MoneyWatch Tech

Yahoo 10-Q: 3 Year Regression, Product Development Emphasis

By Erik Sherman

Updated on: May 11, 2009 / 8:39 AM EDT / MoneyWatch

Back in April, there were plenty of headlines announcing a big drop in Yahoo's revenue and profit when the company released its Q1 numbers. Unfortunately, the 10-Q is never out when the earnings release hits the wires, and it's only about a month or so later that you can start to see what actually happened. In this case, although there have been significant changes since 2008, the numbers show that the real story is how Yahoo has regressed to a financial picture of three years ago.

But start with the year-over-year view. Look at the first couple of lines at the top of the 2009 Q1 income statement.

There was a 13.1 percent drop in top-line revenue, which is bad enough. But the cost of revenues has gone up, so that gross profit in Q1 of 2009 was 55.7 percent, versus 58.5 percent in Q1 or 2008. That would suggest that the company is less efficient in bringing money in, and as I mentioned in the context of Apple, the money that can make its way into a company's door becomes the ultimate gating factor on how well it can do.

In Yahoo's case, the year-over-year drop was $183 million. But, as the total operating expenses line shows, the company has also pulled the reins in on spending, cutting over $163 million, leaving a difference of about $20 million, which you can see in the income from operations number. So what made the jaws drop on the earnings release? Earnings in equity interests. That was a whopping $405.8 million difference. Check Yahoo's 2008 Q1 10-Q and you see that Alibaba.com had an IPO and that Yahoo had a 44 percent ownership interest in the company, so a one-time boost.

Out of curiosity, I kept scrolling back to the 10-Q from Q1 of 2007, which had the comparison to the 2006 numbers.

Look at the 2006 and 2009 numbers and you'll see that the income statement from the two periods look very similar. Yahoo has essentially returned to the financial levels of 2006 and effectively lost three years of progress. It's not a pretty picture.

There are some other trends in the 10-Q. One is the practical emphasis of product development. Look at the 2009 numbers again and notice that operating expenses were significantly cut back in every category but product development. Similarly, stock-based compensation went up sharply in product development, but down for sales and marketing as well as general and administrative, though that can be deceptive, as the amounts can be stock options that have been recognized over time.

Another is that Yahoo's revenue weakness as a percentage is coming largely from outside the US. Domestic revenue was down 9 percent, but international revenue plummeted by 23.5 percent. That ended up disproportionately hurting gross profit, as operating income before depreciation, amortization, and stock-based compensation expense was 24.6 percent in the US, but 29.7 percent internationally.

We can also see details of the compensation for CEO Carol Bartz. In January, she received an option on 5 million shares with a strike price of $11.73, the price on the day, January 30, the option was granted. Since then, the stock is up to $15.15 as of its last close, or a difference of $3.42 per share. The shares vest only if the average closing price for a period of 20 trading days is above certain levels ranging from $17.60 to $35.19 per share, and she'd have to hold the shares until January 1, 2013. The company has estimated that the grant-date fair value of the option is $27 million. Bartz and some other senior officers are potentially in line as well for performance-based stock grants, and their nature shows some of the strategic drives you can expect from Yahoo. One type, which is worth an aggregate $3 million, is based on the company meeting unspecified annual cash flow targets over a period of three years. The other type, worth $13 million and also on a three-year window, is based on shareholder return relative to the NASDAQ 100 Index companies. Of course, there are a lot of days, and some significant goals, between now and then.

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