Demand Media Management Discusses Q1 2013 Results - Earnings Call Transcript

May. 7.13 | About: Demand Media (DMD)

Demand Media (NYSE:DMD)

Q1 2013 Earnings Call

May 07, 2013 5:00 pm ET

Executives

Julie MacMedan - Vice President of Investor Relations

Richard M. Rosenblatt - Co-Founder, Chairman and Chief Executive Officer

Mel Tang - Chief Financial Officer

Analysts

Jordan E. Rohan - Stifel, Nicolaus & Co., Inc., Research Division

Sachin Khattar - Jefferies & Company, Inc., Research Division

Ross Sandler - Deutsche Bank AG, Research Division

Andre Sequin - RBC Capital Markets, LLC, Research Division

Operator

Good afternoon. My name is Jay, and I will be your conference operator today. At this time, I would like to welcome everyone to Demand Media's Q1 2013 Financial Results Call. Today's speakers will include Julie MacMedan, Richard Rosenblatt and Mel Tang. A Q&A session will be made available to all attendees at the end of this call when prompted. [Operator Instructions] And now, we will turn the call over to Julie MacMedan, Vice President of Investor Relations. Ms. MacMedan, you may begin.

Julie MacMedan

Thank you, Jay, and good afternoon, everyone. On behalf of Demand Media, welcome to our first quarter 2013 conference call. You can find our related release along with supplemental materials posted on the Investor Relations section of our corporate website located at ir.demandmedia.com.

On the call with me today are Richard Rosenblatt, our Chairman and Chief Executive Officer; and Mel Tang, our Chief Financial Officer. Following the Safe Harbor statement that I will make, Rich will update you on our business. Mel will then provide details on our first quarter financial performance and key operating metrics and finish with guidance for the second quarter and year ending December 31, 2013. Following the prepared remarks, we will open the lines up for Q&A.

Before we get started, we need to make the following Safe Harbor statements. We would like to remind everyone that during today's conference call, management will make certain forward-looking statements, which are subject to various risks and uncertainties that could cause actual results to differ materially from our current expectations discussed in such forward-looking statements.

In particular, comments about our anticipated future revenue, earnings, operating expenses, page views and growth rates, as well as statements regarding our business strategy and objectives, plans, intentions, operating outlook and planned investments are considered forward-looking statements. Factors that could cause actual results to differ materially from anticipated results are detailed in our press release furnished to the SEC.

I would also like to point out that during this call, we will discuss certain non-GAAP financial measures while talking about the company's financial and operating performance, including Revenue ex-TAC, adjusted EBITDA, adjusted EPS and certain free cash flow metrics. A reconciliation of these non-GAAP financial measures to their most directly comparable GAAP measures can be found in the financial tables included at the end of our press release. In addition, unless otherwise noted, all references to traffic-related metrics in our remarks today are based on comScore data.

Lastly, before we begin, I would like to remind everyone that today's conference call is being recorded and that it is available via webcast on the Internet through the Investor Relations section of our corporate website. A replay will be available on our website.

With that, I'd now like to turn the call over to Richard Rosenblatt, our Chairman and Chief Executive Officer. Rich?

Richard M. Rosenblatt

Thank you, Julie, and welcome, everybody, to our call. In Q1, we continued to execute on our long-term vision and delivered another quarter of solid results. Our continent media business driven by eHow, LIVESTRONG and Cracked, continue to grow in traffic and revenue as we moved to the #12 U.S. web property in March, up from #14 last December. ehow.com ranked as the #10 website in the U.S. in March, up from #13 last December. An important component of this growth was mobile revenues, which grew nearly 300% year-over-year and now represents just over 10% of Content & Media revenue.

Demand Media now reaches over 126 million unique monthly visitors around the world. Our Registrar also posted consistent growth in Q1 as we continue to expand this platform infrastructure to prepare for the launch of new gTLDs. With over 15 million domains under management, an extensive network of 8,800 resellers and Name.com, a recently acquired retail channel, we believe we have a strong competitive advantage in this emerging market.

During the quarter we also began the process of separating Demand Media into 2 distinct publicly traded companies. A leading online media company delivering quality content to over 126 million monthly consumers and a leading end-to-end domain services company supporting millions of businesses and consumers. We believe that a separation will better position each of our businesses to pursue its unique strategic priorities and opportunities.

We continue to target the completion of the proposed spinoff within our previously stated timeline of the end of this year or by early next year.

Now let me discuss the developments in our Content & Media business. During Q1, we continue to improve our content creation, diversify our content distribution and position our business to capitalize on future growth opportunities such as paid content.

First, our studio. We rolled out a number of improvements to our content creation process. We continue to expand our expert segments to drive quality and reorganize our internal editorial staff around these segments. In addition, our studio continues to evolve beyond simple text articles to now support original photography and enhanced video capabilities.

Second, we continue to expand our content distribution in Q1 by growing our network of content channel partners and expanding our international sites. Based on internal data, our content channels posted a 370% increase in paid views year-over-year to over 100 million, driven by a combination of new channel partners and growth on our existing partner sites. We expanded the number of channels by 20% sequentially in Q1, including our first Spanish language content channel and our first content channel in the health category.

In addition, paid views to our international sites increased nearly fivefold year-over-year, surpassing 200 million for the first time. Visits nearly tripled year-over-year to exceed 15 million. This is all based on our internal data.

Lastly, we're diversifying our platform into paid content models. Our content platform, which combines a large intent-driven audience with a high-quality scalable process to create content, provides us a significant competitive advantage as we expand in these models. For example, in March, we acquired Creativebug, a premier online destination for arts and crafts instruction and a strong strategic fit with eHow. In 2012, almost 50 million eHow visitors viewed our top craft categories based on our internal data. We plan to introduce these eHow craft enthusiasts to Creativebug's top artists and designers, driving increased paid views, subscriptions and à la carte video purchases. We're also encouraged by other new paid content-driven products and services we've recently launched in beta.

In addition, we're leveraging LIVESTRONG.COM's 18 million monthly unique visitors and active community to launch a new video-based subscription fitness program called Stronger. This unique digital program incorporates a 30-minute high-intensity daily video series, a personalized meal plan, an interactive dashboard and an engaged community to ensure the user reaches his or her fitness goals.

In short, we are pleased with the Content & Media business's Q1 performance, as well as the progress we made in driving our growth initiatives forward. Turning now to our Registrar and the new gTLD opportunity.

In the coming months and years, the domain industry will be transformed with the introduction of more than 1,000 new gTLDs. We believe this will drive substantial industry growth via increased consumer choice, new and better branding opportunities and improved online discovery experiences for business and consumers. By adding new registry ownership and related services to our existing Registrar distribution platform, we will be a leader in driving this transformation in the domain industry. Our vision is to be the largest end-to-end domain service provider with a strong competitive position that includes the following: a large owned and operated portfolio of TLDs, expansive distribution via owned and partner network, and premium domain services that help customers buy, sell and monetize high-value domains.

We plan to make it simple and profitable for registrars and resellers to sell our gTLDs and easy for consumers to buy them and then get their business online. Our goal is to be a superior partner for anyone participating in this historic expansion of the Internet-named space.

We're pleased with many of the developments out of ICANN's most recent meetings and our first gTLD applications were approved by ICANN. We expect the sales of our first gTLDs to begin as early as Q4 of 2013 according to ICANN's currently published schedule.

The introduction of new gTLDs will drive revenue opportunities for us in 3 phases. First, there's what we call the sunrise period. This is for trademark holders only, where they have exclusive access to their domains. This could be, for example, demandmedia.attorney and that type of name may be registered during this period. This period typically runs for 30 to 60 days. After that, there's the land rush. This is where we, the registry, select and price certain high-value names, for example, realestate.attorney. This period typically runs for another 30 to 45 days. After that, there is what is called general availability. This is where any and all domains can be registered, again, at prices that we determine.

Post-launch, revenue opportunities will primarily be recurring as new domains are registered and as existing domains continue to be renewed. The enthusiasm in the marketplace continues to build and our watch list has already received more than 2 million expressions of interest for domains to be registered with the new gTLDs. In addition, we have already enlisted more than 400 resellers for this new gTLD platform.

In summary, we delivered strong Q1 results while investing in both our content media and domain services businesses to position them as leaders in each of their respective markets. With that, I'll turn the call over to Mel. Mel?

Mel Tang

Thank you, Rich. I'm pleased to report our first quarter results, which were led by strong owned and operator performance and consistent growth from our Registrar. We also delivered record free cash flow, which more than funded growth investment such as our March Creativebug acquisition. As we introduced in February, 2013 is an important investment year for Demand Media as we strived to deliver current results while focusing on long-term opportunity. Now, let's discuss our first quarter results in more detail.

Revenue excluding traffic acquisition costs or TAC, was $95.2 million, up 15% year-over-year. Adjusted EBITDA was $25.4 million, up 16% year-over-year. Adjusted EPS of $0.09 was up 29% year-over-year and free cash flow was a very strong $18.6 million, up 56% year-over-year.

Our Content & Media business drove the majority of our top line growth. More specifically, year-over-year, Q1 Content & Media Rev ex-TAC grew 18% to $59.9 million. Owned and operated revenue grew 26% while network revenue ex-TAC decreased 9%.

Excluding 2012 revenue from YouTube premium channels, which will not recur after Q1 2013, Content & Media revenue ex-TAC grew 22% year-over-year, a sequential acceleration versus 20% growth in Q4 2012.

Our owned and operated revenue increase of 26% was driven by 20% year-over-year growth in owned and operated page views to 3.8 billion, led by growth in eHow and LIVESTRONG. Owned and operated RPMs of $13.15 increased 5% year-over-year, reflecting higher RPMs on certain of our core properties and continued monetization growth from mobile traffic.

Network revenue ex-TAC declined 9% year-over-year, reflecting lower revenue associated with less content delivered year-over-year as we satisfied our final content delivery requirements under the YouTube channel's agreement.

Specifically, we saw a 3% increase in network page views to 4.9 billion due to growth from our IndieClick publisher networks, offset somewhat by lower reported page views from our Pluck social media partners and a 12% decrease year-over-year in network RPMs ex-TAC to $2.09, again reflecting lower revenue associated with our YouTube premium channel agreement. Excluding YouTube, network revenue ex-TAC grew 4% year-over-year.

On to our Registrar. Revenue was $35.3 million, up 9% year-over-year, driven by a 5% year-over-year growth in the end of period domains for which we have recognized revenue to $14 million, due primarily to the Name.com acquisition and organic reseller growth. Annualized revenue per domain or ARPD, of $10.22, increased 3% year-over-year due primarily to the maturation of large resellers in Name.com.

Turning to consolidated operating expenses. Q1 GAAP operating expenses were $99.4 million, up 11% year-over-year. Excluding depreciation, amortization and stock based comp, total operating expenses were $77.2 million, up 150 basis points as a percentage of revenue and driven by higher cost of services due to increased domains and registration costs from last year's aggressive reseller base expansion ahead of a new gTLD, increased sales and marketing, as we've invested in marketing initiatives and sales infrastructure, and product and development expense growth as we ramped headcount in preparation for the launch of gTLD. These increases were offset partially by operating leverage from G&A expenses.

As we discussed last quarter, planned expense growth aligns with the investment strategy we intend to execute in 2013, which takes us to Q1 cash flows. Cash flow from operations was $26.8 million, up 45% year-over-year, benefiting from the timing of certain working capital changes. In Q2, we anticipate that working capital changes will be impacted by the payment of the annual bonuses. Discretionary free cash flow was $22.4 million, up 55% year-over-year due primarily to higher cash flow from operations.

Free cash flow. In Q1, we generated $18.6 million of free cash flow, an increase of 56% year-over-year. Strong cash flow from operations enabled us to deliver a record free cash flow, even as we doubled our content investment year-over-year. And during the quarter, we repurchased 559,000 shares of common stock for $4.8 million.

At March 31, we had more than $200 million of liquidity comprised of approximately $109 million of cash and equivalents and $95 million available under our revolving credit facility. We had no long-term debt at quarter end. Now on to financial guidance.

We are introducing guidance for Q2 and maintaining our guidance for full year 2013. Our guidance continues to reflect the trends I discussed on our February call. We expect top line growth to be driven primarily by high teens Content & Media growth. We anticipate revenue growth to be led by owned and operated revenue growth of more than 20%, driven primarily by page view growth. We forecast growth in owned and operated revenue will be offset somewhat by year-over-year declines in network revenues due, again, to the YouTube channel's comp.

We expect high single-digit Registrar growth, which does not include any revenue from the new gTLD opportunity. It is important to note that the new gTLD launch timetable is dependent on ICANN's process, which we'll continue to monitor.

Adjusted EBITDA. Our guidance reflects continued investment in our business as we've discussed.

Turning now to cash flows. We're still on track to more than double our capitalized content investment in 2013 versus 2012 with our investment ramping up throughout the year. Additionally, we're scheduled to substantially complete the buildout of our new office space by mid-summer so expect to incur the remainder of approximately $7 million of these costs in Q2 and in the early part of Q3. Again, please note that we pay our 2012 annual bonuses in the second quarter.

Finally, depending on the timing of gTLD auctions, we may be making substantial additional investments to determine ownership rights for contested gTLDs as early as late Q2.

Now for our guidance ranges. For Q2, we are guiding to revenue ex-TAC of between $100.5 million and $102.5 million, implying 14% year-to-year growth at the midpoint. Adjusted EBITDA between $26.5 million and $28.5 million, implying a 27.1% margin on rev ex-TAC at the midpoint. Adjusted EPS of between $0.08 and $0.09 per share.

For full year 2013, we're maintaining our guidance of Revenue ex-TAC of between $411 million and $417 million, implying 15% growth at the midpoint. Adjusted EBITDA of between $100.5 million and $114.5 million, implying a 27.2% margin on Rev ex-TAC at the midpoint, and adjusted EPS of between $0.40 and $0.43 per share.

Quick update on our spinoff. As Rich mentioned, we're making progress on separating Demand Media into 2 publicly traded companies, but a large amount of work remains ahead of us. As a reminder, our guidance excludes the costs related to the spinoff activities.

That concludes my prepared remarks. I would now like to open the line up for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Jordan Rohan with Stifel.

Jordan E. Rohan - Stifel, Nicolaus & Co., Inc., Research Division

And guys, forgive me if I missed this data point on the call, but how much of your revenues come from Google today, and what was the percentage of your media revenues that come from eHow and how did that change compared to the last quarter?

Richard M. Rosenblatt

Google as a percentage of total revenues is 40% this quarter. eHow was 34% of total revenues relative to last year. Google with 36% last year, Q1 '12, and eHow at 28%.

Jordan E. Rohan - Stifel, Nicolaus & Co., Inc., Research Division

All right, and has there been any improvement in monetization at Cracked and some other properties that are smaller and not eHow?

Mel Tang

Jordan, thanks for asking about Cracked. We have continued to make progress, this was one of our larger branded quarters for Cracked and we are starting to see some momentum. We've also added a couple of new add units, so I say we are making quarter-over-quarter progress. We still have a long way to go but we feel good that we're moving in the right direction.

Operator

[Operator Instructions] The next question comes from Brian Fitzgerald with Jefferies.

Sachin Khattar - Jefferies & Company, Inc., Research Division

This is Sachin calling in for Brian. Can you talk a little bit more about the kind of the rationale behind the Creativebug acquisition? Is that primarily a subscription product? And then do you guys know how much overlap in UVs there are with eHow?

Richard M. Rosenblatt

Thanks for the question. A couple of things. One, the Creativebug acquisition, which I talked a little bit about in my prepared remarks, is really our first move into paid content. There definitely is a movement on the web where people are willing to pay either on an à la carte, so say, $20 for a course on a subscription base to get very professional content in a detailed way. So we've seen a couple of companies out there where revenues have grown substantially. We acquired Creativebug to get into that market aggressively. When we looked at eHow, we saw that there were over 15 million people that visited just the craft areas of eHow in the last year, in 2012. So we think there's real opportunities by putting the Creativebug product, which we continued to build out, against the eHow audience and be able to continue to diversify our revenue streams from advertising based to also subscription and eCommerce based.

Mel Tang

It's a combination of subscription and à la carte. You can download videos on a à la carte basis on Creativebug as well.

Sachin Khattar - Jefferies & Company, Inc., Research Division

Okay, got it. So basically, it's just -- it's pay-per-view, not advertising. And then, I guess, you guys have talked, you were trying to do something similar on LIVESTRONG and I know that's not live yet, but can you just kind of give us some updates on the timing around that?

Richard M. Rosenblatt

Sure. The project I talked about a little bit is called Stronger. We're excited about it because it's really unique in that we're not sure how it's going to be priced exactly yet, it's launching in the next couple of weeks, but you can say around $10 to $12 per month and it includes a 30-minute intense workout, much like a P90X but not quite as intense, but it also comes with a meal plan, food tracking, all type of statistics and a community. So if you really follow the program from daily tips to daily videos, in the tests we've done, these types of programs really lead to weight loss, customer satisfaction. So we think it's a really unique product. We're starting with the 18 million-plus unique visitors we have at LIVESTRONG, plus you have 100 millions of calories and foods that we've tracked throughout time and the product should launch the latest, end of May.

Mel Tang

So come on in time for you to get ready for the summer, Sachin.

Operator

Next question comes from Ross Sandler with Deutsche Bank.

Ross Sandler - Deutsche Bank AG, Research Division

A couple of questions on the gTLD. So now that the application phase is over, can you guys highlight a little bit more around, which gTLDs you ended up winning? And then, as we go into those phases that Rich laid out, what do you think pricing will look like across some of the gTLDs, can you give us a little bit more color there? And is there any plan down the road? I mean, I know it's mostly to serve as a registry but is there any strategy where you could own and build on some of these new domains that are going to be created?

Mel Tang

Yes. Let me take the first part. The application process, actually, isn't over, it's ongoing, as you will recall. They're processing the applications in order of the lottery number. So certain applications have been approved but they haven't necessarily been fully delegated yet between the initial evaluation review and when they can be available to the market. There's still technical requirements that need to be demonstrated; there's a contract that still needs to be signed with ICANN. So there's still a little bit of work in between, sort of when you get the first indication that your application has been approved to where you can get it delegated. So there's still some movement there. I think we know a few of the applications that we've been approved on but there's still -- clearly, the bulk of it, that is going to roll forward as the lottery numbers come out.

Richard M. Rosenblatt

Right. Ross, so what you'll see is we expect to get maybe the first 4 of ours in Q4 and then they'll continue to roll out throughout 2014. And there'll be revenue opportunities, as I talked about, in all 3 phases, right? So as some come out in Q4 we'll start some of the land rushes and we'll start the dip in 3 phases. So hopefully, each quarter, there will be new TLDs coming out and they'll each be in different phases of revenue opportunities.

Ross Sandler - Deutsche Bank AG, Research Division

The last question was just on, is this mostly going to be facilitation of registrations and running a registry? Or is there any, like, principal strategy that could come into play where you're owning and running domains with these new gTLDs or is that not part of that?

Richard M. Rosenblatt

Oh, got it, you're right. So as you know, the primary part of this business we're excited about is owning a large portfolio of our own gTLDs, which takes our business from a relatively low but scaled wholesale business, low-margin business to a much higher-margin business, right? With, being a registry and being able to sell those TLDs to small businesses and consumers either directly or through our network of partners. On top of that, we think there's a number of different services we could sell them on top of the gTLDs. Whether or not we're going to own our own, that's more of a media business question and I just don't think we've decided that yet.

Operator

[Operator Instructions] The next question comes from Andre Sequin with RBC Capital Markets.

Andre Sequin - RBC Capital Markets, LLC, Research Division

Maybe a bit of a follow-on to Ross' question in terms of what new revenue streams you might see from the gTLDs. As you'll be servicing extensions which other people have won, and see if there are going to be a few hundred new ones available, do you see a possibility to take marketing dollars in order to promote some over others on your sites? And then, additionally, on the last quarter, we talked a little about how the long-form video productions are post-YouTube would still be for direct pay as opposed to ad supported. How much are you actually focusing on that and have you picked any up more clients in that area?

Richard M. Rosenblatt

Great, okay. On the first question, we do see real opportunities for what are called slotting fees, and that actually occurs today. So I mean, the reason -- one of the main reasons why we're spinning off that business is we think it's the only end-to-end provider of domain services, and that everything from whether you want to buy a domain to the registry services to all the service around it to monetization, buying and selling domains. A part of that is, other people's TLDs are going to need distribution, and being the second largest registrar in the world and the largest wholesaler, we think there's a real opportunity, particularly among thousands of them to either slot our own or people that will pay to get that position within what you could call our search results, as people are trying to find domains. So we do see a real revenue opportunity there. On the long-form video, I'm not sure if I answered the question exactly, but where we have 2 forms of video we're doing now. We're doing our regular videos that come through our studio which continue to garner paybacks that fit within our media guidelines and those show up on our own sites and on YouTube and we're doing a couple of thousand of those a month, and then the higher production videos that we're going to sell either through a Creativebug model or through a stronger model and that's going to be their à la carte or paid subscription.

Mel Tang

We also -- Andre, we also do content for some of our brand clients as well.

Richard M. Rosenblatt

Was that what you meant? So...

Andre Sequin - RBC Capital Markets, LLC, Research Division

Yes. I think the last time, we talked a little about separating out the longer form versus the shorter form and how the longer form was direct pay as opposed to ad supported, and how that was kind of the plan going forward. So I mean, I think the subscription response, I think that answers my question. So, I guess, if I might do a quick follow-up on the first question, can you quantify at all how much of that you're doing now to accept slotting fees and put any numbers around that at all, or is that something we'll have to wait for?

Mel Tang

I think it's still a little bit early; you have to see how the landscape shapes up in the competitive environment, I think, before we can feel good about putting a range out there for you guys.

Operator

There are no further questions at this time. I'll turn the call back over to the presenters.

Julie MacMedan

Great, thank you. That concludes our call today. Thank you for joining us and we look forward to speaking with you again next quarter.

Mel Tang

Thank you, very much.

Richard M. Rosenblatt

Thank you. Bye-bye.

Operator

This concludes today's conference call. You may now disconnect.

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