing to attract new registered users, retaining our connected users and converting non-paying current and future users into paying users. To address these challenges, our strategy focuses on continuing to grow our connected and paying user base and on increasing usage of our free and paid products to extend our relationship with our users. We are also seeking to diversify our user base to include more enterprise users. This strategy is described in more detail under “Business—Strategy.”

Our management is similarly focused on addressing the challenges inherent in our rapid growth as a business and an organization. As mentioned above, from a business perspective, we have invested and are continuing to invest in diversifying our portfolio of products, including through acquisitions when appropriate, with the objective of extending the use of Skype in new markets. Management is focused on diversifying our product portfolio, integrating new operations such as the Qik business, prioritizing new products in an optimal manner and addressing technological challenges and the differing needs of customers of these new products. We have a short operating history and operate in a new and rapidly evolving market. We have expanded our headcount, facilities and infrastructure and we anticipate that further expansion in certain areas will be required for us to operate as an independent public company and for the development of some of our businesses. This expansion has placed, and we expect it will continue to place, a significant strain on our management, operational and financial resources. We are addressing these challenges by continuing to invest in our infrastructure, administrative systems and our workforce in order to build the resources to manage our growth.

In addition, as we become a public company and our business continues to grow, we may encounter further regulatory scrutiny of our products. In order to address this, we closely monitor our regulatory position throughout the world and engage frequently with regulators, as appropriate. In the event that our regulatory positioning were to change, we may need to make changes to our products, processes, organization and infrastructure, which could be costly and difficult.

Skype Acquisition

On November 19, 2009, Skype Global acquired the Communications business segment of eBay for consideration valued at $2.7 billion. The Skype Acquisition was accounted for as a business combination using the acquisition method. Assets acquired and liabilities assumed were recorded at their estimated fair values as of the acquisition date. The excess of purchase price over the tangible assets, identifiable intangible assets and

 

87


assumed liabilities was recorded as goodwill in the amount of $2.4 billion. Among other things, the purchase accounting adjustments established increased bases of intangible assets for our customer lists and user base, trademarks and trade names and developed technology. In order to fund the Skype Acquisition in part we incurred long-term indebtedness with an outstanding balance of $807.2 million as of December 31, 2009. We refinanced this debt in February 2010, with aggregate borrowing of $724.9 million outstanding on December 31, 2010 and from operating cash. As a result of the Skype Acquisition and related borrowings, interest expense and non-cash amortization of acquired intangible assets charges have significantly increased.

Qik Acquisition

In January 2011, we acquired Qik Inc., a provider of mobile video software, for approximately $121 million of initial cash consideration and additional contingent payments of approximately $29 million (the “Qik Acquisition”). Qik is a provider of mobile video software and services that enable individuals to capture, share and store video using mobile devices. As part of the Qik acquisition, we added 63 employees from Qik in January 2011. We used $96.0 million of cash from our balance sheet to pay the up-front purchase price and we borrowed a further $25.0 million from our $30.0 million line of credit under the Amended Five Year Credit Agreement to fund this acquisition.

Presentation of Financial Information

For details of our presentation of financial information throughout this prospectus of financial information and, in particular, how we account for the Skype Acquisition, see “Selected Financial Data.” In our management’s discussion and analysis, we refer to all periods prior to November 19, 2009, the date of the Skype Acquisition, as “Predecessor” periods, and all periods from such date as “Successor” periods. For presentation purposes only, we refer in this prospectus to the Predecessor’s combined financial statements of the Skype Companies and the Successor’s consolidated financial statements collectively as our “consolidated financial statements.” Furthermore, we have supplementally provided our consolidated net revenues, costs and expenses for the year ended December 31, 2009 on a pro forma basis, as if the Skype Acquisition had taken place on January 1, 2009. This pro forma statement of operations information excludes certain non-recurring charges associated with the Skype Acquisition. The pro forma adjustments applied to the historical amounts discussed below are the same as those presented in our “Unaudited Pro Forma Condensed Consolidated Financial Information” and the notes thereto included elsewhere in this prospectus.

Key Factors Affecting Results of Operations

Net Revenues. Our revenues are driven mainly by growth in the number of our connected users and by their use of our paid products. We generate revenues primarily from the sale of our paid Internet communications services products. Our SkypeOut product, which has historically generated a substantial majority of our net revenues, enables Skype users to make low-priced voice calls using our Skype software client to traditional fixed line or mobile networks. Other communications services products include SkypeIn, which allows our users to receive incoming calls using our Skype software client from traditional fixed lines or mobile networks, voicemail, SMS, and Skype Access, which allows our users to connect to compatible WiFi networks through our Skype software client. These products are collectively referred to as our communications services products. The portion of our net revenues derived from the sale of our communications services products was 95%, 93% and 93% for 2008, pro forma 2009 and 2010, respectively. The portion of our net revenues attributable to our SkypeOut product represented 87%, 86% and 86% for 2008, pro forma 2009 and 2010, respectively. We license our software application and provide software updates free of charge to our users. Accordingly, we do not derive revenue from the licensing of these software products to users.

Our fees for communications services are primarily charged on a per-minute or subscription basis. Customers of our communications services pay us in advance of using our products. As a result, we record those advance payments as deferred revenue and user advances until we recognize them as revenue when our customers use our products. Our SkypeOut subscription products are a more recent addition to our products than

 

88


pay-as-you-go, or “PAYG,” and their popularity has increased. The portion of our net revenues from communications services attributable to subscription products was 10%, 16% and 20% for 2008, pro forma 2009 and 2010, respectively. We expect this trend to continue as our user base grows and as our PAYG customers increasingly purchase our subscription products. Historically, we have earned less net revenue per billing minute under our subscription products when compared to the net revenue per billing minute under the pay-as-you-go price plans, although this difference has decreased more recently due to pricing actions and to other product optimization initiatives. This is due to users of subscription-based products generally paying a fixed-price and consuming on average more billing minutes per dollar paid than users that only use the pay-as-you-go product. If the popularity of our subscription products continues to grow in the future, or we continue to increase the selection of subscription-based products with unlimited calling features, our revenue per billing minute may continue to decrease in the future.

In addition, we have changed from time to time the pricing of both our pay-as-you-go and our subscription products. We may increase our pricing in the future or may need to decrease the price of our paid products for a number of reasons, including competitive pressures. These future increases and decreases in prices may impact our net revenues in the period in which they are implemented and thereafter.

Only a small percentage of our connected users have historically paid to use our products. For example, in the three months ended December 31, 2010, we generated communications services revenues from approximately 6% of 145 million connected users (which represents a monthly average of connected users during the three month period), illustrating that substantially all of our revenues come from a small portion of our user base. While we are actively seeking to expand the user base that utilize our portfolio of products and to broaden and diversify our product offerings, we expect a high percentage of our revenues to continue in the foreseeable future to be derived from a small percentage of our overall connected users.

Historically, a substantial majority of our revenue has come from our consumer users. As we seek to develop new communications services products and expand our Skype Enterprise offerings, we expect our net revenues attributable to our consumer users to decrease as a percentage of total net revenues and our revenues from business users to increase both in absolute terms and as a percentage of total net revenues. In addition, as we seek to implement our strategy of expanding the use of Skype products across a broader spectrum of platforms, such as mobile devices, television and websites, we expect that our net revenues will, over time, be derived less from desktop users of Skype than has historically been the case. We also expect that the acquisition of Qik in January 2011 will accelerate our development of mobile video products, and that this may lead to a greater portion of our revenues in coming years being generated from mobile video communications services products than we have generated historically. However, we do not expect that the Qik portfolio of products will contribute material net revenues during 2011.

In addition to our communications services products, we also generate net revenue to a much lesser extent from marketing services and other services which allow businesses to leverage our user base to market their products, as well as other licensing arrangements. We expect net revenues from each of marketing services and other services to grow as a percentage of net revenues over time.

Furthermore, as exchange rates may fluctuate significantly between reporting periods, our net revenues may experience significant fluctuations in future periods for reasons unrelated to our operating performance. For more information, see “—Selected Quarterly Operating Results (unaudited)—Effects of Currency Fluctuations on Net Revenues.”

Cost of net revenues and gross margin. Amortization of acquired intangibles expense is the most significant indirect cost of net revenues. Since the Skype Acquisition in November 2009, our cost of net revenues has been adversely impacted as a result of an increase in basis of developed technology intangible assets acquired therein. The net amount of acquired intangibles was $112.9 million as of December 31, 2008, as compared to $788.1 million as of December 31, 2009 and $637.7 million as of December 31, 2010. In the Predecessor period from January 1, 2009 to November 18, 2009, our cost of net revenues represented 47% of net revenues,

 

89


compared to 49% during the Successor period from November 19, 2009 to December 31, 2009, which increase was primarily the result of the purchase accounting adjustments made in connection with the Skype Acquisition, as described above under “—Skype Acquisition.” This increased amortization is expected to have a negative impact on our results of operations for the foreseeable future.

The most significant direct cost of net revenues are termination costs, which are fees paid to telecommunications carriers to connect, or “terminate,” SkypeOut calls to landline and wireless networks. The portion of our cost of net revenues attributable to termination costs was 72%, 64% and 63% for 2008, pro forma 2009 and 2010, respectively. Other costs of net revenues consist of payment processing fees, chargebacks, site operations and customer support. Payment processing fees are paid to third parties to process and collect payments from our users. Our site operations costs include the costs to support our website and network infrastructure. Our customer support function assists our users with queries about our products. We have increased our investment in our customer support function in recent periods to focus on improving the quality and timeliness of our responses to our users seeking assistance. We offer customer support both directly and through a third-party arrangement. Other indirect costs of net revenues include employee-related costs to support carrier relations, payment processing services and site operations.

Compared to our communications services products, cost of net revenues relating to our marketing services are relatively low. For example, we incur minimal costs to allow for third-party software downloads to occur at the same time users download the Skype software client.

We realized gross margins, which we define as the difference between our net revenues and our cost of net revenues, expressed as a percentage of net revenue, of 47%, 48% and 52% for 2008, pro forma 2009 and 2010, respectively. The period-over-period improvements have primarily been driven by reductions in termination costs as a result of the cost advantages associated with expanding our network of providers of termination minutes and the diversification of our revenue streams, particularly through marketing services, including sponsored downloads and other licensing arrangements. In addition, our gross margin was positively affected by price actions that we took in January 2007, September 2009 and September 2010. In the pro forma 2009 period and 2010, the positive trends in gross margin were partially offset by the negative impact of increased amortization expense as a result of the acquired developed technology assets made in connection with the Skype Acquisition.

We expect our gross margin to be relatively stable in the foreseeable future. We may experience modest improvement as we seek to diversify and expand our revenue sources, including marketing services and other services, which have lower associated costs, while continuing to seek to negotiate reductions in termination costs. However, we expect our gross margins to continue to be negatively affected by the increased amortization expense of developed technology intangible assets, the shift from pay-as-you-go to subscription products and our continued investment in our infrastructure and customer support functions. In addition, our gross margin may be affected, either positively or negatively, by a broad range of other factors and events. As a result, we cannot assure you that our future gross margin will be stable or that it will not decline.

Operating expenses. Our operating expenses consist of sales and marketing expenses, product development expenses, general and administrative expenses (including transaction costs associated with the Skype Acquisition), the Joltid litigation settlement, impairment of goodwill and amortization of intangible assets. We discuss below our primary operating expenses.

Sales and marketing. Sales and marketing expenses consist primarily of advertising, marketing and public relations programs as well as employee compensation for staff focused on sales and marketing activities. We direct customers to our website primarily through a number of online marketing channels such as sponsored search, portal advertising, email campaigns and other initiatives. We have the ability to vary our marketing expenses based on growth in revenue and in light of changes in advertising rates. We expect sales and marketing expenses to increase in aggregate amount in future periods as we increase our sales and marketing activities to

 

90


support and promote our growing portfolio of product offerings, including marketing and distribution costs relating to our Skype Enterprise products, as well as the Skype brand more generally. We expect our sales and marketing expenses to fluctuate in future periods, both in aggregate and as a percentage of net revenues.

Product development. Product development expenses consist primarily of employee compensation costs and third-party developer costs that are incurred in connection with the enhancement of the existing Skype software and the development of new products. The costs for research, including predevelopment efforts prior to establishing technological feasibility of new software, and development of new products enabled by our software, are expensed as incurred. In addition, we have benefited historically from relatively low employee costs related to product development compared to many of our competitors, as the majority of our engineers and developers have been based in Tallinn, Estonia. We have recently begun to expand our product development employee base in jurisdictions with higher labor and real estate costs, for example with the planned expansion of our Silicon Valley office which is focusing on developing Skype products for multiple platforms, which is expected to result in relatively higher product development costs. As of December 31, 2010, 374 of our 911 employees, or 41% of our workforce, worked in product development, and we intend to add approximately 200 additional product developers in 2011. In addition, as part of the Qik acquisition in January 2011, we added 63 employees from Qik in January 2011, of whom 47 were product development employees based in Russia. As a result of these initiatives, we expect product development expenses to continue to increase both in absolute terms and as a percentage of net revenues in future periods as we continue to invest in and expand our portfolio of products, such as our Skype Enterprise products and products that are designed for platforms other than desktops, such as mobile devices, televisions and the Internet. In particular, we expect a substantial majority of the approximately $29 million of additional contingent payments resulting from the Qik acquisition will be recognized as a product development expense over a three-year period from 2011 to 2013.

General and administrative. General and administrative expenses consist primarily of employee compensation, including our executive leadership, legal costs and professional fees, management service and advisory fees, transaction costs directly associated with the Skype Acquisition and corporate allocations. Our legal-related costs are mainly incurred in connection with various ongoing litigations and can fluctuate from period to period.

The consummation of this offering will trigger payments in the aggregate amount of $             to affiliates of Silver Lake, eBay, the CPPIB Equity Investments Inc., Andreessen Horowitz and Joltid under management services agreements, which become payable at the time of this offering. For more information, see “Certain Relationships and Related Party Transactions.”

As we become a public company and operate as a stand-alone company, we expect to incur additional operating expenses which could be substantial as a percentage of our revenue, including investor relations, insurance, shareholder administration and regulatory compliance costs, to comply with our obligations under the Sarbanes-Oxley Act and other applicable laws and regulations.

In the short term, we expect general and administrative expenses to increase both in absolute amounts and as a percentage of net revenues as a result of the costs associated with becoming a public company, but in the long-term we expect them to remain stable or decrease as a percentage of net revenues.

Litigation settlement. Prior to the closing of the Skype Acquisition, we and eBay reached a settlement with Joltid regarding our use of technology that facilitates communications in the peer-to-peer network of Skype users. In connection with the settlement, we acquired ownership of the intellectual property rights in the software and related technology known as the “Global Index.” As part of the settlement, Joltid received an approximate 10% share in our share capital, valued at the time at $224.0 million, a cash payment of $85.0 million, and a warrant to purchase an additional 98,680 of our shares valued at $17.2 million, equivalent to a 1% equity stake at such time, exercisable until the earlier of November 19, 2019 or the occurrence of a reorganization event, as defined in the warrant. The warrant has since been transferred to SEP Investments Pty Limited, an entity unaffiliated with Joltid; for more information on the terms of the warrant, see “Capitalization—Warrants.” Joltid

 

91


also made an investment in us by investing $80.0 million in the Company in consideration for an additional approximate 3.4% share in the equity of the Company at such time. In addition, we made payments or commitments to invest an additional $32.3 million to certain affiliated parties of Joltid and reimbursed $20.0 million in legal expenses incurred by Joltid. The aggregate settlement of $378.4 million resulted in a net charge of $343.8 million recorded in the statement of operations for the Predecessor period from January 1, 2009 to November 18, 2009 and reflects the estimated fair value of the net cash and equity relinquished in the settlement less the estimated fair value of intellectual property acquired from Joltid.

In this prospectus, we refer to the settlement with Joltid, our acquisition of the Global Index technology and Joltid’s investment in us collectively as the “Joltid Transaction.” For more information on the Joltid Transaction, see “Certain Relationships and Related Party Transactions—Acquisition-Related Matters—The Joltid Transaction.”

Goodwill and Other Intangible Assets. We carry significant goodwill and intangible asset balances in our statement of financial position that arose upon the Skype Acquisition. The goodwill presented in the Successor period arose upon the establishment of a new basis of accounting in connection with the Skype Acquisition and replaced the goodwill balance presented in the Predecessor period, which arose upon the acquisition by eBay in 2005. We are currently determining the amount of goodwill and intangible assets to recognize in connection with the Qik Acquisition, which we will reflect in our financial statements for the first quarter of 2011. Goodwill is tested annually for impairment or on an interim basis if events and circumstances indicate that goodwill may be impaired and requires estimates of future operating results and operating cash flows. The estimates are derived from our long-term financial outlook; however, due to the early-stage nature of the business and our developing revenue model, there is an increased risk of differences between projected and actual performance that could impact future estimates of the fair value of the Company. The total goodwill balance as of December 31, 2010 was $2.4 billion. This amount, recognized at the time of the Skype Acquisition, represents the excess of purchase price over the tangible assets, identifiable intangible assets and assumed liabilities acquired in the Skype Acquisition. We conducted our annual test of impairment during the fourth quarter of 2010, which concluded that there was no impairment charge to record in 2010. Events or changes in circumstances may indicate that the carrying amount of the goodwill balance is not recoverable, resulting in an impairment charge in the future. In 2007, we recorded a charge of $1.4 billion impairment of the goodwill originally recognized upon our acquisition by eBay in 2005. The impairment charge was determined by comparing the carrying value of goodwill in eBay’s Communications reporting unit with the implied fair value of the goodwill, based on the estimation of future operating results and cash flows discounted using an estimated discount rate.

Other identifiable intangible assets in the amount of $788.1 million as of December 31, 2009 and $637.7 million as of December 31, 2010 consist of assets acquired in connection with the Skype Acquisition, including acquired customer lists and user base, trademarks and trade names, and developed technologies and are being amortized over the shorter of the contractual life or the estimated useful life ranging from two to ten years.

Interest income and other (expense), net. Interest income and other (expense), net, consists of interest earned on cash, cash equivalents and investments, as well as foreign exchange transaction gains and losses and other miscellaneous transactions not related to our primary operations, such as expenses or income associated with our minority equity investments and at-cost investments. Interest expense incurred on our long-term debt is included separately in our results of operations under “—Interest expense,” below.

Interest expense. Our interest expense comprises the expense incurred on our long-term debt. On November 19, 2009, we incurred $806.7 million of indebtedness to finance the Skype Acquisition, of which $681.7 million was attributable to the Five Year Credit Agreement and $125.0 million was a payment-in-kind loan agreement with eBay, each of which is described under “—Liquidity and Capital Resources—Indebtedness.” We refinanced this long-term debt in February 2010, increasing the term loan borrowings and repaying the full amount of the payment-in-kind loan (including accumulated and unpaid interest) from the increased principal amount and from operating cash. As of December 31, 2010, $724.9 million was outstanding

 

92


under our Amended Five Year Credit Agreement. We have the option to prepay the Amended Five Year Credit Agreement at any time, and we are required to prepay it from excess cash flow when certain financial tests are met. For further details, see “—Liquidity and Capital Resources—Indebtedness.”

Income tax. Skype is a global business that operates across multiple taxing jurisdictions. Our favorable geographic mix of income contributes to lowering our overall tax expense. In particular, while our income is generated predominantly by our Luxembourg operating company, our tax expense is significantly lower than the amount computed by applying the Luxembourg statutory tax rate to pre-tax U.S. GAAP income because our taxable income is reduced as a consequence of, among other items, our intercompany licenses of intellectual property and historic net operating losses in Luxembourg. Our cash outflows relating to our taxes for the year ended December 31, 2010 consisted primarily of foreign withholding tax of $4.8 million.

However, the effects described above are partially offset by expenses for which we cannot recognize a current deduction for tax purposes. Furthermore, we have taxable income in some countries and losses in others (in part as a result of our intercompany licensing transactions). Losses in one country cannot be used to offset income in other countries. Additionally, we do not recognize tax benefits of losses, if we believe it is more likely than not that such losses will not be utilized. These factors have contributed to fluctuations in our historical tax expen