Yahoo! Inc. (YHOO) reported first quarter non-GAAP earnings that beat the Zacks Consensus estimate by 4 cents. This represented a 25.9% decline from the seasonally stronger fourth quarter of 2010 and a 25.0% increase from the comparable year-ago quarter.
Engagement on Yahoo properties improved significantly in the last quarter, with Yahoo branded sites seeing a 13% increase from the year-ago quarter and Yahoo properties seeing a 15% increase. Both page views and minutes spent on pages went up.
Revenue
Yahoo reported GAAP revenue of $1.21 billion, which was down 20.4% sequentially and 24.0% year over year. TAC costs declined 53.1% sequentially and 67.8% from last year. Excluding these costs in all periods, net revenue was down 11.7% sequentially and 5.8% from last year, better than management guidance of a 29-33% sequential decline.
Yahoo combines revenue from Owned and Operated (O&O) and affiliate sites under Display and Search. All platforms declined on a sequential basis, although Display saw a nice increase from March 2010.
Display revenues (ex-TAC) dropped 17.0% sequentially, while increasing 10.2% from last year. Technology improvements, a growing ad supply and new ad programs helped display revenues in the last quarter.
Search (ex-TAC) was down 7.9% sequentially and 18.9% year over year. However, search metrics started improving in the last quarter, with U.S. core search query volumes increasing 26% from last year, according to comScore. Search page views also improved, increasing 3% from last year, according to Yahoo. Management stated that the alliance with Microsoft Corp (MSFT) was improving ROI for advertisers, which was increasing spending, especially from financial, auto and retail companies. However, the revenue per search (RPS) remains below Yahoo’s expectations and is not likely to break even before year-end.
Other (fees, listings and leads) revenues saw sequential and year-over-year declines of 5.4% and 10.1%, respectively.
Display, Search and Other platforms represented 44%, 34% and 22% of first quarter revenue, respectively.
Yahoo generated around 73% of revenue on an ex-TAC basis from the Americas (down 12.1% sequentially and 10.6% from March 2010), around 9% came from the EMEA region (down 8.6% sequentially and up 9.2% year over year) and the balance from the Asia/Pacific (up 10.8% and 17.6%, respectively).
Margins
Yahoo generated a gross margin of 68.9% in the last quarter, up 548 bps sequentially and 1,315 bps year over year. Total operating expenses of $628.5 million were down 10.5% and 9.3% from the previous and year-ago quarters, respectively. All expenses increased as a percentage of sales from both the previous and year-ago quarters, looking like management is stepping up investment in the business. The net result was an operating margin of 17.2% that dropped 24 bps sequentially but jumped 460 bps from last year.
Net Income
Yahoo’s pro forma net income was $265.1 million or 21.8% of sales compared to $351.2 million or 23.0% of sales in the previous quarter and $229.0 million or 14.3% of sales in the year-ago quarter. Our pro forma estimate excludes restructuring charges, amortization of intangible assets and losses related to the impairment of an investment held by Yahoo Japan on a tax-adjusted basis.
Including these special items and the amount given out to non-controlling interests, Yahoo’s GAAP net income was $223.0 million ($0.17 per share) compared to $312.0 million ($0.24 per share) in the December 2010 quarter and a net income of $310.2 million ($0.22 per share) in the March quarter of last year.
Balance Sheet
Yahoo has a solid balance sheet, with cash and short term investments of $2.79 billion, down $95.5 million during the quarter. The company generated $143.6 million from operations in the last quarter and spent $112.5 million on capex, netting a free cash flow of around $31.1 million, down from $155.7 million in the fourth quarter. The company also spent $34.4 million on acquisitions and $137.4 million on share repurchases in the last quarter. Yahoo does not have any debt.
Guidance
Yahoo expects second quarter 2011 revenue (ex-TAC) of $1.075-1.125 billion, a 1-6% sequential increase. TAC is expected to come in at $155-165 million and other costs at $915-935 million. This is expected to generate operating income of $160-190 million.
To conclude
Yahoo’s revenue guidance was in line with the Zacks Consensus Estimate and we are encouraged with management’s efforts at turning the company around. While display remains Yahoo’s strength, 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.
The shares carry a Zacks Rank of #3 (short-term Hold recommendation), similar to Google Inc (GOOG), which has the same rank. However Chinese search company Baidu Inc (BIDU) remains more in favor, as indicated by the Zacks Rank of #2 (short-term Buy recommendation) allotted to the shares.
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