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Executives

Marta Nichols - Investor Relations

Jerry Yang - Chief Executive Officer, Director

Susan L. Decker - President

Blake J. Jorgensen - Chief Financial Officer

Aristotle N. Balogh - Chief Technology Officer

Analysts

Ross Sandler - RBC Capital Markets

Christa S. Quarles - Thomas Weisel Partners

Youssef H. Squali - Jefferies & Co.

Imran Khan - J.P. Morgan

Jeffrey Lindsay - Sanford C. Bernstein

Mark S. Mahaney - Citigroup

Sandeep Aggarwal - Collins Stewart

Brian Pitz - Bank of America

James Mitchell - Goldman Sachs

Justin Post - Merrill Lynch

Doug Anmuth - Lehman Brothers

Yahoo! Inc. (YHOO) Q2 2008 Earnings Call July 22, 2008 5:00 PM ET

Operator

Good afternoon, ladies and gentlemen, and welcome to the Yahoo! second quarter 2008 earnings conference call. (Operator Instructions) I will now turn the call over to Ms. Marta Nichols. Ms. Nichols, you may begin.

Marta Nichols

Thank you and good afternoon and welcome to Yahoo!'s second quarter earnings conference call. On the call today are members of our executive team -- Jerry Yang, Sue Decker, Blake Jorgensen, and Ari Balogh.

Before we begin, I would like to remind you that this call’s discussions will 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 indicative of future performance.

The potential risks and uncertainties include, among others, that the expected benefits of Yahoo!'s commercial agreement with Google may not be realized, including as a result of actions taken by United States or foreign regulatory authorities and the response or acceptance of the agreement by publishers, advertisers, users, and employees; the implementation and results of Yahoo!'s ongoing strategic initiatives; the impact of organizational changes; Yahoo!'s ability to compete with new or existing competitors; reduction in spending by or loss of marketing services customers; the demand by customers for Yahoo!'s premium services; acceptance by users of new products and services; risks related to joint ventures and the integration of acquisitions; potential continuing uncertainty arising in connection with Microsoft’s various proposals to acquire all or a part of Yahoo!; the possibility that Microsoft or another person may in the future make other proposals or take other actions which may create uncertainty for our employees, publishers, advertisers, and other business partners; and the possibility of significant cost of defense, indemnification, and liability resulting from stockholder litigation relating to such proposals.

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, July 22, 2008 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 as we talk about the company’s performance, including operating income before depreciation, amortization, and stock-based compensation expense, which will be referred to as operating cash flow; revenue excluding traffic acquisition costs, which will be referred to as revenue ex-TAC; free cash flow; non-GAAP net income; and non-GAAP net income per share. Reconciliations of those non-GAAP measures to the GAAP measures the company considers most comparable can be found on our corporate website, info.yahoo.com, under investor relations.

Jerry, Sue, and Blake have prepared remarks that should last about 30 minutes; then we’ll have a brief Q&A session with Jerry, Sue, Blake, and Ari.

And now I would like to turn the call over to Jerry.

Jerry Yang

Thank you, Marta. That’s quite a disclaimer. Good afternoon and thank you for joining us today. I am looking forward to giving you an update on our progress but before I get into our Q2 results, let me take a moment and address the news from yesterday’s settlement agreement with Carl Icahn and the events of the past few months.

Our board and management are pleased to have reached this agreement to settle the proxy contest. This eliminates the distractions and allows us to move forward to create and deliver shareholder value. We look forward to working with the new board members who will be joining us.

Now, about a year ago, this management team started to perform a comprehensive review of Yahoo!'s strategy and create a long-term strategic plan for the business. The company has been executing against that aggressively ever since. As we will discuss with you in more detail, the indicators of Yahoo!'s progress are promising. Frankly, I think Yahoo!'s ability to perform is especially impressive in light of the extraordinary events surrounding the company this year. It has been nearly six months since Microsoft made an unsolicited proposal for Yahoo! and everyone here -- the board, management, and over 14,000 Yahoos around the world -- have continued to work towards one central goal; maximizing value for our shareholders.

Now, that has been our objective in reviewing each and every alternative from day one of our discussions with Microsoft through to today. During this time, with all this playing out very publicly on virtually a daily basis, this company has accomplished a great deal. We delivered two quarters of performance in line with our strategic plan, demonstrating meaningful progress in both search and display. We signed an important agreement with Google, which has the potential to generate substantial revenues that are expected to enhance our financial results and be reinvested in the company to strengthen our competitiveness.

We have accelerated the pace of innovation, introduced new, important products, and signed many new premier partners and lastly, we have implemented a realignment of our business to accelerate our ability to execute on our strategy and improve overall monetization.

Significantly, we have also actively explored a number of alternatives to maximize value for the company, and we remain open to value creating transactions that provide real and tangible value.

My management team and I believe that this is a solid record of meaningful accomplishments. Now we will direct an even greater focus on growing the business and positioning Yahoo! for continued success in the future.

Let me turn to our Q2 results and give you some top line summary of our progress against the objectives we set out for ourselves nine months ago. Later, Sue will give you a more detailed update on our progress against our key objectives.

A number of highlights stood out for me on our continued progress in Q2. We continue to see strong double-digit user growth and we increased our page views by more than 20% year over year, giving us the opportunity to monetize a large and growing base of high quality, contextually relevant inventory.

Our recent investments in search are paying off, with query growth in the U.S. up more than 11% year over year.

A core part of our strategy is to leverage our leading position in display, owned and operated, by adding high quality affiliates. We are already the number two ad network in the U.S. As we continued to make good progress this quarter, we grew our GAAP display revenue worldwide for our owned and operated and our affiliates by over 20% year over year, or 12% rev ex-TAC.

At the same time, like many companies in our industry, we were affected by the weakness in the overall economy. In some categories, such as CPF and finance, we saw demand for branded display advertising soften and we saw a shift away from branded campaigns towards performance marketing. Because we’ve positioned Yahoo! well in both branding and performance marketing, we were able to continue to grow our display revenue in the quarter.

While overall Q2 GAAP revenue was modestly below our outlook’s midpoint, as a result of managing costs our operating cash flow was on target with our outlook. It’s also worth reiterating that the top line revenue is still being affected by headwinds we set out for you previously -- the Overture Japan transaction from last fall and the AT&T renewal this year. As Blake will detail, if you adjust for those two factors, our GAAP revenue growth would have been 14% year over year.

Before concluding, I would like to take a minute to talk about our exceptional employee base, which we have increased by more than 500 this quarter, to address what they have accomplished and how we continue to build a talented team that will accomplish much more in the months to come.

It should be obvious that this has been a challenging period for our employees, and yet despite the distractions, they have been remarkably focused throughout this period. None of the achievements of the past quarter would have been possible without the work of these creative, dedicated, and passionate Yahoos who simply have done a great job. I am proud of what they accomplished in the past quarter.

Now, over the past year, we’ve been taking deliberate steps to assemble a management team that can best execute our strategy. As part of our recent realignment, we are actively promoting talented executives with strong product and technology expertise into roles that will allow us to build the most innovative products.

Just as important, the senior managers we’ve placed in the last 12 months are nearly equally divided between external recruits and those from within the organization, which we believe strikes the right balance. And we continue to recruit exceptional leaders.

In fact, our CTO, Ari Balogh, who joined us in February and has already done significant progress with our technology organization, he’ll be announcing the addition of an industry veteran to lead our cloud computing and infrastructure group in the coming days.

In summary, we’ve been executing against our strategic plan despite a weakened economy and external events brought on by the Microsoft proposals. This speaks volume to the strength and resilience of the Yahoo! franchise and its dedicated employees. We feel good about Yahoo!'s unique position in our leading audience, search, and display assets. But this is not business as usual. Everyone here, from the board to our newest employee, understands that our most fundamental mission is to maximize shareholder value. The board and management are completely committed to doing so and that includes continuing to actively examine how best to accelerate and realize the strategic potential of this company.

I’m more excited than ever to push Yahoo! to the next stage and look forward to sharing our progress with you.

Now, let me turn the call over to Sue who will share some thoughts on our efforts this quarter. Sue.

Susan L. Decker

Thanks, Jerry and good afternoon, everyone. Notwithstanding a more difficult economic environment than anticipated, and substantial external swirl related to Microsoft, we are on track with our expectations for 2008 both financially and with respect to our customer offerings and product pipeline, which we expect to combine to help drive shareholder returns in 2009 and 2010.

As I did last quarter, I’ll discuss the four primary drivers of our revenue globally, search volume and search yield as measured by queries and revenue per search, or RPS, and display volume and display yield, as measured by page views and effective CPM.

However, I’ll spend most of my time today focusing on two questions that received the most attention by investors in recent months. First, whether our unique position as a principal in both search and display has strategic value to marketers and publishers; and second, whether we are positioned to succeed in web search. We believe the answer to both of those questions is yes and our progress this quarter reinforces our views.

Let’s start with the question of how we are leveraging our unique breadth of our online ad offerings due to our position as the leader in display and a strong number two in search. The financial benefits of what I’m about to describe are likely to affect 2009 and 2010 as per our strategic plan, but competitors, advertisers, publishers alike are taking significant steps today to take advantage of broad and integrated online advertising offerings across search and display.

Consider these examples: we’ve seen it in the M&A landscape, with numerous high profile deals bringing search and display assets together; we’ve seen it with advertisers who are buying integrated solutions across search and display from us on a daily basis and seeing impressive results; and we’ve seen it with publishers who are establishing partnerships with us that leverage the breadth of our advertising offerings.

That final point, that online publishers are working with us to leverage the breadth of our online advertising offerings across search and display, is an absolutely critical leading indicator of where the online advertising market is headed and Yahoo!'s unparalleled position to lead the charge.

Fundamentally, we believe publishers want to drive as much long-term value as possible from their sites and are not concerned with whether it comes from search or display advertising. With our broad capabilities in both areas, we can uniquely optimize the value of their inventory using the best ad at any time for the situation, rather than just the best search or the best display ad.

We’re also managing search and display monetization for such leading publishers as WebMD and CNET, and at the same time their sales forces are bundling Yahoo!'s display inventory with their own to provide greater reach, frequency, and value to their advertisers. These follow our very successful deal with eBay and our growing newspaper consortium, now over 770 newspapers strong, four times those at its initial inception, both of which reinforce the convergence of search and display solutions in the marketplace.

We’ve made a lot of progress with business deals across advertisers, publishers, and agencies despite the fact that we have not had, and the industry does not have, a scalable platform in this yet to make buying and selling display advertising easy.

As you know, our new display ad management platform is squarely focused on doing just that -- making display advertising easier to buy and sell. It launched two critical pilot customers in May and we are on track to commence a broader rollout beginning in Q3. As we roll this out more broadly and continue to expand its capabilities, we anticipate more of these kind of deals.

In terms of convergence, while buying search advertising is relatively straightforward today, buying display is just plain hard. Therefore, developing these capabilities for display ads is a prerequisite to enabling efficient buying and selling across both search and display in a platform. Once we’ve made the process of buying and selling display ad inventory as easy as it is in search, then we will be in a position to unify the process of buying and selling ad inventory across search and display.

By removing significant friction from the process, we believe our platform will greatly accelerate advertiser adoption of online media, as well as the migration of ad dollars from offline to online.

Let’s turn now to the second question we are hearing -- does Yahoo! have the chops and the capital to succeed as a leader in web search? Let’s look at recent results and products to tackle that question. We’ve discussed with you before our goal of driving 10% compound search volume over the next three years. In the second quarter, our query growth rate accelerated from the first quarter rate, allowing us to exceed that goal in the U.S. and meet it on a worldwide basis. In fact, in May and June, Yahoo! gained U.S. query share for two consecutive months for the first time since ComScore began using its current methodology about a year ago.

We are not satisfied with this increase, given the share losses prior to that. But it comes on the back of the product innovations that we indicated to you would start to move the needle, and we are committed to building on these gains.

We start from the basic belief that innovation in search has a long way to go. Most users still 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 and open experience that goes beyond search to discovering relevant information and quickly completing tasks.

Let me review three of our recent algorithmic search initiatives focused on making search results more relevant and useful by opening up search to third-party developers, or changing the presentation to be more intuitive, relevant, and visual.

First, as we discussed on our last call, Search Monkey is providing outside developers unprecedented control over the appearance of their search results, allowing them to create a richer search experience, including photos, logos, and multiple relevant links directly in Yahoo!'s search results.

Fundamentally, this allows developers to innovate right on top of our search technology and it allows users to enjoy search results as rich and dynamic as the businesses and the community of developers can make them.

The response from the developer community has been fantastic, with thousands of developers already actively on the platform and tens of thousands of applications already created.

The second example of search innovation is an exciting new product we launched in India in May, named Glue Pages. Glue Pages go beyond just web links to deliver more relevant, visually appealing search results from across the web in one topical page. Already, Glue Pages have produced a meaningful lift in page views and search sessions for Yahoo! India. While Glue was only out for half the quarter, and on only 4% of the Yahoo! search India queries, user volumes were up 20% and we experienced a 1% search share gain in May, according to ComScore, indicating that Glue is delivering on our commitment to provide a compelling and locally relevant online search experience.

Third and most recently, we launched BOSS, short for Build Your Own Search Service, which opens up our search infrastructure and technology to developers and companies and empowers them to create custom search experiences off Yahoo!. By offering unprecedented access to our algorithmic search infrastructure, Yahoo! is the only major search engine that allows developers to change the ranking and presentation of web search results on their sites. This is great for publishers and developers and increases the number of search options available to consumers.

These moves, coupled with Search Assist launched in the fourth quarter of last year, are the moves of a competitor positioned for success and with the will to invest and to win. These are the results of a fired up and very talented group of Yahoos that is pushing the innovation envelope in search in ways that are being widely recognized by third parties. Moreover, we’re doing it by maximizing focused investments rather than replicating the way search is currently done, with escalating investment requirements.

Let’s turn now to search monetization and the corresponding measure of success in this arena, RPS growth. In Q2, excellent coordination across our functions allowed our talented engineering teams to deploy a number of global monetization initiatives in just eight weeks, the most important of which was minimum bid changes known as -- also known as market reserve pricing, a value-based pricing mechanism.

I am very happy to announce that the combination of solid search volume growth and RPS gains allowed our search business to achieve significant revenue milestones in Q2. In the U.S., GAAP O&O search revenue was up about 19%, on the strong volume gains noted earlier, plus roughly a 5% gain in O&O RPS. In international O&O, we saw double-digit RPS gains.

The RPS run-rate in the U.S. was somewhat negatively affected by the anniversary of Panama, which occurred before the benefit of the various new monetization initiatives that I mentioned rolled out during the quarter, and some of those -- most of them -- were only effective for part of the quarter and on a small percentage of queries. Consequently, we expect RPS growth to accelerate somewhat in the back-half of this year versus the Q2 run-rate as these initiatives are rolled out to more markets and a greater percentage of queries in each market.

We also see our recent agreement with Google as a logical extension of our moves to create a more open advertising environment, leveraging what we call you sell, we sell. We’ve consistently embraced the idea of openness in advertising, starting with our initial write media investment nearly two years ago. By opening up, we are allowing others to sell our inventory if they have a particular expertise. For example, we sell some of our display inventory to ad.com and to other ad networks. We just announced we’re selling some of our sports inventory to Turner to resell, and similarly our you sell arrangement with Google will allow us to offer backfill to advertisers in the best opportunity to reach their target customers in certain cases and for publishers in the network to maximize monetization.

We believe this non-exclusive agreement will provide Yahoo! with more options to improve monetization and to accelerate our long-term strategy and innovation in our business, while maintaining full control over all aspects of search.

In short, our search assets are only growing in value, both in query volume and monetization, and there’s so much more opportunity ahead. We believe we can sustain a three-year average of 15% RPS gains or more, driven by continued strong progress on our monetization roadmap, plus key partnerships with developers and best-of-class monetization opportunities in an open model.

Let’s turn now to the other two variables driving shareholder returns -- display volume and yield. Our goal is to grow display volume by 12% annually and in Q2, we again significantly exceeded that goal.

Considering the huge base on which we’re growing, this is an enormous accomplishment and one we hope to build on by simplifying and making Yahoo! more relevant by rewiring it to become more seamlessly social and open to third-party developers.

I’ll quickly touch upon two relatively new initiatives that we’re excited about. First on the home page, we’ve made great strides in the areas of creating the most relevant starting point through a combination of Yahoo! Buzz and our new content optimization capabilities. Yahoo! Buzz has expanded to over 350 publishing partners who are now providing us content that can be programmed onto the homepage. Yahoo! Buzz quickly surpassed Digg to gain the number one position in its category.

In the coming months, we’ll be expanding this to all publishers, which will increase the breadth of content we can feature on our homepage and increase our overall market position in the social content space.

We also began testing our newly designed content optimization capabilities on the homepage this quarter, a key initiative that should make our homepage more relevant to users. This will allow us to serve content from our homepage personalized to a user’s interest rather than serve the same experience to all users.

The initial results are very promising, with click-through rates on the main section of Yahoo!'s homepage, the today module, up over 30%. As we scale this process more broadly to other parts of the network, this could have a material impact on user engagement and the creation of valuable inventory.

Turning now to display yield, volume and pricing of non-guaranteed ads continues to rise very quickly, with both up strong double-digits in Q2, while in guaranteed we saw more limited volume growth and some pressure on pricing, as you would expect in the current environment.

On an overall basis, both on GAAP and revenue ex-TAC, display revenue worldwide rose double-digits, led by international markets that are not experiencing the economic issues we are seeing in the U.S.

As we anticipated when we first shared our 2008 plan with you, the financial results of the numerous innovative platforms, products, and partnerships we are developing this year are still relatively limited but we believe these groundbreaking partnerships and technological advancements represent clear evidence that we are successfully implementing our strategic plans. While you’ve no doubt been reading a lot of speculation about Yahoo! recently, I really encourage you to look at what industry influencers are saying about our innovations in search, display, mobile, and content. The exceptional response to products like Buzz and BOSS to our industry leading mobile offerings, to our key anchor properties and to Yahoo!'s open strategy, is an important leading indicator of what is to come.

I am particularly grateful for the hard work and dedication of our Yahoo! teams around the world who executed so well this quarter.

With that, let me turn it to Blake to provide more detail on our financial results and outlook.

Blake J. Jorgensen

Thanks, Sue. We delivered another solid quarter with financial results within our April outlook ranges. GAAP revenue was up 6% in the quarter. GAAP revenue would have been up 14% excluding our relationship with Overture Japan from the 2007 and 2008 second quarters to normalize for the restructuring of that partnership we did last August.

Revenue ex-TAC was up 8% year over year to $1.35 billion. We delivered $449 million of operating cash flow on a normalized basis, or $427 million including the $22 million of costs related to the Microsoft proposal and other strategic alternatives, related litigation costs, and now settled proxy contest.

We feel that our business model is holding up well despite the current economic environment. Our success this quarter was due to the fantastic efforts of our employees. We continue to attract some of the best talent in the industry and we ended the quarter with 14,300 employees, up from 13,800 at the end of March.

Our cash and marketable securities balance was $3.22 billion at the end of the quarter, up over $370 million from the prior quarter. At the end of the quarter, the value of our direct and indirect interests in the publicly traded securities of Yahoo! Japan, Alibaba.com, and Gmarket, were valued at approximately $10 billion in the public markets, or over $7 per share. These figures include the value of the shares of Alibaba.com held by Alibaba Group, of which we own approximately 40%. These figures do not include estimates of the value of Alibaba Group’s other privately held businesses, such as [Talbow] and Alipay, which we believe provide significant additional value.

We didn’t engage in any share repurchase activity this quarter due to trading restrictions, but we have approximately $1 billion remaining in our repurchase authorization. We continue to explore alternatives that will help us deliver stockholder value via the strength of our balance sheet.

Now let’s move to the profit and loss statement. GAAP revenue was $1.8 billion in the second quarter, up 6% over Q2 2007. As I mentioned earlier, through August 2007 we accounted for our sponsored search relationship with Yahoo! Japan on a gross basis, and since that time, we have accounted for it on a net basis. Excluding the revenues from our Yahoo! Japan relationship from both the 2007 and 2008 second quarters, our GAAP revenue growth would have been 14%.

Revenue ex-TAC came in at $1.35 billion, advancing 8% year over year. As we mentioned on previous calls, during late 2007 and early 2008, we restructured our broadband relationships with AT&T and Rogers. As expected, the conversion of these deals to revenue sharing has dampened our revenue ex-TAC growth this year. Excluding the revenues from AT&T from both the 2007 and 2008 second quarters, Q2 revenue ex-TAC would have been up 11% year over year. The change in our Yahoo! Japan relationship did not affect the overall revenue ex-TAC growth rates.

In our marketing services business, second quarter GAAP revenue was $1.59 billion, up 7% over last year’s second quarter. Marketing services ex-TAC was $1.14 billion, up 10% versus the prior year. Owned and operated marketing services revenue was up 14% on a GAAP revenue basis, with O&O search up 17% and O&O display up 11%. On an ex-TAC basis, owned and operated marketing services revenue was up 9%, search and display were consistent at that level.

Within our marketing services business, some of the major categories, including entertainment and technology, continued to report strong year-over-year growth in Q2 on both the search and display sides. However, we continue to see softness in finance, travel, and retail, areas that have all been affected by recent economic trends.

Now let’s look at fees revenue -- we generated $211 million of fee revenue in the second quarter, which was flat with the same period last year. We expect our quarterly fee revenue to be roughly consistent with the Q2 level through the back half of the year. As we have communicated to you, the conversion of our broadband partnerships to a revenue sharing model will lead to a decline in fee revenue and increasing TAC payments to our partners, creating a drag on overall revenue growth.

As we anniversary these restructuring deals next year, we believe that our overall revenue growth will more closely reflect the stronger underlying growth in our core advertising business.

U.S. revenue ex-TAC increased 6% year over year. International revenue ex-TAC increased 14%. Acquisitions and currency each contributed approximately 2% to the total revenue ex-TAC growth.

Our effective tax rate for the quarter was about 38%. We expect our effective tax rate for the year to be approximately 41% to 44%. We expect our cash tax rate for the year to be approximately 12% to 15%.

That brings me to our business outlook. We are maintaining the midpoints of the full-year outlook ranges we provided in April. We have narrowed those ranges to reflect that we have completed the first two quarters of the year. We expect full year results in the following ranges: GAAP revenue of $7.35 billion to $7.85 billion; operating cash flow of $1.825 billion to $1.975 billion; and free cash flow of $900 million to $1.05 billion, reflecting $675 million to $775 million of capital expenditure.

Our full year outlook excludes the impact of the strategic workforce realignment we undertook in Q1, the costs associated with the Microsoft proposals, other strategic alternatives, related litigation, and the proxy contest, as well as the positive cash flow impact of the $350 million cash payment we received from AT&T in March.

We expect Q3 results in the following ranges: GAAP revenue in the range of $1.78 billion to $1.98 billion; and OCF in the range of $405 million to $465 million. For the balance of 2008, we expect TAC as a percentage of GAAP revenues to be between 25% and 26%.

Our Q3 outlook excludes the impacts of costs associated with Microsoft’s proposals and other strategic alternatives, related litigation, and the proxy contest. Neither our Q3 nor our full-year outlook includes the impact of our Google agreement, which is currently under regulatory review. As we noted when we announced the Google agreement, we expect $250 million to $450 million of incremental OCF in the first 12 months following implementation.

We continue to execute strongly against our strategic plan, despite the economic environment and the external events of the past two quarters. We are confident about our ability to execute and maximize value from the unique position that Yahoo! enjoys.

Now I would like to turn the call back to Jerry.

Jerry Yang

Thanks, Blake. Let me just conclude by emphasizing a few key points: one, we are executing and delivering against the strategy we laid out, even under extraordinary conditions; two, the results of this quarter, particularly the continued strength in our search and display volume, and the progress on monetization in this economy, demonstrate that we’re on the right track; three, all of us here at Yahoo! are committed to maximizing shareholder value.

Now I’d like to open for questions. Operator.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Ross Sandler, RBC Capital Management.

Ross Sandler - RBC Capital Markets

Thanks for taking my question. Sue, just one question on the non-guaranteed inventory -- can you give us the growth rates there? I think you said double-digit growth in volume and pricing. Can you clarify that? And then the main question would be what percent of Yahoo!'s inventory would be characterized today as non-guarantee, and what kind of CPM lift are you seeing from integrating on Right Media, and is that kind of a one-time step-up or is that a benefit that you are going to realize over the course of several quarters? Thanks.

Susan L. Decker

Okay, thanks, Ross. So just to clarify, I believe I said that worldwide revenue, both on a GAAP and a rev ex-TAC basis, was up double-digits, and also volume as measured by page views was up north of our 12% run-rate.

In terms of how we did on a revenue ex-TAC basis, Jerry talked about roughly 12% display revenue ex-TAC. Our U.S. business did worse than that, more like a mid-single-digit growth rate in revenue on the premium side, and double-digits on -- significant double-digits on the non-premium side. So just to clarify, we are seeing some pricing pressure, as I mentioned in the commentary, very similar to what other companies are describing on the premium end, kind of guaranteed inventory and limited growth in impressions there. On the other hand, we are seeing very, very strong growth from the integration of Right Media and our non-guaranteed business as we become more capable in direct marketing capabilities, so on a weighted average basis, we had double-digit growth in both revenue ex-TAC and GAAP on a global basis.

Operator

Our next question comes from the line of Christa Quarles, representing Thomas Weisel Partners.

Christa S. Quarles - Thomas Weisel Partners

First on your Asian assets, how would you characterize the benefit that they’ve had to your operations over the last several years and sort of the thought process around a spin-off? And then on the amp side, I was just wondering if you could give us your specific goals around how you are going to measure success. Is it the number of publishers, is it page views -- how will we be able to measure the success of the ramp-up of amp, if you will?

Blake J. Jorgensen

I’ll start on the Asian assets and then I’ll let Sue address the amp question. First, I don’t want to speculate on any potential transactions or spin-outs that might have been mentioned in the press. I will say that we have examined various alternatives for Asia and we’ll continue to do that.

In general, these assets have been critical to our ability to expand our franchise into Asia as quickly as possible. They provided unique leverage for us in what are some of the fastest growing markets, and we believe we have excellent partners in each of those markets. There is obviously a tax issue for us because the basis in many of these assets is relatively low, and so any alternative that we have will have to be thought of within the context of trying to minimize or defer taxes as long as possible. We’ll continue to look at this but I think in general, our basic view is that we want to participate in these markets and this team, both the Yahoo! teams in Hong Kong and Taiwan and Southeast Asia have been critical to our success, as well as our partners there.

Susan L. Decker

I’ll take the second part of your question on the new online display ad platform that we’ll be rolling out -- the two primary measures we will be looking at up-front, both of which should drive display yield, that’s ultimately what we’ll be looking at to measure its success, the measures underneath that will be how easy it is to buy an ad campaign. How many hours or minutes does it take to put up an online display ad campaign that runs across multiple publishers? Today it takes several weeks, so we’re very focused on that metric of speed and efficiency and easiness to get the campaign up and running to get to the target audience.

The second one that’s really, really important to us is how many sales channels can we empower by having this open ASP platform? So just as an example, of the close to 800 newspapers that we have in the newspaper consortium, 50 of them are already able to sell Yahoo! inventory during the beta phase, and we expect 100 to be up and launched by year-end. They have more than 750 sales reps and so to put that kind of sales pressure and they are able to go to market and combine it with our local offerings is creating two to three times the CPMs that we could get on our own. So you can see how that, both being able to get up quickly, find your target audience, and to empower other sales channels in ways that drive yield collectively should drive our yield.

Operator

Our next question comes from the line of Youssef Squali, Jefferies.

Youssef H. Squali - Jefferies & Co.

Thank you very much. Given the weakness you are seeing in display, Blake, I was wondering if you could help us -- what kind of growth assumptions have you baked into your second half guidance for that business I guess versus what you did in Q2? And then Jerry, your stock looks fundamentally under-valued to us. If you look at it on a sum-of-the-parts basis, is there a point at which you decide the best course of action is recapitalization of the company? And if so, what would cause that to happen?

Jerry Yang

I’ll start there. I think obviously as we said, we have looked at just about every alternative you can imagine as far as looking at how do we best position the company to go forward, either through transactions and/or financial options. At this point, we clearly are still looking at what the best ways for us to continue to drive shareholder value. We don’t have anything specific that we will talk about but clearly we view that we continue to have very strong balance sheets and we have the ability to generate cash. So we are going to take that into account as we think about what’s the best way to move forward.

I would just remind you that I think we have been under trading restrictions, as Blake said, through this proxy contest and that’s been recently settled, so we have not had an opportunity to go out and talk about any of the other options we may have. And if we do, we’ll be obviously talking about it in the days and weeks and months ahead.

Blake J. Jorgensen

On the first part of the question in terms of weakness in display and how did that impact our second half guidance, we’re not assuming any significant change in our display growth in the second half. I think most of you know that the third quarter is seasonally our weakest and the fourth quarter is seasonally our strongest. What we are seeing in the display business in general is more weakness on the brand level and strength on the performance level, and so much of our effort has been shifting our sales channels into more performance related display advertising. That in combination with a relatively balanced business, we do believe that we will see a significant, or a similar display business in the back half of the year.

A reminder is that we saw a little impact from the economy in the second half of 2007, and so part of that is anniversarying into the back half of 2008.

Operator

As a reminder, please limit yourself to one question. Our next question comes from Imran Khan, J.P. Morgan.

Imran Khan - J.P. Morgan

Thank you for taking my questions. Two questions, actually; first question, if you look at your international growth, Jerry, it’s substantially underperforming some of your competitors and so I was trying to get a better sense, what should be your international strategy? Do you think it makes sense for you to be principally in the international market or would you try a holding company strategy that you did in the international market?

And secondly in the search market, if I look at the search dollar growth, 19%, still underperformed your competitors growth rate by eight points. If you continue to underperform your competitor’s growth rate eight to 10 points, does it make sense to be principal in search? Thank you.

Jerry Yang

I’ll start with your international growth question. I think if you look at our international business, I think the largest area that we still have is the international search affiliates, which is still going through substantial headwinds, as we had outlined previously to you. But if you look at our business, especially in display, where we grew, as Sue alluded to, much stronger rates both in our O&O and in our affiliates, it’s a very strong performance in that regard and even in international search on our O&O, we continue to see strength because of a lot of the monetization features that we are rolling out globally.

So I think if you isolate our international business and you look at the weakness, it really is in that search affiliate business, which we’re cycling through and I think we’ll have more to say about that.

Sue, do you want to talk about the other question?

Susan L. Decker

Sure. So we have addressed this question, I addressed it in my speech here up-front, which is that we think search is a critical component of a broad online advertising offering and we are seeing it in the business deals that we are winning, we’re seeing it in the agency partnerships, ultimately that are starting with display but ultimately we like broad capabilities across both, and we ultimately see an opportunity to converge with display.

So I’d say a search standalone, our approach is not to try to replicate the way it’s being done exactly today but rather to focus on a broad roadmap of differentiation, and I described a few things that we were doing in the quarter. For volume, we saw an acceleration in volume. We’ve seen two months, according to ComScore, of some market share gains. We understand that those are after a number of months of decline, so we’re very cognizant of that but we are very excited about opening up our search index both to developers at the individual listing level and also actually opening up our index to other companies. So I think you are seeing some innovative things here. We also have a pretty broad product roadmap. We talked about just getting Panama out and getting market reserve pricing out, which are the two major initiatives out of the last year, and we’ve seen a third of the narrowing of the gap in the U.S. relative to our major competitor, and we feel by partnering with them in certain cases, that will also help us.

I think if you just look at the difference in the growth rates you said and adjust for the international mix differences, look at our U.S. revenue growth versus their U.S. revenue growth and back out what you think queries did, I think you may see that our -- we think we had another quarter of narrowing the RPS gap in this quarter.

Operator

Our next question comes from Jeffrey Lindsay, representing Sanford Bernstein.

Jeffrey Lindsay - Sanford C. Bernstein

Thank you. Could you give us some further insight into the relative weakness of the affiliate network? Specifically, could you give us some background into whether contracts are being cancelled or renegotiated in line with the current environment?

And then, tax seems to be fairly constant but the revenues have gone down. Is it that partners have renegotiated deals or are the new deals on less attractive terms, diluting down the averages? Thank you.

Jerry Yang

I’ll start but maybe Blake or Sue can jump in. I think one issue on the affiliates is the fact that we are in the transition period, as Blake talked about, with our Yahoo! Japan deal that we did last fall, so you are going to have a different comparison from last year to this year. That’s going to be a major source of that. If you normalize that, I think the affiliate business is, while still going through some of the challenges, it doesn’t compare as badly as what it currently is, given the anniversarying of the deal in the fall.

Blake, do you want to take --

Blake J. Jorgensen

I think the only thing else is that we have seen relatively little canceling or renegotiating on the parts of affiliates. I think the other way around is really what we’ve experienced, where we’ve actually cancelled our relationship with some affiliates due to bad traffic, and we’re trying to continue to improve the traffic and we’re moving forward to try to make sure that we have all the right affiliate partners in place to make sure that we can manage that over time, but we do see some of that impact. But I think most of it is, as Jerry said, driven this quarter primarily by the renegotiation of the Yahoo! Japan situation.

Gross revenues come down where TAC is flat, and the affiliates will grow in the second half as part of that.

Susan L. Decker

And I would just add that as we are managing through some of the affiliate issues in terms of restructuring and quality issues on the search side, as our search performance gets better that’s certainly helping our competitiveness there. But at the same time, we’ve had huge success on the display side, as you can see in all these partnerships we’ve announced this year where we have the monetization advantage, and the growth rate there is very, very strong. From a small base, but very, very strong.

Operator

Our next question comes from the line of Mark Mahaney representing Citigroup.

Mark S. Mahaney - Citigroup

Thank you very much. Jerry and Sue, you talked about the goal of making the purchasing and the selling of display advertising, maybe as automated, maybe as effective, maybe as easy as search. How close do you think long-term, three to five years out, you can make that? How automated do you think display advertising can be and what would be the -- if you had to list them, the one, two, or three major obstacles to getting display advertising as automated as search? Thank you.

Susan L. Decker

Mark, I’ll take that. I think in terms of timing, we expect the strategy that we talked about last summer to be roughly a three-year timeframe as we roll it out, the first phase of which is upon us. It’s not a vision anymore. We’ve got two pilot customers in the San Francisco Chronicle and the San Jose Mercury News. After 10 months of coding, we delivered it within 10 days of plan. We will be rolling that out more broadly in the end of Q3 and we have a very robust roadmap through the end of the year and next year.

What is required to ultimately get there, and the reason it is more complicated than search, although search is a great metaphor for what’s possible, is that display is a lot of different kinds of inventory. Search is one form of inventory. Display has multiple forms of targeting. Search has one form of targeting in terms of the query intent box. Display requires multiple forms of pricing, not just CPM and CPA, but it can be guaranteed against certain kind of content, so you need reservations and forecasting ability, which is something that Right Media and all the exchanges don’t have yet but we will be integrating into the platform.

Display is multiple forms of format, not just text but it can be video, it could be a banner ad, it could be even a text ad like what we do with content maps.

So to do what we are doing in display almost required search as a prerequisite to understand how to automate and aggregate a lot of demand and supply in a univariable dimension across those variables, and that is what we are trying to accomplish in display. And once we get display to that point, and we are well on our way, then we believe we can have a more converged set of platforms that ultimately will allow advertisers to maximize returns. They don’t care whether they are getting it from search or display. They care about meeting their target customer. And it will allow publishers to maximize yield. They care about maximizing yield, they don’t care about what products get there.

So we think fundamentally, we see great customer demand at the publisher level and the advertiser level for this. We see it in our business deals. There is not a platform out there yet for the industry and we are right on the cusp of delivering the first phases.

Operator

As a reminder, please limit yourself to one question. Our next question comes from Sandeep Aggarwal representing Collins Stewart.

Sandeep Aggarwal - Collins Stewart

Thank you. A question on the search -- has your assessment on how quickly Google can start serving ads on Yahoo! unchanged since you announced the deal? And it seems like some of the search metrics are improving. Do you still feel that you can generate incremental benefit from Google, [what you projected] when you announced the deal? Thank you.

Susan L. Decker

I’ll take that. We said at the time of the deal, we expected roughly a hundred day review that we wanted to delay voluntarily implementation for Department of Justice to look at it and we are about halfway through that process now and we do not expect at this time any change from that.

And I would say that it would be premature to put out any different guidance from what we put out before, which was I think $250 million to $450 million -- I’m looking at Blake -- in terms of incremental cash flow that we expected relative to the estimates that the IR team was seeing out there in your models. And I think once we get up and running, we’ll review that and Blake and the team will incorporate that into the guidance if there’s any changes.

Operator

Our next question comes from the line of Brian Pitz representing Bank of America Securities.

Brian Pitz - Bank of America

Thank you. Two quick ones; would you talk about the time you believe it would take to really implement the Google deal, if it is approved? And post the quarter, are there any changes that you would like to make to ’09, 2010 growth mileposts that are currently in place? Thanks.

Jerry Yang

I think we just need to reiterate the timing question. We have not -- we’re not saying there’s anything different from what we said previously. We think after we go through this review period, if we implement it will be some time in Q4, it looks like. And as for Blake -- we don’t give -- we don’t have outlooks out there, but --

Blake J. Jorgensen

I think the three-year plan that we had distributed in the springtime, just to clarify for everyone that that is indeed a strategic plan. It is not three years worth of outlook. We’ll set outlook for 2009 during our normal process in January as part of our Q4 earnings call. That process won’t change. I don’t know if the guidance will be greater or less but we’ll update it at that time for everyone.

Operator

Our next question will come from the line of James Mitchell representing Goldman Sachs.

James Mitchell - Goldman Sachs

Thank you. Just a housekeeping question; it looks like you are increasing your forecast stock-based comp and depreciation and amortization charge for full year ’08 versus your previous guidance. Could you just talk through that?

Blake J. Jorgensen

We have some overlapping stock-based comp that occurs. There are some old programs that are coming close to an end that run through the third quarter and some new programs, some of them retention related, associated with the last year of activity that start up, and so we have some overlap in stock-based comp in Q3. And that will start to normalize by Q4 as the cycle -- it cycles through the recent grants.

And then on CapEx, a similar situation as both our CapEx increases from last year and the depreciation moves along at about the same pace that it has historically. You tend to get the timing effect that overlaps at the same time in Q3.

Operator

As a reminder, please limit yourself to one question. Our next question comes from Justin Post representing Merrill Lynch.

Justin Post - Merrill Lynch

Thanks for taking my question. My question is regarding profitability. Obviously U.S. profitability is down quite a bit year over year. Can you talk about some of the drivers there? And then the guidance implies a pretty big ramp in EBITDA from 3Q to 4Q, a lot bigger than last year. Why do you think you’ll be able to pull that off as you look out 4Q, assuming the Google deal is not in there?

Blake J. Jorgensen

On the profitability issue, just a quick reminder -- the U.S. business bears all the impact from restructuring of the AT&T deal, and so you are seeing reported U.S. GAAP income with revenue growth slowing down. Without the AT&T impact, the U.S. GAAP revenue growth was 14% this quarter, and rev ex-TAC growth was 10%, more in line with the international growth rates.

I think the second thing that we are seeing is that the U.S. economy is weaker than some of the international economies and we are starting to see some of that impact.

In terms of the profitability, I think I mentioned earlier, third quarter tends to be our weakest seasonal quarter. Fourth quarter tends to be our strongest. In addition, with the stock comp expense cycle that I just explained, we tend to see that depressing profitability and increasing profitability -- in the third quarter and increasing it in the fourth quarter, and so that tends to explain the bulk of it plus the leverage of the higher revenue in that last quarter.

Operator

Our final question will come from the line of Doug Anmuth, representing Lehman Brothers.

Doug Anmuth - Lehman Brothers

Thanks for taking my question. My question is on the marketplace reserve pricing and Sue, if you could give some more color there on how much you think that helped RPS during the quarter, in particular relative to the 5% O&O gain? Thank you.

Susan L. Decker

Sure, Doug. I would say that it had a very modest effect, because we rolled it out, we announced late in April, rolled it out through the quarter but did not have a very significant percentage of our queries impacted by it during the quarter. Where we did have the queries impacted by it, it was very positive. So as we look forward and I think embedded in the guidance, our back half RPS gains we expect to be more like Q1 than Q2, where we did about 5% -- and remember, that’s the U.S. Our global RPS gains are higher than that but in the U.S. where we’ve anniversaried Panama, we are now starting to see the MRP impact, we should have a full quarter impact in the U.S. in Q3, so closer to double-digit than 5%.

Jerry Yang

Great. I want to thank everybody for joining us today and we look forward to talking to all of you soon. Thank you.

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Source: Yahoo! Q2 2008 Earnings Call Transcript
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