Yahoo Inc said large advertisers showed a renewed appetite for online display ads in the first quarter, but the Internet company's troubled search business put a damper on the company's comeback plan.

Executives said the company was poised to regain lost ground in search but investors focused on slightly lower than expected first-quarter revenue and indications that current quarter revenue could again miss Wall Street estimates, sending shares down 3.5 percent in after hours trade.

It's somewhat disappointing, said Clay Moran, analyst at Benchmark, noting a 14 percent year-over-year drop in search advertising revenue. So they're continuing to struggle in search and still contracting in a meaningful way.

And with Yahoo shares having risen more than 10 percent since the start of the month, some analysts said Yahoo failed to live up to expectations.

People were expecting a beat. I think expectations got a little ahead, said JMP Securities analyst Sameet Sinha.

Google, the world's No. 1 search engine, reported a 23 percent increase in first-quarter revenue last week. But the 4 percent sequential decline in Google's cost-per-click, the price advertisers pay for search ads, disappointed investors and contributed to a more than 7 percent sell off in Google shares the following day.

Yahoo executives highlighted several improvements in its business on a conference call with analysts, including rising profit margins and strong demand from brand advertisers for the graphical display ads that run on Yahoo's Web sites.

The display market is coming back, said CEO Carol Bartz. With this comeback, the quality of advertisers is on the rise.

Yahoo said revenue from Internet display ads jumped 20 percent year-over-year in the first quarter, while revenue from guaranteed display ads, which marketers reserve ahead of time and typically at higher rates, jumped 24 percent.

Yahoo, the world's No. 2 search engine, behind Google, has been shedding assets and reorganizing under Bartz, who took the helm in January 2009.

In July, she signed a 10-year deal with Microsoft to save hundreds of millions of dollars a year in expenses by shifting Web indexing chores to Microsoft, while Yahoo focuses on improving the consumer search experience.

SAVINGS START TO SURFACE

Some of those savings appeared in Yahoo's first-quarter financial results. The company reported a benefit of $43 million in one-time payments from Microsoft to cover the transition to the new search system, and $35 million as part of the $150 million in search operating cost reimbursements promised by Microsoft under the deal's terms.

Net income rose to $312.3 million, or 22 cents a share, from $118.7 million, or 8 cents a share, a year earlier, helped by the $43 million in Microsoft transition cost payments and the sale of the Zimbra corporate email business.

Excluding those items, Yahoo posted a profit of 15 cents per share, beating the average analyst estimate of 9 cents, according to Thomson Reuters I/B/E/S.

Chief Financial Officer Tim Morse told Reuters in an interview that Yahoo's Internet display advertising business was strong during the first quarter, but that the search business came in a bit weaker than expected.

Search queries just didn't seem to grow at the pace they had previously, said Morse.

Yahoo has seen its search market share erode over the past year: it held 16.9 percent of the U.S. search market by queries in March, according to comScore, down from 21 percent in January 2009. Google's share was 65.1 percent in March.

But Bartz said Yahoo's declining share had hit bottom and was poised to begin growing again.

We stabilized our search share and we believe it will tend up in Q2, Bartz said.

Yahoo's first-quarter net revenue, which excludes the money the company pays to partner websites -- known as traffic acquisition costs (TAC) -- fell 2.6 percent to $1.13 billion, below the average estimate of $1.17 billion, according to Thomson Reuters I/B/E/S.

Yahoo said revenue in the first quarter rose 1 percent to $1.60 billion. It forecast revenue in the second quarter of $1.6 billion to $1.68 billion, with TAC expected to account for 29.5 percent, according to Morse.

Shares of Yahoo, which have risen more than 10 percent since the start of April, fell to $17.73 in extended trading after closing the Nasdaq session nearly flat at $18.38.

(Reporting by Alexei Oreskovic; Editing by Bernard Orr)

(Additional reporting by Bill Rigby and Alexandria Sage; Editing by Gary Hill, Tiffany Wu and Carol Bishopric)

Yahoo Microsoft Google