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Executives

Marta Nichols - Investor Relations

Jerry Yang - Chief Executive Officer, Director

Sue Decker - President

Blake Jorgensen - Chief Financial Officer

Analysts

Christa Quarles - Thomas Weisel Partners

Imran Khan – JP Morgan

Jeetil Patel - Deutsche Bank

Brian Pitz - Banc of America Securities

Robert Peck - Bear Stearns

Anthony Noto - Goldman Sachs

Youssef Squali - Jefferies & Co.

Yahoo! Inc. (YHOO) Q3 2007 Earnings Call October 16, 2007 5:00 PM ET

Operator

Good afternoon, ladies and gentlemen and welcome to the Yahoo! third quarter 2007 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 third quarter earnings conference call. On the call today are members of our executive team, Jerry Yang, Sue Decker and Blake Jorgensen.

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 implementation and results of the company’s ongoing strategic initiatives, the company’s ability to compete with new or existing competitors, the successful implementation and acceptance by advertisers of the company’s new search advertising system, reduction in spending by our 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 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, October 16th, 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 performance, including operating income before depreciation and amortization and stock-based compensation expense, which will be referred to as operating cash flow; revenue excluding traffic acquisition costs, which will be referred to as revenue ex-TAC; free cash flow; non-GAAP net income; and non-GAAP net income per share, and reconciliations of those non-GAAP measures to the GAAP measures the company considers most comparable can also be found on our website under investor relations.

Jerry, Sue and Blake have prepared remarks, and then we’ll have a brief Q&A session. Now I would like to turn the call over to Jerry.

Jerry Yang

Thanks, Marta and welcome to all of you. Thanks for joining us on the call today. I am pleased to be giving you an update on Yahoo!'s transformation. While we still have a lot more to do, we have taken some important steps and made some strong initial progress.

Over the past hundred days, we have thoroughly reviewed key aspects of the rapidly changing Internet marketplace, our company, our strategy and our culture to identify what we need to do to accelerate Yahoo!'s growth and create long-term value for our shareholders.

As a result, we have made important decisions about our future. We have defined a vision of where we want to go. We have developed a set of objectives and strategies that we will follow and devised a rigorous framework that we will use to prioritize and make future choices.

At the same time, we have also taken decisive steps to execute against our priorities. I believe we are now more effectively organized to execute well and ready to take advantage of the tremendous opportunities we see ahead.

I will start by going in more detail on the new direction in which Yahoo! is headed. Sue will then discuss our progress against our objectives and strategy, and Blake will take you through our financial performance. I will conclude as I did last quarter with a few key takeaways.

So as part of our strategic review, we first assess Yahoo!'s market opportunities and where we can win. We believe that online advertising market today is about $45 billion. That market opportunity is growing rapidly and is expected to reach some $75 billion by 2010, just three years from now. We are one of the only few companies that have the scale, the technology, the insights and the expertise to really take advantage of this big opportunity.

To that end, we looked at a number of options to improve our competitive position and financial performance. We determined that to win in this marketplace, we must take advantage of our unique assets to drive value across a broad ecosystem of users, advertisers, publishers and developers.

Now, we could have chosen to focus on a subset of the market but that would limit our ability to generate significant long-term value.

So the goal is to turn Yahoo! into a company that powers and delights all of its communities by creating indispensable experiences. This is a vision and purpose for Yahoo! at which I believe we can succeed.

With our huge audience, strong advertisers and publisher relationships and deep technology, we have all the pieces and we are working from a position of strength. What we must do better is integrate these assets and execute with a clear focus.

I talked in the last quarter’s call about three key strategic differentiators that will be critical drivers to Yahoo!'s success -- insights, openness and offer partner-of-choice solutions. Moving forward, we are going to strengthen and leverage these differentiators to a far greater extent. We will do so by measuring how much more relevant we can become for each member of our ecosystem.

We believe the focus on relevance as a measure will create a unifying focus to our work and drive increased value in everything we do. Sue will talk a lot more about this later but I think there is a lot of room for improvement in driving relevance in our consumer offerings and marketing effectiveness.

We have also established three big, multi-year strategic objectives that will be the core of everything we do at Yahoo! for the next few years. First, become the starting point for the most consumers on the Internet; second, establish Yahoo! as the must buy for the most advertisers; third, deliver industry-leading platforms that attract the most developers.

Let me briefly walk through each one of these objectives.

First, let’s discuss our focus on becoming the starting point for the most consumers on the Internet. Consumers have and will continue to start their Internet use every day through a key set of applications that help them to both discover and better manage their lives.

Starting points must have broad reach and be incredibly relevant to a massive number of people. Today, Yahoo!'s key starting points of the homepage, My Yahoo!, mail, and search drive a tremendous amount of traffic and intent to the remainder of Yahoo!, thereby comprising much of the value to Yahoo!.

In addition to the web on your PC, the mobile experience is emerging as an ever-growing and more important part of that starting point experience.

Therefore, it is critical for us to continue to invest, innovate, and create whatever is necessary to gain more consumers to use Yahoo! as their starting point.

So with respect to all of our consumer offerings going forward, we will prioritize our talent and resources based on how we will fully invest and improve our starting points. We are also identifying services that enhance and support the starting point mission.

For example, sites like Yahoo! Finance, Sports, and News are category leaders in their own right and their high quality impact enhances people’s choice of Yahoo! as their starting point.

As part of this prioritization framework, there are services that don’t apply to Yahoo!'s key starting points. In these instances, we will either not fund or will not direct additional resources.

For example, we have de-emphasized our focus around subscription music in favor of advertising supported music. We have integrated Yahoo! photos in a flicker as a single offering. We intend to transition Yahoo! 360 to a more integrated Yahoo! experience, with things like podcast option in the U.S. and plan to shut down a number of other one-off services throughout the world over the coming months, and we have announced that we are assessing our options for Kelkoo in Europe.

These are but a few examples of areas that we’ve identified and we continue to work through many others. We will be relentless in our pursuit to ensure that we have the leading set of offerings for consumers to begin their experience on the web each and every day.

Our second strategic objective is to establish Yahoo! as the must buy for the most advertisers, as the online ad market continues to grow rapidly in the years ahead. As we have discussed previously, the lines continue to blur in the online advertising space between performance and brand advertising. We believe having a principal position in both search and display advertising is critical to creating that long-term shareholder value.

Yahoo! is poised to lead the industry by providing truly end-to-end advertising products and services. We have taken already important steps to transform Yahoo! from selling primarily just our own and operated inventory to an advertising platform company that delivers comprehensive, integrated and targeted solutions, both on and off Yahoo!'s network.

Sue will give you much more details on the progress we have made there.

Our third strategic objective is to deliver industry leading platforms that attract the most developers, for which we’ll allow for rapid delivery of new products and services from third parties to our consumers and customers.

In the past, we have unintentionally made it more difficult for developers to benefit from our technology platform and data infrastructure. We intend to change this and provide flexibility and access to critical platforms.

Besides building on open APIs, which we are doing more of every day, we are looking at many different ways to open up Yahoo!. We intend to be more flexible with our infrastructure and allow others to benefit from what we have learned. By doing so, we can open up Yahoo! to an ecosystem that is larger than what a closed Yahoo! can provide.

This includes opening up our web pages to let third parties plug in their applications, opening up our data so applications integrate seamlessly into Yahoo!, and building services that other can integrate into their applications.

Our goal is to create a motivated community of developers all building uniquely compelling applications that reach hundreds of millions of Yahoo! users by plugging into the most popular properties or services.

Our users, advertisers and publishers benefit from the rich developer community by having access to the vast array of highly personalized and relevant services to choose from.

While we are early in our pursuit of this objective, we will be investing in driving to transform Yahoo!'s infrastructure and software in the next few years to be a leading platform choice for web developers.

So to summarize, during this past quarter, we’ve established a clear view of our market opportunity, a focus set of business objectives and a strategic framework for execution. We will plan, invest, align our organization, and prioritize everything we do around the three big items I’ve just reviewed.

In June, Sue and I realized that in order for us to succeed, we had to change Yahoo! from the inside out. We’ve been doing just that. We are streamlining our organization, eliminating silos, aligning our leadership team, and putting ourselves in a position to execute quickly and decisively.

We know that we need to act as one Yahoo!, both with our customers and consumers as well as inside the company, and we have established internal milestones by which we will all check our progress.

This is the result of an intense amount of work throughout the quarter by our senior leadership team, much of which hasn’t been visible to the outside world, but that will make all the difference for how we move forward.

We are transforming from a business model that has been focused on developing and selling our own inventory to a much broader business that incorporates strong, owned and operated inventory, broad partnerships, and end-to-end capabilities both on and off Yahoo!'s network.

We will continue to work through this transition in the next few quarters. Having said that, we did a little better in the third quarter than we would have thought three months ago. There are several fundamentals that we believe are starting to improve, as Sue and Blake will talk about. While our overall revenue growth was approximately 14% year over year in the third quarter, we saw encouraging underlying trends with our global owned and operated marketing services growing 22% year over year.

While we are still in a period of transformation, we feel good about this growth and are focused on cycling through some of the factors that are slowing our business, such as transition of our low quality search affiliates.

We’ve started to execute against some of the strategic objectives I’ve talked about. Acquisitions like Zimbra, BlueLithium, Rivals.com among others will help us. We are also busy building out our publisher network with high quality partners, such as the four we announced today.

In conclusion, the Yahoo! we envision today is very different from the Yahoo! of a year ago. We are going to be substantially more open, generate and leverage our insights in an exciting new ways, and enable our partners to derive greater benefits from our technology platform and data infrastructure.

We believe we have the outstanding talent and culture that can strengthen and build on our key assets to become much more competitive and capture the large and growing market opportunity.

Since the company’s founding, Yahoo! has created tremendous value for our users, our partners and our shareholders. We have much of which to be proud. However, our work is not done. Our mandate now is to marshal our substantial strengths to drive growth and create value.

We recognize that we still have considerable work to do and I believe our new strategy puts us on the right path.

With that, I would like to turn the call over to Sue.

Sue Decker

Thanks, Jerry. As Jerry has noted, we’ve been deeply engaged over the last few months reviewing our strategy and business priorities and have made tremendous progress. We are excited by our plan to transform Yahoo! and feel good about the actions already underway.

Yahoo!'s leadership team has worked closely to identify our challenges and our opportunities and we feel a renewed sense of energy, urgency and purpose. And even as we focus on strengthening Yahoo!'s business, our relationships with every element of our ecosystem, users, advertisers and publishers, are becoming stronger. We plan to stay laser focused on building off this strong base.

I’m going to focus my comments today on three primary areas. First, a business and market update; second, how we are driving toward faster, smarter execution; and third, why we believe there is so much upside ahead.

Let’s kick off with a business update and talk about some of the progress we’ve already made against our three major strategic objectives. Jerry noted we are focused on making Yahoo! the starting point for the most consumers on the Internet and we’ve got a great base on which to build.

We ended the quarter with 477 million users, up 14% from a year ago. Our internal estimate of page views grew even faster, up about 20%, implying growing engagement. This is relatively consistent with the growth of the last few quarters, notwithstanding that Yahoo! has the largest user base on the web.

Turning to our starting points, let’s first look at Yahoo! Mail, a worldwide leader for 10 years and our single largest starting point based on numbers of users. There were two major mail developments in Q3. In August, we began rolling out the new Yahoo! Mail with industry-leading features, including built-in instant messaging, text messaging to cell phones, unlimited storage, drag-and-drop functionality, preview panes, and fast and integrated search.

In addition, we recently acquired Zimbra, a leader in next generation e-mail and collaboration software. We believe we can extend some of Zimbra’s very intuitive user features to our consumer service while also addressing a new market for Yahoo!, web-based mail for universities, ISPs, and small businesses.

Search is another critical starting point for Yahoo! users and we just launched our most significant consumer-facing update to our algorithmic search technology since inception. This patented IP is the most advanced assist technology available on the market. It understands when people need help finding what they are looking for and suggests related search concepts to help them.

By better understanding user intent, we believe the new Yahoo! search puts the best results with the most complete information, including multimedia integration across video, images and audio, right into the search results page for the most popular queries, such as music, movies, travel, sports and much more.

Let me give you an example. Users can now play trailers or buy movie tickets, watch music videos or hear song snippets, see their favorite sports star’s current stats and much more directly on the first search results page.

Longer term, our ambition in search is to change the game and in so doing, gain query share. Our research suggests that 85% of all users find they don’t get what they want on their first search with the current state-of-the-art search algorithms. We think Yahoo! is in a wonderful position to provide an integrated experience that goes beyond search to actually complete tasks.

Let’s talk now about our most visible starting point, Yahoo!'s front page and some of the leading anchor properties that support and reinforce its leading position.

As part of our consumer-facing strategy to provide users with the most relevant experiences, Yahoo!'s front page recently launched integrated inline video. The result is a faster, more seamless and intuitive video experience, which consumers love.

We’ve seen a significant increase in front page engagement and we are in the process of extending this enhanced video experience across the network.

We are also beginning to open up the front page to outside content providers to further our goal of offering consumers access to the most comprehensive and relevant content on the web.

When we look beyond starting points, we are equally focused on key anchor properties that support and reinforce users’ starting point choices. Three of these anchor properties, News, Sports, and Finance, now simultaneously hold the number one com score spot for the first time ever in their respective categories in terms of both audience size and engagement.

As we’ve more fully integrated video throughout the network, we’ve also seen a huge increase in video streams. In news alone, we are now streaming more in a single month than we were in an entire quarter a year ago.

With our recent acquisition of BuzzTracker, we are delivering on our commitment to connect our users to the information they’re seeking while enhancing the Yahoo! news experience by bringing in the best and most relevant content from blogs and traditional news outlets.

Our broader ambition is to focus our efforts around building platforms that attract third parties and user generated content, while de-emphasizing original entertainment programming and our premium music business.

Finally, let’s discuss mobile, the biggest emerging starting point. One Search, an entirely new search service designed just for mobile, gives consumers better results and instant answers. One Search has been warmly received by consumers, allowing us to continue rapidly expanding its availability.

We recently announced a global agreement to be the main search engine on Telefonica handsets, potentially reaching over 100 million consumers in 15 countries and bringing the total potential reach of One Search via partnerships to more than 200 million consumers around the world. The deal also leverages other Yahoo! services like Flicker and Yahoo! Mail.

Let’s now move from consumers to advertisers and publishers. We’ve been executing on our objective to become the must buy and most essential marketing partner for the most advertisers on the web.

Starting with search monetization, I’m very pleased to say that our global rollout of Panama is nearing completion. Substantially all of our global advertisers have now been migrated to the new system and we launched the marketplace design algorithm in Japan, the U.K. and Korea in Q3. Over the next few weeks, we will have the new ranking algorithm operational in all of our major global markets, a bit faster than our initial expectations.

The financial gains we began to see in Q2 have continued in Q3, with another quarter of double-digit RPS improvement on our U.S. owned and operated search, up over 20% and bringing U.S. owned and operated search revenue up to over 30% from a year ago.

The international markets where we’ve been launching more recently are also seeing very strong RPS gains as well. Panama’s development platform gives us the ability to rapidly launch enhancements, including two very important features -- quality-based pricing in Q2 and domain controls, which we launched yesterday, providing advertisers with more control over which domains were on their listings.

Both of these features should help increase performance and reduce costs for our advertisers.

Now let’s turn to display inventory, which characterizes about 90% of all advertising industry inventory on the web and also for Yahoo!. As we shared with you a year ago, social networking and a proliferation of publishing tools has fragmented user attention and this trend continues, just the opposite of the situation in search, which has become more concentrated with the top two players.

On the advertiser demand side, this is creating significant friction for advertisers seeking to connect with the users they most want to reach. Similarly, there are major friction points on the publisher side due to closed networks, Byzantine approaches to price discovery, and still limited tools and technology.

We believe these issues are the major reasons for rapid ad network growth in the last 12 months in the display world. According to our research, while the display market in the U.S. is expected to grow 20% to 25% this year, pure ad networks and exchanges are growing much faster, while sites not associated with the network are seeing revenue growth of only 10% to 15%.

While this presented some short-term challenges for Yahoo! in the past, we are already starting to see signs of progress from our recent efforts to address this market shift and we see significant long-term opportunities that Yahoo! can uniquely address.

Let me start with the short-term results. After seeing deceleration in revenue growth for five quarters, we realized an acceleration in year-over-year global display growth in Q3 to nearly 20% versus low to mid teens last quarter.

Ad impression growth is strong, although we have continued to see a shift from guaranteed placement to non-guaranteed buys. As we said in the past, U.S. CPMs on a like unit basis increased year over year across the board, although the mix shift toward non-guaranteed buys in impressions has resulted in modest yield dilution on an overall weighted average basis.

Importantly, the price of non-guaranteed advertising has close to doubled in a positive sense since early 2006, while guaranteed pricing has also risen modestly. Those dynamics have narrowed the gap between the two pricing points considerably, making guaranteed pricing more competitive now with broader market conditions.

What about the longer term? As we think about why these trends reversed in Q3, let’s remember that Yahoo! started from a position of strength. We have long led in both display ad revenue and inventory. Our critical requirement was to supplement this with better direct marketing tools and a focused off-network ability to aggregate quality audiences on which we’ve made considerable progress.

Supplementing our late 2006 and early 2007 exclusive partnerships with e-Bay, Comcast and the newspaper consortium, we are very excited about some of our newest strategic partnerships, including Bebo, WebMD, Cars.com, Forbes.com, and Ziff Davis Media.

The WebMD and Bebo deals include both search and display, while Forbes.com, Cars.com, and Ziff Davis are display deals. We’re beginning to see a real gravitational pull into our ecosystem as we execute on our partner of choice strategy.

As we expand our partnerships and the growing cache of attractive ad inventory available in one-stop shopping, we must also continue to build out the capabilities in tools that allow Yahoo! to fully address advertiser needs on both Yahoo! properties and the sites of our growing base of premium publishing partners.

To this end, we just acquired BlueLithium, the fifth largest ad network in the United States, the second-largest in the United Kingdom, and the fastest growing independent. With their performance management and targeting expertise, BlueLithium will provide access to valuable audiences and give Yahoo! and our partners increased re-targeting capabilities to sell performance-based campaigns both on and off Yahoo!.

In Q3, we also closed on our acquisition of Right Media, the industry’s largest emerging online advertising exchange. Right Media brings industry-leading performance tools to our sales force, as well as broader monetization opportunities. We are now in the process of migrating our non-premium inventory to the exchange and expect to have the majority migrated by year-end.

As we look forward, building a scalable monetization platform across display advertising to supplement and ultimately integrate with our search platform is our highest priority area of investment. We are focused on scaling the exchange to handle significantly greater volume, as well as on developing advertising and publishing ad management tools that take the best of what Yahoo! has to offer in serving premium inventory and the best of what Right Media has to offer for third party inventory into a winning combination for advertisers to better reach their customers and for publishers to better monetize their sites.

Our newspaper partners will be among the first to benefit from these new capabilities. We are also working with some of our new off-network publishing partners to give their sales channels the opportunity to extend their buys to identified audiences on Yahoo! and vice versa. You’ll hear much more about this aggressive roadmap in 2008.

Now that I’ve completed the business update, let me turn now to how we are executing more quickly than in the past. First, we are a much more aligned organization. We announced last quarter that we were integrating our search and display sales teams and this is now well underway. We are receiving very positive feedback from our customers on this change and many have asked to be pilots with us as they consider streamlining their own organizations.

This quarter, we announced further strategic and organizational alignment, bringing together the leadership across ad supply and demand in our newly formed Global Partner Solutions Group, while also moving our local markets and commerce properties to the division in which our audience properties are housed.

As is clear from our many publisher wins, these changes are already helping us to quickly identify and secure the off-network ad inventory that best meets our advertisers’ objectives and that will supplement our key starting points and anchor properties on Yahoo!.

In addition to structural changes, we are focused on better processes to drive speed and discipline in decision-making, clearer accountability and excellence in execution. We’ve consolidated a number of senior positions and decision-making over a broader span of control with our best leaders and have removed impediments to get things done by better and more explicitly defining roles and responsibilities.

We expect to build on these early organizational and execution improvements in the quarters ahead.

Before closing, I want to touch on why we see so much upside in the strategy we’re pursuing. By employing an open platform strategy, attracting best-in-class outside content providers and developers, and utilizing our industry-leading insights about users across Yahoo! and our many partners, we believe we can make Yahoo! experiences meaningfully more relevant for all of our key constituents, users, advertisers, and publishers.

Let’s consider an illustration of what this means. The click-through rates on some of our algorithmic search results can be north of 40%, which is 10 times higher than that on the today module, the featured content at the center of our homepage. A similar order of magnitude gap exists between the clickthroughs on the large branded ads on many of the areas of our network versus the content in the today module.

Pricing for the ads follows suit. Search ad pricing can be multiples higher than ads elsewhere in the network. This difference exists in search because we can match user intention to a much more comprehensive database of information, while elsewhere we often don’t take intention into account or where we do, we match that to a more closed and less comprehensive database of information, content, services, and offers.

Our objective is to apply the search relevancy paradigm wherever possible to create far more relevant experiences on Yahoo!, both in content and in advertising.

As a simple example, we want to move to a place that will show American Idol in the today module to American Idol fans and World Series highlights to baseball fans, rather than showing the same content on the homepage to everyone, as we do today.

Yahoo!'s large scale means slight gains in relevancy can have a material impact on our financial performance. A simple 100 basis point improvement in aggregate network clickthroughs can generate an addition 2 billion page views per month. To put that number into context, that’s the equivalent of four New York Times.com sites, two ESPN.coms, or one Amazon.com. This means that we both have the potential to create better monetization by producing more relevant content in advertising through personalization and targeting and we can potentially produce much more inventory to monetize.

We have a number of initiatives underway that will help unleash this value in the coming years.

In conclusion, we are working diligently to transform Yahoo! on multiple fronts. Specifically, we are sharpening our organization, empowering our leaders and improving processes to ensure focus, speed and accountability.

We are prioritizing our user resources around key starting points and creating strong differentiation in those products. This massive and growing user base creates inventory that offers meaningful incremental monetization opportunities.

And finally, our inventory and that of many publishers on the web, is significantly undervalued in both search and display, which makes us very optimistic that our ability to create value for shareholders through platforms like Panama and what we are now building and extending in display as we strive to become the must buy for the most advertisers.

Although there is a lot more to do, we are really excited about the challenge and encouraged by the progress we’re making. With that, let me turn it over to Blake to provide more detail on our financial results and outlook.

Blake Jorgensen

Thanks, Sue and thanks to everyone for joining us this afternoon. Before turning to the quarter, I would like to briefly touch on the financial side of our strategic review. As Jerry and Sue mentioned, our goal is to generate the maximum long-term value for our assets. We’ve been reviewing our business strategies and where our resources are deployed to determine our highest value opportunities. Given the dynamics of our industry, we view this as a continuous process rather than a one-time event. As such, we are likely to see a continuing evolution in our operations and in the way we do business.

Despite this environment of change, however, we will not change our focus on growing free cash flow, since we believe that is the best way to measure our progress and to deliver value to our shareholders.

We had a very business Q3, and now let’s take a look at our financial results.

I'll begin with free cash flow, which was $310 million in the third quarter, reflecting solid, underlying profitability. Free cash represents 66% of operating cash flow; again, at the high end of our long-term target of 50% to 70%.

Our cash and marketable securities balance was $2.8 billion at quarter end. We invested $320 million in acquisitions that closed during Q3 and we repurchased $350 million of stock in the open market at an average price below $24 per share.

Also during Q3, a $250 million structured stock repurchase contract matured, resulting in the return of approximately 8.4 million shares of stock to the company. With these transactions, we have now repurchased over $1.6 billion of our stock during 2007.

In addition to our cash and marketable securities balances, our ownership stake in several entities provided incremental balance sheet value. Our interest in Yahoo! Japan, the Alibaba Group in China, and G-Market in Korea were valued at approximately $9.2 billion, or over $6.50 per share at quarter end. Since the end of the quarter, we have also closed the Blue Lithium and Zimbra acquisitions, in which we invested approximately $550 million in cash.

Now let's move to the P&L. Beginning with the top line, third quarter revenue excluding traffic acquisition costs, what we refer to as revenue ex-TAC, came in at $1.283 billion, advancing 14% year over year and within the range we provided in July. We saw solid growth in both our marketing services and fees businesses.

Drilling down on marketing services, we generated $1.059 billion of revenue ex-TAC in Q3, up 16% versus the prior year. We are particularly pleased with the revenue growth from our owned and operated sites, which continued to accelerate to 22 % growth in Q3 from 18% growth in Q2, and 14% growth in Q1.

U.S. O&O search revenue grew more than 30% year over year, improving on the strong growth we posted last quarter. RPS, or revenue per search, grew over 20% year over year and out paced last quarter’s mid-teens improvement. Growth in our O&O display advertising business also accelerated during the quarter, showing improvements in both brand and performance marketing ad sales. Our internal estimates of page view growth were around 20% year over year in Q3, with good growth across all three major content and service areas: communications, media and search.

As we've indicated for the last couple of quarters, we continue to face headwinds related to rising TAC rates and to our traffic quality efforts in our affiliate search business. Revenue ex-TAC continued to decline on a year-over-year basis. It's important to note that while the trend in the affiliate search business has impacted our overall growth rates this year, we believe that this part of the business will represent only about 10% of our overall revenue ex-TAC base at the end of 2007.

I'd also like to reiterate that our network quality efforts are part of a deliberate strategy to ensure that we are delivering the highest value traffic to our advertisers, and we believe we're executing on that strategy.

Now let's look at fees revenue. We produced $224 million of fee revenue, up 7% from the same period last year. Excluding the impact of a modest one-time license revenue item in last year’s third quarter, our fees revenue grew 12%. The primary driver of this revenue line is our premium offerings. That is, those services for which consumers and businesses pay us. We exited the quarter with 18.7 million paid relationships, up over 20% year over year and up 1.8 million from Q2 levels. This strong performance was driven by our access relationships including our new relationship with New Zealand Telecom; Fantasy Sports, which is typically strongest in Q3 with the start of the football season; and incremental subscribers from our acquisition of Rivals.com, which provides premium coverage to fans of college and high school sports.

Looking at our international results, revenue ex-TAC grew 13% in the quarter, or 8% excluding the impact of foreign currencies. On the international side, growth was negatively impacted by our affiliate trends, as I mentioned a moment ago. However, our international O&O marketing services revenue grew over 25% during the quarter. Display growth was strong across Europe, in Asia, and in the emerging markets and we anticipate that the completion of the Panama rollout internationally will accelerate international search growth in the coming quarters.

Turning to profitability, operating cash flow came in at $466 million, producing global OCF margins of 36% for the quarter. Despite significant headcount growth in Q3, our margins came in ahead of plan as we continue to focus on managing our cost base while investing in our highest priorities. Timing helped a bit as well, with a variety of small one-off items contributing to a roughly $5 million reduction in Q3 costs and a substantial portion of our headcount additions occurring late in the quarter. By geography, international OCF increased while the U.S. was down due to investment in some of the initiatives that Jerry mentioned, and the impact of the recent acquisitions.

Our effective tax rate for the quarter was 40.6%. We continue to expect our effective tax rate for 2007 to be approximately 43% to 45%. We expect our cash tax rate for 2007 to be between 15% and 17%.

We added approximately 1,200 employees during Q3. This includes net additions from acquisitions, as well as the transition of Overture Japan's employees to Yahoo! Japan in connection with the sale of Overture Japan. The majority of our new hires were in product development. In addition to our hiring being concentrated later in the quarter, we were also successful in pulling forward some of our anticipated Q4 hiring into Q3, as some of our key initiatives began to ramp.

That brings me to our business outlook. Our revised outlook for the full year reflects the Q3 upside as well as the inclusion of both Zimbra and Blue Lithium in our Q4 results. For Q4, we expect revenue ex-TAC of a $1.31 billion to $1.45 billion. We expect operating cash flow of $480 million to $550 million. Our outlook contemplates the hires we made in Q3 as well as the impact of the sale of Overture Japan and the acquisitions of Rivals, Right Media, Zimbra and Blue Lithium.

We've already discussed the acquisitions, but let me provide additional color on the impact of the Overture Japan transaction. We believe that by enabling the Yahoo! Japan sales team to present a unified offering to customers, this deal will be a significant positive to both parties in the long term. As we discussed last quarter, this transition will reduce our reported GAAP revenue and TAC in Q4 and into 2008, resulting in a modest net decrease in revenue ex-TAC.

Yahoo! Japan will pay us a service fee for providing search advertising and support services, and we expect this transaction to be slightly positive in OCF in the short term compared to our previous affiliate arrangement with Yahoo! Japan. As we mentioned in July, we received a small upfront payment and we believe that the majority of the value of this deal will be realized via our long-term relationship with Yahoo! Japan.

Turning now briefly to free cash flow, we anticipate a full-year 2007 range of $1.2 billion to $1.3 billion, reflecting capital spending for 2007 of approximately $625 million to $675 million.

In conclusion, we are pleased with our results for Q3 and we are still continuing to invest in several major growth initiatives. We face challenges in the marketplace, but we are encouraged by the early signs of improvement and the significant opportunities on the horizon.

With that, I'd like to turn the call back to Jerry.

Jerry Yang

Thanks, Blake. Let me conclude by emphasizing a few key points. First, we determined that to win in the marketplace we must take greater advantage of our unique assets to drive value across a broad ecosystem. We believe having a principal position in both search and display advertising is critical to creating that long-term value.

Second, Yahoo! zeroed in on three big multi-year objectives around which we'll organize, fund and prioritize our resources. We want to make Yahoo! the starting point, become the must buy for advertisers, and develop industry-leading platforms for the developers.

Third, we'll use our strategic differentiators of insights, openness and partner of choice to make Yahoo! more relevant and indispensable.

Fourth, we are sharpening our organization, empowering our leaders and improving process to ensure focus, execution and accountability.

Fifth, we're making some initial progress towards executing against our strategy through the launches of a new Yahoo! Search and Mail, gaining category leadership in sports, news, and finance and continued improvement of our search monetization. Several new publisher relationships and acquisitions of Right Media, Blue Lithium, Zimbra, and BuzzTracker.

Sixth, this is a multiple-year effort. As we transform our business over the next few quarters, we are pleased with the growth we're seeing around our owned and operated business. We will continue to work through the headwinds, such as the transition of our lower-quality search affiliates.

We have a lot more work to do, but we're generally excited about where the company is headed. Now let's open the call to some questions.

Question-and-Answer Session

Operator

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

Christa Quarles - Thomas Weisel Partners

Could you just go through some of the organic numbers, both on remnant or total display as well as user and potential page view implications? And also, on the paid relationships? Thanks.

Sue Decker

I'll start on the marketing services side and then hand it off to Blake on the subs and the rest. The organic numbers on display that we talked about were that we grew about 20% in global display revenue this quarter, up from the low teens that we did last quarter. This was the first quarter of acceleration in five quarters. Page views, as we said, were up about 20%. Why don’t I turn it over to Blake on the sub side.

Blake Jorgensen

Hi, Christa, nice to be able to speak to you without a chaperone present. In terms of the subs, is there specific data that you're looking for? I guess you can't answer, so let's jump to the next question and then we'll come back with some more detail on subs for Christa.

Operator

Our next question comes from the line of Imran Khan – JP Morgan.

Imran Khan - JP Morgan

Two questions. You equated a lot of traffic to your partnership, building the ad network and now through the Blue Lithium acquisition, which has a good targeting technology, how do you try to scale the Blue Lithium product to better target this partner traffic and how can you increase the yield of that?

The second question is probably longer term. If your search growth rate is 30% plus and 20% plus is driven by monetization, how should we think about the search growth in the longer term after you anniversary this monetization improvement? Thank you.

Jerry Yang

I'll start with the search query question and then Sue will talk a little bit about the Blue Lithium. As we've all said on the call, we've been spending obviously a lot of our resources in the past year around Panama, and this year we're starting to focus around our ability to generate algorithmic search query share. We've just had the beginning of our new product set launched earlier this month actually, with Search Assist, as Sue referred to.

I think what we are talking about is a reinvestment and redoubling down of our effort in creating better algorithmic search products to continue to drive query share, and it's something that we are really focused on finding ways to change the game through product enhancements. Obviously we're going to continue to look at distribution opportunities, as well as making sure that it integrates better and better with the rest of our network.

Sue, do you want to talk about the Blue Lithium?

Sue Decker

Sure. I will just point to three legs on the broader stool of inventory here. We have the largest amount of inventory on Yahoo! owned and operated sites, of course, and we're supplementing that with high-quality exclusive partnerships, several of which we announced today and had announced earlier in the year, in addition to Blue Lithium which is the fastest-growing independent ad network.

The third leg on the stool would be the Open Ad Exchange in Right Media. Our objective here is to be able to take our very strong internal inventory and be able to leverage that significantly by a multiple in terms of our go-to-market ability to offer advertisers access to audiences all over the web, and exactly the audiences they want.

Both Blue Lithium and Right Media bring to us some direct marketing capabilities and tools which supplement where we were, which is very, very strong premium inventory and serving. So collectively, we think we have a pretty comprehensive offering now and we're working quickly to integrate. We just closed Blue Lithium so we haven't done much integration yet, but we have plans for that very quickly and we have fully integrated Right Media on an organizational level and are already moving a lot of the inventory from our non-premium inventory from the Yahoo! sales to the Exchange.

So collectively, we believe this will reduce friction for buyers, will increase monetization for sellers, and as the largest seller, that should benefit Yahoo!.

Operator

Your next question comes from Jeetil Patel - Deutsche Bank.

Jeetil Patel - Deutsche Bank

First of all, can you talk about the Blue Lithium and Right Media acquisition contributions that you saw in Q3? What do you expect in Q4?

Second, with your current ad partners, what percentage of your users webwide activity do you see today, and what is the threshold at which point you can actually start to increase your targeting in terms of ads that these users see among your partner sites as well as your own site?

Blake Jorgensen

I'll start with the first part and then turn it to Sue. We don't disclose or will not disclose the Blue Lithium and Right Media revenues directly. I think as we made note at the times of the acquisition, there would be some revenue in the back half of the year, growing in 2008 and we would be neutral in terms of our cost and revenue components.

Sue Decker

On the percentage of user activity, measured by page views, Yahoo! O&O sites are roughly 8% or 9% of all page views. In terms of revenue contribution, because it's such premium inventory, it's well higher than that; into the teens.

When you take into account the partnerships that we have already signed up, that adds actually more inventory collectively, if you take partnerships and the acquisitions of Blue Lithium and the Right Media Exchange that we have on Yahoo! and also brings significantly more revenue share.

So on and off Yahoo! we are very quickly assembling the largest ad network out there and that's why we believe our ad revenue growth in display has reaccelerated to roughly in line with what the industry growth rates are expected to be this year.

Operator

Our next question will come from the line of Christa Quarles - Thomas Weisel Partners.

Christa Quarles - Thomas Weisel Partners

I guess they put me back in the queue because I couldn't ask the other question, but I was just trying to understand if you could give any indication around what the contribution was on the page view side? It sounds like you aren't going to comment on the revenue side from Right Media.

While I'm at it, if you could just highlight some of the innovations that you're starting to see emanate from the open platforms on the remnant display side? Thanks.

Blake Jorgensen

Christa, I'll let Sue do the second part. I think your original question that we didn't get answered was around the fees business, and the note that I had made earlier was there was a one-time fee licensing payment in 3Q06 and when you strip that out the fee revenue grew 12% year over year. We had 18.7 million subscribers. That's up 1.8 million from the previous quarter.

Sue Decker

I'll take the other questions. I'm not sure I totally understand the page view question, maybe we can follow up afterwards. Our page views were up about 20% in the quarter. Those wouldn't include any page views from off-network companies or anything. That's the O&O Yahoo! properties.

In terms of the open platforms for remnant inventory, we're well under way in the migration of what we call our non-guaranteed inventory into the Right Media Exchange, but a lot of that process is happening right now so it's a little early to be too definitive on what kind of pricing benefit we will actually realize from the much broader price discovery across user frequency.

Our initial look of it has been strong and consistent with what Right Media has seen in the past as publishers have moved onto its exchange, which is a meaningful lift in their monetization rates.

Operator

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

Brian Pitz - Banc of America Securities

On Q4 guidance, any commentary on your expectation from new partnerships? Because if you factor in the new partnerships plus your better O&O performance, it would suggest to us that the guidance may be a little conservative.

A second part to that, should we be expecting TAC to go up as a percentage and maybe you could talk to some of the factors that drove these new publishers to switch to Yahoo!? Thanks.

Blake Jorgensen

Let me start and then I'll let Sue talk a little bit about the TAC piece of the equation. The mid point of our range reflects our best estimate of where we believe the businesses will perform in any given period. Included in that, we did raise our Q4 revenue outlook for the impact of the acquisitions, including Zimbra and Blue Lithium which have just closed. While display has performed better than expected, we believe in the third quarter we were helped out by a few items that may not reoccur in the fourth quarter such as large movie budgets and other spending.

With that, I think we'll continue to maintain our practice of providing guidance and we'll revisit the guidance for everyone for 2008 at the end of the next quarter.

Sue Decker

I just want to add one point here, that when we look at the affiliate business across Search and Display, and what that means and how we generate value, just to reiterate some of the things that we've said in the past which is that after traffic acquisition costs, we don't expect these partnerships to be meaningful profit centers on a standalone basis. The display marketplace is probably a little less competitive in terms of traffic acquisition costs in Search, but we expect them to converge very quickly.

The most important thing to understand though is that incremental scale in display is significantly more important even than in search, since only two players provide 75% to 80% of all of the inventory in search, and that's actually getting more concentrated. The off-network piece beyond those two players is relatively modest.

In display, we're the largest with about 8% of the page views and close to double that in premium revenue share; but if anything, the inventory is getting more fragmented and we see an amazing opportunity for us if we can aggregate incremental supply of premium inventory to bundle with our existing inventory to reduce friction for the advertisers out there.

So when we think about value creation, it largely accrues to our O&O through pricing and reduction of friction benefits as opposed to looking at the affiliate business on a standalone basis. As far as the display deals we just announced, we wouldn't expect them to add much in this year and longer term, we do expect the scale benefits to be very important to Yahoo!.

Jerry Yang

Brian, one of the factors you asked about to drive partners to come to Yahoo! is, I think to Sue's point earlier about being one of the combined offerings both in terms of search solutions as well as display solutions. We're starting to also, as Sue alluded, to have sales forces from partners who have sales forces avail themselves of inventory that are potentially bundled on Yahoo!.

So there's a multiple way, a multiple offering which we are offering to our partners to monetize their site and we are helping them or they are helping themselves. So again, this is just the beginning for us but we're starting to see the power of combining the sales forces, as well as an end-to-end advertising platform.

Operator

Your next question comes from Robert Peck - Bear Stearns.

Robert Peck - Bear Stearns

You mentioned that RPS was up about 20% and I was wondering if you could give us a breakdown of that? Was it driven by clickthrough rates, CPCs, coverage, et cetera?

Jerry, I was wondering if you could comment a little bit about where you stand on the social network side. You mentioned Yahoo! 360; obviously Yahoo! Mash is coming along here. Could you talk about where you see yourself as far as the investment phase? Do you ultimately see or need a large deal with a Facebook or maybe some of the other social players out there to capture more and more of the page views where they are growing on the net? Thanks.

Jerry Yang

Bob, I'll start and then Sue can talk a little bit about the RPS. As I said in our comments, we are much more focused around a broad set of things that users will do to start their experience on Yahoo! and we have some of the very strong applications around home page content, Search, Mail. We have also openly stated that we feel connecting our users with people who they care about is going to be a priority and that remains such, but only as it fits into our starting point strategy.

We have some offerings out there that have social components. Things like Flickr and Answers continue to be one of the larger social networks, but you can count on us to find ways to integrate our social capabilities even more as we really focus around the starting point strategy.

Sue Decker

On the RPS side, it probably doesn't make sense to get into the individual components of growth, but it's fair to say that the new ranking algorithm is very sensitive to the relevancy of the listings, and therefore you'd imagine that the clickthrough rates are probably moving in a positive direction.

Operator

Your next question comes from Anthony Noto - Goldman Sachs.

Anthony Noto - Goldman Sachs

While the revenue acceleration is obviously a move in the right direction, the level of profitability on an operating income basis is going in the opposite direction, down 5.5% in the quarter, worse than the 4% decline in Q2 based on our accounting methodology, which is slightly different than yours.

I was wondering if you could comment on what's driving that deterioration in profitability, both on a year-over-year basis and then in terms of growth rate? Incremental margins about 1%.

Blake, you'd mentioned about some one-time benefits in the quarter for advertising. Do you think the economic environment is causing them to be one-time or do you just think the box office slate will be slower in the fourth quarter? Thanks.

Blake Jorgensen

On the first part around the margins, we're clearly not happy with where our margins are today. We still are focused very much so on balancing the margin growth with the continued investment in the key initiatives that Jerry and Sue defined. Critical to that, we're continuing to add employees, as we mentioned, in the third quarter and somewhat in the fourth quarter, but we'll continue to keep our focus on improving those margins over time.

In terms of the one-time benefits in the third quarter, I think most of those were more seasonal. We are conscience of economic slowdown. We haven't seen that in any specific sector, but we're conscience that the advertising industry across the board is worried about potential slowdown.

Operator

Your final question comes from Youssef Squali - Jeffries & Co.

Youssef Squali - Jefferies & Co.

Your guidance does not seem to show any margin improvement in Q4 over Q3 out of the higher revenue rate that you're guiding to. In prior years, you've certainly shown that the model scales Q3 to Q4, so can you speak to that? Lastly, can you just clarify how you will classify the Right Media and Blue Lithium revenue since some of it is O&O and some of it is network?

Blake Jorgensen

In terms of the guidance, I think as we mentioned, we hired 1,200 people in the third quarter. Some of that is planned hiring from the fourth quarter, but that will continue to impact our margins in the coming quarter. That's why we've continued to maintain the guidance as we have, as well as the acquisitions of all of the different pieces that will drive both revenue up but also bringing on headcount and associated costs in the near term. So no OCF impact on the positive side.

In terms of the Zimbra and Blue Lithium revenues we, as I said before, have not disclosed how those revenues will be integrated into the revenue statement. I think in future quarters when we give some guidance around the full year we might provide some better visibility on how those will impact the overall 2008 numbers.

Jerry Yang

I want to thank everybody for joining us today and have a great afternoon.

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