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Yahoo! Inc (YHOO)

Q4 2005 Earnings Conference Call

January 17th 2006, 5.00 PM

Executives:

Waddell Nicole, Director of Investor Relations

Terry S. Semel, Chairman and Chief Executive Officer

Susan Decker, Chief Financial Officer

Analysts:

Mark Mahaney, Citigroup

Youssef Squali, Jefferies & Co

Jeetil Patel, Deutsche Banc

Ben Schachter, UBS

Anthony Noto, Goldman Sachs

Heath Terry, Credit Suisse Boston

Lauren Fine, Merrill Lynch

Safa Rashtchy, Piper Jaffray

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Operator

Good afternoon ladies and gentlemen and welcome to the Yahoo Fourth Quarter 2005 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session. Please note that this conference is being recorded. I will now turn the call over to Ms. Waddell Nicole Director of investor relations. Ms. Nicole you may begin.

Waddell Nicole, Director of Investor Relations

Good afternoon and welcome to Yahoo’s Fourth Quarter Earnings Conference Call. On the call today are members of our executive team, Terry Semel, Su 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 plan. Actual results may differ materially from the predicted results and reported results should not be considered as an indication of future performance. The potential risks and uncertainties include among others, the company’s ability to compete with new or existing competitors, reductions and spending by or loss of marketing services customers, demand by customers for Yahoo’s premium services and risks related to the integration of recent acquisitions. All information discussed on this call is as of today January 17 and Yahoo does not intend and undertakes no duty to update this information to reflect future events or circumstances. 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 in file with SEC.

On the call today, we will discuss some non-GAAP financial measures and talking about the company’s performance including operating income before depreciation and amortization, which will be referred to as operating cash flow. Revenue excluding traffic acquisition cost free cash flow and adjusted net income. Reconciliations of those measures to GAAP measures can be also be found on our website under investor relations. Terry and Su have prepared remarks that should last about 30 minutes and then we will have a great Q&A session. And now, I would now like to turn the call over to Terry.

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Terry S. Semel, Chairman and Chief Executive Officer

Good afternoon everybody. I am very proud of the remarkable growth in progress Yahoo has demonstrated throughout this past year. We relentlessly focused on the expanding needs of our consumers and increased the rate of innovation and product development. This in turn translated into great financial results for our company and we’ve accomplished all this while also continuing to pursue emerging opportunities that we believe will help sustain our long-term competitive advantages.

Yahoo reported revenue of $1.5 billion for the quarter, or 11 straight quarter record revenues and up 39% from the fourth quarter of the previous year. This makes our 2005 full year revenue of $5.3 billion, almost a 50% increase over the $3.6 billion in 2004. We achieved balanced growth with contributions across the board from our multiple lines of businesses and geographies. Demonstrating the leverage in our business model, operating income before depreciation and amortization in Q4 was $459 million and $1.6 billion for the full year of ’05, up over 50% from the full year of ’04. Our results demonstrate the power of our great business model, Yahoo continues to attract and engage largest and most valuable audience on the web. This enables us to drive our diverse lines of business around the world, including brand advertising, search marketing, commerce and premium services.

As more people are connecting to the Internet, more often and for more devices, we believe the future holds even greater opportunity. There is a significant platform shift occurring, in which consumers are taking advantage of the Internet being always on, always fast and always with them. As the largest global Internet network we believe now is the time to make investments in new audiences, new ways to engage them and build new revenue opportunities. There are already 1 billion people using the Internet today and it’s only going to get bigger. We believe that the network that has the deepest relationship with the largest number of users connects them to the most activities on the Internet across their multiple devices will ultimately be the most powerful channel for advertisers and publishers. Our innovation in leadership in providing a valuable experience on the Internet is really highlighted when you look at our key audience numbers. Users continue to endorse and reward Yahoo making it the #1 global Internet network, however more impressive is that even with our scale Yahoo’s growth continues to outpace the growth of the worldwide Internet population.

We ended the quarter with approximately 429 million unique users, which include users of Yahoo China, up 24% from approximately 345 million this quarter last year. Our active registered users now stand at approximately 201 million up 21% year-over-year from a 165 million. Starting in Q1 2006, we will report a user number that reflects Yahoo’s global reach including users of Yahoo China and Yahoo Japan, which is approaching 0.5 billion unique users as well as a user number that reflects our consolidated financials. Our growth in users and share has been impressive and very exciting. But it is also our growth in user engagement that really stands out. During the past year, while growing overall users, we also increased the average number of properties consumed by our users by almost 25%. The increase in user engagement on Yahoo gives us an enormous advantage as monetization opportunities on the Internet continued to increase.

Our high user engagement has also positively impacted our success in the growth of our premium services. Our paying subscribers are the fastest growing subset of users on the Yahoo network. We ended the quarter with approximately 12.6 million unique paying relationships, up approximately 1.2 million from the previous quarter and up almost 4.2 million or 50% on a year-over-year basis. This year, we are now poised to surpass the goal of 15 million paying relationships that I previously said several quarters ago. The depth of our audience reach, the quality and engagement positively impact our ability to provide deeper value to our advertisers and is reflected in the success of our marketing services business.

For the quarter, our marketing services business delivered $1.3 billion in revenue representing 39% year-over-year growth as a result of strong comp contributions by all forms of advertising. We are clearly the #1 in the brand advertising segment. Even as the market sees continued enormous growth, Yahoo continues to outperform and take market share. Delivering results is the key to building a sustaining deeper relationships with the world’s largest advertisers, and that is why our average revenue per US brand advertiser in the fourth quarter has more than doubled in less than 2 years.

In Q4, strong year-over-year growth was achieved across several industry categories including financial services, retail, technology and autos which all recorded a strongest quarter ever. Our unique and powerful solutions such as advanced targeting innovative rich media formats and network wide marketing packages by the helping the world’s largest and most important marketers drive the best results on the internet. Our leadership in area such as data and targeting provide a more relevant experience for our users, more effective results for our advertisers and allows Yahoo to maximize revenues efficiently and utilize our inventory accordingly.

Our search advertising numbers during the quarter were also were strong and the business is performing very well. On the sales side, we experienced strong performance in the auto and finance categories as their marketing embraced search as part of their customer acquisition strategies. December revenue in the retail category also experienced a meaningful increase in the course of the holiday season.

We also believe that there is significant potential upside as we improve our monetization capabilities and our tools to publishers and advertisers. We have been quite successful in attracting large content partners and have begun to take advantage of the large number of small publishers on the web.

During the fourth quarter, we further experienced the beta of our self service Yahoo Publisher Network, which is designed to tap into that segment. The beta is ramping up nicely and we now have several thousand publishers in the program with thousands more requesting invitations.

During the quarter, we also rolled out a number of new matching capabilities that have already resulted in increased coverage and improved RPS. Overall, both our brand and search advertising businesses continues to expand. We are making the right investments in audience size, demographics and engagement as well as exciting advances in delivering even better results for our advertisers.

As we move into 2006, we will continue to invest in the services and experiences for which we’ve already received a lot of accolades. We are the Internet leader and we are well-positioned to utilize the technologies, platforms and services that will define our success over the coming years.

I would like to briefly give you an overview of our key priorities for 2006. Our #1 priority is building and expanding the suite of tools services and solutions for Internet marketers and publishers. Just as you seen us systematically build our products and platforms resulting in the world’s best consumer experience, you will see us supply the same focus to our marketing partners, and of course for good reason. We anticipate the overall Internet advertising market has the potential to double in size in the next 5 years.

In search marketing, our monetization efforts can be grouped into 3 categories. First, we are expanding our content match services through the Yahoo Publishers Network to take advantage of the growing number of small publishers on the web. We plan to add new features to beta over the coming quarters including search and enhanced ad targeting. We believe the service will ultimately position Yahoo as one of the preferred advertising partners for small and medium-sized publishers. Second, we are focused on improving RPS to better matching in relevance algorithms. While our matching initiatives will largely benefit coverage, we’re also focused on improving tools to drive higher relevance and click through. And third, we are increasing the number of easy-to-use tools for advertisers and publishers, so they can buy more keywords, touch more creative and add more listings faster.

Importantly, because of the millions of users and hundreds of thousands of partners that depend upon us, we’re going to be very deliberate about rolling out changes and improvements over a period of time.

There are many exciting opportunities in our brand advertising to advance our strong leadership position. We are developing a brand advertising system to more efficiently deliver new forms of advertisers such as video formats, increasing our targeting capabilities and enable advertisers to buy larger campaigns more efficiently.

Yahoo is the only company that has scale and leadership in both brand and search advertising. As companies continue to use both forms of advertising, we have aligned our 2 sales channels under one management structure. In order to help advertisers even more effectively, utilize all of Yahoo’s marketing services. We are on our way to our future where we can help marketers deliver the right message in the right format to the right customer in the right environment at the right time.

Second, we intend to continue to bill audience reach and engagement. We already have a competitive advantage with respect to the size and scale of our audience and the relationships we have with our users. And we plan to build on that position by further expanding and enhancing the content across our network.

We intent to continue to support the full spectrum of advertising and premium supported content. If you’re wondering, I have a cold. So, please try to bear with me. I talked about premium supported content and format on the web including original license and user-generated content. You would also see an increasing emphasis from us on delivering more comprehensive content experiences by beta integrating head and tail content and aiding discovery through community tools. (Bad time to have a cold!) You will also seeing Yahoo open up its network even further through open platforms and through open API and enable developers to build on top of our services, which will expand our audience and business opportunities. We also believe that one of the most explosive content formats of the next few years will be video. Our strategy is to provide users with an end-to-end solution, of course video streaming subscription and downloads.

We believe Yahoo will become a central hub for people to find, create, distribute and watch video. We are already the leader in video with the largest video search engine, the most number of music video stream and through the TV shows, and news live events such as Howard Stern and NASA that we have streamed.

By integrating the world’s best known content and user community that want to connect with, we are building the most comprehensive and relevant experience that delivers on the promise of the shift to my media.

Third, we planned to continue to build tools to play a greater role in people’s connective lines. Users have already invested significant time and energy setting their Internet preferences on Yahoo. We believe that in a connected world, users expect their Internet experiences of course, all devices to be seamlessly integrated and their content to be accessible and personalize. This area should represent new and untapped market opportunities. We’ve raised the bar with the introduction of Yahoo Go earlier this month at CES, which will enable users to have the seamless connection in the three scream world across their desktop, mobile phone and TV.

In 2006, we will rollout those services, fill strong relationships with carriers and device manufacturers and explore new initiatives to enhance the consumer experience even further. We believe this area is a real strength and competitive advantage for Yahoo. Today’s generation does not see this as a parodying shift. They see it as a way of life as we will as well.

And fourth, we will continue to invest in talent. We have been able to attract some of the leading people in the world and it’s ultimately however going to win. I’m very proud that in Yahoo’s first year of eligibility. We were actually included in Fortunes 100 best places to work list. It’s not just the great working environment that makes Yahoo attractive, but our scientists, engineers, design specialists, marketers, product visionaries and business people all thrive on the possibility of solving some of the most challenging opportunities benefiting our hundreds of millions of users.

In 2006, we intent to continue to attract higher end, retain the most qualified and accomplish people across multiple disciplines and geographies. Okay, I can in conclusion and save my voice, I want to thank all the Yahoo employees throughout the world. It’s been another great year for our company. And I see Yahoo extraordinarily well-positioned for the future and believe each of our businesses are still in their infancy. We have the right people, resources and strategy to continue to take advantage of the significant opportunities ahead. I’d now like to turn the call over to Su who’ll review our key financial highlights. Su?

Susan Decker, Chief Financial Officer

Thanks Terry. And thanks to all for you for joining us today. As we close 2005, and commence 2006, we are excited about both our financial results and also about our opportunities ahead. Let me expand on both. First, we believe our strong financial results and balance sheet speak to the fundamental strength of our business model, robust and balance growth across our various lines of business, along with geographic and products diversity, through deliberate acquisitions and internal investment, we believe we’ve placed our chips in right places and we are executing well against those opportunities.

Second, regarding our opportunities ahead, we are very aware that our mission is not simply to deliver strong returns for a few years, but rather to make the appropriate investments and capital allocation decisions to build value over the long term. And the best part of where we said today is that we believe we’ve assembled and integrated the important assets necessary to capitalize on the colorful canvas of opportunities ahead, while also having the financial resources to take advantage of the ever changing landscape. We intend to continue to move quickly to take advantage of these strengths which we believe will position us well to deliver shareholder sustainable and powerful growth over the long-term.

Before we begin, with Q4 results let me start with the few housekeeping items. First, as previously announced, we closed the transaction with Alibaba in Q4. As a result of this, another investing activities in the quarter, we reported a net non-cash pre-tax gain of $310 million in other income. The gain on the Alibaba transaction is based on the difference between Yahoo China’s fair value and its cost basis, adjusted for our continuing ownership interest in the newly combined entity.

Second, our effective tax-rate was 40% for the quarter and for the full year, excluding the benefit related to a legal entity restructuring transaction we completed during the fourth quarter. This transaction, but our reported quarterly and annual effective tax rate down to an unusual level of 2.6% and 30.2% respectively. And it yielded a significant economic benefit, preserving net operating tax loss carry forwards in excess of $500 million. These in while would otherwise have been utilized in connection with close to $1 billion in gain, from the sale of a non-strategic investment earlier on 2005. Consequently, now withstanding the substantial profits we generated from operation and the sale of investments in 2005, our remaining inner wells as of December 31, totaled $3.8 billion down only modestly from year ago.

Excluding these items and assuming in effective tax-rate of approximately 40% in Q4, consistent with our effective tax-rate for the full year our Q4 earnings would have been $247 million or $0.16 per diluted share in the quarter, up 32% from a year ago and up 12% from the $0.15 per share normalized level in Q3.

Let’s talk now about the financial highlights from the quarter, starting with free cash flow, which reviews our most important financial metric, as it relates to value creation. As a reminder, we define free cash flow as cash generated from operation, which include cash cost per taxes and changes in working capital like capital spending. Free cash flow with $313 million for the fourth quarter, up more than 31% from a year ago, and totaled $1.3 billion for the full year of ’05, a new record for the company. And in the level that exceeds our total revenue of only three years ago.

For the quarter, free cash flow represented 31% of revenue ex-tax, and 72% of operating cash flow, demonstrating the ability of our unique collections of business to consistently and efficiently deliver strong cash returns. One very interesting relationship is to compare our earnings through our free cash flow. Q4 free cash flow was 34% greater than our normalized earnings whereas for most companies free cash flow is actually less than earnings.

Now, let’s turn to our consolidated cash balance and detail some of the significant sources and usage in the fourth quarter. Our ending cash and marketable securities balance was $4 billion, up almost 260 million from a year ago, and down about 765 million from last quarter. Please note that this ending cash balance does not include three other important sources of incremental balance sheet value.

First, our Yahoo Japan assets, the value of which is increased 30% to 15.5 billion, an increase of more than $2 per Yahoo share since last quarter to a total of more than $10 per Yahoo share. Second, our investment in Alibaba, which at the time of the transaction was worth 1.4 billion and it’s carried on our balance sheet of that value. And third, $745 million in structured share repurchases transactions that upon maturity will result either in the repurchase of stock or the cash being returned to the company during the first half of 2006.

Moving back to cash generation, in addition to our free cash flow this quarter our other significant sources of cash collectively amounted to approximately $750 million. These sources were comprised of proceeds from the exercise of employee stock options and the recede of cash back from previously initiated share repurchase transactions on which we have generated an annualize return of more than 21%.

Turning to how we invested that cash, we invested close to $2 billion this quarter in various transactions that we believe will yield substantial returns. The three primary areas in which that we invested include first, $1 billion for the cash portion of our investment in Alibaba. Second, $500 million for the purchase of the remaining stakes in our Yahoo Europe and Yahoo Korea joint ventures. And third, we invested or make commitments to invest approximately $260 million in the repurchase or the potential repurchases of our shares. Most of this would $245 million in structured stock repurchase transaction that we entered into and was maturing two charged process in May of ’06. At the final maturity depending on the price for stock, we will need a repurchase that the 6.8 million shares or receive an annualized return of more than 22% on our initial investment.

To summarize, as we look back at 2005, we generated over $3 billion of cash from operating and other activity, we’ve reinvested that cash actively through $1.7 billion of acquisitions, almost 400 million of structured share repurchases and over $600 million net in structured share repurchases, leaving our cash and security balance at almost 260 million from a year ago. We believe the active and management investment of close to $3 billion in cash, it will be value-creating for our shareholders.

Moving now to the P&L, the overall summary is that consistent with our financial strategy we are successfully supporting a massive in growing base of more revenue productive users, which will have allowed us to exceed both previously announced longer term revenue and operating cash flow objective. Specifically, fourth quarter revenue ex-tax came in at $1.68 billion our first more than $1 billion quarter on that basis, advancing 36% from year ago figures and up 15% from Q3, despite the dampening effects from the deconsolidation of our China operations within the quarter and adverse currency movements, since we put out our Q4 business outlook, since October. On a year-over-year basis, currency movements were largely neutral, but they took about $3 million out of revenue versus our earlier expectation.

Now let’s look at the revenue breakdown by lines of business. Global marketing, our largest service generated $882 million of revenue ex-tax for the quarter up 36% year-over-year. As expected, this growth rate reflects a more normalized comparison in our international search operations as compared with that during the first 9 months of the year which were incrementally benefiting from the rollout of new markets to a greater degree than in this quarter. This strength was nicely balanced across our various offerings to advertisers from paper performance to branding. In short, we believe Yahoo is sitting in the pole position relative to our competitors as we have both strong brand and strong search offerings. Advertisers are using the two forms of advertising to compliment each other rather than one medium replacing the other.

Considering the size of many of traditional client’s direct marketing budget, and our ability to drive monetization higher over time, we believe search could provide significant upside as the use of this media became more pervasive. And on the brand side, spending per advertiser doubling over the past two years still leaves us the potential to go much deeper, considering how small the internet is as a percentage of their total spending. Most importantly, this strong positioning is already showing up in the numbers. We believe we gain market share of the global ad business for the fourth consecutive year.

Turning to fees, we produced $186 million of revenue up 38% from a year ago and bringing our full year number to $664 million. The primary driver of this business line is our premium offerings, in which consumers and businesses pay as per our services. We entered the quarter with approximately, ended the quarter with approximately 12.6 million pay relationships up 50% year-over-year, and up 1.2 million or 11% from Q3 level. This strong performance was driven incrementally from Q3, by small business services, content-bundled with access relationships, particularly from the first full quarter of the Verizon deal and from premium music subscribers.

On a year-over-year basis, we added 4.2 million pay relationships in ’05, even more than the 3.5 million we added in 2004. And as we look forward to 2006, we believe we are well-positioned to reach 16 million paid relationships by the end of the year. In 2006, we believe our average ARPU will be $3 to $4 per month as it was in 2005 turning toward the midpoint of this range as our subscriber mix continues to evolve.

Turning to revenue by geographic segment, top line growth remained very robust internationally; up 41% ex-tax over the year ago quarter to close to $260 million, boosted in particular by strong growth in sponsor search, as more and more inventory became monetize although to a lesser degree than earlier in 2005. As a successful completion of the rollouts in Japan, Taiwan and Brazil have now passed their first anniversary.

Let’s turn now to some of the details behind our strong and growing profitability. Specifically, operating cash flow came in at $459 million up 40% year-over-year producing strong global OCF margin of 43% for the quarter and 42% for the year. This strong performance was despite our decision to make various incremental investments and acquisitions driving, sustained driving the future growth. In particular, we accelerated some of our investments in our connected life platforms recently rolled out at CES in January. As you know, the major driver of margin leverage is compensation cost on largest expense, which continues to yield productivity improvements.

Headcount end of the quarter at around 9,820 up about a 160 from Q4 ’05 levels and up about 30% from a year ago. The change of about a 160 people from Q3 to Q4 with the net effect of the deconsolidation of China which had roughly 520 employees, the acquisition of about 50 new employees and the organic addition of about 630. Most of these organic gains was attributable for planned investments in key talents in various products and infrastructure, selectively designed to improve our user experience, strength in our market position, extend new verticals and support our growing businesses. We are very pleased that we’ve been able to make these investments in talent; while still delivering improvements in productivity and margins. We see these as the testament to the network effective our model and our relentless focus on key priority areas.

Let’s turn now to our business outlook for 2006. We’re introducing operating ranges for both Q1 and for the full year. Before getting into these numbers, let me walk you through 3 important factors that are impacting our outlook. First, the divestiture of Yahoo China that occurred late in October 2005, our Chinese operations contributed approximately $30 million of revenue for the first 10 months of ’05, before deconsolidation, and will no longer be included in operating results in 2006.

Second, as we’ve mentioned in the past, we believe the trend to our rising rates of traffic acquisition cost that we share with our affiliates will continue in 2006 as it did in 2004 and 2005. Our outlook contemplates roughly $70 million of revenue ex-tax impact from raising tax rate.

Third, we wanted to remind you of the impact of the MSN relationship ceasing in mid 2006. As we indicated last quarter, MSN contributed about $75 million of revenues ex-tax in ’05 and we are planning for it to drop by $50 million to close the 25 million in the first half of ’06, when the agreement is expected to terminate. The net effect of these changes on our affiliate search business is the planned, was of an estimated 120 million of very profitable revenue, having an impact on overall revenue growth and flow through rate in ’06. As the result, we anticipate the growth and are owned and operated search business, to outpace the growth of our affiliate search business in ’06 and will become a larger part of the mix. Taking into account these factors, we expect first quarter revenue ex-tax to be in a range of 1.40 billion to $1.1 billion, up 30% from a year ago, at the midpoint of the range and reflecting normal seasonality compared with the fourth quarter marketing services revenue.

Turning to profitability, at these revenue levels, we expect to operate within an operating cash flow range of $410 million to $440 million in Q1, up 23% from the year ago at the midpoint. Q1 margins are expected to decrease sequentially to about 40% due to normal seasonality expected on our media ad business together with continued investment in core products and services and the impact of several recent acquisitions that are still in development mode and not yet generating meaningful revenues. In addition, Q1 ’06 we’ll have a tough comparison against Q1 ’05 due the Yahoo Japan $3 million royalty through up a year ago. Please consider that when you examine your sequential and year-over-year trends. For the full year of ’06, we expect revenue ex-tax to range from 4.6 billion to $4.85 billion, up about 28% from a year ago at the midpoint.

Full year operating cash flow for ’06 is expected to be in a range of 1.915 billion to 2.55 billion yielding a full year margin of 42% even after absorbing the loss of some highly profitable affiliate search revenue. On a segment basis, our expectation is that there will be some modest margin expansion in our international operations, resulting in margins being generally similar to those in the US. The net effect of the 3 factors outlined at the outset of my comments in the note on the outlook will combine to shape about 400 basis points from our 2006 revenue ex-tax growth rate and change the margin structure on incremental revenues to be in the 40% to 45% range in ’06 versus the 45% to 50% range that we operated within in the first half and the second half of 2005.

Moving to our most important financial metric, free cash flow, on the hills of the varied productive 2005, where we generated close to 1.3 billion, we anticipate generating free cash flow in the range of 1.4 billion to 1.55 billion in ’06. This outlook contemplates capital spending of approximately $525 million to $625 million representing 27% to 30% of OCF. This range of the tap higher than our historical levels of approximately 24% to 26% of operating cash flow as we expect to absorb the lag effect and some facilities-related investments to accommodate our personal growth and to expand our datas in our capacity. This strong free cash flow outlook represents the conversion of more than 70% inline with our 60% to 80% goal.

To sum up as we reflect upon 2005, we are very pleased with whole year performance. As we look ahead, we are even more excited. Financially, the midpoint of our ranges, our full year outlook for 2006 suggests the financial model but this is extremely attractive. Because for organic revenue ex-tax growth approaching 30%, it suggests delivering more than 40% of that to the OCF line and it anticipates yielding around 70% of that to free cash flow. Moreover, the help of this model is allowing us to absorb expected reduce profitability in the search affiliate business and to make significant investments to drive our premium services monetization efforts to connect the life and to drive our search advertising monetization efforts to the coverage relevancy and efforts to improve advertising experienced that Terry outlined before. We believe that after a deliberate and stage grow out of this search monetization efforts, beginning in the second half of 2006, we will begin to see the financial benefits of these initiatives. Once these are fully rolled out in operational, we expect a more significant incremental contribution to 2007 revenue and beyond. With that, I would like to turn it back to Terry.

Terry S. Semel, Chairman and Chief Executive Officer

Okay thank you Su, so before I start coughing again, I just want you know that, that I was very excited about many of the opportunities that face Yahoo in this year of 2006 and we’re ready for it and we can’t wait and we’ve running on, so I would like to turn it right back to you all for questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question and answer session. If you have a question, please press “*�?then “1�? on your touchtone phone. If you wish to be removed from the queue, please press the “#�? sign or the “#�? key. To ensure that all participants are able to ask a question, please limit yourself to one question. Once you have asked your question you will be immediately placed back into conference. If you are using a speaker phone, you may need to pickup the handset first before pressing the numbers. Once again, if there are any question please press “*�? then “1�? on your touchtone phone.

The first question comes from Imran Khan from JP Morgan. Please go ahead.

Q - Imran Khan

Hi thank you, hi Su and Terry. Couple of questions, if I look at your tax growth in the international market, it seems like it was 3.7% and broad tax was up around 8.9%. In light of increased tax rate, I was trying to better understand, what’s going on that? Did you lose any big affiliates out of that, like Microsoft revenue decreasing? And secondly, you were talking about improving coverage and the click to rate, I will start to get a better sense if you could give us, share some timeline when can we really expect to see some sort of improvement in the monetization and click to rate? Thank you.

A - Susan Decker

Okay thanks. I’ll start, yes the, the tax rate international is up about 4% quarter-to-quarter as compared with 6% last quarter and tax rates in general, where up modestly in this quarter as we seen in the past. I think one point of factor to point out in that international tax growth, is that our international tax has greater exposure to the yen that any of our other lines of business, the only business that we consolidate in Japan is our search business. And you guys know what happened with the yen from quarter-to-quarter, so that’s a factor that shows up in the sequential growth rate of the international tax. MSN, as you mentioned does continue to wind up, its been flat to down, for each of last 4 quarters, but I think if you look at our overall tax rate of 13% in the quarter that, the weighted, I’m sorry, the 9% the weighted average of domestic of 13% and international 4%, the, the, it’s a little bit, its not quite as meaningful as an indicator of our overall search business in this quarter as it has been in the past for that reason. Regarding to coverage and click through, we have talked before about the, 4 buckets that we are undertaking to work on our search monetization efforts which we see as real upside to the company. The coverage initiatives have already been rolling out this year, we’re already seeing benefits from that, our revenue per search was up again in this quarter nicely and up from last quarter as it was in previous quarters and we continue to benefit from that. Regarding click through rate, we do have a number of relevancy initiatives that we said in the past, we will began testing in the first half and we’ll rollout thereafter, we are going to stage a very systematic and a deliberate rollout so it’s not to disrupt, 100s and 1000s of advertisers that depend on us. You’ve seen us do this before in algorithmic with a very careful and phase global rollout and we are going to perform the same way as we rollout with the monetization efforts, where we’re very enthusiastic about that we don’t want to rush it, then we wanted to do it exactly right. So, as I mentioned in the comments, we’ll start to see more of a benefit about in the back half, but really more meaningful as we move into ’07 when we’ve had full rollouts of the initiatives.

Operator

The next question comes from Mark Mahaney from Citigroup. Please go ahead.

Q - Mark Mahaney

Great thanks. Two quick questions, first the organic growth rate relative to the 40%, you reported last quarter is it right, to think about it as, as 30%, 36% sorry, this quarter and then secondly just on the broader point about advertisers looking at both search and the branded or display advertising. It appears increasingly that advertisers see search advertising as a tool for promoting brand awareness. Is that an opportunity, could you comment on whether there’s an opportunity for you or a risk as brand advertisers may look at other search engines to promote brand awareness where they would have used to display advertising in the past? Thank you.

A - Susan Decker

Yeah Mark, I will start. Regarding the organic growth rate of 36% versus 40% in the, prior quarter, that’s correct and that was very consistent with our guidance we came in above the midpoint of our range of guidance. The reason for that is what I outlined in my comments which is we are benefiting to a little lesser degree from incremental rollouts with some of the new search markets Japan, Taiwan and Brazil, which have now anniversaried and so that has an effect on the overall total growth rate.

A - Dan Rosensweig

Mark this is Dan, on the question of brand advertisers, increasing leasing search for brand advertising their primary purposes of using searches is literally for customer acquisition and customer retention. It does affect the brand positively because I could see in more places but of course if its not click through, its not going to stay in those environments, so, they cant get a long-term sustainable impact the way they otherwise would, in the graphical environments where they can be guaranteed place, in a guaranteed location, guaranteed timing, so, we don’t, we think it’s in a benefit to have both because if you’re running brand on the same network you’re running search. That’s a real advantage since we’ve been able to capitalize on that.

Operator

The next question comes from Youssef Squali from Jefferies & Co. Please go ahead.

Q - Youssef Squali

Yes thank you very much, hi Su and Terry, couple of quick ones. On the branded side, did the top 200 US brand advertisers grow faster than all of the company's marketing services on a, we have ex-TAC basis as that they did last quarter? And second, do you expect any ripple effect on Yahoo Japan from the livedoor investigation, we just heard from today Yahoo Japan stock was down 8% today? Thanks.

A - Terry S. Semel

That would Su the first piece and then we’ll switch over for chart for Japan. Thanks.

A - Susan Decker

Yes Youssef, yeah thank you for the question, in both the first quarter and for the full year, the top 200 advertisers have grew our marketing services business on ex-tax as consistent with some of the previous quarters.

A - Terry S. Semel

I think on the Japan thing, obviously the livedoor investigation is limited to the CEO and Chairman and the transactions they performed. So, while there has been a market reaction to it, I don’t think its anything to do with the outlook. Next question please.

Operator

Question comes from Jeetil Patel from Deutsche Banc. Please go ahead.

Q - Jeetil Patel

Hi guys and I hope for Terry you feel better, but a couple of questions. First of all, where there any changes in particular in the quarter around the fees business, any change in the partnership deals, any kind of implementation why is that influenced the fourth quarter, and I guess the, 4 million of so, new paid relationships that you are looking for in 2006. It seems like, in general, you would have a bigger GAAP up, given that you got a new relationship rolling out this upcoming year. Can you talk about what are the underlying drivers of that 4 million incremental for this year and, is the sub rate changing, any because I think, if historically talk about 3 to 5 versus 3 to 4, can you go through that a bit? Thanks.

A - Susan Decker

Okay, I’m going to take that. Thank you. First on the fees revenue, we were up about 35% in the quarter and then I think what the reason you are asking is we’re up 55% in the prior quarter. Remember that we anniversaries the acquisition of Musicmatch and allow their revenues in seasonal and so. You are looking at the run rate organically in Q3, it was 41% compared to the 35% this quarter and the other thing to consider is we deconsolidated in China in this quarter and a good portion of their revenue was from wireless which is in the fees line. So, if you adjust our fees upward for that it was roughly 38% versus 40.1% last quarter very consistent with what we expected. In terms of the outlook, I think the important to thing to consider there is that the Bellsouth deal does not come online until late in 2007. So, we don’t expect, 2006 we don’t expect very big incremental contribution to the overall numbers and when you look in the past remember, we had a number of new access deals that have come on or had ramped up Verizon, Rogers et cetera that, it incrementally boosted the numbers in this last year. So, we don’t think its prudent to plan for more deals when we put out our forecast and we think that the sources of growth would be very consistent with what we have seen in the past, which is very strong organic growth in our content-bundled with access relationships as well as very strong growth in the direct services, the operators, consumers and businesses.

A - Terry Semel

Next question please.

Operator

Next question comes from Ben Schachter from UBS. Please go ahead.

Q - Ben Schachter

Hi guys, just talk about the partners you have in YPN network and specifically refer to the domain parking business. Just wondering if you are happy with the quality of the partners there? And also with the YPN, will you enable advertisers to show virtual media ad, non-text ads there? And also will it be PPC or also impression-based? Thanks.

A - Daniel Rosensweig

Okay, this is Dan. I’ve answered most of that. On the YPN partners obviously as Terry mentioned the size of it is, it’s a very deliberate rollout where we want to pick the partners, we want to learn how to master traffic correctly, we want to get the click through rates right; we want to get the advertisers to be able to get into the network correctly. So, we are taking very deliberate steps in that and so the quality of the network will be as high as our normal quality as, as the network scales and gets larger. So, for the moment, we are learning a lot about the different kinds of partners, different sources of traffic, so we expected to be a super high quality network, like we’ve done before. Won't really comment on our strategy in terms of the kinds of capabilities we are going to offer through YPN and through our network, but we continue to see a really great opportunity to leverage the assets we have to be able to bring all forms of advertising and all forms of pricing to different environments as the years move on because we just think that’s the strength the Yahoo has at the marketplace to benefit from.

A - Terry Semel

Next question please.

Operator

The next question comes from Anthony Noto from Goldman Sachs. Please go ahead.

Anthony Noto

Thank you very much. Su I was wondering on, in the fourth quarter, if you could comment on your EBITDA margin of 42%. That was below even the midpoint, even your revenue was above the midpoint of your guidance. Your guidance in fact 44.2% margin that came in a 43, actually 43 is below even a low on to your margin. I was wondering what happen there, it looks like increased investments, as only if you lack specifically, where those investments for it could have be a benefit in 2006, that you have in attribute a lot to in your guidance. And then, additionally as we look into 2006, I understand the measured rollout of increased monetization, you talk about the bulk of the magnitude to benefit in 2007. Could you give us a range of expectations, of how you define magnitude? How much upside is there in our pitch and where we are today? And even now, you may not launch the second half year, why do you think you don’t get benefit to ’07? Thanks.

A - Susan Decker

Sure thank you, for those Anthony. Starting with the Q4 numbers, we deliver both revenue and EBITDA within our ranges, so we came in pretty much, inline with our expectations from a few moths ago. We did, as I mentioned in my comments, accelerate some investments particularly in the connected life platform that we just rolled out in a CES, we thought that was a smart thing to do, given the opportunity the profile that, so that was one area where we accelerated some investments. We also made a couple of small acquisitions, mahod (ph) and Del.icio.us that were important. They come with cost but very important talent that we think would be very, very helpful to the company in longer term. But they are not yet revenue producing. So, when you look at the relationship between revenue and profit growth that those are two of the factors and then the other factor is currencies incrementally from Q3 to Q4 brought down revenue and EBITDA growth a little bit. So those are the, those are the combination of factors and dynamics went on in Q4. In terms of the RPS rollout the, we are, as I mentioned going to do a stage and very deliberate rollout this has been in the part of our plan. We talked last quarter for the first time about the four buckets of activities that we see as incrementally improving our monetization, that coverage initiative, overall matching initiatives, the YPN initiative, relevant initiatives, I mean of course the advertise sur-tool. Those, later tool, we see coming out in the back half and we think that it would be smart not to roll it out, to turn the switch on the 100% of the world right away, we do have a number of advertisers and publishers that rely on us economically, when we think its very important, that we do this very deliberately and rollout sequentially in various places, so our plan is to do that in the second half, consistent with what we have been saying and so the revenue impact would not be fully kicking in until we have this globally rolled out around the world, and that would be in 2007. Regarding quantifying, no I appreciate the question, we are not putting out 2007 guidance today, we will, we do see this is very significant upside to the company and we will actually do enough. Thanks.

A - Terry Semel

Next question please.

Operator

Next question comes from Heath Terry from Credit Suisse Boston. Please go ahead.

Q - Heath Terry

Right thank you, Susan I’d appreciate it if you would kind of breakout the change in the number of employees from the numbers that you gave to something kind of within your engineering and technology division. So you can just kind of get an idea of where the hiring is happening with in the organization. And then Terry I wish something you could talk a little bit more about the timeline and process for the content creation side of the business. When should we start seeing meaningful content additions to the side and what form will those initially take shaped on?

A - Susan Decker

Okay let me start, in terms of the headcount, I think I gave out some pretty detailed numbers in terms of organic, acquired and deconsolidated headcount, its not our practice to breakout employees by various function, we’re increment, I can’t say though that the largest decisions are definitely in technology group and product developed, product and engineering and we think that struck, the system of the past but also very, very important as we executive on our strategy to rollout some of these new initiatives on product side and then monetization side.

A - Terry Semel

Hi, so it’s Terry and, let’s talk a little bit about our content strategy, it is the same strategy frankly what we’ve talked about in the past. So we look at content in on those 3 different buckets through 3 different ways. So firstly we talk about what we’ve been doing as a company forever, licensing and do aggregating contents to others. We take advantage of our great distribution platform a few that are around the world. That’s always going to be a big thought of what Yahoo does and always has been. We also talk about user generated content to a large degree, we’ve entered those markets twice as already is time to grow more and more, whether its somewhere between a flicker and blogging worlds and other worlds, now I catch the Yahoo News as well. So you see more and more user generated content as we talk entering the platforms of Yahoo and we expect a lot more of that as we go forward. So it’s a very important aspect for us. Also Yahoo has always done some producing or some making of its own stuff if you will, and its been that way since the beginning, you’re really referring to probably as entertainment stuff because we continue today doing facing this sports world and then the travel world and then the news world and a lot of those little pieces have been done by Yahoo, and then other stuff has been licensed as well. So we see real opportunities in that, we’ve also talked about the creation of some original, what we call is payment I think is what you are referring to and we will do a little of that. And will do that kind of help lead the way and doing show and learn ourselves as to what our users are most interested in and keep advantage of lot of the data that we have formally uses, in making some of those decisions, I mean ultimately really look for more and more outside companies to look us is as the partner of choice. So we have the audience, we have the capabilities we have the platforms, and we have the desire to in effect help distribute and help introduce their products to our vast audiences through out the world. So it’s the same strategy that continues going forward and we do think ultimately it’s a very big opportunity. Next question?

Operator

The next question comes from Lauren Fine from Merrill Lynch. Please go ahead.

Q - Lauren Fine

Well thank you just a couple of quick ones, some of the external measurement service have indicated a decline in your search traffic and I am wondering what your measurement it is suggesting. And then secondly, I am just curious how you plan to compete against the mind spaces of the world, I know you have your own strategy in that area, but it seems like the mind space generation is scaling very quickly, so I am wondering if you have any comment on that.

A - Susan Decker

Okay, yeah sure thank you. On the first point the Yahoo search market share, we feel very great about our position we are holding our own. We are on our plan, and its trends really if you look over, reasonable period of time demonstrate broad market share parity between the 2 companies and a widening gap behind the leading 2 companies and all the others. One thing I point out is that when you look at the trends that are put out by external services, you can see broad stability on the domestic side, the international side is influenced by the way comp score worldwide data is calculated, just have 7 countries in that mix. You have Canada, UK, Germany, France, Spain and Italy. So they are primarily looking at countries in which our competitor is quite strong and we are less represented and they are not including the countries in Asia where we are exceptionally strong, and in many cases gaining. So, I would precaution you against using some of those, international service to, to literally but we feel really good about our overall strength as we look at our own internal data, and certainly the domestic external data is a better proxy.

A - Farzad Nazem

On the question of the mind space generation, we obviously are huge believer as Terry and Su pointed out in search media and user generated content and community. And we feel like we have been leader and are leading that space in, one of the things to keep in mind as in the US for example, we’ve reached nearly 3 quarters of everybody that comes on the Internet. So we have plenty of opportunities to touch people and create value for those people particularly that generation is also an enormous user of Yahoo. Our strategy has been to be able to decorate or resembles a series of connected assets and connecting devices. So you’ve seen us with flicker and Del.icio.us Yahoo answers, our search efforts in the community space, and so we are well-positioned for that generation because we offer them value that they can not only get with their community sites but all the other information, all the other activity that they do on the web. So, we are the most visited sites on the web, for example by ages of 12 of, 12 to 24. So we have tremendous relationships with all the different demographic groups, we have assets that are really building on. And our social media efforts and community efforts are actually exploding as well. So we are very excited about that space.

A - Terry Semel

Okay last question please.

Operator

Thank you the final question comes from Safa Rashtchy from Piper Jaffray. Please go ahead.

Q - Safa Rashtchy

Thank you good afternoon. Su and Terry could you talk about the growth trends that you see, your results for this quarter, while within your guidance show that, a marked deceleration from last quarter and your guidance for ’06 suggest even further deceleration, yet the trends in the industry that we see are suggesting that the growth is continuing to be strong in some cases accelerating. And I think you mentioned that you feel you’ve gaining shares, so could you help us kind of help us out of the 2 trends. And I will be want to only course of it actually.

A - Susan Decker

Okay, I will start and anyone wants to join me they can join in here. Yeah, so lets the first quarter, I think we talked about a little bit the growth rates was 36%. I was relative to 48% the quarter before and that was right what we before we planed and I think most people are looking for gain up, in above the midpoint of our range, as I mentioned the only sort of incremental thing there was the currency movement in the quarter. The reason that we plan for actually that way is because we have cycle through some of those new market phase that rollout on the affiliate business that will incrementally contributing to our international search growth in previous 9 months, those are Yahoo Japan and Brazil and Taiwan. They are still building and still growing very rapidly, but the incremental new inventory being monetized there is lesser the factor in this quarter then in the past. As we look forward into the guidance, yeah we’re, I think we have an exceptional model, where it’s providing personal investment, while still producing 30% revenue growth, 40% more than 40% margins in more than 40% flow through and 70% of free cash-flow conversion.

The primary factors that are affecting us are the ones that I outlined in my comments, which one is that our revenue growth would be 30 million higher, if not for the deconsolidation of Yahoo China, which of course we sold and moved into a new investment that we think has great value, we also have the loss of MSN which really didn’t have too much affect on our quarters this year. But we will have an effect next year as we go from a $75 million time margin source of revenue, down to an expected 25 million all in the first half. So that the 50 million swing and then we have a plan increase in tax-rate, but that’s not different from the past few years, but what’s the little difference is that had been incremental inventory coming in new affiliate deals that have add somewhat offsetting factors in the overall numbers and we don’t think its couldn’t plan for that. So we did quantify for you the $70 million that we expect from continuing increase in tax-rate. Price of traffics gone up, spend very much inline of our expectation we’ve been seen at from the outside, we acquired overture, but the affiliate now is very important to our overall network. But it’s not necessarily like it would be major profits in a longer term given the competitive dynamics in the market. So when you take those things into consideration, that takes about 400 basis point software revenue growth rates that we outlined. And it also takes of, couple of points of margin. And those are consistent, and we think it’s prudent to plan in that way for, based on where we stand up right here at the beginning of the year. So hope that helps on the, on the outlook.

Q - Safa Rashtchy

All right.

Terry Semel, Chairman and Chief Executive Officer

So, it’s Terry. All our metrics is we bringing out before continuing to grow extremely well whether its, amount of users, amount of active registered users or time spent on Yahoo everything is growing extremely, extremely well and very, very excited about it all. I think that we feel great about our company and great about our prospects. And we think it is a great upside to our company. So with that thank you all for joining us today and have a good day, thanks.

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