Yahoo! Q4 2006 Earnings Call Transcript

| About: Yahoo! Inc. (YHOO)
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Yahoo! Inc. (NASDAQ:YHOO)

Q4 2006 Earnings Call

January 23, 2007 5:00 pm ET


Marta Nichols - Investor Relations

Terry Semel - Chairman of the Board, Chief Executive Officer

Sue Decker - Chief Financial Officer; Executive Vice President, Finance and Administration


Youssef Squali - Jefferies & Co.

Mark Mahaney - Citigroup Smith Barney

Imran Khan - JP Morgan

Ben Schachter - UBS

Brian Pitz - Banc of America

Anthony Noto - Goldman Sachs

Heath Terry - Credit Suisse

Christa Quarles - Thomas Weisel Partners

Doug Anmuth - Lehman Brothers



Good afternoon, ladies and gentlemen, and welcome to the Yahoo! Q4 2006 earnings conference call. (Operator Instructions) I will now turn the call over to Ms. Marta Nichols. Ms. Nichols, you may begin.

Marta Nichols

Good afternoon and welcome to Yahoo!’s fourth quarter earnings conference call. On the call today are members of our executive team: Terry Semel, Sue Decker, Dan Rosensweig, and Jerry Yang.

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

The potential risks and uncertainties include, among others, the successful implementation and acceptance by advertisers of the company’s new search advertising system, the company’s ability to compete with new or existing competitors, the implementation and results of the company’s announced reorganization, reduction in spending by or loss of marketing services customers, the demand by customers for Yahoo!’s Premium services, acceptance by users of new products and services, and risks related to joint ventures and the integration of recent acquisitions. Other potential factors that could affect the company’s business and financial results are included in the company’s annual and quarterly reports which are on file with the SEC.

All information discussed on this call is as of today, January 23, and Yahoo! does not intend and undertakes no duty to update this information to reflect future events or circumstances. On the call today, we will discuss some non-GAAP financial measures in talking about the company’s financial performance, including operating income before depreciation, amortization and stock-based compensation expense, which will be referred to as operating cash flow; revenue excluding traffic acquisition costs; free cash flow, non-GAAP net income, and non-GAAP net income per share. Reconciliations of those non-GAAP measures to GAAP measures can also be found on our website under investor relations.

Terry and Sue have prepared remarks that should last about 30 minutes, and then we will have a brief Q&A session.

Now, I would like to turn the call over to Terry.


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Terry Semel

Good afternoon, everyone. In October, we laid out some clear, compelling action steps to improve our performance and create greater shareholder value by sharpening our focus on three key priorities:

To improve search monetization.

To widen our lead in graphical advertising.

To seize the opportunity in emerging areas such as social media, video and mobile.

We are aggressively executing against these three key priorities and have made tangible progress on all three. These priorities are part of a broader strategy to capitalize on the future growth of the Internet by leveraging our deep audience insights to create a full-fledged advertising network with a marketplace that meets supply and demand both on Yahoo!'s valuable owned and operated network and across the entire Internet.

To help realize this strategy, we also undertook a major initiative to reshape our organization in order to capture this significant opportunity. By organizing around these three specific groups -- audiences, advertisers and publishers and technology -- we believe we can build deeper relationships with our most valuable audiences and advertisers, scale more effectively and further increase the relevance of Yahoo!.

At the same time, I'm pleased to report that we delivered financial results during the fourth quarter in line with our outlook. We ended the year on a strong note with solid growth in revenues and operating cash flow, strong profitability and healthy growth in users and user activities. Let's look at those areas in which we have moved decisively to improve our performance.

Let me talk about the first one, search monetization. We said we would be resolute about improving search monetization and we are making exciting progress. For our U.S. advertisers, I'm happy to report that we have successfully transitioned the large majority of our revenue to our new search marketing system known as Project Panama. We will continue to send invitations to U.S. advertisers to upgrade to the new system throughout the remainder of the first quarter and anticipate that all U.S. advertisers will have transitioned by the end of this quarter.

To date, we have received an overwhelmingly positive response from customers of all sizes and we're pleased with the level of advertiser engagement with our new features. Since we have already exceeded our targets for migration, I am excited to announce that we will officially launch our new ranking model in the U.S. on February 5th. This will be in effect in both our old and new systems. This means as of February 5th, all U.S. Yahoo! search marketing ads will be ranked by quality in addition to keyword bid price. Ads with a higher quality should receive better placement on the results pages.

We believe this will deliver more relevant text ads to users, which in turn should create greater volume of high quality leads to advertisers. Accordingly, this should encourage even more participation in the network, creating a more valuable marketplace for users, advertisers and publishers, unlocking the full potential of Yahoo!'s search marketing network.

At the same time, we continue to recraft our search network, focusing on the highest quality partners who add value to the network. Looking ahead, we are on-schedule to also begin rolling out the new ad system in international markets in the second quarter on a market by market basis, starting with Japan. We will follow a similar process as in the U.S. in which we will introduce the interface first, followed by our new ranking model. We will be contacting our advertisers in each market with more specific information as the roll out dates approach.

As we have previously discussed, we expect to see the revenue impact of the new search advertising system and ranking model to begin in the second quarter and gain momentum throughout 2007 and beyond. Importantly, the Project Panama system is being built on a flexible platform. You will see ongoing innovation and development of next generation advertising and monetization capabilities both on and off the Yahoo! network.

So let's move to display advertising in which we said we would focused on extending our lead. We've done just that. For the quarter and for the year, we believe that we once again outperformed the marketplace, notwithstanding that we already have the largest display advertising business. Because we are well-positioned to develop greater context and relevance for consumers and advertisers, our aim is to outpace the industry again in 2007.

Drilling down into some specifics, revenue from our top 200 U.S. display advertisers grew nearly 30% in this past quarter. With respect to our categories, growth in the quarter was broad-based. However, highlights included consumer package goods, financial services and pharmaceuticals which all delivered strong year end, year-over-year growth.

We are also benefiting from the online advertising becoming a greater part of the media mix globally and our European display advertising segment was a stand out for the quarter and for the full year.

During the quarter, we undertook several initiatives to further extend our leadership in display advertising by ensuring we continue to provide a large variety of high quality, guaranteed inventory while also addressing the growing long-term interest in non-guaranteed inventory as well.

First, consistent with our focus to become a more customer centric organization, we have begun to shift to an audience-based selling proposition. This enables us to work with marketers on more effective buying practices as they shift advertising dollars towards the web, with the goal to more effectively target audience sectors on factors such as demographics, geography and behavior. Our number one position in each of the most valuable advertiser demographics, our industry-leading targeting capabilities, our advertiser-friendly environments, means we are very well-positioned to help marketers connect with the most relevant audiences on the Internet.

Second, we have a great product road map that will add new opportunities for marketers. For instance, we added high quality inventory on our network with the addition of Yahoo! Personal Finance last week and Yahoo! Food in the fourth quarter. This complements our audience leadership in other premium areas within the network, such as Yahoo! News, Finance, Sports, Music, Yahoo! Home Page and many others.

Third, we are also executing on extending our ad network and added important new advertising partners. Our partnership with eBay is progressing well. We have officially begun filling both graphical advertising and sponsored search within eBay. Our initiative with a consortium of U.S. newspapers adds significant local advertising growth opportunities and has already grown since our original announcement from over 150 newspapers to some 225 at this point. We have begun initial implementation between local newspapers and Yahoo!'s Hot Jobs, providing an enormous database of additional job listing and giving local newspapers a dramatically larger audience.

Fourth, we continue to respond to the changing mix of available inventory. In October, we announced that Yahoo! had acquired a 20% stake in Right Media, the largest emerging online advertising exchange for both buying and selling ad inventory, and that we would also join the Right Media Exchange. As the quarter progressed, we gradually increased our allocation of non-premium inventory to the exchange and worked with direct marketers to educate them on how to utilize Right Media's performance optimization tools. We believe these and other initiatives continue to help ensure that Yahoo! remains the first and most attractive choice for display advertisers.

Moving on to some of our audience initiatives, we have been very active in building on our strengths in social media, video and the mobile web. In social media, we continue to enhance and extend Yahoo! Answers, one of the most successful social media properties on the Internet. Yahoo! Answers has become the largest collection of human knowledge on the web in just over a year since its initial launch, having now grown to almost 75 million unique monthly users worldwide. I believe that with the continued success of Yahoo! Answers and the sharing of human knowledge, Yahoo! has a real opportunity to change the game in search.

We are also making important acquisitions in this area that we believe will, over time, further enhance our position. We have agreed to acquire [] which is an engaging contest platform across categories such as karaoke, dance, comedy and others that will bring a whole new level of sharing, expression, interacting across Yahoo! services.

We also acquired MyBlogLog, an innovative service that is going to change the way publishers connect to their audience, and even the way people connect to each other. In the few days since we announced this acquisition, the number of sites that have adopted their badges to establish relationships with people reading their sites has taken off. In fact, yesterday was a record day with literally millions of these badges viewed across the Internet. Our ultimate goal is to encourage every user on Yahoo! to participate in the consumption and publishing of information and knowledge through tagging, reviewing, sharing and other social media activities.

In the video area, we continue to integrate new original and partner programming throughout the network, enhancing Yahoo!'s position as one of the leading video destinations online. During the quarter, we signed over a dozen video, news, information and entertainment relationships across our media sites, including the BBC, FOX News, ABC News, the Food Network and the CW network.

Video is also a rich medium for advertising, and we saw strong success with some of our innovative ad-sponsored video initiatives such as Nissan live sets on Yahoo! Music, The Nine, which is presented solely by Pepsi, and the Doritos sponsored program to choose a user-submitted commercial that will actually run on this Super Bowl.

Together, Yahoo! Answers. Flickr,, and Yahoo! Video have surpassed 100 million monthly users, continuing our position as a leading force in social media. Interestingly enough within this group, 50% of our users are under the age of 35. To put that into perspective, it puts us ahead of properties such as MySpace and Facebook in this attractive demographic.

Mobile also continues to be a major focus for Yahoo! with the launch of several key new products and strategic partnerships, we have demonstrated our intention of becoming the number one player in mobile, mobile search and mobile monetization.

At CES earlier this month, we announced the beta launch of Yahoo! Go For Mobile 2.0 and partnerships with Motorola, Nokia, Samsung and RIMM. Yahoo! Go 2.0 is available on 70 devices today and we are working to bring it to more than 400 devices by the end of this year.

Yahoo! also redefined the mobile search category with the launch of Yahoo!'s innovative One Search which delivers answers directly in the results rather than a list of web links. One Search will be a key feature on Apple's iPhone, along with Yahoo! Mail, and will be used exclusively in Opera, which is a leading provider for web browsers for mobile phones.

In the fourth quarter, we also extended our leadership in mobile monetization with beta launches of sponsored search and graphical advertising on Yahoo!'s Mobile web service and we formed a strategic alliance with Vodafone to be their exclusive display advertising partner in the U.K.

As you can see, over the fourth quarter we made substantial progress in improving search monetization, widening our lead in graphical advertising, and seizing important opportunities in social media, video and mobile. We will continue our sharp focus in all three areas throughout the coming year.

In conclusion, as I look ahead to 2007 and beyond, I believe the future opportunity for Yahoo! and the industry as a whole is bigger than ever. The Internet is evolving at a rapid pace, projected with some 800 million more users expected to come online by 2010 and online advertising predicted to grow to $55 billion by the same year.

As I said earlier, we have taken a number of concrete steps that are part of a broader vision to capitalize on this transformation and capture the major growth opportunities over the next five years. I'm pleased with the tangible progress we have already made in sharpening Yahoo!'s focus and addressing the company's challenges and opportunities and we're committed to continuing this momentum.

We did a lot in '06 to position the company for continued success in a rapidly evolving Internet marketplace. While we will continue our transition in 2007, we are clear about our objectives and what we need to do to accomplish our goals. As one of the leading companies well-positioned for future growth, I am convinced we're on the right path to deliver long-term shareholder value.

With that, I'd like to turn it over to Sue Decker.

Sue Decker

Thanks, Terry and thanks to all of you for joining us today. As we close 2006 and commence 2007, we're at an interesting confluence of two currents: one operational and one financial. Operationally, we are in the midst of an incredibly exciting product launch, designed to have a lasting and significant impact on our ability to better meet the needs and desires of our advertising and publishing customers.

This new advertising product, Panama, was built modularly and with platform components so we see many exciting opportunities to enhance and extend its capabilities over time, and we intend to do just that. The extra time we took in testing and in deliberate client migration delayed the implementation, but we felt that doing it right was more important that doing it right away, and the positive feedback we're getting from clients tells us this was the right decision.

Financially, we expect to begin to see a positive effect from this new system beginning in Q2 of '07 and then building throughout the year. Consequently, our business outlook implies acceleration in growth beginning in Q2, after we have had a couple of months of the new search ranking algorithm to be fully operational.

Before I review our financial results, I'd like to review two housekeeping items. First, our fourth quarter and full year effective tax rates were 31% and 42% respectively. These rates were lower than expected, primarily due to three items that impacted the provision in Q4. First, we recorded the full year benefit of the federal R&D credit. Second, we were able to utilize more foreign tax losses than originally anticipated. And third, we recorded a one-time reduction in deferred tax liabilities, principally to correct amounts accrued prior to '04. Absent these Q4 items our effectively tax rate in Q4 ’06 would have been 40% and our normalized rate for the full year of ’06 was approximately 43%.

The second housekeeping item is that we released our domestic tax valuation allowance of approximately $1.4 billion. This release was based on expected future profitability which leads us to believe that we will fully utilize our domestic net operating loss carryforwards. This release had no income statement impact and resulted in adjustments to goodwill and equity on our balance sheet. As of December 31, 2006 we continue to have NOL carryforwards of almost $2 billion.

Let's turn now to free cash flow which we view as our most important financial metric as it relates to value creation. As a reminder, we define free cash flow as cash generated from operations which includes cash cost for taxes, tax benefits from stock-based compensation and changes in working capital less CapEx and dividends received.

Free cash flow was $278 million in the quarter, bringing full year free cash flow to $1.267 billion. This reflects solid growth in revenue and operating cash flow, modestly offset by a larger than usual build in accounts receivable, largely reflecting the impact of stronger revenue growth in the latter part of the quarter, which we plan to collect in the ordinary course during first quarter. We also continue to see a modest mix change towards business coming through ad agencies and SEMs which puts a little upward pressure on DSOs and receivables.

In addition to our free cash flow from the quarter, we received $87 million from the proceeds of the exercise of employee stock options, bringing option proceeds for the year to over $318 million.

Turning to how we invested our cash, for the full year of 2006 we significantly stepped up our share repurchase activity, completing nearly $2.8 billion in share buybacks during the year, of which $250 million was repurchased during the fourth quarter. In aggregate we repurchased more than 93 million shares, or more than 6% of our share base at an average price of less than $30 a share.

We also deployed over $140 million into a variety of value-creating equity investments and acquisitions, including a stake in G-Market in Korea, our joint venture with the [Seda] Network in Australia and investment in Right Media and the acquisitions of Ad Interacts and Jump Cut.

Netting out the sources and use of cash, our cash and marketable securities balance ended at $3.5 billion, compared to $4 billion a year earlier. Please note this ending cash balance does not include several other important sources of incremental balance sheet value. Our interest in Yahoo! Japan, Alibaba in China, G-Market in Korea all collectively amount to $9.7 billion in aggregate, or over $6.77 per share, an important complement to the underlying values of our operating assets.

Moving now to the P&L, the overall summary is that although second half growth rates were slower than we originally anticipated, we maintained strong profitability and cash flow while remaining laser-focused on building innovative products for our very large and growing base of users and advertisers.

Specifically, fourth quarter revenue ex-TAC came in at $1.23 billion, advancing 15% over year ago figures. This revenue growth was the same across our two major lines of business, marketing services and fees.

Drilling down on global marketing services, our largest revenue line, we generated just over $1 billion of revenue ex-TAC for the quarter, a little ahead of where we expected to be a few months ago. To give you additional color about the drivers of revenue, I'll comment about our owned and operated network which includes both search and display advertising, and also provide directional information on affiliate growth trends.

Starting with the off-network affiliates, revenue was essentially flat year-over-year, slower than our owned network for two reasons. First, MSN is no longer an affiliate in most markets, having brought its business in-house. The impact of this move is consistent with the figures that we've been providing to you for the last year. Excluding MSN our affiliate business rose in the high single-digits in Q4.

Second, our average TAC rate was up over last year, both including and excluding MSN in line with the expectations that we communicated to you at the beginning of 2006. In the near term we continue to expect our O&O business to outpace our affiliate growth as TAC rates grow and MSN fully transitions off of our base.

Looking at the O&O business, we had very strong performance in the O&O business in the fourth quarter, which includes both display and search, up more than 19% year over year, led by display where our top 200 U.S. advertisers grew nearly 30%; whereas our search business was up in the high single-digits. In the U.S. online display market we continued to gain market share in the quarter and for the year.

Now, let's look closely at the volume and monetization trends on the O&O side. Page views, our best overall measure of volume, grew 22% to over 4 billion per day in December, implying rising page views per user which is a strong measure of growing engagement. The page view growth was strong across all three major content and service areas.

Let's move now to the other driver of revenue, monetization of those O&O page views. In the fourth quarter, our revenue per page was modestly less than in the year-ago period by about 3%. When combined with our 22% average page view growth, this explains our overall O&O growth of 19%. The slight yield decline across the Yahoo! network represented the blended effect of a modest increase in display inventory monetization, actually a bit of an acceleration versus what we saw in Q3, and an expected decline in revenue per query in search, which is likely until Panama is fully operational.

Now let’s look at our other revenue line, fees. We produced $213 million of revenue in the quarter, up 15% year over year. The primary driver of this revenue line is our premium offerings in which consumers and businesses pay us for our services. We exited the year with 16.3 million paid relationships, up 29% year over year and up 800,000 from Q3. In 2006 in aggregate, we added 3.7 million paid relationships to the base, consistent with the 3.5 million to 4 million we added in each of '04 and '05.

As we look forward to '07 we continue to see opportunities to expand this base, and expect to reach 19 million paid relationships by the end of the year. As in 2006, we continue to expect these relationships to produce an average revenue per user, per month of $3 to $4, trending toward the low end of that range as our subscriber mix continues to evolve.

Looking at revenue by geographic segment, international revenue ex-TAC was up 18% over the year ago quarter to $306 million, boosted by solid growth in both sponsored search and display. Holding currencies constant with Q4 ’05 and adjusting for acquisitions and divestitures, our international revenue ex-TAC increased 14% over the year ago. We expect our international growth rates to be a little lower now until we anniversary MSN's loss and the various changes in affiliate relationships and pricing in Korea.

Let's turn now to some of the details behind our profitability; specifically, operating cash flow came in at $540 million, up 18% year over year, producing strong global OCF margins of 44% for the quarter. As you know, the major driver of margin leverage is compensation costs, our largest expense which continues to yield productivity improvements. Headcount ended the quarter at 11,400 up about 400 from Q3 '06 levels and up almost 16% from a year ago, slowing from earlier growth rates earlier in the year. We are very pleased that we have been able to make investments in talent while still delivering strong profitability in margins.

Let's turn now to our business outlook in ‘07. As has been our custom in the past, we are introducing operating ranges for both the first quarter of 2007 and for the full year. Before getting into the specific numbers and ranges, let me walk you through four important umbrella factors that are influencing our outlook in growth and profitability.

First, as we have mentioned in the past, we believe the trend toward rising rates of traffic acquisition costs that we share with our search affiliates will continue in '07 as it did in each of the last three years. Our outlook contemplates $100 million of revenue ex-TAC impact from rising TAC rates.

Second, we want to remind you of the impact of the wind down of the MSN search relationship. As we have indicated previously, MSN contributed approximately $75 million of revenue ex-TAC in 2005 and as expected, that dropped to approximately $25 million in 2006, with most of the revenue contributing to the first half of '06. We expect it to contribute a negligible amount to our '07 results.

Third, I'd like to share with you our high level O&O RPS assumptions as it relates to the introduction of Panama. As we have said in the past, we expect the new ranking algorithm to start to positively affect RPS trends, after it has been operating for a full quarter, allowing the system a chance to learn and incorporate second order effects from advertisers. Consequently, we expect to begin to see a positive impact to our U.S. O&O RPS in the latter part of Q2 and then this should build throughout the second half of the year. Specifically, our outlook reflects double-digit increases in RPS on our O&O sponsored search business in the U.S. during the second half.

For our international business, this effect will be lagged as we expect to be launching the new ranking algorithm most non-U.S. markets during the second half of '07, implying the international positive lift will be more visible in 2008.

Fourth, with respect to our off-network affiliates, we expect to see variable changes in performance across the network with Panama's introduction, driven by two primary factors: first the impact of the new ranking algorithm will affect affiliates differently based on their implementations and current monetization levels. Second, we plan to continue our substantive investments in driving network quality that we discussed last year and will continue in 2007.

Current and future features in Panama give our advertisers more explicit targeting controls in terms of continent opt-out and geo-targeting that will have differing effects on affiliates, depending on their traffic mix. We are factoring into our business outlook some revenue reductions for certain affiliates negatively affected by these factors. We think these actions will create a higher quality network for our advertisers, ultimately benefiting both our high quality affiliates and our owned and operated network.

However, we think there may be a lag effect between the costs and the benefits so we're not modeling any of the benefits in our 2007 year. We believe this represents an important investment in the quality of our network and future growth for Yahoo!.

Keeping in mind those umbrella comments on the outlook, for the first quarter we expect revenue ex-TAC to be in the range of $1.12 billion to $1.23 billion, up 8% from a year ago at the midpoint. This outlook contemplates three factors in our search advertising that will affect Q1 more than it will affect other quarters in '07:

  1. The last tough comparison from the roll off of MSN's business
  2. The lack of expected ranking algorithm impact until Q2
  3. And the toughest year-over-year comparison in TAC.

For these reasons, we expect our Q1 growth rate to be the slowest of our '07 quarters. At these revenue levels we expect to operate within an operating cash flow range of $420 million to $480 million in the first quarter, up about 4% at the midpoint of the range. For the full year of 2007, we expect revenue ex-TAC to range from $4.95 billion to $5.54 billion, up about 14% from year-ago levels at the midpoint.

Importantly, inherent in the forecast, our core O&O business across search and display is expected to grow close to 20% in '07, very similar to the growth trends we realized in '06. It is the traffic quality investments and rising TAC that caused downward pressure on the affiliate business in the near term, reducing the overall growth rate.

Full year operating cash flow for '07 is expected to be in the range of $1.95 billion to $2.2 billion, yielding a full year margin of approximately 39% to 40%. We expect our core O&O margins to continue to rise in '07 as they did in '06, helping to offset the near-term impact of the traffic quality and TAC issues which we believe will create a 200 basis point headwind to 2007 margins.

Moving now to what we consider to be our most important financial metric, free cash flow, we are anticipating a full year 2007 range of $1.2 billion to $1.4 billion, reflecting capital spending of $650 million to $750 million. In that figure, we're assuming cash taxes in the range of 9% to 11% versus approximately 6% in '06, primarily due to the utilization of the state tax NOLs.

As cash taxes grow as a percent of book taxes and as we assume more real estate expenditures for data centers in our CapEx, we expect cash flow to operating cash flow to trend toward the 50% to 70% rage over time.

To sum up, as we reflect on '06 and what lies ahead in 2007, we are cautiously optimistic. We are proud of what we've accomplished so far with our new search system introduction and that we have extended our lead in online display. We believe this market position, combined with the opportunity to build increasing functionality and features into this new advertising system, plus our window into the passions of the world's largest online audience puts us in an almost unique position to create future value.

In addition, we firmly believe that the considered and deliberate allocation of capital into key operational areas, various strategic acquisitions and the repurchase of stock are among our most important responsibilities to shareholders. We are and will remain very focused on making the best and most profitable use of our strong balance sheet and healthy free cash flow.

With that I'd like to turn it back to Terry.

Terry Semel

Thank you, Sue. I truly believe that Yahoo! has tremendous strengths and I'm confident in our ability to capture major new opportunities ahead, for both the Internet and for Yahoo! and to maintain our industry leadership over the long term.

I'll now open up the call for questions and answers.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Youssef Squali - Jefferies & Co.

Youssef Squali - Jefferies & Co.

Thank you very much. Just a quick question for Sue. If we were to just strip out the monetization of Panama, what kind of revenue upside do you see from the introduction of it, either in the second half which will have most of the impacts or for the year? How has the fact that you will still be bringing on a new CFO affected your thinking about fiscal '07 guidance?

Sue Decker

In terms of the revenue upside in the second half, that's incorporated into our guidance which incorporates 14% average growth for the year in revenue but starts at about 8%. We indicated on the call that we expected revenue per search to begin to improve in the latter part of Q2. We actually see Q1 as probably the trough in revenue per search, although we started out actually pretty strong for the first three weeks of the quarter, so we expect it to trough in Q1 and to start picking up in Q2 with double-digit growth in the back half, and that is incorporated into our guidance.

In terms of the new CFO, that had no effect on our approach to the guidance. We are absolutely committed with our guidance to provide the best business outlook we can provide based on all of the information that we have. We always try to target our middle of the range to be our most probable outcome, both for the quarter and for the year.

Terry Semel

I can try to add to that if I could. We feel quite blessed, obviously Sue has been our CFO for the last seven years and the best news of all is that Sue still is our CFO and she will continue to be our CFO until we hire, in her words; and in mine, another outstanding candidate to come into the company. The initial search looks quite great, we are getting some very, very fine people starting to talk to us about it. We have just begun the process. So I feel for Yahoo!’s sake, very blessed. Sue will be running one half of our company, if you will, with a huge upside potential in it and at the same time, you will be sure that you will be poking into every one of our guidance meetings and every one of our financial things and working closely with our next candidate. Next question, please.


Your next question comes from Mark Mahaney - Citigroup Smith Barney.

Mark Mahaney - Citigroup Smith Barney

Thank you. I wanted to get across two things. First on video advertising, to the extent that hits an inflection point on the Internet this year, are you seeing a difference in or a change in the type of budgets that are coming online, particularly attracted by video advertising?

And then quickly on the RPS improvement that you are seeing, to what extent have you been able to test that to know that the knock-on effects or the secondary order of impacts that is maybe a decline in price per click, are more than offset by the increase in the clickthrough rates? Thank you.

Terry Semel

I will start with video advertising. I think that it is really in its early days and I think a lot of learning is starting to take place and a lot of trials are taking place. I mentioned one piece of it which would be the easy one, sponsorships that major companies are now doing in and around video content.

If you think of the infrastructures that are being built and how we have been integrating both user-generated and professional video through our networks, it is going to be a big opportunity down the road and right now today, there is a lot of learning and a lot of opportunity. So I see it ultimately as something that becomes very significant and I think it will get there, but not quite yet.

Sue Decker

Your second question about the RPS improvement, we have been testing on a limited basis the new algorithm throughout the last few months as we have increasingly added new clients to the system. What we have seen so far is that it has basically been neutral to a modest positive in terms of the first order effects.

As you know, some of the variables have positive effects, some have adverse effects but we think the net effect will be broadly neutral in the short term and substantially increase RPS over time. The one thing we can’t test is second order effects, and that would be what we will be able to see once we actually flip the system on. But in terms of first order effects, we see broadly neutral to slight positive results from the new ranking algorithm.


Your next question comes from Imran Khan - JP Morgan.

Imran Khan - JP Morgan

Thank you. I think you said your monetization accelerated in the quarter. I was wondering what drove that acceleration.

Secondly, 22% page view growth. Can you give us some color, what is the volume growth on a year-over-year basis? Thank you.

Sue Decker

In terms of the display yield, it was a very modest acceleration from what we saw last quarter, but it was positive yield from our display business as opposed to the search business. We have done a lot to make sure we understand what is happening in terms of the exciting new inventory that is coming online in the marketplace. We have really focused on that in terms of applying our sales expertise to both premium inventory and also some of the less guaranteed or remnant inventory. We are finding new ways to both sell and package that across an audience-based sell. So we think these are really early days and we are excited about what is happening in the marketplace that we identified to you guys last quarter.

In terms of the color on the page view growth, really across all the major categories it was strong. You guys have the external results from Comscore on search; our search numbers and queries which is incorporated into our page views, are running up nice double-digits. We have said before that we though that Comscore’s counts from a year ago didn’t include all of our queries, so the year-over-year comps that they generate are probably a little higher than what we are realizing on our network, but we are up nicely in the teens. We are seeing very strong results in our email page views, we are the leader on a global basis and continue to see very, very strong growth from there.

I think Terry mentioned a few of the social media initiatives we have underway, so I would say that the vital signs in users and usage across our network remain very strong.


Your next question comes from Ben Schachter - UBS.

Ben Schachter – UBS

Not to get ahead of ourselves, but could you talk a little bit about what you're thinking in terms of the modules for Panama, what it might entail beyond text-based pay per click ads?

Sue Decker

I'm going to start with that, which is that I think the most important thing to understand is that Panama really was built for the future. We think it anticipates the next several years of innovation, not only in terms of the scale at which it can operate, but also in terms of the flexibility for us to expand and migrate the system both for new features which you'll see relatively soon throughout the year, but also as we thing about how to incorporate all forms of advertising, including display and listings and search.

We think we are actually in a fairly unique position to be able to take advantage of that technology and also to take advantage of the enormous data and insight we have on the largest online audience in the world. We can see what people are putting in their search strings. We can see what kinds of ads they click on. We can see what kinds of sites they were on prior to the site they're currently on. That should allow us to serve the most relevant ad regardless of how it is priced, to our consumers and ultimately to share that not only with our large O&O but to all of our publishing partners. We're really excited about that.

Terry Semel

I think Sue answered it entirely correctly. I just wanted to add to it. Obviously our focus in the last number of months has been all about sponsored search and all about improving RPS and that's where we've been totally focused on and I think as you can now see, we're certainly on schedule and we're moving very well and we're starting to feel very good about everything.

All the while, we were fully aware and are fully aware and have expectations of continuous roll outs of additional aids and additional tools and additional things that will help us as we move forward in the advertising world, separate and apart from this search exercise. So it is very exciting. There is a road map for it. We're not at the point where we're going to discuss it because everyone else will race out to try to do the same. But we're very excited about it so thanks for asking the question. Next question, please.


Your next question comes from Brian Pitz - Banc of America.

Brian Pitz - Banc of America

Thank you. A quick question on mobile. When do you expect to see a material impact from your mobile opportunities that you've talked about? Should we expect to see international first followed by the U.S.?

A second question on Right Media, can you give us a sense for the proportion of your total inventory that you either currently are or will place on the Right Media Exchange? Is this inventory that really went unmonetized previously?

Terry Semel

On mobile, look at it, if you will, as we have been for the last year or almost year-and-a-half, I'd say. First, we're building a big audience. So to a large degree, you've seen Yahoo! products now on more and more and more handsets throughout the world, in some cases tied to either Yahoo! Go 2.0 or in other cases, the new Yahoo! Search which is becoming very popular. We very much thank iPhone, we think it will be a great advertisement for us in many areas. You have seen Yahoo! Mail on many different phones and more and more coming.

So we're really looking at this year with two views, if you will. One view is we're starting to build a very large audience on a global basis as more and more handsets and more and more companies start taking the Yahoo! product on -- and they are. On the other hand, we're starting to learn much more about advertising on mobile. That is precisely why we made the deal in with Vodafone in the U.K. The U.K., of course, being the largest market in Europe with us doing more learning here in the U.S. with companies like Opera and others who are starting to work very closely with.

So we see this as a year of continuing to build a big audience, take early leadership in that and throughout this year you'll find us doing a lot of work on advertising pieces and working with other clients to come up with what would be the best answer and the best way to go forward.

Sue Decker

So I will take your question on Right Media. We are very excited about this investment and about the window into that marketplace. We did start allocating some non-premium inventory to Right Media in Q4, but it's fair to say we're largely testing. It's relatively immaterial as yet.

Our plan is to increase our participation in Right Media in 2007 from where we were in 2006. We really see the opportunities in Right Media as severalfold. One is to be able to sell inventory that if the pricing and yields look stronger in Right Media than what we can get we'll sell inventory on the margin there. As well, we think a very strategic opportunity is for us to buy incremental inventory and package it with the inventory we have for our major advertisers. So we see a number of different strategic opportunities, but at this point it's more in a testing mode than full-fledged usage.


Your next question comes from Anthony Noto - Goldman Sachs.

Anthony Noto - Goldman Sachs

Thank you very much. A quick question on RPS. You talked about the fact that the impact of switching to Panama will be neutral to a modest positive at first but much more positive over time. Could you give us a sense of what's the opportunity to improve RPS over time -- and not in any time period, but after you fully have integrated it and advertisers have become comfortable with it, is there a chance to double it, increase it by 50%?

The second question is, what percentage of your page views are currently unsold and could be leveraged through a channel like Right Media? Thanks.

Sue Decker

Anthony, thank you for the question. I think in terms of quantifying the upside, we probably don't want to get ahead of ourselves in terms of that. But we do feel that we should see increasing impact from the roll out of Panama as time goes on, both because the algorithm will have time to learn and advertisers will have time to figure out second order effects. But also because we are rolling it out deliberately we should see more of an impact in the back half and in 2008.

So I think it's fair to say we think it's very significant and that we think that there's at least double-digit opportunity in the back half of this year.

I'm going to turn it over to Jerry who is going to address your second point.

Jerry Yang

Hi, Anthony. On the page views unsold, we utilize all of our page views in different ways and I think the opportunity of Right Media allows us another channel, a potentially more efficient way to sell our advertising. As Sue mentioned, we may even use it as a way to buy it and so I think the way to look at it is it is a way to potentially raise the efficiency in which we can package and sell and package and buy our inventory rather than look at percentage of sold versus unsold.


Your next question comes from Heath Terry - Credit Suisse.

Heath Terry - Credit Suisse

Thank you. Terry, you talked at the beginning of the call about the quality improvements that you're looking to make within the advertising ranking. Can you talk about the components to that quality improvement beyond just revenue ranking? What are the other things that Panama brings to this besides revenue ranking that you think are going to have an impact on quality?

Sue, just a point of clarification. At one point I believe you said that there were no benefits from Panama in this year and then there were some other numbers mentioned. I just wanted to clarify. To what degree are you expecting or does that 9% to 20% growth implied by the guidance include Panama?

Sue Decker

Heath, I'm going to get started on both of those. So let me take your second question first, which is what our business outlook incorporates. The business outlook does incorporate our view that we will start to benefit from the Panama roll out in terms of its impact on our RPS. We expect that to start to take effect late in Q2 after the system has been operational in our U.S. O&O business for a full quarter, and we expect to it to build throughout the year. We are looking for year-over-year growth of double-digit RPS gains in the back half. That's implied in our guidance.

In terms of quality improvements, I think it's fair to say that we see the underlying need of our advertisers is to drive very valuable leads. That's a major source of our business. We have taken a number of steps to make sure that happens and we mentioned actually last year a number of steps we had taken with respect to traffic quality to address lower performing affiliates on an annual basis. Now more automated in the first release of Panama, we are providing advertisers with controls that help them manage both intra-country leads and international traffic sources. In future releases, we plan to release additional features and controls that will enable advertisers to fully optimize their performance.

The goal of all of this, this is great news for advertisers and it's great news for our very high quality publishers and for our O&O. We think these investments make a lot of sense to drive growth in the future.

One other example of what we've been trying to do is actually go acquire off-network publishers that add very high quality such as our eBay partnership and our recent newspaper consortium deal. All of these are part of the bigger picture to drive network quality higher, increase returns to advertisers, ultimately increase returns to our publishers.


Your next question comes from Christa Quarles - Thomas Weisel Partners.

Christa Quarles - Thomas Weisel Partners

First you had indicated that the monetization of your owned and operated was positive. I was wondering if you could discuss those trends in Q1 as it relates to what you're seeing on remnant and premium? Then also just a question on the affiliate side. It seems like that has been where a lot of your difficulty, I guess, and some of the expectations. I was wondering if you could give us your longer term view on how you view your affiliate business? Thanks.

Sue Decker

Let me start with the O&O outlook. I think I said in the full year guidance of up 14% that we actually expected our core O&O business to grow close to 20% and that affiliate trends would likely bring that down to the 14%. The same trends are true in Q1. In fact, in Q1 in particular I noted a few things in search that would have a bigger impact in Q1 than in other quarters. Those things are the roll-off of MSN's international business which will have largely anniversaried by the end of Q1. The TAC increases are more significant year-over-year in Q1 and the traffic quality initiatives, as Panama’s marketplace design turns on. So the actual display business we see growing very nice double-digits throughout all of our quarters in our current outlook.

In terms of the affiliate long-term view, we are very committed to running a very high quality network and that is an important part of the search business but we actually feel one of the most interesting opportunities ahead of us is to extend our lead in terms of our sales force, extend our lead in terms of the breadth of ad products that we offer and extend our technology assets and our data assets and start to serve ads on high quality publishers for all ad products, not just search.

I would say if anything, our off network strategy is becoming more important to our future and that is one of the reasons we're so focused on making sure we have the very highest quality network possible.


Your final question comes from Doug Anmuth - Lehman Brothers.

Doug Anmuth - Lehman Brothers

Thank you. It looks like your graphical business was pretty strong in 4Q with growth probably close to 30%. Terry, I was surprised that you mentioned that financial services was strong during the quarter given that only a few months earlier it seemed to be one of the weaker categories. Can you comment on whether it's something that Yahoo! did to turn that around or if it was more something in the market overall? Also, can you comment on the autos category as well? Thank you.

Terry Semel

I think generally speaking if you look at, I'm going to take the third quarter for a second as almost an anomaly in terms of our graphical business. If you look at Yahoo! in general, we are the first place that large advertisers do come to. We can accommodate most of their needs; I don't suggest all. Our inventory is of top quality. Our user base is of top quality. So it is a place where they do come and when they're doing important advertising as they do in the fourth quarter traditionally, as you know, it's traditionally a very strong quarter for a company like Yahoo!.

I'm going to pick up a second on some of the things Sue just mentioned but without being redundant. What she's really saying is our ability to service large accounts who have high quality needs, starts to grow way beyond graphical. It is obviously in graphical. It is also in search as we improve the quality of our network in search. And as we improve the quality of even off-network accounts like eBay and others who are starting to do more of their work through Yahoo!.

So we see our future and we see it as a very good future, a great future and we see ourselves being able to do a better and better job for advertisers around the world and Panama is the first step to help bring together what we needed in search and you're all very aware of that.

Beyond that, Panama is going to also help us move forward with a lot of the things that we have in design now and working on now, as well as some other platforms.

When asked -- and I am probably every single day and I take it almost as a compliment -- why did you reorg the company? Well if you think about it, it put us in position to do a few things that we were having a harder time doing in the past: (a) on the audience side, it puts us much more close to our best and most valued customers. We get to know them better. They'll get to know us better. We're going to have metrics that identify them and help us identify them to our advertisers and clients as well. We can do a much better job on the audience side by being in focus and being there all the time.

On the advertiser and publishing side, all of our energies there will be dedicated to and everybody working in that huge group will be dedicated towards our abilities to reach out for advertising both on our own network and off of our network, create great engineering teams which we have, all in one place, all financed to go ahead and start building things for the future and have the ability to move forward and be very, very focused on what they do.

So what you're really talking about is we think we're going to lead a transformation of how advertisers connect to their customers and ultimately that should deliver increased relevancy and maximize value to all sides. So to us this is a great opportunity and our intention of course is to continue to be in the forefront of this innovation as online advertising, sales and products keep evolving and changing and I think getting better and better.

With that, thank you all for joining us today. Have a good evening or afternoon.


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