Analysis of Yahoo's 10-K (YHOO)

Stifel Nicolaus analyst Scott Devitt analyzes Yahoo Inc.'s (YHOO) 10-K filing:

We believe Yahoo! is a remarkable company – well managed, easily understandable, highly profitable, and in an industry with solid growth prospects. It is investing wisely and plotting a course for continued future success. Below we review some of the highlights from its recently released 10-K filing:

International presence. In 2005, Yahoo! strengthened its international presence with both acquisitions and key partnerships. During the year, the company entered into a strategic partnership with Alibaba.com, a large e-commerce company in China that operates an online marketplace and an online payment system. In Europe and Korea, Yahoo! acquired the remaining shares of its joint ventures in France, Germany and the United Kingdom and Yahoo! Korea, bringing its ownership in these entities to 100%. In Australia, Yahoo! signed an agreement with Seven Networks Limited, a leading media company in Australia, to combine the Australian Internet business with rich media and entertainment content. The deal was completed in January 2006.

Enhancing Communications Offerings. In 2005, Yahoo! launched a beta version of Yahoo! Mail to provides a faster experience with new features such as drag and drop e-mail organization and message previews in addition to other functionality. Additionally, the company launched a new version of IM, which provides free PC-to-PC calling, photo sharing and enhanced tools to expand online communities. Yahoo! also signed an agreement with Microsoft to globally connect users of Yahoo! Messenger and MSN Messenger to create one of the largest IM communities in the world when released in 2006.

Sales and Revenue. No individual customer represented more than 10% of Yahoo!'s revenues in 2003, 2004 or 2005. In 2005, average monthly revenue per paying user remained consistent at approximately $4, similar to 2004.

Competition from a Shifting Landscape. Yahoo! acknowledges that the company faces competition from companies such as Amazon.com, Inc., and eBay Inc., which are leveraging their scale as e-commerce companies to offer informational, community, and communication features that are competitive with the some of the services Yahoo! provides.

Tax Rate. The effective tax rate for Yahoo! in 2005 was 30%, compared to an effective tax rate of 37% in 2004. The lower tax rate in 2005 was a result of a tax benefit of approximately $248 million related to a subsidiary restructuring transaction completed during 2005. Yahoo! currently expects its effective tax rate to increase in 2006 compared to 2005.

Acquisitions. In addition, during 2005 Yahoo! invested over $2.0 billion in significant acquisitions including business combinations, asset acquisitions and a strategic investment, predominantly internationally. Significant acquisitions included Verdisoft in February 2005, the purchase of remaining outstanding shares in Yahoo! Europe and Yahoo! Korea, and a strategic investment in Alibaba. During the year, Yahoo! also acquired four other companies. The total purchase for these four acquisitions was approximately $79 million and consisted of $73 million in cash consideration, $3 million related to stock options exchanged and $3 million of direct transaction costs.

Costs. Management believes that cost of revenues will continue to increase in absolute dollars in 2006 compared to 2005. TAC is expected to increase as marketing services revenue increases and as TAC rates increase in the competitive search market. Additionally, Yahoo! expects to continue to increase its user base and offerings, which drive network usage and, in turn, higher Internet connection charges and data center costs. Further, higher costs related to the introduction of additional content for new and enhanced services are expected. Product development expenses in 2005, 2004, and 2003 as a percentage of revenues were 10%, 10%, and 13%, respectively, and decreased as a result of the overall increase in revenues and efforts to manage discretionary costs. Management currently believes that product development expenses will increase in absolute dollars in 2006 compared to 2005, as continued investments in product development are required to remain competitive.

FX Effects. Using the average foreign currency exchange rates from 2004, Yahoo!'s international revenues for 2005 would have been lower than reported by approximately $42 million and the international segment operating income before depreciation and amortization would have been lower than reported by $8 million

Use of Cash. Cash used in investing activities is primarily attributable to capex, net cash consideration for acquisitions including the strategic investment in Alibaba and net purchases or sales of marketable securities. Capital expenditures totaled $409 million in 2005. Capex uses have been primarily for purchases of information technology assets to support expanding offerings, the increased number of users and for international growth. The net cash consideration for acquisitions in 2005 included approximately $1.0 billion for the investment in Alibaba, $500 million for the purchase of the outstanding interest in joint ventures in Europe and Korea and $54 million for the Verdisoft acquisition. Capex is expected to increase in 2006 as the company invests in the expansion of its Yahoo! properties.

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