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Yahoo tempers investor euphoria

The search engine company warns Wall Street and regulators that despite recent quarterly profits it faces a tough road ahead.

Yahoo's (YHOO) surprising string of two straight quarterly profits has ignited its stock and has led some pundits to declare that Internet companies, at last, are turning the corner to profitability.

Not so fast, Yahoo declared in a document just submitted to regulators. In the sober statement, filed yesterday to the Securities and Exchange Commission, Yahoo declared: "Although the company reported a profit for the quarter ended March 31, it expects to significantly increase its operating expenses to expand...As a result, there can be no assurances that the company will not incur significant losses on a quarterly and annual basis for the foreseeable future."

Yahoo added that recent revenue growth does not necessarily indicate the rate of revenue growth, if any, that might be experienced in the future. In some future quarters, the company's operating results may fall below Wall Street's expectations, which would likely "materially and adversely" affect its stock price, the company reported.

In the so-called 10-Q filing, Yahoo disclosed that a newly inked advertising agreement with Netscape Communications carries big potential risks, as well as rewards.

The company also disclosed that it has experienced delays in launching Yahoo Marketplace, which it dubs "a consumer navigational media property under development through a joint venture with Visa International." In April 1996, the company said it had struck an agreement with Visa to develop a service that would focus on information and resources relating to the purchase of consumer services and products over the Net.

Though not mentioned in the filing, an Internet music site called "Unfurled," which is being developed with MTV, also hasn't materialized, either.

That's not to say that Yahoo is headed for a slide. Such warnings often are considered "boilerplate disclaimers" in SEC filings, and analysts have praised the company for its ability to expand traffic and advertising, both in the United States and abroad. Yahoo's stock is trading at about 31, almost double the price of last summer but down from a high of 37 earlier this month. In addition, executives last month warned that profits may fluctuate slightly above or below the break-even point through year's end, but said the company was on track to reach sustained profitability in 1998.

But Yahoo's most recent SEC filing is a reminder of the tough road that all Internet companies face--sacrificing short-term profits to ensure long-term growth. That strategy doesn't always sit well with Wall Street, which winces when any company falls short of quarterly expectations. Internet companies seem especially vulnerable these days, turning off many would-be investors.

In Yahoo's case, the company cites a recently signed deal with Netscape as a big bet on its future. Under the pact, Yahoo gets the right to manage "Netscape Guide by Yahoo," a newsy guide on Netscape's Web site, in return for a payment of $5 million, plus advertising revenue guarantees of up to $30 million during the next two years. A separate deal calls for Yahoo to make minimum payments of $3.2 million in cash to be one of four "premium providers" of navigation within the Netscape Web site, the SEC filing states.

Yahoo is betting that the multimillion-dollar expenditure will pay off because Netscape's Web site is so popular with Netizens and, in turn, will draw big advertising dollars. Netscape dominates the software browser market, and many users regularly "default" to the company's Web site. The guide provides users with access to eight of the most popular categories on the Web.

But the deal announced in March also carries big risks, the filing points out. To sell ad space on the guide, Yahoo must build a direct sales staff. It says it will hire a "significant" number of new personnel, which will "significantly" increase sales and marketing expenses.

The deal, Yahoo concedes, subjects the company to "additional risk in the event that advertising revenues from [Netscape] are not sufficient to guarantee payments and related operating expenses."

Providing added pressure, Microsoft's Internet Explorer browser has been making gains on Netscape's Navigator, and the release of an upgraded version could continue to narrow the gap. Some of Yahoo's competitors have scoffed at the terms of the deal, saying it wasn't worth the money.

Only time will tell if Yahoo's bet with Netscape pays off. But in the meantime, investors will have to be willing to roll with the punches or opt out of a market leader in one of the fastest-growing technology sectors.