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Yahoo! Inc. (NASDAQ:YHOO)

Q3 2008 Earnings Call

October 21, 2008 5:00 pm ET

Executives

Marta Nichols - IR

Jerry Yang - CEO

Susan Decker - President

Blake Jorgensen - CFO

Analysts

Brian Pitz - Banc of America

Ross Sandler - RBC Capital Markets

Jeffrey Lindsay - Sanford Bernstein

Sandeep Aggarwal - Collins Stewart

Steve Weinstein - Pacific Crest Securities

Justin Post - Merrill Lynch

Colin Gillis – Cannacord Adams

Youssef Squali - Jefferies & Co.

Scott Kessler – Standard & Poors

Imran Khan - JP Morgan

James Mitchell - Goldman Sachs

Operator

Good afternoon, ladies and gentlemen, and welcome to the Yahoo! third quarter 2008 earnings conference call. (Operator Instructions) I will now turn the call over to Ms. Marta Nichols. Ms. Nichols, you may begin.

Marta Nichols

Thank you and good afternoon and welcome to Yahoo!'s third quarter earnings conference call. On the call today are members of our executive team, Jerry Yang, Susan Decker, and Blake Jorgensen.

Before we begin, I would like to remind you that this call’s discussions will contain forward-looking statements that involve risks and uncertainties concerning Yahoo!'s expected financial performance, as well as Yahoo!'s strategic and operational plans. Actual results may differ materially from the results predicted and reported results should not be considered indicative of future performance.

The potential risks and uncertainties include, among others, that the expected benefits of Yahoo!'s commercial agreement with Google may not be realized, including as a result of actions taken by United States or foreign regulatory authorities and the response or acceptance of the agreement by publishers, advertisers, users, and employees; the implementation and results of Yahoo!'s ongoing strategic initiatives; the impact of organizational changes; Yahoo!'s ability to compete with new or existing competitors; reduction in spending by or loss of marketing services customers; the demand by customers for Yahoo!'s premium services; acceptance by users of new products and services; risks related to joint ventures and the integration of acquisitions; the possibility that Microsoft or another party in the future make other proposals to acquire all or part of Yahoo!; potential continuing uncertainty arising in connection with Microsoft’s various proposals to acquire all or a part of Yahoo!; or take other actions which may create uncertainty for our employees, publishers, advertisers, and other business partners; and the possibility of significant cost of defense, indemnification, and liability resulting from stockholder litigation relating to such proposals.

Other potential factors that could affect the company’s business and financial results are included in the company’s Annual and Quarterly reports which are on file with the SEC.

All information discussed on this call is as of today, October 21, 2008 and Yahoo! does not intend and undertakes no duty to update this information to reflect future events or circumstances.

On the call today, we will discuss some non-GAAP financial measures as we talk about the company’s performance, including operating income before depreciation, amortization, and stock-based compensation expense, which will be referred to as operating cash flow; revenue excluding traffic acquisition costs, which will be referred to as revenue ex-TAC; free cash flow; non-GAAP net income; and non-GAAP net income per share. Reconciliations of those non-GAAP measures to the GAAP measures the company considers most comparable can also be found on our corporate website at www.info.yahoo.com, under Investor Relations.

We have prepared remarks and then we’ll have a brief Q&A session with Jerry, Susan, and Blake.

And now I would like to turn the call over to Jerry.

Jerry Yang

Thank you Marta and thanks for joining us today. I’ll start the call by summarizing our business and the third quarter results in light of the recent global economic conditions, then I’ll outline the actions we’re taking to become a more streamlined and competitive organization.

I’ll finish by talking about our visibility in the fourth quarter and address why we feel we will be well positioned for improved future growth.

In the third quarter we saw mixed trends. We experienced strong growth in our US search business as well as our performance in non-guaranteed display businesses. However demand for branded display advertising slowed further in the US with weakness in categories such as finance and retail where marketers are becoming increasingly cautious.

As well as geographical weakness in branded advertising in Europe and Asia. These factors contributed to the Q3 revenue coming in at the low end of our outlook range. However our operating cash flow on an adjusted basis came in above the mid point of our outlook range.

This is due to the aggressive cost management efforts throughout the year in which we have lined our expenditures with market environment even while making investments.

Based on the uncertain advertising environment that we face now, we are reducing our full year revenue outlook. At the same time we are reaffirming our operating cash flow outlook for the full year. Continued substantial cash flow remains one of our core financial strengths and an important goal for us as well.

We have the balance sheet strength, liquidity, and free cash flow we need to continue to make progress on our core strategies as we work our way through this economic downturn.

Throughout 2008 we have been balancing our investments and key initiatives while also managing our costs to meet profitability goals. As we saw the online ad market decline in the third quarter I decided that Yahoo! needed to accelerate the process of becoming more efficient and competitive.

I believe getting Yahoo! more fit at this time will provide the flexibility necessary for navigating current conditions and strengthen our position for the future.

We are identifying ways we can work more efficiently and taking steps to significantly improve our organization and reduce costs.

Our goal is to reduce the current annualized cost run rate of roughly $3.9 billion by more then $400 million before the end of this year 2008. These efforts will involve streamlining our organization by reducing layers, increasing spans of control, and eliminating redundancies.

Because the majority of our costs are headcount related, we anticipate that we will reduce our global workforce by at least 10% by year-end. This is the first step in a longer-term effort that will last into 2009 and beyond.

Driving efficiency is an ongoing priority for the company. We are looking at all aspects of our operations to improve performance and expect to implement additional structural changes that will benefit Yahoo! in the future years.

Some of these actions might include relocating some operations to lower cost geographies, consolidating real estate, improving procurement and standardizing our global technology platform and we expect that list to grow.

Like all companies facing these difficult decisions, we are very mindful of the impact on our affected employees. We’ll make every effort to ease the transition for Yahoo!s by providing separation packages and job placement services.

Yahoo! is a company that has been through a dramatic down cycle before. Back in 2001’s tough environment Yahoo! continued to grow users and engagement in spite of a fundamental shift in the business model. Similarly this quarter we saw solid growth in page views as well as increased audience engagement with now Yahoo! now responsible for nearly 14% of all the time spent online according to comp score.

We ranked first or second in 21 audience categories in September and consumers continue to make Yahoo! their destination of choice around milestone global events such as the Olympics, the elections and the current financial crisis.

On our [monitorization] efforts we saw revenue per search increase in the US and we launched APT from Yahoo! our new display ad management platform. We believe APT will change the game for advertisers, publishers, networks, and agencies dramatically simplifying the online advertising process while creating a dynamic open and innovative marketplace.

Building APT was a tremendous effort and we’re very proud of its early success. This year’s investments which also included the development of Yahoo! open strategy put in place the key elements of our plans to better capitalize in online ad spending, search and enhancing audience experiences through more open and social features in 2009 and beyond.

Even as we work to simplify our organization and improve our cost structure we will continue to prioritize our spending around these initiatives. Despite a tough environment I remain very optimistic about Yahoo!’s future. While many advertisers are guarding budgets carefully I am encouraged that most display advertisers who are still spending in this environment are spending with Yahoo!.

The fact is Yahoo! represents the most reliable quality option as marketers demand more from scarcer resources. Today we offer advertisers an even more diverse range of marketing opportunities and more sophisticated [in size] and targeting capabilities.

So while overall market remains cautious I believe our platforms, audiences, and strong relationship position as well for the current environment and when the ad market comes back.

Before concluding I’d like to briefly update you on the status of our agreement with Google. As you know we recently delayed implementation of an agreement to continue our discussions with the Department of Justice. We and Google are continuing to work with the DoJ and others regarding the agreement that the benefits it can provide to our advertisers and our users as well as Yahoo!’s overall competitive position in online advertising.

We look forward to bringing the benefits of the agreement to the marketplace as soon as possible. In conclusion this is in many ways an unprecedented macro environment. But even as we operate in a difficult advertising market, usage of Yahoo!’s services continue to increase and while the advertising market goes through this down cycle, we believe the internet ad market will emerge stronger then before with Yahoo! well positioned to take share.

I believe we’re doing the right thing to ensure that Yahoo! has the right cost structure in terms of productivity and efficiency. I’m also pleased that the investments we made to Yahoo!’s ad and audience platforms are taking shape.

Combined with our streamlined organization these investments will provide us with the flexibility the weather the current environment and take advantage of the growth opportunities beyond.

Now I’d like to turn the call over to Susan.

Susan Decker

Thanks Jerry, and good afternoon. In a year in which there have been a number of external challenges, Q3 was no exception as the impact of the credit market crisis became more visible and its tentacles reached into the broader global economy.

The impact of this is quite clear in each of our business lines and consumer metrics that we are reporting today. On the positive users and usage growth continued at a healthy clip as Yahoo! reinforced its position as a core starting point for consumers who want to keep on top of what’s important to them in their world.

The incredible news cycle of the last several months has been a magnet to our large engaged user base. On the negative side overall monetization was lower then expected and experienced the trends you might expect to see. Commitments to higher priced guaranteed advertising slowed further as companies with top line pressure cut back in order to protect their own bottom line results.

A bright spot within display was commitments to performance related advertising which has a more quantifiable positive impact on the short-term revenue of our advertisers and continues to grow rapidly. This was evident in the strength both of our performance advertising in display and also our search revenue in the quarter.

This was not enough however to offset the weaker performance in premium display. Amidst these changes we remained very focused on our internal product roadmaps marking three major milestones since we last spoke; the launch of APT, our new display advertising platform, the testing of our new homepage, a major redesign that we’ve been working on for many months, and just last week the launch of our new profiles audience product, a key cornerstone that will help make our major starting points more open and social.

I’ll focus my comments today providing more detail in two broad areas, first I’ll discuss audience trends, and then I’ll provide some color on monetization in the quarter highlighting product progress within each area.

Let’s begin with the audience trends, audience engagement was clear positive for Yahoo! in the quarter, a consistent theme that you’ll notice with respect to our audience product development efforts is that we are increasingly focused on making Yahoo! the place consumers go to check in on their world and as the quarter demonstrated when major events happened in the world, users flocked to Yahoo!.

The elections, the Olympics, and the global financial crisis drove strong usage gains on our homepage and in key verticals like news, sports, and finance with page views in each of these content categories up strong double-digits earning us the number one position in each of those vertical categories.

This engagement translated into strong production of inventory by our users with global page views up 17% year-over-year. Turning to search volume within that, we saw solid growth with both US and international query growth in Q3 exceeding our long-term goal of 10% worldwide.

Many of you follow com score data to track growth and market share. Our actual US growth rates inquiries have exceeded those estimated by com score in recent quarters. Looking forward our audience product roadmap remains focused on leveraging Yahoo!’s leadership with users as the go to experience to see what’s going on in their world.

We’re making more Yahoo! relevant in three ways, first by opening up to third party content. Second by leveraging the power of our enormous community of users to surface the most interesting content, and third by tailoring what our users see on Yahoo! based on what insights we have about them.

Let me give you examples of each of those three ways. First with respect to being open and personalized, we recently began testing a homepage redesign that will enable users to transform the Yahoo! homepage into a personalized web dashboard giving them many more customization tools including bringing their favorite experiences from many other sites directly onto their Yahoo! homepage.

For example users may select a dashboard allowing them to access all their mail providers including Yahoo! mail, AOL mail, and Gmail in one place. In addition they’ll be able to view content from other leading sites like eBay, NetFliks and many more.

These are just a couple of examples of the very visible changes available to enhance the user experience. Behind the scenes invisible to the outside world this new homepage is being built on a global code base for the very first time in Yahoo!’s history versus our previous structure which used over 20 worldwide code sets.

This will create tremendous efficiencies in our development processes and should allow for faster iterations now and in the future as well as more streamlined costs. The second example of how we’re making the site more relevant is we’re beginning the process of leveraging the power of our user community through the recent launch of the new profiles.yahoo.com, a new social foundation.

Yahoo! profiles is a centralized custom control panel that let’s you manage your identity, activities, interests and connections across Yahoo! and eventually the entire web. This new profile is not intended to be a new social destination on Yahoo! but instead to integrate the social graph as a central dimension of the services you use every day. You’ll see us leverage the new profile over multiple products in coming quarters in order to make our products more relevant.

Third we’ve also begun testing our new content optimization knowledge engine which uses complex algorithms to determine the most engaging content for our users allowing us to serve content in an increasingly relevant and personalized way.

This will ultimately allow our content experiences to differ by user similar to how advertising can be served to different users today. Since launching a test version in May click through rates in the today module of the homepage have increased by more then 30%.

We plan to rollout content optimization on other elements of the homepage as part of our redesign efforts and ultimately to other parts of the network. All of these efforts are fundamentally changing Yahoo! from a one size fits all portal to a personalized starting point for the web.

Let me be quite clear, this is not a minor tweak to our old portal model, but I hope you are beginning to see the visible results of the fundamental shift we took last year. Yahoo! sites will no longer consist of static programmed pages with their behavior, [boats], module selections and profile management tools alongside our technology and algorithms, users will be able to create much more relevant experiences for themselves incorporating both Yahoo! content and services and the best of the web.

Turning now to monetization, we saw mixed trends in the quarter with weakness in premium display more then offsetting strength in search and performance display. Starting with search, revenue per search in the US was up 11% year-over-year accelerating from our Q2 growth rate and boosted by multiple initiatives including the broadening of market reserve pricing to 100% of the US market early in the quarter and improved optimization on which ads we show users and how we display them.

MRP was rolled out in the UK and Japan in Q3 and should benefit RPS there in future quarters and we expect many more major markets will benefit from MRP in Q4 and beyond. Combined with the volume trends discussed earlier global GAAP O&O search revenue advanced 17% consistent with growth in Q2.

Let me now turn to display, overall GAAP O&O display revenue was up 3% globally, decelerating from its double-digit growth pace in the first half of the year. Volume trends remain strong as discussed earlier. In keeping with the overall economic environment weakening however we see marketers adjusting their overall marketing spend with the net result being a decline in display sell through and a decline in weighted average yield.

Underneath these aggregate trends we experienced very strong performance advertising trends but these are being more then offset by weaker trends in premium advertising since this guaranteed inventory represents the majority of our mix.

Using the US as an example guaranteed volume and pricing were flat to down slightly while non-guaranteed CPMs were up strongly driving non-guaranteed revenue up by a strong double-digit percentage.

By geography the US had begun to slow late in Q2 and trends there were modestly weaker then we had anticipated as the Q3 progressed but international display slowed much more significantly then expected as the rest of the world began to feel the effects of what we saw in the US a few months ago.

Touching briefly on what we’re seeing by vertical, while spending was slower across most categories, those that were most responsible for the display deceleration were somewhat consistent with what we saw last quarter including finance, travel, retail, and auto.

Our largest advertisers in the US were roughly flat in Q3, modestly slower then the year-over-year trends in Q2. Smaller advertisers held up better in the first half but the deceleration became more pronounced in Q3 for that category.

Looking forward we’re anticipating slower online advertising growth in Q4 and into 2009 as the real economic impact of recent capital market dislocation takes hold. That said from a competitive standpoint we’re hearing from many ad buyers that they are consolidating budgets with fewer media companies to bring efficiencies to their processes and in some cases this is actually driving increased spending for us.

As well Yahoo! maintains a strong leadership position in the display branded category as we continue to increase the share of budget we capture from many of the top global brands, even as these spends may be under cyclical pressure.

We are also positioning ourselves for competitive improvements through our new ad platform. Our ambition is to come out of this downturn with a stronger market position.

Speaking of that we’re very pleased to announce that APT went live in the quarter with two cornerstone online publishing partners, the San Francisco Chronicle and the San Jose Mercury News, and it is performing well.

We’ve already seen good order volume flowing through APT in its first month of operation and have maintained an aggressive deployment schedule for the remainder of this year and 2009.

Based on the positive results of our deployed partners to date, many partners have requested accelerated launches. The launch of APT from Yahoo! is the culmination of over a year of significant design and development work brought to life by the combined talents of a remarkable engineering and product team working closely with our go to market teams, all of whom deeply understand the needs of our customers.

We’ve developed a game changing web-based solution that allows unprecedented ease of cross selling across a large network of publishers, advertisers, ad networks, and ad agencies. As economic grounds and pressures shift so to have the demands for display advertising and publishing.

As we’ve discussed we’ve seen an increased demand for performance display, requests for more highly tuned targeting to specific audience segments, and higher fidelity and campaign planning, pricing and ad formats across both guaranteed and performance display.

APT’s capabilities improve all of these areas, providing a single and simple interface to determine how to target the best audience across the network at the best possible price. Its not just that APT eliminates manual and highly redundant processes, for advertisers it’s the ability to locate the ideal audience at a better price.

For publishers it allows them the ability to move up the value chain from non premium to premium monetization by giving advertisers the ability to advance buy impressions, add targeting features where they couldn’t before, and sell their audiences against Yahoo! inventory that’s currently being sold as remnant advertising.

To conclude as we manage through a time of uncertainty we feel good about the products we’re rolling out both in terms of how they position us competitively and also in terms of how they can leverage key connections in Yahoo! more efficiently and can be expanded globally in a scalable way.

These are important points because they will help us leverage our improving cost structure in ways that should allow us to batten down the hatches and weather the storm ahead with the goal of delivering operating cash flow growth in 2009 and beyond.

I look forward to sharing more about our plans in 2009 with you in January. Now with that let me turn the call over to Blake.

Blake Jorgensen

Thanks Susan, the third quarter was marked by two main themes; a worsening economic environment leading to revenues that were at the low end of our Q3 outlook range and continuing efforts to manage our costs that enable us to exceed the mid point of our Q3 OCF outlook on an adjusted basis and maintain our full year OCF outlook.

GAAP revenue increased 1% over Q3 2007. Revenue ex TAC increased 3%. We delivered $447 million of operating cash flow or OCF or $410 million including the $37 million of costs related to the Microsoft proposal, strategic alternatives including the Google agreement, the proxy contest, and related litigation.

My comments today in the call regarding our Q3 adjusted OCF exclude the impact of these costs. As Jerry mentioned global economic conditions deteriorated during the third quarter and with the events of the last few weeks we are cautious about the advertising market in Q4.

With a very strong balance sheet and continued cost management initiatives however we believe that we are well positioned to weather the current downturn.

We have no debt. We ended the third quarter with $3.3 billion of cash and marketable debt securities. As of the end of the quarter the value of our direct and indirect interests in the publicly traded securities of Yahoo! Japan, alibaba.com and Gmarket were valued at approximately $7.9 billion in the public markets or over $5.50 a share.

The market value of these interests has been volatile during the recent market turmoil but we continue to believe that these are highly valuable strategic assets. These figures include the value of the shares of alibaba.com held by Ali Baba Group of which we own approximately 40%.

These figures do not include estimates of the value of Ali Baba Group’s other privately held businesses such as [Taobao] and Alipay which we believe provide significant additional value.

We did not repurchase stock during the quarter due to continuing evaluation of strategic alternatives. Given the economic environment and the equity market volatility we have taken a conservative approach to our capital structure and maintain flexibility with our cash and investment portfolio.

Moving to the P&L, GAAP revenue was $1.79 billion. As a reminder, two months of Q3 were non comparable with the same months last year due to our sale of Overture Japan to Yahoo! Japan which was completed on August 31, 2007.

Excluding the revenues from our relationship with Yahoo! Japan from the third quarters of both 2007 and 2008 GAAP revenue growth would have been 6%. Beginning in Q4 our results will be comparable with respect to Overture Japan on a year-over-year basis.

Revenue ex-TAC was $1.33 billion and in addition to the Overture Japan impact I just mentioned the conversion of our relationships with AT&T and our other broadband partners has negatively affected our revenue ex-TAC growth rates in two ways.

First the fees revenue from our broadband partners is no longer growing and will in fact decline over time. The upfront payments received from AT&T and Rogers will allow us to recognize some fee revenue from our broadband relationships though this revenue source will decline over the next several years.

Second these broadband relationships are converting to primarily revenue sharing arrangements. We are now paying TAC to these partners on O&O marketing services revenue in both search and display which drives non-comparability with prior years when we were paying little or no TAC to these partners.

These revenue sharing agreements have contributed to difference between GAAP and the ex-TAC revenue growth this year. However once we anniversary the new partnership terms at the end of Q1 2009 our results will be comparable year-over-year and the TAC payments will no longer be a drag on revenue ex-TAC growth rates.

In our marketing services business total third quarter GAAP revenue was $1.56 billion, up 1% over last year’s third quarter. Total marketing services revenue ex-TAC was $1.1 billion, up 4% versus the prior year’s third quarter with TAC of $461 million.

Within marketing services the owned and operated revenue was $1 billion up 9% on a GAAP revenue basis. O&O search was $438 million up 17% and O&O display was $435 million, up 3%. Listings and other marketing services revenue was $130 million up 3% year-over-year.

Affiliate revenue was $561 million a 10% decrease from last year principally due to the final quarter of a non-comparable results from Overture Japan’s transaction.

This incremental detail on our marketing services revenue is included among the new slides in the earnings presentation we have posted on our Investor Relations website. We think these slide will help in the analysis of our revenue growth over time as well as help to clarify the growth impacts of M&A transactions and currency fluctuations as they occur.

Fees revenue was flat with last year and exceeded our expectations due to a few one-time items related to the renewal of our broadband partnership with Verizon, and our exit of the paid music subscription business.

We expect Q4 fees to decline sequentially and as I mentioned a moment ago, to continue to decline during 2009 as a result of the broadband partnership restructurings.

Looking at geographic breakdown, GAAP revenue in the US increased 7% and revenue ex-TAC increased 3% year-over-year. International GAAP revenue decreased 12% largely as a result of the different comparison with last year due to the Overture Japan transaction.

International revenue ex-TAC increased 4%. Acquisitions contributed 1% to GAAP revenue and currency did not have a material impact on year-over-year GAAP revenue growth in Q3, however currencies did hamper revenue growth by approximately 2% compared to our outlook which was based on trends we saw during the first half of the year.

Adjusted operating cash flow was $447 million for Q3 which exceeded the mid point of our July outlook. There are a few other items from the Q3 financials that I’d like to clarify.

Gross profit fell by approximately $13 million year-over-year due to principally higher amortization of acquired intangibles related to acquisitions we’ve made over the last year. Other income was negatively effected by approximately $13 million in currency fluctuations as volatility during the quarter affected cash balances held in international locations.

Our effective tax rate for the quarter was higher then normal due to changes in our anticipated full year geographic mix of profitability which required us to record additional tax expenses. As we benefit from the recent extension of the Federal R&D tax credit we expect our fourth quarter effective tax rate to be lower then normal.

We continue to estimate a full year tax rate between 41% and 44%. We expect our cash tax rate to be between 10% and 13% for the year.

The earnings and equity interest line item includes and after-tax $30 million non-cash impairment charge on our investment in alibaba.com, the publically traded subsidiary of Ali Baba Group.

The market value of our direct 1% stake in alibaba.com has decreased below our carrying value requiring us to record the impairment. To be clear this impairment had no impact on the carrying value of our investment in Ali Baba Group.

We continue to believe that there is significant value both in our investment and in our relationship with Ali Baba Group and alibaba.com.

Several of the factors I have just outlined negatively effected our reported EPS for the quarter. Our press release includes a table that provides a bridge between the $0.09 per share non-GAAP EPS and our $0.04 per share reported EPS based on these factors.

That brings me to our business outlook, given the weak economic climate we’re lowering our full year revenue outlook, but we are maintaining our operating cash flow and free cash flow outlook. We now expect fourth quarter results in the following ranges.

GAAP revenue of $1.77 billion to $1.97 billion and operating cash flow of $490 million to $570 million. Our fourth quarter and full year OCF outlook excludes costs related to the Microsoft proposal, strategic alternatives including the Google agreement, the proxy contest, and related litigation as well as any charges that may incur related to the cost reduction initiatives that Jerry mentioned.

Turning to free cash flow, we expect free cash flow for the full year of $925 million to $1.025 billion which reflects $700 million to $750 million in capital expenditures for the year. This free cash flow outlook excludes the impact of the upfront $350 million cash payment we received from AT&T in March as well as the strategic alternatives and related matters.

Jerry shared with you our plans to expand the aggressive cost management program that has helped us maintain our profitability goals this year. We plan to implement initiatives before year-end that will lead to significant reductions in both headcount and non-headcount related costs and will meaningfully reduce our expense run rate in 2009.

We expect to incur a one-time charge in Q4 that will cover employee separation packages and other non-headcount related items and we may record additional related costs in 2009.

While uncertainty in the economy is effecting overall demand for online ads we are confident that the actions we’re taking will enable us to improve financial performance even in a difficult business environment.

Now I’ll turn it back over to Jerry.

Jerry Yang

Thank you Blake, we are now ready for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Brian Pitz - Banc of America

Brian Pitz - Banc of America

Clearly the economy is weak but can you talk about some of the things you’re doing to improve monetization on the O&O network and then affiliate revenues accelerated from Q3 levels is this from overall economic environmental weakness or is it really more on the side of network clean up?

Susan Decker

On the O&O side the primary thing we’re doing is launching the new platform that we have talked to you about. That is at first rolling out to our newspaper consortium partners and has very significant benefits to publishers as the webs largest publisher; should have very significant benefits to us. So one of the major integration next steps as we move into 2009 is to move the Yahoo! inventory more fully on that and open that up and avail our sales force to some of those benefits.

Outside of that we’re out there talking to advertisers and we have feedback that we think we are getting consolidation of budgets with us on the brand side but that the overall brand budgets in general are running down as an easy to manage short-term expenses.

Blake Jorgensen

On the affiliate revenue the 10% decline from last year was principally due to the final quarter of the results relative to the Overture Japan transaction but in addition as you mentioned we are continuing to see quality improvements or movement away from low quality affiliates that impact the growth rate but we believe continue to improve the user experience.

Operator

Your next question comes from the line of Ross Sandler - RBC Capital Markets

Ross Sandler - RBC Capital Markets

If we look at the display revenue on a O&O non-GAAP basis can you give us a sense of the mix between premium and performance or non-guaranteed and then can you talk a bit about, you’ve said you’ve rolled out APT on the newspaper publisher partners, what kind of ECPM lift are you seeing once they’re plugged in?

Susan Decker

I think I said that the majority of our business is premium not performance although the performance piece has doubled from a small base but doubled in the last year so we are seeing very good growth on the performance side if you just, looking at the math we released about 3% global growth in O&O display and I mentioned the price and volume of the premium was flat to down slightly. The total revenue of performance was up strongly but you could probably do the math to work out roughly what that would be to get you to 3%.

On the APT side, we don’t have specific data yet back on the CPM lift of transactions running through APT but we had started to rollout the you sell opportunity to our newspaper consortium members, we have several hundred now on that you sell opportunity and they’ve seem premiums on both Class one and Class two of 2 to 3x what we’ve been getting prior to that. Its still very limited because it was a manual process until we got APT up and going. We’ll have more information to report as we have full quarter of APT under our belt.

Operator

Your next question comes from the line of Jeffrey Lindsay - Sanford Bernstein

Jeffrey Lindsay - Sanford Bernstein

Could we ask what specific cost reduction measures you did take in the quarter, what the nature of those were and how repeatable they might be and then in light of the factors affecting the tax rate, could you tell us what the implications are for valuation of the net operating loss carry-forwards?

Blake Jorgensen

On the cost reduction side we have focused all year not just in the quarter on slowing our hiring and more importantly moving much of our hiring to lower cost jurisdictions around the world to continue to take advantage of the expanding base of excellent technology people that we can find in either eastern Europe or India or southeast Asia.

We started a series of initiatives that helped us exceed the mid point, those initiatives also include non-headcount related costs associated with purchasing, managing, T&E, and other items to continue to keep our costs low but at the same time we’re focused on continuing to invest in the APT platform and continuing building out of new parts of our homepage.

In terms of the tax rate the, probably the best would be to take that offline. It’s a little bit complicated in terms of how that will impact the cash carry-forward of operating losses. Its really an anomaly driven by how the different international versus the US tax rates differ and also the timing of the most recently passed R&D tax credit which didn’t get passed until October 3. That’s a retroactive tax credit for the full year but we don’t get credit in it until the fourth quarter so at the end of the day the overall tax rate forecast has not changed, simply the tax rate reported for the third quarter has.

Jerry Yang

I think when we’re talking about the set of initiatives to cost cut and drive efficiency there is much bigger focus around productivity and efficiency going forward in the initiatives I outlined and I think these are intended to be a much more permanent change in our cost structure.

Operator

Your next question comes from the line of Sandeep Aggarwal - Collins Stewart

Sandeep Aggarwal - Collins Stewart

What gives you comfort about your new revenue guidance in terms of not having further downside risk and if you can provide any update on [inaudible] Yahoo! deal especially in terms of if there’s any kind of deadline you are supposed to say yes or no?

Jerry Yang

There is not a lot more I can add to based on what I’ve said. We have agreed to a brief delay to implement and we are having our ongoing dialogue with the DoJ and as I said it is our hope to put this type of agreement into implementation as soon as possible.

Susan Decker

The guidance that we put out today reflects our best forecast of what the quarter is going to look like just as it did three months ago. What it includes today that we did not include three months ago was broad weakening in the rate of growth in Asia and in Europe in display. That’s actually been a real bright spot for us and international O&O display was still up double-digits in the quarter but it has slowed significantly from what the growth rate was earlier in the year.

As we look forward we are still seeing a weakening trend in certain Asian markets and so that’s something we’ll watch very closely. On the US side we are seeing some stability. It been in the few weeks of bookings at the run rates that are reflected in our guidance, our homepage actually is pretty much booked in October and only a few days available in November and December which is better then we might have expected.

We’re looking at all the data points out there. We’re also seeing some cancellations in certain categories, travel in US and elsewhere, but we take all that input into account and we think that the fourth quarter forecast is our best estimate at this time. We are seeing some advertisers spending more with Yahoo! as they drive efficiencies but overall the trend in display has been lower, search of course held up very well with our Q2 run rates in the first few weeks of the quarter are consistent with that.

Operator

Your next question comes from the line of Steve Weinstein - Pacific Crest Securities

Steve Weinstein - Pacific Crest Securities

Regarding the affiliate network, the rate of decline actually increased from what we saw last couple of quarters, yet the impact Yahoo! Japan should have been a little bit less, so can you explain what is going on with the clean up efforts of the affiliates, the quality improvements of the affiliates and with the Overture Japan piece out of the way now, should we expect that to be a growth business going forward or are there things that can continue to hamper that business as we look over the next couple of quarters?

Blake Jorgensen

The bulk of the impact in this quarter was still driven by Overture Japan. We are seeing some growth in the affiliates, at least the higher quality affiliates but I would probably hold off speculating on what the impact of the economy might be on the affiliates versus our own and operated businesses today. Its hard to say exactly how those might change in the future. We’ll clearly see less of a headwind once we’ve anniversaried the Overture Japan side but I would hate to speculate at this point as to how the economy might impact the rest of the affiliate business.

Susan Decker

The affiliate line is a cross current of a number of trends right now and the good news is you’ll have more comparable results in Q4 as we’ve cycled through the Yahoo! Japan transaction. But we also have ongoing TAC rate increases which affects the overall yield of that and there is a mix issue of how much is search versus how much is display. The display affiliate growth has been actually quite strong but its off a much smaller base whereas the search growth is reflecting some of the issues that Blake talked about.

Operator

Your next question comes from the line of Justin Post - Merrill Lynch

Justin Post - Merrill Lynch

In this tough environment do you think there could be some more consolidation in the space. I know its been a topic in the press a lot lately. Would you expect that and do you think there’s opportunities for Yahoo! there and then it looks like your growth rate relative to Google’s O&O has really closed the gap and I’m wondering what you might attribute that to, your search versus their O&O?

Jerry Yang

I think we have been clear that in an environment like this we feel there continues to be a sort of flight to quality in terms of both the consumer behavior as well as the advertiser behavior and while we all don’t know what’s going to happen going forward in terms of how the environment is going to shake out we continue to see the strength of our consumer franchise as well as in the best environment that we could possibly see, some strength in terms of how people are continuing to come to Yahoo! in terms of spending their dollars online as well as forming relationships when the big advertisers come back in terms of stimulating demand. They want to have the conversation with Yahoo! because of our reach. So we see that as a strength.

I think to the extent that we see a way to add on to that scale and strength we think we need to do that not only to maximize shareholder value but also we believe we can gain a lot of scale in this type of environment because there just isn’t a lot of growth in terms of spending so we do see the consolidation both in terms of at the account level but potentially in other ways to improve our strength and improve our positioning.

Susan Decker

Yes, we think that’s true and its probably most visible in comparable by looking at the US numbers because the international mix that we have and Google has are quite are quite different in terms of where our strengths are. But I think the overall O&O revenue growth there are two major variables; one is query growth and I said our growth has maintained north of 10% which was our goal and that’s better then I think a lot of the external surveys say so we’re realizing we’ve had very stable growth, Google’s growth we think has been stronger then that but has been coming down off a large base and so we’re going closer to converging on the query growth front.

On the RPS front I mentioned we grew 11% year-over-year in the quarter so that’s north of a 20% gap search growth rate in the US and that is a factor of, attributed to rolling out a number of the product upgrades we’ve been doing, MRP was probably the most significant in terms of its impact in the quarter, we had a full quarter impact of that in Q3 but we still have the benefit of rolling that around the world. We’re also doing a lot of work on making sure that the ads we serve are influenced by the user click behavior. We have more to do on that front and we think that that’s ahead of us in terms of benefit for the most part. We also think there’s more to do in terms of the user experience at the advertiser level to make it easier to use.

We’re really proud of what we’ve been able to accomplish. We’re rolling these out. We said from the very beginning that [Panama] was the beginning not the end and we still have more ahead that we think will help us close that gap.

Operator

Your next question comes from the line of Colin Gillis – Cannacord Adams

Colin Gillis – Cannacord Adams

Can you talk about the trends you saw in the months in the quarter in particularly September, was there a sharp pull up in reduction and cancelled display campaigns?

Susan Decker

I would say that the trends weakened in the latter part of August and September from certainly what we saw in the first couple of weeks in the quarter. It was most pronounced in Europe at first and then it moved to Asia and we’re continuing to see more weakness in Asia. In the US it also deteriorated somewhat from what the run rate was earlier in the quarter but not as significantly as it did internationally.

Jerry Yang

Just remember I think a lot of the US turmoil hit late in September and so we’re still watching and learning and trying to understand what’s going to happen globally but I think as we’ve all said this is a pretty different environment then even four weeks ago.

Operator

Your next question comes from the line of Youssef Squali - Jefferies & Co.

Youssef Squali - Jefferies & Co.

I guess its fair to assume that the long-term guidance that you put out there about six months ago is no longer valid considering the tougher environment, as you look at 2009 I know you’re not guiding to it now but assuming that things don’t get any worse from here, Susan indicated that things in the US seemed to be stabilizing somewhat but under that assumption do you believe that you can grow revenues at least at the same rate if not faster then what you’ve done in 2008 and just a clarification, I think you talked about acquisitions as having added 100 basis points to growth, is that the case, did [inaudible] and write media added about 100 bps to your overall growth in display?

Jerry Yang

I don’t think we have any visibility into 2009 and I do not even think we can be educated enough to comment on the growth rates in 2009.

Susan Decker

I think I was responding to a question about how we feel about Q4 guidance and giving some indications of what we’re seeing in the first two weeks in each of the major regions around the world, the US in the first two weeks in October was pretty consistent bookings trends with what we saw last month so I wouldn’t take that to mean anything as it relates to 2009 at this point. We feel like our guidance is a good indicator of where we think the quarter will land based on everything we know right now but I wouldn’t use that as anything in 2009 at this point.

Blake Jorgensen

On the acquisition side, yes I did say that acquisitions contributed 1% to GAAP revenue. I think the key to remember there is we have companies like Zimbra that we acquired late last year and [Maeven] Networks in the first quarter of this year, but most important we just added in the third quarter a new acquisition, a company called [Munday] in Taiwan which is also continuing to help.

Jerry Yang

I do think in our comments you can safely say that obviously the cost side of the equation, all the actions we are taking now we’ll be taking the rest of this quarter will influence our cost structure in 2009 so that’s one thing we can comment about 2009 but nothing on revenue.

Operator

Your next question comes from the line of Scott Kessler – Standard & Poors

Scott Kessler – Standard & Poors

Could you detail a bit more about the streamlining actions you’re taking specifically what are the areas of emphasis in terms of departments within Yahoo! or specific functions that might be altered, any additional information and my other question reflects a concern that I think a lot of people have which is over the last number of months obviously you’ve been put in positions where you have to address the notion of shareholder value. Everyone is obviously aware of the fact that you perceived an offer from Microsoft of $31.00 a share and thereabout as not fully valuing the company, but yet now the company, its shares are trading at $12 or $13, you didn’t buy any shares in the quarter. What further actions are going to be taken to unlock shareholder value at this point that you could communicate to us. Obviously one of the things that was indicated is that you’re still evaluating some of those considerations, could you provide more details on your latest thinking.

Jerry Yang

I think we do think that taking aggressive actions around our cost structure is one of the ways that we can unlock shareholder value and hopefully most if not all of the things we’re doing are aligned around that. In terms of details around that I outlined a few things around streamlining our organization both in terms of the way we’re structured and a lot of our core employee base whether its across departments or within the product engineering groups I think there are both organizational efficiencies as well as process redundancies that we can extract and I think this is a perfect time to do that given that we think that there is an opportunity for us to take the time to create a much more standardized way of operating across our regions.

Remember Yahoo! has been growing in terms of a cost base over the last three or four years pretty significantly and during that time we obviously have a lot of room to be able to create some efficiencies which we plan on doing and I think as we get to more of the planning around the streamlining activities whether its within the regions or within ways in which we can put people in different cost jurisdictions, these are all things that we’re going to look at. We also are looking at potentially consolidating real estate and pretty much all the things you would assume we should be doing to make sure we come out of this much stronger and much more nimble.

On the kind of things we should be doing around unlocking value, we are obviously continue to look at what is the best way to enhance shareholder value either through our balance sheet and/or continue to generate cash flow, we have been fairly conservative in terms of looking at share buybacks. We are exploring potentially other ways of using that capital but to be frank in this current environment has created a lot of pause in terms of helping all of us think through what is the right path forward. There’s some pretty big dislocations in the equity markets in the last few weeks and that volatility continues and as we go through that our view is the balance sheet we have is a strength and the liquidity that we have in our balance sheet is a strength and our ability to generate cash is a strength so we are going to use those and evaluate the environment and go from there.

Operator

Your next question comes from the line of Imran Khan - JP Morgan

Imran Khan - JP Morgan

The display advertising growth rate of three percentage point, could you give us some, your sense of what percentage of the growth rate deceleration is associated with the economy, is it entirely economy or do you think you’re losing market share to ad networks and other sites, and in terms of the acquisitions considering what the stock is and considering where is your other investment value, how sensitive you will be in terms of diluting shareholder in terms of potential acquisition?

Susan Decker

On the display growth until other companies report it will be hard for us to ascertain exactly how much was economic and how much was market share. I will say that we looked very carefully of course each quarter at those numbers after the fact, and in Q2 and Q1 it looked to us like we were gaining share in the segments in which we operate. So and certainly within the performance piece of what we do we believe we’re outgrowing the ad network numbers that we’ve seen in aggregate and most of the individual companies so we’re weighted average of the brand side which is probably most comparable to portions of AOL’s business and portions of MSN’s business and I would encourage you to look at our numbers relative to those and on the performance side, we’ve been growing strong double-digits have more then doubled in the last year plus and we think we’re outgrowing the ad networks although we are building that from a small base but we have amassed a reasonably good size business at this point.

Blake Jorgensen

We’ll clearly be very sensitive to dilution. We’re obviously looking at what we believe are the long-term values of some of the franchises that are, may become available in a tougher economic time and we’ll look to make sure that we’re generating long-term positive cash flow and value through any acquisitions but clearly with our stock trading where it is today we have to be conscious about diluting shareholders at a lower price.

Part of that is the reason that we’re very conscious about trying to maintain a cash balance to allow us to do some of the things that we may be looking at today.

Operator

Your final question comes from the line of James Mitchell - Goldman Sachs

James Mitchell - Goldman Sachs

Given you generate substantial GAAP revenue from markets such as Korea and substantial net revenue from markets such as Taiwan and given the large volatility in exchange rates like in Korea in recent weeks, have you considered hedging out some of your exchange risk in those market?

Blake Jorgensen

We have, its something that based on the rapid change in exchange rates, I never thought we’d see quite such a dramatic turnaround, but clearly you named two of the countries in addition to the euro that have kept us focused. Historically the cost of hedging has exceeded the value of hedging in many ways and we’ve tended to set up a natural hedge obviously with much of our costs in local markets on the cost side balancing out the revenues, but we’re going to continue to examine if there are opportunities to do that that are cost effective and look at ways to minimize those risks in the future.

Jerry Yang

I want to thank everybody for joining us today and we’ll talk to you all soon. Thank you.

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Source: Yahoo! Inc. Q3 2008 Earnings Call Transcript
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