10-Q 1 d27304d10q.htm FORM 10-Q Form 10-Q
Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-Q

 

 

 

x

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

For the quarterly period ended September 30, 2015

 

or

 

¨

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

For the transition period from             to            

Commission File Number 000-28018

 

 

Yahoo! Inc.

(Exact name of Registrant as specified in its charter)

 

 

 

Delaware   77-0398689
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)

701 First Avenue

Sunnyvale, California 94089

(Address of principal executive offices, including zip code)

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

 

 

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

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

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

 

Large accelerated filer

 

x

  

Accelerated filer

 

¨

Non-accelerated filer

 

¨  (Do not check if a smaller reporting company)

  

Smaller reporting company

 

¨

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

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

 

Class

 

Outstanding at October 30, 2015

Common Stock, $0.001 par value   944,355,144

 

 

 


Table of Contents

YAHOO! INC.

TABLE OF CONTENTS

 

PART I

 

 

FINANCIAL INFORMATION

 

    

 

3

 

  

 

Item 1.   Condensed Consolidated Financial Statements (unaudited)      3   
  Condensed Consolidated Balance Sheets as of December 31, 2014 and September 30, 2015 (unaudited)      3   
  Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2014 and 2015 (unaudited)      4   
  Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2014 and 2015 (unaudited)      5   
  Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2015 (unaudited)      6   
  Notes to Condensed Consolidated Financial Statements (unaudited)      8   
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations      36   
Item 3.   Quantitative and Qualitative Disclosures About Market Risk      55   
Item 4.   Controls and Procedures      57   

PART II

 

 

OTHER INFORMATION

 

    

 

58

 

  

 

Item 1.   Legal Proceedings      58   
Item 1A.   Risk Factors      58   
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds      73   
Item 3.   Defaults Upon Senior Securities      73   
Item 4.   Mine Safety Disclosures      73   
Item 5.   Other Information      73   
Item 6.   Exhibits      73   
  Signatures      74   

 

2


Table of Contents

PART I — FINANCIAL INFORMATION

 

 

Item 1. Condensed Consolidated Financial Statements (unaudited)

YAHOO! INC.

Condensed Consolidated Balance Sheets

 

                                                     
   

December 31,

2014

    September 30,
2015
 

 

 
   

(Unaudited, in thousands

except par values)

 
ASSETS    
Current assets:    

Cash and cash equivalents

    $ 2,664,098         $ 1,281,160    

Short-term marketable securities

    5,327,412         4,600,889    

Accounts receivable, net

    1,032,704         980,301    

Prepaid expenses and other current assets

    673,504         733,723    
 

 

 

   

 

 

 

Total current assets

    9,697,718         7,596,073    
Long-term marketable securities     2,230,892         940,052    
Property and equipment, net     1,487,684         1,590,439    
Goodwill     5,152,570         5,266,594    
Intangible assets, net     470,842         397,181    
Other long-term assets and investments     554,616         392,744    
Investment in Alibaba Group     39,867,789         22,618,853    
Investments in equity interests     2,489,578         2,333,063    
 

 

 

   

 

 

 
Total assets     $ 61,951,689         $ 41,134,999    
 

 

 

   

 

 

 
LIABILITIES AND EQUITY    
Current liabilities:    

Accounts payable

    $ 238,018         $ 262,588    

Income taxes payable related to sale of Alibaba Group ADSs

    3,282,293           

Other accrued expenses and current liabilities

    665,828         946,311    

Deferred revenue

    336,963         139,934    
 

 

 

   

 

 

 

Total current liabilities

    4,523,102         1,348,833    
Convertible notes     1,170,423         1,217,408    
Long-term deferred revenue     20,774         25,240    
Other long-term liabilities     143,095         125,862    
Deferred tax liabilities related to investment in Alibaba Group     16,154,906         9,126,655    
Deferred and other long-term tax liabilities     1,153,797         1,011,928    
 

 

 

   

 

 

 
Total liabilities     23,166,097         12,855,926    
 

 

 

   

 

 

 
Commitments and contingencies (Note 12)    
Yahoo! Inc. stockholders’ equity:    

Common stock, $0.001 par value; 5,000,000 shares authorized; 949,771 shares issued and 936,838 shares outstanding as of December 31, 2014 and 960,650 shares issued and 943,528 shares outstanding as of September 30, 2015

    945         956    

Additional paid-in capital

    8,499,475         8,716,314    

Treasury stock at cost, 12,933 shares as of December 31, 2014 and 17,122 shares as of September 30, 2015

    (712,455)        (912,287)   

Retained earnings

    8,934,244         9,006,514    

Accumulated other comprehensive income

    22,019,628         11,434,453    
 

 

 

   

 

 

 

Total Yahoo! Inc. stockholders’ equity

    38,741,837         28,245,950    
Noncontrolling interests     43,755         33,123    
 

 

 

   

 

 

 
Total equity     38,785,592         28,279,073    
 

 

 

   

 

 

 
Total liabilities and equity     $     61,951,689         $     41,134,999    
 

 

 

   

 

 

 

 

 

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

 

3


Table of Contents

YAHOO! INC.

Condensed Consolidated Statements of Operations

 

                                                                                   
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,     September 30,     September 30,  
    2014     2015     2014     2015  

 

 
   

(Unaudited, in thousands

except per share amounts)

 
Revenue     $ 1,148,140         $ 1,225,673         $ 3,365,061         $ 3,694,908    
 

 

 

   

 

 

   

 

 

   

 

 

 
Operating expenses:        

Cost of revenue — traffic acquisition costs

    54,180         223,229         143,915         606,598    

Cost of revenue — other

    292,647         302,846         882,036         884,041    

Sales and marketing

    267,875         274,329         823,398         823,990    

Product development

    292,057         272,285         852,099         905,460    

General and administrative

    176,717         151,963         496,221         506,071    

Amortization of intangibles

    15,322         19,622         48,826         59,677    

Gain on sales of patents

    (1,300)               (62,800)        (11,100)   

Asset impairment charge

           41,699                41,699    

Restructuring charges, net

    8,470         26,012         70,578         96,932    
 

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    1,105,968         1,311,985         3,254,273         3,913,368    
 

 

 

   

 

 

   

 

 

   

 

 

 
Income (loss) from operations     42,172         (86,312)        110,788         (218,460)   

Other income (expense), net

    10,308,931         (23,955)        10,281,889         (66,759)   
 

 

 

   

 

 

   

 

 

   

 

 

 
Income (loss) before income taxes and earnings in equity interests     10,351,103         (110,267)        10,392,677         (285,219)   
(Provision) benefit for income taxes     (3,973,402)        93,208         (3,985,762)        75,613    
Earnings in equity interests, net of tax     398,692         95,195         955,946         290,726    
 

 

 

   

 

 

   

 

 

   

 

 

 
Net income     6,776,393         78,136         7,362,861         81,120    
Net income attributable to noncontrolling interests     (2,291)        (1,875)        (7,474)        (5,215)   
 

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Yahoo! Inc.

    $ 6,774,102         $ 76,261         $ 7,355,387         $ 75,905    
 

 

 

   

 

 

   

 

 

   

 

 

 
Net income attributable to Yahoo! Inc. common stockholders per share — basic     $ 6.82         $ 0.08         $ 7.35         $ 0.08    
 

 

 

   

 

 

   

 

 

   

 

 

 
Net income attributable to Yahoo! Inc. common stockholders per share — diluted     $ 6.70         $ 0.08         $ 7.18         $ 0.08    
 

 

 

   

 

 

   

 

 

   

 

 

 
Shares used in per share calculation — basic     993,543         940,822         1,001,066         937,713    
 

 

 

   

 

 

   

 

 

   

 

 

 
Shares used in per share calculation — diluted     1,007,693         946,934         1,017,935         944,160    
 

 

 

   

 

 

   

 

 

   

 

 

 
Stock-based compensation expense by function:        

Cost of revenue — other

    $ 5,817         $ 9,748         $ 35,824         $ 22,957    

Sales and marketing

    31,661         33,317         113,568         111,416    

Product development

    40,783         46,461         94,217         145,444    

General and administrative

    27,535         20,900         73,813         71,435    

Restructuring charges, net

                         2,705    

 

 

 

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

 

4


Table of Contents

YAHOO! INC.

Condensed Consolidated Statements of Comprehensive Income (Loss)

 

                                                                                   
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,     September 30,     September 30,  
    2014     2015     2014     2015  

 

 
    (Unaudited, in thousands)  
Net income     $ 6,776,393         $ 78,136         $ 7,362,861         $ 81,120    
 

 

 

   

 

 

   

 

 

   

 

 

 
Available-for-sale securities:        

Unrealized gains (losses) on available-for-sale securities, net of taxes of $(12,778,134) and $3,646,362 for the three months ended September 30, 2014 and 2015, respectively, and $(12,782,270) and $7,034,475 for the nine months ended September 30, 2014 and 2015, respectively

    18,580,283         (5,299,758)        18,596,799         (10,225,842)   

Reclassification adjustment for realized (gains) losses on available-for-sale securities included in net income, net of taxes of $1,231 and $(44) for the three months ended September 30, 2014 and 2015, respectively, and $1,304 and $(45) for the nine months ended September 30, 2014 and 2015, respectively

    (2,044)        72         (2,165)        74     
 

 

 

   

 

 

   

 

 

   

 

 

 

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

    18,578,239         (5,299,686)        18,594,634         (10,225,768)   
 

 

 

   

 

 

   

 

 

   

 

 

 
Foreign currency translation adjustments (“CTA”):        

Foreign CTA gains (losses), net of taxes of $(839) and $607 for the three months ended September 30, 2014 and 2015, respectively, and $1,431 and $1,061 for the nine months ended September 30, 2014 and 2015, respectively

    (48,649)        (126,774)        (131,567)        (359,876)   

Net investment hedge CTA gains (losses), net of taxes of $(44,951) and $8,252 for the three months ended September 30, 2014 and 2015, respectively, and $(29,389) and $(2,492) for the nine months ended September 30, 2014 and 2015, respectively

    74,490         (13,855)        48,579         4,183    

Reclassification adjustment for realized (gains) losses included in CTA, net of taxes of $30,325 for both the three and nine months ended September 30, 2014

    (50,301)               (50,301)          
 

 

 

   

 

 

   

 

 

   

 

 

 

Net foreign CTA gains (losses), net of tax

    (24,460)        (140,629)        (133,289)        (355,693)   
 

 

 

   

 

 

   

 

 

   

 

 

 
Cash flow hedges:        

Unrealized gains (losses) on cash flow hedges, net of taxes of $(1,427) and $362 for the three months ended September 30, 2014 and 2015, respectively, and $(996) and $(327) for the nine months ended September 30, 2014 and 2015, respectively

    2,799         (1,440)        909         (6,721)   

Reclassification adjustment for realized (gains) losses on cash flow hedges included in net income, net of taxes of $661 and $274 for the three months ended September 30, 2014 and 2015, respectively, and $1,165 and $992 for the nine months ended September 30, 2014 and 2015, respectively

    (854)        869         (1,594)        3,007    
 

 

 

   

 

 

   

 

 

   

 

 

 

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

    1,945         (571)        (685)        (3,714)   
 

 

 

   

 

 

   

 

 

   

 

 

 
Other comprehensive income (loss)     18,555,724         (5,440,886)        18,460,660         (10,585,175)   
 

 

 

   

 

 

   

 

 

   

 

 

 
Comprehensive income (loss)     25,332,117         (5,362,750)        25,823,521         (10,504,055)   

Less: comprehensive income attributable to noncontrolling interests

    (2,291)        (1,875)        (7,474)        (5,215)   
 

 

 

   

 

 

   

 

 

   

 

 

 
Comprehensive income (loss) attributable to Yahoo! Inc.     $ 25,329,826         $ (5,364,625)        $ 25,816,047        $ (10,509,270)   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

 

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

 

5


Table of Contents

YAHOO! INC.

Condensed Consolidated Statements of Cash Flows

 

                                             
    Nine Months Ended  
    September 30,     September 30,  
    2014     2015  

 

 
    (Unaudited, in thousands)  
CASH FLOWS FROM OPERATING ACTIVITIES:    

Net income

    $ 7,362,861         $ 81,120    

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

   

Depreciation

    356,577         355,540    

Amortization of intangible assets

    96,961         102,090    

Accretion of convertible notes discount

    44,583         46,984    

Stock-based compensation expense

    317,422         353,957    

Non-cash asset impairment charge

           41,699    

Non-cash restructuring reversals

    (7,031)        (31)   

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

    27,850         45,607    

Gain on sale of Alibaba Group ADSs

    (10,319,437)          

Gain on sales of patents

    (62,800)        (11,100)   

Loss on Hortonworks warrants

           19,241    

Earnings in equity interests

    (955,946)        (290,726)   

Tax benefits (detriments) from stock-based awards

    111,062         22,990    

Excess tax benefits from stock-based awards

    (114,392)        (33,359)   

Deferred income taxes

    397,415         (52,605)   

Dividends received from equity investees

    83,685         142,045    

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

   

Accounts receivable

    142,648         34,303    

Prepaid expenses and other assets

    21,058         (64,112)   

Accounts payable

    (310)        (29,642)   

Accrued expenses and other liabilities

    120,018         218,037    

Incomes taxes payable related to sale of Alibaba Group ADSs

    3,282,293         (3,282,293)   

Deferred revenue

    (118,850)        (191,989)   
 

 

 

   

 

 

 

Net cash provided by (used in) operating activities

    785,667         (2,492,244)   
 

 

 

   

 

 

 
CASH FLOWS FROM INVESTING ACTIVITIES:    

Acquisition of property and equipment

    (319,275)        (451,813)   

Proceeds from sales of property and equipment

    15,008         11,069    

Purchases of marketable securities

    (1,562,588)        (3,472,587)   

Proceeds from sales of marketable securities

    1,681,735         566,321    

Proceeds from maturities of marketable securities

    868,956         4,889,437    

Proceeds from sale of Alibaba Group ADSs, net of underwriting discounts, commissions, and fees

    9,404,974           

Acquisitions, net of cash acquired

    (313,837)        (174,630)   

Proceeds from sales of patents

    62,800         29,100    

Purchases of intangible assets

    (2,480)        (4,733)   

Proceeds from settlement of derivative hedge contracts

    186,079         120,682    

Payments for settlement of derivative hedge contracts

    (5,218)        (6,594)   

Payments for equity investments in privately held companies

    (60,399)          

Other investing activities, net

    1,239         (203)   
 

 

 

   

 

 

 

Net cash provided by investing activities

    9,956,994         1,506,049    
 

 

 

   

 

 

 

 

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

 

6


Table of Contents

YAHOO! INC.

Condensed Consolidated Statements of Cash Flows (continued)

 

 

                                             
    Nine Months Ended  
    September 30,     September 30,  
    2014     2015  

 

 
    (Unaudited, in thousands)  
CASH FLOWS FROM FINANCING ACTIVITIES:    

Proceeds from issuance of common stock

    247,568         52,297    

Repurchases of common stock

    (2,550,232)        (203,771)   

Excess tax benefits from stock-based awards

    114,392         33,359    

Tax withholdings related to net share settlements of restricted stock units

    (226,425)        (216,061)   

Distributions to noncontrolling interests

    (22,344)        (15,847)   

Other financing activities, net

    (9,240)        (13,554)   
 

 

 

   

 

 

 

Net cash used in financing activities

    (2,446,281)        (363,577)   
 

 

 

   

 

 

 
Effect of exchange rate changes on cash and cash equivalents     (28,685)        (33,166)   

Net change in cash and cash equivalents

    8,267,695         (1,382,938)   
Cash and cash equivalents at beginning of period     2,077,590         2,664,098    
 

 

 

   

 

 

 
Cash and cash equivalents at end of period     $ 10,345,285         $ 1,281,160    
 

 

 

   

 

 

 

 

 

 

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

 

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Table of Contents

YAHOO! INC.

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 1   The Company And Summary Of Significant Accounting Policies

 

The Company. Yahoo! Inc., together with its consolidated subsidiaries (“Yahoo” or the “Company”), is a guide focused on informing, connecting, and entertaining its users. By creating highly personalized experiences for its users, the Company keeps people connected to what matters most to them, across devices and around the world. In turn, the Company creates value for advertisers by connecting them with the audiences that build their businesses. For advertisers, the opportunity to be a part of users’ digital habits across products and platforms is a powerful tool to engage audiences and build brand loyalty. Advertisers can build their businesses by advertising to targeted audiences on the Company’s online properties and services (“Yahoo Properties”) and through a distribution network of third-party entities (“Affiliates”) who integrate the Company’s advertising offerings into their websites or other offerings (“Affiliate sites”). The Company manages and measures its business geographically, principally in the Americas, EMEA (Europe, Middle East, and Africa) and Asia Pacific.

Basis of Presentation. The condensed consolidated financial statements include the accounts of Yahoo! Inc. and its majority-owned or otherwise controlled subsidiaries. All intercompany accounts and transactions have been eliminated. Investments in entities in which the Company can exercise significant influence, but does not own a majority equity interest or otherwise control, are accounted for using the equity method and are included as investments in equity interests on the condensed consolidated balance sheets. The Company has included the results of operations of acquired companies from the date of the acquisition. At the beginning of 2015, the Company began classifying editorial costs as cost of revenue — other rather than including such costs in sales and marketing expense. To conform to the current period presentation, the Company reclassified $26 million and $63 million, respectively, in certain website editorial costs previously included in sales and marketing expense to cost of revenue — other for the three and nine months ended September 30, 2014. Also, at the beginning of 2015, the Company began classifying non-data center facilities-related costs within general and administrative expense. To conform to the current period presentation, the Company reclassified $14 million and $39 million, respectively, in facilities-related costs previously included in product development expense and $16 million and $46 million, respectively, previously included in sales and marketing expense to general and administrative expense for the three and nine months ended September 30, 2014.

During the six months ended June 30, 2015, the Company identified measurement period adjustments of $11 million to previous purchase accounting estimates for acquisitions, which were primarily related to the finalization of tax and other adjustments. These adjustments were immaterial and applied retrospectively to the acquisition dates. Accordingly, the Company’s condensed consolidated balance sheet as of December 31, 2014 has been updated to reflect the effects of the measurement period adjustments.

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

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

These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, as amended. Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. The condensed consolidated balance sheet as of December 31, 2014 was derived from the Company’s audited financial statements for the year ended December 31, 2014, but does not include all disclosures required by U.S. GAAP. However, the Company believes the disclosures are adequate to make the information presented not misleading.

Cost of Revenue — TAC. Traffic acquisition costs (“TAC”) consists of payments made to Affiliates and payments made to companies that direct consumer and business traffic to Yahoo Properties. TAC is either recorded as a reduction of revenue or as cost of revenue—TAC. TAC related to the Company’s Search and Advertising Sales Agreement (as amended, the “Search Agreement”) with Microsoft Corporation (“Microsoft”) is recorded as a reduction of revenue. See Note 17 — “Search Agreement With Microsoft Corporation” for a description of the Search Agreement and License Agreement with Microsoft. The Company also has an agreement to compensate a third party, Mozilla Corporation (“Mozilla”), to make the Company the default search provider on certain of Mozilla’s products in the United States. The Company records these payments as cost of revenue – TAC.

 

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Originally Developed Content and Acquired Content. Originally developed content and acquired content are both carried at cost. Originally developed content is amortized based on the expected pattern of viewing, typically over 18 months. Acquired content is amortized on a straight-line basis over the shorter of each program’s contractual window of availability or estimated period of use, beginning with the month of first availability. Marketing and general and administrative costs are expensed as incurred.

For originally developed content, the Company performs regular recoverability assessments on a program-by-program basis. If there are any events or changes in circumstances indicating that the Company should assess whether the fair value of originally developed content is less than its unamortized costs, the Company performs a fair value analysis using an expected cash flow approach. The amount by which the unamortized costs of the originally developed content exceed estimated fair value is charged to expense as an asset impairment. During the three and nine months ended September 30, 2015, the Company recorded an asset impairment charge of $17 million related to originally developed content.

For acquired content, the Company compares the net realizable value on a program-by-program basis with the unamortized cost. The amount by which the unamortized costs of the acquired content exceed net realizable value is charged to expense as an asset impairment. During the three and nine months ended September 30, 2015, the Company recorded an asset impairment charge of $25 million related to acquired content, primarily driven by a reduction of forecasted revenues to be generated from advertising on Yahoo Properties.

Recent Accounting Pronouncements. In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2014-09, “Revenue from Contracts with Customers,” which supersedes the revenue recognition requirements in Topic 605, “Revenue Recognition” and requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued ASU 2015-14, which defers by one year the effective date of ASU 2014-09. Accordingly, this guidance is effective for interim and annual periods beginning after December 15, 2017 with early adoption permitted for interim and annual periods beginning after December 15, 2016. The Company plans to adopt this guidance on January 1, 2018. The Company is currently evaluating the effects, if any, that the adoption of this guidance will have on the Company’s financial position, results of operations and cash flows.

In September 2015, the FASB issued ASU 2015-16, “Business Combinations,” which simplifies the accounting for measurement-period adjustments by eliminating the requirement to restate prior period financial statements for measurement period adjustments. The new guidance requires the cumulative impact of measurement period adjustments, including the impact on prior periods, to be recognized in the reporting period in which the adjustment is identified. The ASU is effective for public companies for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted for any interim and annual financial statements that have not yet been issued. The Company evaluated the effects of the ASU 2015-16 and elected to early adopt the ASU for the three months ended September 30, 2015. The ASU will be applied prospectively to the acquisitions which require adjustments to the provisional amounts that occurred during the open measurement periods, regardless of the acquisition date.

Note 2   Marketable Securities, Investments And Fair Value Disclosures

 

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

 

                                                                                                   
    December 31, 2014  
   

Cost

Basis

   

Gross

Unrealized

Gains

   

Gross

Unrealized

Losses

   

Estimated

Fair Value

 

 

 
Government and agency securities     $ 850,712          $ 82          $ (792)         $ 850,002     
Corporate debt securities, commercial paper, time deposits, and bank certificates of deposit     6,711,683          612          (4,653)         6,707,642     
Alibaba Group equity securities     2,713,484          37,154,305          -          39,867,789     
Hortonworks equity securities     26,246          77,783          -          104,029     
Other corporate equity securities     230          430          -          660     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total available-for-sale marketable securities

    $ 10,302,355          $ 37,233,212          $ (5,445)         $ 47,530,122     
 

 

 

   

 

 

   

 

 

   

 

 

 

 

 

 

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    September 30, 2015  
   

Cost

Basis

   

Gross

Unrealized

Gains

   

Gross

Unrealized

Losses

   

Estimated

Fair Value

 

 

 
Government and agency securities     $ 781,223          $ 453          $ (31)         $ 781,645     
Corporate debt securities, commercial paper, time deposits, and bank certificates of deposit     4,759,194          1,616          (1,514)         4,759,296     
Alibaba Group equity securities     2,713,484          19,905,369          -          22,618,853     
Hortonworks equity securities     26,246          57,939          -          84,185     
Other corporate equity securities     230          218          -          448     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total available-for-sale marketable securities

    $ 8,280,377          $ 19,965,595          $ (1,545)         $ 28,244,427     
 

 

 

   

 

 

   

 

 

   

 

 

 

 

 

 

                                                 
    December 31,     September 30,  
    2014     2015  

 

 
Reported as:    
Short-term marketable securities     5,327,412          4,600,889     
Long-term marketable securities     2,230,892          940,052     
Investment in Alibaba Group     39,867,789          22,618,853     
Other long-term assets and investments     104,029          84,633     
 

 

 

   

 

 

 

Total

    $ 47,530,122          $ 28,244,427     
 

 

 

   

 

 

 

 

 

Short-term, highly liquid investments of $2.0 billion and $286 million as of December 31, 2014 and September 30, 2015, respectively, included in cash and cash equivalents on the condensed consolidated balance sheets are not included in the table above as the gross unrealized gains and losses were not material as the carrying value approximates estimated fair value because of the short maturity of those instruments. Realized gains and losses from sales of available-for-sale marketable debt securities were not material for both the three and nine months ended September 30, 2014 and 2015.

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

 

                                                 
    December 31,     September 30,  
    2014     2015  

 

 
Due within one year     $ 5,327,412          $ 4,600,889     
Due after one year through five years     2,230,892          940,052     
 

 

 

   

 

 

 

Total available-for-sale marketable debt securities

    $ 7,558,304          $ 5,540,941     
 

 

 

   

 

 

 

 

 

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

 

                                                                                                                             
    December 31, 2014  
    Less than 12 Months     12 Months or Longer     Total  
    Fair     Unrealized     Fair     Unrealized     Fair     Unrealized  
    Value     Loss     Value     Loss     Value     Loss  

 

 
Government and agency securities     $ 744,948          $ (792)         $ -          $ -          $ 744,948          $ (792)    
Corporate debt securities, commercial paper, and bank certificates of deposit     2,601,288          (4,646)         3,234          (7)         2,604,522          (4,653)    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total available-for-sale marketable debt securities

    $     3,346,236          $ (5,438)         $ 3,234          $ (7)         $     3,349,470          $ (5,445)    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

 

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    September 30, 2015  
    Less than 12 Months     12 Months or Longer     Total  
    Fair     Unrealized     Fair     Unrealized     Fair     Unrealized  
    Value     Loss     Value     Loss     Value     Loss  

 

 
Government and agency securities     $ 67,270          $ (31)         $ -        $ -          $ 67,270          $ (31)    
Corporate debt securities, commercial paper, and bank certificates of deposit     1,497,672          (1,513)         2,899          (1)         1,500,571          (1,514)    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total available-for-sale marketable debt securities

    $     1,564,942          $ (1,544)         $ 2,899          $ (1)         $     1,567,841          $ (1,545)    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

The Company’s investment portfolio includes equity securities of Alibaba Group and Hortonworks, Inc. (“Hortonworks”), as well as liquid high-quality fixed income debt securities including government, agency and corporate debt, money market funds, commercial paper, certificates of deposit and time deposits with financial institutions. The fair value of any debt or equity security will vary over time and is subject to a variety of market risks including: macro-economic, regulatory, industry, company performance, and systemic risks of the equity markets overall. Consequently, the carrying value of the Company’s investment portfolio will vary over time as the value of its investment changes.

Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Fixed income securities may have their fair value adversely impacted due to a deterioration of the credit quality of the issuer. The longer the term of the securities, the more susceptible they are to changes in market rates.

Available-for-sale marketable debt securities are reviewed periodically to identify possible other-than-temporary impairment. The Company has no current requirement or intent to sell the securities in an unrealized loss position. The Company expects to recover up to (or beyond) the initial cost of investment for securities held.

The following table sets forth the financial assets and liabilities, measured at fair value, by level within the fair value hierarchy as of December 31, 2014 (in thousands):

 

                                                                                           
    Fair Value Measurements at Reporting Date Using  
Assets   Level 1     Level 2     Level 3     Total  

 

 
Money market funds(1)     $ 373,822          $ -                $ -                $ 373,822     
Available-for-sale marketable debt securities:  

Government and agency securities(1)

    -                850,002          -                850,002     

Commercial paper and bank certificates of deposit(1)

    -                3,602,321          -                3,602,321     

Corporate debt securities(1)

    -                3,327,017          -                3,327,017     

Time deposits(1)

    -                1,361,165          -                1,361,165     
Available-for-sale equity securities:  

Other corporate equity securities(2)

    660          -                -                660     

Alibaba Group equity securities

    39,867,789          -                -                39,867,789     

Hortonworks equity securities(2)

    104,029          -                -                104,029     
Hortonworks warrants     -                -                98,062          98,062     
Foreign currency derivative contracts(3)     -                202,928          -                202,928     
 

 

 

   

 

 

   

 

 

   

 

 

 

Financial assets at fair value

    $   40,346,300          $ 9,343,433          $ 98,062          $ 49,787,795     
Liabilities        
Foreign currency derivative contracts(3)     -                (6,157)         -                (6,157)    
 

 

 

   

 

 

   

 

 

   

 

 

 

Total financial assets and liabilities at fair value

    $ 40,346,300          $ 9,337,276          $ 98,062          $ 49,781,638     
 

 

 

   

 

 

   

 

 

   

 

 

 

 

 

 

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The following table sets forth the financial assets and liabilities, measured at fair value, by level within the fair value hierarchy as of September 30, 2015 (in thousands):

 

                                                                                   
    Fair Value Measurements at Reporting Date Using  
Assets   Level 1     Level 2     Level 3     Total  

 

 
Money market funds(1)     $ 177,280          $ -                $ -                $ 177,280     
Available-for-sale marketable debt securities:        

Government and agency securities(1)

    -                781,645          -                781,645     

Commercial paper and bank certificates of deposit(1)

    -                1,835,483          -                1,835,483     

Corporate debt securities(1)

    -                2,973,809          -                2,973,809     

Time deposits(1)

    -                58,420          -                58,420     
Available-for-sale equity securities:        

Other corporate equity securities (2)

    448          -                -                448     

Alibaba Group equity securities

    22,618,853          -                -                22,618,853     

Hortonworks equity securities(2)

    84,185          -                -                84,185     
Hortonworks warrants     -                -                78,820          78,820     
Foreign currency derivative contracts(3)     -                111,080          -                111,080     
 

 

 

   

 

 

   

 

 

   

 

 

 

Financial assets at fair value

    $     22,880,766          $ 5,760,437          $ 78,820          $ 28,720,023     
Liabilities        
Foreign currency derivative contracts(3)     -                (10,287)        -                (10,287)   
 

 

 

   

 

 

   

 

 

   

 

 

 

Total financial assets and liabilities at fair value

    $     22,880,766          $ 5,750,150          $ 78,820          $     28,709,736     
 

 

 

   

 

 

   

 

 

   

 

 

 

 

 

(1) The money market funds, government and agency securities, commercial paper and bank certificates of deposit, corporate debt securities, and time deposits are classified as part of either cash and cash equivalents or short or long-term marketable securities on the condensed consolidated balance sheets.

(2) The Hortonworks equity securities and other corporate equity securities are classified as part of other long-term assets and investments on the condensed consolidated balance sheets.

(3) Foreign currency derivative contracts are classified as part of either other current or noncurrent assets or liabilities on the condensed consolidated balance sheets. The notional amounts of the foreign currency derivative contracts were: $2.1 billion, including contracts designated as net investment hedges of $1.6 billion, as of December 31, 2014; and $1.9 billion, including contracts designated as net investment hedges of $1.5 billion, as of September 30, 2015.

The amount of cash and cash equivalents as of December 31, 2014 and September 30, 2015 included $702 million and $995 million, respectively, in cash.

The fair values of the Company’s Level 1 financial assets and liabilities are based on quoted prices in active markets for identical assets or liabilities. The fair values of the Company’s Level 2 financial assets and liabilities are obtained using quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets in markets that are not active; and inputs other than quoted prices (e.g., interest rates and yield curves). The Company utilizes a pricing service to assist in obtaining fair value pricing for the marketable debt securities. The fair value of this Level 3 financial asset was determined using a Black-Scholes model.

Activity between Levels of the Fair Value Hierarchy

During the year ended December 31, 2014 and the nine months ended September 30, 2015, the Company did not make any transfers between Level 1, Level 2, and Level 3 assets or liabilities.

Hortonworks Warrants

The estimated fair value of the Hortonworks warrants was $98 million and $79 million as of December 31, 2014 and September 30, 2015, respectively, which is included in other long-term assets and investments on the condensed consolidated balance sheets. During the three and nine months ended September 30, 2015, the Company recorded a loss of $13 million and $19 million, respectively, due to the change in estimated fair value of the Hortonworks warrants during the respective periods, which was included within other income (expense), net in the Company’s condensed consolidated statements of operations. The estimated fair value of the Hortonworks warrants was determined using a Black-Scholes model.

 

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Assets and Liabilities at Fair Value on a Nonrecurring Basis

Convertible Senior Notes. In 2013, the Company issued $1.4375 billion aggregate principal amount of 0.00% Convertible Senior Notes due 2018 (the “Notes”). The Notes are carried at their original issuance value, net of unamortized debt discount, and are not marked to market each period. The approximate estimated fair value of the Notes as of both December 31, 2014 and September 30, 2015 was $1.2 billion. The estimated fair value of the Notes was determined on the basis of quoted market prices observable in the market and is considered Level 2 in the fair value hierarchy. See Note 11 — “Convertible Notes” for additional information related to the Notes.

Other Investments. As of December 31, 2014 and September 30, 2015, the Company held approximately $82 million and $83 million, respectively, of investments in equity securities of privately-held companies that are accounted for using the cost method. These investments are included within other long-term assets and investments on the condensed consolidated balance sheets. Such investments are reviewed periodically for impairment.

Note 3   Consolidated Financial Statement Details

 

Accumulated Other Comprehensive Income

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

 

                                                 
    December 31,     September 30,  
    2014     2015  

 

 
Unrealized gains on available-for-sale securities, net of tax     $ 22,084,960          $ 11,859,192     
Unrealized gains (losses) on cash flow hedges, net of tax     1,856          (1,858)    
Foreign currency translation, net of tax     (67,188)         (422,881)    
 

 

 

   

 

 

 
Accumulated other comprehensive income     $     22,019,628          $     11,434,453     
 

 

 

   

 

 

 

 

 

Noncontrolling Interests

Noncontrolling interests were as follows (in thousands):

 

                                                 
    December 31,     September 30,  
    2014     2015  

 

 
Beginning noncontrolling interests     $ 55,688          $ 43,755     
Distributions to noncontrolling interests     (22,344)         (15,847)    
Net income attributable to noncontrolling interests     10,411          5,215     
 

 

 

   

 

 

 

Ending noncontrolling interests

    $ 43,755          $ 33,123     
 

 

 

   

 

 

 

 

 

Other Income (Expense), Net

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

 

                                                                                           
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,     September 30,     September 30,  
    2014     2015     2014     2015  

 

 
Interest, dividend and investment income     $ 5,148          $ 8,010          $ 16,180          $ 24,888     
Interest expense     (17,292)         (18,411)         (51,461)         (53,540)    
Gain on sale of Alibaba Group ADSs     10,319,437          -                10,319,437          -           
Loss on Hortonworks warrants     -                (12,782)         -                (19,241)    
Foreign exchange losses     (2,109)         (1,490)         (9,048)         (21,017)    
Other     3,747          718          6,781          2,151     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total other income (expense), net

    $ 10,308,931          $ (23,955)         $ 10,281,889          $ (66,759)    
 

 

 

   

 

 

   

 

 

   

 

 

 

 

 

Interest, dividend and investment income consists of income earned from cash and cash equivalents in bank accounts and investments made in marketable debt securities.

 

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Interest expense is related to the Notes and notes payable related to building and capital lease obligations for data centers.

Gain on sale of Alibaba Group ADSs during the three and nine months ended September 30, 2014 is attributable to the pre-tax gain related to the sale of 140 million American Depositary Shares (“ADSs”) of Alibaba Group in the Alibaba Group IPO on September 24, 2014.

During the three and nine months ended September 30, 2015, the Company recorded losses of $13 million and $19 million, respectively, due to the change in estimated fair value of the Hortonworks warrants during the respective periods, which was included within other income (expense), net in the condensed consolidated statements of operations.

Foreign exchange losses consists of foreign exchange gains and losses due to re-measurement of monetary assets and liabilities denominated in non-functional currencies, and unrealized and realized foreign currency transaction gains and losses, including gains and losses related to balance sheet hedges.

Reclassifications Out of Accumulated Other Comprehensive Income

Reclassifications out of accumulated other comprehensive income for the three months ended September 30, 2014 and 2015 were as follows (in thousands):

 

    Three Months Ended      
    September 30,     September 30,      
    2014     2015      
    Reclassified from     Reclassified from      
    Accumulated     Accumulated      
    Other     Other      
    Comprehensive     Comprehensive     Affected Line Item in the
    Income     Income     Statement of Operations

 

Realized (gains) losses on cash flow hedges, net of tax     $ (854)         $ 869        Revenue
Realized (gains) losses on available-for-sale securities, net of tax     (2,044)         72        Other income (expense), net  
Foreign currency translation adjustments (“CTA”):      
Disposal of a portion of the investment in Alibaba Group, net of $30 million in tax     (50,301)         -        Other income (expense), net
 

 

 

   

 

 

   
Total reclassifications for the period     $             (53,199)         $                     941       
 

 

 

   

 

 

   

 

 

Reclassifications out of accumulated other comprehensive income for the nine months ended September 30, 2014 and 2015 were as follows (in thousands):

 

    Nine Months Ended      
    September 30,     September 30,      
    2014     2015      
    Reclassified from     Reclassified from      
    Accumulated     Accumulated      
    Other     Other      
    Comprehensive     Comprehensive     Affected Line Item in the
    Income     Income     Statement of Operations

 

Realized (gains) losses on cash flow hedges, net of tax     $ (1,594)         $ 3,007        Revenue
Realized (gains) losses on available-for-sale securities, net of tax     (2,165)         74        Other income (expense), net  
Foreign currency translation adjustments (“CTA”):      
Disposal of a portion of the investment in Alibaba Group, net of $30 million in tax     (50,301)         -        Other income (expense), net
 

 

 

   

 

 

   
Total reclassifications for the period     $ (54,060)         $ 3,081       
 

 

 

   

 

 

   

 

 

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Note 4   Acquisitions and Dispositions

 

Transactions Completed in 2014.

Flurry Acquisition — On August 25, 2014, the Company completed the acquisition of Flurry, Inc. (“Flurry”), a mobile data analytics company that optimizes mobile experiences for developers, marketers, and consumers. The combined scale of Yahoo and Flurry created more personalized and inspiring app experiences for users and enabled more effective mobile advertising solutions for brands seeking to reach their audiences and gain cross-device insights.

The total purchase price of approximately $270 million consisted of cash consideration. Under the terms of the agreement, the Company acquired all of the equity interests (including all outstanding vested options) of Flurry. Outstanding Flurry unvested options were assumed and converted into equivalent awards for Yahoo common stock valued at $4 million, which is being recognized as stock-based compensation expense as the options vest over periods of up to four years.

In connection with the acquisition, the Company issued restricted stock units valued at $23 million, which are being recognized as stock-based compensation expense as the restricted stock units vest over four years.

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

 

 

 
Cash acquired     $ 12,139     
Other tangible assets acquired     51,235     
Amortizable intangible assets:  

Developed technology

    7,100     

Customer contracts and related relationships

    47,600     

Other

    720     
Goodwill     194,081     
 

 

 

 

Total assets acquired

    312,875     
Liabilities assumed     (43,205)    
 

 

 

 

Total

    $     269,670     
 

 

 

 

 

 

The amortizable intangible assets have useful lives not exceeding five years and a weighted average useful life of five years. The purchase price exceeded the estimated fair value of the tangible and identifiable intangible assets and liabilities acquired and, as a result of the allocation, the Company recorded goodwill of $194 million in connection with this transaction. Goodwill represents the excess of the purchase price over the estimated fair value of the net tangible and identifiable intangible assets acquired and is not deductible for tax purposes.

Other Acquisitions — Business Combinations. During the nine months ended September 30, 2014, the Company acquired eight other companies, all of which were accounted for as business combinations. The total purchase price for these acquisitions was $60 million less cash acquired of $4 million, which resulted in a net cash outlay of $56 million. The purchase price for the assets and liabilities assumed was allocated based on their estimated fair values as follows: $17 million to amortizable intangible assets, $4 million to cash acquired, $10 million to other tangible assets, $5 million to assumed liabilities; and the remainder of $34 million to goodwill. Goodwill represents the excess of the purchase price over the estimated fair value of the net tangible and identifiable intangible assets acquired and is not deductible for tax purposes.

Transactions Completed in 2015.

Polyvore Acquisition On September 2, 2015, the Company acquired Polyvore, Inc. (“Polyvore”), a social commerce website that lets users across the globe discover and shop for their favorite products in fashion, beauty and home décor.

The total purchase price of approximately $161 million consisted of cash consideration. Under the terms of the agreement, the Company acquired all of the equity interests (including all outstanding vested options) of Polyvore. Outstanding Polyvore unvested options were assumed and converted into equivalent awards for Yahoo common stock valued at $7 million, which is being recognized as stock-based compensation expense as the options vest over periods of up to four years.

In connection with the acquisition, the Company is also recognizing stock-based compensation expense of $15 million over a period of four years. This amount is comprised of Yahoo common stock issued to the founders (which had a fair value of $15 million at the acquisition date). The Yahoo common stock issued to the founders is subject to forfeiture and will be released over four years provided they remain employees of the Company.

 

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

 

 

 
Cash acquired     $ 5,923     
Other tangible assets acquired     12,057     
Amortizable intangible assets:  

Developed technology

    17,550     

Tradename

    1,150     

Customer contracts and related relationships

    225     
Goodwill     131,180     
 

 

 

 

Total assets acquired

    168,085     
Liabilities assumed     (7,503)    
 

 

 

 

Total

    $     160,582     
 

 

 

 

 

 

The amortizable intangible assets have useful lives not exceeding five years and a weighted average useful life of three years. The purchase price of $161 million exceeded the estimated fair value of the tangible and identifiable intangible assets and liabilities acquired and, as a result of the preliminary allocation, the Company recorded goodwill of $131 million in connection with this transaction. Goodwill represents the excess of the purchase price over the estimated fair value of the net tangible and identifiable intangible assets acquired and is not deductible for tax purposes. The entire preliminary goodwill amount was recorded in the Americas segment.

Other Acquisitions — During the nine months ended September 30, 2015, the Company acquired one other company which was accounted for as a business combination. The total purchase price for this acquisition was $23 million. The preliminary purchase price allocation of the assets acquired and liabilities assumed based on their estimated fair values was as follows: $5 million to amortizable intangibles; $2 million to net liabilities assumed; and the remainder of $20 million to goodwill. Goodwill represents the excess of the purchase price over the estimated fair value of the net tangible and identifiable intangible assets acquired and is not deductible for tax purposes.

The Company’s business combinations completed during the nine months ended September 30, 2014 and 2015 did not have a material impact on the Company’s condensed consolidated financial statements and therefore actual and proforma disclosures have not been presented.

Patent Sale and License Agreement. During 2014, the Company entered into a patent sale and license agreement for total cash consideration of $460 million. The total consideration was allocated based on the estimated relative fair value of each of the elements of the agreement: $61 million was allocated to the sale of patents (“Sold Patents”), $135 million to the license of existing patents (“Existing Patents”) and $264 million to the license of patents developed or acquired in the next five years (“Capture Period Patents”). The Company recorded $60 million as a gain on the Sold Patents during the three months ended June 30, 2014 and the remaining $1 million gain on the Sold Patents was recorded in the three months ended September 30, 2014 when the payment was due. The amounts allocated to the license of the Existing Patents are being recorded as revenue over the four-year payment period under the license when payments are due. The amounts allocated to the Capture Period Patents are being recorded as revenue over the five-year capture period. The Company recognized $22 million in revenue related to the Existing Patents and the Capture Period Patents during the three and nine months ended September 30, 2014. During the three and nine months ended September 30, 2015, the Company recognized $22 million and $65 million, respectively, in revenue associated with the patent sale and license agreement.

During the three and nine months ended September 30, 2014, the Company sold certain patents and recorded a gain on sales of patents of approximately $1 million and $63 million, respectively. During the three months ended September 30, 2015, the Company did not have any patent sales. During the nine months ended September 30, 2015, the Company sold certain patents and recorded a gain on sales of patents of approximately $11 million.

Note 5   Goodwill

 

The changes in the carrying amount of goodwill for the nine months ended September 30, 2015 were as follows (in thousands):

 

                                                                                           
    Americas(1)     EMEA(2)     Asia Pacific(3)     Total  

 

 
Net balance as of January 1, 2015     $ 4,322,219          $ 532,469          $ 297,882          $ 5,152,570     
Acquisitions and related adjustments     130,303          20,312          -                150,615     
Foreign currency translation adjustments     (2,803)         (25,873)         (7,915)         (36,591)    
 

 

 

   

 

 

   

 

 

   

 

 

 

Net balance as of September 30, 2015

    $ 4,449,719          $ 526,908          $ 289,967          $ 5,266,594     
 

 

 

   

 

 

   

 

 

   

 

 

 

 

 

 

(1)

Gross goodwill balance for the Americas segment was $4.4 billion as of September 30, 2015.

 

(2)

Gross goodwill balance for the EMEA segment was $1.2 billion as of September 30, 2015. The EMEA segment includes accumulated impairment losses of $630 million as of September 30, 2015.

 

(3)

Gross goodwill balance for the Asia Pacific segment was $449 million as of September 30, 2015. The Asia Pacific segment includes accumulated impairment losses of $159 million as of September 30, 2015.

 

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Note 6   Intangible Assets, Net

 

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

 

                                                                                           
    December 31, 2014     September 30, 2015  
    Net     Gross Carrying
Amount
    Accumulated
Amortization(*)
    Net  

 

 
Customer, affiliate, and advertiser related relationships     $ 281,596          $ 370,314          $ (133,107)         $ 237,207     
Developed technology and patents     122,674          209,385          (107,981)         101,404     
Tradenames, trademarks, and domain names     66,572          109,089          (50,519)         58,570     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total intangible assets, net

    $ 470,842          $ 688,788          $ (291,607)         $ 397,181     
 

 

 

   

 

 

   

 

 

   

 

 

 

 

 
(*)

Cumulative foreign currency translation adjustments, reflecting movement in the currencies of the underlying entities, totaled approximately $17 million as of September 30, 2015.

For the three months ended September 30, 2014 and 2015, the Company recognized amortization expense for intangible assets of $32 million and $34 million, respectively, including $17 million and $14 million in cost of revenue — other for the three months ended September 30, 2014 and 2015, respectively. For the nine months ended September 30, 2014 and 2015, the Company recognized amortization expense for intangible assets of $97 million and $102 million, respectively, including $48 million and $42 million in cost of revenue — other for the nine months ended September 30, 2014 and 2015, respectively. Based on the current amount of intangibles subject to amortization, the estimated amortization expense for the remainder of 2015 and each of the succeeding years is as follows: three months ending December 31, 2015: $33 million; 2016: $114 million; 2017: $105 million; 2018: $85 million; 2019: $44 million; and cumulatively thereafter: $1 million.

Note 7   Basic And Diluted Net Income Attributable To Yahoo! Inc. Common Stockholders Per Share

 

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

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

Potentially dilutive securities representing approximately 1 million and 3 million shares of common stock for the three and nine months ended September 30, 2014, respectively, and 14 million and 6 million shares of common stock for the three and nine months ended September 30, 2015, respectively, were excluded from the computation of diluted earnings per share for these periods because their effect would have been anti-dilutive.

The Company has the option to pay cash, issue shares of common stock or any combination thereof for the aggregate amount due upon conversion of the Notes. The Company’s intent is to settle the principal amount of the Notes in cash upon conversion. As a result, upon conversion of the Notes, only the amounts payable in excess of the principal amounts of the Notes are considered in diluted earnings per share under the treasury stock method.

The denominator for diluted net income per share does not include any effect from the note hedges. In future periods, the denominator for diluted net income per share will exclude any effect of the note hedges, if their effect would be anti-dilutive. In the event an actual conversion of any or all of the Notes occurs, the shares that would be delivered to the Company under the note hedges are designed to neutralize the dilutive effect of the shares that the Company would issue under the Notes. See Note 11 — “Convertible Notes” for additional information.

 

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

 

                                                                                                   
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,     September 30,     September 30,  
  2014     2015     2014     2015  

 

 
Basic:        
Numerator:        

Net income attributable to Yahoo! Inc.

    $ 6,774,102          $ 76,261          $ 7,355,387          $ 75,905     

Less: Net income allocated to participating securities

    (61)         -                (66)         -           
 

 

 

   

 

 

   

 

 

   

 

 

 

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

    $ 6,774,041          $ 76,261          $ 7,355,321          $ 75,905     
 

 

 

   

 

 

   

 

 

   

 

 

 
Denominator:        

Weighted average common shares

    993,543          940,822          1,001,066          937,713     
 

 

 

   

 

 

   

 

 

   

 

 

 

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

    $ 6.82          $ 0.08          $ 7.35          $ 0.08     
 

 

 

   

 

 

   

 

 

   

 

 

 
Diluted:        
Numerator:        

Net income attributable to Yahoo! Inc.

    $ 6,774,102          $ 76,261          $ 7,355,387          $ 75,905     

Less: Net income allocated to participating securities

    (60)         -                (65)         -           

Less: Effect of dilutive securities issued by equity investees

    (20,705)         (1,112)         (42,491)         (3,431)    
 

 

 

   

 

 

   

 

 

   

 

 

 

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

    $ 6,753,337          $ 75,149          $ 7,312,831          $ 72,474     
 

 

 

   

 

 

   

 

 

   

 

 

 
Denominator:        

Denominator for basic calculation

    993,543          940,822          1,001,066          937,713     

Weighted average effect of Yahoo! Inc. dilutive securities:

       

Restricted stock units

    10,638          4,551          12,388          5,155     

Stock options and employee stock purchase plan

    3,512          1,561          4,481          1,292     
 

 

 

   

 

 

   

 

 

   

 

 

 

Denominator for diluted calculation

    1,007,693          946,934          1,017,935          944,160     
 

 

 

   

 

 

   

 

 

   

 

 

 

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

    $ 6.70          $ 0.08          $ 7.18          $ 0.08     
 

 

 

   

 

 

   

 

 

   

 

 

 

 

 

 

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Note 8   Investments In Equity Interests Using The Equity Method Of Accounting

 

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

 

                                                                                           
    December 31,     Percent     September 30,     Percent  
    2014     Ownership     2015     Ownership  

 

 
Yahoo Japan     $ 2,482,660          35.5%          $ 2,326,486          35.5%     
Other     6,918          20%          6,577          20%     
 

 

 

     

 

 

   

Total

    $ 2,489,578            $ 2,333,063       
 

 

 

     

 

 

   

 

 

Equity Investment in Yahoo Japan

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

The Company makes adjustments to the earnings in equity interests line in the condensed consolidated statements of operations for any material differences between U.S. GAAP and International Financial Reporting Standards (“IFRS”) issued by the International Accounting Standards Board, the standards by which Yahoo Japan’s financial statements are prepared.

The fair value of the Company’s ownership interest in the common stock of Yahoo Japan, based on the quoted stock price, was approximately $7.7 billion as of September 30, 2015.

During the nine months ended September 30, 2014 and 2015, the Company received cash dividends from Yahoo Japan in the amount of $84 million and $142 million, net of withholding taxes, respectively, which were recorded as reductions to the Company’s investment in Yahoo Japan.

During the nine months ended September 30, 2014, the Company sold data center assets and assigned a data center lease to Yahoo Japan for cash proceeds of $11 million and recorded a net gain of approximately $5 million.

The following tables present summarized financial information derived from Yahoo Japan’s consolidated financial statements, which are prepared on the basis of IFRS. The Company has made adjustments to the Yahoo Japan financial information to address differences between IFRS and U.S. GAAP that materially impact the summarized financial information below. Apart from such adjustments, the other differences between U.S. GAAP and IFRS did not have any material impact on the Yahoo Japan summarized financial information presented below.

 

                                                                                           
    Three Months Ended     Nine Months Ended  
    June 30,     June 30,     June 30,     June 30,  
    2014     2015     2014     2015  

 

 
    (in thousands)  
Operating data:        

Revenue

    $ 963,796        $ 911,735        $ 3,050,516        $ 2,840,393     

Gross profit

    $ 761,802        $ 712,561        $ 2,466,986        $ 2,254,511     

Income from operations

    $ 485,164        $ 402,865        $ 1,452,551        $ 1,266,084     

Net income

    $ 321,534        $ 274,567        $ 942,675        $ 836,081     

Net income attributable to Yahoo Japan

    $ 318,571        $ 273,636        $ 934,098        $ 832,611     

 

 

 

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    September 30,     June 30,  
    2014     2015  

 

 
    (in thousands)  
Balance sheet data:    

Current assets

    $       6,161,126        $       5,729,119     

Long-term assets

    $ 1,908,379        $ 2,198,578     

Current liabilities

    $ 1,948,540        $ 1,800,500     

Long-term liabilities

    $ 35,418        $ 239,240     

Noncontrolling interests

    $ 66,998        $ 163,216     

 

 

Under technology and trademark license and other commercial arrangements with Yahoo Japan, the Company records revenue from Yahoo Japan based on a percentage of advertising revenue earned by Yahoo Japan. The Company recorded revenue from Yahoo Japan of approximately $66 million and $57 million for the three months ended September 30, 2014 and 2015, respectively, and approximately $197 million and $172 million for the nine months ended September 30, 2014 and 2015, respectively. The revenue from Yahoo Japan for the three and nine months ended September 30, 2015 was impacted by unfavorable foreign exchange fluctuations of $6 million and $17 million, respectively, using the foreign currency exchange rates from the three and nine months ended September 30, 2014. As of December 31, 2014 and September 30, 2015, the Company had receivable balances from Yahoo Japan of approximately $47 million and $38 million, respectively.

Alibaba Group

Equity Investment in Alibaba Group. Prior to the closing of the Alibaba Group IPO in September 2014, the Company’s investment in Alibaba Group was accounted for using the equity method, and the total investment, including net tangible assets, identifiable intangible assets, and goodwill, was classified as part of investments in equity interests balance on the Company’s condensed consolidated balance sheets. Prior to the Alibaba Group IPO, the Company recorded its share of the results of Alibaba Group one quarter in arrears within earnings in equity interests in the condensed consolidated statements of operations, including any related tax impacts related to the earnings in equity interest.

Technology and Intellectual Property License Agreement (the “TIPLA”). As a result of the Alibaba Group IPO, Alibaba Group’s obligation to make royalty payments under the TIPLA ceased on September 24, 2014 and the Company’s recognition of the remaining TIPLA deferred revenue was completed on September 18, 2015. For the three months ended September 30, 2014 and 2015, the Company recognized approximately $74 million and $60 million, respectively, and for the nine months ended September 30, 2014 and 2015, the Company recognized approximately $205 million and $199 million, respectively, related to the TIPLA.

Spin-Off of Remaining Holdings in Alibaba Group. On January 27, 2015, the Company announced a plan for a spin-off of all of the Company’s remaining holdings in Alibaba Group into a newly formed independent registered investment company. The name selected for the new company is Aabaco Holdings, Inc. (“Aabaco”). The stock of Aabaco will be distributed pro rata to Yahoo stockholders, resulting in Aabaco becoming a separate publicly traded registered investment company. On July 17, 2015, Aabaco filed its initial Registration Statement on Form N-2 with the U.S. Securities and Exchange Commission (“SEC”), which it subsequently amended on September 28, 2015. Following the completion of the transaction, Aabaco will own, directly or indirectly, all of Yahoo’s remaining 384 million Alibaba Group ordinary shares (the “Alibaba Group shares”) and a 100 percent ownership interest in Aabaco Small Business, LLC (“ASB”), a newly formed entity which will own Yahoo Small Business, a current operating business of Yahoo that will also be transferred to Aabaco as part of the transaction.

The spin-off transaction is subject to certain conditions, including final approval by the Company’s Board, receipt of a legal opinion from Skadden, Arps, Slate, Meagher & Flom LLP with respect to certain tax matters, including the qualification of the spin-off as a tax-free transaction under the Internal Revenue Code of 1986, as amended, the registration of Aabaco’s common stock under the Securities Exchange Act of 1934, the acceptance of Aabaco’s common stock for listing on the Nasdaq Global Select Market, and certain other conditions. In addition, in connection with the spin-off transaction, the Company will be required to comply with applicable covenants in certain material contracts, including compliance with applicable covenants in the indenture governing the Notes.

Each of the conditions may be waived, in whole or in part (to the extent permitted by applicable law), by the Company in its sole and absolute discretion. The Company has reserved the right, in its sole and absolute discretion, to abandon or modify the terms of the transaction at any time prior to the distribution date, even if the conditions to the transaction have been satisfied.

The completion of the transaction is expected to occur prior to the end of January 2016, subject to the conditions described above. The composition of Aabaco’s independent board of directors and management team, and other details of the transaction, including the distribution ratio, will be determined prior to the completion of the transaction.

Upon completion of the transaction, which is subject to the satisfaction or waiver of the conditions specified above, the Company’s consolidated financial position will be materially impacted as the Alibaba Group shares and related deferred tax liabilities will be removed from the Company’s condensed consolidated balance sheet. The Company would no longer hold any Alibaba Group shares and would no longer record changes in fair value within comprehensive income (loss).

 

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Note 9   Foreign Currency Derivative Financial Instruments

 

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

The Company records all derivatives in the condensed consolidated balance sheets at fair value, with assets included in prepaid expenses and other current assets or other long-term assets and investments, and liabilities included in accrued expenses and other current liabilities or other long-term liabilities. The Company’s accounting treatment for these instruments is based on whether or not the instruments are designated as a hedging instrument. The effective portions of net investment hedges are recorded in other comprehensive income as a part of the cumulative translation adjustment. The effective portions of cash flow hedges are recorded in accumulated other comprehensive income until the hedged item is recognized in revenue on the condensed consolidated statements of operations when the underlying hedged revenue is recognized. Any ineffective portions of net investment hedges and cash flow hedges are recorded in other income (expense), net on the Company’s condensed consolidated statements of operations. For balance sheet hedges, changes in the fair value are recorded in other income (expense), net on the Company’s condensed consolidated statements of operations.

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

Designated as Hedging Instruments

Net Investment Hedges. The Company currently hedges, on an after-tax basis, a portion of its net investment in Yahoo Japan with forward contracts and option contracts to reduce the risk that its investment in Yahoo Japan will be adversely affected by foreign currency exchange rate fluctuations. The total of the after-tax net investment hedge was less than the Yahoo Japan investment balance as of both December 31, 2014 and September 30, 2015. As such, the net investment hedge was considered to be effective.

Cash Flow Hedges. The Company entered into foreign currency forward contracts designated as cash flow hedges of varying maturities through December 31, 2016. All of the forward contracts designated as cash flow hedges that were settled were reclassified to revenue during the three and nine months ended September 30, 2014 and 2015, respectively. All current outstanding cash flow hedges are expected to be reclassified into revenue during fiscal years 2015 and 2016. For the three and nine months ended September 30, 2014 and 2015, the amounts recorded in other income (expense), net as a result of hedge ineffectiveness was not material.

Not Designated as Hedging Instruments

Balance Sheet Hedges. The Company hedges certain of its net recognized foreign currency assets and liabilities with foreign exchange forward contracts to reduce the risk that its earnings and cash flows will be adversely affected by changes in foreign currency exchange rates. These derivative instruments hedge assets and liabilities, including intercompany transactions, which are denominated in foreign currencies.

Notional amounts of the Company’s outstanding derivative contracts were as follows (in millions):

 

    December 31,     September 30,  
    2014     2015  

 

 
Derivatives designated as hedging instruments:    

Net investment hedge forward and option contracts

  $ 1,647      $ 1,502     

Cash flow hedge forwards

  $ 222      $ 122     
Derivatives not designated as hedging instruments:    

Balance sheet hedges

  $ 243      $ 257     

 

 

 

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Foreign currency derivative activity for the nine months ended September 30, 2014 was as follows (in millions):

 

    Beginning
Fair Value
    Settlement
Payment
(Receipt)
    Gain (Loss)
Recorded in
Other Income
(Expense),
Net
    Gain (Loss)
Recorded in
Other
Comprehensive
Income (Loss)
    Gain
(Loss)
Recorded
in
Revenue
    Ending Fair
Value
 

 

 
Derivatives designated as hedging instruments:            

Net investment hedges

  $ 209      $ (178   $ -            $ 78   (*)    $ -            $ 109   

Cash flow hedges

  $ 4      $ (2   $ (1   $ (1)       $ 4      $ 4   
Derivatives not designated as hedging instruments:            

Balance sheet hedges

  $ -            $ (1   $ 11      $ -            $ -            $ 10   

 

 

(*)  This amount does not reflect the tax impact of $29 million recorded during the nine months ended September 30, 2014. The $49 million after tax impact of the loss recorded within other comprehensive income was included in accumulated other comprehensive income on the Company’s condensed consolidated balance sheets as of September 30, 2014.

Foreign currency derivative activity for the nine months ended September 30, 2015 was as follows (in millions):

 

   

Beginning

Fair Value

   

Settlement

Payment

(Receipt)

   

Gain (Loss)

Recorded in

Other Income

(Expense),

Net

   

Gain (Loss)

Recorded in

Other

Comprehensive

Income (Loss)

   

Gain

(Loss)

Recorded

in

Revenue

   

Ending Fair

Value

 

 

 
Derivatives designated as hedging instruments:            

Net investment hedges

  $ 185      $ (92   $ 1      $ 7   (*)    $ -            $ 101   

Cash flow hedges

  $ 8      $ (1   $ (1   $ (3)       $ (2   $ 1   
Derivatives not designated as hedging instruments:            

Balance sheet hedges

  $ 4      $ (22   $ 17      $ -            $ -            $ (1

 

 

(*)   This amount does not reflect the tax impact of $3 million recorded during the nine months ended September 30, 2015. The $4 million after tax impact of the gain recorded within other comprehensive income was included in accumulated other comprehensive income on the Company’s condensed consolidated balance sheets.

 

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Foreign currency derivative contracts balance sheet location and ending fair value was as follows (in millions):

 

                                                              
    Balance Sheet   December 31,     September 30,  
    Location   2014     2015  

 

 
Derivatives designated as hedging instruments:      

Net investment hedges

  Asset(1)   $ 190      $ 107   
  Liability(2)   $ (5)      $ (6)   

Cash flow hedges

  Asset(1)   $      $   
  Liability(2)   $ -          $ (1)   
     
Derivatives not designated as hedging instruments:      

Balance sheet hedges

  Asset(1)   $      $   
  Liability(2)   $ (1)      $ (3)   

 

 

 

(1)

Included in prepaid expenses and other current assets or other long-term assets and investments on the condensed consolidated balance sheets.

(2)

Included in accrued expenses and other current liabilities or other long-term liabilities on the condensed consolidated balance sheets.

Note 10  Credit Agreement

 

The Company’s credit agreement with Citibank, N.A., as Administrative Agent entered into on October 19, 2012 (as amended on October 10, 2013, October 9, 2014, and July 24, 2015, the “Credit Agreement”) provides for a $750 million unsecured revolving credit facility, subject to increase of up to $250 million in accordance with its terms. The Credit Agreement terminates on July 22, 2016, unless extended by the parties. As of September 30, 2015, the Company was in compliance with the financial covenants in the Credit Agreement and no amounts were outstanding.

Note 11  Convertible Notes

 

0.00% Convertible Senior Notes

As of September 30, 2015, the Company had $1.4 billion principal amount of Notes outstanding. The Notes are senior unsecured obligations of Yahoo, the Notes do not bear regular interest, and the principal amount of the Notes does not accrete. The Notes mature on December 1, 2018, unless previously purchased or converted in accordance with their terms prior to such date. The Company may not redeem the Notes prior to maturity. However, holders of the Notes may convert them at certain times and upon the occurrence of certain events in the future, as outlined in the indenture governing the Notes (the “Indenture”). Holders of the Notes who convert in connection with a “make-whole fundamental change,” as defined in the Indenture, may require Yahoo to purchase for cash all or any portion of their Notes at a purchase price equal to 100 percent of the principal amount, plus accrued and unpaid special interest as defined in the Indenture, if any. The Notes are convertible, subject to certain conditions, into shares of Yahoo common stock at an initial conversion rate of 18.7161 shares per $1,000 principal amount of Notes (which is equivalent to an initial conversion price of approximately $53.43 per share), subject to adjustment upon the occurrence of certain events. Upon conversion of the Notes, holders will receive cash, shares of Yahoo’s common stock or a combination thereof, at Yahoo’s election. The Company’s intent is to settle the principal amount of the Notes in cash upon conversion. If the conversion value exceeds the principal amount, the Company would deliver shares of its common stock with respect to the remainder of its conversion obligation in excess of the aggregate principal amount (conversion spread). As of September 30, 2015, none of the conditions allowing holders of the Notes to convert had been met.

 

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The Notes consist of the following (in thousands):

 

                                         
    December 31,
2014
    September 30,
2015
 

 

 
Liability component:    

Principal

    $ 1,437,500         $ 1,437,500    

Less: note discount

    (267,077)        (220,092)   
 

 

 

   

 

 

 
Net carrying amount     $ 1,170,423         $ 1,217,408    
 

 

 

   

 

 

 
Equity component (*)     $ 305,569         $ 305,569    
 

 

 

   

 

 

 

 

 

 

(*)

Recorded on the condensed consolidated balance sheets within additional paid-in capital.

The following table sets forth total interest expense recognized related to the Notes (in thousands):

 

                                                                                           
    Three Months Ended     Nine Months Ended  
    September 30,
2014
    September 30,
2015
    September 30,
2014
    September 30,
2015
 

 

 
Accretion of convertible note discount   $ 15,056      $ 15,867      $ 44,583      $ 46,984   

 

 

The estimated fair value of the Notes, which was determined based on inputs that are observable in the market (Level 2) was as follows (in thousands):

 

                                                                                           
    December 31, 2014     September 30, 2015  
    Fair Value     Carrying Value     Fair Value     Carrying Value  

 

 
Convertible senior notes   $ 1,175,240      $ 1,170,423      $ 1,248,922      $ 1,217,408   

 

 

Note 12  Commitments And Contingencies

 

Lease Commitments. The Company leases office space and data centers under operating and capital lease agreements with original lease periods of up to 15 years which expire between 2015 and 2025. A summary of gross and net lease commitments as of September 30, 2015 was as follows (in millions):

 

                                                                       
    Gross
Operating
Lease
Commitments
    Sublease
Income
    Net Operating
Lease
Commitments
 

 

 
Three months ending December 31, 2015     $ 29         $ (4)        $ 25    
Years ending December 31,      
2016     $ 107         $ (12)        $ 95    
2017     $ 80         $ (9)        $ 71    
2018     $ 56         $ (7)        $ 49    
2019     $ 45         $ (5)        $ 40    
2020     $ 31         $ (2)        $ 29    
Due after 5 years     $ 84         $ (4)        $ 80    
 

 

 

   

 

 

   

 

 

 
Total gross and net lease commitments     $ 432         $ (43)        $ 389    
 

 

 

   

 

 

   

 

 

 

 

 

 

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    Capital Lease
Commitments
 

 

 
Three months ending December 31, 2015     $ 6     
Years ending December 31,  
2016     15     
2017     10     
2018     9     
2019     5     
2020     -           
Due after 5 years     -           
 

 

 

 
Gross capital lease commitments     45     
Less: interest     8     
 

 

 

 
Net capital lease commitments included in other accrued expenses and current liabilities and other long-term liabilities     $ 37     
 

 

 

 

 

 

Affiliate Commitments. The Company is obligated to make payments, which represent TAC, to its Affiliates. As of September 30, 2015, these commitments totaled $1,682 million, of which $100 million will be payable in the remainder of 2015, $401 million will be payable in 2016, $400 million will be payable in 2017, $375 million will be payable in 2018, $375 million will be payable in 2019, and $31 million will be payable thereafter.

Non-cancelable Obligations. The Company is obligated to make payments under various non-cancelable arrangements with vendors and other business partners, principally for marketing, bandwidth, co-location, and content arrangements. As of September 30, 2015, these commitments totaled $191 million, of which $52 million will be payable in the remainder of 2015, $101 million will be payable in 2016, $23 million will be payable in 2017, $13 million will be payable in 2018, and $2 million will be payable in 2019.

Intellectual Property Rights. The Company is committed to make certain payments under various intellectual property arrangements of up to $18 million through 2023.

Finance Lease Obligations. The Company is deemed to be the owner after occupancy of a certain facility that was constructed as a build-to-suit lease arrangement and previously reflected as accrued expenses and current liabilities on the Company’s condensed consolidated balance sheet. As such, this arrangement is accounted for as a finance lease. As of September 30, 2015, this commitment totaled $18 million, of which less than $1 million will be payable in 2016, $1 million will be payable in 2017, $2 million will be payable in 2018, $2 million will be payable in 2019, $2 million will be payable in 2020, and $10 million will be payable thereafter.

Construction Liabilities. The estimated timing and amounts of payments for rent associated with the build-to-suit lease arrangement that has not been placed in service totaled $40 million, of which less than $1 million will be payable in the remainder of 2015, $2 million will be payable in 2016, $3 million will be payable in 2017, $4 million will be payable in 2018, $4 million will be payable in 2019, $4 million will be payable in 2020, and $22 million will be payable thereafter.

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

As of September 30, 2015, the Company did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Accordingly, the Company is not exposed to any financing, liquidity, market, or credit risk that could arise if the Company had such relationships. In addition, the Company identified no variable interests currently held in entities for which it is the primary beneficiary.

 

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Legal Contingencies

General. The Company is regularly involved in claims, suits, government investigations, and proceedings arising from the ordinary course of the Company’s business, including actions with respect to intellectual property claims, privacy, consumer protection, information security, data protection or law enforcement matters, tax matters, labor and employment claims, commercial claims, as well as actions involving content generated by users, stockholder derivative actions, purported class action lawsuits, and other matters.

Patent Matters. From time to time, third parties assert patent infringement claims against the Company. Currently, the Company is engaged in lawsuits regarding patent issues and has been notified of other potential patent disputes.

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

Since June 6, 2011, two purported stockholder class actions were filed in the U.S. District Court for the Northern District of California against the Company and certain officers and directors of the Company by plaintiffs Bonato and the Twin Cities Pipe Trades Pension Trust. In October 2011, the District Court consolidated the two actions under the caption In re Yahoo! Inc. Securities Litigation and appointed the Pension Trust Fund for Operating Engineers as lead plaintiff. In a consolidated amended complaint filed December 15, 2011, the lead plaintiff purported to represent a class of investors who purchased the Company’s common stock between April 19, 2011 and July 29, 2011, and alleged that during that class period, defendants issued statements that were materially false or misleading because they did not disclose information relating to Alibaba Group’s restructuring of Alipay. The complaint purported to assert claims for relief for violation of Section 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and for violation of Rule 10b-5 thereunder, and sought unspecified damages, injunctive and equitable relief, fees, and costs. On August 10, 2012, the District Court granted defendants’ motion to dismiss the consolidated amended complaint. Plaintiffs appealed. On May 15, 2015, the U.S. Court of Appeals for the Ninth Circuit affirmed the dismissal.

On April 22, 2015, a stockholder action captioned Cathy Buch v. David Filo, et al., was filed in the Delaware Court of Chancery against Yahoo and all current members of the Board. The complaint asserts both derivative claims, purportedly on behalf of Yahoo, and class action claims, purportedly on behalf of the plaintiff and all similarly situated stockholders, relating to the termination of, and severance payments made to, our former chief operating officer, Henrique de Castro. The plaintiff alleges that the board members breached their fiduciary duties by enabling or acquiescing in the payment of severance to Mr. de Castro, and by allowing Yahoo to make allegedly false and misleading statements regarding the value of his severance. The plaintiff has also asserted claims against Mr. de Castro. The plaintiff seeks to recoup the severance paid to Mr. de Castro, an equitable accounting, disgorgement in favor of Yahoo, monetary damages, declaratory relief, injunctive relief, and an award of attorneys’ fees and costs. The Company has filed a motion to dismiss the action.

Mexico Matters. On November 16, 2011, plaintiffs Worldwide Directories, S.A. de C.V. (“WWD”), and Ideas Interactivas, S.A. de C.V. (“Ideas”) filed an action in the 49th Civil Court of Mexico against the Company, Yahoo! de Mexico, S.A. de C.V. (“Yahoo! Mexico”), Yahoo International Subsidiary Holdings, Inc., and Yahoo Hispanic Americas LLC. The complaint alleged claims of breach of contract, breach of promise, and lost profits in connection with various commercial contracts entered into among the parties between 2002 and 2004, relating to a business listings service, and alleged total damages of approximately $2.75 billion. On December 7, 2011, Yahoo! Mexico filed a counterclaim against WWD for payments of approximately $2.6 million owed to Yahoo! Mexico for services rendered. On April 10, 2012, plaintiffs withdrew their claim filed against Yahoo International Subsidiary Holdings, Inc. and Yahoo Hispanic Americas LLC.

On November 28, 2012, the 49th Civil Court of Mexico entered a non-final judgment against the Company and Yahoo! Mexico in the amount of USD $2.75 billion and a non-final judgment in favor of Yahoo! Mexico on its counterclaim against WWD in the amount of $2.6 million. The judgment against the Company and Yahoo! Mexico purported to leave open for determination in future proceedings certain other alleged damages that were not quantified in the judgment.

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

Plaintiffs appealed the Superior Court’s decision to the Mexican Federal Civil Collegiate Court for the First Circuit (“Civil Collegiate Court”). The Company appealed the Superior Court’s decision not to award it statutory costs in the underlying proceeding. Yahoo! Mexico appealed the Superior Court’s award of $172,500, the Superior Court’s decision not to award it additional moneys beyond the $2.6 million award on its counterclaims, and the Superior Court’s decision not to award it statutory costs. On January 14, 2015, the Civil Collegiate Court denied all of the appeals.

 

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On February 16, 2015, plaintiffs filed a petition for review by the Supreme Court of Mexico, where review is limited to constitutional questions under Mexican law. The plaintiffs’ petition was denied. Plaintiffs then filed an additional petition seeking to reverse the denial through further review. On September 22, 2015, the Supreme Court of Mexico issued its written decision denying that petition. This decision concludes plaintiffs’ appeals in Mexico.

On September 10, 2014, the same plaintiffs in the Mexico litigation described above filed an action in U.S. District Court for the Southern District of New York against Yahoo! Inc., Yahoo! Mexico, Baker & McKenzie, and Baker & McKenzie, S.C. Plaintiffs allege that defendants conspired to influence the Mexican courts and “illegally obtain a favorable judgment” in the above litigation. Plaintiffs advance claims for relief under the Racketeer Influenced and Corrupt Organizations Act of 1970 (“RICO”), which provides for treble damages in certain cases, conspiracy to violate RICO, common-law fraud, and civil conspiracy. Their operative amended complaint seeks unspecified damages. The Company and Yahoo! Mexico have filed a motion to dismiss the amended complaint. The Company believes the plaintiffs’ claims in this action are without merit.

The Company has determined, based on current knowledge, that the amount or range of reasonably possible losses, including reasonably possible losses in excess of amounts already accrued, is not reasonably estimable with respect to certain matters described above. The Company has also determined, based on current knowledge, that the aggregate amount or range of losses that are estimable with respect to the Company’s legal proceedings, including the matters described above, other than the remaining Mexico matter, would not have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows. Amounts accrued as of September 30, 2015 were not material. The Company did not accrue for the judgment in Mexico, which was reversed as explained above. The ultimate outcome of legal proceedings involves judgments, estimates and inherent uncertainties, and cannot be predicted with certainty. In the event of a determination adverse to Yahoo, its subsidiaries, directors, or officers in these matters, the Company may incur substantial monetary liability, and be required to change its business practices. Either of these events could have a material adverse effect on the Company’s financial position, results of operations, or cash flows. The Company may also incur substantial legal fees, which are expensed as incurred, in defending against these claims.

Note 13  Stockholders’ Equity And Employee Benefits

 

Stock Options. The Company’s Stock Plan, the Directors’ Plan, and stock-based awards assumed through acquisitions (including stock-based commitments related to continued service of acquired employees, such as holdbacks by Yahoo of shares of Yahoo common stock issued to founders of acquired companies in connection with certain of the Company’s acquisitions) are collectively referred to as the “Plans.” Stock option activity under the Company’s Plans for the nine months ended September 30, 2015 is summarized as follows (in thousands, except per share amounts):

 

                                                 
    Shares     Weighted Average
Exercise Price Per
Share
 

 

 
Outstanding at December 31, 2014(1)     9,225       $ 18.57    
Options granted          $ -         
Options assumed in acquisitions     407       $ 11.89    
Options exercised(2)     (1,709)      $ 16.59    
Options expired     (579)      $ 19.11    
Options cancelled/forfeited     (313)      $ 19.89    
 

 

 

   
Outstanding at September 30, 2015(1)     7,031       $ 18.56    
 

 

 

   

 

 

 

(1) 

Includes shares subject to performance-based stock options for which performance goals had not been set as of the date shown.

 

(2) 

The Company generally issues new shares to satisfy stock option exercises.

As of September 30, 2015, there was $31 million of unamortized stock-based compensation expense related to unvested stock options, which is expected to be recognized over a weighted average period of 1.8 years.

 

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The fair value of option grants, including assumed options from acquisitions, was determined using the Black-Scholes option pricing model with the following weighted average assumptions:

 

                                                                                                                                                   
    Stock Options     Stock Options     Stock Options     Stock Options  
      Three Months Ended         Three Months Ended         Nine Months Ended         Nine Months Ended    
    September 30,     September 30,     September 30,     September 30,  
    2014     2015     2014     2015  

 

 
Expected dividend yield     0.0%        0.0%        0.0%        0.0%     
Risk-free interest rate     1.1%        0.9%        1.3%        0.9%     
Expected volatility     32.7%        34.5%        35.8%        34.5%     
Expected life (in years)     3.30        2.5        3.77        2.5     

 

 

Restricted Stock Units. Restricted stock unit (“RSU”) activity under the Plans for the nine months ended September 30, 2015 is summarized as follows (in thousands, except per share amounts):

 

                                                     
    Shares     Weighted Average
Grant Date
Fair Value
Per Share
 

 

 
Awarded and unvested at December 31, 2014(1)     40,677       $ 32.38     
Granted(2)     14,799       $ 42.37     
Assumed in acquisitions     -             $ -         
Vested     (13,844)      $ 28.30     
Forfeited     (9,918)      $ 32.93     
 

 

 

   
Awarded and unvested at September 30, 2015(1)     31,714       $ 38.66     
 

 

 

   

 

 

 

(1) 

Includes the maximum number of shares issuable under the Company’s performance-based restricted stock unit awards (including future-year tranches for which performance goals had not been set) as of the date shown.

 

(2) 

Includes the maximum number of shares issuable under the performance-based restricted stock unit awards granted during the nine months ended September 30, 2015 (including future-year tranches for which performance goals had not been set during the period); excludes tranches of previously granted performance-based restricted stock units for which performance goals were set during the nine months ended September 30, 2015.

As of September 30, 2015, there was $764 million of unamortized stock-based compensation expense related to unvested restricted stock units which is expected to be recognized over a weighted average period of 2.4 years.

During the nine months ended September 30, 2014 and 2015, 16.0 million shares and 13.8 million shares, respectively, that were subject to previously granted restricted stock units, vested. These vested restricted stock units were net share settled. During the nine months ended September 30, 2014 and 2015, the Company withheld 6.0 million shares and 5.3 million shares, respectively, based upon the Company’s closing stock price on the vesting date, to satisfy the Company’s tax withholding obligation relating to the employees’ minimum statutory obligation for the applicable income and other employment taxes. The Company then remitted cash to the appropriate taxing authorities.

Total payments for the employees’ tax obligations to the relevant taxing authorities were $226 million and $216 million, respectively, for the nine months ended September 30, 2014 and 2015 and are reflected as a financing activity within the condensed consolidated statements of cash flows. The payments were used for tax withholdings related to the net share settlements of restricted stock units. The payments had the effect of share repurchases by the Company as they reduced the number of shares that would have otherwise been issued on the vesting date and were recorded as a reduction of additional paid-in capital.

Performance Options. The financial performance stock options awarded by the Company in November 2012 to Ms. Mayer and Mr. Goldman include multiple performance periods. The number of stock options that ultimately vest for each performance period will range from 0 percent to 100 percent of the target amount for such period stated in each executive’s award agreement based on the Company’s performance relative to goals. The financial performance goals are established at the beginning of each performance period and the portion (or “tranche”) of the award related to each performance period is treated as a separate grant for accounting purposes. In March 2015, the Compensation Committee established performance goals under these stock options for the 2015 performance year. The 2015 financial performance metrics (and their weightings) under the performance stock options are GAAP revenue (one-third), revenue ex-TAC (one-third), and adjusted EBITDA (one-third). The grant date fair value of the 2015 tranche of the November 2012 financial performance stock options was $31 million, and is being recognized over the twelve-month service period. The Company began recording stock-based compensation expense for this tranche in March 2015, when the financial performance goals were established.

 

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Performance RSUs. In March 2015, the Compensation Committee approved additional annual financial performance-based RSU awards to Ms. Mayer and other senior officers, and established the 2015 annual performance goals for these awards as well as for the similar performance-based RSUs granted in February 2013 and February 2014. The 2013, 2014, and 2015 performance-based RSU awards are generally eligible to vest in equal annual target amounts over four years (three years for Ms. Mayer) based on the Company’s attainment of annual financial performance goals as well as the executive’s continued employment through each vesting date. The number of shares that ultimately vest each year will range from 0 percent to 200 percent of the annual target amount, based on the Company’s performance. Annual financial performance metrics and goals are established for these RSU awards at the beginning of each year and the tranche of each RSU award related to that year’s performance goal is treated as a separate annual grant for accounting purposes. The 2015 financial performance metrics (and their weightings) established for the performance RSUs are: GAAP revenue (one-third), revenue ex-TAC (one-third), and adjusted EBITDA (one-third). The grant date fair value of the first tranche of the March 2015 performance RSUs was $9 million, the grant date fair value of the second tranche of the February 2014 performance RSUs was $11 million, and the grant date fair value of the third tranche of the February 2013 performance RSUs was $19 million. These values are being recognized over the tranches’ twelve-month service periods. The Company began recording stock-based compensation expense for these tranches in March 2015, when the financial performance goals were established.

Stock Repurchases. In November 2013, the Board authorized a stock repurchase program with an authorized level of $5 billion. The November 2013 program, according to its terms, will expire in December 2016. The aggregate amount available under the November 2013 repurchase program was approximately $726 million at September 30, 2015. In March 2015, the Board authorized an additional stock repurchase program with an authorized level of $2 billion. The March 2015 program, according to its terms, will expire in March 2018. The aggregate amount available under the March 2015 repurchase program was $2 billion at September 30, 2015. Repurchases under the repurchase programs may take place in the open market or in privately negotiated transactions, including structured and derivative transactions such as accelerated share repurchase transactions, and may be made under a Rule 10b5-1 plan. During the nine months ended September 30, 2015, the Company repurchased approximately 4 million shares of its common stock under its November 2013 program at an average price of $47.65 per share for a total of $204 million.

Note 14  Restructuring Charges, Net

 

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

 

                                                                                           
    Three Months Ended     Nine Months Ended  
      September 30,         September 30,         September 30,         September 30,    
    2014     2015     2014     2015  

 

 
Employee severance pay and related costs     $ 4,086         $ 16,597         $ 7,759         $ 67,746    
Non-cancelable lease, contract termination, and other charges     4,545         11,103         72,983         33,123    
Reversals of previous charges     (161)        (2,590)        (3,133)        (6,611)   
Non-cash accelerations of stock-based compensation expense     -              -              -              2,705    
Other non-cash charges (credits)     -              902         (7,031)        (31)   
 

 

 

   

 

 

   

 

 

   

 

 

 

Restructuring charges, net

    $ 8,470         $ 26,012         $ 70,578         $ 96,932    
 

 

 

   

 

 

   

 

 

   

 

 

 

 

 

The Company has implemented various restructuring plans to reduce its cost structure, align resources with its product strategy and improve efficiency, which have resulted in workforce reductions and the consolidation of certain real estate facilities and data centers. For the three months ended September 30, 2014, the Company recorded expense of $4 million, $1 million and $3 million related to the Americas, EMEA, and Asia Pacific segments, respectively. For the nine months ended September 30, 2014, the Company recorded expense of $59 million, $8 million and $4 million related to the Americas, EMEA, and Asia Pacific segments, respectively. For the three months ended September 30, 2015, the Company recorded expense of $9 million and $17 million related to the Americas and EMEA segments, respectively. For the nine months ended September 30, 2015, the Company recorded expense of $62 million, $31 million, and $4 million related to the Americas, EMEA, and Asia Pacific segments, respectively.

 

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The Company’s restructuring accrual activity for the nine months ended September 30, 2015 is summarized as follows (in thousands):

 

                        

 

 
Accrual balance as of December 31, 2014     $ 83,608    
Restructuring charges     96,932    
Cash paid     (102,657)   
Non-cash accelerations of stock-based compensation expense     (2,705)   
Foreign currency translation and other adjustments     (910)   
 

 

 

 
Accrual balance as of September 30, 2015     $ 74,268    
 

 

 

 

 

 

The $74 million restructuring liability as of September 30, 2015 consisted of $19 million for employee severance pay expenses, which the Company expects to pay out by the end of the second quarter of 2017, and $55 million relating to non-cancelable lease costs, which the Company expects to pay over the terms of the related obligations through the fourth quarter of 2025, less estimated sublease income.

The restructuring accrual by reportable segment consisted of the following (in thousands):

 

                                                 
    December 31,
2014
    September 30,
2015
 

 

 
Americas     $ 65,949         $ 51,891    
EMEA     16,797         22,372    
Asia Pacific     862           
 

 

 

   

 

 

 
Total restructuring accruals     $ 83,608         $ 74,268    
 

 

 

   

 

 

 

 

 

Note 15 Income Taxes

 

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

The Company recorded income tax expense of $4 billion and income tax benefit of $93 million for the three months ended September 30, 2014 and 2015. The Company recorded income tax expense of $4 billion and income tax benefit of $76 million for the nine months ended September 30, 2014 and 2015. The income tax expense for the three and nine months ended September 30, 2014 was primarily associated with the Company’s taxable gain from the sale of 140 million ADSs in the Alibaba Group IPO on September 24, 2014. The income tax benefit for the same periods in 2015 was primarily a result of the Company’s loss before income taxes and earnings in equity interests.

On July 27, 2015, the United States Tax Court issued an opinion in Altera Corp. et al. v. Commissioner, which invalidated the 2003 final Treasury rule that requires participants in qualified cost-sharing arrangements to share stock-based compensation costs. Based on the decision of the Tax Court, the Company could be entitled to a future income tax benefit by excluding stock-based compensation costs from its cost sharing with affiliated entities for the period of time that the Company had the cost-sharing structure in place. However, there is uncertainty related to the IRS response to the Tax Court opinion, the final resolution of this issue, and the potential favorable benefits to the Company. The Company will continue to monitor developments related to this opinion and the potential impact of those developments on its current and prior fiscal years.

As of September 30, 2015, the Company does not anticipate repatriating its undistributed foreign earnings of approximately $3.2 billion. Those earnings are principally related to its equity method investment in Yahoo Japan. If those earnings were to be repatriated in the future, the Company may be subject to additional U.S. income taxes (subject to an adjustment for foreign tax credits). It is not practicable to determine the income tax liability that might be incurred if these earnings were to be repatriated.

The Company’s gross amount of unrecognized tax benefits as of September 30, 2015 was $1.1 billion, of which $1.0 billion is recorded on the condensed consolidated balance sheets. The gross unrecognized tax benefits as of September 30, 2015 increased by $30 million from the recorded balance as of December 31, 2014. The majority of the increase related to transfer prices among entities in different tax jurisdictions.

 

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The Company is in various stages of examination and appeal in connection with its taxes both in the U.S. and in foreign jurisdictions. Those audits generally span tax years 2005 through 2013. As of September 30, 2015, the Company’s 2011 through 2013 U.S. federal income tax returns are currently under examination. The Company has protested the proposed California Franchise Tax Board’s adjustments to the 2005 through 2008 returns, but no conclusions have been reached to date. It is difficult to determine when the examinations will be settled or their final outcomes, certain audits in various jurisdictions are expected to be resolved in the foreseeable future. The Company believes that it has adequately provided for any reasonably foreseeable adjustment to its tax returns and that any settlement will not have a material adverse effect on its consolidated financial position, results of operations, or cash flows. It is reasonably possible that the Company’s unrecognized tax benefits could be reduced by up to approximately $152 million in the next twelve months.

In the three months ended March 31, 2015, we satisfied the $3.3 billion income tax liability related to the sale by Yahoo! Hong Kong Holdings Limited, our wholly-owned subsidiary, of Alibaba Group ADSs in the Alibaba Group IPO on September 24, 2014. As of September 30, 2015, the Company accrued deferred tax liabilities of $9.1 billion associated with the Alibaba Group shares retained by the Company. Such deferred tax liabilities will be subject to periodic adjustments due to changes in the fair value of the Alibaba Group shares. These deferred tax liabilities will become obligations of Aabaco upon completion of the planned spin-off transaction.

The Company may have additional tax liabilities in China related to the sale to Alibaba Group of 523 million Alibaba Group shares that took place during the year ended December 31, 2012 and related to the sale of the 140 million Alibaba Group ADSs sold in the Alibaba Group IPO that took place during the year ended December 31, 2014. Any taxes assessed and paid in China are expected to be ultimately offset and recovered in the U.S. through the use of foreign tax credits.

Tax authorities from the Brazilian State of Sao Paulo have assessed certain indirect taxes against the Company’s Brazilian subsidiary, Yahoo! do Brasil Internet Ltda., related to online advertising services. The assessment is for calendar years 2008 through 2011 and, translated into U.S. dollars as of September 30, 2015, totals approximately $86 million. The Company currently believes the assessment is without merit. The Company believes the risk of loss is remote and has not recorded an accrual for the assessment.

Note 16  Segments

 

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

 

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

 

                                                                                           
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,     September 30,     September 30,  
    2014     2015     2014     2015  

 

 
Revenue by segment:        

Americas

    $ 873,306          $ 987,374          $ 2,545,769          $ 2,964,305     

EMEA

    89,058          79,614          278,475          246,530     

Asia Pacific

    185,776          158,685          540,817          484,073     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total Revenue

    $ 1,148,140          $ 1,225,673          $ 3,365,061          $ 3,694,908     
 

 

 

   

 

 

   

 

 

   

 

 

 
TAC by segment:        

Americas

    $ 42,607          $ 201,855          $ 106,997          $ 549,332     

EMEA

    7,980          12,745          27,385          37,399     

Asia Pacific

    3,593          8,629          9,533          19,867     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total TAC

    $ 54,180          $ 223,229          $ 143,915          $ 606,598     
 

 

 

   

 

 

   

 

 

   

 

 

 
Revenue ex-TAC by segment:        

Americas

    $ 830,699          $ 785,519          $ 2,438,772          $ 2,414,973     

EMEA

    81,078          66,869          251,090          209,131     

Asia Pacific

    182,183          150,056          531,284          464,206     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total Revenue ex-TAC

    1,093,960          1,002,444          3,221,146          3,088,310     
 

 

 

   

 

 

   

 

 

   

 

 

 
Direct costs by segment(1) :        

Americas

    66,516          84,582          213,000          240,406     

EMEA

    23,166          23,196          66,505          63,947     

Asia Pacific

    53,954          47,214          148,921          149,764     
Global operating costs(2)     646,042          603,215          1,903,194          1,916,240     
Gain on sales of patents     (1,300)         -              (62,800)         (11,100)    
Asset impairment charge     -              41,699          -              41,699     
Restructuring charges, net     8,470          26,012          70,578          96,932     
Depreciation and amortization     149,144          152,412          453,538          457,630     
Stock-based compensation expense     105,796          110,426          317,422          351,252     
 

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

    $ 42,172          $ (86,312)         $ 110,788          $ (218,460)    
 

 

 

   

 

 

   

 

 

   

 

 

 

 

 

 

(1)

Direct costs for each segment include costs associated with the local sales teams and other cost of revenue. Prior to the fourth quarter of 2014, marketing, media, costs associated with Yahoo Properties and ad operation costs were managed locally and included as direct costs for each segment. Such costs are now included in global operating costs. Prior period amounts have been revised to conform to the current presentation.

 

(2)

Global operating costs include product development, marketing, real estate workplace, general and administrative, and other corporate expenses that are managed on a global basis and that are not directly attributable to any particular segment. Beginning in the fourth quarter of 2014, marketing, media, costs associated with Yahoo Properties and other ad operation costs are managed globally and included as global costs. Prior period amounts have been revised to conform to the current presentation.

 

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    Three Months Ended     Nine Months Ended  
    September 30,     September 30,     September 30,     September 30,  
    2014     2015     2014     2015  

 

 
Capital expenditures, net:        

Americas

    $ 105,437          $ 139,796          $ 269,754          $ 401,984     

EMEA

    3,034          4,616          22,070          19,265     

Asia Pacific

    3,783          5,969          12,443          19,495     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total capital expenditures, net

    $ 112,254          $ 150,381          $ 304,267          $ 440,744     
 

 

 

   

 

 

   

 

 

   

 

 

 

 

 

 

                                             
    December 31,     September 30,  
    2014     2015  

 

 
Property and equipment, net:    

Americas:

   

U.S.

    $ 1,382,597          $ 1,494,905     

Other

    787          495     
 

 

 

   

 

 

 

Total Americas

    $ 1,383,384          $ 1,495,400     
 

 

 

   

 

 

 

EMEA

    34,649          31,710     

Asia Pacific

    69,651          63,329     
 

 

 

   

 

 

 

Total property and equipment, net

    $ 1,487,684          $ 1,590,439     
 

 

 

   

 

 

 

 

 

See Note 5 — “Goodwill” and Note 14 — “Restructuring Charges, Net” for additional information regarding segments.

Enterprise Wide Disclosures

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

 

    Three Months Ended     Nine Months Ended  
    September 30,     September 30,     September 30,     September 30,  
    2014     2015     2014     2015  

 

 
Search     $ 452,355          $ 509,478          $ 1,325,540          $ 1,562,270     
Display     446,980          508,617          1,336,257          1,472,726     
Other     248,805          207,578          703,264          659,912     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    $ 1,148,140          $ 1,225,673          $ 3,365,061          $ 3,694,908     
 

 

 

   

 

 

   

 

 

   

 

 

 

 

 

 

                                                                                           
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,     September 30,     September 30,  
  2014     2015     2014     2015  

 

 
Revenue:        

U.S.

    $ 839,080          $ 958,394          $ 2,444,696          $ 2,887,134     

International

    309,060          267,279          920,365          807,774     
 

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    $ 1,148,140          $ 1,225,673          $ 3,365,061          $ 3,694,908     
 

 

 

   

 

 

   

 

 

   

 

 

 

 

 

Revenue is attributed to individual countries according to the online property that generated the revenue. No single foreign country was material to revenue for the three or nine months ended September 30, 2014 and 2015.

 

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Note 17  Search Agreement With Microsoft Corporation

 

On December 4, 2009, the Company entered into the Search Agreement with Microsoft. On February 18, 2010, the Company received regulatory clearance from both the U.S. Department of Justice and the European Commission and on February 23, 2010 the Company commenced implementation of the Search Agreement on a market-by-market basis.

On April 15, 2015, the Company and Microsoft entered into the Eleventh Amendment to the Search Agreement (the “Eleventh Amendment”) pursuant to which the terms of the Search Agreement were amended. Previously under the Search Agreement, Microsoft was the exclusive algorithmic and paid search services provider to Yahoo on personal computers for Yahoo Properties and for search services provided by Yahoo to Affiliate sites. Microsoft was the non-exclusive provider on mobile devices. Pursuant to the Eleventh Amendment, Microsoft will provide such services on a non-exclusive basis for Yahoo Properties and Affiliate sites on all devices. Commencing on May 1, 2015, Yahoo agrees to request paid search results from Microsoft for 51 percent of its search queries originating from personal computers accessing Yahoo Properties and its Affiliate sites (the “Volume Commitment”) and will display only Microsoft’s paid search results on such search result pages.

Previously under the Search Agreement, the Company was entitled to receive a percentage of the revenue (the “Revenue Share Rate”) generated from Microsoft’s services on Yahoo Properties and on Affiliate sites after deduction of the Affiliate sites’ share of revenue and certain Microsoft costs. The Revenue Share Rate was 88 percent for the first five years of the Search Agreement and then increased to 90 percent on February 23, 2015. Pursuant to the Eleventh Amendment, the Revenue Share Rate increased to 93 percent, but Microsoft now receives its 7 percent revenue share before deduction of the Affiliate site’s share of revenue. The Affiliate site’s share of revenue is deducted from the Company’s 93 percent Revenue Share Rate.

Additionally, pursuant to the Eleventh Amendment, The Company has the ability in response to queries on both personal computers and mobile devices to request algorithmic listings only, paid listings only or both algorithmic and paid listings from Microsoft. To the extent the Company requests algorithmic listings only or requests paid listings but elects not to display such paid listings, the Company pays Microsoft serving costs but not a revenue share. In other cases and with respect to the Volume Commitment, the Revenue Share Rate applies.

Previously under the Search Agreement, Yahoo had sales exclusivity for both the Company’s and Microsoft’s premium advertisers. Pursuant to the Eleventh Amendment to the Search Agreement, this sales exclusivity terminated on July 1, 2015. The Company and Microsoft have commenced transitioning premium advertisers for Microsoft’s paid search services to Microsoft on a market-by-market basis. The Eleventh Amendment requires this transition to be completed by January 31, 2016.

The term of the Search Agreement is 10 years from its commencement date, February 23, 2010, subject to earlier termination as provided in the Search Agreement. As of October 1, 2015, either the Company or Microsoft may terminate the Search Agreement by delivering a written notice of termination to the other party. The Search Agreement will remain in effect for four months from the date of the termination notice to provide for a transition period; however, the Company’s Volume Commitment will not apply in the third and fourth months of this transition period.

The Company currently reports as revenue the revenue share it receives from Microsoft under the Search Agreement as the Company is not the primary obligor in the arrangement with the advertisers and publishers as the underlying search advertising services are provided by Microsoft. Approximately 36 percent and 33 percent of the Company’s revenue for the three months ended September 30, 2014 and 2015, respectively, and approximately 36 percent of the Company’s revenue for both the nine months ended September 30, 2014 and 2015 was attributable to the Search Agreement.

As of December 31, 2014 and September 30, 2015, the Company had collected total amounts of $52 million and nil, respectively, on behalf of Microsoft and Microsoft’s affiliates, which was included in cash and cash equivalents with a corresponding liability in accrued expenses and other current liabilities. The Company’s uncollected revenue share in connection with the Search Agreement was $330 million and $280 million, which is included in accounts receivable, net, as of December 31, 2014 and September 30, 2015, respectively.

On December 9, 2010, in connection with entering into the Search Agreement, the Company also entered into a License Agreement with Microsoft (as amended, the “License Agreement”). Under the License Agreement, Microsoft acquired an exclusive 10-year license to the Company’s core search technology and has the ability to integrate this technology into its existing Web search platforms. Pursuant to the Eleventh Amendment, the exclusive licenses granted to Microsoft under the License Agreement became non-exclusive. The Company also agreed pursuant to the Eleventh Amendment to license certain sales tools to Microsoft to use solely in connection with Microsoft’s paid search services pursuant to the terms of the License Agreement.

 

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Table of Contents

Note 18  Subsequent Events

 

Google Services Agreement. On October 19, 2015, Yahoo and Google Inc. (“Google”), entered into a Google Services Agreement (the “Services Agreement”). The Services Agreement is effective as of October 1, 2015 and expires on December 31, 2018. Pursuant to the Services Agreement, Google will provide Yahoo with search advertisements through Google’s AdSense for Search Service (“AFS”), web algorithmic search services through Google’s Websearch Service, and image search services. The results provided by Google for these services will be available to Yahoo for display on both desktop and mobile platforms.

Under the Services Agreement, Yahoo is not obligated to send any minimum number of search queries to Google. The Services Agreement is non-exclusive and expressly permits Yahoo to use any other search advertising services, including its own service, the services of Microsoft, or other third parties.

Google will pay Yahoo a percentage of the gross revenues from AFS ads displayed on Yahoo Properties or Affiliate sites. Yahoo will pay Google fees for requests for image search results or web algorithmic search results.

The Services Agreement is subject to regulatory review in the U.S.

 

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

Forward-Looking Statements

 

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

 

 

expectations regarding our proposed spin-off of our remaining holdings in Alibaba Group Holding Limited (“Alibaba Group”);

 

 

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

 

 

expectations about growth in users;

 

 

expectations about changes in our earnings in equity interests and net income;

 

 

expectations about changes in operating expenses;

 

 

anticipated capital expenditures;

 

 

expectations about our share repurchase activity;

 

 

expectations about the financial and operational impacts of our Search and Advertising Services and Sales Agreement (the “Search Agreement”) with Microsoft Corporation (“Microsoft”);

 

 

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

 

 

expectations about the growth of, the opportunities for monetization in and revenue from, the mobile industry and mobile devices;

 

 

expectations about the growth of, the opportunities for monetization in and revenue from, our offerings in mobile, video, native, and social (“Mavens”);

 

 

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

 

 

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

 

 

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

 

 

expectations regarding the future outcome of legal proceedings in which we are involved.

These statements involve certain known and unknown risks and uncertainties that could cause our actual results to differ materially from those expressed or implied in our forward-looking statements. You are urged to carefully review the disclosures made concerning risks and uncertainties that may affect our business or operating results, which include, among others, those listed in Part II, Item 1A. “Risk Factors” of this Report. We do not intend, and undertake no obligation, to update or revise any of our forward-looking statements after the date of this Report to reflect new information, actual results or future events or circumstances.

Overview

 

Yahoo! Inc., together with its consolidated subsidiaries (“Yahoo,” the “Company,” “we,” or “us”) is a guide focused on informing, connecting, and entertaining our users. By creating highly personalized experiences for our users, we keep people connected to what matters most to them, across devices and around the world. In turn, we create value for advertisers by connecting them with the audiences that build their businesses. For advertisers, the opportunity to be a part of users’ digital habits across products and platforms is a powerful tool to engage audiences and build brand loyalty. Advertisers can build their businesses through advertising to targeted audiences on our online properties and services (“Yahoo Properties”) or through a distribution network of third party entities (“Affiliates”) who integrate our advertising offerings into their websites or other offerings (“Affiliate sites”). Our revenue is generated principally from search and display advertising.

We continue to manage and measure our business geographically, principally in the Americas, EMEA (Europe, Middle East, and Africa) and Asia Pacific.

 

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

 

 

Key Financial Metrics;

 

 

Significant Transactions;

 

 

Results of Operations;

 

 

Liquidity and Capital Resources;

 

 

Critical Accounting Policies and Estimates; and

 

 

Recent Accounting Pronouncements.

Key Financial Metrics

 

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

 

                                                                                   
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2014     2015     2014     2015  

 

 
    (in thousands)  
Revenue   $ 1,148,140      $ 1,225,673      $ 3,365,061      $ 3,694,908     
Revenue ex-TAC   $ 1,093,960      $ 1,002,444      $ 3,221,146      $ 3,088,310     
Income (loss) from operations(1)   $ 42,172      $ (86,312   $ 110,788      $ (218,460)    
Adjusted EBITDA   $ 305,582      $ 244,237      $ 952,326      $ 737,053     
Net income attributable to Yahoo! Inc.   $ 6,774,102      $ 76,261      $ 7,355,387      $ 75,905     
Net cash provided by (used in) operating activities   $ 289,192      $ 137,275      $ 785,667      $ (2,492,244)    
Free cash flow(2)   $ 212,230      $ 18,028      $ 512,107      $ (3,041,674)    

 

 
(1) Includes:        

Stock-based compensation expense

  $ 105,796      $ 110,426      $ 317,422      $ 351,252     

Restructuring charges, net

  $ 8,470      $ 26,012      $ 70,578      $ 96,932     

(2) During the nine months ended September 30, 2015, we satisfied the $3.3 billion income tax liability related to the sale of Alibaba Group American Depositary Shares (“ADSs”) in Alibaba Group’s initial public offering (“Alibaba Group IPO”) in September 2014.

Non-GAAP Financial Measures

Revenue ex-TAC. Revenue ex-TAC is a non-GAAP financial measure defined as GAAP revenue less cost of revenue—TAC. TAC consists of payments made to Affiliates and payments made to companies that direct consumer and business traffic to Yahoo Properties.

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

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

For additional information about these non-GAAP financial measures, see “Non-GAAP Financial Measures” included in our Annual Report on Form 10-K for the year ended December 31, 2014, as amended, under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

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Revenue

 

    Three Months Ended September 30,     Percent     Nine Months Ended September 30,     Percent  
    2014     2015     Change     2014     2015     Change  

 

 
    (dollars in thousands)  
Revenue     $ 1,148,140          $ 1,225,673          7%          $ 3,365,061          $ 3,694,908          10%     
Less: TAC     54,180          223,229          312%          143,915          606,598          321%     
 

 

 

   

 

 

     

 

 

   

 

 

   

Revenue ex-TAC

    $ 1,093,960          $ 1,002,444          (8)%          $ 3,221,146          $ 3,088,310          (4)%     
 

 

 

   

 

 

     

 

 

   

 

 

   

 

 

For the three and nine months ended September 30, 2015, revenue increased $78 million, or 7 percent, and $330 million, or 10 percent, respectively, compared to the same periods of 2014. For the three and nine months ended September 30, 2015, TAC increased $169 million, or 312 percent, and $463 million, or 321 percent, respectively, compared to the same periods of 2014. For the three and nine months ended September 30, 2015, revenue ex-TAC (a non-GAAP financial measure) decreased $92 million, or 8 percent, and $133 million, or 4 percent, respectively, compared to the same periods of 2014. The increase in revenue for the three and nine months ended September 30, 2015 was primarily attributable to an increase in search and display revenue resulting from an increase in revenue from distribution partners, including Mozilla Corporation (“Mozilla”), revenue from mobile devices and incremental revenue from BrightRoll, a programmatic video advertising platform that we acquired in December 2014. The increase in TAC for the three and nine months ended September 30, 2015, which exceeded the revenue increases for the same periods resulting in declines in revenue ex-TAC, was primarily driven by higher payments to distribution partners, including Mozilla, TAC associated with Gemini, and incremental TAC related to the BrightRoll acquisition.

Of the $78 million increase in revenue and $169 million increase in TAC for the three months ended September 30, 2015, $94 million and $94 million, respectively, were attributable to the agreement we entered into in November 2014 to compensate Mozilla for making us the default search provider on certain of Mozilla’s products in the United States (the “Mozilla Agreement”). Of the $330 million increase in revenue and $463 million increase in TAC for the nine months ended September 30, 2015, $297 million and $281 million, respectively, were attributable to the Mozilla Agreement. See “Results of Operations” for a more detailed discussion of the factors that contributed to the changes in revenue and TAC during these periods.

Gemini is our unified marketplace for search and native advertising on Yahoo Properties and Affiliate sites. Gemini ads appear on search results pages in response to queries and also as native ads alongside display content. Advertisers place ads on the Gemini platform through our simple self-serve interface, as well as through Yahoo’s traditional sales force; we do not source Gemini ads from Microsoft or other third-party providers. Because we are the primary obligor to Gemini advertisers, we recognize Gemini revenue gross of the related TAC paid to Affiliates. In the third quarter of 2015, we increased the proportion of search queries being routed to the Gemini platform in order to train our ad placement algorithms. During Gemini’s ramp-up phase, which is continuing, this change is resulting in reduced Price-per-Click as we work to optimize the system.

We anticipate that the anniversaries of our November 2014 agreement with Mozilla and our BrightRoll acquisition, as well as our continued ramp-up of the Gemini platform, may negatively impact both GAAP revenue and revenue ex-TAC on a year-over-year basis during the remainder of fiscal year 2015. We also expect other revenue to be impacted on a year-over-year basis beginning in the three months ending December 31, 2015 as the recognition of the remaining deferred revenue associated with the Technology and Intellectual Property License Agreement (the “TIPLA”) with Alibaba Group was completed on September 18, 2015. We recognized the remaining $60 million of deferred TIPLA revenue during the three months ended September 30, 2015. No revenue from the TIPLA will be recognized during the three months ending December 31, 2015, or in any periods thereafter. Over time, we expect GAAP revenue to grow faster than revenue ex-TAC as we anticipate gaining scale and market share in our core advertising businesses.

Mavens Revenue

One of our primary strategies is to invest in and grow our Mavens offerings. Revenue from our Mavens offerings is generated from, without duplication, (i) mobile (as defined below), (ii) video ads and video ad packages, (iii) native ads, and (iv) Tumblr ads and fees. Mavens revenue for the three months ended September 30, 2015 increased 43 percent to $422 million, compared to $295 million for the three months ended September 30, 2014. Mavens revenue for the nine months ended September 30, 2015 increased 54 percent to $1,189 million, compared to $773 million for the nine months ended September 30, 2014. The increase in Mavens revenue for the three and nine months ended September 30, 2015 was primarily related to growth in mobile advertising, and to a lesser extent, growth in native and video advertising.

We expect our Mavens revenue to continue to increase for the remainder of 2015 on a year-over-year basis.

Mobile Revenue

With the significant platform shift to mobile devices, we continue to focus on mobile products and mobile ad formats. We have refreshed the user experience on mobile across a number of Yahoo Properties, including Fantasy Sports, Sports, Flickr, Weather and Tumblr. Mobile revenue is generated in connection with user activity on mobile devices, including smartphones and tablets (a “device-based” approach), regardless of whether the device is accessing a mobile-optimized service. Mobile revenue is primarily generated by search and display advertising. Mobile revenue also includes leads, listings and fees revenue and ecommerce revenue allocated to user activity on mobile devices.

 

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Mobile revenue for the three months ended September 30, 2015 increased 31 percent to $271 million, compared to $207 million for the three months ended September 30, 2014. Mobile revenue for the nine months ended September 30, 2015 increased 47 percent to $757 million, compared to $514 million for the nine months ended September 30, 2014. The increase in mobile revenue for the three and nine months ended September 30, 2015 was primarily attributable to growth in display revenue on mobile devices driven by native advertising. Additionally, the increase in mobile revenue for the nine months ended September 30, 2015 was attributable to growth in search revenue on mobile devices. Mobile revenue is included within Search, Display, and Other revenue that we have reported. As of September 30, 2015, we had more than 600 million monthly mobile users (including mobile Tumblr users).

We expect the contribution of mobile revenue to our total revenue to be consistent with the third quarter of 2015 for the remainder of 2015.

Adjusted EBITDA (a Non-GAAP Financial Measure)

 

    Three Months Ended September 30,     Percent     Nine Months Ended September 30,     Percent  
    2014     2015     Change     2014     2015     Change  

 

 
    (dollars in thousands)  
Net income attributable to Yahoo! Inc.     $ 6,774,102          $ 76,261          (99)%        $ 7,355,387          $ 75,905          (99)%     
Advisory fees     -          -          0%        -          8,000          100%     
Depreciation and amortization     149,144          152,412          2%        453,538          457,630          1%     
Stock-based compensation expense     105,796          110,426          4%        317,422          351,252          11%     
Asset impairment charge     -          41,699          100%        -          41,699          100%     
Restructuring charges, net     8,470          26,012          207%        70,578          96,932          37%     
Other (expense) income, net     (10,308,931)         23,955          (100)%        (10,281,889)         66,759          (101)%     
Provision for income taxes     3,973,402          (93,208)         (102)%        3,985,762          (75,613)         (102)%     
Earnings in equity interests, net of tax     (398,692)         (95,195)         (76)%        (955,946)         (290,726)         (70)%     
Net income attributable to noncontrolling interests     2,291          1,875          (18)%        7,474          5,215          (30)%     
 

 

 

   

 

 

     

 

 

   

 

 

   

Adjusted EBITDA

    $ 305,582          $ 244,237          (20)%        $ 952,326          $ 737,053          (23)%     
 

 

 

   

 

 

     

 

 

   

 

 

   
           
Percentage of Revenue
ex-TAC(1)(2)
    28%            24%            30%            24%         
 

 

 

   

 

 

     

 

 

   

 

 

   

 

 

 

(1)

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

 

(2)

Net income attributable to Yahoo! Inc. as a percentage of GAAP revenue for the three and nine months ended September 30, 2015 was 6 percent and 2 percent, respectively. Net income attributable to Yahoo! Inc. as a percentage of GAAP revenue for the three and nine months ended September 30, 2014 was not meaningful.

For the three months ended September 30, 2015, adjusted EBITDA decreased $61 million, or 20 percent, compared to 2014, mainly due to higher TAC that was not fully offset by higher revenue, partially offset by a decline in global operating costs.

For the nine months ended September 30, 2015, adjusted EBITDA decreased $215 million, or 23 percent, compared to 2014, mainly due to higher TAC that was not fully offset by higher revenue as well as a lower benefit from patent sales year-over-year and an increase in direct costs in the Americas segment.

Adjusted EBITDA may be impacted during the three months ending December 31, 2015 if we do not have any patent sales or our patent sales in that period are less than our $35 million gain on sales of patents in the same period of 2014. We also expect adjusted EBITDA to be impacted beginning in the three months ending December 31, 2015 as the recognition of the remaining deferred revenue associated with the TIPLA with Alibaba Group was completed on September 18, 2015. We recognized the remaining $60 million of deferred TIPLA revenue during the three months ended September 30, 2015. No revenue from the TIPLA will be recognized during the three months ending December 31, 2015, or in any periods thereafter.

 

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Free Cash Flow (a Non-GAAP Financial Measure)

 

                                                                                           
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2014     2015     2014     2015  

 

 
    (in thousands)  
Net cash provided by (used in) operating activities     $ 289,192          $ 137,275          $ 785,667          $ (2,492,244)    
Acquisition of property and equipment, net     (112,254)         (150,381)         (304,267)         (440,744)    
Excess tax benefits from stock-based awards     35,292          31,509          114,392          33,359     
Dividends received from equity investees     -          (375)         (83,685)         (142,045)    
 

 

 

   

 

 

   

 

 

   

 

 

 

Free cash flow

    $ 212,230          $ 18,028          $ 512,107          $ (3,041,674)    
 

 

 

   

 

 

   

 

 

   

 

 

 

 

 

For the three months ended September 30, 2015, free cash flow decreased $194 million, or 92 percent, primarily due to a decline in net income attributable to Yahoo! Inc., cash paid for restructuring activities and an increase in capital expenditures year-over-year.

For the nine months ended September 30, 2015, free cash flow decreased $3.6 billion, primarily due to satisfaction of the $3.3 billion income tax liability related to the sale of Alibaba Group American Depositary Shares (“ADSs”) in September 2014.

Significant Transactions

 

Acquisition of Polyvore

On September 2, 2015, we completed the acquisition of Polyvore, Inc. (“Polyvore”), a social commerce website, for $161 million. Polyvore lets users across the globe discover and shop for their favorite products in fashion, beauty and home décor.

See Note 4—“Acquisitions and Dispositions” in the Notes to our condensed consolidated financial statements for additional information.

Search Agreement with Microsoft Corporation

The term of the Search Agreement is 10 years from its commencement date, February 23, 2010, subject to earlier termination as provided in the Search Agreement. Under the current terms of the Search Agreement, we are entitled to receive a percentage of the revenue (the “Revenue Share Rate”) generated from Microsoft’s services on Yahoo Properties and on Affiliate sites equal to 93 percent. Microsoft receives its 7 percent revenue share before deduction of the Affiliate site’s share of revenue. The Affiliate site’s share of revenue is deducted from our 93 percent Revenue Share Rate.

Previously under the Search Agreement, Yahoo had sales exclusivity for both Yahoo’s and Microsoft’s premium advertisers. Pursuant to the Eleventh Amendment to the Search Agreement, this sales exclusivity terminated on July 1, 2015. Yahoo and Microsoft have commenced transitioning premium advertisers for Microsoft’s paid search services to Microsoft on a market-by-market basis. The Eleventh Amendment requires this transition to be completed by January 31, 2016.

Approximately 36 percent and 33 percent of our revenue for the three months ended September 30, 2014 and 2015, respectively, and approximately 36 percent of our revenue for both the nine months ended September 30, 2014 and 2015 was attributable to the Search Agreement.

See Note 17 — “Search Agreement With Microsoft Corporation” in the Notes to our condensed consolidated financial statements for additional information.

Spin-Off of Remaining Holdings in Alibaba Group 

On January 27, 2015, we announced a plan for a spin-off of all of our remaining holdings in Alibaba Group into a newly formed independent registered investment company. The name selected for the new company is Aabaco Holdings, Inc. (“Aabaco”). The stock of Aabaco will be distributed pro rata to our stockholders, resulting in Aabaco becoming a separate publicly traded registered investment company. On July 17, 2015, Aabaco filed its initial Registration Statement on Form N-2 with the U.S. Securities and Exchange Commission (“SEC”), which it subsequently amended on September 28, 2015. Following the completion of the transaction, Aabaco will own, directly or indirectly, all of Yahoo’s remaining 384 million Alibaba Group ordinary shares (the “Alibaba Group shares”) and a 100 percent ownership interest in Aabaco Small Business, LLC (“ASB”), a newly formed entity which will own Yahoo Small Business, a current operating business of Yahoo that will also be transferred to Aabaco as part of the transaction.

The spin-off transaction is subject to certain conditions, including final approval by our Board, receipt of a legal opinion from Skadden, Arps, Slate, Meagher & Flom LLP with respect to certain tax matters, including the qualification of the spin-off as a tax-free transaction under the Internal Revenue Code of 1986, as amended, the registration of Aabaco’s common stock under the Securities Exchange Act of 1934, the acceptance of Aabaco’s common stock for listing on the Nasdaq Global Select Market, and certain other conditions. In addition, in connection with the spin-off transaction, the Company will be required to comply with applicable covenants in certain material contracts, including compliance with applicable covenants in the indenture governing the Notes.

 

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Each of the conditions may be waived, in whole or in part (to the extent permitted by applicable law), by us in our sole and absolute discretion. We have reserved the right, in our sole and absolute discretion, to abandon or modify the terms of the transaction at any time prior to the distribution date, even if the conditions to the transaction have been satisfied.

The completion of the transaction is expected to occur prior to the end of January 2016, subject to the conditions described above. The composition of Aabaco’s independent board of directors and management team, and other details of the transaction, including the distribution ratio, will be determined prior to the completion of the transaction.

Upon completion of the transaction, which is subject to the satisfaction or waiver of the conditions specified above, our consolidated financial position will be materially impacted as the Alibaba Group shares and related deferred tax liabilities will be removed from our condensed consolidated balance sheet. We would no longer hold any Alibaba Group shares and would no longer record changes in fair value within comprehensive income (loss).

Results of Operations

 

 

    Three Months Ended September 30,     Percent     Nine Months Ended September 30,     Percent  
    2014     2015     Change     2014     2015     Change  

 

 
    (dollars in thousands)  
Revenue for groups of similar services:            
Search            

Yahoo Properties

    $ 381,835          $ 435,616          14%          $ 1,113,620          $ 1,374,083          23%     

Affiliate sites

    70,520          73,862          5%          211,920          188,187          (11)%     
 

 

 

   

 

 

     

 

 

   

 

 

   

Total search revenue

    $ 452,355          $ 509,478          13%          $ 1,325,540          $ 1,562,270          18%     
 

 

 

   

 

 

     

 

 

   

 

 

   
Display            

Yahoo Properties

    $ 395,317          $ 312,442          (21)%          $ 1,191,473          $ 1,000,708          (16)%     

Affiliate sites

    51,663          196,175          280%          144,784          472,018          226%     
 

 

 

   

 

 

     

 

 

   

 

 

   

Total display revenue

    $ 446,980          $ 508,617          14%          $ 1,336,257          $ 1,472,726          10%     
 

 

 

   

 

 

     

 

 

   

 

 

   
Other     $ 248,805          $ 207,578          (17)%          $ 703,264          $ 659,912          (6)%     
 

 

 

   

 

 

     

 

 

   

 

 

   

Total revenue

    $ 1,148,140          $ 1,225,673          7%          $ 3,365,061          $ 3,694,908          10%     
           
Cost of revenue — TAC     $ 54,180          $ 223,229          312%          $ 143,915          $ 606,598          321%     
Cost of revenue — other     292,647          302,846          3%          882,036          884,041          0%     
Sales and marketing     267,875          274,329          2%          823,398          823,990          0%     
Product development     292,057          272,285          (7)%        852,099          905,460          6%     
General and administrative     176,717          151,963          (14)%          496,221          506,071          2%     
Amortization of intangibles     15,322          19,622          28%          48,826          59,677          22%     
Gain on sales of patents     (1,300)         -          (100)%          (62,800)         (11,100)         (82)%     
Asset impairment charge     -               41,699          100%          -               41,699          100%     
Restructuring charges, net     8,470          26,012          207%          70,578          96,932          37%     
 

 

 

   

 

 

     

 

 

   

 

 

   

Total operating expenses

    $     1,105,968          $     1,311,985          19%          $     3,254,273          $     3,913,368          20%     
 

 

 

   

 

 

     

 

 

   

 

 

   

Income (loss) from operations

    $ 42,172          $ (86,312)         (305)%          $ 110,788          $ (218,460)         (297)%     
 

 

 

   

 

 

     

 

 

   

 

 

   

Includes:

           

Stock-based compensation expense

    $ 105,796          $ 110,426          4%          $ 317,422          $ 351,252          11%     

 

 

 

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

 

    Three Months Ended September 30,     Nine Months Ended September 30,  
    2014     2015     2014     2015  

 

 
Revenue for groups of similar services:        
Search        

Yahoo Properties

    33%            36%            33%            37%       

Affiliate sites

    6%            6%            6%            5%       
 

 

 

   

 

 

   

 

 

   

 

 

 

Total search revenue

    39%            42%            39%            42%       
 

 

 

   

 

 

   

 

 

   

 

 

 
Display        

Yahoo Properties

    34%            25%            35%            27%       

Affiliate sites

    5%            16%            5%            13%       
 

 

 

   

 

 

   

 

 

   

 

 

 

Total display revenue

    39%            41%            40%            40%       
 

 

 

   

 

 

   

 

 

   

 

 

 
Other     22%            17%            21%            18%       
 

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    100%            100%            100%            100%       
       
Cost of revenue — TAC     4%            18%            4%            16%       
Cost of revenue — other     26%            25%            26%            24%       
Sales and marketing     23%            22%            25%            22%       
Product development     26%            22%            25%            25%       
General and administrative     15%            12%            15%            14%       
Amortization of intangibles     1%            2%            2%            2%       
Gain on sales of patents     0%            0%            (2)%            0%       
Asset impairment charge     0%            4%            0%            1%       
Restructuring charges, net     1%            2%            2%            2%       
 

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    96%            107%            97%            106%       
 

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

    4%            (7)%            3%            (6)%       
 

 

 

   

 

 

   

 

 

   

 

 

 

Includes:

       

Stock-based compensation expense

    9%            9%            9%            10%       

 

 

 

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Management Reporting

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

 

    Three Months Ended September 30,     Percent     Nine Months Ended September 30,     Percent  
    2014     2015     Change     2014     2015     Change  

 

 
    (dollars in thousands)  
Revenue by segment:            

Americas

    $ 873,306          $ 987,374          13%          $ 2,545,769          $ 2,964,305          16%     

EMEA

    89,058          79,614          (11)%          278,475          246,530          (11)%     

Asia Pacific

    185,776          158,685          (15)%          540,817          484,073          (10)%     
 

 

 

   

 

 

     

 

 

   

 

 

   

Total revenue

    $ 1,148,140          $ 1,225,673          7%          $ 3,365,061          $ 3,694,908          10%     
 

 

 

   

 

 

     

 

 

   

 

 

   
TAC by segment:            

Americas

    $ 42,607          $ 201,855          374%          $ 106,997          $ 549,332          413%     

EMEA

    7,980          12,745          60%          27,385          37,399          37%     

Asia Pacific

    3,593          8,629          140%          9,533          19,867          108%     
 

 

 

   

 

 

     

 

 

   

 

 

   

Total TAC

    $ 54,180          $ 223,229          312%          $ 143,915          $ 606,598          321%     
 

 

 

   

 

 

     

 

 

   

 

 

   
Revenue ex-TAC by segment:            

Americas

    $ 830,699          $ 785,519          (5)%          $ 2,438,772          $ 2,414,973          (1)%     

EMEA

    81,078          66,869          (18)%          251,090          209,131          (17)%     

Asia Pacific

    182,183          150,056          (18)%          531,284          464,206          (13)%     
 

 

 

   

 

 

     

 

 

   

 

 

   

Total revenue ex-TAC

        1,093,960              1,002,444          (8)%              3,221,146              3,088,310          (4)%     
 

 

 

   

 

 

     

 

 

   

 

 

   
Direct costs by segment(1):            

Americas

    66,516          84,582          27%          213,000          240,406          13%     

EMEA

    23,166          23,196          0%          66,505          63,947          (4)%     

Asia Pacific

    53,954          47,214          (12)%          148,921          149,764          1%     
Global operating costs(2)     646,042          603,215          (7)%          1,903,194          1,916,240          1%     
Gain on sales of patents     (1,300)         -          (100)%          (62,800)         (11,100)         (82)%     
Asset impairment charge     -          41,699          100%          -          41,699          100%     
Restructuring charges, net     8,470          26,012          207%          70,578          96,932          37%     
Depreciation and amortization     149,144          152,412          2%          453,538          457,630          1%     
Stock-based compensation expense     105,796          110,426          4%          317,422          351,252          11%     
 

 

 

   

 

 

     

 

 

   

 

 

   

Income (loss) from operations

    $ 42,172          $ (86,312)         (305)%          $ 110,788          $ (218,460)         (297)%     
 

 

 

   

 

 

     

 

 

   

 

 

   

 

 

 

(1)

Direct costs for each segment include costs associated with the local sales teams and other cost of revenue. Prior to the fourth quarter of 2014, marketing, media, costs associated with Yahoo Properties and ad operation costs were managed locally and included as direct costs for each segment. Prior period amounts have been revised to conform to the current presentation.

 

(2)

Global operating costs include product development, marketing, real estate workplace, general and administrative, and other corporate expenses that are managed on a global basis and that are not directly attributable to any particular segment. Beginning in the fourth quarter of 2014, marketing, media, costs associated with Yahoo Properties and other ad operation costs are managed globally and included as global costs. Prior period amounts have been revised to conform to the current presentation.

 

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Revenue

We generate revenue principally from search and display advertising on Yahoo Properties and Affiliate sites, with the majority of our revenue coming from advertising on Yahoo Properties. Our margins on revenue from advertising on Yahoo Properties are generally higher than our margins on revenue from advertising on Affiliate sites, as we pay TAC to our Affiliates. Additionally, we generate revenue from other sources including listings-based services, facilitating commercial transactions, royalties, patent licenses, and consumer and business fee-based services. For additional information about how we generate and recognize revenue, see “Results of Operations — Revenue Mobile Revenue, Search Revenue, — Display Revenue, and —Other Revenue” included in our Annual Report on Form 10-K for the year ended December 31, 2014, as amended, under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Search Revenue

Search revenue for the three months ended September 30, 2015 increased $57 million, or 13 percent, compared to the same period of 2014. This increase in search revenue was attributable to increased revenue on Yahoo Properties of $54 million, primarily in the Americas segment, resulting from higher search volume on desktop due primarily to the Mozilla Agreement, which contributed $94 million, as well as an increase in revenue from search advertising on mobile devices. The increase was partially offset by a decline in click volume on other visits to Yahoo Properties. Additionally, Affiliate search revenue increased in the Americas segment by $11 million, which was partially offset by declines in the Asia Pacific and EMEA segments of $6 million and $2 million, respectively.

Search revenue for the nine months ended September 30, 2015 increased $237 million, or 18 percent, compared to the same period of 2014. This increase in search revenue was attributable to increased revenue on Yahoo Properties of $260 million, primarily in the Americas segment, resulting from higher search volume on desktop due primarily to the Mozilla Agreement, which contributed $297 million, as well as an increase in revenue from search advertising on mobile devices. The increase was partially offset by a decline in click volume on other visits to Yahoo Properties. The increases noted above were partially offset by a decline in Affiliate search revenue of $24 million, driven by declines in the Asia Pacific and EMEA segments of $24 million and $14 million, respectively, partially offset by an increase in the Americas segment of $14 million.

The increase in search revenue for the three and nine months ended September 30, 2015 described above included the impact of unfavorable foreign exchange fluctuations of $12 million and $33 million, respectively, using the foreign currency exchange rates from the three and nine months ended September 30, 2014.

Display Revenue

Display revenue for the three and nine months ended September 30, 2015 increased $62 million, or 14 percent, and $136 million, or 10 percent, respectively, compared to the same periods of 2014. For the three months ended September 30, 2015, the increase in display revenue was driven by increased Affiliate revenue in the Americas, EMEA and Asia Pacific segments of $123 million, $11 million and $9 million, respectively, partially offset by declines in display revenue on Yahoo Properties in the Americas, EMEA and Asia Pacific segments of $51 million, $13 million, and $17 million, respectively. For the nine months ended September 30, 2015, the increase in display revenue was driven by increased Affiliate revenue in the Americas, EMEA and Asia Pacific segments of $286 million, $21 million and $19 million, respectively, partially offset by declines in display revenue on Yahoo Properties in the Americas, EMEA and Asia Pacific segments of $114 million, $35 million, and $40 million, respectively.

The increase in Affiliate display revenue for the three and nine months ended September 30, 2015 resulted primarily from an increase in video and native advertising, including incremental revenue from the BrightRoll acquisition and an increase in revenue from native advertising on mobile devices. The decrease in display revenue on Yahoo Properties for the three and nine months ended September 30, 2015 was primarily driven by declines in volume of premium and audience advertising, partially offset by an increase in volume and pricing of native advertising.

The increase in display revenue for the three and nine months ended September 30, 2015 described above included the impact of unfavorable foreign exchange fluctuations of $18 million and $46 million, respectively, using the foreign currency exchange rates from the three and nine months ended September 30, 2014.

Other Revenue

Other revenue for the three and nine months ended September 30, 2015 decreased $41 million, or 17 percent, and $43 million, or 6 percent, respectively, compared to the same periods of 2014. For the three months ended September 30, 2015, the decrease in other revenue was primarily due to declines in fees revenue of $25 million, including Alibaba Group-related fees revenue, and listings-based revenue of $16 million. For the nine months ended September 30, 2015, the decrease in other revenue was primarily attributable to a decline in listings-based revenue of $52 million, partially offset by an increase in fees revenue of $8 million despite the decline in Alibaba Group-related fees revenue mentioned above.

We expect other revenue to be impacted beginning in the three months ending December 31, 2015 as the recognition of the remaining deferred revenue associated with the TIPLA with Alibaba Group was completed on September 18, 2015. We recognized the remaining $60 million of deferred TIPLA revenue during the three months ended September 30, 2015. No revenue from the TIPLA will be recognized during the three months ending December 31, 2015, or in any periods thereafter.

 

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Search and Display Metrics

We present information below regarding the number of “Paid Clicks” and “Price-per-Click” for search and the number of “Ads Sold” and “Price-per-Ad” for display. This information is derived from internal data.

“Paid Clicks” are defined as clicks by end-users on sponsored search listings (excluding native ad units, which are defined as display ads that appear in the content streams viewed by users) on Yahoo Properties and Affiliate sites. Advertisers generally pay for sponsored search listings on a per-click basis. “Search click-driven revenue” is gross search revenue (GAAP search revenue plus the related revenue share with third parties), excluding the Microsoft RPS Guarantee and search revenue from Yahoo Japan. “Price-per-Click” is defined as search click-driven revenue divided by our total number of Paid Clicks.

“Ads Sold” consist of display ad impressions for paying advertisers on Yahoo Properties (including mobile) and Affiliate sites (including Flurry and BrightRoll). “Price-per-Ad” is defined as display revenue from Yahoo Properties (including mobile) and Affiliate sites (including Flurry and BrightRoll) divided by our total number of Ads Sold. Our price and volume metrics for display are based on display revenue which we report on a gross basis (before TAC), and include data for graphical, sponsorship, and native ad units on Yahoo Properties (including mobile) and Affiliate sites (including Flurry and BrightRoll).

We periodically review, refine and update our methodologies for monitoring, gathering, and counting number of Paid Clicks and Ads Sold and for calculating search click-driven revenue, Price-per-Click, and Price-per-Ad. Commencing in the three months ended March 31, 2015, our display price and volume metrics (Price-per-Ad and Ads Sold) include (a) results from Yahoo Properties worldwide (other than Japan, where Yahoo branded sites are operated by third-party licensees), whereas previously those metrics excluded countries and regions where historical data was not previously retained in a manner that would support period-to-period comparisons; (b) results from Affiliate sites (including Affiliates of Flurry and BrightRoll) and (c) historical Tumblr data commencing in the three months ended June 30, 2013, whereas previously Tumblr data was limited to (i) native ad results commencing in the three months ended March 31, 2014 and (ii) other display ad results commencing in the three months ended September 30, 2014. Prior period amounts have been updated to conform to the current presentation.

Search Metrics

For the three and nine months ended September 30, 2015, Paid Clicks increased 5 percent and 13 percent, and Price-per-Click decreased 2 percent and increased 1 percent, respectively, compared to the same periods of 2014. The increase in Paid Clicks for both the three and nine months ended September 30, 2015 was primarily attributable to an increase in Paid Clicks on Yahoo Properties in the Americas segment, attributable to our agreements with Mozilla and other distribution partners, partially offset by a decline in Paid Clicks from Affiliate traffic. The decrease in Price-per-Click for the three months ended September 30, 2015 was attributable to an increase in lower monetizing Paid Clicks, primarily related to the Gemini ramp-up, partially offset by an increase in the mix of Paid Clicks from the Americas segment, which is higher monetizing than the Asia Pacific and EMEA segments. The increase in Price-per-Click for the nine months ended September 30, 2015 was attributable to the increase in mix of Paid Clicks from the Americas segment, as discussed above. Improvements in the search metrics resulted in year-over-year growth of 3 percent and 14 percent in search click-driven revenue for the three and nine months ended September 30, 2015, respectively.

Display Metrics

For the three and nine months ended September 30, 2015, the number of Ads Sold increased 8 percent and 14 percent, and Price-per-Ad increased 8 percent and 1 percent, respectively, compared to the same periods of 2014. The increase in Ads Sold year-over-year for the three and nine months ended September 30, 2015 was attributable to an increase in native and video ad units sold which was partially offset by a decline in premium ad units sold. Native ad units represented approximately 45 percent and 42 percent of total Ads Sold for the three and nine months ended September 30, 2015, respectively, as compared to 37 percent and 28 percent of total Ads Sold for the three and nine months ended September 30, 2014, respectively. The increase in Price-per-Ad was due to improved pricing for native advertising and video representing a larger share of the inventory mix, partially offset by a shift in the mix of Ads Sold from premium advertising to native advertising.

Revenue and Revenue ex-TAC by Segment

Americas

Americas revenue for the three and nine months ended September 30, 2015 increased $114 million, or 13 percent, and $419 million, or 16 percent, respectively, compared to the same periods of 2014. The increase in Americas revenue for the three months ended September 30, 2015 was primarily attributable to increases in search and display revenue of $71 million and $72 million, respectively, partially offset by a decline in other revenue of $29 million. The increase in Americas revenue for the nine months ended September 30, 2015 was primarily attributable to increases in search and display revenue of $266 million and $171 million, respectively, partially offset by a decline in other revenue of $19 million. The increase in Americas search revenue for the three and nine months ended September 30, 2015 included $94 million and $294 million, respectively, attributable to the Mozilla Agreement, partially offset by a decline in click volume on other visits to Yahoo Properties. The increase in Americas display revenue for the three and nine months ended September 30, 2015 was primarily associated with incremental revenue from the BrightRoll acquisition and an increase in revenue from mobile devices driven by native advertising. The decrease in Americas other revenue for the three months ended September 30, 2015 was primarily attributable to a decline in fees revenue and to a lesser extent listings-based revenue. The decrease in Americas other revenue for the nine months ended September 30, 2015 was primarily attributable to a decline in listings-based revenue, partially offset by an increase in fees revenue.

 

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Revenue in the Americas accounted for approximately 81 percent and 80 percent of total revenue for the three and nine months ended September 30, 2015, respectively, compared to 76 percent for both the three and nine months ended September 30, 2014.

Americas revenue ex-TAC for the three and nine months ended September 30, 2015 decreased $45 million, or 5 percent, and $24 million, or 1 percent, respectively, compared to the same periods of 2014, due to an increase in TAC partially offset by an increase in revenue as discussed above. TAC in the Americas segment increased $159 million and $442 million for the three and nine months ended September 30, 2015, respectively, due to increased payments to distribution partners, including Mozilla, TAC associated with Gemini, and incremental TAC from the BrightRoll acquisition.

Revenue ex-TAC in the Americas accounted for approximately 78 percent of total revenue ex-TAC for both the three and nine months ended September 30, 2015, compared to 76 percent for both the three and nine months ended September 30, 2014.

EMEA

EMEA revenue for the three and nine months ended September 30, 2015 decreased $9 million, or 11 percent, and $32 million, or 11 percent, respectively, compared to the same periods of 2014, primarily due to unfavorable foreign exchange fluctuations of $11 million and $35 million for the three and nine months ended September 30, 2015, respectively, using the foreign currency exchange rates from the three and nine months ended September 30, 2014.

Revenue in EMEA accounted for approximately 6 percent and 7 percent of total revenue for the three and nine months ended September 30, 2015, respectively, compared to 8 percent for both the three and nine months ended September 30, 2014.

EMEA revenue ex-TAC for the three and nine months ended September 30, 2015 decreased $14 million, or 18 percent, and $42 million, or 17 percent, respectively, compared to the same periods of 2014, primarily due to unfavorable foreign exchange fluctuations of $9 million and $29 million for the three and nine months ended September 30, 2015, respectively, using the foreign currency exchange rates from the three and nine months ended September 30, 2014. In addition to unfavorable foreign exchange fluctuations discussed above, the decline in EMEA revenue ex-TAC for the three and nine months ended September 30, 2015 was primarily driven by an increase in display TAC of $4 million and $8 million, respectively, associated with an increase in Affiliate TAC payments to partners.

Revenue ex-TAC in EMEA accounted for approximately 7 percent of total revenue ex-TAC for both the three and nine months ended September 30, 2015, compared to 7 percent and 8 percent for the three and nine months ended September 30, 2014, respectively.

Asia Pacific

Asia Pacific revenue for the three and nine months ended September 30, 2015 decreased $27 million, or 15 percent, and $57 million, or 10 percent, respectively, compared to the same periods of 2014, primarily due to unfavorable foreign exchange fluctuations of $15 million and $38 million for the three and nine months ended September 30, 2015, respectively, using the foreign currency exchange rates from the three and nine months ended September 30, 2014. In addition to unfavorable foreign exchange fluctuations discussed above, the decline in Asia Pacific revenue for the three months ended September 30, 2015 was driven primarily by a decrease in other revenue of $8 million. In addition to unfavorable foreign exchange fluctuations discussed above, the decline in Asia Pacific revenue for the nine months ended September 30, 2015 was driven primarily by a decrease in display and other revenue of $7 million and $11 million, respectively.

Revenue in Asia Pacific accounted for approximately 13 percent of total revenue for both the three and nine months ended September 30, 2015, compared to 16 percent for both the three and nine months ended September 30, 2014.

Asia Pacific revenue ex-TAC for the three and nine months ended September 30, 2015 decreased $32 million, or 18 percent, and $67 million, or 13 percent, respectively, compared to the same periods of 2014, primarily due to unfavorable foreign exchange fluctuations of $14 million and $36 million for the three and nine months ended September 30, 2015, respectively, using the foreign currency exchange rates from the three and nine months ended September 30, 2014. In addition to unfavorable foreign exchange fluctuations discussed above, the decline in Asia Pacific revenue ex-TAC for the three and nine months ended September 30, 2015 was driven primarily by an increase in display TAC of $5 million and $10 million, respectively, associated with an increase in Affiliate TAC payments to partners.

Revenue ex-TAC in Asia Pacific accounted for approximately 15 percent of total revenue ex-TAC for both the three and nine months ended September 30, 2015, compared to 17 percent and 16 percent for the three and nine months ended September 30, 2014, respectively.

Direct Costs by Segment

Starting in the fourth quarter of 2014, direct costs for each segment include costs associated with the local sales teams and other cost of revenue. Prior to the fourth quarter of 2014, marketing, media, costs associated with Yahoo Properties and ad operation costs were managed locally and included as direct costs for each segment. Prior period amounts have been revised to conform to the current presentation.

 

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Americas

For the three months ended September 30, 2015, direct costs attributable to the Americas segment increased $18 million, or 27 percent, compared to the same period of 2014, primarily due to higher compensation costs of $13 million, marketing and public relations expense and bandwidth and other cost of revenue of $4 million.

For the nine months ended September 30, 2015, direct costs attributable to the Americas segment increased $27 million, or 13 percent, compared to the same period of 2014, primarily due to higher compensation costs of $22 million, marketing and public relations expense of $5 million, and bandwidth and other cost of revenue of $4 million, partially offset by lower content costs of $5 million.

Direct costs attributable to the Americas segment represented approximately 11 percent and 10 percent of Americas revenue ex-TAC for the three and nine months ended September 30, 2015, respectively, compared to 8 percent and 9 percent for the three and nine months ended September 30, 2014, respectively.

EMEA

For the three months ended September 30, 2015, direct costs attributable to the EMEA segment were roughly flat compared to the same period of 2014. For the nine months ended September 30, 2015, direct costs attributable to the EMEA segment decreased $3 million, or 4 percent, compared to the same period of 2014, due to declines in compensation costs.

Direct costs attributable to the EMEA segment represented approximately 35 percent and 31 percent of EMEA revenue ex-TAC for the three and nine months ended September 30, 2015, respectively, compared to 29 percent and 26 percent for the three and nine months ended September 30, 2014, respectively.

Asia Pacific

For the three months ended September 30, 2015, direct costs attributable to the Asia Pacific segment decreased $7 million, or 12 percent, compared to the same period of 2014, primarily attributable to a decline in compensation costs.

For the nine months ended September 30, 2015, direct costs attributable to the Asia Pacific segment increased $1 million, or 1 percent, compared to the same period of 2014, primarily attributable to an increase in other cost of revenue of $12 million related to our ecommerce business in the region, partially offset by a decline in compensation costs of $11 million.

Direct costs attributable to the Asia Pacific segment represented approximately 31 percent and 32 percent of Asia Pacific revenue ex-TAC for the three and nine months ended September 30, 2015, respectively, compared to 30 percent and 28 percent for the three and nine months ended September 30, 2014, respectively.

Operating Costs and Expenses

Cost of Revenue — TAC

Cost of revenue — TAC consists of payments made to Affiliates and payments made to companies that direct consumer and business traffic to Yahoo Properties. We also have an agreement to compensate Mozilla for being the default search provider on certain of Mozilla’s products in the United States. We record those payments as cost of revenue — TAC.

Cost of revenue — TAC for the three and nine months ended September 30, 2015 increased $169 million, or 312 percent, and $463 million, or 321 percent, respectively, compared to the same periods of 2014, primarily due to increased payments to distribution partners (including Mozilla which contributed $94 million and $281 million respectively) as well as increased TAC associated with Gemini, and incremental TAC from the BrightRoll acquisition.

We expect cost of revenue — TAC to continue to grow in the remainder of 2015 as we invest in scaling and optimizing our businesses and partnerships, including Gemini, BrightRoll, Mozilla, and other distribution partners.

Cost of revenue — TAC represented approximately 18 percent and 16 percent of GAAP revenue for the three and nine months ended September 30, 2015, respectively, compared to 4 percent for both the three and nine months ended September 30, 2014.

Cost of Revenue — Other

Cost of revenue — other consists of bandwidth costs, and other expenses associated with the production and usage of Yahoo Properties, including content expense and amortization of developed technology and patents. Cost of revenue — other also includes costs for Yahoo’s technology platforms and infrastructure, including depreciation expense and other operating costs, directly related to revenue generating activities.

Cost of revenue — other increased $10 million, or 3 percent, for the three months ended September 30, 2015 compared to the same period of 2014. The increase for the three months ended September 30, 2015, compared to 2014, was primarily attributable to higher cost of revenue of $10 million primarily related to algorithmic serving costs, as well as increases in depreciation and amortization expense of $5 million and stock-based compensation expense of $4 million. This was partially offset by declines in compensation costs of $7 million and bandwidth costs of $4 million.

 

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Cost of revenue — other increased $2 million, or roughly flat, for the nine months ended September 30, 2015 compared to the same period of 2014. The increase for the nine months ended September 30, 2015, compared to 2014, was primarily due to higher cost of revenue of $37 million related to algorithmic serving costs, our ecommerce business in the Asia Pacific segment, and BrightRoll video advertising fees and an increase in depreciation and amortization expense of $6 million. This increase in cost of revenue— other was partially offset by declines in bandwidth costs of $22 million, stock-based compensation expense of $13 million, and compensation costs of $6 million.

Cost of revenue — other represented approximately 25 percent and 24 percent of GAAP revenue for the three and nine months ended September 30, 2015, respectively, compared to 26 percent for both the three and nine months ended September 30, 2014.

Sales and Marketing

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

Sales and marketing expenses for the three months ended September 30, 2015 increased $6 million, or 2 percent, compared to the same period of 2014, primarily attributable to increases in marketing expense of $14 million, and outside service provider and other expenses of $6 million, partially offset by a decline in other compensation costs of $17 million. The increase in marketing expense was primarily due to costs associated with a new partner deal and brand marketing campaigns in 2015 for which there were no similar campaigns in 2014. The decline in other compensation costs was primarily driven by a 12 percent decline in headcount year-over-year.

Sales and marketing expenses for the nine months ended September 30, 2015 increased $1 million, or roughly flat, compared to the same period of 2014, primarily attributable to an increase in marketing expense of $30 million offset by declines in other compensation costs of $25 million. The increase in marketing expense was primarily due to costs associated with a new partner deal and brand marketing campaigns in 2015 for which there were no similar campaigns in 2014. The decline in other compensation costs was primarily attributable to a 12 percent decrease in headcount year-over-year, as well as a decline in transition and relocation costs.

Sales and marketing expenses represented approximately 22 percent of GAAP revenue for both the three and nine months ended September 30, 2015, compared to 23 percent and 25 percent for the three and nine months ended September 30, 2014, respectively.

Product Development

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

Product development expenses for the three months ended September 30, 2015 decreased $20 million, or 7 percent, compared to the same period of 2014, primarily attributable to decreases of $13 million in compensation costs, $9 million in depreciation and amortization expense and $7 million in facilities and equipment expense. This decrease was partially offset by an increase in stock-based compensation expense of $6 million. The decrease in compensation costs was primarily attributable to a 16 percent decline in headcount year-over-year.

Product development expenses for the nine months ended September 30, 2015 increased $53 million, or 6 percent, compared to the same period of 2014, primarily attributable to increases of $51 million in stock-based compensation expense, as well an increase in investment activities supporting our search, communications and other product initiatives of $30 million. This increase was partially offset by a decline in facilities and equipment expense of $15 million and a decline in depreciation and amortization expense of $17 million. The increase in stock-based compensation expense was due to an increase in the number of awards granted at a higher fair value.

Product development expenses represented approximately 22 percent and 25 percent of GAAP revenue for the three and nine months ended September 30, 2015, respectively, compared to 26 percent and 25 percent for the three and nine months ended September 30, 2014, respectively.

General and Administrative

General and administrative expenses consist primarily of compensation-related expenses (including stock-based compensation expense) related to corporate departments and fees for professional services and includes costs related to our non-data center facilities.

General and administrative expenses for the three months ended September 30, 2015 decreased $25 million, or 14 percent, compared to the same period of 2014, primarily attributable to a decline in compensation costs of $9 million, outside service provider expenses of $7 million, stock-based compensation expense of $7 million, and facilities and equipment expense of $4 million, partially offset by an increase in depreciation and amortization expense of $4 million.

 

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General and administrative expenses for the nine months ended September 30, 2015 increased $10 million, or 2 percent, compared to the same period of 2014, primarily attributable to increases of $15 million due to net gains on disposal of assets and legal settlements in 2014 for which there are no similar benefits in 2015, and $6 million in depreciation and amortization expense. This increase in general and administrative expense was partially offset by declines in facilities and equipment expense of $9 million and compensation costs of $6 million.

General and administrative expenses represented approximately 12 percent and 14 percent of GAAP revenue for the three and nine months ended September 30, 2015, respectively, compared to 15 percent for both the three and nine months ended September 30, 2014.

Amortization of Intangibles

We have purchased, and expect to continue purchasing, assets and/or businesses, which may include the purchase of intangible assets. Intangible assets include customer, affiliate, and advertiser-related relationships and tradenames, trademarks and domain names. Amortization of developed technology and patents is included in the cost of revenue — other and not in amortization of intangibles.

Amortization of intangibles for the three and nine months ended September 30, 2015 increased $4 million, or 28 percent, and $11 million, or 22 percent, respectively, compared to the same periods of 2014. For the three and nine months ended September 30, 2015, the increase in amortization of intangibles was primarily driven by incremental amortization of intangible assets related to BrightRoll, which we acquired in the fourth quarter of 2014, partially offset by a decline in expense for fully amortized assets.

Amortization of intangibles represented approximately 2 percent of GAAP revenue for both the three and nine months ended September 30, 2015, compared to 1 percent and 2 percent for the three and nine months ended September 30, 2014, respectively.

Gain on Sales of Patents

During the three months ended September 30, 2015, we did not have any patent sales. During the nine months ended September 30, 2015, we sold certain patents and recorded gain on sales of patents of approximately $11 million. During the three and nine months ended September 30, 2014 we sold certain patents and recorded gain on sales of patents of approximately $1 million and $63 million, respectively.

We may not have any patent sales or our patent sales in the three months ending December 31, 2015 may be less than our $35 million gain on sales of patents in the same period of 2014.

Asset Impairment Charge

During the three and nine months ended September 30, 2015, we recorded an asset impairment charge of $17 million related to originally developed content equal to the amount by which the unamortized cost of the originally developed content exceeded its estimated fair value and $25 million for acquired content equal to the amount by which the unamortized cost of the acquired content exceeded its net realizable value. This content included programming such as Community and Sin City Saints.

Restructuring Charges, Net

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

 

                                                                                   
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2014     2015     2014     2015  

 

 
Employee severance pay and related costs     $ 4,086         $ 16,597         $ 7,759         $ 67,746    
Non-cancelable lease, contract termination, and other charges     4,545         11,103         72,983         33,123    
Reversals of previous charges     (161)        (2,590)        (3,133)        (6,611)   
Non-cash accelerations of stock-based compensation expense                          2,705    
Other non-cash credits            902         (7,031)        (31)   
 

 

 

   

 

 

   

 

 

   

 

 

 

Restructuring charges, net

    $ 8,470         $ 26,012         $ 70,578         $ 96,932    
 

 

 

   

 

 

   

 

 

   

 

 

 

 

 

We have implemented various restructuring plans to reduce our cost structure, align resources with our product strategy and improve efficiency, which have resulted in workforce reductions and the consolidation of certain real estate facilities and data centers. For the three months ended September 30, 2014, we recorded expense of $4 million, $1 million, and $3 million related to the Americas, EMEA, and Asia Pacific segments, respectively. For the nine months ended September 30, 2014, we recorded expense of $59 million, $8 million, and $4 million related to the Americas, EMEA, and Asia Pacific segments, respectively. For the three months ended September 30, 2015, we recorded expense of $9 million and $17 million related to the Americas and EMEA segments, respectively. For the nine months ended September 30, 2015, we recorded expense of $62 million, $31 million, and $4 million related to the Americas, EMEA, and Asia Pacific segments, respectively.

 

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The $74 million restructuring liability as of September 30, 2015 consisted of $19 million for employee severance pay expenses, which we expect to pay out by the end of the second quarter of 2017, and $55 million relating to non-cancelable lease costs, which we expect to pay over the terms of the related obligations through the fourth quarter of 2025, less estimated sublease income.

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

Other Income (Expense), Net

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

 

                                                                                   
    Three Months Ended September 30,     Nine Months Ended September 30,  
    2014     2015     2014     2015  

 

 
Interest, dividend and investment income     $ 5,148          $ 8,010         $ 16,180         $ 24,888    
Interest expense     (17,292)        (18,411)        (51,461)        (53,540)   
Gain on sale of Alibaba Group ADSs     10,319,437                10,319,437           
Loss on Hortonworks warrants            (12,782)               (19,241)   
Foreign exchange losses     (2,109)        (1,490)        (9,048)        (21,017)   
Other     3,747         718         6,781         2,151    
 

 

 

   

 

 

   

 

 

   

 

 

 

Total other income (expense), net

    $ 10,308,931         $ (23,955)        $ 10,281,889         $ (66,759)   
 

 

 

   

 

 

   

 

 

   

 

 

 

 

 

Interest, dividend and investment income consists of income earned from cash and cash equivalents in bank accounts, and investments made in marketable debt securities. Interest, dividend and investment income increased $3 million and $9 million for the three and nine months ended September 30, 2015, respectively, compared to the same periods of 2014, primarily due to an increase in interest income.

Interest expense increased $1 million and $2 million for the three and nine months ended September 30, 2015, respectively, compared to the same periods of 2014. Interest expense is primarily related to the accreted non-cash interest expense related to the 0.00% Convertible Senior Notes due 2018 (“Notes”) that we issued in November 2013.

Gain on sale of Alibaba Group ADSs during the three and nine months ended September 30, 2014 was attributable to the pre-tax gain related to the sale of 140 million ADSs of Alibaba Group in Alibaba Group’s IPO on September 24, 2014.

During the three and nine months ended September 30, 2015, we recorded losses of $13 million and $19 million, respectively, due to the change in estimated fair value of the Hortonworks warrants during the respective periods, which was included within other income (expense), net in the condensed consolidated statements of operations.

Foreign exchange losses consists of foreign exchange gains and losses due to re-measurement of monetary assets and liabilities denominated in non-functional currencies, and unrealized and realized foreign currency transaction gains and losses, including gains and losses related to balance sheet hedges.

Income Taxes

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

We recorded income tax expense of $4 billion and income tax benefit of $93 million for the three months ended September 30, 2014 and 2015. We recorded income tax expense of $4 billion and income tax benefit of $76 million for the nine months ended September 30, 2014 and 2015. The income tax expense for the three and nine months ended September 30, 2014 was primarily associated with our taxable gain from the sale of 140 million ADSs in the Alibaba Group IPO on September 24, 2014. The income tax benefit for the same periods in 2015 was primarily a result of our loss before income taxes and earnings in equity interests.

On July 27, 2015, the United States Tax Court issued an opinion in Altera Corp. et al. v. Commissioner, which invalidated the 2003 final Treasury rule that requires participants in qualified cost-sharing arrangements to share stock-based compensation costs. Based on the decision of the Tax Court, we could be entitled to an income tax benefit by excluding stock-based compensation costs from our cost sharing with affiliated entities for the period of time that we had the cost-sharing structure in place. We will continue to monitor developments related to this opinion and the potential impact of those developments on our current and prior fiscal years.

As of September 30, 2015, we do not anticipate repatriating our undistributed foreign earnings of approximately $3.2 billion. Those earnings are principally related to our equity method investment in Yahoo Japan. If those earnings were to be repatriated in the future, we may be subject to additional U.S. income taxes (subject to an adjustment for foreign tax credits). It is not practicable to determine the income tax liability that might be incurred if these earnings were to be repatriated.

 

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Our gross amount of unrecognized tax benefits as of September 30, 2015 was $1.1 billion, of which $1.0 billion is recorded on our condensed consolidated balance sheets. The gross unrecognized tax benefits as of September 30, 2015 increased by $30 million from the recorded balance as of December 31, 2014. The majority of the increase related to transfer prices among entities in different tax jurisdictions.

We are in various stages of examination and appeal in connection with our taxes both in the U.S. and in foreign jurisdictions. Those audits generally span tax years 2005 through 2013. As of September 30, 2015, our 2011 through 2013 U.S. federal income tax returns are currently under examination. We have protested the proposed California Franchise Tax Board’s adjustments to the 2005 through 2008 returns, but no conclusions have been reached to date. It is difficult to determine when the examinations will be settled or their final outcomes, certain audits in various jurisdictions are expected to be resolved in the foreseeable future. We believe that we have adequately provided for any reasonably foreseeable adjustment to its tax returns and that any settlement will not have a material adverse effect on our consolidated financial position, results of operations, or cash flows. It is reasonably possible that our unrecognized tax benefits could be reduced by up to approximately $152 million in the next twelve months.

In the three months ended March 31, 2015, we satisfied the $3.3 billion income tax liability related to the sale by Yahoo! Hong Kong Holdings Limited, our wholly-owned subsidiary, of Alibaba Group ADSs in the Alibaba Group IPO on September 24, 2014. As of September 30, 2015, we accrued deferred tax liabilities of $9.1 billion associated with the Alibaba Group shares that we retained. Such deferred tax liabilities will be subject to periodic adjustments due to changes in the fair value of the Alibaba Group shares. These deferred tax liabilities will become obligations of Aabaco upon completion of the spin-off.

We may have additional tax liabilities in China related to the sale to Alibaba Group of 523 million Alibaba Group shares that took place during the year ended December 31, 2012 and related to the sale of 140 million Alibaba Group ADSs sold in the Alibaba Group IPO that took place during the year ended December 31, 2014. Any taxes assessed and paid in China are expected to be ultimately offset and recovered in the U.S. through the use of foreign tax credits.

Tax authorities from the Brazilian State of Sao Paulo have assessed certain indirect taxes against our Brazilian subsidiary, Yahoo! do Brasil Internet Ltda., related to online advertising services. The assessment is for calendar years 2008 through 2011 and, translated into U.S. dollars as of September 30, 2015, totals approximately $86 million. We currently believe the assessment is without merit. We believe the risk of loss is remote and have not recorded an accrual for the assessment.

Earnings in Equity Interests

Earnings in equity interests for the three and nine months ended September 30, 2014 was $399 million and $956 million, respectively, compared to $95 million and $291 million, respectively, for the same periods in 2015. The decrease for the three and nine months ended September 30, 2015 was due primarily to Alibaba Group. Following the Alibaba Group IPO in September 2014, we no longer use the equity method to record our proportionate share of Alibaba Group’s financial results in our condensed consolidated financial statements. Since we no longer use the equity method to account for our interest in Alibaba Group, our earnings in equity interests and net income have been and will continue to be materially lower in periods since the Alibaba Group IPO. See Note 8 — “Investments in Equity Interests Using the Equity Method of Accounting” in the Notes to our condensed consolidated financial statements for additional information. Earnings in equity interests primarily consist of our proportionate share of Yahoo Japan’s financial results, which we record one quarter in arrears.

Noncontrolling Interests

Noncontrolling interests represent the noncontrolling holders’ percentage share of income or losses from the subsidiaries in which we hold a majority, but less than 100 percent, ownership interest and the results of which are consolidated in our condensed consolidated financial statements. Noncontrolling interests recorded in the three and nine months ended September 30, 2014 and 2015 were related to the Yahoo!7 venture in Australia and New Zealand.

Liquidity and Capital Resources

 

 

                                             
    December 31,
2014
    September 30,
2015
 

 

 
   

(dollars in thousands)

 

 
Cash and cash equivalents     $     2,664,098          $ 1,281,160     
Short-term marketable securities     5,327,412          4,600,889     
Long-term marketable securities     2,230,892          940,052     
 

 

 

   

 

 

 
Total cash, cash equivalents, and marketable securities     $     10,222,402          $ 6,822,101     
 

 

 

   

 

 

 
Percentage of total assets     17%        17%   
 

 

 

   

 

 

 

 

 

 

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Nine Months Ended September 30,

 
Cash Flow Highlights   2014     2015  

 

 
   

(in thousands)

 

 
Net cash provided by (used in) operating activities   $ 785,667         $ (2,492,244)     
Net cash (used in) provided by investing activities   $ 9,956,994         $ 1,506,049      
Net cash used in financing activities   $ (2,446,281)        $ (363,577)     

 

 

Our operating activities for the nine months ended September 30, 2015 did not generate positive cash flow as we satisfied the $3.3 billion income tax liability related to the sale of Alibaba Group ADSs in September 2014.

As of September 30, 2015, we had cash, cash equivalents, and marketable securities (excluding Alibaba Group and Hortonworks equity securities) totaling $6.8 billion compared to $10.2 billion at December 31, 2014. During the nine months ended September 30, 2015, we purchased Polyvore for $153 million in cash consideration, net of cash acquired, we repurchased 4 million shares of our outstanding common stock for $204 million, and we settled the $3.3 billion income tax liability related to the sale of Alibaba Group ADSs in September 2014.

Our foreign subsidiaries held $512 million of our total $6.8 billion of cash and cash equivalents and marketable securities (excluding Alibaba Group and Hortonworks equity securities) as of September 30, 2015. The cumulative earnings remaining in our consolidated foreign subsidiaries, if repatriated to the U.S., under current law, would be subject to U.S. income taxes with an adjustment for foreign tax credits. As of September 30, 2015, we do not anticipate repatriating our undistributed foreign earnings of approximately $3.2 billion. Those earnings are principally related to our equity method investment in Yahoo Japan. It is not practicable to determine the income tax liability that might be incurred if these earnings were to be repatriated.

On October 19, 2012, we entered into a credit agreement with Citibank, N.A., as Administrative Agent (as amended, “Credit Agreement”) that provides for a $750 million unsecured revolving credit facility, subject to increase by up to $250 million in accordance with its terms, which is scheduled to terminate on July 22, 2016. As of September 30, 2015, we were in compliance with the financial covenants in the Credit Agreement and no amounts were outstanding.

We currently hedge a portion of our net investment in Yahoo Japan with forward and option contracts to reduce the risk that our investment in Yahoo Japan will be adversely affected by foreign currency translation exchange rate fluctuations. The forward contracts are required to be settled in cash and the amount of cash payment we receive or could be required to pay upon settlement could be material. The amount of cash paid or received on the option contracts would only be required if the exchange rate is outside a predetermined range.

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

We use cash generated by operations as our primary source of liquidity and believe that existing cash, cash equivalents, and investments in marketable securities, together with any cash generated from operations, and borrowings under the Credit Agreement, will be sufficient to meet normal operating requirements and capital expenditures for the next twelve months.

Cash Flow Changes

Net cash provided by (used in) operating activities. For the nine months ended September 30, 2015, operating activities used $2,492 million in cash primarily due to satisfying the $3.3 billion income tax liability related to the sale of Alibaba Group ADSs in September 2014. Net income for the nine months ended September 30, 2015 was $81 million, which was adjusted for the following increases related to non-cash items: depreciation, amortization of intangibles and accretion of Notes discount of $505 million, stock-based compensation expense of $354 million, loss from sales of investments, assets, and other, net of $46 million, loss from Hortonworks warrants of $19 million, asset impairment charge of $42 million, and tax benefits from stock-based awards of $23 million, partially offset by reductions for non-cash items including: earnings in equity interests of $291 million, gains on sale of patents of $11 million, excess tax benefits from stock-based awards of $33 million, and deferred income taxes of $53 million. Additionally, we received dividends from equity investees of $142 million, had sources of cash from working capital of $252 million, offset by uses of cash from working capital of $3,568 million, which included the reduction of the income tax liability related to the sale of Alibaba Group shares in September 2014, as noted above.

For the nine months ended September 30, 2014, operating activities provided $786 million in cash. Net income for the nine months ended September 30, 2014 was $7,363 million, which was adjusted for the following increases related to non-cash items: depreciation, amortization of intangibles and accretion of convertible notes discount of $498 million, stock-based compensation expense of $317 million, tax benefits from stock-based awards of $111 million, deferred income tax expense of $397 million, and losses from sales of investments, assets and other of $28 million, offset by the gain on sale of Alibaba Group ADSs of $10.3 billion and other reductions for non-cash items including: earnings in equity interests of $956 million, excess tax benefits from stock-based awards of $114 million, restructuring reversals of $7 million, and gains on sales of patents of $63 million. Additionally, we received dividends of $84 million from Yahoo Japan and working capital sources of cash of $3,566 million, which were partially offset by working capital uses of cash of $119 million.

 

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Net cash (used in) provided by investing activities. In the nine months ended September 30, 2015, the $1,506 million provided by investing activities was due to proceeds from sales and maturities of marketable securities, net of purchases, of $1,983 million, $29 million proceeds from the sale of patents, and $114 million in net proceeds from settlement of derivative hedge contracts, partially offset by $441 million used for capital expenditures, net, $175 million used for acquisitions, and $5 million used for the purchase of intangibles and other activities.

In the nine months ended September 30, 2014, the $9,957 million provided by investing activities was due to $9,405 million in cash proceeds from the sale of Alibaba Group ADSs in the Alibaba Group IPO, net of underwriting discounts, commissions, and fees, net proceeds from sales of marketable debt securities of $988 million, $186 million in proceeds received from settlement of derivative hedge contracts and $63 million in proceeds from sales of patents, partially offset by $304 million used for capital expenditures, $314 million used for acquisitions, $60 million used for additional equity investments, $5 million used to settle derivative hedge contracts, and $2 million used for the purchase of intangibles and other activities.

Net cash used in financing activities. In the nine months ended September 30, 2015, the $364 million used in financing activities was due to $204 million used for the repurchase of 4 million shares of common stock at an average price of $47.65 per share, $16 million used for distributions to non-controlling interests, and $230 million used for tax withholding payments related to net share settlements of restricted stock units and other financing activities. This use of cash was partially offset by $52 million in cash proceeds received from employee stock option exercises and employee stock purchases made through our employee stock purchase plan, and an excess tax benefit from stock-based awards of $33 million.

In the nine months ended September 30, 2014, the $2,446 million used in financing activities was due to $2,550 million used for the repurchase of 55 million shares of common stock (including $1.1 billion prepaid in the September 2014 accelerated share repurchase, which included an initial delivery of approximately 15 million shares), $22 million used for distributions to noncontrolling interests, and $236 million used for tax withholding payments related to net share settlements of restricted stock units and other financing activities. This use of cash was partially offset by $248 million in cash proceeds received from employee stock option exercises and employee stock purchases made through our employee stock purchase plan, and an excess tax benefit from stock-based awards of $114 million.

Stock Repurchases

In March 2015, the Board approved an additional share repurchase program of $2 billion (the “March 2015 Program”), which will expire in March 2018. The amount of shares of common stock authorized to be repurchased under the March 2015 Program is in addition to the amount of shares of common stock remaining available for repurchase under the November 2013 program. Repurchases under the March 2015 and the November 2013 Programs may take place in the open market or in privately negotiated transactions, including structured and derivative transactions such as accelerated share repurchase transactions, and may be made under a Rule 10b5-1 plan.

During the nine months ended September 30, 2015, we repurchased approximately 4 million shares of our common stock at an average price of $47.65 per share for a total of $204 million. The following table provides the remaining authorization and repurchases by program:

 

                                                              
    November 2013
Program
    March 2015
Program
    Total  

 

 
    (in millions)  
January 1, 2015     $ 930         $        $ 930    
Authorized Share Repurchase amount under March 2015 Program            2,000         2,000    
Total repurchases in the first quarter     (204)               (204)   
Total repurchases in the second quarter                     
Total repurchases in the third quarter                     
 

 

 

   

 

 

   

 

 

 
September 30, 2015     $ 726         $ 2,000         $ 2,726    
 

 

 

   

 

 

   

 

 

 

 

 

Capital Expenditures, Net

Capital expenditures are generally comprised of purchases of computer hardware, software, server equipment, furniture and fixtures, real estate, and capitalized software and labor for internal use software projects. Capital expenditures, net, were $441 million for the nine months ended September 30, 2015 compared to $304 million in the same period of 2014. The increase in capital expenditures was primarily due to incremental investment in hardware to support Company initiatives, facilities expansions and improvements, partially offset by a decline in capitalizable software projects.

We expect capital expenditures, net in the three months ending December 31, 2015 to be lower than in the three months ended September 30, 2015; however, we continue to expect capital expenditures, net to increase in 2015 from the amount recorded in 2014 as a result of increased investment activities supporting our search, communications and other product initiatives.

 

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Contractual Obligations and Commitments

The following table presents certain payments due under contractual obligations with minimum commitments as of September 30, 2015 (in millions):

 

                                                                                              
    Payments Due by Period  
    Total     Due in
2015
    Due in
2016-2017
    Due in
2018-2019
    Thereafter  

 

 
Convertible notes(1)     $ 1,438         $        $        $ 1,438         $   
Operating lease obligations(2)     432         29         187         101         115    
Capital lease obligations     45                25         14           
Affiliate commitments(3)     1,682         100         801         750         31    
Non-cancelable obligations(4)     191         52         124         15           
Intellectual property rights(5)     19                                
Finance lease obligations(6)     18                              12    
Uncertain tax positions, including interest and penalties(7)     1,123                              1,121    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
Total contractual obligations     $ 4,948         $ 193         $ 1,148         $ 2,324         $ 1,283    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

 

(1)

During the year end December 31, 2013, we completed an offering of the Notes, which are due in 2018. The amount above represents the principal balance to be repaid. See Note 11—“Convertible Notes” in the Notes to our condensed consolidated financial statements for additional information.

 

(2)

We have entered into various non-cancelable operating lease agreements for our offices throughout the Americas, EMEA, and Asia Pacific regions with original lease periods up to 15 years, expiring between 2015 and 2025. See Note 12—“Commitments and Contingencies” in the Notes to our condensed consolidated financial statements for additional information.

 

(3)

We are obligated to make minimum payments under contracts to provide sponsored search and/or display advertising services to our Affiliates or to be the default search provider, which represent TAC.

 

(4)

We are obligated to make payments under various arrangements with vendors and other business partners, principally for marketing, bandwidth, and content arrangements.

 

(5)

We are committed to make certain payments under various intellectual property arrangements.

 

(6)

We are obligated to make payments for rent and tenant improvements associated with build-to-suit lease arrangements.

 

(7)

As of September 30, 2015, unrecognized tax benefits and potential interest and penalties resulted in accrued liabilities of $1,123 million, classified as other accrued expenses and current liabilities and deferred and other long-term tax liabilities on our condensed consolidated balance sheets. It is difficult to determine when the examinations will be settled or their final outcomes. See Note 15 — “Income Taxes” in the Notes to our condensed consolidated financial statements for additional information.

Construction Liabilities. The estimated timing and amounts of payments for rent associated with the build-to-suit lease arrangement that has not been placed in service totaled $40 million, of which less than $1 million will be payable in the remainder of 2015, $2 million will be payable in 2016, $3 million will be payable in 2017, $4 million will be payable in 2018, $4 million will be payable in 2019, $4 million will be payable in 2020, and $22 million will be payable thereafter.

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

 

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As of September 30, 2015, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Accordingly, we are not exposed to any financing, liquidity, market, or credit risk that could arise if we had such relationships. In addition, we identified no variable interests currently held in entities for which we are the primary beneficiary. In addition, as of September 30, 2015, we had no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our consolidated financial condition, results of operations, liquidity, capital expenditures, or capital resources.

Critical Accounting Policies and Estimates

 

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

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

For a discussion of our critical accounting policies and estimates, see “Critical Accounting Policies and Estimates” included in our Annual Report on Form 10-K for the year ended December 31, 2014, as amended, under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” We have made no significant changes to our critical accounting policies and estimates from those described in our Annual Report on Form 10-K for the year ended December 31, 2014, as amended.

Recent Accounting Pronouncements

 

See Note 1 — “The Company and Summary of Significant Accounting Policies” in the Notes to our condensed consolidated financial statements.

 

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

We are exposed to financial market risks, including changes in currency exchange rates and interest rates and changes in the market values of our investments. We may use derivative financial instruments to mitigate certain risks in accordance with our investment and foreign exchange policies.

We enter into master netting arrangements, which are designed to reduce credit risk by permitting net settlement of transactions with the same counterparty. We present our derivative assets and liabilities at their gross fair values on the condensed consolidated balance sheets.

Interest Rate Exposure

 

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

In November 2013, we issued $1.4375 billion of the Notes. We carry the Notes at face value less unamortized discount on our condensed consolidated balance sheets. The fair value of the Notes changes when the market price of our stock fluctuates.

 

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Investments in fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if forced to sell securities that have declined in market value due to changes in interest rates or changes in credit quality. A hypothetical 100 basis point increase in interest rates would result in a $31 million and $26 million decrease in the fair value of our available-for-sale debt securities as of December 31, 2014 and September 30, 2015, respectively.

Foreign Currency Exposure

 

The objective of our foreign exchange risk management program is to identify material foreign currency exposures and identify methods to manage these exposures to minimize the potential effects of currency fluctuations on our reported condensed consolidated cash flows and results of operations. All counterparties to our derivative contracts are major financial institutions. See Note 9 — “Foreign Currency Derivative Financial Instruments” in the Notes to our condensed consolidated financial statements for additional information on our hedging programs.

We transact business in various foreign currencies and have international revenue, as well as costs denominated in foreign currencies. This exposes us to the risk of fluctuations in foreign currency exchange rates.

We had net realized and unrealized foreign currency transaction losses of $2 million and $9 million for the three and nine months ended September 30, 2014, respectively. We had net realized and unrealized foreign currency transaction losses of $1 million and $21 million for the three and nine months ended September 30, 2015, respectively. These include the impact of balance sheet hedging and remeasurements of foreign denominated assets and liabilities on the balance sheets of the Company and our subsidiaries.

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

A Value-at-Risk (“VaR”) sensitivity analysis was performed on all of our foreign currency derivative positions to assess the potential impact of fluctuations in exchange rates. The VaR model uses a Monte Carlo simulation to generate thousands of random price paths assuming normal market conditions. The VaR is the maximum expected one day loss in fair value, for a given statistical confidence level, to our foreign currency derivative positions due to adverse movements in rates. The VaR model is used as a risk management tool and is not intended to represent either actual or forecasted losses. Based on the results of the model using a 99 percent confidence interval, we estimate the maximum one-day loss in the net investment hedge portfolio was $22 million and $16 million, respectively, at December 31, 2014 and September 30, 2015. The maximum one-day loss in the cash flow hedge portfolio was $3 million and $1 million, respectively, at December 31, 2014 and September 30, 2015. The maximum one-day loss in the balance sheet hedge portfolio was $2 million and $3 million, respectively, at December 31, 2014 and September 30, 2015. Actual future gains and losses associated with our derivative positions may differ materially from the sensitivity analysis performed as of September 30, 2015 due to the inherent limitations associated with predicting the timing and amount of changes in foreign currency exchange rates and our actual exposures and positions. In addition, the VaR sensitivity analysis may not reflect the complex market reactions that may arise from the market shifts modeled within this VaR sensitivity analysis.

Revenue ex-TAC and related expenses generated from our international subsidiaries are generally denominated in the currencies of the local countries. Primary currencies include Australian dollars, British pounds, Euros, Japanese yen, and Taiwan dollars. The statements of operations of our international operations are translated into U.S. dollars at exchange rates indicative of market rates during each applicable period. To the extent the U.S. dollar strengthens against foreign currencies, the translation of these foreign currency-denominated transactions results in reduced consolidated revenue and operating expenses. Conversely, our consolidated revenue and operating expenses will increase if the U.S. dollar weakens against foreign currencies. Using the foreign currency exchange rates from the three and nine months ended September 30, 2014, revenue ex-TAC for the Americas segment for the three and nine months ended September 30, 2015 would have been higher than we reported by $6 million and $13 million, respectively; revenue ex-TAC for the EMEA segment would have been higher than we reported by $9 million and $29 million, respectively; and revenue ex-TAC for the Asia Pacific segment would have been higher than we reported by $14 million and $36 million, respectively. Using the foreign currency exchange rates from the three and nine months ended September 30, 2014, direct costs for the Americas segment for the three and nine months ended September 30, 2015 would have been higher than we reported by $2 million and $3 million, respectively; direct costs for the EMEA segment would have been higher than we reported by $3 million and $9 million, respectively; and direct costs for the Asia Pacific segment would have been higher than we reported by $4 million and $10 million, respectively.

 

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Investment Exposure

 

We are exposed to investment risk as it relates to changes in the market value of our investments. We have investments in marketable securities and equity instruments of public and private companies. As of the date of the Alibaba Group IPO, we no longer account for our remaining investment in Alibaba Group using the equity method and no longer record our proportionate share of Alibaba Group’s financial results in the consolidated financial statements. Instead, we now reflect our remaining investment in Alibaba Group as an available-for-sale equity security on the condensed consolidated balance sheet and adjust the investment to fair value each quarterly reporting period with changes in fair value recorded within other comprehensive income (loss), net of tax. The change in the classification of our investment in Alibaba Group from an equity method investment to an available-for-sale equity security exposes our investment portfolio to increased equity price risk. The fair value of the equity investment in Alibaba Group will vary over time and is subject to a variety of market risks including: company performance, macro-economic, regulatory, industry, and systemic risks of the equity markets overall.

Our cash and marketable securities investment policy and strategy attempts primarily to preserve capital and meet liquidity requirements. A large portion of our cash is managed by external managers within the guidelines of our investment policy. We protect and preserve invested funds by limiting default, market, and reinvestment risk. To achieve this objective, we maintain our portfolio of cash and cash equivalents and short-term and long-term investments in a variety of liquid fixed income securities, including both government and corporate obligations and money market funds. As of December 31, 2014, net unrealized losses on these investments were $5 million. As of September 30, 2015, net unrealized gains on these investments were not material.

A sensitivity analysis was performed on our marketable equity security portfolio to assess the potential impact of fluctuations in stock price. Hypothetical declines in stock price of ten percent, twenty percent, and thirty percent were selected based on potential near-term changes in the stock price that could have an adverse effect on our marketable equity security portfolio. As of December 31, 2014 and September 30, 2015, the fair value of our marketable equity security portfolio was approximately $40 billion and $23 billion, respectively. As of September 30, 2015, declines in stock prices of ten percent, twenty percent and thirty percent would have resulted in a $2 billion, $5 billion and $7 billion decline, respectively, in the total value of our marketable equity security portfolio.

We performed a separate sensitivity analysis on our Hortonworks warrants for which we estimate fair value using the Black-Scholes model. We have held all other inputs constant and determined the impact of hypothetical declines in stock price of ten percent, twenty percent, and thirty percent, based on potential near-term changes in the stock price that could have an adverse effect on the fair value of the warrants and result in a loss recorded to the consolidated statements of operations. As of December 31, 2014 and September 30, 2015, the fair value of the Hortonworks warrants was approximately $98 million and $79 million, respectively. As of September 30, 2015, declines in stock prices of ten percent, twenty percent and thirty percent would have resulted in a $8 million, $16 million and $24 million decline, respectively, in the total value of the Hortonworks warrants.

 

 

Item 4. Controls and Procedures

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

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

 

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PART II — OTHER INFORMATION

 

 

Item 1. Legal Proceedings

For a description of our material legal proceedings, see the section captioned “Legal Contingencies” included in Note 12 — “Commitments and Contingencies” in the Notes to our condensed consolidated financial statements, which is incorporated by reference herein.

 

 

Item 1A. Risk Factors

We have updated the risk factors previously disclosed in Part I, Item 1A. of our Annual Report on Form 10-K for the year ended December 31, 2014, which was filed with the SEC on February 27, 2015 (“2014 Annual Report”), as amended, as set forth below. We do not believe any of the changes constitute material changes from the risk factors previously disclosed in our 2014 Annual Report, as updated by our Quarterly Reports on Form 10-Q for the periods ended March 31, 2015 and June 30, 2015.

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

We face significant competition from online search engines, sites offering integrated internet products and services, social media and networking sites, ecommerce sites, and broadcast and print media. In a number of international markets, especially those in Asia, Europe, the Middle East and Latin America, we face substantial competition from local Internet service providers and other entities that offer search, communications, and other commercial services.

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

A key element of our strategy is focusing on mobile products and mobile advertising formats, as well as increasing our revenue from mobile. A number of our competitors have devoted significant resources to the development of products, services and apps for mobile devices. Several of our competitors have mobile revenue significantly greater than ours. If we are unable to develop products for mobile devices that users find engaging and that help us grow our mobile revenue, our competitive position, our financial condition and operating results could be harmed.

In addition, a number of competitors offer products, services and apps that directly compete for users with our offerings, including e-mail, search, video, social, sports, news, finance, micro-blogging, and messaging. Similarly, our competitors or other participants in the online advertising marketplace offer advertising exchanges, ad networks, demand side platforms, ad serving technologies, sponsored search offerings, and other services that directly compete for advertisers with our offerings. Additionally, as the use of programmatic advertising continues to increase, we compete with companies that have also invested in programmatic platform offerings. We also compete with traditional print and broadcast media companies to attract domestic and international advertising spending. Some of our existing competitors and possible entrants have greater brand recognition for certain products, services and apps, more expertise in particular market segments, and greater operational, strategic, technological, financial, personnel, or other resources than we do. Many of our competitors have access to considerable financial and technical resources with which to compete aggressively, including by funding future growth and expansion and investing in acquisitions, technologies, and research and development. Further, emerging start-ups may be able to innovate and provide new products, services and apps faster than we can. In addition, competitors may consolidate or collaborate with each other, and new competitors may enter the market. Some of our competitors in international markets have a substantial competitive advantage over us because they have dominant market share in their territories, have greater local brand recognition, are focused on a single market, are more familiar with local tastes and preferences, or have greater regulatory and operational flexibility due to the fact that we may be subject to both U.S. and foreign regulatory requirements.

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

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

For the three and nine months ended September 30, 2015, 83 percent and 82 percent, respectively, of our total revenue came from search and display advertising. Our ability to retain and grow search and display revenue depends upon:

 

 

maintaining and growing our user base and popularity as an Internet destination site;

 

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maintaining the popularity of our existing products, introducing engaging new products and making our new and existing products popular and distributable on mobile and other alternative devices and platforms;

 

 

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

 

 

achieving a better traffic mix from our Yahoo Properties and Affiliates and improving our monetization rates on such traffic;

 

 

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

 

 

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

 

 

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

 

 

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

 

 

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

 

 

effectively monetizing mobile and other search queries;

 

 

continuing to innovate and improve users’ search experiences;

 

 

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

 

 

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

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

As more people access our products via mobile devices rather than PCs and mobile advertising continues to evolve, if we do not continue to grow our mobile users and revenue, our financial results will be adversely impacted.

The number of people who access the Internet through mobile devices rather than a PC, including mobile telephones, smartphones and tablets, is increasing and will likely continue to increase dramatically. More than 600 million of our monthly users are now joining us (including Tumblr) on mobile devices. In addition, search queries are increasingly being undertaken through mobile devices. As a result, our ability to grow advertising revenue is increasingly dependent on our ability to generate revenue from ads displayed on mobile devices.

A key element of our strategy is focusing on mobile devices and we expect to continue to devote significant resources to the creation and support of developing new and innovative mobile products, services and apps. However, if our new mobile products, services and apps, including new forms of Internet advertising for mobile devices, do not continue to attract and retain mobile users, advertisers and device manufacturers and to generate and grow mobile revenue, our operating and financial results will be adversely impacted. We are dependent on the interoperability of our products and services with mobile operating systems we do not control and we may not be successful in maintaining relationships with the key participants in the mobile industry that control such mobile operating systems. The manufacturer or access provider might promote a competitor’s or its own products and services, impair users’ access to our services by blocking access through their devices, make it hard for users to readily discover, install, update or access our products on their devices, or charge us for delivery of ads, or limit our ability to deliver ads or measure their effectiveness. If distributors impair access to or refuse to distribute our services or apps, or charge for or limit our ability to deliver ads or measure the effectiveness of our ads, then our user engagement and revenue could decline.

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

We plan to continue to manage costs to better and more efficiently manage our business. However, our operating expenses might increase as we expand our operations in areas of desired growth, continue to develop and extend the Yahoo brand, fund product development, build or expand data centers, acquire additional office space, and acquire and integrate complementary businesses and technologies. If our expenses increase at a greater pace than our revenue, or if we fail to effectively manage costs, our profitability will decline.

If we are unable to provide innovative search experiences and other products and services that generate significant traffic to our websites, our business could be harmed, causing our revenue to decline.

Internet search is characterized by rapidly changing technology, significant competition, evolving industry standards, and frequent product and service enhancements. Although we use Microsoft’s paid search platform, we still need to continue to invest and innovate to improve our users’ search experience to continue to attract, retain, and expand our user base and paid search advertiser base. We also need to continue to invest in and innovate on the mobile search experience. Pursuant to the Search Agreement with Microsoft, we are also dependent on Microsoft to continue to invest and innovate to maintain and improve its algorithmic and paid search services.

 

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We generate revenue through other online products, services and apps, and continue to innovate the products, services and apps that we offer. The research and development of new, technologically advanced products is a complex process that requires significant levels of innovation and investment, as well as accurate anticipation of technology, market and consumer trends. If we are unable to provide innovative products and services which gain user acceptance and generate significant traffic to our websites, or if we are unable to effectively monetize the traffic from new products and services, our business could be harmed, causing our revenue to decline.

Risks associated with our Search Agreement with Microsoft may adversely affect our business and operating results.

Under our Search Agreement with Microsoft, Microsoft was the exclusive provider of algorithmic and paid search services for Yahoo Properties and Affiliate sites on personal computers and the non-exclusive provider of such services on mobile devices. As of April 15, 2015, Microsoft became the non-exclusive provider of such services on all devices. Commencing on May 1, 2015, the Company has agreed to request paid search results from Microsoft for 51 percent of its search queries originating from personal computers accessing Yahoo Properties and its Affiliate sites (the “Volume Commitment”) and will display only Microsoft’s paid search results on such search result pages. Approximately 33 percent, 36 percent and 35 percent of our revenue for the three and nine months ended September 30, 2015 and the year ended December 31, 2014, respectively, were attributable to the Search Agreement. Our business and operating results would be adversely affected by a significant decline in or loss of this revenue.

Pursuant to the Search Agreement with Microsoft, to maintain and grow a substantial portion of our search revenue, we are dependent on Microsoft continuing to invest and innovate to maintain and improve its algorithmic and paid search services and to be competitive with other search providers. If Microsoft fails to do this, our revenue and profitability could decline and our ability to maintain and expand our relationships with Affiliates for search and paid search advertising could be negatively impacted. Further, our competitors may continue to increase revenue, profitability, and market share at a higher rate than we do.

The term of the Search Agreement is 10 years from its commencement date, February 23, 2010, subject to earlier termination as provided in the Search Agreement. On or after October 1, 2015, either the Company or Microsoft may terminate the Search Agreement by delivering a written notice of termination to the other party. The Search Agreement will remain in effect for four months from the date of a termination notice to provide for a transition period. If Microsoft terminated the Search Agreement and the Company was unable to rely on its own services or to find an alternate provider of algorithmic and paid search services, the termination could have an adverse impact on our business, revenue and operating results.

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

Our future success depends in part on our ability to aggregate compelling content and deliver that content through our online properties. We license from third parties much of the content and services on our online properties, such as news, stock quotes, sports and weather data, video, maps and photos. In addition, our users also contribute content to us. We believe that users will increasingly demand high-quality content and services. We may need to make substantial payments to third parties from whom we license or acquire such content or services. Our ability to maintain and build relationships with such third-party providers is critical to our success. In addition, as users increasingly access the Internet via mobile and other alternative devices, we may need to enter into amended agreements with existing third-party providers to cover new devices. We may be unable to enter into new, or preserve existing, relationships with the third-parties whose content or services we seek to obtain. In addition, as competition for compelling content increases both domestically and internationally, our third-party providers may increase the prices at which they offer their content and services to us, stop offering their content or services to us, or offer their content and services on terms that are not agreeable to us. An increase in the prices charged to us by third-party providers could harm our operating results and financial condition. Further, because many of our licenses for our content and services with third parties are non-exclusive, other media providers may be able to offer similar or identical content. This increases the importance of our ability to deliver compelling editorial content and personalization of this content for users in order to differentiate Yahoo from other businesses. If we are unable to license or acquire compelling content at reasonable cost, if other companies distribute content or services that are similar to or the same as that provided by us, if we do not develop or commission compelling editorial content (including personalized content), or if we do not receive compelling content from our users, the number of users of our services may not grow as anticipated, or may decline, or users’ level of engagement with our services may decline, all or any of which could harm our operating results.

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

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

 

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the difficulty of integrating the operations, personnel, systems, and controls of acquired companies as a result of cultural, regulatory, systems, and operational differences;

 

 

the potential disruption of our ongoing business and distraction of management;

 

 

the incurrence of additional operating losses and operating expenses of the businesses we acquired or in which we invested;

 

 

the difficulty of integrating acquired technology and rights into our services and unanticipated expenses related to such integration;

 

 

the failure to successfully further develop an acquired business or technology and any resulting impairment of amounts currently capitalized as intangible assets;

 

 

the failure of strategic investments to perform as expected or to meet financial projections;

 

 

the potential for patent and trademark infringement and data privacy and security claims against the acquired companies, or companies in which we have invested;

 

 

litigation or other claims in connection with acquisitions, acquired companies, or companies in which we have invested;

 

 

the impairment or loss of relationships with customers and partners of the companies we acquired or in which we invested or with our customers and partners as a result of the integration of acquired operations;

 

 

the impairment of relationships with, or failure to retain, employees of acquired companies or our existing employees as a result of integration of new personnel;

 

 

our lack of, or limitations on our, control over the operations of our joint venture companies;

 

 

in the case of foreign acquisitions and investments, the impact of particular economic, tax, currency, political, legal and regulatory risks associated with specific countries; and

 

 

the impact of known potential liabilities or liabilities that may be unknown, including as a result of inadequate internal controls, associated with the companies we acquired or in which we invested.

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

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

We are required under generally accepted accounting principles to test goodwill for impairment at least annually and to review our amortizable intangible assets, investments in equity interests (including investments held by any equity method investee), and our other investments, for impairment when events or changes in circumstance indicate the carrying value may not be recoverable. Factors that could lead to impairment of goodwill, amortizable intangible assets (including goodwill or assets acquired via acquisitions) and other investments include significant adverse changes in the business climate and actual or projected operating results (affecting our company as a whole or affecting any particular reporting unit) and declines in the financial condition of our business. Factors that could lead to impairment of investments in equity interests include a prolonged period of decline in the stock price or operating performance of, or an announcement of adverse changes or events by, the companies in which we invested or the investments held by those companies. Factors that could lead to an impairment of U.S. government securities, which constitute a significant portion of our current assets, include any downgrade of U.S. government debt or concern about the creditworthiness of the U.S. government. We have recorded and may be required in the future to record additional charges to earnings if our goodwill, amortizable intangible assets, investments in equity interests, including investments held by any equity method investee, or other investments become impaired. Any such charge would adversely impact our financial results.

Our business depends on a strong brand, and failing to maintain or enhance the Yahoo brands in a cost-effective manner could harm our operating results.

Maintaining and enhancing our brands is an important aspect of our efforts to attract and expand our user, advertiser, and Affiliate base. We believe that the importance of brand recognition will increase due to the relatively low barriers to entry in certain portions of the Internet market. Maintaining and enhancing our brands will depend largely on our ability to provide high-quality, innovative products, and services, which we might not do successfully. We have spent and expect to spend considerable money and resources on the establishment and maintenance of our brands, as well as advertising, marketing, and other brand-building efforts to preserve and enhance consumer awareness of our brands. Our brands may be negatively impacted by a number of factors such as service outages, product malfunctions, data protection and security issues, exploitation of our trademarks by others without permission, and poor presentation or integration of our search marketing offerings by Affiliates on their sites or in their software and services.

Further, while we attempt to ensure that the quality of our brands is maintained by our licensees, our licensees might take actions that could impair the value of our brands, our proprietary rights, or the reputation of our products and media properties. If we are unable to maintain or enhance our brands in a cost-effective manner, or if we incur excessive expenses in these efforts, our business, operating results and financial condition could be harmed.

 

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We are regularly involved in claims, suits, government investigations, and other proceedings that may result in adverse outcomes.

We are regularly involved in claims, suits, government investigations, and proceedings arising from the ordinary course of our business, including actions with respect to intellectual property claims, privacy, consumer protection, information security, data protection or law enforcement matters, tax matters, labor and employment claims, commercial claims, as well as actions involving content generated by our users, stockholder derivative actions, purported class action and class action lawsuits, and other matters. Such claims, suits, government investigations, and proceedings are inherently uncertain and their results cannot be predicted with certainty. Regardless of the outcome, such legal proceedings can have an adverse impact on us because of legal costs, diversion of management and other personnel, and other factors. In addition, it is possible that a resolution of one or more such proceedings could result in reputational harm, liability, penalties, or sanctions, as well as judgments, consent decrees, or orders preventing us from offering certain features, functionalities, products, or services, or requiring a change in our business practices, products or technologies, which could in the future materially and adversely affect our business, operating results, and financial condition. See Note 12 — “Commitments and Contingencies” in the Notes to our condensed consolidated financial statements.

Our intellectual property rights are valuable, and any failure or inability to sufficiently protect them could harm our business and our operating results.

We create, own, and maintain a wide array of copyrights, patents, trademarks, trade dress, trade secrets, rights to domain names and other intellectual property assets which we believe are collectively among our most valuable assets. We seek to protect our intellectual property assets through patent, copyright, trade secret, trademark, and other laws of the U.S. and other countries of the world, and through contractual provisions. However, the efforts we have taken to protect our intellectual property and proprietary rights might not be sufficient or effective at stopping unauthorized use of those rights. Protection of the distinctive elements of Yahoo might not always be available under copyright law or trademark law, or we might not discover or determine the full extent of any unauthorized use of our copyrights and trademarks in order to protect our rights. In addition, effective trademark, patent, copyright, and trade secret protection might not be available or cost-effective in every country in which our products and media properties are distributed or made available through the Internet. Changes in patent law, such as changes in the law regarding patentable subject matter, could also impact our ability to obtain patent protection for our innovations. In particular, recent amendments to the U.S. patent law may affect our ability to protect our innovations and defend against claims of patent infringement. Further, given the costs of obtaining patent protection, we might choose not to protect (or not to protect in some jurisdictions) certain innovations that later turn out to be important. There is also a risk that the scope of protection under our patents may not be sufficient in some cases or that existing patents may be deemed invalid or unenforceable. To help maintain our trade secrets, we have entered into confidentiality agreements with most of our employees and contractors, and confidentiality agreements with many of the parties with whom we conduct business, in order to limit access to and disclosure of our proprietary information. If these confidentiality agreements are breached it could compromise our trade secrets and cause us to lose any competitive advantage provided by those trade secrets.

If we are unable to protect our proprietary rights from unauthorized use, the value of our intellectual property assets may be reduced. In addition, protecting our intellectual property and other proprietary rights is expensive and time consuming. Any increase in the unauthorized use of our intellectual property could make it more expensive to do business and consequently harm our operating results.

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

Internet, technology, media, and patent holding companies often possess a significant number of patents. Further, many of these companies and other parties are actively developing or purchasing search, indexing, electronic commerce, and other Internet-related technologies, as well as a variety of online business models and methods.

We believe that these parties will continue to take steps such as seeking patent protection to protect these technologies. In addition, patent holding companies may continue to seek to monetize patents they have purchased or otherwise obtained. As a result, disputes regarding the ownership of technologies and rights associated with online businesses are likely to continue to arise in the future. From time to time, parties assert patent infringement claims against us. Currently, we are engaged in a number of lawsuits regarding patent issues and have been notified of a number of other potential disputes.

In addition to patent claims, third parties have asserted, and are likely in the future to assert, claims against us alleging infringement of copyrights, trademark rights, trade secret rights or other proprietary rights, or alleging unfair competition, violation of federal or state statutes or other claims, including alleged violation of international statutory and common law. In addition, third parties have made, and may continue to make, infringement and related claims against us over the display of content or search results triggered by search terms, including the display of advertising, that include trademark terms.

 

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