Yahoo! Q4 2007 Earnings Call Transcript

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Yahoo!, Inc. (YHOO) Q4 2007 Earnings Call January 29, 2008 5:00 PM ET


Marta Nichols - Investor Relations

Jerry Yang - Chief Executive Officer

Susan Decker - President

Blake Jorgensen - Chief Financial Officer


Youssef Squali – Jefferies

Imran Khan - JP Morgan

Mark Mahaney - Citigroup

David Joseph – Morgan Stanley

Brian Pitz - Banc of America

Heath Terry - Credit Suisse

Jason Helfstein - CIBC World Markets

Justin Post - Merrill Lynch


Good afternoon, ladies and gentlemen and welcome to the Yahoo! fourth quarter 2007 earnings conference call. (Operator Instructions) I will now turn the call over to Ms. Marta Nichols. Ms. Nichols, you may begin.

Marta Nichols

Thank you and good afternoon. Welcome to Yahoo!’s fourth quarter earnings conference call. On the call today are members of our executive team: Jerry Yang, Sue Decker and Blake Jorgensen.

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

The potential risks and uncertainties include, among others, the implementation and results of the company’s ongoing strategic initiatives; the company’s ability to compete with new or existing competitors; reduction in spending by, or loss of, marketing services customers; the demand by customers for Yahoo!’s premium services; acceptance by users of new products and services; and risks related to joint ventures and the integration of acquisitions.

Other potential factors that could affect the company’s business and financial results are included in the company’s annual and quarterly reports which are on file with the SEC.

All information discussed on this call is as of today, January 29, 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 in talking 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 also be found on our website under investor relations.

Jerry, Sue and Blake have some prepared remarks and then we’ll have a brief Q&A session.

Now I’d like to turn the call over to Jerry.

Jerry Yang

Thank you, Marta. Welcome and thanks for joining us on the call. In October, we outlined our strategy to achieve a significant multi-year transformation of Yahoo!’s business in order to capture the large and growing market opportunity that we see ahead for the Internet. We’re making good progress executing on this strategy, and I am confident that we’re headed in the right direction.

You’ll recall that we identified three strategic objectives to accelerate our growth and create long-term value for Yahoo! Shareholders:

To become the starting point for the most consumers on the Internet;

To establish Yahoo! as the “must buy” for the most advertisers;

To deliver industry leading platforms that attract the most developers.

We are seeing early signs of success as a result of this clear new focus, with core business areas growing faster in the second half of 2007 than the first half. To build on this momentum, I will discuss our investment priorities for 2008 aimed at priming the pump for our key initiatives and the technologies that will fuel them. Sue will provide an update on how we are executing against these objectives; and Blake will take us through our financial performance and 2008 outlook. I will conclude with a few key takeaways before opening up the call to Q&A.

In the fourth quarter we deliver financial results slightly above our expectations. However, what may not be as evident in our numbers are the underlying trends that reveal what we believe is building momentum in our core business. We saw another quarter of healthy growth in our owned and operated(O&O) sites in both search and display, higher than the first six months of 2007. Our total O&O marketing services revenues grew 20% year over year, driven by promising trends in both display and search, which Sue will discuss in more detail with you in a moment. Our efforts to build a large scale, premium display advertising network and improved search monetization are beginning to pay off.

Let me underscore that we are making profound, fundamental changes to virtually all aspects of our business, from building a definitive, open advertising network to creating world-class platforms that power our products and power the world’s developers, to pursuing broad partnerships on and off Yahoo!’s O&O sites.

We believe these are all significant, forward-thinking, and game-changing investments cemented in a long-term strategy that we believe is starting to bear fruit. This sort of transformation takes time but we have the talent and the strong cash flow to succeed.

Looking at 2008, we are taking an aggressive investment posture, prioritizing and allocating resources towards our key growth drivers. We are confident that this approach will generate the best possible long-term return. We are investing in some of the most important pieces of our advertising platform as well as our starting points to allow us not only to compete, but to differentiate in the marketplace.

First on advertising, this is a pivotal time for our industry and for Yahoo! as the online advertising market undergoes a major shift and audiences, advertisers and publishers engage in new and exciting ways. This market is still young and expectations for growth are significant. Many projections have the online ad market doubling in the next four years.

As an Internet leader, we have the unique opportunity right now to get ahead of the curve and capture significant share of the market’s growth, provided we make the necessary investments. With consolidation favoring only a few players, we believe Yahoo! is in a strong position to become one of the leading advertising networks and platform companies.

Our formula for achieving that goal is based on the strategic decision we made last year to internally build the leading advertising network platform, supplemented by strategic acquisitions like Right Media and BlueLithium. We were deliberate in choosing the build strategy, as it provides the best opportunity to leverage our market strengths: our leadership and display advertising, our growing network of high quality partners, a uniquely integrated approach to display and search and our ability to leverage insights across consumers and advertisers.

Continuing to build and differentiate this platform is one of our key investment priorities in 2008. With portions slated to be launched in the back half of the year, it’s our goal to accelerate our overall advertising revenue growth by the time we exit 2008.

Our second investment priority is aimed at improving the experience of our key consumer starting points. We believe a more relevant Yahoo! experience will simplify our users’ lives on the Internet. Our goals are to leverage our strength in the Front Page, My Yahoo!, Mail, Search and Mobile and anchor properties like News, Sports and Finance to create the most compelling, innovative products and services and to leverage our new “One Yahoo!” approach to become more nimble and unified in that effort.

Underlying our starting point investments, we are creating a platform that allows Yahoo! services to become more scalable and flexible while opening them up to third parties. You can expect to see continued launches and progress against the starting point and platform initiatives throughout the year.

As Blake will discuss in more detail, our outlook assumes substantial investment in our biggest growth opportunities. At the same time, we are conducting a strategic workforce realignment by mid-February that will help us more appropriately allocate resources against key initiatives. This is a necessary next step in our transformation. Rather than across-the-board cuts, we will make targeted reductions alongside targeted investments and plan to eliminate redundancies in bureaucracy and redeploy talent. I am committed to instilling a culture of continuous improvement in our operating efficiencies, constantly challenging all Yahoos to seek new, streamlined ways of approaching our business.

I strongly believe that increased investment is the only appropriate measure at this time. Investment is the only way we can capitalize on our unique position, build market share, and achieve sustainable revenue growth. As we make the necessary investments to fund our long-term growth, we’re also making some deliberate moves with respect to our broadband partnerships that will impact our 2008 outlook.

These relationships were the genesis of our partner of choice model more than six years ago. At their core, they paired the strengths of Yahoo! and our broadband partners to create a more vibrant Internet service and help transition millions of consumers to broadband. We are enhancing and expanding these relationships to provide innovative connections, both on and off the PC, while ensuring that the agreements reflect market dynamics and economics.

Today we are pleased to announce that we have expanded our relationship with AT&T to be their ad platform partner in Search and Display for their Portal and Mobile platforms. This also represents a great milestone in our starting point strategy. Sue and Blake will provide more color on these revised agreements, but broadly speaking the new terms align our mutual incentives to benefit both partners more favorably over time.

We see 2008 as a key year in our transformation; an opportunity to endow the basis of our future growth. We expect that we will exit 2008 with many of the priorities I’ve outlined deployed in the marketplace.

It is important to note that underlying the transformation we’re making, we expect our core business which excludes the effect of the broadband partnership and our sale of Overture Japan to grow in the mid to high teens. We strongly believe that the steps we’re taking and the investments we’re making, as well as unrelenting focus on execution, can translate into double-digit cash flow growth beginning in 2009. Sue will get into the operating measures that can put us in that position.

To conclude, we have a real sense of urgency about addressing the opportunities we face. We continue to make brisk progress against organizational, strategic, market and talent initiatives. On that note, we announced today the appointment of Ari Balogh as our Chief Technology Officer. He will join us in February to lead Yahoo!’s global engineering organization and manage all technical operations. Ari joins us from VeriSign, where he was recently named one of the top 25 CTOs by InfoWorld magazine. I am personally very excited to fill this important role with such a strong talent as Ari.

As we continue the most important transformation in Yahoo!’s history, I’d also like to thank the thousands of Yahoos around the world who remain so dedicated to our core purpose. I continue to be inspired by their passion and fighting spirit. There is much work ahead, but we’re encouraged by our progress and we’ll continue to lay a strong foundation for long-term growth and the creation of shareholder value.

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

Susan Decker

Thanks, Jerry. We’re excited by our plan to transform Yahoo! and we’re pleased with the actions already underway and the progress we’re making. We’re putting substantial talent and resources behind two of the major strategic objectives that we believe will drive our next leg of growth: becoming the starting point for the most users and becoming a must buy for the most advertisers.

I’m going to focus my comments today on how we’re executing on those two strategic objectives and also how we’re thinking about resource allocation.

Let’s begin with the user and starting points. Consumers’ web experiences have become deeper and richer. They’re more social, more mobile and more open. People seek out and find content from multiple sources, sites and social networks. Consequently, they’re gravitating toward those starting points that will help them simplify, yet also tap the broad richness of what the web has to offer. These starting points may send people to the far reaches of the web, but they come back to them because they satisfy our needs to communicate and find things on a daily basis.

Not surprisingly, given the criticality and frequency of these starting points to users, they tend to attract the vast majority of the ad revenue on the web. Therefore, we’re placing an increased emphasis on bringing all of the web’s capabilities together in a way that is personally relevant and simple. For Yahoo!, the five properties that are most critical in this regard are our Home Page, Search, Mail, My, and Mobile.

There are also a few anchor property verticals like Sports, Finance and News that drive traffic to those starting points and therefore play a central role in our strategy. We believe that by leveraging Yahoo!’s enormous scale, insights and deep relationships with users and employing an open approach we are uniquely positioned to become the most frequent online starting point for users.

To bolster this focus and our ability to execute on these most important services, we’re deemphasizing, opening up to third parties or outsourcing many of our other properties and initiatives. For example, we’ve discontinued or deemphasized almost a dozen properties including Photos, 360, Brand Universe, Premium Music, Podcasts, Directory, Voice and others. We’ve also decentralized marketing, consolidated our video development, aggregated lifestyle resources and moved the Answers development to Europe to better optimize resources. You’ll see more of this in the future.

As a result of this effort to de-prioritize or shut our non-core operations, when looking at third-party services such as comScore to assess unique users or time spent the aggregated figures may not tell the story of what’s happening and the key, value-creating starting points for consumers and advertisers. Our internal logs show that the metrics we’ve discussed with you in the past, such as uniques and page views, continue to grow in the double-digits in Q4 with unique users now topping 500 million and page views about 4 billion per day.

With consumers accessing the web in so many ways, we’ve looked for a more unifying global metric that’s more flexible across Yahoo!’s and our partners’ properties and useful across multiple devices and geographies. We expect to use visits to Yahoo!’s global starting points and anchor sites to be the most relevant metric going forward.

Visits are defined by comScore as the number of times a unique person accesses content within an entity and they capture the fact that consumers may visit a property multiple times a day from different locations or devices; not just whether they touched a site once per month.

For individual properties or geographies we may still reference unique users or page views/queries as appropriate. Our goal is to grow visits to key Yahoo! starting points and properties by approximately 15% per year over the next several years.

Now let me briefly discuss some examples of the progress we’re making toward this goal. Let’s start with our front door, the homepage. In the fourth quarter, our internal estimate of U.S. users grew strongly in the double-digits year over year on our front pages. This was driven by deliberate efforts to program relevant information from across the web, regardless of whether the landing page is a Yahoo!-owned site or a third party site, which we’ve increasingly integrated into a more open home page since October. This focus has resulted not only in growing usage but growing engagement as measured by page views per user and click-through rates. The front page continues to be the most-visited page on the Internet with almost 2 billion visits per month in the U.S. alone.

In Search, since making significant improvements to our algorithmic technology in Q3, we are making Search more visible to our users. Let me start with the front end: the combination of a more prominent Search box on Yahoo!’s front pages, our new Search Assist technology and the integration of content and Search results are driving strong growth in searches on our front pages. Our ambition in Search is to change the game and in so doing, to gain query share, supporting our broad objective to be the primary starting point on the web.

Innovation in Search has a long way to go. Most users still don’t get what they want on their first search, with current state-of-the-art algorithms. We think Yahoo! is in a wonderful position to provide an integrated experience that goes beyond Search to actually completing tasks.

Although we haven’t elaborated on this much publicly, on the back end we have made a major investment in open source development of grid computing which provides a substantially greater scalability at fast iteration on core technologies. This is already dramatically impacting our competitiveness in algorithmic search and advertising.

For example, in some cases we have an order of magnitude 10x improvement in indexing speed. This has been a multi-year project and we’re on track to have our future Search and advertising systems built on the new infrastructure, positioning us well for acceleration in iteration and experiments that are likely to lead to significant future product enhancements.

In Mail, Yahoo! has been a worldwide leader for ten years with hundreds of millions of users visiting our site well over 1 billion times every month. There are a number of very exciting developments in the pipeline for this critical product and Jerry shared some of those concepts at CES. As he illustrated, the team is focused on creating a smarter inbox by helping users more easily manage communication from the people who matter most, and by opening Mail to third-party applications. We have remained at the forefront of innovation in Mail and we continue to see strong momentum, particularly for our new mail service with integrated SMS and instant messaging services.

We see a lot of opportunity for Zimbra as well. It has enjoyed continued success in penetrating the ISP and university markets and we’re pursuing opportunities to leverage its technology framework to the benefit of all Yahoo! Mail users.

In Mobile, we proudly announced Yahoo! Go 3.0 at CES a few weeks ago with a cleaner and simpler user interface and also began providing access to third-party widgets from leading publishers through Yahoo! Go and the new Yahoo! Mobile front page, a scalable and open way to improve the user experience.

At the same time, we introduced a new widget developer platform which we expect will accelerate the availability of rich mobile services and applications to our millions of mobile users.

Let’s now shift our attention from our Starting Point strategic objective to our “must-buy” objective. Fragmentation of media usage among consumers presents a key challenge for advertisers as they seek the right way to engage in a dialog with their most valuable audiences without their message getting lost in the noise. We’re doing more than ever to offer our marketing partners the ability to reach not only the hundreds of millions of users on Yahoo!’s marquee properties but also the millions more users that start their web experiences elsewhere, which takes friction out of the buying process for our marketers.

Our long range objective is to grow market share of total online advertising, becoming a “must-buy” platform for the most marketers both on and off our sites, implying that we must see and touch much more demand than flows directly to Yahoo!.

While we historically gauged the success of our ad business by focusing on metrics related to our owned and operated sites, in order to better drive execution against this objective we are now introducing a goal to increase the percentage of our total online advertising demand that we touch to 20% of our addressable market over the next several years from an estimated 15% in 2007. We define demand touch to include GAAP revenue that we earn on and off Yahoo! and the ad spend that flows through Right Media.

Now let me briefly discuss some examples of progress we’re making toward achieving this goal. Starting with Panama, the financial gains that we have seen in the last two quarters continued in Q4 with another quarter of roughly 20% improvement in U.S. O&O RPS, consistent with what we saw in Q2 and Q3; and U.S. O&O search revenue growth of over 30%. In international O&O search, we also saw RPS gains accelerate into the high teens.

We continue to rapidly launch new enhancements and tools such as domain controls and ad quality filtering, both of which should lead to improved lead quality and advertiser ROI over time but which may actually have limited revenue growth in Q4. As we seek other ways to drive meaningful improvements in relevance for consumers, we’ve been focused on page optimization on the front end as well so users see fewer, but more relevant ads.

Turning to display, which characterizes about 90% of all ad inventory on the web and for Yahoo!, we’re continuing to build out our network of premium partners including eBay, Comcast, AT&T and more than 550 newspapers. In Q4, we went live selling inventory on Comcast sooner than we expected, and with many of our newspaper partners as well. We’ve seen some of Yahoo!’s biggest advertisers funnel an increasing share of their marketing spending across Yahoo!’s extended network of partners as we rapidly established a position as one of the leading online ad networks.

We successfully migrated the majority of Yahoo!’s non-premium inventory into the Right Media exchange in Q4 and as anticipated, that inventory continues to sell well in the new environment. We also closed our acquisition of BlueLithium and integrated its sales teams and ad products into our go-to-market offerings.

We’re pleased that these actions translated into strong results. Display revenue had another good quarter, up roughly 20% in Q4. Our fourth quarter organic growth was broadly consistent with what we realized in Q3 and well above the first half. The supply side metrics in Q4 were a continuation of what we’ve seen the past year: ad impression growth is strong and we’ve seen a continuation of shifting from guaranteed placement to non-guaranteed buys. U.S. CPMs on a like-unit basis increased year over year across the board where pricing is up sharply for our class 2 or non-guaranteed inventory.

Importantly, the price of non-guaranteed graphical ad pricing has close to tripled since early 2006 while guaranteed has risen modestly, narrowing the gap between these two price points from nearly 10x to less than 3x and making guaranteed pricing more competitive with broader market conditions.

By category, the trends were more variable in Q4 than in Q3. We experienced solid, and in many cases accelerating, growth in a number of our largest categories in Q4 including auto, pharma, telecom and consumer packaged goods. At the same time, we experienced deceleration in growth or year-over-year declines in financial, travel and retail; the areas you would have expected to be affected by the broader economic issues.

On balance, the diverse nature of our ad base has produced strong overall growth and has tended to offset pockets of weakness that have cropped up from time to time. The majority of the key categories we serve are projecting online growth in budgets in 2008 and we’ve seen a solid start to the year. At the same time, we’re obviously watching economic developments very closely.

Looking forward, we’re investing in next generation tools, technology and support infrastructure in display to support our growing off-network partner business. Its fair to say that building a scalable monetization platform across display advertising to supplement and ultimately integrate with our search platform is our highest priority area of investment. These initiatives leverage Panama’s application platform and data systems, response prediction technologies, computing infrastructure and development talent.

In order to accomplish the transformation of Yahoo! into a key starting point for consumers and the must-buy platform for advertisers, we need to catch up in some areas where we had fallen behind. We need to wean ourselves of various non-competitive or low quality business development deals in our P&L and we need to begin investing to truly differentiate.

First, to catch up and get to parity over the last 12 to 24 months we’ve taken a number of steps, including the huge undertaking of Panama and the grid computing core infrastructure required to accelerate development of our search and marketing platforms.

Second, to evolve to a higher quality, faster-growing revenue base in the future, we’ve restructured many business development deals in two major categories. First in Search we’ve established a higher quality Search affiliate network by deliberately eliminating revenue from partners that we didn’t feel enhanced the network as a whole and we’ve also become much more market competitive in our pricing to our partners. To that end, we’ve renegotiated TAC rates for our affiliate partners from approximately 72% in ‘06 to a more market competitive level of close to 80% in ’08, excluding Yahoo! Japan.

Second, we renewed and expanded our relationships with our broadband and cable access partners. We have structured these new partnerships to reflect current market dynamics and putting BT, Rogers and AT&T among our key ad network partners with revenue sharing agreements that are NPV positive to Yahoo! relative to the past deals over the full term of the agreements, notwithstanding a drop in year 1 revenue.

Third, to differentiate and innovate which is what is now occupying a much greater share of our development and investment dollars, we are intensely focused on improving product excellence and relevance across our key starting points, building an off-network, integrated display product in a scaled, open exchange that reduces friction for all and increases pricing and liquidity for inventory owners; and going to market with an integrated, simple customer solutions-oriented approach to leveraging our insights.

While our competitors have chosen to pursue a buy strategy to advance their advertising business objectives and pay for it primarily through their balance sheets rather than their P&L, we are executing primarily a build strategy which should enable us to take advantage of the convergence of Search and Display in a way that will be truly differentiating versus existing legacy systems.

Our advertisers have recognized the strategic advantage of being able to target their audience with the right ad, in the right place, at the right time in the most compelling format. We believe this requires platforms specifically designed to deliver on this promise at scale, with new levels of insight, transparency and openness. We believe the ROI on these investments will be very favorable, just as the ROI on Panama and behavioral targeting initiatives have been in the past.

Although our expected non-TAC cost structure in ‘08 is less than that of our major competitors, we feel we can be more efficient by better aligning our priorities against tightly-defined objectives and by embarking upon a strategic workforce realignment that reinforces this focus.

At the same time, we’ll continue to aggressively attract and hire talent and deploy resources in support of our major strategic initiatives, because the market and the returns are very large if we accomplish our objectives.

In conclusion, we’re working diligently to transform Yahoo! on multiple fronts. We are streamlining our organization, empowering leaders and improving processes to ensure focus, speed of execution and accountability. We’re prioritizing our resources around key starting points and creating differentiation in those products. We’re pursuing meaningful, incremental monetization opportunities for our inventory and that of our partners.

Although there is much more to do, we’re excited that we are increasingly moving from a catch-up mode to one of true differentiation. As we move beyond the renegotiated business development deals that held back growth in ‘07 and will again in ‘08, the favorable growth in our underlying core businesses is likely to become much more visible.

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

Blake Jorgensen

Thanks, Sue. First I’ll walk you through the fourth quarter and full year 2007 results and then we’ll spend some time on the 2008 outlook. I’ll begin with free cash flow which was $330 million in the fourth quarter and $1.337 billion for the full year. These figures reflect receipt of a $52 million payment from Rogers Communications related to the successful renewal of our broadband partnership. Excluding this one-time item, our free cash flow for the full year was $1.285 billion. For the year, free cash flow excluding the one-time Rogers payment represented 67% of operating cash flow.

Our cash and marketable securities balance was $2.4 billion at year end. We invested over $600 million in acquisitions that closed during Q4, including BlueLithium and Zimbra. We repurchased over $200 million of stock in open market transactions. For the full year, we invested nearly $1 billion in acquisitions and repurchased over $1.8 billion of our stock.


In addition to our cash and marketable securities balances, our equity interest in several entities provided incremental balance sheet value. The value of our direct and indirect interests in the publicly traded securities of Yahoo! Japan, and Gmarket were valued at approximately $14 billion in the public markets or over $10 per share at year end. These figures include the value of the shares of held by Alibaba Group of which we own 40%. These figures do not include estimates of the value of Alibaba Group’s other privately-held businesses such as Taobao, Alipay and China Yahoo! which we believe provide additional value.

Let’s now move to the P&L. While we have focused on revenue ex-TAC in recent years, we increasingly view GAAP revenue as an important measure of our overall advertising reach, as our display advertising partnerships become a more strategic part of our overall business. GAAP revenue was $1.832 billion in the fourth quarter. Revenue ex-TAC came in at $1.403 billion, advancing 14% year over year. Of the 14% growth, acquisitions and exchange rates each contributed approximately 2 points.

Beginning with our marketing services business, fourth quarter revenue ex-TAC was $1.161 billion, up 14% versus the prior year. Owned and operated marketing services revenue was up 20% over last year, with O&O Search up nearly 30%, reflecting continued strong performance from Panama. O&O display grew in the high teens, about the same pace as last quarter and above the levels we saw in the first half of the year. We believe that these core components of the business are growing at very healthy rates.

As Jerry and Sue noted, some of our 2008 investment plans are designed to help us scale for the greater growth opportunities we anticipate in the next few years as marketers continue to move their budgets online.

Revenue ex-TAC from the affiliate Search business continues to decline during Q4, as we expected. As we previewed on the October earnings call, this business represented approximately 10% of total revenue ex-TAC in Q4. We expect a moderate decline in this business in 2008 as we continue to work through rising TAC rates and network quality initiatives.

Offsetting this trend in the affiliate Search business we expect to see a favorable impact from our off-network display initiatives during 2008. While this business is still relatively small, we expect good growth as our major partnerships gain momentum. Ultimately, we believe that our display partnerships and the Right Media Exchange will help pricing for both our partners and our O&O inventory.

Now, let’s look at fees revenue. We produced $242 million of fees revenue in the fourth quarter, up 14% from the same period last year. Growth was relatively consistent across the various components of our fees business, which included our broadband partnerships, our small business products, royalties we received from joint venture partners, and other premium consumer services. We ended the year with 19 million paid relationships, up 17% year over year and up 300,000 from Q3 levels.

Looking at our international results, revenue ex-TAC grew 13% during the fourth quarter or 5% excluding the impact of exchange rates. Our international O&O marketing services revenue grew in the high teens during the quarter, driven by strong display growth and O&O Search gains help by the Panama rollout. International growth was negatively impacted by the affiliate trends I mentioned a moment ago.

Turning to profitability, operating cash flow (OCF) came in at $527 million, producing global OCF margins of approximately 38% for the fourth quarter. Our fourth quarter results were impacted by certain legal settlements totaling approximately $15 million which were above our normal run rates. For the year, we generated $1.927 billion of OCF.

Our effective tax rate for the quarter was 33.4%. Our effective tax rate for the full year was 39.7%. This reflects a normalized annual rate of approximately 46%, offset by some one-time items. Our cash tax rate for the year was approximately 17%.

Now that brings me to our business outlook. Before moving into the details, I would like to outline a few trends and one-time factors that are affecting our expectations for 2008. First, as a reminder, we sold Overture Japan to Yahoo! Japan in Q3 2007. We continue to provide search advertising and support services to Yahoo! Japan in exchange for a service fee, based on revenues from Yahoo! Japan’s enhanced offerings. We expect GAAP revenue as a result of this transaction to decrease approximately $110 million to $130 million per quarter compared to our run rate prior to the Overture Japan sale.

Our revenue ex-TAC, however, is expected to decline only modestly and we expect this to be more than offset by the lower costs from having sold the Overture Japan business and related workforce to Yahoo! Japan. Overall, we anticipate that the deal will be modestly accretive to OCF in 2008 and grow in profitability over the life of the deal.

Second, our outlook reflects the evolution of our broadband partnerships from a premium service model to an ad revenue-sharing model. We renewed our BT and Rogers partnerships during 2007 and as Jerry noted, we announced the renewal of our AT&T partnership today. The market has clearly moved to an environment in which ad revenue sharing is the prevailing model and we are evolving our partnerships accordingly.

As a result of the renewal terms of these deals, we expect our GAAP revenue to decline modestly and our aggregate revenue ex-TAC from the broadband deals to decline by approximately $150 million to $200 million compared with our 2007 run rate.

We anticipate an upfront payment of between $300 million and $400 million from AT&T and we expect to recognize that revenue from this payment and the Rogers $52 million upfront payment over the terms of the respective contracts.

While the near term economics of the renewal will impact our 2008 revenue and OCF, we expect the overall economics of these renewals to be positive. The partnerships will provide an excellent platform for sustainable growth in high quality traffic and advertising revenue and will create greater value for Yahoo! over the life of the partnerships.

Third, we expect our tax rate for 2008 to be in the range of 44% to 46%. We expect our 2008 cash tax rate to be between 17% and 20%.

Fourth, our outlook contemplates a workforce realignment of approximately 1,000 people that we will be implementing in mid-February. We expect to record a cash charge of approximately $20 million to $25 million during Q1 which is outside of the outlook we are presenting today.

During Q1, we also expect to recognize our proportionate share of Alibaba Group’s one-time gain related to the IPO. As a result, we anticipate that our equity earnings will reflect a gain of approximately $450 million to $550 million. This item is also not reflected in our outlook as it will not affect revenues or OCF.

For the remainder of 2008 we will provide quarterly updates to our GAAP revenue and OCF outlook. Beyond Q1, we will no longer provide revenue ex-TAC outlook as we are increasingly managing our business around GAAP revenue.

With those factors as a background, in our outlook we expect GAAP revenues to be in the range of $1.68 billion to $1.84 billion for Q1. We expect revenue ex-TAC to be in the range of $1.28 billion to $1.38 billion for the first quarter, up 12% at the midpoint. For the full year we expect GAAP revenue to be in the range of $7.2 billion to $8 billion and revenue ex-TAC to be in the range of $5.35 billion to $5.95 billion, up 10.5% at the midpoint.

We expect operating cash flow of $400 million to $450 million for Q1 and $1.725 billion to $1.975 billion for the full year.

Turning now briefly to free cash flow, we anticipate a full year 2008 range of $850 million to $1 billion, reflecting capital spending for 2008 of approximately $675 million to $775 million. This outlook does not include the expected payment from AT&T that we spoke of before.

We view this as an evolutionary and transformative year for Yahoo! Despite some of the structural changes in the business we’re implementing in 2008, our outlook reflects strong underlying growth in our core O&O marketing services business and some very positive -- though early -- trends in our emerging off-network display advertising business.

Excluding the effects of the broadband partnerships and our transaction with Yahoo! Japan, we expect revenue growth in the mid to high teens.

We’re continuing to invest in the important initiatives that Jerry and Sue mentioned which we expect to help us achieve our goal of returning to double-digit operating cash flow growth in 2009 and beyond. Our top priority is to maximize the long-term value of our assets and we’re confident that our significant investments this year will pay off in the form of long-term value creation.

Now I’ll turn the call back to Jerry.

Jerry Yang

Thanks, Blake. Let me conclude by emphasizing a few key points we covered on the call.

First, this is a pivotal time for our industry and Yahoo! We plan to take advantage of a unique window of time in the growth of the online advertising market to get ahead of the curve and capture a significant piece of the market and create value for our shareholders.

Second, the steps we’ve taken represent profound fundamental changes to virtually every aspect of our business. We’re not tinkering around the edges; we’re making significant, and what we believe are game-changing, investments in Yahoo!’s future.

Third, as we increase the investments in the key areas of our business we’re making necessary decisions to streamline our organization.

Fourth, we’re executing aggressively against our strategic priorities and our clear focus is starting to bear fruit. While we continue to face headwinds, we expect our positive momentum to build this year.

Fifth, we’re letting out the benchmarks that will help all of you gauge our progress. Our goal is to grow monthly visits to our core starting points by 15% annually and touch 20% of total online advertising demand over the next several years.

Lastly, we’re confident that the steps we’re taking will help us exit 2008 stronger and more competitive and put us in a position to return to strong double-digit cash flow growth in 2009.

Thanks. I’d like to open the call up for questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Youssef Squali – Jefferies.

Youssef Squali – Jefferies

What was your organic growth in display when you exclude the recent acquisitions, Right Media and BlueLithium? , Related, what kind of organic growth is implied in your guidance for marketing and services for ‘08? Thanks.

Jerry Yang

On the acquisition piece, we don’t disclose the economics of our acquisitions but they collectively added about 2 percentage points to the Q4 revenue growth. The display question is high teens.


Your next question comes from Imran Khan - JP Morgan.

Imran Khan - JP Morgan

Jerry and Sue, if I look at your revenue per headcount -- even after a 1,000 employee reduction -- your revenue per headcount is significantly higher than your competitors. So I am trying to understand if there is any difference in the business model that you can increase your productivity, revenue per headcount? Could you give us some color on how you potentially see that?

Secondly, considering more than 50% of your market cap is tight to the publicly traded other assets, would you consider selling those assets and buyback some shares? Thank you.

Jerry Yang

Thanks, Imran. I’ll take the second question first. Obviously, as you know, we believe in our investments -- particularly in China and Japan – are very long-term, strategic investments. They represent our play in those footprints and we think that they have somewhat of a longer-term value in them, especially as is the case in China. So we’re definitely long-term believers in those markets and we think they are strategic to the company.

Sue, do you want to take on the revenue per employee question?

Susan Decker

Sure. When we look at the overall cost structure we compare it to the competitors that we think have the most similar strategies and businesses in terms of the areas in which they would choose to be principals. We actually think our overall cost structure is lower than our two major competitors if you look at the cash costs, ex-TAC.

In terms of what the overall revenue is, it is affected by the monetization rates that we can achieve, given a cost structure. The strategy that we’ve outlined is ultimately around building a broad-based, integrated display and search network in which we think we will be able to achieve very significant monetization advantages over time.

So we’re very focused on allocating resources in the most effective way to achieve that kind of economic model in future years. That’s why I think Jerry indicated he thought we could return to double-digit cash flow growth as we get towards 2009 and get some of these legacy deals behind us.


Your next question comes from Mark Mahaney - Citigroup.

Mark Mahaney - Citigroup

You made some comments about some macroeconomic uncertainty. What kind of impact in a hard recessionary environment do you think you could see in your display and search advertising, whether one would be more insulated than the other? Specifically in Search, to the extent that you were to see a major negative macroeconomic impact, do you think you would see that more in terms of advertiser demand or a change in user or searcher behavior? Thank you.

Blake Jorgensen

Why don’t I start on the economy question and then Sue may want to add to the search component of it. We haven’t changed our guidance process as we are looking out into the economy. We feel like we cannot predict the economy. We made our forecast based on what we know now, our current business trends, our advertisers and feedback we’re getting from the marketplace.

I think the outlook reflects solid growth in our display business, growth in our O&O RPS and the rising TAC rates, as well as the change in the broadband relationships that we’ve had.

Susan Decker

Just going back to some of the comments I made in my script, we have, from time to time, seen pockets of weakness and certainly a couple of pockets in the fourth quarter as I outlined. We’ve also had areas of strength that have been offsetting.

The challenge in answering your question is clearly the secular trends in online advertising have historically, and even today, very much been overwhelming the cyclical environment. It’s early to tell though if the weakness in the housing and financial and travel sectors -- a little bit in retail -- will start to affect the consumer more broadly and the advertiser more broadly and therefore searches in terms of what kind of commercial searches happen.

I don’t think we have a crystal ball in that, but we are encouraged, actually, by how much offsetting strength we’ve seen in some of the other categories which has kept our overall marketing services growth rate in line in display and Search with what we saw earlier in the third quarter, or actually even a little bit better.


Your next question comes from Mary Meeker - Morgan Stanley.

David Joseph – Morgan Stanley

It is actually Dave Joseph. Mary and I have one question. It seems like as 2007 was a transitional year for Search we should be expecting now 2008 to be a transitional year for display advertising, which is about 40% of your revenue. At the same time, you’re talking about increased investment which makes us think that we shouldn’t be really expecting the incremental operating margin to improve any time soon. So you’re expecting investors to have some patience -- or increased patience.

This question is for Jerry. One is, what gives you the high conviction that we should be expecting even the investment or display advertising to show improving growth towards the latter half of this year when there are a lot of uncertainties or variables around that, especially around the non-guaranteed inventory, for example?

But also -- and I will ask the economic or the recessionary question a little bit differently – it seems that online display advertising is a little bit more exposed, especially to sectors like financial services or retail or travel. Can you give us a little bit of a sense of your exposure? Thank you.

Jerry Yang

Thanks, David. I think you’ve inherited Mary’s way of asking one question quite well. Let me just say that as Sue has basically said and we all feel this way is we’re not in the business of prognosticating economy. What we are seeing so far is that like she said that the online ad market continues to grow and whether that grows in spite of a weak economy or what, we really don’t know. We are giving you our best visibility that we see right now.

Why are we convinced that investment will yield improvement in second half? Well, I think the way we look at it is the following: we already show, as I said in my remarks and Sue supplemented that, we saw pretty good display growth in the second half of 2007 of about 20% growth year over year in that area. As we’ve tried to give you guys some more visibility, we’ve seen a core business, what we’re defining as O&O marketing services -- both Search and display -- and then merging our display ad network business. That business is growing in rates that we think are relatively healthy in the fourth quarter and obviously we think that’s going to continue.

We are already seeing some trends that we think have defined that growth. The challenge we’ve outlined is we have some broadband revenues that we need to cycle through and we actually are deliberate and proactive in that. We want to make sure that ‘08 is a year where we can exit, allowing most of our broadband effect to hit this year rather than the out years.

That’s why I said I think we will, based on the current momentum alone, have some pretty good indication, the broad economy aside.

Then the question really is, are we making the right investments? We do believe that the investments we are making right now in the display network and the platform will enable some key things that differentiate ourselves in the market. Sue really emphasized the differentiation point as we get into these bigger network partners, whether it is the newspapers or the telcos or broadband partners. I think those will be adding, hopefully in the back half of the year, to the momentum that we’re seeing.

So I wouldn’t have characterized it as the same as ‘07 where it was a transformation year, meaning that we’re not going to see stuff. I do think you are going to see progress along all of these fronts in the first half of the year. It is just that the platform pieces will kick in in the back half.

Susan Decker

I think Jerry clarified that the reason for growth rates in ‘08 comparable to ‘07 has to do with the broadband deals not the display environment in terms of what we’re projecting.

The second thing I wanted to make sure we clarify though was in my conference call comments I said that the ratio between guaranteed and non-guaranteed pricing had over the last eight to ten quarters gone from 10x to less than 3x. So we’re actually seeing much more favorable trends here and that’s not because guarantees come down. It has been relatively flat to up, whereas the class 2 has dramatically increased close to tripling. So we feel like the competitiveness of guaranteed versus non-guaranteed is as strong as it has ever been and we’re feeling less worried about that risk going forward than we were in the past.


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

Brian Pitz - Banc of America

Would you comment on whether you continue to see click-through rate improvements from Panama accelerating since Q3?

Separately for Sue, regarding budget increases you mentioned for some key categories, could you provide some additional color? Are overall ad budgets up or is it just the online portion?

Also, would you provide a range or the magnitude of increase in the budgets that you may be seeing?

Susan Decker

Brian, the click-through rate improvements have been the primary driver of the RPS gains, as we have said in the past. We don’t get too specific on all the components, but I did mention that in Q4 a couple of initiatives that will help advertiser ROI actually may have limited our gains and were deliberate moves against coverage. We have seen continued improvement in click-through rates and as I mentioned, the RPS gains in Q4 were pretty consistent with what we saw in the prior two quarters of close to 20%.

In terms of the ad budgets I don’t know that we have any more visibility on total ad budgets than you guys do, other than conversations with various marketers. We are seeing growth in display budgets on Yahoo! of close to 20% and when we look back at Q3 numbers, we think we actually gained market share in display in Q3. We are feeling good about our position.

As you know, we went through a year of transition in display that ended in the third quarter as we saw the inventory coming on very broadly. We made a number of quick acquisitions and internal operating investments to address that and we’re feeling good about how we’re growing now.


Your next question comes from Heath Terry - Credit Suisse.

Heath Terry - Credit Suisse

If I understand what you were saying on the call, particularly in your investment area, it sounds like a lot of the investments are really aimed at your advertisers and improving the methods for buying inventory on the site and getting more for the inventory that you’ve got.

I’m curious how you’re planning to attack more the supply side of the equation and building inventory, particularly in the premium areas like finance and entertainment where generally we’ve been seeing stronger share losses than your overall page view number.

To the extent that you can from a numbers perspective help us with the math a little bit on the investments that you’re making, obviously with the reduction in revenue from AT&T as well as Rogers and then we try and net out the layoffs, can you give us an idea of exactly what percentage of the change in EBITDA on a year-over-year basis you would attribute to the investments that are being made?

Susan Decker

We are focused on investments in three primary areas which are “must-buy” and you mentioned that in your question; a very, very important area for us is monetization. The second area that I talked about in my comments was starting points for consumers. Third, Jerry has talked a lot about the platform investments we’re making.

Going back to starting points, there are five primary areas: the Front Page, Mail, Search, My and Mobile that we defined as those key starting points. I also mentioned in my comments key anchor properties like Finance, Sports and News in which our starting points serve primarily as a navigation tool to get to those properties because they are so strong.

At the moment, we are actually leading in all three of those for the first time in maybe ever and certainly in recent years and feel very strong about our competitive position. I may not know what you’re looking at in your comments about our Finance site and maybe we could follow up with you after that.

I think it’s fair to say that we are looking at ways of opening up all of our sites and making them more social and really taking advantage of the social graph across the Yahoo! network in ways that light up the engagement on all of these properties.

We have very detailed consumer road maps behind each of these properties. I’m glad you asked the question, because while you’ve seen a lot of acquisitive activity and internal operating investment in some of the “must-buy” objectives in the last year, this area is absolutely as important a priority for us in building inventory in addition to monetizing it.

Blake Jorgensen

On the second piece of the question, Heath, we’re continuing -- as Jerry and Sue both said -- to invest aggressively in the areas where we see the most growth potential: the Starting Points, the “must-buy”, the open platforms, what we refer to as our big bets. We’ll continue to reduce our emphasis in other areas and take costs out of those areas over time.

We’re not able to give anyone an idea of what the exact investments are but I think you can assume that it’s hundreds of millions of dollars. I think if you look at the OCF forecast we’ve provided, knowing that we’re taking roughly $150 million to $200 million in revenue out of the business from the broadband renegotiations, you can assume that you’re seeing the bulk of the investment going forward.


Your next question comes from Jason Helfstein - CIBC World Markets.

Jason Helfstein - CIBC World Markets

Can you give us some color on the affiliate weakness? How much of that was pricing versus volume?

What was headcount at the end of the quarter?

Blake Jorgensen

On the headcount front we didn’t disclose headcount in this conversation but it is roughly 14,300. As a reminder, we closed two acquisitions during the fourth quarter that added approximately 200 heads to that group.

Sue, I don’t know if you want to talk at all about affiliate weakness.

Susan Decker

On the affiliate -- this is Search affiliate, just to be clear on that -- the overwhelming majority of it is price. I said in my comments that the TAC rate for the last two years really looking at 2006 to what is implied in our projections for ‘08 has gone from 72% to about 80% on TAC-attributable revenue and that excludes the Yahoo! Japan deal which has been restructured.

Most of that increase happened in 2007. There is still some upward pressure that we expect on pricing in 2008 but most of that is behind us. The ‘08 issues are really more the broadband deal renegotiation.

In terms of volume, the only real volume changes have been some traffic quality partners and really not much else.


Your final question comes from Justin Post - Merrill Lynch.

Justin Post - Merrill Lynch

On query volume, I know market share has been an issue for The Street. Can you talk about how your query volume growth has trended both U.S. and internationally over the last three or four quarters?

I think your free cash flow guidance was 850 to 1,000 and if I’m correct, that’s down year over year more than your EBITDA guidance. What’s changed with the conversion rate on that?

Susan Decker

On the Search side we talked about our overall revenue being up about 30% plus in Q4 and RPS being up about 20%. You can do the math, but the implied query growth is up about 10% double-digits.

Blake Jorgensen

On the free cash flow, just to repeat, our range was $850 million to $1 billion. That has $675 million to $775 million in capital spending and as you can see, the midpoint is indeed down. Some of that comes from obviously capital; investment CapEx spending increases; some of it comes from EBITDA margin decline; some of it comes from slightly higher cash tax rate; and last but not least some of it comes from working capital utilization as we continue to blend the salesforce to service both display and Search we are seeing a slight uptick in DSOs I think you can observe in the fourth quarter and that flows through into ‘08 as well.

Jerry Yang

I want to thank all of you for joining us and we’ll talk to all of you soon. Thank you.

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