Updated from April 23

Overture Services

(OVER)

slashed 2003 earnings guidance Wednesday, sending its stock plunging 26% Thursday morning.

The pay-per-click search engine operator reduced its fiscal-year earnings forecast by some 39%, cutting its target to a range of 35 cents to 42 cents a share. Wall Street analysts had been forecasting earnings of 63 cents.

The company gave three reasons for the shortfall: lower-than-expected revenue in the U.S., traffic acquisition costs at the high end of the company's previously forecast range, and increased technology and infrastructure expenses, including investments in World Wide Web searching.

These issues represent a mixture of old and new concerns facing investors in Overture. For the past year, Overture's stock has been weighed down by debate over traffic acquisition costs -- the percentage of revenue that Overture pays to Internet properties in return for using Overture's search results on their sites.

On Thursday, U.S. Bancorp Piper Jaffray analyst Safa Rashtchy cut his rating on the stock two notches, to market perform from strong buy. He trimmed his target price to $16 from $36.

"The level of miss yesterday leaves us bewildered, confused, and disappointed," Rashtchy wrote in a note Thursday. Overture shares plunged $4.37 to $12.11 Thursday, putting them within 50 cents of a 52-week low.

Short-sellers have argued that because Overture's revenue is concentrated among partnerships with a few other companies -- a majority comes from agreements with

Yahoo!

(YHOO)

and

Microsoft

(MSFT) - Get Report

-- Overture is at the mercy of these companies, and thus will be forced to turn over an increasing percentage of revenue for TAC.

Indeed, TAC rose from 54% of revenue in the first quarter of 2002 to 64% in the first quarter of 2003.

Yet Overture has argued -- and continues to argue -- that the potential for revenue growth in the paid search market outweighs the threat of rising margins. But that vision of an ever-expanding market is muddled by the lowered U.S. revenue forecast.

On a conference call with analysts Wednesday evening, Overture Chief Financial Officer Todd Tappin attributed the lower forecast to delayed introduction of new, complex initiatives, competition for new deals and a smaller expected share of the market in 2003.

Meanwhile, competition from search destination Google and other sources has forced Overture to expand quickly into new lines of business -- notably Web search, which has led to the company's acquisitions of two search businesses: Fast Search & Transfer and AltaVista. On the call, Overture CEO Ted Meisel said market conditions compelled the company to forgo its prior plans to make investments at a more measured pace. "Sacrificing short-term results to create long-term value is not a decision we take lightly," he said.

Later in the call, Meisel indicated that Overture's paid inclusion service, which the company hoped to jumpstart through its acquisition of FAST, would take longer to get going than the company had originally expected. In a paid inclusion service, Web site operators pay to have a search engine comb its site frequently in the hopes of improving its placement among relevant search results.