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QuinStreet (NASDAQ:QNST)

Q3 2013 Earnings Call

April 30, 2013 5:00 pm ET

Executives

Erica Abrams - Co-Founder and Managing Director

Douglas Valenti - Chairman and Chief Executive Officer

Kenneth R. Hahn - Chief Financial Officer and Chief Operating Officer

Analysts

Carter Malloy - Stephens Inc., Research Division

Stephen Ju - Crédit Suisse AG, Research Division

Nathaniel H. Schindler - BofA Merrill Lynch, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the QuinStreet Third Quarter Financial Results Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would like to now introduce your host for today's conference, Ms. Erica Abrams of The Blueshirt Group. Ma'am, you may begin.

Erica Abrams

Thank you, operator. Thank you, and good afternoon, ladies and gentlemen. Thank you for joining us today as we report QuinStreet's third quarter fiscal 2013 financial results. Joining me on the call today are Doug Valenti, CEO; and Ken Hahn, COO and CFO of QuinStreet. This call is being simultaneously webcast on the Investor Relations section of our website at www.quinstreet.com.

Before we get started, I would like to remind you that the following discussion contains forward-looking statements. These are statements that relate to future events or financial performance and involve risks and uncertainties. QuinStreet's actual results may vary materially from those discussed here. Factors that may cause the results to differ from our forward-looking statements are discussed in our most recent 10-Q filing with the SEC completed on February 15, 2013. Forward-looking statements are based on current expectations, and the company does not intend to and undertakes no duty to update this information to reflect future events or circumstances.

Now I'll turn the call over to Doug, CEO of QuinStreet. Please go ahead.

Douglas Valenti

Thank you, Erica. Hello, everyone. Thank you for joining us today. Financial results for the quarter came in at the higher end of the outlook we provided in our last call. Revenue for the quarter was $79 million. Adjusted EBITDA was 16% of revenue. Normalized free cash flow was $8.2 million, or 10.4% of revenue. We closed the quarter with $114 million in cash and marketable securities, increasing net cash to $16 million. We were generally pleased with the execution in our traditional business footprint and with the initiatives to expand our products, markets and media.

In our Financial Services client vertical, revenue was up 22% sequentially, primarily due to strong execution, especially in the auto insurance and mortgage businesses. Volume, pricing and margin were all up quarter-over-quarter in Financial Services.

In auto insurance, we continue to make very good progress rolling out our expanded product set and launching new clients. In our Education client vertical, revenue was up 8% sequentially due to both good execution and seasonality. As in Financial Services, volume and pricing were both up mostly due to programs to improve inquiry quality and to clients' increasing willingness to pay for those improvements.

We continue to make good progress on new product, market and media initiatives in Education. Our click and call products grew nicely, and we are seeing strong client demand for those offerings. We continue to expand our business with nonprofit schools. Our international education businesses in Brazil and India are developing well, and our efforts to develop new and proprietary media sources are progressing.

Performance in our Other client verticals was disappointing relative to our expectations, mostly due to disruptions in marketing budgets with some of our largest B2B technology clients. Weakness in Other was offset by the better-than-expected performance in Financial Services and Education.

In summary, financial results for the third quarter were solid due to strong execution in our core client verticals. We also continued to make good progress on initiatives that we believe will allow us to return to year-over-year growth. While we work to restore growth, we will continue to manage the company with characteristic financial discipline, generating attractive EBITDA and free cash flow margins with minimal nondiscretionary demands for capital.

Looking ahead, we expect June quarter revenue to be in the range of $72 million to $77 million, consistent with typical seasonality. Adjusted EBITDA margins are expected to be in the mid-teens.

With that, I'll turn the call over to Ken for a more detailed discussion of our financials.

Kenneth R. Hahn

Thanks, Doug. Hello, and thanks again for joining us today. For our third quarter fiscal 2013, we posted $79 million of revenue, a 15% decline compared to the same quarter last year. Adjusted net income for fiscal Q3 was $6.8 million, or $0.16 per share on a fully diluted basis. Adjusted EBITDA was $12.4 million, or a 16% margin.

We are pleased to have delivered results toward the top of the guidance range we provided on our previous earnings call, and we are pleased to have demonstrated further stabilization in the business. The initiatives to restore growth that we've been discussing are progressing, and we believe we are closer to returning to growth.

Please see the supplemental data sheets available for download on the Investor Relations page of our corporate website. They provide in tabular form the figures that I will now walk through with you.

Revenue by client vertical. Our Education client vertical represented 45% of Q3 revenue, or $35.2 million. The year-over-year decline in revenue moderated to 9% as we continued to execute on our various growth initiatives and adapt, with our clients, to regulatory change. As a quick reminder of the context of our Education client vertical, one, this is a solid, profitable client vertical for QuinStreet; two, we believe we are the leader in the space in terms of revenue, market expertise and competitive assets; three, clients have been adapting to various regulatory changes for some time now; four, we seek to be a high-quality provider in partner with our clients as they adjust; and five, initiatives in place to support our efforts to returning growth -- to return to growth include our relatively new click and call products and our international efforts in Brazil and India.

The Financial Services client vertical represented 41% of Q3 revenue, or $32.2 million. While revenue is down, as expected, on the year-over-year basis, the decline moderated. It was a nice execution in both our traditional click business in auto insurance, as well as progress on our expanded model. As a quick reminder of the context for our Financial Services client vertical: one, auto insurance is the largest market in our overall Financial Services client vertical; two, client marketing budgets in auto insurance are large, very large, and this is an early market, particularly for performance marketing online; and three, our primary growth initiative is the adoption of our expanded model in which we still offer clicks, our historic model, with the addition of leads, calls and down policies.

We told you last quarter that we expected to see progress going forward with our top line trend in Financial Services. We did deliver on this and continue to see the indicators of improving performance, primarily client signings, client rollouts and better monetization of media due to the expanded model.

Revenue from our other client verticals, which include B2B technology, home services and medical, represented 14% of our total fiscal Q3 revenue, or $11.6 million, a 24% year-over-year decline.

Moving to a discussion of EBITDA. For adjusted EBITDA, we delivered $12.4 million or 16% margin, consistent with the mid-teens guidance we provided last quarter. Remember that our historical adjusted EBITDA target has been 20%, and we believe that it's the right structural target for our long-term model. But as discussed with our guidance 2 quarters ago, we've eased that constraint for the near term to provide continued investment in the initiatives that we believe will return us to growth.

On the tax front, our rate, as we're close to breakeven on a tax basis, is not meaningful. For your modeling purposes, we expect our ongoing rate to be approximately 40%, as it has been for the past year or so.

Moving to the balance sheet. Our cash and marketable securities balance at quarter end totaled $114 million, an increase of $6 million as compared to the previous quarter. Total debt decreased to $97 million from $100 million in the previous quarter due to repayments, and we have no new borrowings. Our net cash position is positive $16 million.

Normalized free cash flow was $8.2 million, or 10% of revenue, and cash flow from operations was $10.2 million during the quarter.

To summarize, no victory laps yet, but we delivered some better results than we have been for our recent past, and we're seeing nice progress in what we believe are indicators that we're moving closer to return to growth. While we work hard to return to top line growth, we continue to deliver good profitability and generate significant cash on a consistent basis.

With that, I'll turn the call to the operator to open for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Carter Malloy of Stephens.

Carter Malloy - Stephens Inc., Research Division

So first, and you may have spoken about this a bit little earlier, but can you give us a little more color on the business mix inside of your guidance in terms of where the growth is and more importantly, why the pickups or the declines?

Douglas Valenti

You're talking about in terms of the forward guidance, Carter?

Carter Malloy - Stephens Inc., Research Division

Correct.

Douglas Valenti

We typically, as you probably know, have a seasonal dip from the calendar first quarter into the calendar second quarter. And so we expect that we're going to have a dip pretty consistent with typical seasonality in the quarter we're in versus last quarter. That's good news in that the past couple of years, driven by the challenges we've had in the business, the dip has been considerably higher than that what we've seen on a more typical historic basis. So we feel very good about that. In terms of the business mix, I think the business mix will be pretty close to what we saw this quarter in terms -- and I think the businesses will -- we expect that performance -- the relative performance of the businesses to mirror pretty closely to what we saw in terms of the mix this quarter as they were last quarter.

Carter Malloy - Stephens Inc., Research Division

Okay. And then on the Financial Services side of business, good to see the stability within that. Can you discuss the market dynamics there and importantly, the cost of media there if you're seeing some stabilization?

Douglas Valenti

Yes, market dynamics are much more stable, I guess, than they have been for the past year or so or year or more. I think that the competitive intensity has moderated some. We're past a number of the shocks that had been affecting us for a while. Those are kind of old and cold at this point. And I would say that the efforts we've had to both improve our competitive capabilities with the SureHits click platform relative to some of the challenges by continuing to improve the quality of what we deliver and to continue to deliver what the clients want and to deliver it in a form and at a price point that they want to see, combining that in a traditional business, which, by the way, was the biggest part of the success this past quarter in auto insurance, with continued progress on the auto insurance broader model, are providing us with a lot more stability and with the confidence to say that we, again, we think that we'll have a more typical seasonal drop. Rather than, again, the past couple of years, that's been atypically high kind of quarter-to-quarter and from first to second quarter.

Operator

Our next question comes from Doug Anmuth.

Unknown Analyst

This is Diana speaking for Doug Anmuth. I just wanted to ask if you can provide some additional details regarding the continued roll out of expanded product offerings in auto insurance and what kind of traction or incremental revenues you're seeing with that.

Douglas Valenti

On the expanded model, is that right?

Unknown Analyst

Yes.

Douglas Valenti

Yes, we continue to see very good progress. We had 9 new clients in the quarter on the expanded product offering. We had indicated last quarter that we thought the number of new clients could grow -- number of clients on the new products could grow by 50% over the next 6 months. We almost got to that 50% just this past quarter by adding 9 to what was about 16 on the new products before. So we made very good progress. We're continuing to launch, integrate these clients. We had our biggest revenue month ever as you might expect, and therefore, I think our biggest revenue quarter ever on the expanded product set in auto insurance last quarter, the biggest month was March, which, of course, was the most recent month. And so I'd say that we're very pleased with the progress. There continues to be a lot of moving parts that we're putting together for ramping. But if you combine the client launches, the client integrations, the progress on revenue per inquiry, which was up 32% on a year-over-year basis -- I'm sorry, sequential basis. The revenue per inquiry capacity of the new product model was up 32%, which is an indicator of client demand and the performance of the relative products. We're feeling very good about it. So it was very good progress, continuing good progress as strong or stronger than we saw the previous quarter.

Operator

And our next question comes from Stephen Ju of Credit Suisse.

Stephen Ju - Crédit Suisse AG, Research Division

Doug, I just wanted to make it kind of crystal clear. On your prepared comments, you were talking about price and volume metrics being up, and that's being up on a sequential basis for most...

Douglas Valenti

That's correct, Steven.

Stephen Ju - Crédit Suisse AG, Research Division

Okay, got you. So volume actually being up on a sequential basis, now is that coming pretty much from the consumer side or from your -- I guess we can look at it any number in different ways, right? Is there an increased consumer demand in terms of inquiries coming in, which you were able to monetize? Or is it just more of an increased willingness among your client base to actually do a bit more in terms of activity?

Douglas Valenti

And are we talking about Financial Services or across the board?

Stephen Ju - Crédit Suisse AG, Research Division

Across the board.

Douglas Valenti

Across the board?

Stephen Ju - Crédit Suisse AG, Research Division

Yes.

Douglas Valenti

In both Financial Services and Education, we had increased media flows or traffic or consumers. And that was on all of the properties and the properties that we partner with or access with. And so that volume was up. Pricing, though, was also up. And by the way, with that volume being up on the media side, we had matching client demand, and interestingly and positively, we had increased pricing from clients, so the demand -- their demand was strong relative to the supply we could give them and the quality we were providing met a higher quality standard or better value standard for them. So it was a combination of increased media flows or traffic or consumer flows and demand for that or increased demand for that from the clients, as well as a better mix quality, which allowed us to increase pricing pretty materially in both Financial Services and Education. So then those were the businesses that drove the results in the quarter.

Stephen Ju - Crédit Suisse AG, Research Division

Got you. So the incremental volume was also converting at the equivalent rates so that you were able to take advantage?

Douglas Valenti

Yes.

Operator

[Operator Instructions] And the next question comes from Nat Schindler from Bank of America.

Nathaniel H. Schindler - BofA Merrill Lynch, Research Division

I'm just trying to figure out your guidance a little bit on this and want to understand what is the usual seasonal declines that you see in the Financial Services industry and how seasonal is that revenue line.

Douglas Valenti

Sure, Nat. What we have historically seen in our leading click businesses is, on average, about a 5% drop from the first calendar quarter to the second calendar quarter or, of course, our fiscal Q3 to Q4. And that is in years, of course, where we were growing. The guidance, the kind of middle of the guidance range you'll see is about at that point. Coming up with a range is -- we have a range because we still would acknowledge that there are -- there is volatility. There are still challenges. There are still a lot of dynamics in the marketplace that aren't 100% settled out and stabilized. But we have seen those -- the main reason in performance marketing that you typically see a dip from the fourth quarter calendar to first quarter calendar versus, say, a display business, which usually peaks or often peaks in the fourth quarter, has to do with client capacity to handle particularly lead volumes because leads are usually followed up by an agent or a call center rep. In the fourth quarter, when you have Thanksgiving and Christmas and New Year's, you have a lower capacity of -- or fewer people available to follow up because they're taking a holiday. And the other dynamic is in the fourth quarter calendar year, because of the demand for display or for marketing generally in display and performance formats, many of our programs get squeezed out by holiday spend. And then when you hit the first quarter, everybody's back at work, and the holiday advertising spend is gone. So those are the dynamics that we see in pretty much all of our performance marketing-driven verticals, which is, of course, all of our verticals. And we have a little bit of display in our B2B business, which has a little bit of the -- it gets bigger in the fourth quarter dynamic, which is, again, more typical for display. But it's such a small -- display is generally such a small piece of our business, the pattern of fourth quarter to first quarter jump, first quarter to second quarter dip has held in pretty much all of our performance businesses.

Operator

I'm showing no further questions. Ladies and gentlemen, this does conclude your conference call. The webcast will be available live on the Investor Relations section of the company's website at http://www.quinstreet.com and via replay by dialing 1 (800) 585-8367 in the U.S. and Canada or 1 (404) 537-3406 for international callers using passcode 34801813 and then the pound key. Have a good day. You may now disconnect.

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