Yahoo!

(YHOO)

continued its winning streak in the first quarter,

beating analysts' estimates and guiding toward a strong second quarter as well. Its shares added 4% early Wednesday.

TheStreet.com

spoke with Yahoo Chief Financial Officer Susan Decker following the earnings report, getting her thoughts on search-advertising trends, possible acquisitions and why free cash flow is important.

TSC: What trends are you seeing among advertisers insearch-related advertising? Is pricing a big factor? In your conference call, you suggested there were better measures.

Decker

: You could look at revenue from search in a variety ofdifferent ways. We're saying: Start with the customers and look atwhether they're getting value from advertising through sponsored search.

Sue Decker

We can measure that by how many more of them are coming to our network. We also look at how much revenue per advertiser is increasing and whether they are increasing their budget or not. We think that's the most important thing.

As for how they spend it, it can be across more inventory, or it can be in buying higher-priced words. There's been a lot of focus on the how of that. It's really hard to make conclusions by going out and sampling prices and keywords, which is something that happened last quarter. There was a bit of an intraquarter discussion and a little controversy over whether pricing was falling off or not.

Revenue per search, which is one measure of pricing, has actually been flat to barely growing for probably six quarters now, but the search business has been very very robust. It's because of how they're spending it, which now happens to be on volume because inventory is expanding.

What evidence are you seeing of search growth?

It shows because they keep increasing their budgets more andmore. They measure their paying on a price-per-click basis and how many of those clicks are actually converted into sales. They measure that very, very carefully. And as long as the return on investment is high for the ad dollars they spend and they attract customers at an attractive rate, then they're likely to keep using the medium. And we're seeing their budgets go up.

Are you seeing many advertisers from the brand side crossover onto the search side, and vice versa?

It's hard to know. The major categories in the two forms aresomewhat different today. The one industry that crosses both forms the most extensively is financial. Financial services is one of the largest brand categories and one of the largest search categories. Travel and retail are among the largest search categories. But both tend to be between Nos. 5 and 10 in rank for the brand side.

To date, the industries that are the largest in one category have tended not to be largest in another, except in the financial category, where you see a lot of spending on both.

TSC: Like a lot of Internet companies, Yahoo! has been making a number of small acquisitions. Do you think that trend will increase or decrease from here?

Decker: It's hard to predict how much money we'll spend because it will depend on what kind of things emerge, where we see attractive return and where we see great integration potential. We spent just under $800 million last year on 10 to 12 deals. Some were larger like

European comparison-shopping site Kelkoo and

U.S. music software MusicMatch. But some smaller technology deals also helped us with speed to market or new technology we didn't have.

Our intention is very much to continue doing the same. If anything, we're looking at more and more things. We're very encouraged by what we're seeing in terms of value-creating opportunities. But it's tough to predict when they'll close, or whether they'll close or exactly how many well do. But we don't expect any conceptual change in what we'll do.

Some of these companies, like Flickr, have lots of promisebut are still very much startups. How do you value them?

Decker: I'm very involved in that process. Here's the process we go through: We do a discounted free cash flow analysis on everything we buy, and we compare the returns on buying something and integrating it into our assets with the kind of returns we'd get if we built it ourselves.

In most cases we do build. When we choose to make acquisitions, it's in part the speed-to-market advantage by buying and that the marketplace is growing quickly in terms of dollars, giving us actually a higher ROI than if we built it ourselves. In other cases when we buy it, it could be because of certain expertise of the people we think are different andincremental to what we have, and can usually be extensible acrossdifferent platforms to help leverage the rest of Yahoo!.

It's very hard to look at any individual transaction and the price paid and glean what return we might get. What's hard to see especially with small technology deals is what role we see them playing on the rest of Yahoo!, along with the financial returns.

TSC: You discussed Yahoo!'s free cash flow in the quarter and pointed to its 61% growth year on year to $318 million. Recently, other growing tech companies like Amazon.com (AMZN) - Get Report have called investor attention to that figure. Why is it such a valuable metric?

Decker: Free cash flow is the really definition of value. Look at bonds, equities, real estate: anything you look at, the cash it throws off is how it's valued. And if you were to look at the market over any period of time in any industry or any geography, you see almost no correlation between values and P/E ratios and almost always a very strong correlation between values and investment on capital, which is another way of looking at free cash flow.

It's a time-tested concept. I've focused it on since the mid-'80s when I entered Wall Street. On every call for the past four years, I've emphasized it because we want people to understand how strong our free-cash generation is compared with other models. We don't have to invest in our balance sheet to grow to a great extent.

I emphasize it every quarter. It's something we give guidance along with earnings. It's something you see more and more companies talking about it primarily because return on invested capital is increasingly empirically a better measure than earnings.