Marta Nichols – Investor Relations
Carol Bartz – Chief Executive Officer
Tim Morse – Chief Financial Officer
Imran Khan - J.P. Morgan
Benjamin Schachter - Broadpoint AmTech
Youssef Squali - Jefferies & Co.
James Mitchell - Goldman Sachs
Mark Mahaney - Citigroup
Justin Post - BofA Merrill Lynch
Spencer Wang - Credit Suisse
Jason Helfstein - Oppenheimer & Co.
Brian Pitz - UBS
Douglas Anmuth - Barclays Capital
Yahoo! Inc. (YHOO) Q1 2010 Earnings Call April 20, 2010 5:00 PM ET
Good afternoon ladies and gentlemen, and welcome to the Yahoo! Q1 2010 earnings conference call. (Operator Instructions) I will now turn the call over to Miss Marta Nichols. Miss Nichols, you may begin.
Thank you operator and good afternoon. Welcome to Yahoo!’s first quarter 2010 earnings conference call. On the call today will be Carol Bartz, Chief Executive Officer and Tim Morse, Chief Financial Officer.
Before we begin I’d like to remind you that today’s call will contain forward-looking statements concerning matters such as our expected financial and operational performance, our search alliance with Microsoft, our marketing and product plans, 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. 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-K, filed with the SEC February 26, 2010, as well as in the earnings release included as Exhibit 99.1 to the From 8-K we furnished today to the SEC.
All information discussed on this call is as of today, April 20, 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’ll also discuss non-GAAP financial measures as we talk about the company’s performance. These may include total expenses less traffic acquisition costs or total expenses less tax, depreciation and amortization, and stock-based compensation expense, non-GAAP net income and non-GAAP net income per share. Reconciliations of those non-GAAP measures to the GAAP measures we consider most comparable can be found on our corporate website, info.yahoo.com, under Investor Relations.
Carol and Tim have prepared remarks that will last about 30 minutes and then we’ll have a brief Q&A session. And with that I’d like to turn the call over to Carol.
Thanks Marta. Hello everybody and thanks for joining us this afternoon. Today we’ll talk about the quarter and our financial results in detail, address some topics of interest including the display and search ad markets, the implementation of our search agreement with Microsoft, and an update on reinvestments. And of course, we’re happy to answer your questions.
First let’s talk about Q1. The economy continues to improve. We delivered what I’d call a solid quarter. Revenues stabilized and profits were up. The headline news is that display advertising grew 20% year-over-year ahead of the market. More importantly, guaranteed display grew by 24% as large advertisers came back. That means their purse strings are starting to loosen up. A lot of them have been lying dormant or only doing the minimum. And now as the economy does better they’re re-emerging to aggressively position their brands online. As the market leader in display, we’re well positioned to benefit from this trend.
As for search, we told you last quarter that we really intensified our focus and efforts around search volume. These efforts, such as marketing search on and off the Yahoo! network, new toolbar and browser offers and search integration across our properties have paid off. As a result I’m very pleased to report that we stabilized our search share and believe it will trend up in Q2.
And of course due to regulatory clearance this quarter, we have more tangible information to share with you on the Microsoft transition.
One last thing before I turn it over to Tim. On a directional note, we started doing some really forward thinking and creative things on the advertising side. They have our sales team, agencies and advertisers really energized. We’re already seeing some of these initiatives help us engage with advertisers on a whole new level. I’ll talk about this and more, but first Tim will cover the financials. Tim?
Thanks Carol. Although revenue landed roughly 2% shy of the midpoint of our outlook, this quarter we made important strides across a wide variety of areas impacting both our income statement and balance sheet. Today I’ll review first quarter financial performance in detail, provide our second quarter outlook, and additionally outline our full year expectations for the expense impact of the Microsoft search alliance.
I’ll begin with a summary of our headline metrics, revenue, operating income and earnings per share. These numbers were affected by a couple of large items this quarter; namely, Microsoft reimbursements related to our search alliance and the sale of Zimbra, which I’ll separate out for you.
GAAP revenue of $1.597 billion grew by 1% year-over-year, the first growth we’ve registered since 3Q ’08. Operating income of $188 million grew by an impressive 87%, aided by two reimbursements from Microsoft, $35 million of search operating expense reimbursement and $43 million in net transition cost reimbursement. Neither of these reimbursements was included in the outlook we provided in January and we believe you should treat these reimbursements as two separate and unique items.
Let me provide a bit more color there. The $35 million for search operating expenses represents the initial step on the path to the long-term cost savings we anticipate as a result of the alliance. So the favorability is an ongoing piece of our cost structure. The $43 million, on the other hand, relates to reimbursement of transition expenses incurred in 2009. That amount should be treated as non-recurring. Excluding the non-recurring item, operating income was $145 million, up 44% year-over-year with operating margin expansion to 90%. This result is the first tangible financial benefit of the search alliance.
Turning to earnings, the $0.22 per diluted share we reported included $0.07 of unusual items, primarily $0.05 from the sale of Zimbra and $0.02 from the non-recurring transition reimbursement I just discussed. Excluding those items, EPS of $0.15 per diluted share was up 77% year-over-year due to cost structure and tax rate improvements.
I’ll return to the impact of the search alliance in more detail later, but with that as high level background, let’s start at the top of the P&L and walk through the results in more detail, beginning with our O&O display revenue. O&O display registered very solid, 20% year-over-year growth. We saw particular strength in guaranteed placement, with revenue up 24% on strong double digit yield improvements versus last year. Non-guaranteed revenue grew modestly compared to 2009 on lower impressions offset by better yields. With an improving economy, we’re seeing demand shift from non-guaranteed placement to guaranteed, as expected.
Geographically speaking, all regions grew versus prior year, with North America and Asia up strong double digits. Our latest international acquisition, Maktoob, performed in line with plan. Finally, with respect to category performance, seven of ten industry segments rose versus last year and three were roughly flat. Though the improvement was broad based, led by retail, travel, autos, and CPG.
O&O search was more of a mix story for the quarter. Year-over-year, revenue declined 14% driven mostly by lower RPS. We’re pleased, however, that the RPS trajectory improved sequentially for the second straight quarter, led by 2% growth in the U.S. That’s particularly significant given that the December quarter is traditionally the strongest for monetization, typically followed by a lower 1Q.
From a category perspective, half of our industry segments were flat to up and half were down versus last year. We saw particular strength in CPG and telecom, and weakness in finance. Our global search volume grew slightly on a sequential basis and by 7.5% year-over-year. From a U.S. perspective, while we under performed the market in January and February, our share stabilized in March. As Carol noted, we’re aggressively working on a combination of product enhancements, search related marketing spend and perhaps most importantly, harnessing the power of the Yahoo! network as a search distribution channel. As a result of these efforts, we believe our search query this year has bottomed and will begin to trend upward in the second quarter.
Moving to our affiliate business, results there were up 7% compared to prior year, primarily driven by currency gains and the Dom affiliate win back we discussed on our January call.
Rounding out the top line results, our listings fees and leads businesses registered a decline of 12%, with the biggest impact coming from the shifts in our broadband relationships, which have moved from being fee driven to advertising driven.
Turning now to costs, as you heard in my opening remarks this quarter’s results obviously have some puts and takes to them, so I’ll discuss each element to insure clarity. First, traffic acquisition costs were 29.2% of revenue, just a touch above the high end of our projected range. For the quarter, total expenses, including both costs of revenue and operating expenses, were $1.409 billion. Excluding tax of $467 million, our expenses were $942 million, down 11% from prior year. As previously noted, our expenses benefited by $78 million related to the search alliance.
I’ll take a moment now to explain the two components I mentioned earlier, the $43 million in net transition reimbursements and the $35 million in search operating reimbursements in more detail. Slide 14 of the earnings presentation may also help. Looking first at the transition cost element, recall that Microsoft agreed to pay us up to $150 million to help defray the costs associated with our transitions to their systems. Think of these costs as unique to entering into the alliance. Costs like legal fees, retention, engineering, consulting, training and more, all direct and incremental costs related to getting our search to ultimately be powered by Microsoft. If you think of the $150 million as a declining balance, this quarter we billed $43 million of 2009 costs and $24 million of 1Q 2010 costs against it. In other words, we’ve used up $67 million and there’s $83 million left. For the remainder of 2010, the transition costs we incur each quarter should roughly wash with the transition reimbursement billings, so you shouldn’t see an impact to our P&L.
Now I’ll move to the $35 million in operating reimbursements. Since we received regulatory clearance and began implementation on February 23, Microsoft has been responsible for the costs of running our paid and algorithmic search platforms. Until we move to their system, Microsoft will be reimbursing us for specific search operating expenses. As you build your own financial projections, understand that the $35 million represents the first evidence of the ongoing savings we anticipate from executing the search alliance.
Finally, let’s put the Microsoft related items aside. Our underlying expenses were about $45 million favorable to guidance. Roughly $13 million of that is due to spending efficiencies and the remainder was primarily attributable to stock-based compensation. Both share price and forfeitures were favorable to our original estimates.
Continuing down the income statement, I already touched on the ongoing operating income of $145 million, up 44% from 2009. I’d briefly add that 9% operating margin on GAAP revenue is a 3 point improvement from last year’s 6% margin. As you’ll recall, we are committed to expanding margins to 15% to 20% by 2012.
Below operating income, we had two other notable contributors to our net income and EPS. First, our sale of Zimbra generated a $66 million pretax gain. We had sufficient capital losses to offset capital gain, so the full $66 million fell through to net income with no tax impact. Second, we took the benefit of certain tax advantage transactions this quarter that lowered our effective tax rate. I’ll return to this topic in a moment, when I update our full year tax rate expectations.
Before moving to the second quarter outlook, let’s take a moment to review a few key balance sheet metrics. Cash and marketable debt securities ended the quarter at roughly $4.2 billion. During the quarter, we picked up the pace of our stock repurchases significantly, buying 24.8 million shares at an average price of $15.54 per share, for a total of about $385 million. Our cash flow from operating activities was roughly $144 million. While this result was lower than implied by our operating income result, over $100 million of accrued Microsoft reimbursements were not actually received as cash within the quarter. CapEx was $113 million for the quarter due to a pickup in a typical data server and other equipment purchases.
Finally, as of March 31, the pretax value of our 35% stake in Yahoo! Japan, and our 29% indirect stake in Alibaba.com was $10.4 billion or approximately $7.35 per share. These figures are based on public market quotes and do not include estimates of the value of Alibaba group’s privately held businesses.
Now let’s look at our outlook for second quarter. On the top line, we see revenue in the range of $1.600 billion to $1.680 billion. At the midpoint of this range represents roughly 4% growth compared to second quarter 2009. Traffic acquisition costs should be roughly 29.5% of revenue. Our total expenses less tax are expected to be in the range of $970 million to $990 million, including D&A and stock-based compensation expense of roughly $225 million. These ranges yield an operating income outlook of roughly $155 million to $195 million, up 130% at the midpoint versus Q2 ’09, or up 24% excluding the $65 million restructuring charge we took last year.
Taxes for the quarter should return to the 35% to 40% range and ultimately drop to 25% to 30% for the full year.
Before we leave second quarter, let’s insure that everyone understands the cost component of our guidance. Most notably, the total impact of the search alliance will be roughly the same in 2Q as it was in 1Q. The total search alliance benefit in first quarter was $78 million, with $43 million of non-recurring transition cost pickup. In 2Q, we won’t have that $43 million, but we will have a full quarter of the ongoing search operating reimbursements, which we anticipate to be in the range of $75 to $85 million. Therefore, excluding the Microsoft impact from both quarters, our costs are expected to be up approximately $40 million sequentially. The biggest drivers of any additional spending are salary increases, search advertising and seasonal marketing costs.
We intend to stick with our practice of providing only quarterly guidance for revenue in operating income this year, but since there are so many ins and outs to our 2010 expenses, we’d like to provide more insight regarding the full year view. This year we anticipate our total expenses less tax to be in the range of $3.850 billion to $3.925 billion, including roughly $880 million to $900 million of D&A and stock-based comp. At the midpoint of this range, expenses will therefore be down about 10% versus 2009. Excluding tax, D&A and stock-based comp, our core spending will be roughly flat with 2009.
As a final note, comparing our 2010 cost structure to that of 2008, total expenses less tax and goodwill impairments are down approximately 20% over the two year period. I realize that’s a lot of data to digest, so thanks for staying with me on it.
Before turning the call back to Carol, I’d just like to take things up a level for a moment. Our underlying business performance is clearly improving. Our revenue is returning to year-over-year growth, led by display. We’re transforming our cost structure to support our growth and profitability objectives, and our earnings metrics are showing substantial gains versus last year. And now back to Carol.
Great job Tim. Your favorite numbers are 35 and 43?
How many times did I say those in the script?
A lot. Thanks a lot. Now I’d like to talk to all of you about a few things that are important to Yahoo! and the investor community. First up, the ad market. As I mentioned earlier, the display market is coming back. With this comeback the quality of advertisers is on the rise, and that means the quality of ads are also up. These advertisers are looking for new, creative ways to get in front of consumers. In response, we’re talking about we were taking what were ad hoc processes in the past and putting real business processes around them. This includes packaging and marketing our absolutions in a really differentiated way. We’re talking to advertisers about taking the digital canvas we own and doing something unique and creative with it, something that engages consumers on another level. And we’re merging it with our science that keeps getting better with our targeting deep consumer insights and tools that use these insights to optimize performance in real time.
We’ve been actively promoting our position in the marketplace with what we like to call the Power of Three; science, art and scale. You see only Yahoo! offers all the pieces needed for great online advertising today; the science to understand and target an audience, the art to create lasting engagements with consumers through context, and the scale to reach the right person in the right setting in meaningful numbers.
Nobody’s taking advantage of this new approach better than one of our biggest advertisers, Wal-Mart. They wanted moms to know that Wal-Mart is the best resource for making life easier and they wanted to reach moms wherever they are, in store and online. We already knew where moms were on the web, so it was easy for us to develop a custom marketing plan to deliver Wal-Mart’s messages across the Yahoo! network. This is Wal-Mart’s single biggest digital advertising initiative to date in terms of dollars, scale, creativity, you name it; it’s huge. Each month Yahoo! will help Wal-Mart reach an estimated 23 million moms an average of 5.6 times. Put another way, more than 7 out of 10, listen to that, 7 out of 10 online moms will see this marketing message in an average month. Wal-Mart’s been very impressed.
Now I’d like to talk for a moment about search. I don’t think it’s any secret that for the past 18 to 24 months we’ve had a tough row to hoe in search. And there was definitely a sugar low after we announced the Microsoft search alliance last year. We had a lot of work to do internally to get ready for it, and we weren’t aggressive enough on volume, even though we were focusing on improving RPF. But all of that is past now. We believe search share has bottomed and will trend up in the second quarter, thanks to our work to grow volume. A key part of these efforts has been using the power of the Yahoo! network, not just externally but internally as well. Our teams are now integrated and aligned around our goal, and I can tell you that in addition to this play, there’s a renewed energy among Yahoo!s around search. We’re really excited about our product plan.
And that also includes work to improve relevance in a ROI for advertisers that will continue until the transition to Microsoft is complete. Speaking of Microsoft, we’re deep into detailed planning to insure we transition users, advertisers and publishers with quality. Our aim is a high quality transition starting with the U.S. prior to the 2010 holiday season. Both companies are very engaged in this process, and there’s a lot of work to do. Remember, it’s all about providing the best product to users, advertisers and publishers, and we’ll only begin the transition when we’re absolutely ready.
Tim already walked you through the financials around the Microsoft search alliance and how we plan to use some of the cost savings to reinvest back in the company. Hopefully these plans come as no surprise. A year ago on this call, I talked about major initiatives we had planned to better position Yahoo! And I really want to re-emphasize where we’re putting our dollar. First, our investment to globalize, modernize and improve our consumer products and second, our efforts to improve the advertising experience and ad serving and monetization platforms. As I said then, that first initiative was a two year effort. We’re right in the middle of the process of modernizing our platforms and we won’t see these costs begin to fall until the summer of next year. The idea is to develop platforms in the cloud where we can quickly retrieve content, and put it anywhere on any property in the world. And of course, that gives us greater scale and efficiencies.
On the second initiative, we’re continuing to enhance our ad platform. The latest release allows for improvements in forecasting and delivery management, to drive better accuracy and yields. We also deployed the next generation of our behavioral targeting capabilities and we’re experimenting with yield optimization across guaranteed and non-guaranteed marketplaces. Look for us to roll off our two old ad platforms to this latest release of app over the next 18 months, first in the U.S., then in international markets.
We anticipate that all of the investments I just mentioned will run $200 million this year. If you remember back to when we talked to you about the efficiencies and rationale behind the Microsoft search alliance, this is where the reinvestments we discussed are going.
I want to discuss another item, and that’s the interest that people seem to have around executive transitions. To be honest, it’s borderline strange, the obsession some of these folks have. What surprises me is all the great people we’re tracking seem to get less attention. I mentioned last quarter we hired Shashi Seth, an expert in the search industry, to lead our efforts around search. And of course we just announced our new Chief Product Officer, Blake Irving. Blake brings large scale Internet experience, most recently with Microsoft as Corporate VP of the Windows Live Platform group. Blake will lead our talented team and is responsible for the vision, strategy, design and development of our global consumer and advertising products.
I’d also like to take a moment to thank Ari Balogh, who’s been our CTO and head of Products. Ari’s been instrumental in our product initiatives and we wish him all the best and safe travels.
Let’s move on to discuss some of our user highlights from the quarter. I know a lot of you tuned in to our Olympic coverage in February, and we are so pleased, as you are, with our performance. We racked up 70% more users and logged 40% more time spent than NBC’s online Olympics coverage. And we didn’t pay a cent for broadcast rights. We’ve always been focused on specific events like the Olympics, not just as short term traffic drivers but also as ways to draw users into the Yahoo! experience, and more deeply engage with them over time. Yet we know we can’t run a business just waiting for major sporting events, award shows and natural disasters. In earlier quarters you heard me mention that we need to attract these types of audiences every day. That’s why we’ve been using our unique approach of combining human editors to choose great stories, and letting our content optimization engine determine the best content for our users.
I want to talk with this content engine for a second because it’s an amazing technology that has been growing more and more advanced over the last several months. In its first iteration, our content optimization engine recommended the most popular news items to our users. The result was 100% click through rate increase over time. In January, we introduced release two of the engine, which included some of our behavioral targeting technology. This capability, coupled of course with great content, led our today module to experience click through rates 160% over pre-engine implementation. Our large and engaged audience is also an important reason why our content partners choose to work with us.
Case in point, this past quarter Yahoo! Sports scored an exclusive deal with major league baseball to become the league’s official Fantasy Baseball Game. And while we’re on the subject of sports, we also made an important acquisition with Citizen Sports. They create popular games for the iPhone, Android, Facebook and more. In fact, their Sportsacular iPhone app is ranked in the top 20 for sports, and is highly rated by users. Citizen Sports brings to Yahoo! a combination of mobile, social and interactive experience that will begin with our sports properties but will then be incorporated to really jazz up our other media sites. Look for us to remain focused on acquisitions like these that improve the Yahoo! experience.
Elsewhere on the social front, we entered into a global partnership to integrate Twitter’s real time social experiences throughout Yahoo!’s global network, not just in search but on our homepage and all of our media properties, too. And you know we’re also increasing the level of integration with Facebook, allowing users to update their Yahoo! Social and Facebook status at the same time. These kinds of integrations are important to us. While we’re not a social network, social interactions are becoming increasingly important to everything we do.
Just look at what happened when we recently introduced comments on our news stories. Two weeks after launching the feature, we had more than 60,000 comments on just one article. It’s an amazing example of how our users want to interact on our network.
On the mobile side, we signed a major mobile search and search advertising dealer with Telefónica in Europe. We also released a trio of new apps; Yahoo! Sketch-a-Search and Yahoo! Search for the iPhone. And we were one of the first apps on the iPad, with Yahoo! Entertainment. All of these apps have gotten great reviews from users and have been ranked highly in their respective categories.
And just last week we launched a product from our video partnership with Reveille. The show called Who Knew? is sponsored by Toyota and runs on Yahoo! News. Already it’s a proven success. On its second day, it hit 1 million streams. That’s an insanely high number in the world of online original programming for a show that just launched. Now all of our key verticals, sports, news, finance, entertainment have sponsored video programs. We’ve been doing a lot of these programs on our own out of a closet in Santa Monica, but now we have producers in their agencies like Reveille coming over the transom to work with us. Consumers love these videos and they’re in very high demand with advertisers because they command consumer attention in a much more impactful way. By the way, that means not just higher ROI for advertisers, but premium pricing for us. Look for more of these original, low cost, highly relevant video snacks from us in the future.
These branded entertainment partnerships are just one example of how we’re using our unique combination of science, art and scale to improve the importance and outcome of online advertising. We’re constantly finding new ways to go to market with advertisers to help them shift their budgets online. Toyota and Wal-Mart are just two examples. Look for us to launch new ad experiences around cooking, travel, and more in the future.
It’s all about creating a new approach to help advertisers with the biggest challenges they share with us. One, they want to shift more budget to where consumers are online. They want to stand out and be creative in how they reach consumers. And they want a Yahoo! that’s easier and meets their needs.
We recently took on a challenge that faced the PhRMA industry, how to use interactive online video to brand their products while at the same time meeting FDA legal requirements. So we developed a compelling new ad unit for the industry called an enhanced, interactive ad. And we’re doing it at a scale that only Yahoo! can deliver. We just launched this and already we’re getting great feedback. Last week a huge PhRMA advertiser told us that this new ad unit now gives them the justification to move a significant amount of TV dollars online. And that’s just scratching the surface.
We’re now innovating at a much more rapid pace. In the last three weeks alone, we’ve created multiple new ad units that have major retailers and auto manufacturers excited to use our network to reach their target audience. And this isn’t just talk. Just this week, Yahoo! ranked first in a survey about value for the investments among online media. The survey, conducted by Jack Myers Media Business Report, puts us ahead of Google, AOL, MSN and everyone else.
Before I close, I’d like to draw your attention to a significant event that occurred on March 2, Yahoo!’s 15th birthday. We’ve come a long way from our humble beginnings in a trailer at Stanford to our more than 600 million users today. And while many major sites have come and gone on the web, we’re still here and thriving. Yahoo! is important to a huge consumer audience and a key ingredient in many, many media plans. We’re looked to for innovation and leadership within the digital space; not many other Internet companies can say that.
And while I’ve only been here a little more than a year out of those 15, I can guarantee you that we have much, much more in store. We’re excited about it, and it’s why I’d like to remind you to join us for our upcoming investor day on May 26 at the San Jose Fairmont.
And with that, let’s bring this part of the call to a close. As you come away from today, I’d like you to remember at least three important things. One, we’re hard at work executing the Microsoft search alliance. Two, we’re investing for growth and efficiency. And three, we are leaders in online advertising as evidenced by meaningful 20% growth year-over-year in our display performance.
Now let’s open up the call to your questions. Operator?
(Operator Instructions) Your first question comes from Imran Khan - J.P. Morgan.
Imran Khan - J.P. Morgan
Two quick questions, one, trying to understand the search business. You know it was down 14% year-over-year. How much was search revenue growth rate was negatively impacted because of clean up like paid inclusion? Can you give us some color? And do you still think your search revenue will be up for the year? And secondly with regards to display business, displays up 20% year-over-year, you know can you give us some color? Like do you expect the growth rate to accelerate as we get into the second and third quarter? Can you give us some color on that?
On search, the impact of the various clean ups including the inclusion is roughly $30 million year-over-year. And as far as total year, we’re just going to continue to take it quarter by quarter and we’ll see how the year unfolds. I would say if you look at display, we feel great about our position there. We feel, as Carol said, that the purse strings are continuing to open up and we’re in a unique position to serve our customers, the advertisers, allowing them to engage the way they want to with their target audiences. So we feel great about our momentum. We’re not going to break out our guidance for next quarter nor for any of the coming quarters, but again I think we’re well positioned. We feel good. I mean 20% growth in display year-over-year for the quarter and 24% increase as both Carol and I said on the guaranteed side feels real good.
Next question, please.
Your next question comes from Benjamin Schachter - Broadpoint AmTech.
Benjamin Schachter - Broadpoint AmTech
In the Slide presentation you talk about page views being flat year-over-year. I’m wondering one, is that the right metric we should think about? And more broadly speaking, how do you increase the engagement? How do you get more relevancy back for Yahoo!? And then just want to follow up briefly if you can give us any specifics on how you’re going to use the Yahoo! network for more search distribution.
Let me take a whack at that. Listen, all these metrics that people look at, we consider important. Engagement I believe is among these as the most important, and we’re working really hard to drive engagement up. Engagement’s really flopped around a lot by mail engagement, which when it just hiccups a little bit it moves the whole company around. But we talk about how to get it up, we’re focusing a lot on this and this is everything from having more interactivity on our sites through comments and voting and buzzing, video, real time content, better targeting. Because if we target better, people will stay engaged. For instance, on my home page I see something different than Tim does. You know he gets sports, I’m right now getting diet recipes, which is irritating a little bit. I don’t know why they targeted that, but the point of the matter is better targeting, more video, more interactivity, these are things we’re working on because these things really affect engagement.
Your next question comes from Youssef Squali - Jefferies & Co.
Youssef Squali - Jefferies & Co.
Just want to go back to the search discussion. When you talk about seeing stabilization in search query share, are you talking about the whole quarter or are you basically using the same data we’re looking at from third party that says that you’ve seen that in March. Also as you look at your RPS it was down slightly, I think you said. Do you also believe that it’s going to basically be bottoming out here? And how much of the pressure there really came from advertisers, large advertisers in particular becoming smarter about their ad spend and maybe moving towards more SCO and long tail key word buy in?
So on the search share, in March we stabilized up 8 basis points. We’re just quoting the same external sources as you. And as Carol said, we’re going to trend upward here in the second quarter. As far as RPS, RPS was yes down on a year-over-year basis which contributed to a bunch of the decline in the revenue but for the second straight quarter as I said in my script, up in terms of sequential growth. So from fourth quarter to first quarter, most notably up 2%. You know we feel like we’re doing a really good job on RPS, put in a lot of improvements in the fourth quarter that I think contributed if I remember the numbers correctly 8% sequential growth then. So we feel like that’s on a pretty good trajectory.
As far as large advertisers becoming smarter, you know the different ways they buy and the key words, I’d say I don’t know that we’ve seen anything like that, certainly not as a contributor to RPS.
Well, we’re not a long tail buy. Our strength is search and display and the combination of doing a good job with that. So you know that is what encourages our advertisers. We have a presence in the tail, but it’s, you know, head and torso, that’s where the big dollars are.
Your next question comes from James Mitchell - Goldman Sachs.
James Mitchell - Goldman Sachs
I wanted to see if you could provide a little more color on your tax guidance for the rest of the year and what’s driving the tax rate lower. And also just as a kind of clarification, I think in the 10-K you guided for O&O revenue to be up year on year and affiliate revenues to be flat year on year in the first quarter, which I assume reflected quality based price, whereas in reality O&O was flat and affiliate was up. So I wondered what changed between the 10-K and the end of the quarter.
So first on our taxes, well I guess I could actually be more specific. Over the last few quarters we have certain tax advantage transactions that, depending on factual circumstances you put up reserves against. And as those facts and circumstances change, you release reserves. So some of these transactions we’re able to release reserves this quarter, so in classic kind of tax language that’s a discrete item as was the fact that Zimbra fell through to the bottom line without tax, because we had sufficient capital losses on our balance sheet to offset the capital gains. So that’s kind of what happened with first quarter.
If you take out, you know, versus the guidance the normalized rate was in the low 20s versus guidance of 35 to 40, so there was probably $28 million aside from Zimbra that you could tag to the discrete item.
In terms of total year being down in the 25 to 30% range, essentially what you see is 18% from first quarter, 35 to 40% in the second quarter. That puts the half at roughly 25% if you do the math. And so what we’re implying then is the second half will also be maybe a little bit north of that, maybe as high as 30%. When you put them together you get 25 to 30%. So what we’re doing is we’re working on a number of items, discrete items, yes, there could be more discrete items, but the things that are more interesting to me are the structural items. Just changing the ongoing baseline tax rate for our company, and I would say that we probably made from the typical baseline that people think about in the low 40s, we’ve probably made 5 or a little bit more than 5 points progress there. And we’re continuing to kind of bash away at that.
In terms of your second question on results, with O&O flat, what ended up happening is we saw some good strength in display, basically as expected. Search was a little bit weaker than we expected, primarily based on volume. And from what I’ve read anyway, the whole market was a little bit slower pace in the first quarter than we had anticipated. So even though we a little bit under performed the market in January and February, shares stabilized in March but for the whole industry from what I’ve read that volume query growth was no great shape. So that was definitely part of it. And then of course affiliates picked up a little bit to obscure some of that. And that’s basically kind of the math on it.
Your next question comes from Mark Mahaney – Citigroup.
Mark Mahaney - Citigroup
Two quick questions. International, any particular color on the nice growth you saw in international markets year-over-year or is that mostly just the Dom agreement? And then one more time on the search query share, you know it struck us that a lot of the comScore data that everybody seems to point to is relatively inconsistent with some of the trends that you yourself have reported. So is there something else you’re seeing in that March quarter other than the comScore data that indicates to you that there’s stabilization? It seems to us it’s exaggerated the strength and now the weakness in your search results.
Well, Mark, we’re very careful at looking at what you look at. And so you look at comScore, yes, we have a lot of internal data, but we’re not fighting comScore on this. So we’re looking at what you are and we’re looking at what we’re doing internally, which is why we’re forecasting that we will actually trend up. We know that one month is only a data point, but we’re sticking it out here with you and saying we have a lot of effort going into this and really believe that we not only stabilize but we’ll drive volume up and therefore share up.
International growth, the drivers, you know, good display advertising in Asia, very strong. Actually, strong in Europe as well, just not up to double digits, so we actually performed well all over the world.
And Mark, the currency impact was primarily on the affiliate line. There wasn’t nearly as much currency impact just to our own either O&O display or O&O search.
Your next question comes from Justin Post - BofA Merrill Lynch.
Justin Post - BofA Merrill Lynch
First on the spending, I think $40 million quarter over quarter, Carol how do you plan to measure that or we as investors understand the benefit? And when would you expect to start seeing that pay off with some positive returns? And then, any update on the asset distribution in China or any way you can kind of monetize those assets which make up a significant portion of the value of your company?
Yes, let me first talk about the investment and maybe give you even a little more color beyond the script. I think it was exactly this call a year ago when I talked about globalization and product silos and so forth, and maybe a few months after that as I was busy discovering things talked about the fact that we had three ad platforms and we really needed to get that modernized. You know, and at the time I said this was a two year process. Let me tell you what it really gives us and by the way as I said in the script, that’s when you’ll start seeing the costs start filtering off is mid next summer. What it really means for us is a lot more speed and flexibility in serving up great content for our users.
Now, what do I mean by that? Right now, just as our products are in silos, our content is in silos. So if for instance finance wants to put a news article up, if they didn’t do a deal with that news feed, they can’t find that piece of data because that’s owned by the front page or the newsgroup. And so everybody’s out there, on their own, in each property and each property times each country, trying to get information up on the site. Equally important is, for instance when we do the Twitter deals and Facebook deals we talked about, every property has to integrate it uniquely. So for instance we can’t just integrate Twitter across our media properties or Facebook across our media properties. Everything has to be done one off, which is why we’re doing what we’re doing. So we’re talking about content agility in the cloud, we’re talking about just faster and more real time information for our users, and our benefit of really sharing content around the world.
The other thing that I would tell you is so important is we are for the first time putting in a consistent video platform for the company. We have had, again, every property had a unique video platform so we could not serve videos up in a consistent way, even in the U.S., much less anyplace else. And as I just said, video drives engagement. Video is exactly what advertisers are interested in. In fact, there’s an interesting fact that a TV user is willing to watch 6 to 7 minutes of video ads per month on a site versus an average of 4 minutes on it with everybody else. So getting video in a big way for us is really important.
So when you ask, you know, what are you going to see? Well, you are going to see costs coming off. You’re also going to see a lot more real time and interesting content on our site.
If you’re looking how to measure the payoffs of any of the spending that we’re doing, just remember that we guided to expand our margins to 15% to 20% by 2012 and that, to me, is the best way to chart this course. You know we’re up at 9% right now, you know, 3 points better than kind of that base line of 6% that we typically talk about. And our efforts are around driving the right investments to take out costs, the right investments to drive our growth and profitability so that we can keep marking progress toward that 15 to 20%. And there’s an awful lot that we’re working on that we feel very good about in that regard.
In terms of monetizing the China assets, you know to be honest, again, we see those as a terrific investment that are becoming more and more valuable over time. It’s a great way to play the Chinese market, the management team there is fantastic, they’ve got a great position. We’re very happy to be part of that. We think that that’ll be worth much more again as we go forward here. So really, you know, not a whole bunch we can do, especially when you talk about the private parts of Alibaba group.
Your next question comes from Spencer Wang - Credit Suisse.
Spencer Wang - Credit Suisse
So I guess the first question is for Tim. Just on the search expense reimbursements, I guess the guidance is for about $275 million for 2010 and it does represent I guess the long-term cost savings. Where could that go to in 2011 before you get to the $650 number in 2012? And then just lastly, the buyback of $385 million this quarter, is that what we should be thinking about as a quarterly pace for you guys?
On the first question I would say, you know, if you look at roughly $80 million per quarter of reimbursements, that’s fairly representative of the product and infrastructure piece of ultimately the $650 savings that we’re going to generate from this transaction or this alliance. Where that goes in 2011 really depends on how quickly we transition onto all of the platforms and start to get more of the, if you recall the $650 savings is broken down into $225 of kind of the non-cash charges, which we’re starting to make progress on and we’ll continue to make progress on I think into next year, some good progress. The other piece then is $425 of what we used to call cash costs. So you could say 80 times 4 is 320, 320 of the 425 is this product cost. So that say $100 million delta, you know we’re continuing to work on it and have to figure out how much of that we can do now before complete transition, how much of it takes a couple of years.
A lot of kind of moving pieces to this, so we’re not really in a position to give you really good numbers for next year yet, but we’ll continue to work in that direction obviously.
In terms of the share repurchase in first quarter, you know, we’ve said that we want to offset dilution of our equity programs. We made some great progress on our equity program expense obviously this quarter, some of which is just pure accounting tailwinds for us as earlier years at much higher volatility rates and share price rates kind of roll off from the expense statement. So a lot of it is a lot of discipline on our part, too, and getting better on awarding people with stock-based compensation in more targeted ways. So that has come down. But nevertheless we are committed to continuing to offset that dilution. I wouldn’t say necessarily in any one quarter over any one year. I mean what you saw in the first quarter is we had a great opportunity to buy the stock at you know prices that we thought were terrific and represented on a long-term value. I mean we bought them at $15.54 if you recall from the script. So that felt like the right thing to do. We’re always going to be looking opportunistically to buy back stock where we see a great deal.
I’m obviously not going to tip our hand in terms of quarterly run rates or anything like that because I think it defeats our purpose. But you can definitely look for us to always be opportunistic in this regard.
Your next question comes from Jason Helfstein - Oppenheimer & Co.
Jason Helfstein - Oppenheimer & Co.
Long question on search. We’ve heard that you guys are now offering advertisers to buy both O&O and network search separately. Can you talk about the ramifications on search because one would assume that would be positive on your O&O monetization?
You know, what you’re talking about we talked about last call, called network distribution. We’re always adding features to our search offerings. As far as we’re concerned, they’re features, so there’s nothing to discuss actually about that specific feature. We thought it was important because it’s something our competition does. And it’s just another one of our initiatives that we’re trying to do to stay up with competition, to make sure that we can continue to differentiate, I love that word. And again whether it’s quality, safe pricing, domain blocking, all those sorts of things. So there’s nothing special to talk about with network distribution.
Your next question comes from Brian Pitz – UBS.
Brian Pitz - UBS
Carol, as a follow on from earlier comments regarding engagement and content on the site, could you update us on your thoughts on the right mix of premium content versus longer tail, essentially [curated] content going forward, especially in the context of what some of your competitors may be doing? And then just secondly and related, could you discuss really what type of content you’re advertisers may be specifically asking you for.
Well actually, you know, we think we are really the content play on the Internet. And you know whether that’s partnerships or our original content, you know one of the things that if you look over the last quarter, we’ve hired three very interesting editorial folks, one from political, one from ESPN and one from Good Morning America, ABC, to do some of the premium content for us. We’re also very interested in blogging and getting what you would call long tail curated content.
And you know the other thing that I think is very unique to Yahoo! is our entertainment content or our video snacks. So as to what our advertisers are looking for, they love video. They love video. There was a major advertiser in that I met with this morning on campus. This is the theme I’ve heard all quarter, creativity, how to appear special online, movement, immersion, interactive ads. You know people are just interested in new formats and just new applications. And you’re going to hear us talk a lot about our digital canvas. We’re actually trying to think of that screen as much more of an artistic canvas because ultimately we like advertising to be as interesting as content.
Your next question comes from Douglas Anmuth - Barclays Capital.
Douglas Anmuth - Barclays Capital
First, Tim, can you just clarify the $75 to $85 million Microsoft benefit for 2Q is in the $155 to $195 in operating income that you guided to? And then secondly, is the paid search integration with Microsoft on track for before the holiday season? And when should we expect the algorithmic piece to roll out?
So Doug, easy answer on the first one, yes the $75 to $85 is in the op income guidance, absolutely. On the second one, we’re.
Algo actually can go before paid. That’s a lot simpler. That’s basically just throwing a switch to another data center. Now my tech guys are going to shoot me, because it’s never that simple. The paid migration, again we are planning it to be before this holiday season, because that’s of course when a lot of action takes place. But we’re not going to switch unless both of us decide that it can be a quality transition. So while we’re planning before holiday season, if we get close to it and say that it’s not high quality enough, we’ll wait until January. But so far we’re on track.
And importantly the operating reimbursements, the equivalent of the $35 million in the first quarter or the $75 to $85 million ongoing, those continue until we switch over. So whatever the date is, that’s when they’ll continue to.
So appreciate everyone being on the call. Thank you very much for taking the time and we’re up.
Yes, look forward to talking to you.
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!