October 22, 2002 4:00 PM PDT

Overture sees profit woes ahead

Overture Services on Tuesday reported third-quarter earnings that beat analysts' expectations, but executives warned of profit problems through the end of the year.

The company, which charges advertisers to pay for placement on its Web search engine, reported a net income of $16.9 million, or 28 cents per share, on revenue of $172.7 million. That's compared with a net income of $9 million, or 15 cents a share, in the same period last year.

Wall Street analysts expected the company to earn 21 cents per share, according to a survey of analysts by First Call.

Overture has distribution deals with some of the Internet's biggest names, including Yahoo and Microsoft's MSN. Because Overture pays its affiliates a percentage of the revenue it receives from advertisers bidding to be listed on its search results, the company has offered a significant financial windfall for big players, most notably Yahoo.

Analysts estimated Yahoo generated more than $30 million from its relationship with Overture, underscoring the partnership's mutual success.

Still, Overture faces stiff competition from the likes of Google, which staged its own coup by signing a deal in May with America Online, formerly an Overture partner. Google also has a pay-for-placement deal with EarthLink.

Earnings before interest, taxes, depreciation and amortization (EBITDA) reached $29.8 million, a 153 percent increase from the same period last year. That's down slightly from the second quarter, when the company recorded EBITDA of $32.3 million.

For the fourth quarter, the company expects further declines in EBITDA to $26 million. Revenue, however, is expected to rise to $190 million.

Overture also said the average price for its listings reached 34 cents, up from 21 cents last year. Yet the number of paid results declined to 500 million from 515 million in the previous quarter.

The third quarter showed that Overture relies heavily on its two biggest partners, MSN and Yahoo. The two companies accounted for 63 percent of Overture's revenue--up from 57 percent in the previous quarter.

The percentage of revenue paid to partners reached 59 percent during the third quarter, and is expected to jump to 61 percent in the fourth quarter. For fiscal 2003, the company expects the percentage to grow from between 61 percent and 63 percent.

This change is expected to be a major factor in causing EBITDA to fall from this quarter's $29.8 million to $26 million next quarter.

Still, the increase in percentage of revenue paid to advertisers was not a shock to Overture executives.

"I believe traffic acquisition costs are coming into a more stable range," Overture CEO Ted Meisel said.

While the increased costs may have a questionable effect on Overture, it signals good news for the likes of MSN and Yahoo, companies that will be getting a bigger slice of the pie.

Safa Rashtchy, an analyst at U.S. Bancorp Piper Jaffray, had also factored in the increased costs for Overture.

"We were expecting fourth-quarter traffic costs to go up," he said.

 

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