ALTABA INC. 10-Q 2014
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended September 30, 2014
For the transition period from to
Commission File Number 000-28018
(Exact name of Registrant as specified in its charter)
701 First Avenue
Sunnyvale, California 94089
(Address of principal executive offices, including zip code)
Registrants 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.
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 issuers classes of common stock, as of the latest practicable date.
Table of Contents
Condensed Consolidated Balance Sheets
The accompanying notes are an integral part of these condensed consolidated financial statements.
Condensed Consolidated Statements of Income
The accompanying notes are an integral part of these condensed consolidated financial statements.
Condensed Consolidated Statements of Comprehensive Income
The accompanying notes are an integral part of these condensed consolidated financial statements.
Condensed Consolidated Statements of Cash Flows
The accompanying notes are an integral part of these condensed consolidated financial statements.
Condensed Consolidated Statements of Cash Flows (continued)
See Note 8 Investments in Equity Interests regarding the fair value of the Alibaba Group Holdings Limited (Alibaba Group) shares and Note 15 Income Taxes for information about the non-cash deferred tax liabilities recorded related to the investment in Alibaba Group.
The accompanying notes are an integral part of these condensed consolidated financial statements.
Note 1 THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The Company. Yahoo! Inc., together with its consolidated subsidiaries (Yahoo or the Company), is focused on making the worlds daily habits inspiring and entertaining. By creating highly personalized experiences for its users, the Company keeps people connected to what matters most to them, across devices and around the world. The Company creates value for advertisers by connecting them with the audiences that build their businesses. For advertisers, the opportunity to be a part of users daily 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 Companys online properties and services (Yahoo Properties) or through a distribution network of third-party entities (Affiliates) who integrate the Companys advertising offerings into their Websites or other offerings (Affiliate sites and, together with Yahoo Properties, the Yahoo Network). 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 significant intercompany accounts and transactions have been eliminated. Investments in entities in which the Company can exercise significant influence, but does not own a majority equity interest or otherwise control, are accounted for using the equity method and are included as investments in equity interests on the condensed consolidated balance sheets. The Company has included the results of operations of acquired companies from the date of the acquisition. Certain prior period amounts have been reclassified to conform to the current period presentation.
The accompanying unaudited condensed consolidated interim financial statements reflect all adjustments, consisting of only normal recurring items, which, in the opinion of management, are necessary for a fair statement of the results of operations for the periods shown. The results of operations for such periods are not necessarily indicative of the results expected for the full year or for any future periods.
The preparation of consolidated financial statements in conformity with generally accepted accounting principles (GAAP) in the United States (U.S.) requires management to make estimates, judgments, and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses and the related disclosure of contingent assets and liabilities. On an ongoing basis, the Company evaluates its estimates, including those related to revenue, the useful lives of long-lived assets including property and equipment and intangible assets, investment fair values, stock-based compensation, goodwill, income taxes, contingencies, and restructuring charges. When these carrying values are not readily available from other sources, 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. 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 Companys Annual Report on Form 10-K for the year ended December 31, 2013, 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, 2013 was derived from the Companys audited financial statements for the year ended December 31, 2013, 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.
Recent Accounting Pronouncements
In April 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standard Update (ASU) 2014-08, Reporting of Discontinued Operations and Disclosures of Disposals of Components of an Entity, which provides a narrower definition of discontinued operations than under existing U.S. GAAP. ASU 2014-08 requires that only a disposal of a component of an entity, or a group of components of an entity, that represents a strategic shift that has, or will have, a major effect on the reporting entitys operations and financial results should be reported in the financial statements as discontinued operations. ASU 2014-08 also provides guidance on the financial statement presentations and disclosures of discontinued operations. The amendments in ASU 2014-08 are effective for all disposals of components of an entity that occur within annual periods beginning on or after December 15, 2014, and interim periods within annual periods beginning on or after December 15, 2015, with early application permitted. The Company does not anticipate that this adoption will have a significant impact on its financial position, results of operations, or cash flows.
In May 2014, the FASB issued 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. The amendments in ASU 2014-09 are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, with early application not permitted. The Company is currently evaluating the effects, if any, that the adoption of this guidance will have on the Companys financial position, results of operations and cash flows.
In August 2014, the FASB issued ASU 2014-15, Disclosure of Uncertainties about an Entitys Ability to Continue as a Going Concern, which provides guidance around managements responsibility to evaluate whether there is substantial doubt about an entitys ability to continue as a going concern and to provide related footnote disclosures. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted. The adoption of this standard is not expected to have a material impact on the Companys financial statements.
Note 2 MARKETABLE SECURITIES AND INVESTMENTS
The following tables summarize the available-for-sale marketable securities (in thousands):
Short-term, highly liquid investments of $1.5 billion and $9.7 billion as of December 31, 2013 and September 30, 2014, 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 immaterial as the carrying value approximates fair value because of the short maturity of those instruments. Realized gains and losses from sales of available-for-sale marketable securities were not material for the three and nine months ended September 30, 2013, and 2014, excluding the pre-tax gain of $10.3 billion from the sale of Alibaba Group ADSs.
The contractual maturities of available-for-sale marketable debt securities were as follows (in thousands):
The following tables show all available-for-sale marketable 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):
The Companys investment portfolio consists of Alibaba Group equity securities, liquid high-quality fixed income government, agency and corporate debt securities, money market funds, and time deposits with financial institutions. The change in the classification of the Companys investment in Alibaba Group from an equity method investment to an available-for-sale marketable 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: macro-economic, regulatory, industry, company performance, and systemic risks of the equity markets overall. Consequently, the carrying value of our investment portfolio will vary over time as the value of our investment in Alibaba Group 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. Investments are reviewed periodically to identify possible other-than-temporary impairment. The Company has no current requirement or intent to sell the securities in an unrealized loss position. The Company expects to recover up to (or beyond) the initial cost of investment for securities held.
The following table sets forth the financial assets and liabilities, measured at fair value, by level within the fair value hierarchy as of December 31, 2013 (in thousands):
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, 2014 (in thousands):
The amount of cash and cash equivalents as of December 31, 2013 and September 30, 2014 included $569 million and $611 million, respectively, in cash deposits.
The fair values of the Companys Level 1 financial assets and liabilities are based on quoted market prices of the identical underlying security. The fair values of the Companys Level 2 financial assets and liabilities are obtained using quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets in markets that are not active; and inputs other than quoted prices (e.g., interest rates and yield curves). The Company utilizes a pricing service to assist in obtaining fair value pricing for the majority of the investment portfolio.
Activity between Levels of the Fair Value Hierarchy
During the year ended December 31, 2013 and the nine months ended September 30, 2014, the Company did not make any transfers between Level 1 and Level 2 assets or liabilities.
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 December 31, 2013 and September 30, 2014 was $1.1 billion and $1.2 billion, respectively. 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.
Investments in Privately-Held Companies
The Company holds approximately $95 million in investments in privately-held companies that are included within other long-term assets on the condensed consolidated balance sheets. Such investments are held at cost and fair value measurements are not applied. These 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):
Noncontrolling interests were as follows (in thousands):
Other Income, Net
Other income, net was as follows (in thousands):
Interest, dividend and investment income consists of income earned from cash in bank accounts, investments made in marketable debt securities and money market funds, and dividend income on the Alibaba Group Preference Shares.
Interest expense is related to the Notes and capital lease obligations for buildings and data centers.
The Company recorded a pre-tax gain of approximately $10.3 billion in the three and nine months ended September 30, 2014 related to the sale of Alibaba Group ADSs. See Note 8 Investments in Equity Interests for additional information.
Other income (expense), net consists of gains and losses from sales or impairments of marketable securities and/or investments in privately-held companies, foreign exchange gains and losses due to re-measurement of monetary assets and liabilities denominated in non-functional currencies, 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, 2013 and September 30, 2014 were as follows (in thousands):
Reclassifications out of accumulated other comprehensive income for the nine months ended September 30, 2013 and September 30, 2014 were as follows (in thousands):
Note 4 ACQUISITIONS AND DISPOSITIONS
Transactions completed in 2013
Tumblr. On June 19, 2013, the Company completed the acquisition of Tumblr, Inc. (Tumblr), a blog-hosting Website that allows users to post their own content as well as follow or re-blog posts made by other users. The acquisition of Tumblr brought a community of new users to the Yahoo Network.
The purchase price exceeded the fair value of the net tangible and identifiable intangible assets acquired and, as a result, the Company recorded goodwill in connection with this transaction. Under the terms of the agreement, the Company acquired all of the equity interests (including all outstanding vested options) in Tumblr. Tumblr stockholders and vested optionholders were paid in cash, outstanding Tumblr unvested options and restricted stock units were assumed and converted into equivalent awards for Yahoo common stock, and a portion of the Tumblr shares held by its founder were exchanged for Yahoo common stock.
The total purchase price of approximately $990 million consisted mainly of cash consideration. The allocation of the purchase price of the assets acquired and liabilities assumed based on their fair values was as follows (in thousands):
In connection with the acquisition, the Company is recognizing stock-based compensation expense of $70 million over a period of up to four years. This amount is comprised of assumed unvested stock options and restricted stock units (which had an aggregate fair value of $29 million at the acquisition date), and Yahoo common stock issued to Tumblrs founder (which had a fair value of $41 million at the acquisition date). The Yahoo common stock issued to Tumblrs founder is subject to holdback and will be released over four years provided he remains an employee of the Company. In addition, the transaction resulted in cash consideration of $40 million to be paid to Tumblrs founder over four years, also provided that he remains an employee of the Company. Such cash payments are being recognized as compensation expense over the four-year service period.
The amortizable intangible assets have useful lives not exceeding six years and a weighted average useful life of six years. No amounts have been allocated to in-process research and development and $749 million has been allocated to goodwill. Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired and is not deductible for tax purposes. This acquisition brings a community of new users to the Yahoo Network by deploying Yahoos personalization technology and search infrastructure to deliver relevant content to the Tumblr user base.
Other Acquisitions Business Combinations. During the nine months ended September 30, 2013, the Company acquired 17 other companies, which were accounted for as business combinations. The total aggregate purchase price for these other acquisitions was $218 million. The total cash consideration of $218 million less cash acquired of $2 million resulted in a net cash outlay of $216 million. The allocation of the purchase price of the assets and liabilities assumed based on their estimated fair values was $77 million to amortizable intangible assets, $2 million to cash acquired, $42 million to other tangible assets, $28 million to assumed liabilities, and the remainder of $125 million to goodwill.
The Companys business combinations completed during the nine months ended September 30, 2013 did not have a material impact on the Companys condensed consolidated revenue or net income, and therefore pro forma disclosures have not been presented.
Transactions completed in 2014
Flurry. 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 is expected to create more personalized and inspiring app experiences for users and enable more effective mobile advertising solutions for brands seeking to reach their audiences and gain cross-device insights.
The purchase price of $270 million exceeded the estimated fair value of the net tangible and identifiable intangible assets and liabilities acquired and, as a result, the Company recorded goodwill of $194 million in connection with this transaction. Under the terms of the agreement, the Company acquired all of the equity interests (including all outstanding vested options) in Flurry and Flurry stockholders and vested option holders were paid in cash. 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.
The total purchase price of approximately $270 million consisted of cash consideration. 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):
In connection with the acquisition, the Company issued restricted stock units valued at $23 million, which is being recognized as stock-based compensation expense as the restricted stock units vest over four years.
The amortizable intangible assets have useful lives not exceeding five years and a weighted average useful life of five years. No amounts have been allocated to in-process research and development and $194 million has been allocated 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. Of the goodwill amount, $146 million was recorded in the Americas segment, $12 million in the EMEA segment and $36 million in the Asia Pacific segment.
Other Acquisitions Business Combinations. During the nine months ended September 30, 2014, the Company acquired 8 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 preliminary purchase price allocation of the assets acquired and liabilities assumed based on their estimated fair values was $37 million allocated to goodwill, $17 million to amortizable intangible assets, $4 million to cash acquired, $9 million to other tangible assets, and $7 million to assumed liabilities.
The Companys business combinations completed during the nine months ended September 30, 2014 did not have a material impact on the Companys condensed consolidated revenue or net income, and therefore pro forma disclosures have not been presented.
Patent Sale and License Agreement
During the second quarter of 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 to 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 second quarter of 2014 and recognized the remaining $1 million gain on the Sold Patents during the third quarter of 2014. 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. The amounts allocated to the license of the Existing Patents is recorded as revenue over the four year payment period under the license when payments are due. The amounts allocated to the Capture Period Patents is recorded as revenue over the five year capture period.
Note 5 GOODWILL
The Companys goodwill balance was $4.7 billion as of December 31, 2013, of which $3.8 billion was recorded in the Americas segment, $0.6 billion was recorded in the EMEA segment, and $0.3 billion was recorded in the Asia Pacific segment. As of September 30, 2014, the Companys goodwill balance was $4.9 billion, of which $4.0 billion was recorded in the Americas segment, $0.5 billion was recorded in the EMEA segment, and $0.4 billion was recorded in the Asia Pacific segment. The increase in the carrying amount of goodwill of $181 million during the nine months ended September 30, 2014 was primarily due to foreign currency translation losses of $34 million, additions to goodwill of $231 million related to acquisitions, and $16 million related to adjustments made to prior year acquisitions.
Note 6 INTANGIBLE ASSETS, NET
The following table summarizes the Companys intangible assets, net (in thousands):
For the three months ended September 30, 2013 and 2014, the Company recognized amortization expense for intangible assets of $31 million and $32 million, respectively, including $16 million and $17 million in cost of revenue other for the three months ended September 30, 2013 and 2014, respectively. For the nine months ended September 30, 2013 and 2014, the Company recognized amortization expense for intangible assets of $68 million and $97 million, respectively, including $38 million and $48 million in cost of revenue other for the nine months ended September 30, 2013 and 2014, respectively. Based on the current amount of intangibles subject to amortization, the estimated amortization expense for the remainder of 2014 and each of the succeeding years is as follows: three months ending December 31, 2014: $30 million; 2015: $104 million; 2016: $78 million; 2017: $70 million; and thereafter $97 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 1996 Directors Stock Plan (the Directors Plan)). Diluted net income per share is computed using the weighted average number of common shares and, if dilutive, potential common shares outstanding during the period. Potential common shares are calculated using the treasury stock method and consist of unvested restricted stock and shares underlying unvested restricted stock units, the incremental common shares issuable upon the exercise of stock options, and shares to be purchased under the 1996 Employee Stock Purchase Plan (the Employee Stock Purchase Plan). The Company calculates potential tax windfalls and shortfalls by including the impact of pro forma deferred tax assets.
The Company takes into account the effect on consolidated net income per share of dilutive securities of entities in which the Company holds equity interests that are accounted for using the equity method.
Potentially dilutive securities representing approximately 4 million and 12 million shares of common stock for the three and nine months ended September 30, 2013, respectively, and 1 million and 3 million shares of common stock for the three and nine months ended September 30, 2014, respectively, were excluded from the computation of diluted earnings per share for these periods because their effect would have been anti-dilutive.
The following table sets forth the computation of basic and diluted net income per share (in thousands, except per share amounts):
Note 8 INVESTMENTS IN EQUITY INTERESTS
The following table summarizes the Companys investments in equity interests as of December 31, 2013 (dollars in thousands):
The following table summarizes the Companys investments in equity interests as of September 30, 2014 (dollars in thousands):
Alibaba Group IPO. On September 24, 2014, Alibaba Group closed its initial public offering (IPO) of American Depositary Shares (ADSs). Each Alibaba Group ADS represents one ordinary share of Alibaba Group. Yahoo! Hong Kong Holdings Limited (YHK), a wholly owned subsidiary of the Company, sold 140,000,000 Alibaba Group ADSs in the IPO at an initial public offering price of $68.00 per ADS. The Company received $9.4 billion (net of underwriting discounts, commissions, and fees of approximately $115 million) in cash for the 140 million Alibaba Group ADSs sold. The Company recorded a pre-tax gain of $10.3 billion (including a $1.3 billion gain reflecting the Companys proportionate share of the IPO proceeds from the IPO) for the three months ended September 30, 2014, which is included in other income, net on the condensed consolidated statements of income. The after-tax gain was approximately $6.3 billion. Following completion of the sale in the IPO, the Company retained 383,565,416 Alibaba Group ordinary shares, representing approximately 15 percent of Alibaba Groups outstanding ordinary shares.
As a result of the IPO, the Company no longer accounts for its remaining investment in Alibaba Group using the equity method and will no longer record its proportionate share of Alibaba Groups financial results in the condensed consolidated financial statements. The Company reflects its remaining investment in Alibaba Group as an available-for-sale equity security on the condensed consolidated balance sheet and adjusts the investment to fair value each quarterly reporting period with changes in fair value recorded within other comprehensive income (loss), net of tax. Also, in connection with the IPO, each of Yahoo and YHK entered into a lock-up agreement with the underwriters restricting the sale of its remaining ordinary shares of Alibaba Group (Alibaba Group shares) for a period of one year, subject to certain exceptions.
In connection with the IPO, Yahoo entered into a voting agreement with Alibaba Group, Jack Ma, Joe Tsai, SoftBank Corp. and certain other shareholders of Alibaba Group, pursuant to which Yahoo agreed to certain voting arrangements with respect to all of its Alibaba Group shares, including an agreement to vote for the director nominee of SoftBank Corp. and the director nominees of the Alibaba Partnership (a partnership comprised of members of management of Alibaba Group, one of its affiliates and/or certain companies with which Alibaba Group has a significant relationship). Yahoo also granted a proxy to Jack Ma and Joe Tsai, Alibaba Groups executive chairman and executive vice chairman, respectively, to vote, subject to certain exceptions, 121.5 million of the Companys Alibaba Group shares or, if less, the remaining Alibaba Group shares then owned by the Company.
See Note 2 Marketable Securities and Investments for additional information.
Initial Repurchase by Alibaba Group. On September 18, 2012 (the Repurchase Closing Date), Alibaba Group repurchased 523 million of the 1,047 million Alibaba Group shares owned by the Company. The repurchase was made pursuant to the terms of the Share Repurchase and Preference Share Sale Agreement entered into by Yahoo! Inc., Alibaba Group and YHK, on May 20, 2012 (as amended on September 11, 2012, October 14, 2013 and July 14, 2014). Yahoo received $13.54 per Alibaba Group share, or approximately $7.1 billion in total consideration, for the 523 million Alibaba Group shares sold to Alibaba Group. Approximately $6.3 billion of the consideration was received in cash and $800 million was received in Alibaba Group Preference Shares, which Alibaba Group redeemed on May 16, 2013. During the six months ended June 30, 2013, the Company received cash dividends from Alibaba Group of $58 million related to the Alibaba Group Preference Shares. The Company recorded a pre-tax gain of approximately $4.6 billion for the year ended December 31, 2012.
Technology and Intellectual Property License Agreement (the TIPLA). On the Repurchase Closing Date, the Company and Alibaba Group entered into an amendment of the existing TIPLA pursuant to which Alibaba Group made an initial payment to the Company of $550 million in satisfaction of certain future royalty payments under the existing TIPLA. As a result of the IPO, the TIPLA will terminate on September 18, 2015 and Alibaba Groups obligation to make royalty payments under the TIPLA ceased on September 24, 2014. The royalty revenue recognized was approximately $27 million and $37 million for the three months ended September 30, 2013 and 2014, respectively, and approximately $83 million and $100 million for the nine months ended September 30, 2013 and 2014, respectively. The remaining initial TIPLA deferred revenue of $268 million is now being recognized ratably over the remaining term of the TIPLA, through September 18, 2015. For the three months ended September 30, 2013 and 2014, the Company recognized approximately $34 million and $37 million, respectively, of this deferred revenue. For the nine months ended September 30, 2013 and 2014, the Company recognized approximately $103 million and $105 million, respectively, of this deferred revenue.
The following table presents Alibaba Groups U.S. GAAP financial information, as derived from the Alibaba Group financial statements (in thousands):
The investment in Yahoo Japan Corporation (Yahoo Japan) is being accounted for using the equity method and the total investment, including net tangible assets, identifiable intangible assets, and goodwill, is classified as part of the investments in equity interests balance on the Companys condensed consolidated balance sheets. The Company records its share of the results of Yahoo Japan, and any related amortization expense, one quarter in arrears within earnings in equity interests in the condensed consolidated statements of income.
The Company makes adjustments to the earnings in equity interests line in the condensed consolidated statements of income for any differences between U.S. GAAP and International Financial Reporting Standards (IFRS), the standards by which Yahoo Japans financial statements are prepared.
The fair value of the Companys ownership interest in the common stock of Yahoo Japan, based on the quoted stock price, was approximately $8 billion as of September 30, 2014.
During the nine months ended September 30, 2013 and 2014, the Company received cash dividends from Yahoo Japan in the amount of $77 million and $84 million, net of withholding taxes, respectively, which were recorded as reductions to the Companys 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 within general and administrative operating expenses.
The following tables present summarized financial information derived from Yahoo Japans 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. Due to these adjustments, the Yahoo Japan summarized financial information presented below is not materially different than such information presented on the basis of U.S. GAAP.
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 $65 million and $66 million for the three months ended September 30, 2013 and 2014, respectively, and approximately $199 million and $197 million for the nine months ended September 30, 2013 and 2014, respectively. As of both December 31, 2013 and September 30, 2014, the Company had net receivable balances from Yahoo Japan of approximately $42 million.
Note 9 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 liabilities included in accrued expenses and other current liabilities or capital lease and other long-term liabilities. The Companys 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 income when the underlying hedged revenue is recognized. Any ineffective portions of net investment hedges and cash flow hedges are recorded in other income, net on the Companys condensed consolidated statements of income. For balance sheet hedges, changes in the fair value are recorded in other income, net on the Companys condensed consolidated statements of income.
The Company enters into master netting arrangements, which are designed to reduce credit risk by permitting net settlement of transactions with the same counterparty. The Company presents its derivative assets and liabilities at their gross fair values on the condensed consolidated balance sheets. However, under the master netting arrangements with the respective counterparties of the foreign exchange contracts, subject to applicable requirements, the Company is allowed to net settle transactions. 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 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, 2013 and September 30, 2014. 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, 2014. The cash flow hedges were considered to be effective as of December 31, 2013 and September 30, 2014. The Company expects all of the forward contracts designated as cash flow hedges to be reclassified to revenue within fiscal year 2014, as it expects to recognize the hedged forecasted revenue related to these contracts by December 31, 2014.
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 Companys outstanding forward contracts as of December 31, 2013 and September 30, 2014 (in millions) were as follows:
Foreign currency forward contracts activity for the nine months ended September 30, 2013 was as follows (in millions):
Foreign currency forward contracts activity for the nine months ended September 30, 2014 was as follows (in millions):
Foreign currency forward contracts balance sheet location and ending fair value was as follows (in millions):
Note 10 CREDIT AGREEMENT
The Companys credit agreement (the Credit Agreement) with Citibank, N.A. was scheduled to terminate on October 9, 2014. The Credit Agreement, as amended, provides for a $750 million unsecured revolving credit facility, subject to increase of up to $250 million in accordance with its terms. As of September 30, 2014, the Company was in compliance with the financial covenants in the Credit Agreement and no amounts were outstanding. See Note 18 Subsequent Events for additional information regarding an amendment to the Credit Agreement to extend its existing term.
Note 11 CONVERTIBLE NOTES
0.00% Convertible Senior Notes
As of September 30, 2014, 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 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 Yahoos common stock, or a combination thereof, at Yahoos election. The Companys 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 in respect to the remainder of its conversion obligation in excess of the aggregate principal amount (conversion spread). As of September 30, 2014, none of the conditions allowing holders of the Notes to convert had been met.
The Notes consist of the following (in thousands):
The following table sets forth total interest expense recognized related to the Notes for the three and nine months ended September 30, 2013 and 2014 (in thousands):
The fair value of the Notes, which was determined based on inputs that are observable in the market (Level 2), and the carrying value of debt instruments (the carrying value excludes the equity component of the Notes classified in equity) was as follows (in thousands):
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 12 years which expire between 2014 and 2025.
A summary of gross and net lease commitments as of September 30, 2014 was as follows (in millions):
Affiliate Commitments. The Company is obligated to make payments, which represent traffic acquisition costs (TAC), to its Affiliates. As of September 30, 2014, these commitments totaled $218 million, of which $29 million will be payable in the remainder of 2014, $138 million will be payable in 2015, $26 million will be payable in 2016, and $25 million will be payable in 2017.
Intellectual Property Rights. The Company is committed to make certain payments under various intellectual property arrangements of up to $20 million through 2023.
Other Commitments. In the ordinary course of business, the Company may provide indemnifications of varying scope and terms to customers, vendors, lessors, joint ventures and business partners, purchasers of assets or subsidiaries, and other parties with respect to certain matters, including, but not limited to, losses arising out of the Companys 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 Companys 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 Companys condensed consolidated financial statements.
As of September 30, 2014, 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.
See Note 17 Search Agreement with Microsoft Corporation for a description of the Companys Search and Advertising Services and Sales Agreement (the Search Agreement) and License Agreement with Microsoft Corporation (Microsoft).
Intellectual Property and General Matters. From time to time, third parties assert patent infringement claims against the Company. Currently, the Company is engaged in lawsuits regarding patent issues and has been notified of other potential patent disputes. In addition, from time to time, the Company is subject to other legal proceedings and claims in the ordinary course of business, including claims of alleged infringement of trademarks, copyrights, trade secrets, and other intellectual property rights, claims related to employment matters, and a variety of other claims, including claims alleging defamation, invasion of privacy, or similar claims arising in connection with the Companys e-mail, message boards, photo and video sites, auction sites, shopping services, and other communications and community features.
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 Groups restructuring of its subsidiary Alipay.com Co., Ltd. (Alipay) and related disclosures. On June 7, 2012, the courts approved stipulations staying the California Derivative Litigation pending resolution of the Federal Derivative Litigation, and deferring the Federal Derivative Litigation pending a ruling on the motion to dismiss filed by the defendants in the related stockholder class actions, which are discussed below. On December 16, 2013, the U.S. District Court for the Northern District of California granted the Companys motion to stay the Federal Derivative Litigation pending resolution of the appeal filed by the plaintiffs in the related stockholder class actions.
Since June 6, 2011, two purported stockholder class actions were filed in the 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 purports to represent a class of investors who purchased the Companys common stock between April 19, 2011 and July 29, 2011, and alleges that during that class period, defendants issued statements that were materially false or misleading because they did not disclose information relating to Alibaba Groups restructuring of Alipay. The complaint purports 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 seeks unspecified damages, injunctive and equitable relief, fees, and costs. On August 10, 2012, the court granted defendants motion to dismiss the consolidated amended complaint. Plaintiffs have appealed.
On March 14, 2014, a stockholder derivative action captioned Hughes Trust v. de Castro, et al. was filed in the Delaware Court of Chancery purportedly on behalf of Yahoo against current and former members of the Board and our former chief operating officer, Henrique de Castro. The plaintiff alleges that the directors who approved Mr. de Castros employment agreement in 2012 wasted corporate assets and breached their fiduciary duties by failing to adequately inform themselves about how much compensation Mr. de Castro would be entitled to receive. The plaintiff further alleges that the directors failed to provide adequate disclosure regarding Mr. de Castros compensation. The plaintiff asserts a claim against Mr. de Castro for unjust enrichment. Plaintiff seeks unspecified damages and restitution in favor of Yahoo, an order directing Yahoo to reform its corporate governance and internal procedures, and attorneys fees and costs. The Company intends to file 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. The judgment was issued by a law clerk to the trial court judge who presided over the entire case during the trial court proceedings but stepped down from his position shortly before the judgment was entered.
On December 12, 2012 and December 13, 2012, respectively, Yahoo! Mexico and the Company appealed the judgment to a three-magistrate panel of the Superior Court of Justice for the Federal District (the Superior Court). On May 15, 2013, the Superior Court reversed the judgment, overturned all monetary awards against the Company and reduced the monetary award against Yahoo! Mexico to $172,500. The Superior Court affirmed the award of $2.6 million in favor of Yahoo! Mexico on its counterclaim.
Plaintiffs have appealed the Superior Courts decision to the Mexican Federal Civil Collegiate Court for the First Circuit (Civil Collegiate Court). The Company has appealed the Superior Courts decision not to award it statutory costs in the underlying proceeding. Yahoo! Mexico has appealed the Superior Courts award of $172,500, the Superior Courts decision not to award it additional moneys beyond the $2.6 million award on its counterclaims, and the Superior Courts decision not to award it statutory costs. In the pending appeals, review is limited to whether the Superior Courts decision is unconstitutional, unlawful, or both.
The Company believes the plaintiffs claims are without merit. First, the plaintiffs claims are based on agreements that were either terminated by agreement with releases or had expired or terminated in accordance with their terms, a non-binding letter of intent pursuant to which no definitive agreements were ever entered into by the parties, and correspondence that did not constitute agreements. Second, the loss of profits of the type claimed by plaintiffs are not awardable under Mexico law because they were not a direct and immediate consequence of a breach of contract. Of the $2.75 billion in total damages alleged by plaintiffs, more than $2.4 billion were for loss of profits. Third, the plaintiffs alleged damages and loss of profits were further precluded by the agreements at issue through, among other things, contractual and legal limitations of liability. Fourth, the plaintiffs pleadings in the complaint, as well as documentary evidence filed by the plaintiffs in support of their allegations, were generally deficient to support or establish plaintiffs claims. Fifth, the decision failed to consider substantially all of the defenses asserted by the Company and Yahoo! Mexico. Finally, the Company believes that the law clerk who entered the judgment lacked the requisite authority to issue the judgment. The Company has not recorded an accrual for the judgment, which was reversed, as explained above. On September 10, 2014, the plaintiffs in the Mexico litigation 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 (which is still pending on appeal). 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. The complaint seeks unspecified damages. The Company believes the plaintiffs claims in this action are also 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 Companys legal proceedings, including the matters described above other than the Mexico matters, would not have a material adverse effect on the Companys consolidated financial position, results of operations or cash flows. Amounts accrued as of December 31, 2013 and September 30, 2014 were not material. The ultimate outcome of legal proceedings involves judgments, estimates and inherent uncertainties, and cannot be predicted with certainty. In the event of a determination adverse to Yahoo, its subsidiaries, directors, or officers in these matters, the Company may incur substantial monetary liability, and be required to change its business practices. Either of these events could have a material adverse effect on the Companys 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
Employee Stock Purchase Plan. As of September 30, 2014, there was $1 million of unamortized stock-based compensation expense related to the Companys Employee Stock Purchase Plan, which will be recognized over a weighted average period of 0.1 years.
Stock Options. The Companys 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 the holdback by Yahoo of shares of Yahoo common stock issued to Tumblrs founder in connection with the Companys acquisition of Tumblr in June 2013) are collectively referred to as the Plans. Stock option activity under the Companys Plans for the nine months ended September 30, 2014 is summarized as follows (in thousands, except per share amounts):
As of September 30, 2014, there was $16 million of unamortized stock-based compensation expense related to unvested stock options, which is expected to be recognized over a weighted average period of 0.7 years.
The fair value of option grants is determined using the Black-Scholes option pricing model with the following weighted average assumptions:
Restricted Stock and Restricted Stock Units. Restricted stock and restricted stock unit activity under the Plans for the nine months ended September 30, 2014 is summarized as follows (in thousands, except per share amounts):
As of September 30, 2014, there was $742 million of unamortized stock-based compensation expense related to unvested restricted stock and restricted stock units, which is expected to be recognized over a weighted average period of 2.6 years.
During the nine months ended September 30, 2013 and 2014, 11.8 million shares and 16.0 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, 2013 and 2014, the Company withheld 4.3 million shares and 6.0 million shares, respectively, based upon the Companys closing stock price on the vesting date, to satisfy the Companys 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 $106 million and $226 million, respectively, for the nine months ended September 30, 2013 and 2014, and are reflected as a financing activity within the condensed consolidated statements of cash flows. The payments were used for tax withholdings related to the net share settlements of restricted stock units and tax withholding related to the reacquisition of shares of restricted stock. The payments had the effect of share repurchases by the Company as they reduced the number of shares that would have otherwise been issued on the vesting date and were recorded as a reduction of additional paid-in capital.
Performance-Based Executive Incentive Equity Awards.
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 executives award agreement based on the Companys 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 February 2014, the Compensation and Leadership Development Committee of the Board (the Compensation Committee) established performance goals under these stock options for the 2014 performance year. The 2014 financial performance metrics (and their weightings) under the performance stock options are GAAP revenue (70 percent) and adjusted EBITDA (30 percent). The grant date fair value of the 2014 tranche of the November 2012 financial performance stock options was $38 million, and is being recognized over the twelve-month service period. The Company began recording stock-based compensation expense for this tranche in February 2014, when the financial performance goals were established.
Performance RSUs. In February 2014, the Compensation Committee approved additional annual financial performance-based restricted stock unit (RSU) awards to Ms. Mayer and other senior officers, and established the 2014 annual performance goals for these awards as well as for the similar performance-based RSUs granted in February 2013. The 2013 and 2014 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 Companys attainment of annual financial performance goals as well as the executives 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 Companys 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 years performance goal is treated as a separate annual grant for accounting purposes. The 2014 financial performance metrics (and their weightings) established for the performance RSUs are: GAAP revenue (70 percent) and adjusted EBITDA (30 percent). The grant date fair value of the first tranche of the February 2014 performance RSUs was $9 million, and the grant date fair value of the second tranche of the February 2013 performance RSUs was $17 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 February 2014, when the financial performance goals were established.
Stock Repurchases. In May 2012, the Board authorized a stock repurchase program allowing the Company to repurchase up to $5 billion of its outstanding shares of common stock from time to time. That repurchase program was exhausted during the first quarter of 2014. In November 2013, the Board authorized an additional 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 remaining under the November 2013 repurchase authorization was approximately $2.5 billion at September 30, 2014. Repurchases under the repurchase program may take place in the open market or in privately negotiated transactions, including structured and derivative transactions such as accelerated share repurchase transactions, and may be made under a Rule 10b5-1 plan.
In September 2014, the Company entered into an accelerated share repurchase agreement (ASR) with a financial institution to repurchase shares of its common stock. Under the agreement, the Company prepaid $1.1 billion and approximately 15 million shares were initially delivered to the Company on September 30, 2014 and are included in treasury stock. Final settlement occurred on October 17, 2014, resulting in a total of approximately 23.5 million shares, inclusive of shares initially delivered, repurchased for $933 million. The Company received a return of cash for the remaining amount not settled in shares of $167 million. This ASR was entered into pursuant to the Companys existing share repurchase program.
The Company accounted for the September 2014 ASR as two separate transactions: (i) approximately 15 million shares of common stock initially delivered to the Company, and $600 million was accounted for as a treasury stock transaction and (ii) the unsettled contract of $500 million was determined to be a forward contract indexed to the Companys own common stock. The initial delivery of approximately 15 million shares resulted in an immediate reduction, on the delivery date, of the outstanding shares used to calculate the weighted-average common shares outstanding for basic and diluted net income per share. The Company has determined that the forward contract, indexed to its common stock, met all of the applicable criteria for equity classification.
The Company recorded $600 million as treasury stock and recorded $500 million, the implied value of the forward contract, in additional paid-in capital on the condensed consolidated balance sheets as of September 30, 2014. As the remainder of the shares are delivered to the Company, in the fourth quarter of 2014, the forward contract will be reclassified from additional paid-in capital to treasury stock and the final number of shares to be repurchased will be based on Yahoos volume-weighted average stock price during the term of the transaction, less a discount. See Note 18 Subsequent Events for additional information regarding the final settlement of this ASR.
In addition to the repurchase under this ASR, during the nine months ended September 30, 2014, the Company repurchased approximately 40 million shares of its common stock under its stock repurchase program at an average price of $36.09 per share for a total of approximately $1.5 billion.
Note 14 RESTRUCTURING (REVERSALS) CHARGES, NET
Restructuring (reversals) charges, net was comprised of the following (in thousands):
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, 2013, the Company recorded expense of $2 million related to the Americas segment, and reversals of $2 million and $1 million related to the EMEA and Asia Pacific segments, respectively. For the three months ended September 30, 2014, the Company recorded expense of $4 million, $1 million, and $3 million related to Americas, EMEA, and Asia Pacific segments, respectively. For the nine months ended September 30, 2013, the Company recorded reversals of $3 million and $1 million related to the 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. The amounts recorded during the nine months ended September 30, 2014 were primarily related to the consolidation of a data center as the Company ceased use of that facility pursuant to a restructuring plan initiated by the Company in 2011.
The Companys restructuring accrual activity for the nine months ended September 30, 2014 is summarized as follows (in thousands):
The $75 million restructuring liability as of September 30, 2014 consists of $4 million for employee severance expenses, which the Company expects to pay out by the end of the fourth quarter of 2014, and $71 million related to non-cancelable lease costs, which the Company expects to pay over the terms of the related obligations through the fourth quarter of 2021, less estimated sublease income.
Restructuring accruals by segment consisted of the following (in thousands):
Note 15 INCOME TAXES
The Companys effective tax rate is the result of the mix of income earned in various tax jurisdictions that apply a broad range of income tax rates. Historically, the Companys 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 effective tax rate reported for the three months ended September 30, 2014 was 38 percent compared to 32 percent for the same period in 2013. The effective tax rate reported for the nine months ended September 30, 2014 was 38 percent compared to 24 percent for the same period in 2013. The effective tax rates for the three and nine months ended September 30, 2014 included current and deferred tax expense of $4.0 billion associated with the Companys taxable gain from the sale of 140 million Alibaba Group ADSs in the IPO in September 2014. The lower effective tax rates for the three and nine months ended September 30, 2013 were related to a reduction of tax reserves that were recorded as tax audits were favorably settled and a tax benefit from the resolution of certain tax matters associated with a one-time foreign earnings distribution made in 2012.
As of September 30, 2014, the Company does not anticipate repatriating its undistributed foreign earnings of approximately $2.9 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 Companys gross amount of unrecognized tax benefits as of September 30, 2014 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, 2014 increased by $360 million from the recorded balance as of December 31, 2013 primarily related to tax reserves associated with the sale of the Alibaba Group ADSs and foreign tax credits. The Company believes that it has adequately provided for any reasonably foreseeable adjustments and that any settlement will not have a material adverse effect on the Companys consolidated financial position, results of operations, or cash flows.
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 2012. The IRS Appeals division is currently finalizing the Companys protest of the 2007 and 2008 audit results, while the IRS exam team is finalizing the examination of the Companys 2009 and 2010 U.S. federal income tax returns. The Company has protested the proposed California Franchise Tax Boards adjustments to the 2005 and 2006 returns, but no conclusions have been reached to date. The 2007 and 2008 California tax returns have been examined without any significant adjustment to the Companys financial statement positions. While it is difficult to determine when the examinations will be settled or their final outcomes, certain audits in various jurisdictions related to multinational income tax issues are expected to be resolved in the foreseeable future. As a result, it is reasonably possible that the Companys unrecognized tax benefits could be reduced by up to approximately $80 million in the next twelve months.
The Company accrued deferred tax liabilities of $13.8 billion associated with the Alibaba Group shares that it retained. Such deferred tax liabilities will be subject to periodic adjustments to reflect changes in the fair market value of Alibaba Group shares.
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 IPO that took place during the three months ended September 30, 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 with respect to the sale in 2012. Any taxes assessed and paid in China are expected to be ultimately offset and recovered in the U.S. with respect to the sale in 2014 through the use of foreign tax credits to the extent there is sufficient foreign source income.
During the year ended December 31, 2012, tax authorities from the Brazilian State of Sao Paulo assessed certain indirect taxes against the Companys Brazilian subsidiary, Yahoo! do Brasil Internet Ltda., related to online advertising services. The assessment totaling approximately $85 million is for calendar years 2008 and 2009. The Company currently believes the assessment is without merit. The Company 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 ex-TAC, which is defined as revenue less TAC, direct costs excluding TAC by segment, and consolidated income from operations for making decisions related to the evaluation of the financial performance of, and allocating resources to, the Companys segments.
The following tables present summarized information by segment (in thousands):