Yahoo Q1 2011 Mixed: Display Up, Search Down, Revenues $1.06 Billion

Yahoo reported Q1 revenues of $1,064 million, which represented a 6 percent decline vs. a year ago. The company essentially blamed the search deal with Microsoft for the decline:

[The decline was] primarily due to the required change in revenue presentation related to the Search Agreement and the associated revenue share with Microsoft. For transitioned markets (U.S. and Canada), Yahoo! now reports revenue associated with the Search Agreement on a net (after TAC) basis rather than a gross basis. Excluding the impact of these two items and the impact of the divestitures of Zimbra and HotJobs, broadband deferred revenue amortization, and certain fee rate reductions, revenue for the first quarter of 2011 decreased 8 percent compared to the first quarter of 2010.

Display revenue increased 10 percent but overall search revenue was down 19 percent (or more depending on the accounting methods used):

  • Display revenue ex-TAC increased 10 percent to $471 million, compared to $427 million for the first quarter of 2010.
  • GAAP display revenue increased 6 percent to $523 million, compared to $491 million for the first quarter of 2010.
  • Search revenue ex-TAC was $357 million, a 19 percent decrease compared to $440 million for the first quarter of 2010.
  • GAAP search revenue was $455 million, a 46 percent decrease compared to $841 million for the first quarter of 2010.

Here’s what Yahoo said specifically about “Search Alliance Costs and Reimbursements”:

Yahoo!’s results for the first quarter of 2011 reflect $56 million in search operating cost reimbursements and $11 million in transition cost reimbursements from Microsoft under the Search Agreement, which amounts are equal to the search operating costs and the transition costs incurred by Yahoo! in the first quarter. Search operating cost reimbursements are expected to continue to decline as Yahoo! fully transitions all markets to Microsoft’s search platform and the underlying expenses are removed from our cost structure. Our business outlook for total expenses reflects these anticipated savings. The net impact of the transition costs and transition cost reimbursements were neutral to total operating expenses in the first quarter, as expected.

Here are some of the earnings slides:

The search deal with Microsoft may have saved some costs for Yahoo but it has yet to bear fruit as promised when the search alliance was formed. Yahoo has some bright spots in display but otherwise it seems a company very much stuck in neutral.

Postscript From Danny Sullivan:

I generally don’t dive deep into our earning calls coverage, but the news of Yahoo having a drop of search revenues certain caught my ears. So, I’ve gone through the earning slides myself. A few questions and observations.

NOTE: You can read the section below, but I’ve also turned this into a more organized stand-alone article: The Yahoo Search Revenue Disaster.

“Contextual” Queries Don’t Earn?

First, there’s this metrics chart:

That’s all pretty rosy sounding. Search-related pageviews are reported as up over the past two quarters, first a 6% rise for the fourth quarter of 2010 compared to the same quarter in 2009, then a 3% rise for the same year-to-year comparison for the first quarter of 2011.

Search queries are also said as being up — double-digit rises, even.

So what gives with all these views going up but search revenues being down? I’d bet that the “contextual” searches that Yahoo has manufactured to generate pageviews that look good on paper aren’t doing the same for revenues.

The pageview figures are Yahoo’s own. The search queries come from comScore. But these are “core search” queries from comScore, not “explicit core search” queries that comScore also provides — and which exclude some of Yahoo’s manufactured searches, things such as where going through a slideshow in Yahoo News generates a new “search” on each click.

The articles below provide more information about this:

Search Revenues Down

Next, look back at that “Revenue ex-TAC by Source” chart above. I’ve pulled out just the search revenue-related figures to make a new chart from that, below:

The bars show the total amount of search revenue earned in each quarter, excluding any payments Yahoo owed partners in relation to generating this revenue. These payments are called “traffic acquisition costs” or TAC, in short.

The percentages above each bar show how much revenue dropped in that quarter versus the same quarter for the previous year. It’s all bad news. Yahoo tries to paint the last two quarters as merely “headwinds” caused by new payments it makes to Microsoft in relation to outsourcing its search services. Microsoft gets 12% of Yahoo’s search-related revenues.

Part of this seems correct. Last quarter, Yahoo says that it paid Microsoft $36 million off the net search revenues it earned. IE, in Q1 2011, Yahoo earned net search revenues of $357 million, but this was less the 12% it owned Microsoft on search revenue earnings. Before those were taken, it had earned (apparently) $393 million.

Hang on to that figure $393 million figure. I’ll be coming back to it. Yahoo didn’t report what Microsoft got for Q4 2010, but given the drop, it seems likely similar.

The problem with the drops is that Yahoo’s deal was supposed to let Yahoo keep earning as much — if not more — than ever before despite Microsoft’s skimming off the top. That’s how Yahoo pitched the deal. It would allow Yahoo to keep earning plenty on search, because Yahoo argued that search technology itself was just a “chip” that it could plug-in.

By borrowing Microsoft’s “Bing chip,” Yahoo would lose tons of cost involved with making that chip but still enjoy plenty of revenue. These figures paint a picture of that not being the case. The opposite, actually — thanks in part to the Microsoft-Yahoo deal, Yahoo’s earning less off search than ever before.

Microsoft Payments Aren’t TAC Payments

Keep in mind this important point. Microsoft gets 12% of search revenues after TAC has been deducted, not before. Yahoo’s earnings talk about reporting revenues on a new “post-TAC” or “net” basis. That gives the impression that Microsoft’s cut is somehow new, slicing further into revenues.

Well, it is new. But it’s not a TAC cost — payments that Yahoo makes to various distribution partners. Instead, it’s a payment that Yahoo makes over and beyond those other payments.

That leads to another chart I’ve made from the Yahoo earnings deck:

This is how much Yahoo has paid in traffic acquisition costs related to search. In other words, in the first quarter of 2010, Yahoo made $841 million in search revenues but paid $401 out to various partners in relation to deals to generate those revenues. That’s what the first bar shows, the $401 paid out, which was 48% of everything it earned. That’s what the percentage shows.

Something big happened in the last quarter. Yahoo’s search-related TAC massively dropped. What this was isn’t clear. I’m checking on it. It suggests that Yahoo has lost a major distribution partner (or two) that, despite costing a lot, was sending traffic that monetized very well.

Microsoft & Guaranteed Revenue

Under the terms of the deal, Yahoo is guaranteed a certain amount of revenue by Microsoft from when the deal starts. How much? I’m checking to see if I can get any solid figures. This is from what we originally reported on Yahoo-Microsoft deal, when it was announced back in July 2009:

Yahoo is guaranteed to receive payments for the first 18 months of the deal to match a “baseline” of what it was earning before the deal starts, we were told. How far back does the baseline go? We couldn’t get details on that.

The payments are even more important to know now because they might be masking even bigger drops with Yahoo is having with search revenues. Clearly, something type of “rebate” is happening already. Consider these figures from the most recent quarter:

  1. Net search revenue, post Microsoft = $357 million
  2. Payments to Microsoft = $36 million
  3. Net search revenue, before Microsoft = $393 million

OK, (1) is the figure that Yahoo gave for net search revenues. As for (2), this is how much Yahoo said it paid Microsoft on net revenues, an amount that was deducted before the $357 million shown. As the Yahoo slide deck says:

YOY Growth in Search revenue ex-TAC $ and Total revenue ex-TAC were negatively impacted in Q1’11 by $36M and $63M in headwinds, respectively.

Got it? That’s Yahoo saying it earned $357 million and that the “headwinds” of paying $36 million helped produce that low $357 million amount. The $36 million came off the top, producing that final figure.

That’s where (3) comes in, the net search revenue that was paid before Microsoft. And that leads to these figures:

  1. Net search revenue, before Microsoft = $393 million
  2. 12% of net search revenue owned to Microsoft = $47 million
  3. Amount actually paid to Microsoft = $36 million
  4. Unaccounted for = $11 million

Why didn’t Yahoo pay Microsoft $47 million, rather than $36 million? I think the $11 million is a form of a rebate — that Microsoft promised that Yahoo would earn a certain amount, and if it fell short, it would deduct from what it was owed.

I did the same thing for Q4 2010 and found an $18 million gap. Yahoo paid Microsoft $32 million, but should have paid $50 million.

Here’s what I think is happening, after playing with a bunch of numbers and scenarios.

I believe Microsoft promised Yahoo that it would earn in any quarter about 92.5% of what it earned for that same quarter the year before. If it didn’t, then Microsoft would pretend that Yahoo earned that much and rebate an amount from its own share.

Here’s my figuring:

  • Q4 2009 net search revenues = $473 million
  • 92.5% of Q4 2009 as Q4 2010 baseline = $438 million
  • Q4 2010 net search revenue, pre-Microsoft payment = $420 million
  • Difference = $18 million
  • 12% of Q4 baseline owed to Microsoft = $50 million
  • Actually paid to Microsoft = 32 million
  • Difference = $18 million

See? Microsoft guaranteed that Yahoo would earn at least 92% in Q4 2010 of whatever it earned in Q4 2009 — that that Microsoft would get 12% of that figure, or $50 million. But if Yahoo fell short, Microsoft would deduct whatever the difference was from that share. Yahoo fell short by $18 million, so that $18 million came out of the $50 million Microsoft would have earned.

Here it is again for the most recent quarter:

  • Q1 201o net search revenues = $440 million
  • 92.5% of Q1 2010 as Q1 2011 baseline = $407 million
  • Q1 2011 net search revenue, pre-Microsoft payment = $393 million
  • Difference = $14 million
  • 12% of Q1 baseline owed to Microsoft = $50 million
  • Actually paid to Microsoft = 36 million
  • Difference = $14 million

Alternatively, it might be that Microsoft guaranteed that Yahoo would earn at least enough in net search revenues to pay Microsoft $50 million per quarter — and that if it didn’t, Microsoft would pay Yahoo any difference. That sure makes the calculations easier.

Yahoo looks to get four more months of this type of guarantee for four more quarters, reports AllThingsD.

Blame Microsoft, Says Yahoo

A final puzzling part for me revolves around the blame game that Yahoo’s doing. Why are its search revenues down? Aside from what it now has to pay Microsoft, it says that Microsoft’s ads aren’t working. From the Wall Street Journal live blogging:

The first quarter was “a mixed bag” for search. The good news, Ms. Bartz says, is that many of Yahoo’s most important advertisers are seeing much higher return on investment and thus spending more. But she takes Microsoft to task for technology problems. “It will take Microsoft longer to achieve the goals” that the companies have, she said, saying revenue per search should be back up where it used to be by the end of the year….

So there’s a weird situation in this deal with Microsoft: Some advertisers are apparently benefiting a lot from the new service, which seems to contradict the news that something is wrong with the technology. Microsoft’s ad tool “doesn’t have a good handle on” how to serve new ad buyers, Ms. Bartz says. So existing advertisers do well in the new system, but “many of the new advertisers can’t even get their campaigns in,” Ms. Bartz says.

OK, but the Microsoft ads went on Yahoo’s site back in October. Yahoo talks about the deal being in full effect from October. We know the Microsoft ads themselves started at the end of October. So why wasn’t Q3 2010 so down? Why did at least two months in that quarter work out just fine, then all the months after that have been trouble-ridden?

Well, I’m checking with Yahoo about this and some related questions. I’ll report back on what I learn.

Postscript: See our follow-up story, The Yahoo Search Revenue Disaster.

Related Topics: Channel: SEM | Yahoo: Business Issues | Yahoo: Partnerships | Yahoo: Search | Yahoo: Search Ads

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About The Author: is a Contributing Editor at Search Engine Land. He writes a personal blog Screenwerk, about SoLoMo issues and connecting the dots between online and offline. He also posts at Internet2Go, which is focused on the mobile Internet. Follow him @gsterling.

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  • http://www.outsidethecurve.com Ryan Bruss

    I’m wondering if the earnings loss has anything to do with revenue generate through Yahoo Partner sites. In the old Yahoo system as an advertiser I could not opt out of the Partner traffic. All I could do is block certain sties and Yahoo set the max number of sites to block at 500. My experience was that the Partner traffic was of very poor quality to me as an advertiser. It rarely converted, but cost a lot. My guess is that this traffic made Yahoo a lot of money. In the new system I can, and did, opt out of the Partner traffic.

    In the above graph if TAC is the money Yahoo paid those Partner Sites, then the decrease in the last two quarters indicates advertisers are either opting out of the Partner traffic or Bing’s system serves ads differently on those sites or both.

  • Michael Tannenbaum

    Nice analysis. My only comment is that revenues are not earnings. More importantly to Yahoo is what is the profit of the deal long term. I would be concerned about declining revenue no matter how much the company is saving by effectively outsourcing search technology costs to MSFT. You might be missing an important point about valuation: profits not revenue drive valuation.

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