Yahoo reported on Tuesday a drop in quarterly earnings, as display-advertising growth slowed and affiliate third-party revenue dragged its bottom line.

Net income dropped to $161 million, compared with $164 million for the same period last year. Yahoo also lowered its forecast for the rest of the year below analysts’ expectations.

Yahoo has faced continual struggles in its battle with Google for search supremacy. Yahoo dropped to 25.1 percent of U.S. searches in June from 28.5 percent last year while Google leaped to 49.5 percent from 44.7 percent last year, according to comScore.

Yahoo co-founder and new CEO Jerry Yang said the company is changing the way it operates, making faster decisions, investing in technology, and de-emphasizing parts of the business that don’t fit.

“There are no sacred cows,” Mr. Yang said. “We are absolutely committed to faster decision-making and faster execution… I’m very well aware of the challenges we have. There’s a significant gap between where Yahoo is and where we need to be.”

Yahoo’s new president, Sue Decker, outlined mistakes Yahoo has made in recent years, such as keeping Overture’s performance-based search advertising system as a separate business, which delayed Panama and allowed Google to leapfrog Yahoo, and not driving innovation in display advertising.

By focusing on its strength—display advertising with big-brand advertisers—Yahoo was slow to move into performance-based marketing and servicing smaller advertisers, Ms. Decker said. 

Performance marketing is associated with smaller direct response marketers who usually pay based on cost per user click or other action such as purchase, whereas large brand advertisers often pay for cost per user view or impression. These smaller marketers—known as part of the “long tail”—have been scooped up by Google’s search engine ads and other new publishers such as MySpace and Facebook.

Ms. Decker said Yahoo is addressing those mistakes by integrating its search and display ad sales forces so that there is one point of contact for advertisers, and by its recent purchase of Right Media, which operates an advertising exchange for the buying and selling of nonpremium ad inventory.

A bright spot is Yahoo’s long awaited Panama search advertising platform, which has provided increased revenues per search in Yahoo-owned sites of about 15 percent to 20 percent, Ms. Decker said. The system has already been rolled out in the United States and will launch in Asia and Europe this year. Yahoo will also later this year and next year see financial effects of its partnership with a large newspaper consortium and its newly released SmartAds.

Revenue from affiliate third-party sites was down because those sites were paying more in traffic-acquisition deals with the sites that send them Web surfers. Also, because Panama ranks search results differently in an effort to improve relevance, Yahoo received less money from sites that were ranked lower down by the new system.

CFO Blake Jorgenson said the quality of Panama’s results will eventually lead to gains for Yahoo but that there’s a lag in benefits to the bottom line while the change takes place. Mr. Yang also differentiated the struggles of affiliate sites from the 18 percent growth enjoyed by Yahoo-owned properties.

Yahoo's stock price fell nearly 4 percent in after-hours trading from $27.53 to $26.49, with investors aware of the steep competition Yahoo will continue to face from search leader Google and social networking upstarts Facebook and MySpace.