January 13, 2004 4:46 PM PST

Yahoo accounting change in earnings spotlight

Accounting changes at Yahoo will be in the spotlight Wednesday, when the Web advertising bellwether reports its latest quarterly earnings--the first to include results from its $1.6 billion acquisition of Overture Services.

Analysts anticipate a strong showing from Yahoo, with Thomson First Call reporting a consensus for net profits of 11 cents a share on revenue of $495.5 million for the fourth quarter of 2003, excluding certain items. For the same period a year earlier, the Web portal reported a net profit of 8 cents a share on sales of $285.8 million.

Despite positive expectations, Yahoo is bracing for financial complications from the inclusion of Overture's numbers, which bring significant expenses in the form of payments to third parties that display the company's advertisements. In the third quarter, Overture passed about three-fifths of the advertising revenue generated through Yahoo and Microsoft's MSN Web portal back to those two partners. The payments, known as traffic acquisition costs (TAC), have been climbing steadily as Overture has competed for business with Google.

"Overture was in a no-win situation as a standalone business," said Derek Brown, an analyst at Pacific Growth Equities. "It was very clear that TAC was increasing dramatically as a percentage of gross revenue."

Yahoo declined to comment for this story. But executives appear eager to downplay the growing TAC expense.

Yahoo will report financials according to generally accepted accounting principles (GAAP), including revenue totals such as TAC. But the company argues that traffic acquisition costs distort its true financial picture. It has lobbied analysts to exclude TAC from its revenue total, rather than book TAC as an expense.

Some analysts, including Brown, said they are taking a wait and see approach to the move, which could have the effect of making Yahoo's profit margins appear fatter than they would be under GAAP. But most have agreed to go along for now. First Call's consensus figure is for revenue minus TAC.

Yahoo's accounting changes come as the company's fortunes have rebounded in the past year, thanks to revenue growth fueled by acquisitions and the beginnings of a recovery in the online advertising market. Bolstered by profits from its search business, the company is riding a crest of investor enthusiasm that has pushed its shares to 52-week highs, heading briefly north of $50 a share in trading on Tuesday. But, with a price-per-earnings ratio hovering around 146, Yahoo's shares may have already run well ahead of reasonable expectations.

Even with the changes in Yahoo's definition of revenue, Wall Street is expecting the company to continue its path out of recovery and into solid growth. Key to Yahoo's performance is continued success from its biggest business in online advertising.

"I think the health of the company is pretty good," said Frank Gristina, an equity analyst at Avondale Partners. "We have seen continued growth in paid search and seen a recovery in brand advertising. We want to see an acceleration in those two categories."

Other areas, such as paid services, also are expected to show solid growth. The biggest contributor to this business is Yahoo's deal with SBC Communications to provide DSL (digital subscriber line) access. Yahoo gets a cut from every subscriber who signs up for SBC Yahoo. This quarter, SBC has already announced that it added 378,000 new DSL subscribers.

Yahoo CEO Terry Semel said in a speech last week that the company surpassed 5 million subscribers who pay for products such as DSL, online personals and premium e-mail.

 

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