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October 19, 2011
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Revenue
Yahoo reported GAAP revenue of $1.22 billion, which was down 1.0% sequentially and 24.0% year over year. TAC costs declined 5.2% sequentially and 69.6% from last year. Excluding these costs in all periods, net revenue was flat sequentially and down 4.7% from last year, in line with consensus estimates and management’s guidance.
Yahoo combines revenue from Owned and Operated (O&O) and affiliate sites under Display and Search.
Display revenues (ex-TAC) dropped 3.7% sequentially, while increasing 0.3% from last year. Yahoo’s display issues remained limited to the U.S., while the international business was quite strong. Management stated the EMEA and Asia/Pacific regions grew 30% in the last quarter.
In North America, too, there were a few reasons for cheer (sell-through rates, display page views and guaranteed placements growing). Management attributed these positives to the streamlined sales force, which apparently did a good job. However, they did not explain why non-guaranteed placements, such as those on mail and other high-reach sites did badly.
Yahoo’s performance in display is particularly disappointing, since most market research firms are projecting strong growth here due to underlying drivers, such as brand building. Since Yahoo does not appear to be gaining from this trend the way archrival Google Inc (GOOG) appears to be gaining, it looks like the company is steadily losing market share not just to Google but emerging Internet company Facebook.
Search (ex-TAC) was up 1.0% sequentially, but declined double-digits year over year for the fourth straight quarter. Segment results were a shade better than management expectations, due to better performance at O&O sites. As expected, the revenue per search (RPS) guarantee from Microsoft Corp (MSFT) helped results. Yahoo stated that the RPS guarantee with Microsoft had been extended up to March 2012.
For the quarter, worldwide query volumes were down mid-single-digits, while RPS was up mid-single-digits. U.S. query volumes and RPS were both up slightly from the year-ago quarter. The alliance with Microsoft continues to improve ROI for advertisers, which is having a positive impact on spending.
Other (fees, listings and leads) revenues were up 3.8% sequentially and down 0.1% from last year.
Display, Search and Other platforms represented 42%, 35% and 23% of Yahoo’s third quarter revenue, respectively.
Yahoo generated around 70% of revenue on an ex-TAC basis from the Americas (down 1.9% sequentially and 11.8% from September 2010), around 9% came from the EMEA region (down 8.2% sequentially and up 14.1% year over year) and the balance from the Asia/Pacific (up 9.4% and 19.7%, respectively).
Margins
Yahoo generated a gross margin of 70.5% in the last quarter, up 67 bps sequentially and 1,299 bps year over year. Total operating expenses of $674.4 million were up 2.5% from the previous quarter and down 6.0% and year-ago quarter. S&M and G&A increased as a percentage of sales from both the previous and year-ago quarters, while cost of sales went down from both the previous and year-ago quarters.
G&A was flattish sequentially, although up significantly from the year-ago quarter. The net result was an operating margin of 15.0% that dropped 121 bps sequentially but jumped 236 bps from last year.
Net Income
Yahoo’s pro forma net income was $278.6 million or 22.9% of sales compared to $245.7 million or 20.0% of sales in the previous quarter and $215.3 million or 13.4% of sales in the year-ago quarter. Our pro forma estimate excludes restructuring charges, amortization of intangible assets and a $25.1 million gain related to dilution of ownership in Alibaba on a tax-adjusted basis.
Including these special items and the amount given out to non-controlling interests, Yahoo’s GAAP net income was $293.3 million ($0.23 per share) compared to $237.0 million ($0.18 per share) in the June 2011 quarter and net income of $396.1 million ($0.29 per share) in the September quarter of last year.
Balance Sheet
Yahoo has a solid balance sheet, with cash and short-term investments of $2.11 billion, down $438.7 million during the quarter. The company generated $356 million from operations in the last quarter and spent $123 million on capex, netting a free cash flow of around $233 million, significantly higher than $159 million in the second quarter. The company also spent $593 million on share repurchases in the last quarter. Yahoo does not have any debt.
Guidance
Yahoo expects fourth quarter 2011 revenue (ex-TAC) of $1.14 billion, or up 16.2% sequentially. TAC is expected to come in at $150-160 million and other costs at $925-975 million. This is expected to generate operating income of $200-260 million.
To Conclude
Yahoo’s revenue guidance was lower than the Zacks Consensus Estimate of $1.23 billion and we remain skeptical about management’s ability to turning the company around. While display remains Yahoo’s strength, the last quarter was a mixed bag. In the meantime, search remains dependent on Microsoft protection. Search-related issues are likely to continue for a few more quarters at least. In the meantime, we are unlikely to see very strong revenue growth.
Cost controls and efficiencies are likely to continue (Yahoo generated a solid gross margin in the last quarter). However, we expect management to continue investing in the business (particularly product development and sales), which could be a pressure on operating margins.
We believe that Yahoo will continue to benefit from an improving ad market, which coupled with a leaner cost structure will help cash flow and earnings growth. However, competitive pressures may be expected to intensify going forward.
The encouraging things here are the gains from Alibaba, the extension of the search agreement and a possible takeover by Microsoft.
The shares carry a Zacks #3 Rank (short-term Hold recommendation). We are also neutral longer term (3-6 months).
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