Yahoo! Inc. (YHOO) reported fourth quarter non-GAAP earnings that beat the Zacks Consensus Estimate by a couple of cents. The 18.7% sequential increase and 1.9% year-over-year decline were better than what most investors were expecting. Yahoo shares did not respond much however, losing 0.89% after the company reported.
Revenue
Yahoo reported GAAP revenue of $1.32 billion, which was up 8.8% sequentially and down 13.2% year over year. TAC costs increased 7.2% sequentially but dropped 51.4% from last year. Excluding these costs in all periods, net revenue was up 9.1% sequentially and down 3.0% from last year, in line with consensus estimates and management’s guidance.
Yahoo combines revenue from O&O and affiliate sites under Display and Search.
Display revenues (ex-TAC) grew 21.4% sequentially, while declining 3.8% from last year. The sequential increase was seasonal. Yahoo attributed its weaker-than-expected revenue to macro-economic issues in Europe and guaranteed placements in the U.S. However, overall, for the year, display issues were largely limited to the U.S., while the international business (EMEA and Asia/Pacific) grew 20%.
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 arch rival 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 flat sequentially, but declined 3.1% year over year. Segment results were a shade better than management expectations, due to better performance at O&O sites (first growth in nearly four years). As expected, the RPS guarantee (stays for another quarter) from Microsoft Corp (MSFT) helped results. But even excluding this benefit, RPS strengthened, offsetting the lower query volumes.
For the quarter, worldwide query volumes were down slightly, while RPS was up mid single-digits. U.S. query volumes and RPS were both up 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 flat sequentially and down 1.0% from last year.
Display, Search and Other platforms represented 47%, 32% and 21% of Yahoo’s fourth quarter revenue, respectively.
Yahoo generated around 72% of revenue on an ex-TAC basis from the Americas (up 11.4% sequentially and down 5.5% from December 2010), around 9% came from the EMEA region (up 13.9% sequentially and 3.8% year over year) and the balance from the Asia/Pacific (down 1.0% sequentially and up 3.9% year over year).
Margins
Yahoo generated a gross margin of 70.2% in the last quarter, down 28 bps sequentially and 675 bps year over year. Total operating expenses of $662.1 million were down 1.8% from the previous quarter and 5.7% and year-ago quarter.
S&M and G&A were down similarly as a percentage of sales on a sequential basis, with product development declining at a lower rate. All expenses increased as a percentage of sales from the year-ago quarter. The net result was an operating margin of 20.2% that expanded 515 bps sequentially and 279 bps from the year-ago quarter.
Net Income
Yahoo’s pro forma net income was $325.8 million or 24.6% of sales compared to $278.6 million or 22.9% of sales in the previous quarter and $351.2 million or 23.0% of sales in the year-ago quarter. Our pro forma estimate excludes restructuring charges and amortization of intangible assets in the last quarter.
Including these special items and the amount given out to non-controlling interests, Yahoo’s GAAP net income was $295.6 million ($0.24 per share) compared to $293.3 million ($0.23 per share) in the September 2011 quarter and net income of $312.0 million ($0.24 per share) in the December quarter of last year.
Balance Sheet
Yahoo has a solid balance sheet, with cash and short term investments of $2.05 billion, down $59.2 million during the quarter. The company generated $431.3 million from operations in the last quarter and spent $130.3 million on capex, netting a free cash flow of around $301 million, significantly higher than $233 million in the third quarter.
The company also spent $255.0 million on acquisitions net of cash acquired and $416 million on share repurchases in the last quarter. Yahoo does not have any debt.
Guidance
Yahoo expects first quarter 2012 revenue (ex-TAC) of $1.06 billion, or down 19.6% sequentially. TAC is expected to come in at $95-155 million and other costs at $825-795 million. This is expected to generate operating income of $105-155 million.
To conclude
Yahoo’s revenue guidance was lower than the consensus estimate of $1.08 billion and we remain skeptical about new management’s ability to turn the company around. While display remains Yahoo’s strength, the last quarter was a mixed bag.
In the meantime, Yahoo’s search business remains very weak, with market share numbers dwindling. Search-related issues are likely to continue for a few more quarters at least and even after that, growth remains uncertain given the tough competition.
Cost controls and efficiencies are likely to continue. However, we expect management to continue investing in the business (particularly product development and sales), which could be a pressure on operating margins.
Therefore, while the improving ad market will continue to benefit Yahoo and a leaner cost structure will help cash flow and earnings growth, these factors will be mitigated by competitive pressures.
The shares carry a Zacks Rank of #3 (short-term Hold recommendation). We are also neutral longer term (3-6 months).
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