Yahoo: It Coulda Been Worse

The Net portal impressed investors in search advertising and cost controls, though the outlook is still cloudy

By Robert D. Hof

Thanks to aggressive cost-cutting and surprising strength in search advertising, Yahoo! (YHOO) pleased investors on Oct. 21 with third-quarter earnings that managed to meet expectations. But the performance is cold comfort to some 1,500 Yahoo employees who will be laid off as the company looks to slash its $3.9 billion in annual expenses by more than 10% before the end of the year.

The embattled Internet portal said net profit fell 64%, to $54.3 million, or 4¢ a share, from a year ago, on a 1% increase in gross revenues, to $1.79 billion. Excluding special items such as stock option expenses, the profit of 9¢ a share met analysts' expectations. Net revenues, after payments to partners for traffic, rose a meager 3%, to $1.33 billion, just under what analysts had forecast.

All in all, the quarter's results were a relief to investors, who had pushed Yahoo's stock down from the high 20s earlier this year when Microsoft (MSFT) was pursuing the company. In extended trading, Yahoo's stock, which had fallen 6% before the report, to 12.07 a share, rose about 8%. "They didn't go off the rails," explained Jeffrey Lindsay, an analyst with Sanford C. Bernstein. "People reacted positively to their taking decisive action to cut costs."

Search Queries on the Rise

Investors also were somewhat encouraged by the relatively strong performance in search advertising. Yahoo had fallen so far behind No. 1 search engine Google (GOOG) that by June, it forged a deal to run Google ads on Yahoo pages, an agreement that hasn't yet been implemented while it is being reviewed by regulators. Even so, Yahoo said the number of search queries rose 10% in the quarter, and revenue per search jumped a reassuring 20%, due to improvements in its search ad system called Panama.

Still, Yahoo's outlook remains cloudy at best. Thanks to the cost-cutting, Yahoo left in place its forecast for 2008 operating cash flow. But it lowered its 2008 revenue outlook to between $7.18 billion and $7.38 billion, from a previous forecast of $7.35 billion to $7.85 billion. Given that there's only one quarter left in the year—a historically strong one because of holiday advertising—that's a hefty cut in the fourth-quarter outlook.

Much of the downside came in branded display ads, the pictorial and video banners that run at the top and sides of Web pages. Display revenue on Yahoo's pages rose only 3% in the quarter. So-called performance-based display ads, which directly prompt potential customers to click and potentially buy a product, grew faster. But with the economy prompting large advertisers to cut budgets even online, Yahoo's mainstay branding-oriented display ads were much weaker, co-founder and Chief Executive Jerry Yang said during a conference call with analysts. "This is in many ways an unprecedented operating environment," he said.