Yahoo! Inc. (YHOO) reported second quarter non-GAAP earnings that beat the Zacks Consensus Estimate by a penny, pretty much as we had previewed.
The 5.9% sequential decline was the result of internal problems at Yahoo, despite stronger end markets. The result increased 14.0% from the comparable quarter in the prior year
Yahoo shares opened lower today and have since lost around 7%, as investors reacted to the weakness in display, for which expectations were high.
Revenue
Yahoo reported GAAP revenue of $1.23 billion, which was up 1.2% sequentially and down 23.3% year over year. TAC costs increased 1.9% sequentially although it was down 67.7% from last year. Excluding these costs in all periods, net revenue was up 1.1% sequentially and down 4.6% from last year, missing the Zacks Consensus Estimate by 3.1%. However, it was just within management’s guidance of a 1-6% sequential increase.
Yahoo combines revenue from Owned and Operated (O&O) and affiliate sites under Display and Search. Revenues were generally flattish on a sequential basis, although search improved. However, all except display revenue declined from June 2010.
Display revenues (ex-TAC) dropped 0.9% sequentially, while increasing 5.0% from last year. Yahoo stated that the softness in display revenue was not on account of competitive developments, but because of their own reorganization efforts, which lowered the number of active sales people. This impacted sales closures at several big accounts. Yahoo’s display woes were however limited to the U.S. The business did very well internationally, growing 27% in the EMEA region and 20% in the Asia/Pacific.
Search (ex-TAC) was up 3.9% sequentially although it was down 15.4% year over year. Segment results were better than management expectations, due to better performance at O&O sites. Yahoo continued to face transition issues at affiliate sites, although the situation started improving toward the end of the quarter, according to management.
As expected, the revenue per search (RPS) guarantee from Microsoft Corp (MSFT) helped results. However, Yahoo’s U.S. search query volumes for June declined in line with the market, with market share losses to both Google Inc (GOOG) and Microsoft (comScore).
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 flattish compared to 2010, including the guarantee from Microsoft. 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 flattish sequentially and down 2.6% from last year.
Display, Search and Other platforms represented 43%, 35% and 22% of Yahoo’s second quarter revenue, respectively.
Yahoo generated around 71% of revenue on an ex-TAC basis from the Americas (down 1.6% sequentially and 9.7% from June 2010), around 10% came from the EMEA region (up 8.7% sequentially and 16.0% year over year) and the balance from Asia/Pacific (up 8.3% and 8.6%, respectively).
Margins
Yahoo generated a gross margin of 69.8% in the last quarter, up 88 bps sequentially and 1,243 bps year over year. Total operating expenses of $658.2 million were up 4.7% from the previous quarter and down 9.3% and year-ago quarter. All expenses increased as a percentage of sales from both the previous and year-ago quarters, with the exception of cost of sales, which declined from both the previous and year-ago quarters. The net result was an operating margin of 16.2% that dropped 91 bps sequentially but jumped 418 bps from last year.
Net Income
Yahoo’s pro forma net income was $247.3 million or 20.1% of sales, compared to $265.1 million or 21.8% of sales in the previous quarter and $230.6 million or 14.4% 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 $237.0 million ($0.18 per share), compared to $223.0 million ($0.17 per share) in the March 2011 quarter and net income of $213.3 million ($0.15 per share) in the June quarter of last year.
Balance Sheet
Yahoo has a solid balance sheet, with cash and short term investments of $2.55 billion, down $235.1 million during the quarter. The company generated $331 million from operations in the last quarter and spent $172 million on capex, netting a free cash flow of around $159 million, significantly higher than $31.1 million in the first quarter. The company also spent $472 million on share repurchases in the last quarter. Yahoo does not have any debt.
Guidance
Yahoo expects second quarter 2011 revenue (ex-TAC) of $1.05-1.10 billion, or a 2.4% sequential decline to a 2.2% sequential increase. TAC is expected to come in at $150-160 million and other costs at $765-775 million. This is expected to generate operating income of $135-165 million.
To conclude
Yahoo’s revenue guidance was lower than the Zacks Consensus Estimate and we are growing skeptical about management’s success at turning the company around. While display remains Yahoo’s strength, the business did poorly in the last quarter, merely because management miscalculations.
In the meantime, search failed to make any major headway, remaining 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.
Shares carry a Zacks Rank of #3 (short-term Hold recommendation).
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