Yahoo Revenue Hurting Prices - Analyst Blog

Yahoo! Inc. (YHOO) reported fourth quarter earnings that beat the Zacks Consensus estimate by 6 cents. This represented a 72.8% sequential and 179.2% year-over-year increase in earnings.

Yahoo's revenue presentation is nothing short of confusing, making comparisons with prior periods extremely difficult. The company states that only revenues from markets that have transitioned to Microsoft Corp's (MSFT) platform are being reported on a net basis (ex-TAC), while other revenues are being reported on a gross basis.  

Additionally, Yahoo's revenue guidance was extremely disappointing, and share prices are sliding in the pre-market (down 2.00%).

Revenue

Yahoo reported revenue of $1.53 billion, which was down 4.8% sequentially and 11.9% year over year (at the high end of the guided range). Since Microsoft's revenue share was small, we have compared results on the assumption that the entire revenue was reported on a gross basis.

TAC costs declined 32.9% sequentially and 32.4% from last year. Excluding these costs in all periods, net revenue was up 7.2% sequentially but down 4.2% from last year.

Yahoo also changed the segment reporting structure, combining revenue from Owned and Operated (O&O) and affiliate sites under Display and Search. Since numbers for preceding quarters were not available, we could only note changes from December 2009.

Accordingly, Display revenues (ex-TAC) increased 15.9%, while search declined 18.0% from December 2009. Other (fees, listings and leads) revenues declined 15.5%. Yahoo stated that search revenue for the quarter included $32 million from the alliance program with Microsoft.

Display, Search and Other categories represented 47%, 32% and 21% of fourth quarter revenue, respectively. Display was clearly the high point and management expressed great optimism about Yahoo's position here, stating that big customers, such as Wal-Mart Stores (WMT), Macy's (M) and Toyota Motor Corp (TM) were increasingly opting for the Yahoo platform. Management assured that search innovations and the partnership with Microsoft would support strong growth by the middle of the year.

Yahoo generated around 82% of revenue on an ex-TAC basis from the Americas (up 15.9% sequentially and 2.7% from 2009), around 14% came from Europe (up 94.0% and 49.0%, respectively) and the balance from the Asia/Pacific (up 100.1% and 101.5%, respectively).

Margins

Yahoo generated a gross margin of 63.4% in the last quarter, up 595 bps sequentially and 672 bps year over year. Although total operating expenses of $702.1 million were down 2.2% and 10.1% from the previous and year-ago quarters, only product development costs increased as a percentage of sales in both comparisons.

Sales and marketing expenses declined sequentially, but increased slightly from last year as a percentage of sales. The net result was an operating margin of 17.4% that jumped 472 bps sequentially and 576 bps year over year. Clearly, Yahoo's cost-cutting efforts have paid off, driving the fourth straight quarter of significant operating margin expansion from the respective year-ago quarters.

Net Income

Yahoo's pro forma net income was $351.2 million or 23.0% of sales compared to $215.3 million or 13.4% of sales in the previous quarter and $140.6 million or 8.1% of sales in the year-ago quarter. Our pro forma estimate excludes restructuring charges and amortization of intangible assets on a tax-adjusted basis.

Including these special items and the amount given out to non-controlling interests, Yahoo's GAAP net income was $312.0 million ($0.24 per share) compared to $396.1 million ($0.29 per share) in the September 2010 quarter and a net income of $153.0 million ($0.11 per share) in the December quarter of last year.

Balance Sheet

Yahoo has a solid balance sheet, with cash and short term investments of $2.88 billion, up $64.7 million during the quarter. The company generated $403.1 million from operations in the last quarter and spent $247.4 million on capex, netting a free cash flow of around $155.7 million, down from $182.6 million in the third quarter.

The company also spent $45.0 million on acquisitions, but did not purchase any share in the last quarter. Yahoo does not have any debt.

Guidance

Management expects first quarter 2011 revenue (ex-TAC) of $1.02-1.08 billion, a 29-33% sequential decline. TAC is expected to come in at $130-150 million and other costs at $890-920 million. This is expected to generate operating income of $130-160 million.

To conclude

We are encouraged by management's efforts at turning the company around and believe cost cuts were largely responsible for the continued expansion of operating margins right through the year.

At the same time, we are concerned about the top line numbers that seem to be dropping at an alarming rate. Display is the one area showing some encouraging growth and Yahoo seems to be solidifying its position here.

However, search remains a sore point, and near-term revenues are likely to be impacted by the Microsoft deal (Microsoft is picking up 12% of net revenues in transitioned markets). We expect continued volatility in this business until the transition is completed.

We believe that Yahoo will continue to benefit from an improving ad market, which coupled with a leaner cost structure will generate earnings growth and solid cash flows. However, near-term catalysts are limited and top line numbers are disappointing.

The shares carry a Zacks #3 Rank (short-term Hold recommendation), but we think shares could take a beating. We are reiterating our longer-term Neutral recommendation, since we expect improved sentiments once the bottom line improves significantly.

 
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