Yahoo! Inc. (YHOO) reported third quarter earnings that beat the Zacks Consensus estimate by 2 cents. This excluded a gain of 14 cents a share from the sale of HotJobs during the quarter. Yahoo shares opened 2.19% higher this morning and have continued to climb higher since then.
Yahoo management was upbeat about the results, stating that the revenue per search (RPS) went up 1% from both the previous and year-ago quarters, the first year-over-year increase since the third quarter of 2008.
Revenue
Gross revenue of $1.60 billion was flat sequentially and up 1.6% year over year, in the middle of the guided range. Management stated that revenue growth would have been more substantial if some advertisers had not deferred spending until the transition to Microsoft Corporation’s (MSFT) platform went through.
Marketing services (nearly 90% of total revenue), comprising revenue from Owned and Operated (O&O) and affiliate sites was down 0.3% sequentially and up 4.1% from the year-ago quarter.
Total revenue from Yahoo O&O sites was down 0.5% sequentially and up 3.0% year over year. While all portions of the business were flattish in sequential comparisons, year-over-year comps varied.
Yahoo’s display business (around 29% of total revenue) was the most encouraging part of O&O), growing 16.2%. Display gained from guaranteed placements that were up 20%, as 7 of the 10 verticals addressed by Yahoo grew from the year-ago quarter.
Management stated that there was particular strength in the retail and technology and particular weakness in telecom. The display business in the Americas and Asia/Pac grew strong double-digits, while that in the EMEA region declined strong single-digits.
However, search, which was around 21% of total revenue in the last quarter, disappointed yet again. Revenues declined 6.7% from the year-ago quarter. Although auto and retail categories were quite strong, the strength was almost totally offset by weakness in entertainment and finance categories.
The transition to Microsoft’s platform also had a temporary negative impact on paid clicks, which caused the RPS to drop below expectations. Overall query volume was flat both sequentially and year over year, although page views declined due to quicker finding of results, according to Yahoo.
Listings and other marketing (5% of revenue) declined 1.5% sequentially and by over 14% from a year ago.
Lastly, marketing services revenue from affiliate sites accounted for a 35% revenue share, and was flat sequentially and up 5.6% year over year.
Fees-based revenue, which accounted for the remaining 10% of total revenue, grew 2.7% sequentially, but declined 15.5% year over year.
Yahoo reported third quarter revenue under three geographic segments — The Americas, EMEA and Asia/Pacific. Accordingly, the three regions generated 72%, 8% and 20%, respectively, of quarterly revenue. While the Americas and the EMEA declined at single-digit percentage rates, the Asia/Pacific grew 26.0%.
Net Revenue
Excluding traffic acquisition cost (the portion of revenue shared with Yahoo’s partners), net revenue for the quarter was down 0.3% sequentially and 0.6% year over year. Net revenue in the Americas segment was up 0.4% sequentially and down 2.7% year over year. EMEA net revenue declined 6.7% sequentially and 8.2% year over year. The Asia/Pacific declined 0.7% sequentially and 14.9% from last year.
Traffic acquisition cost (TAC) in the Americas segment is around 25.4% of sales, while TAC in the EMEA and Asia/Pacific regions were 36.6% and 42.4%, respectively. TAC increased as a percentage of sales across segments.
Yahoo generated a gross margin of 57.5% in the last quarter, up 12 bps sequentially and 248 bps year over year. The increase in gross margin was most likely due to improvement in the RPS, which was however partially offset by higher traffic acquisition costs.
Operating expenses of $717.5 million were down 1.1% from the previous quarter’s $725.4 million and up around 4.1% from the year-ago quarter. The operating margin was 12.7%, up 60 bps sequentially and 518 bps year over year. Clearly, Yahoo’s cost-cutting efforts have paid off, driving the third straight quarter of significant operating margin expansion from respective year-ago quarters.
Net Income
Yahoo’s pro forma net income was $215.3 million or 13.4% of sales compared to $230.6 million or 14.4% of sales in the previous quarter and $119.5 million or 7.6% of sales in the year-ago quarter. Our pro forma estimate excludes restructuring charges, amortization of intangible assets and the gain on sale of Hotjobs on a tax-adjusted basis.
Including these special items and the amount given out to non-controlling interests, Yahoo’s GAAP net income was $396.1 million ($0.29 per share) compared to $213.3 million ($0.15 per share) in the June 2010 quarter and a net income of $186.1 million ($0.13 per share) in the September quarter of last year.
Balance Sheet
Yahoo has a solid balance sheet, with cash and short-term investments of $2.82 billion, up $59.8 million in the last quarter. The company generated $346.5 million from operations in the last quarter and spent $163.9 million on capex, netting a free cash flow of around $182.6 million, up from $156.7 million in the second quarter. The company spent $868.0 million on share repurchases in the last quarter. Yahoo does not have any debt.
Guidance
Management expects fourth quarter 2010 revenue of $1.40-1.53 billion, down 8.5% sequentially at the mid-point. TAC is expected to come in at $275-305 million and operating income at $200-280 million. The effective tax rate is expected to be 15-20%.
In Conclusion
We are encouraged by management’s efforts at turning the company around and believe opex cuts were largely responsible for the continued expansion of operating margins compared to the margins in the June 2009 and June 2008 quarters.
At the same time, top line numbers are also improving, with the company seeing significant improvement in the display business. We note that although some sectors saw particular strength, there was broad-based recovery across multiple markets. Search remains a sore point, although the Microsoft deal is a positive. 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. Hence we are reiterating our Neutral recommendation on the shares.
We also do not expect much movement in the shares over the next 1-3 months and this is reflected in the Zacks #3 Rank (short-term Hold ra) on Yahoo shares.
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