Yahoo! Inc. (NASDAQ:YHOO)
Q4 2009 Earnings Call
January 26, 2010 5:00 pm ET
Marta Nicols – Investor Relations
Carol Bartz – Chief Executive Officer
Tim Morse – Chief Financial Officer
Imran Khan - JP Morgan
Sandeep Aggarwal - Collins Stewart
Ben Schachter - Broadpoint Amtech
Mark Mahaney - Citigroup Smith Barney
Jason Helfstein – Oppenheimer & Co.
James Mitchell – Goldman Sachs
Justin Post – Bank of America Merrill Lynch
Doug Anmuth - Barclays Capital
Brian Pitz – UBS
Scott Kessler – Standard & Poors Equity
Youssef Squali - Jefferies & Company
Jeetil Patel – Deutsche Bank
Heath Terry – FBR Capital Markets
Mary Meeker and Scott Devitt – Morgan Stanley
Good afternoon, everyone and welcome to Yahoo!'s fourth quarter 2009 earnings conference call. On the call today will be Carol Bartz, Chief Executive Officer and Tim Morse, Chief Financial Officer.
Before we begin, I would like to remind you that today’s call will contain forward-looking statements concerning matters such as our expected financial and operational performance, our marketing and product plans, our cost initiatives, planned investments, technology improvements and corporate strategy, as well as our expectations for the economy in general and online advertising in particular. Actual results may differ materially from the results predicted in our statements and reported results should not be considered indicative of future performance.
The potential risks and uncertainties that could cause our business and financial results to differ materially from our forward-looking statements are described in our form 10-Q filed with the SEC on November 6, 2009, as well as in the earnings release included as Exhibit 99.1 to the form 8K we furnished today to the SEC. All information discussed on this call is as of today, January 26, 2010 and Yahoo! does not intend and undertakes no duty to update this information to reflect future events or circumstances.
On today’s call we will also discuss some non-GAAP financial measures as we talk about the company's performance. These may include 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 we will refer to as revenue ex-TAC; non-GAAP net income and non-GAAP net income per share. Reconciliations of these non-GAAP measures to the GAAP measures we consider most comparable can be found on our corporate website, info.yahoo.com, under Investor Relations.
We will have prepared remarks that will last about 30 minutes and then we will have a brief Q&A session with Carol and Tim. Now I would like to turn the call over to Carol.
Thanks Marta and welcome back. Good afternoon and thank all of you for joining us. Today we are going to briefly recap 2009 and the progress we made during a year of significant change at Yahoo!, talk about our financial results in detail, address some of the key topics of interest of Yahoo! and our industry and outline our strategy and some of our plans for 2010.
I recently celebrated my one-year anniversary with the company and what a ride it has been. In fact I might say I made it through my first year with the company and it was a wonderful ride. Very bumpy and frankly like many other business leaders I am very, very glad it is over. But it was also a great opportunity restructure, reset and reposition Yahoo! for the next era of growth.
I view my first year at Yahoo! in three phases. First I took a look at our consumers and the experience we provide them. I realized that we had to invest in the products that users engage with the most like the Homepage, mail, messenger, news, sports, finance and entertainment. We also decided to close down products that didn’t drive engagement or proudly represent Yahoo! In that same vane I even asked employees to sign their names next to projects they have done and if they can’t then they need to go back and make it right so they are proud of what they deliver.
The second phase was listening to advertisers. Working to improve our relationships with them and to continue to deliver quality data, insight and innovative ad platforms. With 600 million users on Yahoo! branded sites we have one of the largest, most valuable and highest quality audiences on the Internet and we are constantly coming up with new ways to connect advertisers with the consumers they seek.
Then came the third phase. I really started to focus on how we generate value. For us it is the vast amount of data we gather and use to deliver a better, more personal experience for users and a better, more targeted audience for our advertisers.
Let’s look at our homepage for example. Since we began paring our content optimization technology with editorial expertise we have seen click through rates in the Today module more than double and we are making additional improvements to the technology that will make the user experience even more personally relevant. While we have extremely sophisticated technology and brilliant scientists powering these efforts, we have been letting great data about the consumers, data that is very attractive to advertisers fall to the floor. We are the leader in targeting and insight but we simply aren’t even close to maximizing the value of our massive audience for advertisers.
Truth be told, no one has uncovered the holy grail of making advertising as relevant as content is 100% of the time. Beyond just offering advertisers a specific bucket, say women aged 35-45 and have children, we instead need to deliver many more specific attributes of scale. For example, women aged 35-45 with kids under three who are shopping for a minivan, and on and on and on and on. If we can do this we can create a better experience for both the user and the advertiser.
Meanwhile of course we are also taking steps to improve consumer privacy and transparency online. Last month we launched our ad interest manager that allows users to select how we serve ads to them on our network.
So that was 2009. Along the way we made progress in many areas. We reset the management team and reorganized the company. We launched a new homepage and a suite of great mobile products and apps. We refreshed mail, messenger and some of our other key products. We introduced new ad products and upgraded existing platforms to drive improved advertiser ROI and I will talk more about that in a minute. And of course we signed the search agreement with Microsoft. We did all of this during one of the worst economic climates ever.
Most of the S&P 500 suffered with declining revenue last year and includes many of our largest customers. In that [line] Yahoo!’s revenue decline of only 10% is pretty darned good. Compare that with traditional media who were really struggling and we all held up well.
After the fourth quarter things definitely began to pick up. We beat our overall revenue guidance range and display strengthened sequentially, growing 26% from Q3. In fact, a number of our premium properties including homepage sold out due to high demand from top brands and advertisers. Meanwhile search revenue continued to stabilize and then some. We actually grew O&O search revenue sequentially in Q4 for the first time since Q3 2008.
Overall things seem to be returning to a more normal state in the online ad business. Let me be clear. These results are not just the result of an improving economic climate. These are the direct result of hard work that culminated in Q4 and will continue into this year and beyond.
Now Tim, let’s take a more in-depth look at our financial performance.
Thanks Carol. We are pleased with our fourth quarter performance. Revenue came in above the top end of our guidance range as did operating income excluding restructuring and Microsoft related costs. We saw strong demand in our core display and search marketplaces in 4Q and we believe that the ad market recovery is underway.
Diving right into the detailed results, revenue was $1.732 billion for the quarter. While this was a 4% decrease from 2008 it was up 10% sequentially which is our best 4Q sequential performance in several years. As the economy seems to be gaining a firmer footing and ad budgets are recovering Yahoo! continues to be the place that marketers come for unique, high quality ad placements that are scarce on the internet.
O&O display was essentially flat year-over-year which was a big improvement compared with where we were earlier in 2009. The best news was that display grew an impressive 26% sequentially. 4Q is of course a seasonally strong quarter but this year’s sequential growth was the strongest we had seen since 2006.
Drilling into the components of display revenue, our guaranteed inventory performed very well in the quarter and continued to increase as a percent of total display revenue. Demand was strong throughout the quarter and several of our key placements were sold out. Pricing recovered this quarter after a challenging 2009 with guaranteed pricing for some of our most important properties returning to fourth quarter 2008 levels.
The strength we saw on the guaranteed side also improved the performance of our non-guaranteed inventory. Advertisers bid up the price of the non-guaranteed placements due to the scarce availability of premium guaranteed buys. Of the major advertiser categories we track in display, 9 out of 10 improved sequentially. Year-over-year half were up and half were down. The retail, consumer products and telecom segments grew strongly compared to last year. Autos was about flat and entertainment and finance declined year-over-year offsetting the growth in the stronger categories.
Turning to search there is encouraging news to report as well. Compared to last year we registered a revenue decline of 15% on query growth of greater than 10% globally and mid single digits in the US. More importantly on a sequential basis we grew revenue by 4%, the first time we have done so since the third quarter of 2008. The primary drivers of fourth quarter performance were improvements to our matching algorithms that yielded better than expected positive results including an 8% sequential increase in global revenue per search.
Just last week we also introduced network distribution, a search platform enhancement that enables advertisers to more precisely tune their keyword bids to maximize ROI and we believe this will further improve our O&O RPS in 2010. Compared to last quarter eight of our ten advertiser categories grew. Year-over-year entertainment, consumer products, health and telecom were the growth leaders for the quarter while travel and finance were relatively weak.
Before moving on, let’s take a moment to put our search business in perspective. Search is an important part of Yahoo! Growing search revenue is a key company priority. We are focused on pulling both the volume and monetization levers to improve results. On the volume side we are using a combination of product enhancements, search oriented marketing spending and the power of the Yahoo! network as a search distribution channel to reaccelerate query volume. On monetization I mentioned the matching technology we recently brought into the marketplace that benefited the RPS. That is just the first step of an aggressive roadmap of monetization enhancements we are executing on.
Returning to the quarterly highlights the affiliate business outpaced our overall growth rate in 4Q and in fact grew year-over-year. Some of this growth was attributable to favorable currency fluctuations but we also benefited from signing new partners. Our 4Q signing of Dom in South Korea which we won back from Google is evidence of our ability to compete for these deals.
Transitioning to profitability GAAP operating income was $119 million. This includes $32 million in costs related to our search agreement with Microsoft and $40 million in lingering restructuring charges without which we would have been well above the high end of our guidance range. OCF was $404 million including $21 million of cash restructuring charges and $32 million of Microsoft related costs. This is the last time we are going to report OCF. As I mentioned at Investor Day, operating income is our key profitability metric.
Operating costs landed within our expected range the fourth quarter enabling strong flow through of incremental revenue to the bottom line. We are working hard to maximize the productivity in our spending and our business also has great operating leverage which will benefit us during the economic recovery.
We exited the quarter with 13,900 employees which was an increase of about 700 from our Q3 levels including about 250 employees from two acquisitions. About 1/3 of those new hires were in product development and the balance was in sales and marketing.
Turning to the balance sheet we ended 2009 with $4.5 billion of cash and marketable debt securities. During the fourth quarter we invested $170 million in CapEx and repurchased $23 million in stock. At the end of the quarter the pre-tax value of our 35% stake in Yahoo! Japan and our 29% indirect stake in Alibaba.com was $9.5 billion or nearly $6.75 per share. These figures are based on public market quotes and do not includes estimates of the value of Alibaba Group’s privately held businesses.
Looking ahead to 2010 we expect first quarter revenue in a range of $1.575 billion to $1.675 billion. This reflects seasonality on a sequential basis and 3% year-over-year growth at the midpoint despite the short-term negative impact of our revenue quality initiatives. It is also noteworthy that a return to top line growth will be our first since the third quarter of 2008.
To round out revenue guidance, traffic acquisition costs should be 28-29% of GAAP revenue. We also expect 1Q operating income in a range of $90-110 million including depreciation and amortization of roughly $170 million and stock based compensation of about $95 million. This guidance excludes advisory and retention costs related to the Microsoft agreement and any restructuring charges related to our ongoing cost initiatives.
Briefly touching on total year 2010, we expect to grow revenue including both O&O search and display and we plan to expand GAAP margins. For the year our effective tax rate should be in the 35-40% range and our CapEx spending between $600-700 million. As a remind on the Microsoft deal we don’t expect revenue sharing to begin in 2010 but once the deal closes we will start to get reimbursements from Microsoft for the cost of running our [inaudible] and paid search businesses.
For 2011 and 2012 we still start to share revenue as the page search business is combined by region. We will provide further guidance on the revenue sharing, cost reimbursement and timing of the $150 million of payments from Microsoft as well as the financial statement presentation of all these items after items after we begin implementation.
Before I turn the call back to Carol I would like to reiterate some of our 2010 financial priorities. First, we will continue to invest for growth. As we proved in 4Q this business has strong operating leverage so we need to seize every opportunity to grow the top line. That means investments to accelerate share shift, improvement to our advertising and analytics platforms and continuing investment in our key audience properties. Whether this is via internal development and M&A activity we are positioning Yahoo! for its next phase of growth.
Second, we will continue to simplify and streamline Yahoo! to drive margin expansion and ROIC that exceeds our cost of capital. As I outlined at investor day our goal was to generate 15-20% operating margin and 15-20% ROIC by 2012. As a point of reference, our operating margin for 2009 was 6% and our ROIC was 5%. The Microsoft deal will improve the economics of our search business which will free up resources for investment in other areas of the company. We believe the combination of investment for future growth, more efficient operations and Microsoft related savings will enable us to significantly improve Yahoo!’s financial performance. We are building an execution machine here and you will start to see that emerge even more during 2010.
Third and final, we are committed to transparency and consistency. Given some of the complexities of the Microsoft deal we will be making extra efforts to help you understand the run rate of the business versus the effects of the various interim steps of the search transaction. I look forward to reporting back to you on our progress throughout the year. With that I will hand the call back to Carol.
Thanks Tim. Now I would like to talk to you about a few things that are top of mind. First up let’s talk about display advertising. While many of you didn’t believe me, I kept saying throughout 2009 that brand advertising would come back. It always has. Demand for our guaranteed display inventory is growing. We are seeing advertisers reach farther into 2010 to book premium Yahoo! sites and events so we expect the positive momentum to keep building.
We have some of the best if not the best premium inventory on the internet. Advertisers are competing for it now as their businesses are getting healthier and larger budgets are working their way back into the hands of CMOs. As these marketers look to position new products and brands in the marketplace they will need display ads to tell their story. You can’t position a brand with keywords. As a result of better guaranteed sell through in Q4 the obvious happened; non-guaranteed demand also shot up during the quarter. Because we made significant improvements to the right media platform last year we were able to respond to this increased demand without a hitch. We are now delivering relevant audiences at scale faster and more accurately than ever before.
In addition to right media we have done a tremendous amount of work on all of our ad products, systems and analytics. For example, we introduced and implemented innovative new formats such as Rich Ads in search. We have got many more new products planned for this year. We are also working on our relationship with advertisers. This includes making Yahoo! easier to do business with and being a better creative partner while delivering the insight that helps marketers manage great campaigns. Much of what we are working on this year will allow advertisers to buy specific, targeted audience at huge scale. They will increasingly be able to measure their online advertising with the same kind of consistent, easy to use tools they use for offline media.
By the way, we are still ahead in the display game and we intend to keep it that way. Frankly our competition is television. That is where major advertisers spend most of their money and where we are taking share. As a result, video is becoming increasingly important. It is now an area where we believe in the concept of video [snaps]. Our TV recap show, Primetime in No Time is one of the most streamed shows on the web. It attracts millions of streams each month and even hit 12 million streams on one day in November. That is more than the TV audience who tuned into the recent season premier of 24.
But we are only getting started. Our recently announced partnerships with Group M and Electus expand our capabilities in this space. The partnership with Electus for example brings heavy hitting Hollywood firepower to Yahoo! through Ben Silverman, an Emmy and Golden Globe winning producer. He has been behind top shows like The Office, 30 Rock and more. We are excited about this because Ben and his team understand the power of Yahoo!’s audience. We give Electus massive reach but remember we are not trying to mimic traditional TV formats. We are about developing low cost, high quality web content for our users that is created in partnership with advertisers.
Another subject we are asked about a lot is social, usually in the context of Facebook and Twitter. We are happy to say we are partnering with Facebook to deliver familiar social experiences within the Yahoo! network and to enable simpler, broader sharing of great Yahoo! content as well. We view both social and video as features that should not exist in a silo. They are features that should be tightly integrated into all of Yahoo!’s properties as a way to expand and enhance the user experience.
So that is display, video and social but we also have a very important search business and after the Microsoft deal is implemented it is a business that we believe will become even more powerful and profitable while delivering a more engaging and relevant user experience. Yahoo! Search is also picking up steam. Last quarter our O&O search revenue grew 4% versus Q3, the first sequential increase in Q3 2008.
Our combination of ad solutions across search and display is a great competitive advantage and search is an obvious part of our overall success. As Tim said, we did very well on the RPS side last quarter. Our work on the monetization will continue even as we now aggressively tackle search volume. Search is a top priority for us. We recently hired Shashi Seth, an expert on the search industry to lead our efforts. Our dedication to improving the search experience and accelerating volume growth will be very visible.
We have already made significant changes to our search ad capabilities to capture more value from queries. In 2009 we built on our dynamic pricing ability, continued to optimize on the way we serve search ads based on user behavior, enabled advertisers to port search campaigns from Google and other engines directly into Yahoo! and rolled out substantially better matching technology. These efforts drove up RPS in Q4 and we have even more on the roadmap this year.
We are also focused on consumer engagement and search volume. For instance, we have a new Breaking News shortcut. Search a news item like Haiti and you will get multiple tabs of results from all over the web and the best of Yahoo! Network including news, photos, video and Twitter feeds. We will also market search on and off the Yahoo! network, implement new toolbar and browser offers and launch other great new features. Using our leading homepage, mail and messenger products and key media verticals we can effectively market our search capabilities to people who already know and love Yahoo! But we won’t stop there. We have done a great job so far revitalizing the Yahoo! brand with our marketing campaign and search will be a key ingredient of our message as we now shift to more product centric advertising.
Mobile is generating a lot of buzz right now so I want to spend a few minutes talking about our strategy. Users clearly expect to have access to the same kind of services they use on the PC but designed for their mobile phones and they want to interact with brands they know and trust. Our strategy is to grow and monetize the Yahoo! audience on mobile.
To do this we are focused on building great experiences that our users love like our mobile homepage, mail, messenger, finance, Flickr and fantasy sports. Today people in 187 countries use our mobile internet services and we have been developing these experiences across thousands of handsets including high end devices like the iPhone, Blackberry and soon Android.
Mobile monetization is in the early stages for everyone right now but it is growing quickly for us. We are having the mobile advertising discussion with our biggest clients every day. In fact we recently signed one of the largest mobile ad buys ever with a major auto manufacturer.
Partners continue to be an important part of our mobile strategy. We are a trusted partner in this space and work with over 100 OEMs and carriers to help distribute our products. We are looking to partner with the right players and ecosystems who can help us reach the largest number of engaged users.
Moving on, I know another topic of interest is what we are going to buy and what we are going to sell. You have probably heard we recently signed an agreement to sell Zimbra to VMware. We will continue to look at other parts of the business where divestitures, partnerships or outsourcing could generate incremental value and help us improve our focus. But 2010 is not about divestitures for Yahoo! Sure there might be a few but it will be an ongoing part of our business just like it is for any other company.
For us 2010 is about acquisitions and investments to make Yahoo! even stronger. We think about acquisitions in three buckets. The first are the small to medium acquisitions where we acquire important technology and the people behind it. The second is content related where we acquire a company for their audience, content or community. There are a lot of niche sites that have highly engaged users and specialty content that would fit well with our portfolio and our advertiser needs. Third is geographic, where we will make an acquisition to move into or strengthen markets like our deal with Maktoob.
What we don’t have is any current plans for big acquisitions, peer to peer type plays, because they seldom create value. Tim and I both know that success in acquisitions is as much about integration and performance measurement as it is about negotiating deals. Yahoo! hasn’t always focused well on post deal accountability but you can be sure we are committed to it now.
So what is ahead for us this year? We are done looking inward. We are looking outward at the incredible opportunities ahead and we are focused on the following areas; Great experiences for our consumers including more social, mobile and video features and improved local content. Super serving the largest display advertisers with our impressive reach and frequency, insight and analytics and of course ROI. Continuing to grow our search business with a focus on volume and revenue improvement. Moving forward with the search deal with Microsoft and of course continuing to drive operational excellence throughout the company to drive margin expansion.
So that is where we have been and where we are going but we are just getting started and we are feeling good heading into 2010. We look forward to telling you more about our progress next quarter and at our next Investor Day which will be late May. Moving forward we will meet each spring to update you on our business so please save May 26th on your calendar and we will get more detail to you very soon.
With that I would like to open up the call to questions.
Question and Answer Session
(Operator Instructions) The first question comes from the line of Imran Khan - JP Morgan.
Imran Khan - JP Morgan
I have one housekeeping question and one real question. Can you give us a sense of how much of your revenue was impacted because of cleanup this quarter? I think last quarter you talked about a $240 million impact, $60 million per quarter because of cleanup. Do you still think it will have that kind of impact? Then the real question I think recently some of the publishers are talking about how they will take back some of the inventory from the ad network and a couple of years ago given that kind of inventory being under significant pressure on the pricing. As you think about the display advertising growth next year? Obviously the economic improvement will help. How do you think the pulling inventory away from ad network that some other publishers will impact the industry?
What we had originally guided to third quarter was about 15 going to 25 of the ad quality initiatives. Instead of the 25 I would say it came in less than half that. The plain truth is we get great backfill. You saw it both in our guaranteed and our non-guaranteed side so I think that worked out really well. We had also previously guided we would go from 25 in the fourth quarter to 60. I think that is about 35 more of impact for the last installment of these initiatives. I think it is probably a little bit less than that but probably still in that 30 range from fourth quarter to first quarter. Overall I would say because of the backfill and some of this investment is bearing fruit a little more quickly than we had even hoped I would say the total impact of these initiatives instead of $240 million I would put it at well south of $200 million and maybe even something like $150 million.
As far as the exchange question it’s called or even the inventory question is called, I think there are still a lot of moving parts. First of all I think we have great relationships with most of the content providers out there. We also right now have the largest exchange in right media. We have 120,000 active buyers and sellers to there would have to be a major shift to cause any kind of a problem with display inventory. We are focusing on quality. We are focusing on quality partners. As far as I am concerned I don’t see any [plutonic] shift coming any time soon.
The next question comes from the line of Sandeep Aggarwal - Collins Stewart.
Sandeep Aggarwal - Collins Stewart
On the page views, we saw the continuation of the declining page views. Can you let me know by when we can expect a pickup in page views growth and especially in the backdrop of your global ad campaign you launched in September?
Let me talk a little bit about page views and you can too as well. A lot of the metrics people are starting to back away from page views because there is a lot happening. For instance a lot of the technology we are putting on our pages now drives page views away whether that is streaming quotes or what have you. So we are actually trying to look at as much as anything engagement. Frankly what we are really trying to look at is really great revenue growth because we deliver such good quality insights to our ad partners.
We will look at engagement because you look at engagement but seriously it really is about taking these 600 million unique and the engagement which is already number one on the internet to time spent to delivering just great revenue and insights for us and our CMOs.
As far as impact on the ad campaign, it has been out there three months now. It has sort of two real different vectors. The vector in the US is not to grow users but to change attitudes and behavior and to sort of reacquaint them with the Yahoo! brand and its vision. In places like India, parts of Europe it is to not only engage but to get known better and to grow and we have seen both things happen. Even though 3 months is way, way too soon to judge any ad campaign.
The other thing I mentioned on the prepared remarks and I would like to repeat is that the team will now be moving to a product focus. Products around promoting Homepage, promoting Mail, Messenger and that sort of thing. This will be online media mostly. Not TV. The first was just to wake people up about the fact that Yahoo! is an interesting and exciting brand, change their attitudes about us and now we roll on into introducing them to our wonderful product sets.
The next question comes from the line of Ben Schachter - Broadpoint Amtech.
Ben Schachter - Broadpoint Amtech
I wonder if you could comment on where the strength is coming from for the affiliates and how will the network distribution bidding change impact that going forward? On housekeeping, if you could comment on the comp score search share numbers. A, could you tell us if you think they are accurate? B, how much is the toolbar and where do you think that number bottoms?
On the first question the affiliate strength was really two parts as I said in my script. The currency impact, the translation of foreign currency and the win back specifically of Dom in South Korea. So those two really make up just about the whole increase. On the second question in terms of search, we are not going to comment on comp score numbers. Toolbar is obviously important but we are focused on our O&O and O&O distribution. If you look at our search volume we great it over 10% globally year-over-year for the fourth quarter. We think that is pretty good but clearly we want to do better and better and better. I devoted some space in my script to this topic and so did Carol. This is a key priority for the company. You can absolutely look for us to be very active in the space of actively increasing our volume.
Plus to make sure through quality based pricing the advertisers get great content. It really is a theme that will be driving home continuously is to have a great neighborhood. Advertisers trust us. Our users trust us. We want to always make sure we have a great neighborhood.
I didn’t address that part of the question. The network distribution clearly will have pricing gravitate towards the highest quality sites. We believe that is where we play extremely well and frankly it gives everybody else the opportunity to improve their own quality as well and see it reflected in their RPS. I think it is good for everybody.
The next question comes from the line of Mark Mahaney - Citigroup Smith Barney.
Mark Mahaney - Citigroup Smith Barney
First to do with the margin outlook for Q1. I know it is just a quarter and I know there is negative seasonality or weaker seasonal quarter but that 6% operating margin I know that is not what your long-term goal is. Are there any costs that are going to be unusual in that quarter or anything that flipped from Q4 into Q1? Then secondly could you talk a little bit about international and where you want to bring out the best improvement, where are you weakest now you really want to boost your strength and where are you most happy with your progress to date internationally?
On the first question what you have is essentially the confluence of two bad seasonal effects. Number one, it is a seasonally down quarter in terms of our top line. And it is a seasonally up quarter in terms of many of our costs. Especially in the benefits and compensation area. You have payroll taxes. You have the way vacation accrual accounting works and the like. So you will see usually a spike up in the costs in the first quarter and then a downdraft on them in compensation for the rest of the year excluding obviously the impact of any headcount hires. So it is really the mix of those two different things. We have excluded any transition costs related to Microsoft and any restructuring charges and there is nothing else that kind of missed the fourth and went into the first.
I think overall if you look at our cost structure on a normalized basis fourth quarter was about $800 million for just that short-term piece of OpEx, what we used to call cash costs and this quarter it is maybe a little bit less than $800 million. So we are taking an awful lot down in order to just make room for the benefits, payroll taxes, etc. that will naturally increase in the first quarter. Then we will continue to improve our cost position we believe and reinvest in the business to reallocate costs to more growth areas as we go through the year and beyond. So that is kind of how I would look at that guidance.
As far as international is concerned, most happy with our performance in the Asia Rim. We have great market share, great penetration. Least happy with I would say if I had to pick a country, Germany is such a big economy and we really don’t do well there. There is a long history behind that. Spain would be another one but obviously not as important as Germany. Where we are going to focus is where the bit internet populations are coming online. Indonesia, India, Brazil, Mexico, the obvious. In some of the smaller markets like Viet Nam we have great penetration. Just think of us as following internet users coming on line and that is why of course mobile is so important to us.
The next question comes from the line of Jason Helfstein – Oppenheimer & Co.
Jason Helfstein – Oppenheimer & Co.
I just wanted to follow back up on the marketing point. Do you have any kind of metrics you can share with us linked to the homepage of what the positive impact was of the marketing campaign? When you think about that longer term growing traffic and usage to the homepage do you think that will help improve the search trends?
Talking about the Homepage, of course we gave you a bit of an update at the Analyst Day. Usage continues to grow faster than the rest of the Yahoo! Network. We are very happy with the content optimization in the Today module. We have doubled our click through rate because the content is more engaging relative to what is happening that day. We also have a 200% click through increase in the local part of the news. So that is really important especially as we focus on local.
Some things we didn’t get right. In fact we are going to remove the hovers tonight it just so happens. It wasn’t for you guys but it just happened that there were enough people we were driving crazy and enough advertisers we were driving crazy because we were covering their ads. We listened and in fact that is coming off tonight.
The goal of the marketing campaign in the first part wasn’t behavior driven especially in the US. It was just about awareness of what Yahoo! is. We are just happy with what is happening with the homepage. To me that is separate from what is happening with the ad campaign.
I would just add if you look at the ad campaign itself and you pan out we are spending somewhere between 1-1.5% of revenue on that brand awareness which is right in line and maybe even still a little bit low compared to large technology companies and definitely low versus the benchmarks we have for other Internet companies. Just to put some perspective that way.
The next question comes from the line of James Mitchell – Goldman Sachs.
James Mitchell – Goldman Sachs
I am personally glad to hear you are removing the homepage hovers which certainly slowed down my Yahoo! experience. I was a little bit surprised at the entertainment revenue on the display O&O side was down year-over-year. Do you think you are seeing more competition for that vertical from pure play rivals such as You Tube?
Actually that isn’t what we think at all. Entertainment always depends to be a bit lumpy. It depends a lot on what movies are coming out and so forth. In this particular quarter believe it or not because of all the pre-buzz Avatar didn’t think it needed to have that much of an online budget. So even something as simple as that will drive entertainment. It wasn’t down all that much anyway. We don’t think it has anything to do with competition. We think it is more to do with just a seasonal ad spend.
Interestingly Entertainment was down year-over-year on the display side but it was up reasonably strongly on the search side. I don’t know what you make of it to be honest.
The next question comes from the line of Justin Post – Bank of America Merrill Lynch.
Justin Post – Bank of America Merrill Lynch
First, you had 3% growth in the first quarter and I think O&O was down I think 9% in the fourth quarter. So do you see sequentially it getting better to the point where O&O is matching your overall growth rate or is there any kind of abnormal affiliate activity in the first quarter? Secondly on the EBITDA calculation starting from the bottoms up and adding in the 170 depreciation and the 95 in SBC we get to 355-375. I am just wondering if that build is correct?
On the first question we are not going to break out O&O versus affiliates in our guidance. We will always give you that detail when we get to the end of the quarter but we are not going to go there for guidance. On OCF I encourage you to follow-up. I am just not going to talk about OCF. That is not our metric. We are moving away from it. It is operating income and if you are 90-110 in operating income and I gave you the other two numbers I think it is pretty straight forward. We would rather not talk about it because we are really moving away.
The next question comes from the line of Doug Anmuth - Barclays Capital.
Doug Anmuth - Barclays Capital
On the search side, a few new initiatives I was hoping you could talk about. The first one is network quality scores which I think started maybe late 3Q or early 4Q and also if you could talk about network distribution more in 2010 and what you think the impact of that is going to be. Also on your TAC rate for 1Q I think the 28-29% seems relatively high versus what we have seen over the last couple of years. I am curious if there is anything we should keep in mind here perhaps other than the [Dom] deal coming back?
We actually think that in network distribution that it really is going to have a very positive impact on search. It is just starting so I don’t want to forecast a specific feature or operation but it is part of a lot of efforts we have going on. We took our eye off the ball a little bit this summer as we were all digesting and helping the teams here digest the Microsoft situation and then we went full board back into development to make sure that we really added to our search quality for both the advertisers as well as real, honest to God ROI through again we talked about matching and so forth. So there is a whole lot we will probably be able to even talk about on Analyst Day we have been focusing on. I don’t want to just pull out one area.
I guess what I would add to that before going to the TAC question is if you look at quality based pricing and you looked at network distribution it is really just the next in the evolution in providing best pricing for traffic quality. That is where it is at. The goal of the quality scores is to take the quality based pricing and the network distribution and increase advertiser ROI. So we think matching pricing with the highest quality traffic is great for us and increasing advertiser ROI is obviously great for advertisers.
One more thing, back to network distribution, this is part of a series of visibility analytics that we will be giving our advertisers to really manage campaigns the way they want to manage a campaign. One of the things Yahoo! has been a little light on is the tools and analytics and things in front of the curtain instead of the Wizard of Oz behind the curtain. So you will see us continue to focus on that a lot.
Quickly on your TAC question if you look at first quarter year-over-year for TAC it was just shy of 27% last year. There is an increase in the FX rates we anticipate if everything holds of about 7/10th of a percent so that will take you in the mid 27.5% so from there you are seeing a little bit of mix of geography and a little bit of rate that will have developed over the course of the last year. I have talked about that on a couple of calls that there has definitely been a little bit of pressure on TAC rates but what you will see is somewhere in this range for most of the quarters and then in the fourth quarter it kind of fleshes downward like you saw last year. Overall that is how we look at the TAC rate. There is nothing necessarily unusual going on in first quarter especially year-over-year.
The next question comes from the line of Brian Pitz – UBS.
Brian Pitz – UBS
Based on your prior experience migrating advertisers from Panama could you give us a sense of the advertising churn you expect from the transition to Microsoft? Second, would you provide any additional detail on RPS growth between both US and international?
You know, I am not really an expert on advertiser churn. I wasn’t here for Panama. The inquire I have done just on the high levels because I am obviously interested in making sure this transition goes right, but from what I have been told without specifics it actually went very well. We were very careful about managing it marketplace by marketplace so that advertisers felt there was a working market by the time they got over to the other platform. I think we know how to do this. Of course [inaudible] knows how to do this on the Microsoft side. Nobody has put any red flags in front of me. I think that is the easiest way to say it.
On the other part, international versus US, RPS we saw advances in both. It was stronger in the US but we saw advances both in international and the US quarter-over-quarter.
That kind of stands to reason because the features roll into the US Platform first. So this technology including the matching technology we talked about is not yet available internationally as an example. So that will be something that we will be benefiting from in 2010.
The next question comes from the line of Scott Kessler – Standard & Poors Equity.
Scott Kessler – Standard & Poors Equity
Some questions have been asked and answered relating to international, I was wondering if you could provide an update about your search for a new leader within that organization? Obviously it has been the better part of a year since I think we have had someone in place. Just looking for some details.
I actually announced internally a couple of weeks ago and now that I think about it I am surprised it didn’t get out that I have decided to reorg the international arena into three regions; EMEA, Europe Middle East and Africa; Asia Pac which is everything over to India and the Americas which of course sweeps in South America. Therefore to not have an emerging markets standalone anymore and instead to have all three regions report directly into me.
I did this for a couple of reasons. I was sick of searching for the international leader and frankly didn’t find anybody I thought was up to our needs and the caliber of leader we wanted that really understood the space but more importantly as I learned over the length of time I really wanted the emerging parts of the world to be attached to more mature markets so the marketing teams and the audience teams would be able to help impact the emerging markets, give then some of their advice and learning and also to come back and be a flag bearer for what we need in emerging markets. Such as more speed, products that serve up in mobile. So instead of only one leader bringing that back to the product teams and to executive staff that we actually have three leaders worry about emerging markets and being able to affect our business there.
The next question comes from the line of Youssef Squali - Jefferies & Company.
Youssef Squali - Jefferies & Company
On Q1 guidance how much including revenues and cash flow would you say are you foregoing in that number since this is something you are stopping starting January 1 I guess? Your partner, Alibaba, came out pretty boldly criticizing your position on the Google China issue. Carol I was wondering if you could help us understand the nature of your relationship there beyond just being a passive shareholder and long-term prospects for that relationship?
We are going to continue with our practice of not breaking out individual products and certainly not their profitability. I will say as I said earlier, we used to think going from fourth quarter to first quarter was probably about a 35 negative impact. Then I said well now updated it looks like maybe more negative 30 or so. I would say the majority of that is that that paid inclusion product. Again, we are not going to break out cash flow and profitability by product.
Relative to Alibaba, we have a good relationship with Alibaba as we said. We have an investment in Alibaba. Gerry sits on their board. Really that is all there is to it.
The next question comes from the line of Jeetil Patel – Deutsche Bank.
Jeetil Patel – Deutsche Bank
You talked about revenues in O&O search up 8% sequentially, overall price…actually RPS of 8% sequentially and revenues were up about 5% in O&O search. I guess a 3% drop in click volume sequential. Can you elaborate a bit more about how that occurs when you have got the seasonal strength of the fourth quarter? Second if you look at just the overall O&O display market for you what percentage of the growth in that business line will actually come from pricing versus compression as you look forward?
On the first question, let me get the number and see what it was last quarter. Again, what you have seen is more of a focus for us certainly on the paid clicks and away from the toolbar distribution that we have spoken about a lot. Again, if you look at our volume yes I think it was down a little bit quarter-over-quarter. Let me try to put my finger on what it was third quarter to fourth quarter last year. We are focused on growing the volume which we did year-over-year and we are focused on RPS which increased quarter-over-quarter. As we go forward as Carol said we will have browser upgrade offers, toolbar offers, homepage set offers, messenger updates and toolbars go along with that. We have a lot of new products in there trending now which is really helping the soft searches, putting that maybe across the rest of the network, doing marketing on and off the Yahoo! network.
Given what you have heard externally over the last few months it is not a huge surprise what the volume is doing. I think what the good news is that RPS was up 8%.
The next question comes from the line of Heath Terry – FBR Capital Markets.
Heath Terry – FBR Capital Markets
You started to touch on this a little bit but can you give us a sense of what you are seeing in engagement? We obviously gauge this through comp score and Nielsen but there does seem to be a bit of a disconnect between what they are reporting and some of the recent comments from Yahoo! We would certainly appreciate your stance on that.
We are actually encouraged by engagement especially in some of our new areas like the today module and obviously in mail. Some are in media properties. We are actually pretty excited about some of the things that are going to be coming out in video. You know what I don’t like and what is hard to phase into is the fact that people are still engaged in our site but they are also of course playing around on Facebook. They are engaged on Facebook so you are seeing as a percent you are seeing those numbers go up very fast. We are actually happy with the engagement we are seeing with us we just can’t keep up with that kind of engagement. Does that make sense?
What we have actually worked on or what is new for us, we are driving engagement and are happy with that. We know that some of our sites, obviously sports and fantasy and so forth, engagement with lifestyles, gossip and all of that is really high. We have got less engagement for instance right now on finance because last year they were hanging on the finance pages every second trying to figure out what was melting down. When we think of integrated social, video, having sort of a more multi-dimension experience I think engagement is going to continue to grow for us.
Let me just follow-up on Jeetil’s question too because I finally found the number I was looking for. Last year sequentially O&O searches globally grew 3%. This year they were down 3%. So it is not like 4Q is this big barn burner usually. RPS yes because you get more monetizeable queries. So if you look at it up 3%, down 3%. Again I would direct this to all of our efforts in improving volume going forward and we are certainly very focused there.
The next question comes from the line of Mary Meeker and Scott Devitt – Morgan Stanley.
Mary Meeker and Scott Devitt – Morgan Stanley
So your homepage is certainly becoming more relevant as measured by recent usage and advertisers have obviously noticed as you indicated you have sold out positions, etc. At the same time, traditional content providers, the video and text guys, are at the margin aiming to change the way they expand their distribution and monetize their content. A couple of recent examples are Fox, Comcast and also the focus on the Apple Tablet. The question is with all the video usage increasingly you have on the homepage and the strong usage trends you have, is this additive to the content providers, are the traditional guys good for you or bad for you?
Do you want both questions out or do you want me to answer it? I will answer it. When we think of content, obviously let me just give you a content pitch because actually content is really very, very core to our strategy. When we think of a combination of original content, license content and links to the best of the web and then our ability to optimize this to serve up the right mix for our user, including real-time content I think we have been a good content partner and I think you can go to most publishers and they will tell you that. We also have a great relationship of course with the newspapers and with AP and with Yellow Pages and whatever. I personally don’t think as much as maybe Rupert, the fearless Mr. Jobs, think that this whole concept thing is not going to switch overnight.
A lot of content is not unique enough that unless everybody immediately goes to paid, a lot of content is not unique enough to have a special pay-per value. We certainly know content like the Wall Street Journal would be but normal news like Haiti content, Haiti content is all over. What we want to do is optimize real time on that content to add value. That is what of course a lot of other media channels can’t. So trust me, we are doing a lot of thinking on this. In light of the tablet and whatever it might be, in light of mobile, I think there is a runway to figure this out. I don’t think anything is going to flip overnight, the next quarter or the quarter after that. We are going to be in the mix because content is extremely critical to us.
Mary Meeker and Scott Devitt – Morgan Stanley
I just had one other question, the data in the quarter suggested the large online retailers grew double digits and small online retailers actually lost share and Google suggested a couple of times in its call that large advertisers outperformed small. We were wondering if you could also just comment on ad spending trends by advertiser size in both search and display?
What I will say in general because I don’t think we go to that fine line, but when large advertisers come back into the mix they come in with big dollars. So by definition they can really put a pop on it and especially when you have scarcity of high quality, high reach inventory which is what Yahoo! is. You are going to see the large guys with the money grab it. Without breaking down specific trends, that is logically you might imagine what we saw.
Thank you everybody. We look forward to talking to you next quarter and seeing you at the analyst meeting in May.
Thank you ladies and gentlemen that concludes today’s conference. Thank you for your participation. You may now disconnect.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: email@example.com. Thank you!