By Eric Auchard and Michele Gershberg

SAN FRANCISCO/NEW YORK (Reuters) - Yahoo Inc reported a drop in quarterly profit on Tuesday and forecast 2008 revenue below Wall Street expectations as it tries to shore up its Web advertising business.

Shares in Yahoo fell nearly 11 percent in extended trading. Yahoo's revenue forecasts for the first quarter and full year disappointed investors, even though Wall Street analysts had already slashed their expectations of Yahoo's ability to grow Internet advertising in a weakened U.S. economy.

The company also announced a renewed deal with AT&T Inc that analysts expect to bring in less revenue this year and outlined a plan to cut about 1,000 jobs. It said the efforts would help produce improved cash flow next year.

"I would classify the results as mediocre and the guidance as cautious," said Ryan Jacob, a fund manager at Jacob Internet Fund in Los Angeles. "I think Yahoo is telegraphing the fact that they will be spending more in 2008 to try and regain their competitive position against Google."

Yahoo's fourth-quarter profit fell more than 23 percent to $205.7 million (103.4 million pounds), or 15 cents per share, from $268.7 million, or 19 cents per share, a year ago. Overall revenue rose 8 percent to $1.83 billion and revenue excluding payments to advertising partners rose 14 percent to $1.4 billion.

Analysts, on average, had forecast earnings per share of 11 cents on revenue of $1.41 billion excluding traffic acquisition costs, according to Reuters Estimates.

Yahoo's larger share of the display market for corporate advertising makes it more vulnerable to any spending pullbacks in a recession. Analysts expect key rival Google Inc to fare better in a downturn with its dominance of paid search, a form of advertising viewed as more closely tied to sales.

2008 HEADWINDS