Yahoo! (YHOO) Marissa A. Mayer on Q3 2015 Results - Earnings Call Transcript

Oct. 20, 2015 10:29 PM ETAltaba, Inc. (AABA)10 Comments
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Yahoo!, Inc. (YHOO) Q3 2015 Earnings Call October 20, 2015 5:00 PM ET


Lauren Lyster - Reporter, Yahoo! Finance

Marissa A. Mayer - President, Chief Executive Officer & Director

Kenneth A. Goldman - Chief Financial Officer


Anthony DiClemente - Nomura Securities International, Inc.

Mark S. Mahaney - RBC Capital Markets LLC

Mark A. May - Citigroup Global Markets, Inc. (Broker)

Eric J. Sheridan - UBS Securities LLC

Diana R. Kluger - JPMorgan Securities LLC

Justin Post - Bank of America Merrill Lynch

Brian Nowak - Morgan Stanley & Co. LLC

Ron Victor Josey - JMP Securities LLC

Youssef H. Squali - Cantor Fitzgerald Securities

Stephen D. Ju - Credit Suisse Securities (USA) LLC (Broker)


Good afternoon and welcome to Yahoo!'s third quarter 2015 earnings video webcast. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. As a reminder this conference call's being recorded. The webcast today will be moderated by Lauren Lyster.

Before getting started, I want to remind you that today's presentation will contain forward-looking statements about the planned spinoff of our remaining stake in Alibaba Group as well as our expected financial and operational performance, including business and financial strategies, growth, revenue, product plans, and cost controls. Actual results might differ materially from our projections. Potential risks that could cause these differences are described in our press release issued this afternoon and related slide presentation on our Investor Relations website and our Form 10-Q filed with the SEC on August 7, 2015.

All information in this video is as of today, October 20, 2015, and we undertake no duty to update it for subsequent events. Today's discussion will include non-GAAP financial measures. Reconciliations of our non-GAAP results to the GAAP results we consider most comparable can be found in our earnings slides, which also contain full versions of the financial charts and graphs you'll see in today's video. We encourage you to review the complete slide presentations on our Investor Relations website at under earnings.

And with that, let me turn the program over to Lauren.

Lauren Lyster - Reporter, Yahoo! Finance

Welcome to Yahoo!'s third quarter 2015 earnings video webcast. I'm Lauren Lyster, I'll be moderating today's earnings event. Here with me are Marissa Mayer, Yahoo!'s Chief Executive Officer; and Ken Goldman, Yahoo!'s Chief Financial Officer. Today we bring you prepared remarks from both Marissa and Ken around Yahoo!'s third quarter performance. Later, they'll be answering your questions.

I'd like to now turn it over to Marissa to discuss Yahoo!'s third quarter business update. Marissa?

Marissa A. Mayer - President, Chief Executive Officer & Director

Good afternoon and welcome to our live earnings webcast hosted on Yahoo! Finance. For my portion of today's call, I will discuss our quarterly performance, our planned spinoff of Aabaco Holdings, as well as the core of our business.

Let's begin with a summary of our financial performance. We delivered $1.226 billion of GAAP revenue, up 7% year over year. In terms of revenue ex-TAC, we delivered $1.002 billion, down 8% year over year. Throughout the quarter, we continued to balance our investments and costs delivering $244 million of adjusted EBITDA. Our display revenue continues to see double-digit growth of 14% year over year on a GAAP basis and 2% growth on a revenue ex-TAC basis. On the search side, our GAAP revenue grew 13% and was down about 13% on an ex-TAC basis due to investments in our Yahoo! Gemini platform and traffic acquisition costs.

Looking ahead, our Q4 outlook, which Ken will return to later, is not indicative of the performance we want. While there are some well-known headwinds, year over year and even quarter over quarter like the loss of the Alibaba TIPLA, we are also experiencing continued revenue headwinds in our core business, especially in the legacy portions.

With the spinoff of Aabaco Holdings pending and our annual planning for next year in full swing, we see a unique moment and opportunity for Yahoo! as we move into 2016 to narrow our strategy and focus on fewer products with higher quality to achieve better growth and better results. We will share the details of this plan in which we aim to delineate our focus, improve our execution, and define our relevance to users at our next earnings release, if not before.

I'd like to now speak about our Q3 results in the context of the key drivers of our business: people, products, traffic, and revenue. Starting with people, we ended the quarter with 10,700 full-time employees and just under 800 contractors, bringing our overall head count down 14% year over year and down 32% over the current management's tenure. We will continue to be disciplined on our head count and our thoughtful work on this area has helped appreciably on expenses.

In Q3, we maintained our focus on attracting and retaining a strong sales and technical workforce to accelerate our growth. In all, roughly seven out of every 10 new employees were hired into sales or engineering. Our hiring process continues to be rigorous and primarily focused on the talent that will help us drive user engagement and revenue growth.

Recently, there has been external interest and speculation in a few shifts amidst our management team. The design and changes in Yahoo!'s leadership team are the result of careful planning to achieve the necessary skills, passion, and the ability to execute growth in our business. Our leadership team today is unequivocally the strongest during my tenure.

Turning to our product progress, we continue to pride ourselves on being the indispensable guide to digital information across search, communications, and digital content. Ultimately, this is about informing, connecting, and entertaining our users. Let's start with search. Yahoo! has a healthy search market share today and our Q3 numbers reflect some of the growth levers we're exploring. As our investors know, we've made large strategic changes to the business to improve the quality of our traffic and our partners, investing in our own search marketplace while introducing even more competitive monetization choices.

This long-term strategy will not be defined by a single quarter. Over the next few quarters, we're working to differentiate our product across both algorithmic and paid search results. We'll also continue the momentum needed to drive our Gemini platform forward by moving additional demand to the system and building a robust marketplace. As we discussed on our last earnings call, this investment will suppress revenue in the short-term but will result in better monetization over the long-term.

Mobile search continues to be a critical area of investment for us and one of the key ways we are investing is by moving additional traffic and advertisers to the Gemini platform in order to fully optimize and train our ad system. Overall, we remain optimistic about growth opportunities in search.

As you know, in April we amended our search alliance with Microsoft, which provided us with significant additional flexibility. Our relationship with Microsoft remains strong and vibrant, and the teams have been working through the changes in our relationship and marketplace very effectively. I'd like to thank Satya [Nadella] and his team for their terrific efforts and partnership.

In addition, today I'm pleased to announce that we have signed a three-year partnership with Google to bolster our search capabilities. This partnership will be supplementary to our existing relationship with Microsoft. The partnership with Google is non-exclusive and does not have minimum volume commitments. It covers both desktop and mobile traffic in the United States and many of our primary international markets. It is subject to a voluntary regulatory review by the Department of Justice and will only be implemented after that.

Overall, we believe that by establishing partnerships with both leaders in the search space, we can achieve a competitive search dynamic that will provide a better experience for our users and advertisers and will improve our monetization.

Looking at our search monetization in Q3, we saw click-driven revenue grow 3% year over year. In terms of click volume, we saw 5% growth, driven primarily by our distribution partners. Meanwhile, we saw Price-per-Click decline 2%.

At an overall level, while we saw the search revenue grow 13% on a GAAP basis, it declined by 13% on a revenue ex-TAC basis. We will continue to work hard to grow search on both a GAAP and revenue ex-TAC basis.

On the product side, our teams continue to iterate and innovate across mobile and desktop search to deliver enhanced experiences to all of our users.

On the consumer side, we launched a new hotel search experience in partnership with TripAdvisor, which offers details on hotel ratings, reviews, and photos directly on the search page. We're also seeing that mobile devices are transforming shopping behaviors, and we want to leverage the power of mobile search and native ads to help advertisers connect with shoppers.

In Q3 we rolled out Gemini Product Listing Ads, giving merchants access to Yahoo!'s smartphone search inventory, to help them drive even more shoppers to their products. And with the launch of Click-to-Call ads, advertisers can now add a call button to their native search ad that brings users one tap away from a conversation with them.

Overall, we have significantly changed the business in ways that are strategically advantageous, but these changes will take a few quarters to translate into higher growth and margins. Achieving those improved margins and higher growth in search is a key priority for us.

Next, communications; for the past 18 years Yahoo! Mail has been a key driver of engagement for our users, and creating the most innovative inbox experience remains an important goal for us. In Q3, our product teams were hard at work improving the design and differentiation of Yahoo! Mail to grow engagement and to bring new users to the product.

Just last week, we launched the new Yahoo! Mail mobile application to an extremely positive reception. In addition to focusing on back end improvements to improve speed and performance, we also refreshed the design, making Mail more beautiful and intuitive. We introduced multiple account support, making it easier for users to access their other e-mail accounts directly from Yahoo! Mail, and we took an industry-leading step towards a password-free future with the announcement of Yahoo! Account Key, which pushes notifications to your phone to provide a fast, convenient, and secure way to access your Yahoo! accounts without having to memorize a password. This also makes it significantly easier to protect our users' accounts going forward. Overall, we are optimistic about our prospects in the communications space.

Digital content is all about entertaining our users across their interests. During our last earnings call, we announced that we had launched our Yahoo! Sports Daily Fantasy product for Major League Baseball, and in September we kicked off the NFL season. We've been in the fantasy sports business for 18 years, and these most recent launches have helped Yahoo! improve the overall fantasy experience for our users. To date, our Daily Fantasy Sports offerings have exceeded our expectations in engagement and revenue. Daily Fantasy Sports is still a nascent industry, and we're monitoring industry trends and events closely. Daily Fantasy Sports is an exciting and evolving space, and we've been really pleased with how our product has been received.

Last quarter, we also announced our partnership with the NFL to deliver the first free global live stream of an NFL game. We invite you to tune in this coming Sunday, October 25, when the Buffalo Bills and the Jacksonville Jaguars face off in the NFL International Series game in London, streamed live across Yahoo!'s properties globally, including Yahoo! Sports and Tumblr. We know our users will be very excited to see this game, and our advertisers have been too. We've already sold out all of our game day advertisements.

This quarter we acquired Polyvore, a leading social commerce site that lets users across the globe discover and shop for their favorite products in fashion, beauty, and home décor. This acquisition brings Polyvore's expertise and community-driven experiences and retailer-supported commerce to Yahoo! and is aligned with our Mavens businesses. Already, the Polyvore team has hit the ground running, successfully integrating more than 400 of our advertisers with Yahoo! Product Listing Ads. These ads have started appearing in Yahoo! Search results. And while the integration is still in the early stages, we see great promise.

Let's turn to Tumblr. We're pleased with the growth of mobile engagement on Tumblr, with mobile usage increasing at the industry rate, if not faster. We now see 81% of Tumblr daily active users coming through mobile devices. On the product front, we refreshed the user interface for re-blogging to improve readability of conversations and better utilize screen space on mobile. Continuing to lift Tumblr engagement on mobile through new and engaging features has been and will continue to be an important priority.

Finally, we're continuing our commitment to mobile growth with our developer offerings. In August, we hosted over 500 developers at the Yahoo! Mobile Developer Conference in New York, where we announced new additions to the Yahoo! Mobile Developer Suite. With Tumblr in app sharing, developers can now integrate Tumblr share buttons into their applications, giving users the ability to post content to Tumblr and link back to the source application.

We also announced an update to Flurry Analytics that will allow developers to have instant insight into their apps' real-time activity, and developers interested in monetization can integrate native video ads into their apps. We have found native video ads to be one of the best performing ad formats.

Our overall network, including Tumblr, continued to serve a global user base of more than 1 billion monthly active users. Yahoo!'s mobile audience of over 600 (sic) [600 million] users continues to show growth. We already have substantial user scale, so one of our key focuses heading into 2016 is improving user engagement on our products, especially on mobile.

Now turning to revenue, as we endeavor to build a truly global advertising business, it's critical for us to create a unified global effort for our customers. To that end, in Q3, Lisa Utzschneider was promoted to Chief Revenue Officer. As part of this change, we have aligned our sales team under Lisa's leadership to sync our efforts more closely and create a unified global voice for our advertisers. Lisa's operational rigor and client-centric thinking is exactly what we need in order to grow revenue.

Our Mavens businesses, which include mobile, video, native, and social, delivered Q3 GAAP revenue of approximately $420 million, up 43% year over year, nearly 35% of overall GAAP revenue. These businesses represent the fastest growing areas of digital advertising and will continue to be strategic to our transformation.

Mobile has been our biggest win for the company so far. I'm delighted to report that, in Q3, mobile revenues generated approximately $270 million in GAAP revenue, up 31% year over year. This equates to gross revenue of more than $420 million. Mobile now contributes at least 24% of our traffic-driven revenue.

Now let's turn to video. Our video GAAP revenue has more than doubled year over year and video Price-per-Ad is helping drive our overall Price-per-Ad growth. Global video streams nearly doubled year over year, and time spent watching videos is up 82% year over year across our original editorial and partner content. Native video ads are also performing well on both mobile and desktop with revenue up approximately 40% quarter over quarter.

This quarter, we announced our plans to unify all of our programmatic advertising technology under the BrightRoll brand, which we acquired last year as part of our M&A strategy. The BrightRoll DSP is our efficient programmatic buying platform for video, display, and native advertising. And the BrightRoll Exchange is our marketplace that connects buyers and sellers of video and display inventory to be run across Yahoo! and other premium publishers. This exchange is integrated with more than 100 DSPs and enables access to thousands of sites and applications via real-time bidding, private marketplaces, and programmatic direct. With the video advertising industry continuing to grow significantly, we're excited to catch this wave.

Online advertising is also continuing an aggressive shift towards native ads, especially as they continue to prove their effectiveness. On average, native ads get three times more attention than other display ads and about 50% more emotional resonance than traditional ads. Tapping into this industry shift, we introduced our Gemini platform, the first unified marketplace for mobile search and native advertising, and the native side of Gemini's platform has shown terrific momentum.

In Q3 2015, Gemini native ads delivered an increase of over 90% year over year and 10% quarter over quarter. A large driver of this growth is syndicated supply through the Flurry network, which was up approximately 65% year over year in the United States. In particular, Yahoo! App Publishing from our Mobile Developer Suite now makes up nearly 40% of the total mobile Gemini revenue and more than a quarter of the total Gemini supply. Also, we saw international supply increase by approximately 35% over last quarter as we deployed new ad units on Gemini internationally.

Turning to social. Tumblr continues to be a long-term strategic play for us. Over the quarter, we have worked hard to integrate the sales and operations teams and continued to make enhancements to the ad products to drive monetization. In Q2, we launched a new ad format, the Tumblr Sponsored Day that allows brands to advertise at the top of the Tumblr dashboard for 24 hours. And in Q3, we enhanced the Sponsored Day visual experience with a big beautiful banner and extended this ad unit to our mobile experiences, where most of our daily active users engage with us.

We're also focused on ramping up app-install ads on Tumblr. With apps comprising 90% of the time spent on mobile, we think there's a lot of promise, especially for Millennials. We're seeing demand from advertisers as Tumblr's client base for app-install ads grew more than 60% last quarter. Our sponsored video ads have also grown to be a significant portion of Tumblr's business. Revenue from these ads are up 35% quarter over quarter and nearly 60% since launching in Q4 of last year.

Moving on from the Mavens businesses, I'd also like to take a moment to discuss our broader display trends. Over the quarter, ads sold were up 8% year over year, driven in part by syndicated native ads as well as video inventory growth from BrightRoll. This was partially offset by a decrease in premium and audience ads. Price-per-Ad was up 8% year over year driven by increases in native globally and video representing a larger share of the inventory mix.

Before I hand it over to Ken to discuss our financial results in greater depth, I wanted to take a moment to comment on the planned spinoff of Aabaco Holdings. We continue to make good progress and strive to complete the spin in Q4. We do want to note that due to the time needed to satisfy certain conditions, including completing the required SEC process, the final approval of both the Yahoo! and Aabaco boards, compliance with the notice requirements under the convertible note indenture, and taking into consideration holiday market closures at the end of the quarter, the transaction may ultimately conclude in January.

I also want to take this opportunity to thank everyone who's been working tirelessly on the spin. It's an important moment for the company, for our investors, and a significant event in Yahoo!'s history.

Overall, I have very aggressive expectations for Yahoo!'s core business. We have the right talent, the right strategy, and the right assets to drive long-term sustainable growth for our investors. As we look towards a post-spin 2016, we think there's a unique opportunity to reset and realign against the most impactful areas of focus. This will require us to simplify our structure, improve expense discipline, and prioritize our investments to improve growth and profitability.

We remain deeply committed to doing what's best for Yahoo! and delivering the most value to our shareholders. And we believe more strongly than ever that continued focus will help us accelerate our long-term growth and set us up for future success.

Now, I'd like to turn it over to Ken to talk more about Q3.

Kenneth A. Goldman - Chief Financial Officer

Thanks, Marissa. Good afternoon, everyone, and thank you for joining us today. Today, I plan to review our third quarter operational results in more detail and also provide an update on the Aabaco spinoff transaction, and later close with outlook for the upcoming quarter.

We continued to grow GAAP revenue in Q3 to $1.226 billion, representing a 7% increase year over year. Through additional partnerships and affiliates, we increased the total advertising dollars in our ecosystem, leading to search and display revenue growth of 13% and 14%, respectively.

Traffic acquisition costs increased by $169 million year over year to $223 million due to the additional contribution of off-network traffic and affiliate revenue. This resulted in revenue ex-TAC of $1.002 billion.

In Q3, we effectively managed our cost base to deliver EBITDA of $244 million and non-GAAP operating income of $92 million.

We allocated appropriate resources and capital for growth initiatives while also realizing operating efficiencies through office consolidations and workforce expenses to reduce our cash operating cost to $758 million in the quarter.

And similar to prior trends, our full-time employee base declined by approximately 300 in the quarter, ending at 10,700. This results in a year-over-year reduction of 1,800 or 14%, even after including the acquisitions of BrightRoll and Polyvore. Our technical head count remains steady at approximately half our employee base while G&A-related personnel costs have decreased.

As we continue to remix and align resources to focus on key growth areas, we are mindful of our overall cost structure and improving operational efficiencies to focus on sustainably improving our EBITDA margins over time.

Before diving further into the financial details for the quarter, let me make a couple comments on the Aabaco spinoff transaction. After carefully considering the company's options and feedback we received from our shareholders, our board authorized the company to continue to pursue the planned spinoff without a private letter ruling on the basis of a receipt of a favorable tax opinion from counsel.

As Marissa noted, there are a number of factors to consider as we drive the transaction to conclusion including regulatory processes, respective board approvals, notice requirements, and holiday market closures. We remain focused on executing the transaction as soon as possible and look forward to updating you with a complete spinoff as well as our go-forward plan for core Yahoo! on our Q4 earnings call.

I am focusing on the following for Q4: one, working diligently to complete the spinoff transaction; two, build a 2016 financial and operational plan that is realistic and executable in achieving our goals for revenue, earnings, EBITDA, and free cash flow; three, develop a plan and strategy to communicate to investors our core company direction post-spin, which includes how best to optimize our investment in Yahoo! Japan; and finally, finish 2015 financially as strong as possible to set the stage for 2016.

Now let's run through our third quarter financial results in more detail. Once again, I will focus most of the discussion around the non-GAAP results, which excludes stock-based compensation expense of $110 million, restructuring charge of $26 million, and asset impairment charge of $42 million, and $13 million non-cash loss on Hortonworks warrants. Please see our earnings slides on our Investor Relations website for a complete reconciliation between our GAAP and non-GAAP results.

Our financial highlights for Q3 can be seen on slide five. GAAP revenue was $1.226 billion, up 7% year over year or 10% excluding the impact of foreign exchange. Traffic acquisition costs were $223 million, which were up $169 million compared to the prior year, primarily due to our Mozilla partnership, Gemini search, and growth in affiliate and mobile display from our BrightRoll platform and Flurry business on Yahoo! App Publishing. Revenue ex-TAC was $1.002 billion, which includes a negative foreign-exchange impact of approximately $30 million on a year year-over-year basis.

Taking a closer look at search, GAAP search revenue was $509 million, up 13% year over year. Search revenue ex-TAC declined 13% year over year, driven by increasing partner payments relative to click-driven revenue growth of 3% as well as our investment in Gemini, as Marissa has discussed. We are making good progress in our internal search efforts under Gemini. Our sales teams have already secured thousands of accounts on Gemini search platform and we fully expect to drive more advertisers and traffic onto the platform over the next quarter.

Now moving to display, we saw a continuation of growth trends from the prior quarter. GAAP display revenue was also $509 million, up 14% year over year as a result of our growing affiliate partnerships and video business. Display ads sold and PPA each increased 8% year over year. The Americas saw a strong PPA increase of 24%, driven by native and improved mix of video inventory. Native PPA continued to see meaningful growth from the prior year. Our advertisers are seeing success in mobile by leveraging targeting capabilities available to Flurry. Display revenue ex-TAC grew 2% year over year or 6% excluding the impact of foreign exchange.

In our Mavens businesses, we saw 43% GAAP revenue growth year over year for those areas in aggregate. Mavens now contributes 38% to our traffic-driven revenue, up from 29% in the prior year. Video enjoyed a good quarter of growth, as we continue to increase supply and demand across all areas of video business. For example, our fast-growing autoplay video supply is now fully available in the unified BrightRoll platform. We're also looking forward to delivering premium video content in our upcoming webcast of the London NFL game this Sunday, October 25.

Mobile GAAP revenue grew 31% year over year. We held our second Mobile Developer Conference in New York City this past quarter and continue to see strong native growth through Yahoo! App Publishing in our international regions. Our native display revenue across all devices reached approximately $145 million in the quarter, driven by growth in both volume and pricing year over year.

For Tumblr, our priority remains user growth and engagements, which will lead to improved monetization. We are pursuing multiple paths to achieve increased monetization through our unified Yahoo! sales force, including deeper integration with our rapidly growing Gemini marketplace. We expect to update financial performance for Tumblr at the end of the year.

Other revenue ex-TAC declined 6% year over year, due primarily to the decline in Alibaba related fees of $14 million, Taiwan e-commerce, and other operational declines across leads, listings, and fees.

For revenue detail by region, please refer to slide 10. Americas GAAP revenue grew 13% year over year due to strong growth in search of 20% and display of 22%. APAC GAAP revenue was down 15%. Excluding FX headwinds, GAAP revenue was down 6%. EMEA GAAP revenue was down 11%, but excluding FX, GAAP revenue was up 2%.

Now let's take a couple of minutes to go through our expenses and income in a bit more detail. Non-GAAP total operating expenses were down 3% year over year. D&A has remained consistent over the past several quarters at approximately $150 million. Our non-GAAP cash expenses for the full quarter came in better than our expectations at $758 million, declining 4% year over year. This was a result of our ongoing improvements to drive operating efficiencies for the company. One, a $38 million decrease in workforce expenses achieved through a reduction of full-time employees while integrating acquisitions and redeploying resources to our strategic areas. Two, a $10 million decrease in facilities as we see the continued benefits of our office consolidation. And three, an $8 million reduction in our discretionary expenses and outside service providers through tight budget controls. At the same time, we have offset with marketing investments in key partnerships and product launches.

Included in our GAAP total operating expenses, we incurred an asset impairment charge of $42 million related to a change of strategy on certain original long-form video content. Construction costs of $26 million related to resource realignment and location consolidations as noted, and stock-based compensation of $110 million.

Our effective cost management helped to deliver EBITDA of $244 million in Q3 with a margin of 24% based on revenue ex-TAC. Non-GAAP operating income was $92 million for the quarter.

Rounding out the income statement, earnings and equity interest were $95 million. Our non-GAAP tax rate is 35%, and this is the estimate we expect to use for all of our 2015 non-GAAP presentations. Non-GAAP earnings per share was $0.15. And our Q3 average fully diluted share count decreased year over year by 6% to 947 million shares, and our ending diluted share count for the period was also 947 million.

Quickly turning to the balance sheet, our Alibaba investment was $23 billion on the balance sheet, reflecting the Alibaba share price at the end of Q3, as this is marked to market. At the end of Q3, we had $6.8 billion in cash and marketable securities, or $5.5 billion net of our convertible and other debt. The change in cash balance from Q2 to Q3 was primarily driven by: free cash flow of $18 million, which includes capital spending of $150 million related to our products in mail, search, and Mavens; acquisitions of $153 million; and positive proceeds of $50 million from yen hedges, which actually brings the cumulative total to approximately $630 million since 2012.

Now let me cover guidance. Before I walk through the outlook, the guidance that I'm about to enumerate includes discussion from our earlier remarks. We expect to continue to grow GAAP revenue before revenue ex-TAC, as we gain scale and market share in our core advertising businesses. Although we have historically seen a sequential increase in revenue ex-TAC in Q4, the TIPLA amortization has now ended, resulting in a headwind of $60 million from Q3 to Q4. Additionally, the anniversaries of Mozilla and BrightRoll together with our continued investments in Gemini will put pressure on our GAAP and ex-TAC revenue growth. TAC increases will continue to reflect the growth of our affiliate display platforms on BrightRoll and App Publishing as well as the increase in search traffic flowing through our own Gemini platform.

For non-GAAP cash expenses, we will continue our tight control of head count and spending. For Q4 guidance, we expect the following: GAAP revenue range of $1.16 billion to $1.2 billion; TAC of approximately $240 million; revenue ex-TAC in the range of $920 million to $960 million; adjusted EBITDA in the range of $160 million to $200 million; and non-GAAP operating income in the range of $10 million to $50 million.

In closing, as we prepare for the upcoming Aabaco transaction, we are also working through a multiyear transformation to position Yahoo! to win in a highly competitive marketplace. We look forward to the opportunity at hand. We will be a more focused company in 2016 with the anticipated spin of Aabaco behind us as well as Alibaba-related revenue. While we have incurred challenges this year and have not achieved the financial results and performance we had hoped for, we are committed as a management team to improved execution in Q4 and 2016. We remain committed to executing towards EBITDA stabilization and growth over time. We have already executed a number of partnerships and investments in both search and our display properties which we believe establish a good foundation for the upcoming year.

At our Q4 earnings call, we look forward to sharing additional information on our plans for the core Yahoo! business post-spin.

With that, Marissa and I would like to take your questions. Lauren?

Question-and-Answer Session

Lauren Lyster - Reporter, Yahoo! Finance

Thank you, Ken. That brings us to the Q&A portion of our live earnings event. Please limit yourself to one question. The first question will come from Anthony DiClemente of Nomura Securities. You may proceed.

Anthony DiClemente - Nomura Securities International, Inc.

Thanks a lot. I have two. First, for Marissa, I wanted to just ask about the Google agreement. The deal is non-exclusive. It sounds like Yahoo! has the discretion as to which of the ad services it uses to monetize search queries. So can you just, for our benefit, walk us through the mechanics of how Yahoo! determines which of the queries are monetized by Microsoft, by Google, by Yahoo!? And then just broadly, how much do you think that this deal, this agreement could potentially improve search monetization?

Marissa A. Mayer - President, Chief Executive Officer & Director

Sure. Obviously, this is a new development for us. We're excited to be announcing the partnership today. It is still subject to the regulatory review and we won't be implementing the partnership with Google until after that. And as part of this process, we're going to be investing in understanding how to balance the marketplace of our search queries in terms of how to provide the best results as well as the best monetization, and so we see some opportunities in terms of providing coverage of more ads on more queries. We also see some opportunities in different international regions to just achieve a different blending.

And I would also say we're very confident in our Yahoo! Gemini platform for search. And when we look at mobile we actually, as you know, have a different view in terms of what mobile search should be over time and what the best possible ways to monetize that are and really provide value to advertisers. And so for us the Yahoo! Gemini platform is really where we want to invest particularly on mobile in new formats, new ideas, and so I think you should expect to see a lot of our mobile traffic move to Yahoo! Gemini and for us to basically develop a technology that does a good job competitively balancing both the Bing and Google opportunities in terms of monetization.

Anthony DiClemente - Nomura Securities International, Inc.

Okay, thanks, Marissa. And then just one for Ken. Ken, this is an Aabaco-related question. Some investors are wondering, where does the post-spinoff tax liability reside? Our understanding is that if the spinoff were to incur a tax liability kind of after the transaction, Aabaco would then payback Yahoo! for any taxes that Yahoo! would have to pay such that Aabaco would be liable in non-core Yahoo!. So can you confirm that for us or just weigh in on how that all works?

Kenneth A. Goldman - Chief Financial Officer

I think that's primarily related. You can see it all it in the N-2 and it very clearly says, first of all, it's all hypothetical hopefully relative to taxes, so that's first of all. But also in terms of who pays the taxes, the indemnifications thereon, that's all really quite laid out in the N-2 and I'd prefer not to sort of just say it right now.

Lauren Lyster - Reporter, Yahoo! Finance

All right.

Anthony DiClemente - Nomura Securities International, Inc.

Okay, thanks.

Lauren Lyster - Reporter, Yahoo! Finance

Next we go to Mark Mahaney with RBC Capital. Go ahead with your question

Mark S. Mahaney - RBC Capital Markets LLC

Thanks. I want to stick with the search business and Marissa it seems like there is something of a negative inflection point if we look at the growth in the Paid Clicks and the growth in the Search click-driven revenue. So could you provide a little bit more color behind that? And was that kind of the impetus to do the Google deal, but really what's the why? Why did we have this inflection point, because you had a couple of quarters here of really steady growth until now? Thank you.

Marissa A. Mayer - President, Chief Executive Officer & Director

As you know, we've been investing in our syndication business both bringing on new partners but also honing the quality of the partners that we have and the clicks that we have and how well they convert for advertisers and operate in the marketplace. And so, and when we look at the overall impact on the click-driven revenue in search and why we saw a bit of a decline this quarter, about half of that comes from click volume, which is a result of us both adding some high-quality partners but also reducing some partners where we felt the quality really wasn't what we wanted. And about half of that decline is also from our investment in Gemini, which largely manifests in terms of Price-per-Click. And obviously, this is something under our control.

And we discussed on our last earnings call, it was an investment we feel is important to make. But as we optimize that system we're bringing new verticals on, it's not exactly clear how to rank our ads. And so we use the search traffic to learn, but that does mean when we're first doing our ad placements, we don't get them exactly right. Our system has actually been learning faster than we expected it to learn and we're excited about the progress that we're making in Gemini search. But we did see some PPC depression this quarter, which we expected as part of that investment.

Lauren Lyster - Reporter, Yahoo! Finance

The next question comes from Mark May with Citi. You may proceed with your question.

Mark A. May - Citigroup Global Markets, Inc. (Broker)

Okay, thanks. Thanks for having me. A question on Aabaco. Given that the board has decided to proceed with the spinoff without written confirmation from the IRS, what can you say to investors to make them comfortable that the IRS will not come back and challenge the structure of this deal in the future? And I guess second kind of somewhat related question in terms of pushing out the potential timing of the deal until maybe January. It sounded like a number of the things that you listed there are more around when not if related that's more around timing. But can you just give us a sense for some of the things that you still need to get done to get the deal to happen? What if any risks you see if not being able to get board approval or SEC, et cetera? Thanks.

Marissa A. Mayer - President, Chief Executive Officer & Director

Sure, I'll start and then Ken can fill in. In terms of the IRS actions, we prefer obviously not to speak with them. That said, we do feel that we have a very good legal opinion that's very strong around the fact that this transaction would be tax efficient under current law. In terms of the when not if, yes, I think that's correct. When you look at overall some of the things that may cause us to ultimately conclude in January, we are making great progress on getting these completed. Some of these do, for example, like the notice on the convertible bond indenture, some of these do have fixed timelines. And we also want to make sure we pick an ideal time to do the spinoff. And we prefer to avoid some of the holiday market closures towards the end of the quarter just in terms of introducing the new trading entity. But we do feel really confident overall about the transaction.

Kenneth A. Goldman - Chief Financial Officer

I think that's true. I think I would just say this. We have made a tremendous amount of progress. There is a lot of work that has been done and accomplished here. Believe it or not, we can see the goal line. So we are very confident relative to that. We have a few things to do as we enumerated. We're following through on all of those. We tend not to want to speak for the IRS, so we're not going to do that. But we work very closely with our tax and legal advisors and so that's allowed us to make the statements that we have made. But I can assure you we have all hands on deck, whether it's the management team, the board, and so forth to achieve this and to achieve a positive outcome in the timeframe that we established for this spinoff.

Mark A. May - Citigroup Global Markets, Inc. (Broker)


Lauren Lyster - Reporter, Yahoo! Finance

The next question will come from Eric Sheridan with UBS. You can go ahead with your question.

Eric J. Sheridan - UBS Securities LLC

Thanks so much for taking the question. Marissa, maybe can you give us a little bit of color against the investments you're making on the Gemini platform? Where do you sit in terms of the broader scope of your advertisers adopting the platform, and what critical mass or full adoption might mean for the results going forward?

And then maybe, Ken, if I can do one more, in terms of the revenue guidance for Q4, I wanted to know if you could put some numbers around some of the headwinds and tailwinds that you tied out in your own commentary around either TAC or maybe even some of the product commentary that Marissa had earlier in the call in terms of refining the strategy going forward. Thanks.

Marissa A. Mayer - President, Chief Executive Officer & Director

Okay, I'll try and give a fulsome answer around the overall Gemini investment. As I said, we see a lot of new exciting formats in search both on mobile and on desktop, and this is an area where we can see a really nice dovetailing between our Gemini search offering as well as Gemini native. A lot of the same formats work very well in either location or in either setting, and so we really want to have both of those marketplaces grow together and ultimately strengthen each other.

In terms of the investment and the way that it works, a lot of people would expect it to show up as an investment in short-term operating expense, but the way it actually works is that it shows up as suppressed revenue. The analogy that works particularly well here is one of a class. If you're given the final exam of a class on the first day of the course you don't do very well, but by the time you've actually learned over the course of the class you can do much better.

Each of our search queries is essentially a test, and whether or not we can place those ads in the appropriate order in terms of quality and the ability to monetize and targeting is really the challenge. And so when we first start trying that, we don't necessarily place all of those correctly, which results in slightly lower monetization. But each interaction with the user, each click in terms of where it lands teaches us something. And over the course of learning, we actually can improve our performance in terms of monetization, basically improve our performance on the test. And that's the process we're going through now.

We've been transitioning our advertisers to the Gemini platform vertical-by-vertical. At this point, we have thousands of advertisers on the Gemini search platform. It's been a really exciting transition and we've been really heartened by the way search advertisers have been willing to adopt this platform and learn with us. It's been really exciting. And as we transition each vertical, we anticipated it would be two to three quarters of learning until we really got to optimum. But when we get to optimum, it ultimately yields better monetization and improved margins.

Kenneth A. Goldman - Chief Financial Officer

I think as we thought about Q4, there's a variety of things. And how I started with is we looked at Q3 to Q4 sequentially. We looked at Alibaba, which is very, very well known. So that gets you about – it takes you $60 million down. And then we looked at what are the ups and downs from that.

Clearly, as Marissa noted, we are going to look at – as we position for 2016 – what products and regions make the most sense to really focus on that can be strong winners for them – for us and really focus on those. And some other areas we may basically disinvest, if you will, or defocus, and so some of that will affect Q4 as well.

And so, as we looked at it – and then Marissa also talked about search, and so search, in terms of some of the things that we have to concern ourselves about the Q3 to Q4, relates to some of the investments we're making and some of the changes as we go forward. So we looked at search and how that may not grow as much as we would normally see Q3 to Q4. And display, while it grows, may also not grow quite as much because again, some of the focus we're making in terms of, here are the key products we want to drive and work on versus some other products – or regions, for that matter – that maybe we don't want to put as much focus on. And how that works is how we sort of thought about developing the guidance, if you will, for Q4, and probably as importantly how we think about how we can set the stage for 2016.

Lauren Lyster - Reporter, Yahoo! Finance

Now we go to Doug Anmuth with JPMorgan. Please proceed with your question.

Diana R. Kluger - JPMorgan Securities LLC

Hi, this is Diana in for Doug, just two quick questions, if you could. Just going back to the Google deal, if you could give any color on economics potentially how it differ across mobile, desktop, and then you talked about how you're leaving it open for other partnerships – maybe some color and what other examples we could expect going forward? And then just on the cash OpEx, we saw a nice decrease there from last quarter. Just wanted to get some color on expected sustainability or the pace of that going forward.

Marissa A. Mayer - President, Chief Executive Officer & Director

Okay, I'll take the first question and Ken can take the second. On the new partnership with Google, we are filing an 8-K, and we will disclose what we intend to disclose there in terms of some of the financial relationships. What I can say is that overall we're enthusiastic about it. We think that by having partnerships with both leading search providers provides for greater competition, it really improves search in terms of the user experience as well as in terms of the business. And it really allows us, as we think about how we want to evolve our search, to build and really be able to invest in differentiating our product, particularly on mobile. And so overall, we're happy to have achieved this. By having three different search marketplaces available to us, it really does allow for greater competition and provides greater stability as well as choice and a better user experience.

Kenneth A. Goldman - Chief Financial Officer

So on cash OpEx, if you go through, you can see the assumed numbers are pretty comparable to Q3 in terms of $758 million. And again, the assumption in Q4 is pretty consistent with that. We're going to continue looking at that so I don't have a lot more I want to talk about relative to go forward. We will develop our plans as we think about 2016. We did make a couple of comments. Marissa said it; I said it. We do take EBITDA very, very important, so we are looking at that very clearly in how we can optimize EBITDA and grow EBITDA going forward. So we will develop our expense plan in conjunction with as we develop our revenue plan and in conjunction on how we focus on those products and those regions that make the most sense for us to win and succeed in, and we'll do that.

At the same time, I can tell you have a very good clamp, if you will, on discretionary expenses where we don't have to spend. So we're working very, very hard on those expenses, facilities expenses, travel, entertainment, and so forth. We're working very tightly on those. I didn't talk about it before. We're working tightly on CapEx and how we manage that, so I expect capital spending to go down a bit here also in Q4 from Q2 or Q3. So we're working all the aspects, if you will, on expenses because, again, we take to heart the fact that we need to be nicely profitable. We need to be strongly EBITDA growth. And so we are going to think through that as we think about our plans and our revenue for 2016.

Lauren Lyster - Reporter, Yahoo! Finance

Justin Post with B-of-A Merrill Lynch is next. Please proceed with your question.

Justin Post - Bank of America Merrill Lynch

Thank you. My question is also about search. With all the affiliate ads over the last year or so and the Gemini effort, it's hard to tell what's going on with O&O traffic. Can you talk about those trends? Have they been stable or decelerating or declining, and also how the mobile transition is affecting your O&O search business? Thank you.

Marissa A. Mayer - President, Chief Executive Officer & Director

Sure. In terms of search, what we see on O&O is we see a slight decline on desktop. But overall things are reasonably stable, although it overall follows the general market pattern we see across the industry and network, so we're seeing some traffic shift away from desktop. Mobile has been a growth driver for us. We see great opportunities, particularly on iOS, where we've been able to acquire new users through various search set technologies. And so mobile has been nicely growing for us. That said, we do feel that we may see our clicks under pressure in the future just given some of these shifts and declines.

Justin Post - Bank of America Merrill Lynch

Thank you.

Lauren Lyster - Reporter, Yahoo! Finance

Now we go to Brian Nowak with Morgan Stanley. Go ahead with your question.

Brian Nowak - Morgan Stanley & Co. LLC

Thanks for taking my questions. I have two. I guess the first one on Gemini investment. Could you just help us understand tangibly what you see yourself investing in in Gemini over the next year? Is it engineers? Is it servers? Where are you going to be investing in in Gemini?

And the second one on mobile search, help us understand how you're going to make the decision on whether to use Gemini or whether to switch any of the mobile traffic over to Google. Thanks.

Marissa A. Mayer - President, Chief Executive Officer & Director

Sure. The Gemini investment, there's a modest investment in servers. There's a reasonable investment in engineers, but that's been in place now for some quarters as we've been building the overall Gemini marketplace. The primary investment for Gemini comes in the form of suppressed revenue. In order for our system to learn, we basically need to receive the search, decide that we might be willing to make less money on it, rank the ads ourselves, get the user feedback, and ultimately learn from it. Because these are reinforced learning systems, and so they basically need to see how users interact and respond to some options that we have in order to actually improve over time. And so the investment really does come in the form of suppressed revenue as opposed to in short-term operating expense or capital expense.

And in terms of mobile search, overall we really want to think about what enhances the user experience. We've been really excited to be introducing rich card experiences into our algorithmic search on mobile. And in fact, today, we actually power more than half of our experiences or our searches, our search results, the organic results on mobile with our own technology that we think provides a richer, more action-oriented set of experiences on mobile. We want the ads to match that. We really ultimately want that experience. One of the things that's great about search ads is a lot of times they actually improve the search experience and provide you with a better result. So we want to figure out through the Gemini platform how to make the ads equally actionable, perhaps oriented towards applications and/or deep linking, et cetera. And by having our own platform, it really allows us the opportunity to experiment.

And so I would think that we will swing more of our traffic on mobile towards the investment piece for learning. But obviously, we want to have a strong and vibrant business. And so we are going to hold all of this in balance with the partnerships with Microsoft and Google.

Lauren Lyster - Reporter, Yahoo! Finance

Next we'll go to Ron Josey with JMP Securities. Please proceed.

Ron Victor Josey - JMP Securities LLC

Great, thanks for taking the question. I wanted to just follow up, Marissa, on your comment on a more focused Yahoo! in 2016. It feels like you've been more focused now for the past few years just with improved quality of products and efficiency, so any more detail there would be helpful in terms of what you mean around narrowing your focus.

And then, Ken, just a quick follow-up, you talked about a $42 million impairment charge. Any additional detail there would be helpful. I thought you said it was around video content, but I wasn't sure. Thank you.

Marissa A. Mayer - President, Chief Executive Officer & Director

Sure and thank you. We have worked hard to overall focus the business and focus our talent on the areas that matter most, and certainly by getting really focused on informing, connecting, and entertaining our users as well as the areas of growth being mobile, video, native, and social. These have all been incredibly helpful. That said, there's always more work to do. There are always new challenges in terms of what we can work on. And one of the key challenges for Yahoo! really to achieve the level of success that I hope it does and I'm sure all of our investors and board and company hope it does is around engagement.

We ultimately need to work to improve our relevance to end users and how many times they come to us. With more than 1 billion users, we essentially have most people who are online over the course of a month or on any given day coming to Yahoo! either on the web or on mobile. And as we move forward, the focus will shift even more towards mobile and really getting more usage per user every day, which is essentially engagement.

And so, we think it's important going into 2016 to get very focused on what will ultimately drive engagement because while there's always many different business areas to focus on and optimize, that's ultimately what will drive long-term growth.

Kenneth A. Goldman - Chief Financial Officer

Let me add a couple of things. One is, we thought long and hard about it and what we concluded is certain of our original video contents we couldn't see our way to make money over time. And so, I'm thinking of Community, I'm thinking of Sin City Saints and so forth. And so, there what we had basically had spent money and had some assets on our balance sheet, we elected to write those off. That actually helps us going forward in that we won't have that expense to amortize going forward.

In thinking through that, we thought about not only what is the cost but also what is the cost to market and create the streams you need to make it successful. And so, again, we're not saying we're not going to do these at all in the future, but what we are saying is in three cases at least it didn't work the way we had hoped it to work and we decided to move on and basically write-off those assets to balance sheet and therefore preclude us from having to amortize that going forward.

Ron Victor Josey - JMP Securities LLC

Thank you very much. Appreciate it.

Lauren Lyster - Reporter, Yahoo! Finance

The next question comes from Ben Schachter of Macquarie. Go ahead with your question.

Kenneth A. Goldman - Chief Financial Officer

Hello, Ben?

Lauren Lyster - Reporter, Yahoo! Finance

Ben? Do we have Ben on the line? Okay, I guess we do not have Ben. Let's go to Youssef Squali with Cantor Fitzgerald. Mr. Squali, go ahead with your question.

Youssef H. Squali - Cantor Fitzgerald Securities

Okay, thank you very much. I have two. First, Marissa, I want to talk a little bit about programmatic advertising. I was wondering because this is actually the first time where you actually had a fair amount of discussion in your prepared remarks and the press release. How much of the display inventory was actually sold programmatically? And just in the big scheme of things when you look at the competitive landscape, how do you position Yahoo! in what is becoming a pretty intense environment?

And then, Ken, just going back to your Q4 guidance not on the revenue but on the EBITDA, at the midpoint it implies about a 19% margin down from I think 34%, 35% last year. I was just wondering if you can just walk us through the big components of that, because it seems a little too much, but I don't know. Thanks.

Marissa A. Mayer - President, Chief Executive Officer & Director

Sure. I'll take the piece on programmatic display. We haven't actually provided the exact percentage of how much of our inventory is sold programmatically, but it is the majority. And, obviously, that's even accelerating with the introduction of BrightRoll into our offering and obviously unifying all of our DSP offerings and programmatic offerings under the BrightRoll brand, it really provides for a strong basis.

In terms of how do we position ourselves in that programmatic space, it is a very crowded space, but we have an incredibly premium site. Advertisers really like being able to get access to Yahoo! inventory through our programmatic offerings. We also have a lot of data, data in terms of overall user habits and trends as well as analyses in terms of what their interests are that are unique to Yahoo! and obviously our reach puts us among one of the top Internet players in terms of how many different people come to Yahoo! O&O properties, let alone the broader network. And we do allow for a lot of different customization for our advertisers in terms of how we report, how we pixel different advertisements, and our flexibility there. And so I would really say the things that set us apart are data, reach, and customization. And obviously, we're always working to make our products as easy to use and intuitive and as well-integrated as we possibly can across a wide array of products and so that breadth also helps us

Kenneth A. Goldman - Chief Financial Officer

I think on EBITDA margin percentages, frankly, it's really just driven by revenue. And I say that when I think about we lose, basically with no expenses, the full TIPLA revenue which was close to $70 million year over year, so $70 million last year and zero this year, so that sort of falls right to the bottom line. It was non-cash, but it does fall right to the bottom line. And then – so it's really primarily driven by revenue. From an expense point of view, we think the Q4 expense is consistent with Q3. The way I've always thought about expenses is that they are pretty much sequentially thought. I mean there are some seasonal expenses you have, like benefits sometimes are higher in Q1, but generally expenses fall pretty much sequentially. And so, Q4 is pretty consistent with our Q3 and does take into account some of the comments I made before.

But really the EBITDA margin percentage for Q4 is primarily driven by revenue. Now, as we think about 2016, we'll be thoughtful and mindful that we are focused on EBITDA. We are focused on profitability and we have to think about the mix and match between what's realistic from a revenue point of view. As I talked about earlier and then what we can do on expenses so that we get a competitive EBITDA and, frankly, operating profit margin and free cash flow,

Lauren Lyster - Reporter, Yahoo! Finance

The next question will be our last question. It comes from Stephen Ju with Credit Suisse. You can go ahead.

Stephen D. Ju - Credit Suisse Securities (USA) LLC (Broker)

Thanks. So, Marissa, I have a question on the product side. You have a partnership with TripAdvisor and Yelp to show their content on search results and you've just acquired Polyvore. So I'm just wondering if you can help thread these properties together into your overall search strategy. Thanks.

Marissa A. Mayer - President, Chief Executive Officer & Director

Sure and thank you. That's very insightful question because I do think there are a lot of common threads that run across the Polyvore acquisition as well as TripAdvisor and Yelp. Overall, we feel that search results especially on mobile need to involve a lot more. They need to be richer. They need to be more graphical. They need to be more action-oriented. Our Flurry Analytics system, which is the largest analytics system in the world, now monitors more than 2 billion devices or sees more than 2 billion devices overall has measured that more than 90% of time on phones is being spent in apps as opposed to in the browser. And that really means that users are expecting an app-like experience. And so, we're constantly looking at search both in terms of how it behaves in the browser as well as opportunities in-app, which we do through our Mobile Developer offerings and our Mobile Developer Suite, we try and make our search available.

But by having these rich content sources, one, it's about the extra content and visuals that we can put on the page to give people a more informed answer on their search. But even more so is about empowering them in terms of actions. Can they book a restaurant on Yelp? Can they book a flight or a hotel on TripAdvisor? With Polyvore, can they move on to a site or into an application where they can directly buy the product that they're looking at and liking? And so, we really think that on the mobile phone, search becomes that much more action-oriented. And by having these strong partnerships with the leaders in their spaces, this is something that allows us to really create a differentiated product that we think is something that can set us apart over time.

Lauren Lyster - Reporter, Yahoo! Finance

And that concludes Yahoo! third quarter earnings video webcast. Thank you for joining us this afternoon, and we'll see you next quarter.

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