Marchex, Inc. (NASDAQ:MCHX)
Q2 2009 Earnings Call Transcript
August 5, 2009 5:00 pm ET
Ethan Caldwell – Chief Administrative Officer and General Counsel
Russell Horowitz – Chairman and CEO
Michael Arends – CFO
John Keister – President
Ross Sandler – RBC Capital Markets
Christa Quarles – Thomas Weisel Partners
Ryan Bergan – Craig-Hallum Capital
Robert Colbert [ph]
Sameet Sinha – JMP Securities
Good afternoon, my name is Brendan and I will be your conference operator today. At this time, I would like to welcome everyone to the Marchex second quarter 2009 earnings conference call. (Operator instructions)
Thank you. Mr. Ethan Caldwell, Chief Administrative Officer, you may begin your conference.
Thank you. Good afternoon, everyone, and welcome to Marchex's business update and second quarter 2009 conference call.
Joining us today are Russell Horowitz, Chairman and Chief Executive Officer; John Keister, President; Peter Christothoulou, Chief Operating Officer; Michael Arends, Chief Financial Officer; and Matthew Berk, Executive Vice President of Product Engineering.
During the course of this conference call, we will make forward-looking statements that involve substantial risks and uncertainties. All statements, other than statements of historical fact, included on this call regarding our strategy, future operations, future financial position, future revenues, and other financial guidance, acquisitions, projected costs, prospects, plans and objectives of management are forward-looking statements.
We may not actually achieve the plans, intentions, or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions, and expectations disclosed in the forward-looking statements we make.
There are a number of important factors that could cause Marchex's actual results to differ materially from those indicated by such forward-looking statements as are described in the Risk Factors section of our most recent periodic report and Registration Statement filed with the Securities and Exchange Commission.
All of the information provided on this conference call is as of today's date, and we undertake no duty to update the information provided herein.
During the course of this conference call, we will also reference certain non-GAAP measures of financial performance and liquidity, including OIBA, adjusted OIBA, adjusted EBITDA, and adjusted non-GAAP EPS.
A reconciliation of these non-GAAP financial measures to the comparable GAAP financial measures is contained in today's earnings press release, which is available on the Investor Relations section of our website and definitions of these measures as used by us and the reasons why we believe these measures provide useful information are also contained in today's earnings press release.
At this time, I would like to turn the call over to Russell Horowitz, our Chairman and Chief Executive Officer.
Thank you, Ethan; and welcome everyone. On today’s call, I will start by highlighting second-quarter business trends, Mike will review our financial results, and I will cover our ongoing operational focus and product initiatives, before we open it up for Q&A.
Let me begin with a few key takeaways from the quarter. We are still in a challenging economic environment and visibility for many of our advertisers and partners continues to be limited. While we are seeing and hearing about signs of stabilization and slowing rates of erosion, the advertising environment remains challenging for our customers. Because of the resulting fluidity in the market, it continues to be very difficult to assess our near-term outlook.
Despite the current uncertainties in the market, by focusing on our products, our customer's needs, and our cost structure, we continue to generate cash from operations and have tangible catalysts to increase our cash generating capabilities. As a result, we have greater flexibility to invest in the initiatives we believe will determine our long-term growth.
As we remain very optimistic on the long-term opportunity in local performance-based advertising, we believe it is critically important to invest in the product areas that will enable us to fully capitalize on it. History has shown that companies who invest widely during downturns emerge stronger and better positioned because of it.
The fact that we continue to gain traction with advertisers in this environment is an indication that the products we are investing in are meeting the needs of the market. In the second quarter, we continued to add thousands of new advertisers to our reseller partnerships and direct sales channel. However, largely due to economic pressures, a meaningful number of advertisers across multiple categories reduced, and in some cases, eliminated their budgets on a year-over-year basis. Because of these reductions, the total number of active Marchex advertisers has remained largely unchanged on a sequential basis. Even in light of these macro-challenges, we continue to believe that our sales progress will translate into our advertiser totals growing this year.
With that backdrop, I would like to have the call over to Mike.
Thanks, Russ. During the quarter, we made meaningful financial progress across three initiatives. First, in reducing the risk in our business by lowering our dependence on certain financially-challenged customers in the Yellow Pages category, which as we mentioned in last quarter's call, were the top priority. Second, through expense management, we continue to focus on driving cost savings in light of a difficult and less predictable revenue environment, where visibility from advertisers is low. And third, during the quarter, we made progress in implementing long-term cost controls, as part of our reorganization efforts earlier in the year. These initiatives will enable Marchex to build greater long-term efficiencies in our cost structure.
As a result of these efforts, we continue to generate meaningful cash flow from the business. Additionally, we increased our business visibility by focusing on advertisers with healthier financial profiles and by focusing on our long-term cost saving initiatives, which are increasingly putting the business in a position to realize incremental operating leverage over the long-term.
Turning to details, revenue for the second quarter was $21.1 million. Revenue from local advertising services was $14.6 million. Revenue from publishing, otherwise known as our proprietary traffic sources, was $6.5 million.
Looking at local advertising services, while the current economic environment continued to impact advertiser’s budgets on a broad basis compared to a year ago, we did see some flattening of budgets on a sequential basis in certain areas as well as a slowing in the rate of decline in other areas, while certain verticals like finance remained weak. It is important to note that visibility remains low with advertisers as we head into the summer and budget allocations remain shorter term in nature compared to a year ago.
Furthermore, during the second quarter, Yahoo! Search Submit Pro, also known as Paid Inclusion, which is a product that provides distribution within the Yahoo algorithmic search results, accounted for a little less than $2 million in revenue. While the situation remains fluid with Yahoo and we don't expect any changes in our relationship in the near term, visibility with this product and associated revenue may be impacted by what ultimately happened with the new Yahoo/Microsoft search relationship. Demand for this product for advertisers as part of a diversified budget fulfillment approach continues to be solid, but we did want to share some specific data here in light of some of the recent changes in the search landscape. These conversations are ongoing and we will update you on subsequent calls as appropriate.
Similar to the last quarter, it is also worth noting that the year-over-year trends among larger advertisers continues to impact revenue, and is unfortunately masking the progress we are making with our products that predominantly service small and medium-sized advertisers, such as Marchex Connect and our call products.
Looking at our publishing revenue, we made substantial progress in lowering our dependence on certain financially-challenged customers in the Yellow Pages category in the second quarter. In addition, the Yellow Pages industry, as a category of advertisers, continues to be disproportionally impacted by the present economic environment. The combination of both factors led to the vast majority of the sequential decrease in our publishing revenue. As advertisers on our local search network, the Yellow Pages category accounted for 19% of total revenue, as compared to 34% in the first quarter.
While the decision to unwind our exposure to certain partners was difficult, as it had a disproportionate impact on our overall revenue for the second quarter, we believe that diversifying into other customer categories was the right long-term strategy for our business. While conversations with these partners are still ongoing, and the category overall continues to be challenged, we have made solid progress in a relatively short amount of time. In subsequent quarters, we will update you on our ongoing progress in adding business with new strategic advertisers, as well as important existing advertising partners.
Excluding stock-based compensation and amortization of intangible assets, total operating costs were $19.6 million for the second quarter of 2009. In looking at the mix in operating costs for the second quarter, excluding stock-based compensation, our service costs increased as a percentage of revenue on a year-over-year basis, largely due to the shift in our revenue mix, which led to a larger mix in revenue coming from local advertising sources.
Excluding stock compensation expense, sales and marketing was $3.2 million. During the quarter, we reduced our marketing expense as part of our efforts to find greater efficiencies in our business. It is important to note that we may spend more in the back half of the year in support of new product initiatives in our pipeline.
Adjusted operating income before amortization for the second quarter was $1.5 million. Adjusted EBITDA was $3.1 million. Adjusted operating income before amortization and adjusted EBITDA are two of the principal metrics we use to measure the progress of our business, liquidity, and our ability to generate cash.
GAAP net loss applicable to common stockholders was $1.2 million for the second quarter of 2009 or $0.04 per diluted share. This compares to a GAAP net income applicable to common stockholders of $509,000 for the same period of 2008 or $0.01 per diluted share.
Adjusted non-GAAP earnings per share, an estimate some Wall Street investors utilize as a supplemental measure of our operating progress, was $0.03 per share. During the second quarter, we generated $4.2 million in operating cash flow and had approximately $28.7 million cash on hand as of June 30, 2009.
Additionally, during the quarter, we sold a small number of nonstrategic domains that yielded nearly $1 million in incremental cash flow. There is still significant demand for high quality domains and we believe that will remain the case in 2009 and beyond. As a result, we believe we will add millions of dollars of excess balance sheet flexibility to our capital structure throughout the remainder of 2009 and beyond.
During the quarter, we acquired approximately 246,000 common shares for a total price of $1 million, bringing our total shares acquired under our repurchase program to 7.8 million shares or 23% of our common shares outstanding. While we will continue to be opportunistic with respect to share purchases, we believe it is also important to maintain a significant cash position for financial flexibility.
To provide an update on our outlook, as previously mentioned, we remain in a period of limited visibility with many of our advertising partners, particularly as we head into the summer months. And as a result of this fluid advertising environment, we are not releasing guidance today.
However, to give some additional color, first, in looking at the third-quarter revenue, although we are seeing some signs of stabilization across both revenue sources, it is early in the quarter, and as previously mentioned, visibility is still very limited. Typically, the third quarter is weaker due to seasonality, and given our limited visibility, the general economic environment, and communications from advertisers, we are taking an appropriate approach until we get more data regarding stabilization of advertiser budgets.
Second, in looking at the costs side of the equation, although we made significant progress in the second quarter, we are focused on driving greater efficiencies in our business longer-term. It is important to note that we continue to make the investments that are critical to Marchex achieving leadership in the local performance advertising market. We believe there is substantial opportunity for Marchex to continue taking market share in the coming year and we are committed to investing more dollars in our product and customer initiatives.
In terms of our ongoing investments in our products and people, we expect that we will realize increased benefits and gain certain efficiencies when we return to a more normalized advertising environment, even if in the short term, we see margins stay in the stable range. We are continuing to evaluate the business opportunities that will form our long-term cost outlook, and this is something we will update you on in subsequent calls.
In addition, we continue to work through the dynamic elements of our business to inform the metrics we are considering communicating in future reporting. Throughout 2009, the way in which we support advertisers and fulfill their budgets is increasingly centered on providing leads in various forms, including an increasing proportion of calls, rather than just click-based events. In subsequent quarters, we will share data that will highlight the progress we are making in this area of our business.
And lastly, despite the challenging revenue environment, as a result of our focus and effort to control costs beginning the fourth quarter of last year, and the ongoing momentum we are seeing in Marchex Connect and our call products, we expect to generate a meaningful amount of operating cash this year.
With that, I would like to turn the call back to Russ.
Thank you, Mike. In the second quarter, we oriented our business around two primary initiatives.
The first was to reduce the financial risks associated with certain partners for better aligning our cost structure to take advantage of the long-term opportunities we see in our business. The second was to continue to invest in the products and customer relationships that will enable us to drive financial growth and market share gains over the long-term.
We are primarily investing in and innovating on Marchex Connect and our call-based products. These products are best supporting the evolving needs of advertisers, as they increasingly adopt the models and methods that most efficiently drive new customer acquisition across online, off-line, and mobile sources.
In the coming weeks, we are releasing an update to Marchex Connect that will provide our reseller partners with enhanced functionality, including self-serve online advertiser acquisition capabilities. These capabilities will expand our partnership opportunities with large resellers, who may or may not have large direct sales forces as their primary means of acquiring local advertisers.
Additionally, we are continuing to expand our differentiated footprint of online, offline, and mobile distribution, and further innovating on our local search network, which today is a valuable and in-demand subset of overall distribution network. We will share more specifics regarding our product and customer progress in this area over the balance of the year.
And lastly, we are further innovating on our call-based advertising products, namely Pay-For-Call and Call Analytics. Incoming calls are the main growth catalyst for small and medium-sized businesses, as well as for large service-based businesses. As a result, we have continued to see momentum from direct advertisers, agencies, and resellers with these products, despite the tough economy. We are adding new Call Analytics capabilities that will enable advertisers to better measure the value of the calls they receive, and more efficiently utilize Call Analytics across their online and offline media to more fully realize the return from their advertising spends. As noted, we see adoption of call products accelerating.
Marchex has a leadership position in each of these product areas. We intend to leverage this leadership to garner an increasing share of locally-focused advertising spending, as it continues to shift to more efficient performance-based models in the online, offline, and mobile arenas. We will continue to exercise careful discipline with our cost structure, and we do expect that further efficiencies from our reorganization efforts and our narrowed product focus will deliver additional cost savings and operating leverage over the long-term.
Marchex continues to be a strong company with a healthy cash position, tangible catalysts to increase our cash generating capabilities over the long-term, and no debt. We have the right strategy with the right products, and we are winning the high-value advertising relationships that will enable us to fully capitalize on the local opportunity and create long-term value. But we cannot say today when the economy and advertiser budgets will return to a more normalized state. We believe Marchex will be in a very good position to realize meaningful long-term growth when it does.
With that, we would like to open it up for questions.
(Operator instructions) Your first question comes from the line of Ross Sandler.
Ross Sandler – RBC Capital Markets
Hey, guys. Just two questions. So first on the Yellow Pages side. So it looks like you took out another $5 million or so of Yellow Pages exposure from 1Q to 2Q. And I think you had talked about $3 million of exposure from the two most problematic partners last quarter. So are there now other partners removing in the kind of the problem area and is the 19% of revenue, is that a stable level? Do you think it needs to come down any more from there? And then I got one more follow-up.
The first part of the question is, yes, a couple of those advertisers did go down more than $3 million sequentially from Q1 to Q2 and yes, there was a decrease in some of the spend of – number of the other advertisers in that area and part of it is, raise as well as just volume. And I think one of the things that we characterized in the past is – this sector, the Yellow Pages category is a challenged sector right now, it is a challenged category, and we saw that again in the second quarter. So nothing new or particularly surprising in that sense, but it is a challenged area.
In terms of second part of the question, in terms of what we see from a stabilization perspective, I think we have seen in the last part of the second quarter, some stabilization. At the same time, we have visibility from our advertisers that is fairly limited in that sense. And just in terms of the outlook, they are giving us fairly short-term visibility and when I say short-term, they are looking out 30 or 60 days in providing that feedback to us. So that is the kind of visibility we have right now. So I think it is harder or uncertain for us to say clear-cut that there is absolute stabilization there.
Ross Sandler – RBC Capital Markets
Okay. And then, one of your largest Yellow Pages customers is not in a lot of trouble. Do you get the sense that your share within that account is stable and it is just kind of macro or is there some share shift going on there?
And then, the other question I had was the sales and marketing line was down, was kind of about half from 1Q levels, you just took out stock based comp. So what are the key areas that allowed guys to cut back in sales and marketing and is this current run rate of just over $3 million sustainable and then for how long? That is it.
So Ross, this is Michael. I will follow on the second part of the question first, which is the sales and marketing.
We do have some new product introductions in the next six-month plus timeframe, and so in thinking about the sales and marketing number just in terms of aggregate total expense, we see that there could be up to $1 million of spend just in some of the launch efforts as part of that. I think the other part of sales and marketing, there is a significant variable component that is fluid with revenue. So obviously, if revenue moves, that variable component moves along with it. So that could be the other major fluctuating part of it, but hopefully that gives you some context in where we think it will go over the next six months or so.
And this is John Keister. On AT&T, while we can’t provide all the specifics of the relationship, that relationship is very stable, the revenue is stable, and we are working with them on an ongoing basis to roll out new products that could help grow the relationship.
Ross Sandler – RBC Capital Markets
Your next question comes from the line of Christa Quarles.
Christa Quarles – Thomas Weisel Partners
Hi. I was wondering if you could give us the Yellow Pages exposure from a year ago, for Q2 2008. And then, I have a couple of other questions.
I think, Christa, it was a much larger number, multiples and I don't have this exact specifics off the top right now. So I think we can get back to you with the color but it did make up a significant portion of the publishing revenue, it was the majority of the publishing revenue if you go back into Q2 of 2008.
Christa Quarles – Thomas Weisel Partners
Okay. And then if you could just conceptually talk about the (inaudible) stock that you have there, that makes up the voting structure of the firm and how you guys think about your current independence and/or willingness to partner up with other firms, just curious to get your view and perspective on independence.
And then, the other question is, are you going to continue to repurchase stock? Again, most of my companies seem to be holding onto cash. I'm curious on the outlook there. Thanks.
Sure. This is Russ. I will answer the second one first. We do still think, based on our ability to generate excess cash, that repurchasing shares selectively make sense. And our activity was lower in the most recent quarter, and as a result, I think we added $3 million plus to our cash balances. And so, when we look at our different uses of cash, knowing that they can accrue to the balance sheet, and in turn stay there, get invested in acquisitions or other new internal initiatives or selectively buy shares, that is the ongoing question we ask. Our posture is still the same, which is adding cash on a net basis makes sense, and selectively acquiring shares, where we think it is the best use of our cash, also makes sense. And I think our behavior will reflect that going forward.
As it relates to our independence, and kind of the voting structure of our company, we work closely with the other company to start with when you look at inside ownership and you also have the differential voting. Our standards as relates to governance we think have always been really the highest in the public world, regardless of that, and we think that is important for a lot of obvious reasons. And outside of getting this question, it is really not something we think too much about, because first and foremost, we really try and focus on running our company for all shareholders. So as relates to independence, we have high aspirations for our value, and clearly, that is reinforced based on the fact that we have been meaningful consistent buyers of our own stock, and are very comfortable continuing to be, and while we are managing for disruptions in parts of our business, we think the progress we are making, while unfortunately masked with that disruption around our call products and with Marchex Connect are going to be meaningful catalysts for getting that value recognized over time.
We would love to see all of our public shareholders rewarded. They have been very patient with us. That being said, we are in a consolidating world and it is our job to listen and look at if and when that may make sense. So we don’t have a foot down on staying independent at all costs versus not, but we are here, committed to building Marchex and getting its value recognized, and extending it over time, based on what we believe are doing some things right. At some point, we believe this progress will reflect itself in our financial results, and people have been patient with us in our focus on rewarding them.
Christa Quarles – Thomas Weisel Partners
Got it. Thank you.
Your next question comes from the line of Ryan Bergan, and please limit yourself to one question.
Ryan Bergan – Craig-Hallum Capital
Hey, guys. Just give me an idea of how many domain names you sold in the quarter. I think you said you sold about $900,000 to $1 million worth, but how many actual domain names were sold. And then, what was CapEx in the quarter?
The domain names, it was 20 in the second quarter. And the CapEx was $400,000, some purchases of computer equipment and the like.
Your next question comes from the line of Robert Colbert [ph].
Good afternoon. Quick question on Yahoo. The $2 million Paid Inclusion that you noted on the call. First on, does that seem like the totality of the Yahoo relationship at this point? Also, what is your sense as to what direction Paid Inclusion could take and what is the margin on that revenue, in rough terms? And then also, I don't remember if you were still giving any update on revenue-generating events or users. Thank you.
Sure. This is Russ. Overall, we have a multifaceted, very positive relationship with Yahoo, and we see lots of opportunities to continue that and extend it. In the Paid Inclusion area, right now, you have a rapidly evolving search industry. We thought it made sense to share some specifics there, but Paid Inclusion has been a valuable part of budget fulfillment for a lot of years for customers of ours and customers of lots of other companies. And so, its value in the marketplace is clear and we think that is going to sustain itself, but how exactly that manifests itself longer-term based on what Yahoo and MSN architect – it is a question I think all of us have. And we do have a relationship with Yahoo on our publishing side, where they provide us advertisers, that is part of our yield and relevant for monetization strategy with our proprietary ad set. So, there are some areas beyond that almost $2 million we quantified.
And was there another question I didn't address?
Well, yes. If you take it as an idea. Usually, the margin contribution on that $2 million, I would imagine it is pretty high but – and then, also if you are able to give an update on the revenue-generating events that were referrals, I can't remember if you decided not to continue giving those measures, it can also be users.
Yes, actually for us it is – for Yahoo I believe it has been publicly talked about that it is a high-margin project for them. For us, it is a lower margin product. And the most important element of being able to include it is it enhances the return on investment for our advertisers amongst the variety or hundreds of sources we utilize. So we can't assure of something specific, but it is a lower margin product for us, although a valuable one for our advertisers. As it relates to revenue-generating events, it is not a metric that we are providing based on our communications throughout the quarter, but I am fine sharing with you that kind of comments that with the decline in revenue, we did see a decline in revenue-generating events.
All right. Thank you.
(Operator instructions) And your next question comes from the line of Sameet Sinha.
Sameet Sinha – JMP Securities
Yes, thank you very much. So in terms of the cost structure of the firm, since you have brought it down quite significantly, and Mike, you spoke about incremental spend about $1 million. Can you just help us – should we expect product development or sales and marketing or a combination; and in terms of investing for more longer-term products, where else could you be investing?
And my second question would be, when you look at the longer-term, where do you see the Yellow Pages relationship going, maybe even if you look in 2010, any sense of where that could go? Any chances you could expand those relationships beyond what you have right now?
Well, I will start with the first part of the question, and that is more than the cost structure. I think I have shared before that our fixed cost structure still makes up about half or slightly more than half of our total cost arrangement. That remains the case today. I think if you look at where some of our investment areas are, we feel comfortable with the level of investments today, with some of the product development initiatives in the rollout. And again, we are very cognizant of where the revenue is, but we don't want to under-invest, until we think that the levels that we are at right now from a cost perspective are more stable.
And as I noted before, there are a couple of places in the marketing area, where if we do have in the near-term some of our product rollouts, that we do expect to spend a little bit more from a sales and marketing perspective of up to an aggregate of about $1 million over the next six months, based on – there is some variability there based on the timing of the rollouts. But as I mentioned, the remainder of the cost structure, the variable component is more variable, just as the revenue moves and then the fixed cost structure, obviously, it is not fixed in the long-term, but we do have some stabilization, we feel comfortable from the development perspective.
This is Russ, Sameet. The second question relating to Yellow Pages customers and how much of our business they may represent going forward, when you look at how we grow our business and form relationships with the end advertisers, we sell them directly and we reach them through resellers, some of them are Yellow Pages companies. And so when you prospectively look at our business, we think that we have got an opportunity to grow our direct relationships meaningfully, if that turns out to be the higher growth area, that is fine. Within the reseller initiative, the Yellow Pages companies we work with today tend to be the more stable ones. And so, we think there are opportunities to grow it. We also know that there are broader thematic challenges they face. And so, it is not that we can say there aren't risks in that area at this stage and prospectively. So on that basis, since they represent a part of what we do in the reseller area, and we do expect to see our direct relationships grow, perhaps at a faster rate, the elevated contribution could grow, but at the same time, decrease in terms of overall contribution to Marchex’s business.
Sameet Sinha – JMP Securities
Okay, thank you.
Now, I would like to turn the call over to Russell for closing remarks.
We appreciate everyone's participation and we will be speaking with you all in the coming quarter. Thank you again.
This concludes today's Marchex second quarter 2009 earnings conference call. You may now disconnect.
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