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Local Corporation (NASDAQ:LOCM)

Q4 2012 Earnings Call

February 14, 2013 5:00 p.m. ET

Executives

Heath Clarke - Chairman and CEO

Ken Cragun - CFO

Analysts

Edward Woo - Ascendiant Capital

Jon Hickman - Ladenburg Thalmann

Operator

Welcome to Local Corporation’s Fourth Quarter and Full Year 2012 conference call. On the call today are Local’s Chairman and CEO, Heath Clarke; and Chief Financial Officer, Ken Cragun. Heath and Ken will discuss fourth quarter and full year 2012 results and guidance for the full year 2013. We’ll then open the line for questions.

Today’s discussion includes forward-looking statements that are subject to risks and uncertainties that can cause actual results to differ materially from those expressed in the forward-looking statements. These risks and uncertainties will be outlined at the end of this conference call and are detailed in Local Corporation’s SEC filings. Any forward-looking statements are only made as of the date of this conference call and the company undertakes no obligation to update such statements to reflect subsequent events or circumstances.

The company uses non-GAAP financial measures in evaluating financial performance. Please refer to the Press Release issued today for how the company defines such non-GAAP financial measures and the reasons for using them, as well as a detailed review of our fourth quarter and full year 2012 results, including the corresponding GAAP financial measures and a reconciliation of non-GAAP to GAAP financial measures. This conference call is publicly available via audio webcast through the company's website and a replay of the call will be available for the next 90 days.

I’d now like to turn the call over to the CEO, Heath Clarke.

Heath Clarke

Thanks, moderator. During the fourth quarter we achieved record levels of organic and mobile traffic and we received two new patents. One of which we think will be instrumental in how our industry monetizes local mobile search. We have ended this year strongly and although it's early days, we are tracking to our 2013 revenue forecast of about $94 million, which is growth of 12% over our fourth quarter exit run rate. We are also tracking to deliver adjusted net income in the first quarter and to return the company to positive cash flow in the second quarter.

I am going to keep my comments brief in this presentation so I have more time for Q&A. Our space changes quickly and we have overcome many changes and challenges in the past two years to deliver record revenue in 2012. In the second half 2012, we absorbed ad policy changes and RPC declines from a major partners. We also sold certain assets and in early January we right sized our workforce in order to best position ourselves to achieve two strategic objectives in 2013, growth of our network business and margin expansion of our owned and operated business.

Coupled with the actions we have already taken, achievement of these two objectives will drive revenue growth and importantly, quickly drive our bottom line to a profit. Our network represents our highest margin revenue business, because nearly all the traffic is organic which means we don’t have to pay for it. There are three areas that will drive continued growth in this business. The first is adding more sites. We have over 1200 sites today, up 200 from the prior quarter. The second is adding more content to those sites and we are rolling out a new product directory as we speak, which is based on our Krillion acquisition of 2011. And we plan to expand our content further throughout the year.

The third is to incrementally improve monetization of network sites, something we excel at. Our scalable platforms all these efforts and we believe that 2013 will be a record year for our network business, helping to drive a large positive swing on our bottom line. Our second strategic goal is to expand margins in our O&O business which is our largest revenue stream and is primarily from our Local.com website. Although we were impacted by Google's ad policy change in the fourth quarter, we responded quickly. It represented a reset in revenues, so we are ahead of schedule in gaining back the margin we lost. To drive further margin gains we plan to deploy proprietary SCM tools to our team, which we are in development now and are expected to began rolling at next month. We believe these will drive the margin gains in O&O.

We have great technologies and a lot of great partners but when you strip it all down, we are a publisher of local business information and we monetize that information with ads. Key to growing business is expanding the content we publish in the places we publish to and monetizing more efficiently with ads. While there are occasional monetization dislocations like we experienced in the fourth quarter, these aren’t show stoppers. They are characteristics of our space and we adapt to those. Let me touch on one more thing before I wrap this up. We made a decision to cease our direct sales efforts earlier this quarter because our modeling showed that it would take two years before we turned to profit.

In light of both the commitment of management's time and energy into what would be a limited revenue of just $3 million in 2013, plus a comparatively large commitment of capital, we felt it prudent to focus on the more scalable areas of our business. I am happy to discuss this more during Q&A. We ended 2012 with record organic and mobile traffic and we are optimistic that we can continue to build on those gains in 2013. We believe is 2013 is shaping up to be a great year for us with a forecast of our second highest adjusted net income ever and with a far more defensible blend of revenue and traffic.

We are looking forward to reporting our first quarter numbers. Over to you, Ken.

Ken Cragun

Thank you, Heath. As Heath mentioned, we achieved near record levels of overall traffic with approximately $100 million monthly unique visitors to our site and network. And we achieved record organic and mobile traffic. $45 million and $25 million MUVs respectively. Due to unexpected RPC declines in the previously announced fourth quarter as policy changes, we came in below our prior guidance. Comparing our COGS and operating expenses to the prior quarter, Q4 cost of revenue decreased $2.6 million primarily related to lower traffic acquisition costs as we optimize our paid search campaign to the lower monetization during the fourth quarter.

As a percent of revenue, cost of revenue increased slightly from last quarter, lowering our gross margin percentage by one point. Q4 sales and marketing expense decreased approximately $100,000 from the prior quarter, related to lower personal costs, partially offset by higher advertising and marketing expenses. Q4 G&A expense increased $1.5 million from Q3, related to an increase in our reserve from the long-term LEC receivable or reserve related to the long-term LEC receivable associated with our legacy subscribers. Q4 R&D cost increased $170,000, primarily due to higher amortization of capitalized web development assets.

Q4 amortization expense decreased by $1.4 million from the prior quarter as the prior quarter included accelerated amortization of intangible assets related to the legacy LEC subscribers. The Q4 impairment expense of $4.1 million was related to our Spreebird Daily Deals business. The impairment is a result of further declines in the market value of deals companies coupled with lower projections for this business line due to the elimination of our direct sales force. During Q4 we had a GAAP net loss of $7.9 million or $0.36 per share on 22.1 million shares. This compares to a GAAP net loss in Q3 of $3.8 million or $0.17 per share on $22.1 million.

During Q4, we had an adjusted net loss of $925,000, down from the Q3 adjusted net income of $36,000. After cash and liquidity, we ended the fourth quarter with cash of $3.7 million, about flat from the Q3 cash balance. During the fourth quarter 2012, we had cash proceeds from the sale of the Rovion assets of $3.5 million and an additional draw on the line of credit of $2.4 million. Fully offset by cash used in operations and capital expenditures. We expect our cash burn to be significantly reduced as we enter 2013, due to recently announced cost savings, improvements in our O&O margins, and growth in our network business.

As a result of cost cutting in January and improving margins, we expect to swing to adjusted net income in the first quarter, followed by a return to positive cash flow in the second quarter of 2013 and steady cash flow growth throughout the remainder of the year. We are pleased to announce that Square One Bank has renewed and extended our $12 million credit facility for two more years on substantially the same terms. We are reiterating our financial guidance for full year 2013. We expect revenue to be in the rage of $93 million to $95 million, which is just a mid-point, is an increase of 12% compared to the fourth quarter 2012 exit run rate with adjusted net income of $5 million.

Note that beginning in Q1 2013, in line with our peers, we will also disclose network revenue ex-tax, which is defined as network revenue less traffic acquisition costs. I would now like to open the call up to Q&A. Moderator?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Ed Woo.

Edward Woo - Ascendiant Capital

Yeah, I had a question on your direct sales force. Are you eliminating it in your Spreebird business as well and what do you see kind of like your longer term plans for that business.

Heath Clarke

Yes, so the direct sales for us relates only to -- or the elimination of the direct sales force relates only to the Launch by Local SMB solution. So we still have a team of people at Spreebird. It's only a small sales force at Spreebird at this time anyway. And in terms of that company or that business, I should say, we have a team of people that are working on a variety of different ideas around growing that business. That business is at breakeven. Our commitment when we brought it was to manage it to breakeven by 2012. We obviously thought it would be a much larger business. But that segment had a lot of change. So today it's a breakeven business. Maybe throwing off a small profit and we are reinvesting that into trying -- experimenting with different things for that. It's not a material portion of our revenues going forward.

Ken Cragun

Maybe I could just add on to that. In our outlook for Spreebird, we had included integrating offers from the Spreebird platform into our small business bundle that we were selling with the launch by Local sales team. So by eliminating that launch by Local sales team, we lost some leverage on assets that we were going to be able to sell against the Spreebird assets.

Edward Woo - Ascendiant Capital

Okay. And the other question is, you know there was obviously this location or the changes in your advertising on your website. Do you think that most of the issues have been resolved and do you anticipate any further changes in the near-term?

Heath Clarke

Yeah, this is Heath. We believe that we have kind of set a new base line for that towards the end of the fourth quarter. If I can provide a little color on that. So basically Google implemented a policy change for all advertisers and they rolled it out across October and November and it was finalized in early December. So after early December, we had an opportunity to began doing what we do which is optimizing against that. And we have really made very good progress on that front. We are ahead of where we thought we would be right now. Google does make and Yahoo, Bing, they do make policy changes from time to time. So those are ordinary course. This is actually a series of changes which is why there was a two months rollout period.

We don’t expect something like that. We do expect policy tweaks from time to time but we don’t expect wholesale changes like that, certainly for the foreseeable future. It was a fairly significant change. And so our view at this point is, all things being equal, the normal policy changes that occur from time to time we will be able to get out to. And in terms of this one, although it resulted in the monetization reset from Q4, the margin which is what we are managing to, we have been able to regain most of that already.

Operator

And your next question comes from the line of Jon Hickman.

Jon Hickman - Ladenburg Thalmann

I have a couple of questions. Could you elaborate on, you just talked about the effects of the Google policy changes. Can you tell me why the price per click, PCP, was lower?

Heath Clarke

So there really were two impacts in our fourth quarter and they were kind of independent of each other. So the ad policy change for us anyway -- by the way there was the change of series of changes, most of which didn’t impact us. Only one did. Other companies had bigger impacts perhaps because maybe more than one of the policy changes may have hit them. So the policy change that impacted us was really, I will say it as simply as I can, hopefully I achieve that. So if you are an advertiser on Google, a consumer who clicks on one of your ads, when they land on that page on your site, the policy change impacted how many ads you could have on the page on your site. And so, obviously, we are a big advertiser on Google, Yahoo and Bing. So it relates specifically to traffic that we drive from search engine marketing only, from Google only.

And it really meant that we could display less ads on the page. It went from about 60% ad coverage to about 50% on the page above default. So that’s an immediate monetization reduction. And that actually has a two-fold affect for a company like ours. Certainly it impacts the margin immediately. And campaigns that were profitable for us in terms of positive margin, because of a reduction in margin, may go negative. So we would turn those campaigns off. So it's a double negative because we will have less margin and potentially less traffic.

Now the flip side is, as you adapted that and turned it around, it's a double positive on the way back up. And we have seen a significant improvement in margin and what we are looking to do off of that is to actually activate campaigns that we had de-activated. During this implementation period. So that’s the one policy change. And that when we forecast, we knew about that, we forecasted that, in my opinion, very accurately as it relates to Q4. What we weren’t anticipating, which was the other section unrelated to this, was Google had a 6% year-over-year revenue per click decline in the fourth quarter. And we expected RPCs actually to increase in the fourth quarter, so that caught us a little bit by surprise. And again that was unrelated to us and that was disclosed by Google publicly.

Jon Hickman - Ladenburg Thalmann

So is that getting better?

Heath Clarke

We don’t comment on the RPCs of any of our partners. We are obviously -- we are under NDA. That’s just public information, but it is consistent with what we saw. We anticipate that -- again, what we are managing to, what's most important to us kind of going forward is the margin. Whether the RPC is three times higher or 30% lower, if we can derive the margin that we are looking for, obviously RPC has a big impact on our revenue also. But as it relates to our bottom line which we have a laser focus on, that margin is what we are managing to. And again, we can't really disclose their RPCs because of our NDA.

Jon Hickman - Ladenburg Thalmann

As far as Spreebird goes, have you completely written that off now?

Ken Cragun

We have -- it was a $12 million purchase price and we did a mid-year write-down in 2012. About half of that to $6 million. And then we are doing an incremental 4.1. So there is still roughly 2.5 million goodwill related to Spreebird right now.

Jon Hickman - Ladenburg Thalmann

Okay. And then can you -- what give you the -- if you are going to do $94 million this year, is that kind of gradual improvement through the year or is there a big (inaudible) at the end.

Heath Clarke

No, what we see is kind of an incremental, steady incremental improvement throughout the year. We had a little bit of seasonality as we described it in Q3 last year, in 2012. Even taking that into account with some of the other gains that we anticipate from some of the things that we are doing across our network. For example, we expect to still counter that seasonality. So we are seeing a fairly consistent, fairly straight line from the bottom left to the top right, quarter-over-quarter. And a similar kind of line on the bottom line as well. Obviously you know -- go ahead.

Jon Hickman - Ladenburg Thalmann

Can you tell what it is that’s making you feel comfortable with that guidance?

Heath Clarke

Well, sure. If I can talk about the -- I guess two pieces of the guidance. You got the top line of course and the bottom line. In terms of the top line as I mentioned there is the -- we get potentially a double positive as we kind of adapt to these things that occur in the marketplace. These monetization changes that occur from time to time. When you are adopting to them, it's a double negative and then that can kind of accentuate that negative and then as you adopt to them it's a double positive. And so what we see right now is that we have responded from a margin standpoint, more rapidly than we actually thought we were going to be able to. And that’s an excellent outcome for us. Every margin percentage of our owned and operated business is a big number for our business overall. And so we have confidence based on what we have been able to achieve so far.

We also have confidence based on our network. Our network is at 45% of all traffic, it's a record level as a percentage of traffic. And we have, as I mentioned, we have a new network product coming out and that’s our product directory that will roll out. It's actually starting to roll our now. And so we do anticipate that’s going to drive more organic traffic and we have long-term goal of 50% of organic traffic. We were expecting to hit that in 2014. We may hit that a little sooner. And by the way that was the end of 2014 so we may hit that a little sooner. And that’s very high margin for us. That’s traffic. And so we have got about six things that roll in to our O&O and network initiatives for the year and that’s what's driving this incremental expectation around revenue. On the bottom line in particular, it's a pretty big swing and we are saying about $5 million in adjusted net income and about half of that is achieved through the cost reductions we have already implemented with our direct sales force. It was burning about $200,000 per month. And then the second piece is this margin expansion of O&O, in part, obviously there's some on the network, but in part it's driven the margin expansion of O&O and we are feeling good about that because we are well ahead of schedule on that margin expansion.

Jon Hickman - Ladenburg Thalmann

So where will I see that in the gross margin?

Ken Cragun

Yeah, we should have incremental improvement in margin percentage as well as revenue growth.

Jon Hickman - Ladenburg Thalmann

Okay. And the network business is not -- I mean Google could make all the changes they want that wouldn’t affect the network, right?

Heath Clarke

Well, yes and no. So generally -- so there is two pieces obviously to our business. One is the traffic and then the other one is the monetization. So all traffic routes -- basically all traffic at some point comes from the major search engines. So anything those major search engines do, ultimately can impact traffic. What we have seen though -- and this is a multi-year visibility. We have seen all the things that Google has done, frankly, to increase the relevance of their index, has been beneficial to us. There may have been a month or two where traffic dropped, but directionally speaking, and it's on our current corporate deck, we have almost doubled organic traffic in our business. That was the last two years. That’s been huge for us. And that’s while Google has been doing Panda and Penguin and all the other changes that they make each week.

So we think, that being the case and our desire and capability of being able to publish more content, we have confidence that that content is valuable to the major search engines and that will continue to grow. The other piece is the monetization. And on our network business in particular, we are not partnered with Google for the network, that’s a group of other partners. So any of these monetization policy changes, at least as it relates to Google, only impacts what we do with Google. And so that’s very much insulated from Google at least in that instance. It's more connected to Yahoo.

Operator

Thank you. This does conclude the question-and-answer portion of today's call. I will turn the call back over to Ken for closing remarks.

Ken Cragun

Thank you. Thanks for being on today's call. I would now like to turn the call back over to the moderator for our final disclosures.

Operator

This conference call contained certain forward-looking statements within the meaning of section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Words or expressions such as anticipate, believe, estimate, plans, expect, intend, project, forecast, potential, feel and similar expressions and phrases are intended to identify such forward-looking statements. Any forward-looking statement is based on the beliefs of our management as well as assumptions made by and information currently available to our management.

Actual results could differ materially from those contemplated by the forward-looking statements as a result of certain factors, including, but not limited to, our advertising partners paying less revenue per click and revenues to us for our search results; our ability to purchase advertising form third parties to drive users to our sites including at a profit; our ability to adapt our business following the shifts in our monetization partners; our ability to monetize the Local.com domain, including at a profit; our ability to retain monetization partner for the Local.com domain and other web properties under our management that allows us to operate profitably; our ability to develop, market and operate our local-search technologies; our ability to market the Local.com domain as a destination for consumers seeking local search results; our ability to adopt to policy changes promulgated by our advertising partners and traffic acquisition partners; our ability to grow our business by enhancing our local search services, including through businesses we acquire, the integration and future performance of our Spreebird business and our Krillion business; the possibility that the information and estimates used to predict anticipated revenues and expenses associated with the businesses we acquire are not accurate; difficulties executing integration strategies or achieving planned synergies; the possibility that integration costs and go-forward costs associated with the businesses we acquire will be higher than anticipated; the possibility of impairment of assets associated with the businesses we have acquired; our ability to successfully expand our sales channels for new and existing products and services; our ability to increase the number of businesses that purchase our advertising products; our ability to successfully bill our monthly subscription customers; our ability to expand our advertiser and distribution networks; our ability to integrate and effectively utilize our acquisitions; technologies; our ability to develop our products and sales, marketing, finance and administrative functions and successfully integrate our expanded infrastructure, as well as our dependence on major advertisers; competitive factors and pricing pressures; changes in legal and regulatory requirements and general economic conditions.

Any forward-looking statements reflect our current views with respect to future events and are subject to these risks and other factors, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this paragraph. Unless otherwise stated, all site traffic and usage statistics are from third-party service providers engaged by the company. This concludes the call for today. Thank you for your interest in Local Corporation.

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