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SourceForge, Inc. (LNUX)

Q1 2009 Earnings Call

May 28, 2009 5:00 pm ET

Executives

Patricia S. Morris – Chief Financial Officer & Senior Vice President

Scott Kauffman – President and Chief Executive Officer.

Jonathan Sobel – Group President, Media

Analysts

Jon Hickman – MDB Capital Group

Robert Colbreth – Thinkequity Partners

Operator

Welcome to the SourceForge financial results conference call. (Operator Instructions). It is now my pleasure to introduce your host, Ms. Patty Morris, Chief Financial Officer for SourceForge.

Patricia Morris

Good afternoon and welcome to SourceForge’s conference call reviewing our first quarter of our new calendar year 2009 financial results. Joining us today is Scott Kauffman, our President and CEO,and Jon Sobel, our GM and President of the Media Group.

Some of the statements that we make today will be forward-looking, and these statements involve a number of risks and uncertainties that could cause actual results to defer materially. Please note that these forward-looking statements reflect our opinions only as of the date of this call, and we undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements in light of new information or future events. Please refer to our SEC filings as well as our financial results press release for a more detailed description of the risk factors that may affect our results. These documents are available at our website, sourceforge.com, and at the SEC’s website, sec.gov.

As a reminder, on April 29, 2009, we changed our fiscal year end from July 31 to December 31 effective as of January 1, 2009, to align our operational goals and reporting cycle with the companies in our industry. Accordingly, this is the first quarter of our new calendar and fiscal year ending December 31, 2009. We will file a report on form 10-QT for the transition period from August 1, 2008, through December 31, 2008, and we’ll also file a quarterly report on form 10-Q for this first calendar quarter next month. We will not be reporting on the transition period during this earnings call.

During our call today, we’ll discuss certain non-GAAP financial measures. In our press release and our filings with the SEC, each of which is posted on our website, you’ll find additional disclosures regarding these non-GAAP measures including reconciliations of these measures with comparable GAAP measures. Unless otherwise stated, all comparisons in this call will be against our results for the comparable period of 2008.

A supplemental schedule of our statement of operation and operation statistics for the five calendar quarters in the period ended March 31, 2009, is available on our website at web.sourceforge.com/cyresults. A replay of this conference call will be available on our website later today. The replay will also be available by telephone, toll free at 1-877-660-6853 or 201-612-7415, referencing replay account 286 and call ID 322061.

With that, I’ll turn the call over to Scott Kauffman, our President and CEO.

Scott Kauffman

Good afternoon everyone. I’m coming up on my 5-month anniversary with the company which means that I have 90 more days under my belt than the last time we all gathered at the 60-day mark. On today’s call, I want to establish some guiding principles, remind you of the strategy we laid down 3 months ago, and then update you on our progress against that strategy, but before I do, let me get one thing out of the way. The Q1 results that Patty will review shortly are simply not acceptable. I’m deeply dissatisfied with them, and yet I’m more convinced than ever about the merits of our strategy. Before we revisit that strategy, I have three guiding principles that I want to share with all of you. These principles inform how we has a management team are approaching the opportunities at hand.

Principle number 1: We’ll speak openly. As a company with strong roots and open source, we’re going to strive to be open with all our constituents especially on these calls as we all surely appreciate the pageantry of earnings calls could be stifling, and we’re just not going to go down that path. If you’re invested in us at this time, it can only be because you believe in this company’s potential, and as we strive to execute in one of the more interesting business environments I have been a part of, we’re going to do our best to earn your trust and then keep it. We’ll be candid. We’ll share with you how we assess our progress and then respectfully suggest how you should measure us as well. We’re going to do our best to say what we get right and what we get wrong. No management team gets it right all the time, and when we share the inevitable mistakes and corrections, we’ll continue to speak plainly.

Principle number 2: We’ll continue to take risks and invest in our business. Despite all the promise of our assets, our company’s market value continues to languish. As an enterprise, we trade for not much more than the value of our cash. Topline media growth numbers have been up in some quarters and down in others, but on an absolute basis, it’s all minor variations around the same theme, and it’s all disappointing. In a world of small numbers, negligible swings result in large percentage gains, but to us this all distils down to a discussion of unacceptably small numbers. Moreover, as we look ahead from this position, gradual incremental growth is clearly not interesting to us, nor we presume to you. Conclusion: In keeping with the laws of risk and reward, we’re going to take intelligent risks, and we’re going to continue to invest in our company. We’re going to look for and when appropriate make prudent acquisitions and stakeout a clear identity in the market, and we’re going to lean forward because moments of disruption and retreat such as the environment we find ourselves in today are the perfect time to lay track and take market share. It’s simple: No risk, no reward. Now, as guiding principles go, I doubt any of you have real concerns about us speaking openly and taking risks.

The third and final guiding principle, however, might prove to be a little more difficult to stomach. I know that many of you have been invested in the company for quite some time. For years, this company’s media business has been striving to break out of the same revenue range, and in these frustrating circumstances, it is tempting and only natural to dwell on the past, but I will not succumb to this temptation. So permit me to say this directly and as openly as I possibly can. I’m not looking back. I’m asking our employees, our partners, and our investors to look ahead because we need every ounce of energy and focus on what’s in front of us to grow our business, so guiding principle number 3, we will not look back. We’ll speak openly. We’ll continue to take risks by investing in our business, and we will not look back, and with that backdrop, I want to remind you of what we discussed on our last call.

We told you three months ago that the media business is stuck in a narrow revenue band, that ThinkGeek is solid and stable, that our main site SourceForge is a mile wide and an inch deep, lots of people, not so many page views; that our other media property, SlashDot, is a yard wide and a mile deep, but despite well known brands in the geek world, we remain the best kept secret on Madison Avenue. The commodity advertising just won’t cut it anymore. We also told you that we were not going to blame the economy for poor performance, that we did not capture the data necessary to be the 21st century internet media company that we enjoy a unique place in the world and that our fate is in our hands. These observations led us to develop our Awareness Data Site strategy. You’ll note the acronym, ADS, and while I convey this with some levity, we’re deadly serious about moving purposefully on all three fronts.

Here is what has transpired since the last call. Let us start with the media business. On the awareness front, we begin with the challenge of having to maintain relevancy to four distinct communities—developers, consumers, advertisers, and investors or to use a popular convention of light—the cloud, main street, Madison Avenue, and Wall Street. Our first investments here are focused on establishing our brand identity, particularly to Madison Avenue. In advertising, share of voice and brand awareness get you on the media buy, and to earn the right to carry premium ads, we need a hardworking brand. All elements of our corporate identify are under review at present up to and including our company name. As I think about what we stand for as a company, I want our name to do a better job of communicating our value to all of our community.

Turning to data, as you might already know, today we announced the acquisition of Ohloh.net, an open source data aggregation platform that crawls over 3500 open source software code libraries including ours and captures both data and actual code for 300,000 open source software projects. They also track the activity of 300,000 developers and collect one of the most comprehensive open source data sets in the world. Geeks love data and so do marketers. Ohloh has a clean modern site and they are a valued provider of strategic data to several top-tier technology companies.

Acquiring Ohloh accelerates our progress into numerous ways. This acquisition gives us insight into the entire open source ecosystem, not just activity on our side. As open source activity continues to fragment, Ohloh strengthens our position as an aggregator. Ohloh’s data also enhances our ability to target our advertiser. It will help us connect our open source forge to many other forges and it brings talented individuals into the company.

In sum, Ohloh helps us advance our data strategy by enabling better targeting for advertisers, setting us up to provide better strategic insignts to clients and partners and ultimately surfacing more insights for consumers. It strengthens our medial business model in the near term and lays groundwork for other possible streams of revenue in the future, such as data and services.

Completing the ADS paradigm are sites. In the past month, we’ve begun a complete site overhaul of Sourceforge. The company has steadily been laying the groundwork for this in the past year with a new data center last summer, new APIs this winter, and all kinds of foundational engineering work. We are now in a position to completely rebuild the site and we’re doing just that. I’m putting a stake in the ground right here. We’re going to have an elegant modern website by our next call which will be at the end of July when we report on our new second quarter. Our site will have a completely new look and improved functionality while continuing to serve our core audience—the world’s smartest most desirable geeks.

And most important, when someone from an ad agency visits our media sites, they’ll now know exactly what is going on. Serving geeks and advertisers at the same time is no easy feat, but our ad products already work exceedingly well. Along with new targeting capabilities from Ohloh, when we get the site design right, this change will be a significant lever for us. To give you a sense of the cultural change that is underway, much of our SourceForge site currently operates on 10-year-old web code, which in any other industry would rival 19th century machinery. Think riverboat, iron horse, cotton gin. It served us and our audience well in the past and it got us here, but now it’s time to move on. Enough said.

That’s it for ADS—awareness, data, and sites. I believe in the merits of our strategy, and as I mentioned earlier, I’m more convinced than ever that we are on the right track. All the more so given the certain realities of the internet industry, and let me speak plainly here. I believe that without these changes and improvements and continued risk taking, we would be forever doomed to the most mediocre trajectory imaginable. In particular as is increasingly well understood, internet ad inventory is fast becoming ubiquitous. Until recently and for a long run, internet advertising businesses could expect to grow simply by growing their traffic, bolting on more ads and then doing it again—wash, rinse, repeat. That run is over. The industry is forever changed, and for anyone who can pencil out a supply and demand curve, there are obvious implications from the imbalance between an infinite supply of pages and a finite roster of advertisers. Although we anticipated this shift, it is clearly accelerating, so we have to become a company that commands premium pricing and we have to have the goods to do it. Conclusion: For us, brand matters; having modern, clean, well-lit sites matters. Offering distinctive services to marketers matters, and data matters. These are the key elements of the differentiation strategy and the only way a modern internet media company can pull itself out of the slump of infinite inventory.

Now let’s move over to Thinkgeek, the e-commerce side of our business where almost everything is heading in the right direction. Despite a slight revenue decrease year over year, we have experienced a 16% growth in orders, phenomenal growth in this market, with a 9% increase in conversions year over year. Customer are spending a little less per order, but they are spending and the volume continues to grow, but in keeping with the guiding principle of not looking back and despite the fact that this business is humming along, again outperforming many peers in the industry, we believe we can do better, and our overall focus for Thinkgeek is also on awareness, data, and sites.

On the awareness front, we continue to gain new customers and followers from both Twitter and Facebook, which have both become remarkable tools for customer growth and feedback. In addition, Twitter has begun to serve as a customer service feedback channel for our support team. We believe there is opportunity for us to expand our brand beyond the organic growth we have seen historically. We are also placing a renewed focus on our public relations activities. We view increased PR as a real opportunity for incremental awareness to a brand that has already received a tremendous amount of inbound free press from publications—both large and small.

For data, we are placing more emphasis on investments in marketing and implementing stronger analytic tools which will give us better insight to customer behaviors. Initial areas of focus where we believe we have opportunity to improve include our email marketing and promotional programs.

Finally the site as I referenced on our last call is due to some changes, and we are well along in a site redesign scheduled to go live later this summer. There is a lot of internal work packed into these initiatives, and they are ongoing, but as is true with any e-tail business, much of this work will be timely as we drive closer to our next holiday season.

In summary, these are all big moves on both sides of the company, and our strategy will take time. I can’t say precisely when these efforts will impact our financial results, which are the acid test of all of this, and in the spirit of speaking openly, we will not be giving guidance. We will place all of our contemplated big bets by the end of this year, and with regard to strategy and execution, my colleagues and I understand that time is of the essence. Once everything is in motion, the only metrics that I want us to be evaluated on are financial bottomline results. To track our progress in the short run, for media, watch our traffic, watch unique visitors, watch revenue per 1000 page, and watch for news and discussion about our brand. For Thinkgeek, keep an eye on order growth, AOV, and conversion rates, and then in a few quarters, start to watch our financial results.

Patty, back to you.

Patricia Morris

As we previously announced, we’ve undergone a fiscal year end change resulting in this quarter being the first quarter of our new calendar year end. We hope that you’ll find it easier to analyze our results with the December year end going forward as it aligns with those of our peers in both our e-commerce and media groups.

With that said, let me remind you that I’ll focus my remarks on the results for the quarter ended March 31, 2009. As reported in our press release, first quarter 2009 revenue came in at $10.4 million. Our net loss on a GAAP basis for the first quarter was $0.12 per share including the $4.6 million impairment charge on our investment in CollabNet and $0.03 per share on a non-GAAP basis. Media revenue for the first quarter was $3.8 million, a decrease of 18% over the $4.6 million of revenue for the same period last year.

This decrease was driven by the 58% erosion of traditional display advertising; however, we increased premium revenue by 172% to $1 million, and last summer’s ad network’s optimization efforts yielded $1.4 million in net revenue, a 49% year over year increase.

E-commerce revenue for the first quarter declined 3% to $6.6 million from $6.9 million for the same period last year. E-commerce gross margin was 15% for the first quarter of fiscal 2009, relatively flat with the same period last year. While the average order value for Thinkgeek declined from $71 to $61 from the prior year’s first quarter. Thinkgeek shipped 116,000 orders, a 16% increase from the first quarter of last year.

Our overall operating expenses in the first quarter of fiscal 2009 increased to $6 million as compared with $5 million in the first quarter of fiscal 2008. This increase is due to headcount and related expenses, primarily in the sales and engineering groups. Backtracking for a minute, on our last call in late February, we announced changes in our cost structure specific to a reduction in the size of our salesforce. While the severance costs associated with the salesforce reduction are included in the numbers just reported, the cost savings are not fully reflected in the first quarter results and will be captured in our second fiscal quarter.

For the first quarter of fiscal 2009, GAAP loss was $7.4 million, or $0.12 per share compared with a GAAP loss of $900,000 or $0.01 per share for the same period last year. Our annual review of our cost method investments led to the $4.6 million impairment charge on our CollabNet investment. Non-GAAP loss which excludes stock-based compensation and the impairment charge was $2.2 million or $0.03 per share, compared with $400,000 or $0.01 per share for the same period last year. We finished the first fiscal quarter with cash and investments including restricted cash of $47.4 million. Just after the close of the quarter, we used $3 million for the repurchase of 3.7 million shares of our common stock.

Now, let’s talk about the metrics of our business. Comparing the first quarter of calendar 2009 with the first quarter of calendar 2008, on the media side of the business, premium product grew 172% to $1 million, ad network revenue increased 49%, media uniques improved 7% to $37 million, RPM decreased to $8.09 from $9.89, page views increased 1%, revenue per user decreased to $0.41 from $0.53, and page views per unique remained relatively constant at 4 page views.

Moving now to ThinkGeek, we shipped 116,000 orders, a 16% increase year-over-year. Average order size decreased from $71 to $61, and our visitor conversion rate for Q1 ’09 was 1.56% compared to 1.44% for the same period last year. We continue to believe that these are solid metrics to measure the health of our businesses.

Now let me turn over the call to Scott.

Scott Kauffman

Just to recap, we have three guiding principles—speaking plainly, taking risks while investing in our business, and not looking back. They have formed how we approach our strategic imperatives of awareness, data, and sites, and we will continue to invest and place a series of bets throughout the year to produce tangible measurable results starting early next year.

Let’s get to a conversation. Doug, please open the line.

Question-And-Answer Session

Operator

Ladies and Gentlemen, at this time, we will be conducting a question-and-answer session. (Operator Instructions) Our first question is from Jon Hickman – MDB Capital Group.

Jon Hickman – MDB Capital Group

Can you give me any sense of the profitability of Ohloh.Net? Are they making money now? Is it accretive to you? Are they monetizing their sites the same way you are trying to monetize yours, etc.?

Jonathan K. Sobel

Ohloh.Net does not come with a lot of revenue currently. They make some money, but not an amount that’s material to our operations from the sale to data to several leading high technology companies. They have a growing website, but with a relatively small number of page view relative to ours. They run Google on that, but it in and of itself is nothing that in the near terms at least is going to make any difference to our results. The reasons for the acquisition include as Scott mentioned the superior targeting that our data is going to allow us to provide for advertisers and in general the value of data to each of the constituents that we serve—advertisers, software developers, and consumers.

Jon Hickman – MDB Capital Group

Patty, this one is for you. Can you give us some sense of what severance costs were for the salespeople and what the savings might be on a quarterly basis going forward?

Patricia Morris

From a severance perspective, we had about $100,000 of severance costs, and as we talked about last quarter, we’re looking at annual savings of $1.5 million from this. So breaking that out, it’s $1.5 million for the year.

Jon Hickman – MDB Capital Group

Jon, could you describe for me again so I can get a better picture your premium product advertising? Those are the downloads, and then the banner ads, that business, are you moving away from that to go to these other directions or is it just that the market there is so bad?

Scott Kauffman

Everything you just said. When we discuss premium products, a large part of that are the customized interstitial ads that we place in the download flow when we’re downloading software for our consumers. Those continue to be of interest. They’re high-priced products. The rate card CPM for that is $90 to $100; in some cases a little less, in some cases a little more depending on what we’re going for the client. That overall level has continued to hold steady despite the pressure on marketing budgets especially for high-priced advertising, so we feel good about that. That’s holding strong. The number of clients using those products is growing, and we’re getting fantastic results. At the same time, as you pointed out, traditional IAB standard internet advertising is under real pressure in the market. We made the decision some time ago not to base our future on that segment of our business. I think that has turned out to be a good course. The pressure on that is happening faster and more broadly than I think many anticipated, and so that’s one of the things that you see in our results. Our premium is holding steady. Our networks are up, our traditional advertising is way down.

Jon Hickman – MDB Capital Group

Is there a point in the not too distant future where the traditional stuff will be not important any more?

Scott Kauffman

This is an opinion, and we’ll just have to see how it goes. There will always be a place for that advertising. There is going to be some natural relatively small amount of our business that is devoted to that. I don’t know whether we’ve gotten all the way to that point or if that will come in the next couple of quarters, but I do believe, I think we all do, that the patterns that we’re describing to you—growth in premium for us, growth in networks, and no growth and if anything continued pressure on traditional IAB in near term—is going to continue, and at some point, there is only so much of that that you can wring out. I don’t know exactly when that is, but we’re planning for a world where we’re not nearly as dependent on it as we have been in the past.

Jon Hickman – MDB Capital Group

Could you tell me the timeframe again for when we will see the new site or the results of the rebuild?

Scott Kauffman

On the SourceForge side, we said at the time of the next earnings call, which will be in late July roughly.

Operator

Your next question comes from the line of Robert Colbreth with Thinkequity Partners.

Robert Colbreth – Thinkequity Partners

I was wondering if you might be able to comment a little bit more detail on the targeting opportunity with you and Ohloh going forward. Is it limited to the 350K developers in terms of monitoring developer behavior and then potentially advertising across SourceForge and some of the other properties? I’m sure there’s a lot more than that, but anything else you can comment on there?

Scott Kauffman

I appreciate the question. It’s an interesting area for us. A couple of observations. We’ve actually been working with Ohloh prior to the acquisition. We wanted to explore and speaking candidly test the wisdom of combining their date with our traffice, so we’ve been to a number of agencies and clients, and we’ve begun to work with them on how to use for starters, and there are all kinds of other ways to target an audience, but for starters our table of contents of software projects on the sites as a way to target. We can do other things of course like geography, licensing languages—that’s something that Ohloh tracks in connection with various projects—and so as you add criteria into the mix, you can start to more finely slice and dice the kinds of targeting that you do. There’s one overarching point I want to make, and I appreciate your question. There is a developer cell that Ohloh enables. There is also a consumer cell. One of things that Ohloh allows us to do that we could not do before is correlate activity associated with downloading to certain types of interest or anticipated needs by consumers. So for example, Ohloh helps us understand if someone is downloading project A, they may be especially inclined to be interested in project B or an associated project—a certain kind of server, a certain piece of software—that is highly correlated with the project they’re downloading. So we’ve begun very detailed rigorous conversations with our marketing clients about using Ohloh data to target not just developers, but consumers as well.

Robert Colbreth – Thinkequity Partners

So it sounds like it’s not just a matter of observing behavior there and Ohloh, but using it as a predictive tool for what you should be doing and to raise sell-through on the premium.

Scott Kauffman

Absolutely, to get more buys and to raise the price, and one of the agencies that we spoke with representing a prominent technology company 5 minutes into the explanation said, oh by goodness, this is behavior targeting for your sites. I think that’s a nice way to capture what Ohloh helps us do.

Robert Colbreth – Thinkequity Partners

The gross margin seemed to take a step down during the quarter compared to what we had for the January quarter at least and the last few reported on the old fiscal year. Any comments on what was impacting that, shipping or order mix or has discounting also been a factor, and then finally if you can make any comments, we don’t have lot of historical information on the new fiscal year, but just anything to keep track of as we’re attempting to put forecast together in terms of seasonality with respect to the new fiscal year?

Patricia Morris

In terms of the gross margins, are you looking at the media business or are you looking at e-commerce or as a whole?

Robert Colbreth – Thinkequity Partners

I’m talking about e-commerce especially.

Patricia Morris

The e-commerce margins were actually relatively flat year over year, if you are looking at Q1 ’08 to ’09. If you are looking sequentially, we always tend to see higher margins in the fourth quarter which is the holiday season, and it’s partly volume based. It certainly is product mix related. You get more benefit from the customers during the fourth quarter as they’re buying more per order. Your shipping costs are going to be lower, so it’s kind of hard to do a sequential comparison from Q4 to Q1 from the margins perspective. In terms of the fiscal year, we commented we posted on our website the statement of operations for the four quarters of 2008 as well as the first quarter of 2009 to level set you from what the quarters look like historically, not a calendar year basis, and I think those might be helpful for you in terms of modeling the business on a go-forward basis.

Operator

At this time, I’d like to hand the call back over to management for closing comments.

Scott Kauffman

Thanks to everyone on the call. We look forward to following up with you in about 90 days’ time with a first foray into the new site designs which will give you a window into the new and improved SourceForge. Thank you very much.

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