Yahoo! Inc Q2 Earnings Call Transcript

123jump.com Staff
27 Jul, 2009
New York City

Internet major Yahoo second quarter revenue declined 13% to $1.57 billion but cost cutting measures paid off and net income rose 8% to $141 million. Earnings per share were 10 cents compared to 9 cents in the prior year quarter. New Homepage was also introduced with new features.

Yahoo! Inc. ((YHOO))
Q2 2009 Earnings Call Transcript
July 21, 2009 5:00 p.m. ET

Executives

Marta Nicols – Investor Relations
Carol Bartz – Chief Executive Officer
Tim Morse – Chief Financial Officer

Analysts

Sandeep Aggarwal - Collins Stewart
Youssef Squali - Jefferies & Company
Jeffrey Lindsey – Sanford Bernstein
Mark Mahaney - Citigroup
Imran Khan - JP Morgan
James Mitchell – Goldman Sachs
Christa Quarles - Thomas Weisel Partners
Collin Gillis – Brigantine Advisors
Jason Helfstein - Oppenheimer & Company
Spencer Wang – Credit Suisse
Justin Post - Merrill Lynch
Ben Schachter – Broadpoint AmTech
Douglas Anmuth - Barclays Capital

Presentation

Operator

Welcome to the Yahoo! second quarter 2009 earnings conference call. (Operator Instructions) I will now turn the call over to Ms. Marta Nicols. Ms. Nicols you may begin.

Marta Nichols – Investor Relations

Good afternoon and welcome to Yahoo!''s second quarter earnings conference call. On the call today will be Carol Bartz, Chief Executive Officer, and Tim Morse, Chief Financial Officer. Before we begin, I would like to remind you that today’s call will contain forward-looking statements concerning matters such as our expected financial performance, our expectations for the economy in general and online advertising in particular, our product plans, our cost initiatives, planned investments and corporate strategic alternatives. Actual results may differ materially from the results predicted in our statements and reported results should not be considered indicative of future performance. The potential risks and uncertainties that could cause our business and financial results to differ materially from our forward-looking statements are described in our form 10K filed with the SEC on February 27, 2009, our form 10Q filed with the SEC May 8, 2009 as well as any earnings release included as Exhibit 99.1 to the form 8K we furnished today to the SEC. All information discussed on this call is as of today, July 21, 2009 and Yahoo! does not intend and undertakes no duty to update this information to reflect future events or circumstances.

On today’s call we will also discuss some non-GAAP financial measures as we talk about the company''s performance. These will include 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 we will refer to as revenue ex-TAC; free cash flow, non-GAAP net income and non-GAAP net income per share. Reconciliations of these non-GAAP measures to the GAAP measures we consider most comparable can be found on our corporate website, info.yahoo.com, under Investor Relations. We have prepared remarks that will last about 30 minutes and then we''ll have a brief Q&A session with Carol and Tim.

With that I''d like to turn the call over to Carol.

Carol Bartz – Chief Executive Officer

Thanks Marta. Good afternoon and thanks all of you for joining us today. I would also like to welcome Tim Morse, our new CFO. Tim has just been a joy to work with. He has been with us a little over a month and already I can tell you he brings real passion for efficiency and process that will serve us well. I am also very happy to announce that our new Homepage will be available in the U.S. starting today. This is an exciting part of our effort to provide a “wow” experience to our users. I will get to that a bit later in the call but first I would like to update you on the quarter. Then I will turn it over to Tim for more on our financials and I will end the call with a discussion about our vision and we will touch on our user and ad initiatives before opening it up for questions.

First on the quarter, considering the economy I am pleased with our results. Revenue was a little ahead of the midpoint of our outlook with lots of the upside coming from currency and our affiliate business. Our teams did a great job controlling costs but as Tim and I will discuss later, we are ramping up spending on our priorities this quarter. Overall we are seeing less fear in the marketplace and advertisers are planning their spending more actively than they did earlier this year. As far as the economy goes it is easy to assume it is bumping along the bottom but in all honesty there is just so much conflicting information in the market that it is just too early to call. Our goal in the midst of this is to run our business and focus on what we can control. We will leave the economic predictions to others. Beyond the numbers this past quarter we have three themes. One, we put a great leadership team in place. With Tim coming on board we are essentially solidifying my staff and we are closing in on someone to head our international region. Two, we continue to define our audience priorities. This includes identifying our most important vertical experiences like the Homepage, mail and our media properties as well as the capabilities that support all of them like open, social, video, mobile and more. It also includes advertising. We need to ensure ads are more relevant and quite frankly less irritating to users. And three, we are focused on our internal and external business processes. In other words, we are hard at work making ourselves a better company to work for and to do business with.

Before I go into more detail about what all this means moving forward, I will turn it to Tim so he can dive into the quarter’s financials. Tim?

Tim Morse – Chief Financial Officer

Thanks for the warm welcome Carol. I am excited to be here. Before turning to second quarter, I would like to provide some perspective on my background. I have spent the last two and a half years as CFO at Altera where we reshaped the financial organization to help drive significant margin expansion. Prior to Altera I spent 15 years at General Electric in a variety of different roles throughout the company. GE taught me a lot about organizing, streamlining and growing businesses and I look forward to putting those skills to work here at Yahoo! At each step in my career I have worked on developing and transforming organizations to improve value creation. I will share more about my initial priorities later in the call but now let’s turn to our 2Q results.

The economic environment continues to be challenging but we did a good job controlling costs in 2Q. Although revenue declined, user engagement and volume numbers remained strong in our key audience products with overall page views up 7%. Our users continue to check in with us every day to catch up on the things that matter most to them and we saw spikes in traffic around significant news events during the quarter. We are continuing to invest in our key products to ensure that we are in the best position to capture advertising budgets when the economy recovers. With respect to top line results, revenue was $1.573 billion which was ahead of our guidance midpoint although it declined 13% versus last year. Excluding the impact of currency rate fluctuations and divested business lines, revenue declined only 6%. As a housekeeping item, throughout this call my comments on growth rates will refer to year-over-year changes unless otherwise indicated.

Worldwide owned and operated search revenue declined 15% to $359 million. The U.S. portion of O&O search revenue declined 13%. Query volume grew strongly at 9%. However, RPS declined substantially due to lower click yields as economic conditions continued to diminish the commercial intent of users. International search revenue was down 27%, though only 13% on a constant currency basis. International search was affected by the same factors as the U.S. business with query volume growth more than offset by RPS declines. While search remains a great value proposition for advertisers, broad softness across all sectors persists with finance, travel and entertainment leading the decline as expected.

Now turning to display, worldwide O&O display revenue declined 14% to $393 million. U.S. display declined 11% which was slightly better than first quarter’s decline. International declined 20% on a reported basis, but only 5% on a constant currency basis. Non-guaranteed display revenue continued to grow strongly which partially offset the year-over-year decline on the guaranteed side. However, on a sequential basis guaranteed display revenue increased. Our sell through rate for guaranteed inventory improved in 2Q based on strong demand from large advertisers. This is an encouraging sign but we remain cautious about the economic environment generally. The telecom, health and consumer products categories grew modestly year-over-year. However, most other categories declined. On a sequential basis, we saw growth in the health, travel and telecom sectors and there are signs of stabilization in the automotive sector. While some increased activity among advertisers is evident, we are cautious about trying to predict the timing and magnitude of a recovery. Nonetheless, we are confident that when the economy does recover we will be one of the first places advertisers look to deploy their budgets.

Transitioning now to the affiliate business, which is still principally search, revenue declined 9% to $520 million. The affiliate search business was somewhat stronger than O&O during 2Q but we believe this was a temporary deceleration in the longer term trend of this business. Traffic acquisition cost was 28% of total GAAP revenue. TAC rates continued to rise slightly year-over-year as a result of higher TAC on new deals and a mix of affiliate revenue during the quarter. Rounding out the revenue line, listings revenue was down 21% to $106 million on a reported basis but down 6% excluding the impact of the sale of Kelkoo. Fees revenue was down 8% to $195 million primarily due to the transitional revenue items we have outlined on previous calls. Turning to profitability, second quarter OCF was $385 million. Excluding the cash portion of restructuring charges incurred in 2Q however, OCF was $451 million. We invested $95 million in CapEx during the quarter and generated $266 million of free cash flow.

Cash costs came in at the low end of our expectations due to savings from the restructuring actions we’ve taken over the last several quarters. As Carol mentioned on our last earnings call, we plan to redeploy most of those cost savings into growth initiatives. For example, we are continuing to build technology platforms that operate at scale, we are planning to hire additional sales people and we’ll be investing significantly in our branding efforts. We need these investments now to ensure that we are ready to seize the growth opportunities that will come as the economy recovers. Before turning to the balance sheet I would like to call out two additional items from the P&L. First, we recorded a $65 million restructuring charge during the quarter. Approximately $40 million of the charge related to ongoing real estate consolidation initiatives. The remaining $25 million related to headcount reductions that we implemented during the quarter. Second, we also recorded a $67 million pre-tax gain from the sale of our stake in Gmarket.

Moving now to the balance sheet, we ended the quarter with $4.2 billion of cash and marketable securities. We have a strong balance sheet and have positioned our portfolio in highly rated securities, money market funds and deposits. At the end of the quarter the market value of our direct and indirect interests in the publicly traded securities of Yahoo! Japan and Alibaba.com was over $9 billion or approximately $6.50 per share. These figures do not include estimates of the value of Alibaba Group’s privately held businesses. Turning to our third quarter guidance, we expect GAAP revenue to be in the range of $1.450 billion to $1.550 billion. For modeling purposes, you should expect TAC to be approximately 26% of GAAP revenue for the quarter. We are continuing to see mixed signals in the advertising markets and we are implementing some initiatives to improve the user experience which will impact revenue in the short-term. Carol will provide more color on these initiatives later in the call.

We expect 3Q OCF to be in a range of $330 million to $370 million. As I mentioned earlier, we will be investing in the business during the second half of the year via both headcount growth in strategic areas of the business and more aggressive branding initiatives. It is important to note, however, that our investment plans do not represent a return to pre-restructuring priorities and behaviors. We are running a disciplined process and that means taking our time to ensure that growth priorities get funded intelligently while we continue to improve efficiency in the underlying cost structure.

Our entire leadership team is aligned to ensure that future investment decisions put us on the right path for users, advertisers and most importantly for our shareholders. Before I turn the call back to Carol I would like to outline some of my early impressions and talk about my priorities as CFO. I have been here at Yahoo! for about a month now and I have consistently been impressed with the quality of our leadership teams. With respect to the finance organization specifically, we have a wealth of knowledge and skill that will be instrumental in moving our business forward. I am excited to help build processes, metrics and scalable infrastructure that will support the company’s growth plans. Yahoo! has tremendous potential to improve shareholder value. We have one of the largest audiences on the internet and we are at the forefront of the accelerating shift of ad budgets from off line to online. Our finance organization will play an important role in capturing these opportunities and keeping the company on the path to profitable, sustainable growth.

As for my game plan as CFO, I break it down into a few categories all of which are connected by the common thread of operational excellence. First, help the business to grow revenue via both organic and inorganic means and develop processes to ensure sustainability. Second, expand margins over the long-term while preserving our ability to continually reinvest for future success. Third, simplify and focus the company to improve competitiveness and enable more effective resource allocation. We will be disciplined about where we are spending our time and money. And finally, maximize capital efficiency to fund our growth plans while delivering appropriate returns for shareholders. That last point is worth expanding upon for a moment. All of our initiatives from the highest level strategies to the everyday tactics need to be linked directly to building sustainable, long-term shareholder value. Creating value was my top priority at GE and Altera and it will continue to be our most important goal here at Yahoo! I am looking forward to operationalizing these priorities and sharing progress updates with you on our quarterly earnings calls. I am excited to be here at Yahoo!. I am thrilled at the opportunities we have ahead of us and I am confident in our ability to execute.

With that I will turn the call back over to Carol.

Carol Bartz

Thanks Tim. Now I want to talk to you more about our vision and the power of Yahoo! It is interesting, as we took a step back to look at our priorities and define what Yahoo! is, it actually became very clear. Our vision, quite simply is to strive to be the center of people’s online lives. Yahoo! is the place where millions go to see what is happening with the people and things that matters to them most. We are the largest online media company in the world and that makes Yahoo! the most compelling and unique advertising proposition for marketers. I know I am putting a big stake in the ground by declaring we are the largest online media company so let me give you some facts to back it up. Worldwide Yahoo! is number one in news, sports, finance and a leader in key entertainment properties. In fact, one out of every two internet users come to our more than 100 leading sites around the globe. In the U.S. alone in June Yahoo! was the top ranked site in eleven categories and the second ranked site in fourteen more.

For news, 50 million monthly unique users put us first in the U.S., ahead of the New York Times and in sports and finance we lead by a healthy margin over our closest competitors. Of all these leadership positions, our Homepage continues to be the big dog. Yahoo! Homepages lead all others with the most visits in the U.S. and several other countries. But we are not satisfied. As a company we have made it a goal to do a better job of listening to the voice of our users. Having a real understanding of what people want and need ensures that our innovations are making everyone’s lives easier, more efficient and more productive. As evidence of that commitment, I am extremely pleased that our new Homepage is available today in the U.S. and in coming days in the U.K., France and India. The global roll out will continue to the rest of Europe and Latin America next month and into Asia early next year. This launch represents the most significant change to our Homepage since the company’s inception. The new Homepage makes it much easier for our users to bring together their online world in a single destination. Users can put virtually anything on their new Homepage in just a click or two whether it is content from Yahoo! or anywhere on the web.

And starting next week they can sync their desktop with their mobile phone to get the same experience wherever they go. This redesign is the best example yet of how our open strategy will benefit our users and it enables us to become the center of their internet experience. Some examples of the more than 65 apps that users can add to their personalized Homepage include Facebook, MySpace, AOL Mail, EBay, Gmail, the Wall Street Journal and much more. This will continue to grow as time goes on and of course there are country-specific apps to ensure a more relevant experience to our users in whatever country they live. The design of our new Homepage calls attention to something that is often overlooked but is very, very powerful. We are internet king makers at the center of the online ecosystem. Yahoo!’s Homepage sends millions of page views to sites around the internet every day. The incredible volume of traffic redirected from our site can actually set records and define winning sites. In a span of just two hours last month a link from our Homepage sent more than 9 million page views to the New York Times article about bargain housing. That link broke traffic records at the Times.

This demonstrates the sheer power of our Homepage and the increasing importance of our open strategy. Due to the huge amount of traffic Yahoo! can generate, everybody wins in this scenario. Yahoo! wins for relevance, publishers win for traffic and monetization and users win because they get the best of the web all in one place. In the end, we work with publishers, not against them. As I mentioned earlier, beyond the new Homepage we clearly defined the vertical that will be our highest priority including our leading media verticals like sports, finance and news. We also officially added entertainment as a priority global category. Entertainment is huge for us globally and it is what our users want. The category is growing faster than any other on our network with 95 entertainment sites spread across 20 different countries. And big chunk of the searches conducted on Yahoo! are entertainment related. Just like our other verticals, the key to this category is to manage our great global presence even better. That means developing a platform where we can skillfully manage related fees and videos across our network to create more pop when we need it. And of course, it will give us greater scale and efficiency. We are also doubling down on one of the most important on-wraps to our network, Yahoo! Mail. Our focus here is to provide open and social features in mail and make improvements to speed, performance and especially engagement.

In addition to these improvements in mail and all of our priority verticals, we also need to focus on the ad experience. First, let me just say that we have fantastic ad partners who run compelling and creative ads across out network. Many of them are winning awards and setting standards for what online advertising should be and we are very, very proud to partner with them. But, it is no secret that many of our users are put off by a few irritating and high frequency ads that detract from their time with us. They know the difference between good advertising and annoying ones. These kinds of ads don’t just frustrate users they actually are a detriment to us, decreasing user and premium advertiser engagement and cheapening the Yahoo! brand. Dealing with these ads will be a high priority for us and it is just as important as the features we are working on to improve the content and services we offer. The Q3 outlook Tim discussed reflects both of these major initiatives to better position Yahoo!, first, our investments to globalize and improve our user products, and second our efforts to improve the advertising experience.

First on spending, it will go to re-architecting and globalizing our products to make them more open, social, scalable and mobile enabling. And we will make it easier to distribute our content anywhere it needs to be around the world. This is all essential to continue to provide the best of the web to our users and to speed innovation on our sites. In addition, we are hard at work on plans to reposition our most valuable asset, Yahoo!’s brand. Our Q3 plans include an initial wave of incremental marketing spend which will increase substantially into Q4 and next year. We will also focus on continuing to develop our ad platforms to be more feature-rich and scalable. Recall that when we announced headcount and other cost reduction initiatives last quarter, we said we would reallocate resources to invest in key products and platforms that we believe will generate strong, long-term returns for us and our shareholders. Our outlook for Q3 assumes we will spend roughly $75 million versus Q2 on those priority products and platforms.

The second initiative around improving the ad experience is similar to what we’ve done to optimize user relevance and monetization with ads on our search affiliate network. We are now focusing on O&O search and display ads, improving relevancy, decreasing the frequency of some ads and potentially eliminating others. All of this is specifically designed to raise user satisfaction. Better ad relevance increases user engagement and better user engagement delivers more ROI to advertisers. We expect this effort to take approximately $75 million of revenue out of our quarterly baseline. It is important to put these numbers in perspective especially in contrast to the billions in advertising revenue we generate. We are confident these are the right moves to get us on the best path for better user experience and engagement and therefore growth and profit for the long-term. While we clearly have our challenges and what company does these days, we have a lot to be proud of. People come to us in massive numbers because there is so much we do right and our users aptly know it. The second quarter’s biggest news event provides a very clear example. When Michael Jackson died the world instantly turned to Yahoo! We had the highest clicked on story ever on our Homepage, a whopping 800,000 clicks in 10 minutes.

Yahoo! news set an all-time record with more than 16 million unique visitors and the memorial was the single most streamed live video in our history. Outside of the U.S. our sites in countries like the U.K., Denmark, Italy, France and Spain also saw record numbers. Meanwhile, many other sites on the web were either overloaded by the massive volumes of increased traffic or had trouble interpreting and responding quickly and accurately to the spikes in queries.

While we have been talking about creating the best, most complete online experience on the PC, mobile devices are just as important. Our mobile momentum is so strong I want to spend a moment on it. When it comes to global reach our numbers are very impressive. The new Yahoo! mobile experience is available in 17 countries across 400 devices. We have teamed with more than 100 carriers and OEM’s globally to ensure Yahoo!’s services are front and center whenever users access the mobile web. Our leading position in so many vertical categories and markets attract top tier mobile partners all over the world. These partners clearly recognize the power and draw of Yahoo!’s services on their devices and networks. For example, we recently announced a partnership with a leading telecom service provider in Taiwan to bring our mobile search to their users, displacing Google. And our partners aren’t just distributing our services. Many partners around the globe, especially in Asia, are proactively promoting our search and other mobile services because the experience is that good. So we have spent a lot of time on what we are doing for our users.

Let’s turn to advertisers and all we are doing to strengthen our ties with marketers and agencies. We continue to focus our top 200 advertisers on the importance of our massive user base and our deep understanding of their preferences. That is why Yahoo! continues to be an important tool for advertisers to build brand, inspiration and awareness online. In display, our Homepage is an essential ad buy for summer blockbuster movies and large advertisers such as Bank of America come to us because of our leading sites and large reach. We are partnering with B of A to promote its small business answer center. The center is integrated with our popular social assets such as Yahoo! Answers and Yahoo! Group to capture user engagement and it is promoted across our network through related search and display ads. We have also continued to innovate by introducing new ad solutions. This includes our Smart Ads partner program. It pairs Yahoo!’s massive reach and targeting capabilities with leading third-party ad technologies. This quarter we also piloted My Display Ad, a new self-service solution designed to help small and medium sized businesses easily reach their target audience on Yahoo! and extend our network of partner sites.

This emphasis on doing business with small and medium marketers is important. We see a huge opportunity to help these advertisers better understand online advertising and shift their ad budgets online. We also know that local relevance of both content and advertising is increasingly important to our users and capturing more of the local ad market is a big focus for us. To this end, we have announced today that we have expanded our relationship with AT&T to include the reselling of Yahoo! display ad inventory by AT&T’s advertising sales force. Grouped with our strategic newspaper consortium partnership we now have a local sales force 13,000 reps strong. These relationships extend our reach into this fast growing local online advertiser segment. All the things I have discussed, our huge user reach, our improved organization and focus, our mobile leadership and our strategic relationship with advertisers and partners illustrates a momentum that will allow us to deliver growth and profitability long-term. And I am excited by the foundation we have laid down for the company.

To sum it up, we have a clear, simple vision to strive to be the center of people’s lives online. We are backing that vision with important initiatives and investments in the user and ad experience whether through great products like our Homepage, innovative new solutions for advertisers or improving the user experience by removing disruptive ads. And we are uniquely positioned to win our game as we sit at the center of the online ecosystem. We are the largest online media company in the world and that makes us a huge draw for users and a unique opportunity for advertisers. At the end of the day, we know what we are and more importantly we know what we have to do to win. I look forward to sharing more about how we are doing with all these initiatives and where we are headed at our Analyst Day in October.

Now I would like to open the call to Q&A. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Thank you. We’ll now begin the question-and-answer session. If you have a question please press * then 1 on your touchtone phone. If you wish to be removed from the queue please press * then 2. To ensure that all participants are able to ask a question please limit yourself to one question. Once you have asked a question you’ll be immediately placed back into the conference. If you are using a speakerphone you may have to pick-up the handset before pressing the numbers. Once again if there are any question press * then 1 on your touchtone phone. Our first question comes from Sandeep Aggarwal from Collins Stewart LLC. Please proceed.

Sandeep Aggarwal - Collins Stewart

Thanks for taking my question and Tim welcome aboard. Good luck with the job. Carol if I can ask what is your first impression on Bing? And are you seeing any visible changes in user behavior at Yahoo! search after the Bing launch? Thank you.

Carol Bartz

I think actually Bing is a good product. It actually extends sort of the experimentation around search and how people use it instead of just thinking like a standard blue link. I think they have done a good job. Unfortunately it is only a month into it so it is pretty hard to understand whether it is just curiosity driving what is happening or they are actually going to gain share. But I think Microsoft should be given kudos for Bing. I think they have done a nice job.

Operator

Your next question comes from the line of Youssef Squali with Jefferies & Company. Please proceed.

Youssef Squali - Jefferies & Company

Thank you very much. Two very quick questions, first to Carol, your search business seems to have deteriorated quarter-over-quarter. Your display business showed sequential improvement which is very encouraging. As you look at your investment priorities where do you see the best ROI, display or search? I guess we are at a time now you are probably going to have start choosing one or the other. And second with Tim, how do you reconcile the RPS commentary you had? The RPS was substantially down in the U.S. versus the commentary out of your competitors, basically Google, about seeing sequential improvement in CPC’s? Thanks.

Carol Bartz

First of all our search did decline quarter-over-quarter. I don’t think that is a stake in the ground of any particular meaningful trend. In fact, our volume was healthy. It is more that there was RPS pressure. I wouldn’t sort of take anything out of that. The whole idea is to continue to optimize and drive relevancy for advertisers’ ROI so some of that was purposeful in that it looks like advertisers again being smarter just chose less keywords and so forth. I don’t think there is any particular trend to say in that yet. As far as investment priorities, frankly at the end of the day our investment priority is the user. What we are looking for, if we can increase our audience which we know we can, we are going to drive both display and search revenue. That is just very, very clear. We have to be able to provide both technology to our ad partners, but what we really need to provide to our ad partners is an engaged audience.

Tim Morse

On the the second part of search question and this is Tim. I would say let’s back up for a second. When you look at search volume actually feels pretty good. It was up year-over-year and it was up slightly quarter-over-quarter. As you observed it is the RPS side of the equation. We don’t exactly publish the same way our major competitor does so it is tough to get a really good comparison. We think if you look at all the, I guess the term is CPC’s in their language, on an individual basis they are not all that different. What we are seeing is a mix in the queries that reflects the diminished commercial intent of the users that I talked about in my script. Next question please.

Operator

Your next question comes from the line of Jeffrey Lindsey with Sanford Bernstein. Please proceed.

Jeffrey Lindsey – Sanford Bernstein

Thank you. We noticed there was some improvement in listings and fees. Could you give us some insight into what the background of that was? And then secondarily, when you are making linking to sites like Facebook and MySpace do you actually get any remuneration for that? Thank you.

Carol Bartz

Let me first talk about links to Facebook and MySpace. No, it really is to give our audience an experience that they can have on Yahoo! without leaving the Yahoo! site so they can check in on what’s happening on Facebook. They can check in with MySpace. They can check their mail anywhere and it really is about making sure that we improve the whole relevance of Yahoo! to any online user back to being the center of their online life. It isn’t about money. It is really about helping them organize what is going on online. There is so much out there and if they feel they can come to Yahoo! and trust it and they can get all the things they want to get done, checking in with Facebook, MySpace, Gmail or whatever, checking in on USA Today and the New York Times, but stay on Yahoo! that is really important to them. That is really what the new Homepage is set up to do and that is what you will see as we have an even broader, more open strategy in all of our sites over time.

Tim Morse

On the listing and fees question I think it might look a little bit better than 1Q when you look at it year-over-year. I think it is a little bit easier comp in 2Q than it was in 1Q. If you look sequentially, listings up, very slightly 5%, fees actually down 1% quarter-over-quarter, so virtually flat. So there is really not a whole lot happening from quarter-to-quarter. It is probably that easier comparison versus 2Q last year. Next question please.

Operator

(Operator instructions) As a reminder please limit yourself to one question. Our next question comes from the line of Mark Mahaney with Citigroup. Please proceed.

Mark Mahaney – Citigroup

Thanks. I just wanted to get at the margin outlook. After printing a quarter in which you had EBITDA margins higher than for about three years, you are guiding to margins the lowest since 2003 by our tracking. You talked about the $75 million in incremental costs, $75 million take away in revenue but then I think you also said that you would be ramping up branding spending in the quarter and it would increase beyond that. Can you give us a sense of how we should think about the margins going forward so like is Q3 the trough that builds from there or could things deteriorate further from there as you continue to build out the branding campaign?

Carol Bartz

So Mark, first of all when we gave the guidance last quarter we told you that we were going to do a layoff specifically to have room to put the same costs back into the system to reinvest in our business. So if you really look Q1 to Q3 we are pretty much on target with that. And by the way the marketing spend that we are talking about for third quarter is in these additional costs already so there is not something additional to that. Now to what we are adding, we are adding people back into product, engineering. As I said last time, we have too few engineers and too many people sort of planning products. So, we are hiring back in engineering. We have sales people coming into the quarter. So, it is all these things we talked about when we finally realized going through extensive planning what our product plans were. Now we are putting engineers, sales people and marketers against those product people. There is nothing…that is frankly what that is all about.

Tim Morse

If you want to be the center of people’s online lives you have got to reposition the cost structure. So, we’ve drained some buckets with some in my opinion having not been here, so an objective opinion, just great execution on the restructuring initiatives. So, I think the company did all the right things, drained all the right buckets. Now we are filling back up different buckets. As I talked about in the script it is different stuff that we are putting in. We are being intelligent about it. Certainly we could have rushed in and put more cost in the second quarter but we are taking our time to make sure the investments are going to the right places. What we can do in this time is control what is controllable to us. And that means repositioning the company to get after this vision of being the center of people’s online lives. That’s what we are doing. The revenue will grow over the long-term. We are not going to predict quarters out or anything like that. We are going to do what we need to do to invest in the business to expand and make it be successful over the long-term.

Operator

Your next question comes from the line of Imran Khan with JP Morgan. Please proceed.

Imran Khan - JP Morgan

Yes thank you very much for taking my question. I have one question and a quick follow up. My first question is on guaranteed display advertising. You talked about the display ad business improved slightly in the domestic market. Can you please talk about what kind of pricing environment you are seeing and what percentage of your display advertising revenue is coming from selling guaranteed inventory versus non-guaranteed inventory? And the follow-up question on Mark’s question most are interested to know, how should we think about the cost base of the company. As we think about it you drained some buckets and you are putting new money in a new bucket so you have a better sense. How should we think about the yearly cost structure of the company if the revenue stays flat?

Tim Morse

On display, let’s take that one first. We don’t break out the numbers between guaranteed and non-guaranteed or Class I and Class II. We did see strength on the guaranteed side, the Class I side, quarter-over-quarter. So it is down year-over-year, make no mistake about it. But quarter-over-quarter we did see it grow in the high single digits. There is a variety of different pricing and volumes in there that are tough to kind of pull out on their own. Overall though, I think we saw some really good strength in call it seven out of ten categories that we track. The big industry categories like finance, travel and health and consumer products, etc. So I saw some nice trends there. On the non-guaranteed side, the Class II side, a little bit of sequential growth but not a whole lot different from the first quarter. Then to address the cost structure question I would say again as we have said a couple of times we took the cost out. We have previously instructed you to kind of think about it at a higher level than certainly your coming out of first quarter or second quarter. Ultimately we want to resize the cost structure certainly to be correct with our revenue growth rates but in the meantime, again, we are repositioning the business. I don’t know how to define a normal time or a steady state at this point because of the economic backdrop. All I can tell you is we are going to reposition. Carol and I both articulated where we are putting the money in. It is going to have long-term benefit and over the long term I think we both guarantee we are going to drive margin expansion. In the interim here, there are things we have to get done and there is a lot we don’t control in the economic climate.

Carol Bartz

Imran I think another way to enhance what Tim is saying is if you look at two factors, one is the economy which seems to be as we said bouncing along. Perhaps not getting worse but someday will get better. I think we all want to certainly believe that. If you also look at the whole trend of ad spending and it will shift online. So, we have that factor going for us. There certainly is reason to believe that the revenue will not stay flat forever. I certainly believe that. And I know your next question will be, “okay then, tell us exactly when it is going up.” Of course I won’t answer that. But it won’t stay flat forever. And we really do believe, by the way, that these investments we are making will actually make us more efficient both on the product side and some of the process investments. We actually believe there is a time where we will get efficiency inside the company. We are going to get efficiency and we think revenue is going up and that is the reason we have the guts here to make this investment now and pull these margins down as you say because we think for the long-term we are running a good company doing that.

Operator

Your next question comes from the line of James Mitchell with Goldman Sachs. Please proceed.

James Mitchell – Goldman Sachs

Right thank you very much for taking my question, if I can just follow-up with Mark’s excellent question again, can you talk broadly about how much of the $75 million incremental spend in the third quarter might be transient such as brand marketing versus ongoing such as more sales people? And then Tim, I guess your predecessor had guided for a 26% tax rate this quarter. You came in at 28%. That is fine given lots of other things moving in the right direction. Can you just talk about what specifically changed, that made the traffic acquisition costs diverge?

Tim Morse

Well, will you go first or I will go.

Carol Bartz

You go first.

Tim Morse

Okay on tax, in the quarter we had guided to 26% and came out at 28%. Really the biggest driver there was the mix of affiliate business versus O&O. They are very different TAC rates on those pieces of businesses. That was the biggest thing that surprised us in the quarter. Looking forward in the third quarter I think it is important to note that we have guided 26% again. Really we are going from the 28% down to the 26%, really as a result of that same kind of mix returning to normal levels. So there are no changes in the rate anticipated, the individual rate that is, anticipated in moving from 2Q to 3Q.

Carol Bartz

What I would say as well on the $75 million how much incremental, most of it is really people. The branding and our whole campaign of advertising is just starting. However, you have to understand that this is an ongoing campaign. It is not transient at least for the next year or so. We are really going to move to reposition the Yahoo! brand and Yahoo! Company. Right now consider that as cost that is in the system.

Operator

(Operator instructions) As a reminder please limit yourself to one question. Your next question comes from the line of Christa Quarles with Thomas Weisel Partners. Please proceed.

Christa Quarles - Thomas Weisel Partners

I was wondering if you could talk about stepping away from the broader vision of APT that was discussed maybe before your tenure, even Carol, to what I am perceiving it is today around just basically making the buying process on Yahoo! a whole lot easier. I would love for you to kind of outline the metrics to highlight how inefficient the Yahoo! buying process is today and what the goal for efficiency will be as you kind of streamline APT to make buying easier. Then I have just a really quick housekeeping question. Tim, if you could just remind us the difference between the affiliate revenue on page six of the presentation of $520 million versus page eight where it says $518 million? Thanks.

Carol Bartz

Hi Christa, APT is certainly part of the process of making buying easier, in fact, a large part. It is not so much that it is APT. It is transitioning off two older platforms onto APT so that APT can become fully functional. So, both the advertisers and our own sales people have to do a lot of steps just to pass information between three systems, if you will. That will certainly help. We have not backed off. APT is a very important platform for us. It is just that I think it was sort of over promised. It has great architecture. It just needs to get through some more releases to get those old platforms finalized. The other part of the efficiency problem is that we have a lot of checks and balances in the system whether it is financial reviews, legal reviews, spreadsheets being fed into this and that thing. In other words it is a lot of efficiency stuff that we can do by physically changing our process. It is like between 30 and 40 steps to buy a display ad from us and we have got Jeff Russakow who is our Customer Advocacy EVP really heading a cross functional group, I mean a bunch of mad dogs here to really help tie a good ad experience and our processes together so that we can have just a much, much easier way to do business. So it is both if you will, the technology part of it with APT and the process part of it. We are really looking forward to making this better. And that’s one of the things I was talking about in improvement down the line because we have to throw a lot of bodies at these things now because they are inefficient. And over time, give us a year or so and a lot of those bodies can come out because we will have technology and better processes that will make these, work like they should.

Tim Morse

On the small housekeeping item, the difference between the 520 affiliate and the 518 you see on the page is just a small classification issue regarding leads. We would be happy to follow-up and describe it in more detail after the call with you. Next question please.

Operator

Your next question comes from the line of Collin Gillis with Brigantine Advisors. Please proceed.

Collin Gillis – Brigantine Advisors

This is Collin. I am just trying to get to drill down a bit more on the advertiser dynamic between tier one and tier two. Could you just talk a little bit about maybe how the growth in Q2 is breaking down? Is it tier one customers reallocating spend? Is it new customers coming in or maybe existing tier two customers looking to spend?

Carol Bartz

Well we certainly don’t actually break this down and we don’t reallocate between the two. But in fairness to your question, your exact question is both. There are those people who are experimenting more with non-guaranteed that were only guaranteed before and there are new customers coming in with guaranteed. By the way, by getting a lot more into mid market like small and medium business and the local business that is going to focus a lot on people not buying guaranteed but buying non-guaranteed because that is the first set of online experience. We just see it as a very, very important growth sector where frankly important advertisers like the newspapers and like the big announcement today with AT&T can sell into a local, very relevant ad space.

Tim Morse

And we are doing well, very well with our top advertisers, just to kind of dovetail the point. On display we are actually up a little bit even year-over-year on our top ten advertisers for display, the same thing for search. A little bit less strongly in search but the big advertisers we are doing well with and I think that is good news. Next question please.

Operator

Your next question comes from the line of Jason Helfstein with Oppenheimer Inc. Please proceed.

Jason Helfstein - Oppenheimer & Company

I just wanted to drill a little bit more into the O&O search and the affiliate. The sense we got from Google was that things were generally stable. Yet O&O search fell off and then affiliate actually improved. Did you basically, did O&O search lose share to your affiliate sites or just talk a little more there. I think it is hard to understand how one got a lot worse and one got better in the context of what we are seeing in industry trends. Thanks.

Carol Bartz

I actually don’t think there is a trend here. I think we just had a couple of affiliates that just had a good quarter. We are not actually all that far off what is happening in the industry. I don’t actually view this as…I didn’t view this as an interesting item, frankly because we are just not that far off.

Tim Morse

Next question please.

Operator

(Operator instructions) Once again as a reminder please limit yourself to one question. Our next question comes from the line of Spencer Wang with Credit Suisse. Please proceed.

Spencer Wang – Credit Suisse

Thanks and just one question on the investment side but maybe in two parts if I could. So, Tim you talked a little bit about increasing investment to help re-grow the revenue line. I was wondering if you could talk a little bit about your philosophy in terms of distribution deals and how that could impact your TAC rate beyond this year. And then Tim I think in your remarks you said you were interested in growing revenues both organically and I think inorganically you said. In the context of the latter, if you could just talk about does that mean acquisitions and how central of a role would that play? Thanks.

Tim Morse

I’ll take the first one for the inorganic question. I do lead up the business development or corporate development as we call our teams here which include a wide variety of acquisitions and divestitures. I mean really looking at the portfolio in total. That is what I was referring to, getting involved in those kinds of items. Again, who knows what events bring and what deals come our way. We will pursue the stuff that makes sense for us in the long-term and continue to let our product portfolio evolve. That is kind of what I meant.

Carol Bartz

On the distribution deals again it really is profitability. And so if it makes sense, it makes sense. Otherwise, we are not going to do distribution for the sake of distribution.

Tim Morse

You just answered that. I will develop a philosophy around that. Next question, yeah.

Operator

Your next question comes from the line of Justin Post with Merrill Lynch. Please proceed.

Justin Post - Merrill Lynch

Thanks for taking my question. It looks like U.S. was down 13% year-over-year. The last few quarter’s you had really caught up towards Google on the U.S. search business. It really looks like your queries have held in there well so it is RPS pressure. Was there anything abnormal you did on RPS in the quarter or why you might have deteriorated faster than Google? Maybe on a big picture question for you Carol, do you think scale does matter in search if you want to address that based on some conversations you have been having recently?

Carol Bartz

Well of course scale matters on search. I mean I’ll switch positions. That will be fun. Of course it matters. I think the real interesting issue is even though there is a lot of volume, when you get fewer click throughs and you get really fewer buyer intent, if you have scale and you have a longer tail you get to monetize more. It is just as simple as that. It absolutely does matter, no doubt about it. Literally, our search volume is holding fine. It is just that we have got to continue to get, we have to convince those buyers to get off the chair and push buy.

Tim Morse

Next question please.

Operator

Your next question comes from the line of Ben Schachter with Broadpoint AmTech. Please proceed.

Ben Schachter – Broadpoint AmTech

Hey guys congratulations on the launch of the new Homepage. I was wondering if you could address sort of one, why the launch today? I think it is ahead of what most people were expecting. And then if you could talk about how we should think about how you are actually going to monetize that new Homepage and what it means. Any quantifications you can do there and also any kind of lead to new monetization methods like a CPA model? Why not make the tab that goes to eBay an affiliate tab? Thanks.

Carol Bartz

First of all, I think I even said on the first call we really took a look at the new Homepage and said we are not launching until we are ready. In fact, we held it up a bit. At some point we actually talked about launching next week. So a couple of weeks ago we said that was kind of silly to launch it a few days after we have earnings and frankly go through all the work twice. If you want it was probably held up four or five days. Considering how long we have been working on our new Homepage we are just so thrilled that it is out. As far as monetizing, we actually feel really good about the opportunity to monetize Homepage. You have to understand that for awhile it is opt in. We won’t be rolling over everybody in the U.S. until later in the year because now they can experiment and grow to like it and we can grow to see and make sure it is working for them even though we have done extensive bucket testing. We actually think the ability to monetize Metro and because people will stay more engaged with our site is really looking forward to it. There is a lot of opportunity to do new things with users, new things with advertisers, experimentation and that all leads to revenue over time.

Tim Morse

Operator let’s take our last question please.

Operator

Your final question comes from the line of Douglas Anmuth with Barclays Capital. Please proceed.

Douglas Anmuth - Barclays Capital

Thanks for taking my question. I just wanted to follow-up on the RPS conversations and you mentioned specifically improving relevancy and monetization of ads. And I sort of interpreted when you talked about taking down some ads and some things that may be potentially annoying as more on the display side. Can you talk about sort of the levers that you can pull in terms of driving RPS other than just the macro improvement and how do you view the new Homepage in terms of impacting search, both share and monetization?

Carol Bartz

A lot of what we are talking about when we talk about relevance is display. You know what the irritating ads are when you see them online. It is that sort of thing. As far as RPS, we really are working hard to optimize to drive relevancy, to be very purposeful about matching techniques and driving the right ad to the right query, better targeting, all those things. That is what our advertisers are looking for. As far as how Metro will impact search share, first of all we really are pleased with sort of the prominent search positions on the new front page, Homepage, and also pleased by the fact that all of our new applications come right there. So, I think all of our actions to improve quality in display, improve relevance in search and make search a more prominent active place, will help us long-term to drive user engagement, drive loyalty and then frankly drive advertisers to what they are looking for and that is monetization for them. So that is part of the whole reason. Listen, again as I said a few minutes ago, you have to get the users to say, “Wow, I like this,” because then they come and then they tell their friends. They tell their friends that Yahoo! has taken some of the bad ads off mail and so it is actually a better experience now. Guess what? People stay. They go around other sites, making the whole site healthier, more relevant, more fun, more engaging and open so it reaches out to other parts of their online world, all of that is a better experience. All of that will drive advertisers to us.

Tim Morse

Thank you very much.

Carol Bartz

Thank you everybody. And go check that Homepage out.

Operator

Thank you. Ladies and gentlemen this concludes today’s conference. Thank you for participating. You may all disconnect.