QuinStreet Management Discusses Q1 2014 Results - Earnings Call Transcript

| About: QuinStreet, Inc. (QNST)

QuinStreet (NASDAQ:QNST)

Q1 2014 Earnings Call

November 05, 2013 5:00 pm ET


Matthew Hunt

Douglas Valenti - Chairman and Chief Executive Officer

Gregory Wong - Chief Financial Officer and Senior Vice President


Bo Nam - JP Morgan Chase & Co, Research Division

Nathaniel H. Schindler - BofA Merrill Lynch, Research Division


Good day, ladies and gentlemen, and welcome to the QuinStreet First Quarter Fiscal 2014 Earnings Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would like to turn the call over to Matthew Hunt with The Blueshirt Group for Investor Relations. Please go ahead.

Matthew Hunt

Thank you, and good afternoon, ladies and gentlemen. Thank you for joining us today to report QuinStreet's first quarter fiscal 2014 financial results. Joining me on the call today are Doug Valenti, CEO; and Greg Wong, CFO of QuinStreet. This call will be 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-K filing with the SEC, completed on August 20, 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, Matt. Hello, everyone, and thank you for joining us today. Revenue in the quarter was $77 million, just above the midpoint of the range we provided last call and just about flat with last year, our best year-over-year revenue performance in 8 quarters. Adjusted EBITDA was 13% of revenue, also just above what we projected. Our cash flow and balance sheet remain strong. Normalized free cash flow in the quarter was $7 million, and we closed the quarter with net cash of $37 million.

Turning to the business. Overall, we are continuing to work through challenges, but this is also a period of progress and innovation along an unprecedented range of initiatives that are important to overcoming the challenges and returning to growth.

Our Financial Services client vertical grew year-over-year in the quarter, fueled by insurance and mortgage. This was the first year-over-year growth we've seen in Financial Services in 9 quarters. Expanded product lines drove the growth. For example, policy sales in auto insurance were up 172% year-over-year, and though still very early in our rollout of that product, generated more than $1 million in revenue in the quarter. Mortgage clicks were up 67% year-over-year in the quarter and are now generating over $5 million in revenue per quarter.

Education client vertical revenue was down 5% year-over-year, the best year-over-year performance in that client vertical in 8 quarters. We are making good progress expanding our products, media and clients in Education. We saw strong growth in new segments in all of those areas, though not yet quite enough to fully offset continuing for-profit industry headwinds.

For example, growth in nonprofit client revenue was up 161% year-over-year in the quarter, now approaching $3 million per quarter. Growth among underpenetrated for-profit clients that we specifically targeted for increases in share of wallet grew 98% year-over-year in the quarter or by over $4 million. Our click product in Education grew 148% year-over-year in the quarter, and our call product was up 472%. With those combined products, now accounting for well over $3 million per quarter in revenue. We expect all of the above to eventually result in overall growth in Education in time.

I also want to say a few words about mobile, where our efforts have really heated up. Last year, or our fiscal 2013, we did approximately $20 million in revenue from mobile traffic. That was up an estimated 30% over the previous year in a year when overall revenue was down 18%. Maybe more important, we demonstrated across the business that mobile traffic, when specifically targeted and optimized, can be monetized effectively for us, for our media partners and for our clients. Our mobile efforts and initiatives this year are much expanded, and our target is to double revenue for mobile traffic year-over-year.

Turning to our outlook for next quarter. The December quarter has always been our seasonally most difficult. We expect revenue in the range of $67 million to $70 million, in line with historic sequential seasonality trends and down low- to mid-single digits year-over-year.

Adjusted EBITDA margin is expected to be approximately 10%, down from last quarter, but by the amount predicted by the seasonal revenue decline and related loss of top line leverage. We continue to invest in growth initiatives, including those I highlighted earlier.

As many of you know, Greg Wong was recently appointed Chief Financial Officer. Greg is in his sixth year with the company and was previously our Chief Accounting Officer, and prior to that, our Vice President of Finance, Senior Director of Finance and Accounting and Director of Financial Planning and Analysis. Greg replaces Ken Hahn, of course, our previous Chief Financial Officer, who is here with us on the call today. Ken is now focused full time on his Chief Operating Officer and Executive Vice President duties.

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

Gregory Wong

Thanks, Doug. Hello, and thanks again for joining us today. For the first quarter of fiscal 2014, we posted $77 million of revenue, a 2% decline compared to the same quarter last year. Adjusted net income for fiscal Q1 was $4.4 million or $0.10 per share on a fully diluted basis. Adjusted EBITDA was $9.6 million or a 13% margin. Revenue for the quarter was close to flat with the prior year, our best year-over-year performance in 8 quarters. We continue to generate free cash flow and adjusted EBITDA margin, while at the same time, spending on initiatives that we believe will return us to growth over time.

I'll now discuss the details of our fiscal Q1 results. Please see the supplemental data sheets available for download on the Investor Relations page of our corporate website. They provide essentially all of the figures that I will now walk you through.

For revenue by client vertical, our Education client vertical represented 43% of Q1 revenue or $33 million. The year-over-year decline in revenue moderated for the fourth consecutive quarter to 5% as we continue to execute on various growth initiatives focused on both product and market expansion.

To provide some context for this 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. This is a great long-term business for us if challenged in the near term. Three, clients are continuing to adapt to various regulatory changes, and we seek to be a high-quality provider and partner with our clients as they adjust. And four, initiatives in place to support our return to growth include product expansion around our relatively new click and call products and market expansion to both broaden our client base with nonprofit schools, which is the vast majority of the postsecondary educational institutions, as well as further our penetration with international markets in Brazil and India.

Our Financial Services client vertical, which represented 41% of Q1 revenue, grew 5% compared to the year-ago quarter to $31.8 million. We are pleased to have delivered year-over-year growth in Financial Services, driven by growth in our auto insurance and mortgage client verticals, the main component of that growth being progress with our broader product initiatives.

To provide some context for this client vertical, one, auto insurance is the largest market in our overall Financial Services client vertical. Two, client marketing budgets in auto insurance are substantial, and this is an early market for performance marketing online. Three, our primary growth initiative in auto insurance is the expansion of our products from which we still offer clicks, with the addition of leads, calls and bound policies. We continue to see improvement in monetization this past quarter and are continuing to aggressively ramp our investment in media, which we believe will drive meaningful revenue growth and good margins once we work our way up to monetization and media optimization curves. And four, continued success with our expanded product offerings drove our growth in mortgage.

Revenue from our Other client verticals, which include B2B technology, Home Services and Medical, represented 16% of Q1 revenue or $12.2 million. Over time, we like these verticals and the market opportunity they represent.

Moving to the cost side of the income statement, I'll provide you the results excluding stock-based compensation, amortization of intangibles and depreciation because that is how most of you model our company. Our cost of revenue was $56.4 million in the first quarter, representing a 27% gross margin. Our gross margin declined 2% sequentially, driven by the media investment to support our expanded product offerings in auto insurance. Our cost of revenue includes all the costs used to produce our measurable marketing results, including media and personnel cost.

Moving on to operating expenses. Our operating expense structure has remained stable, with operating expenses at a similar percentage of revenue as they've been historically. Product development costs were $4.2 million or 5% of revenue. Sales and marketing costs were $3.3 million or 4% of revenue. And general administrative costs were $3.4 million or 4% of revenue. All of which were the same percentage of revenue as this past quarter and the year-ago quarter.

For adjusted EBITDA, we delivered $9.6 million or a 13% margin, slightly above the guidance we provided last quarter. As we discussed on our last earnings call, we have temporarily lowered our adjusted EBITDA target as we have chosen to more aggressively spend on media primarily as an investment to grow our expanded product offerings in auto insurance.

On the tax front, our rate, as we are close to breakeven on a tax basis, is not meaningful. For your modeling purposes, we expect our ongoing rate to be approximately 40%.

Moving to the balance sheet. Our cash and marketable securities balance at quarter end was $127 million. Total debt decreased to $90 million from $93 million in the previous quarter due to repayments and we have no new borrowings. As a reminder, we have made no new acquisitions in over 1.5 years. Our net cash position is a positive $37 million. Normalized free cash flow was $6.9 million or 9% of revenue.

To summarize, we ended the first quarter with results demonstrating real progress with the initiatives around our product expansion strategy. While we work hard to return to top line growth, our balance sheet remains strong, and we continue to deliver solid free cash flow and EBITDA margins, while at the same time, aggressively spending on our long-term growth initiatives.

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

Question-and-Answer Session


[Operator Instructions] Our first question comes from Douglas Anmuth with JPMorgan.

Bo Nam - JP Morgan Chase & Co, Research Division

This is Bo Nam on for Doug Anmuth. Just 2 questions here. Can you kind of give us a little bit more color on your cost structure for next quarter that's implied in your guidance and a little bit more details on what you mean by the amount predicted by the seasonal revenue decline and resulting loss of top line leverage? And then secondly, can you just give us a little bit more detail also about some of the investments that you're making in media for the auto insurance side?

Douglas Valenti

Sure. And Bo, happy to take questions. Let me let Greg answer the first questions on the cost structure and the amount predicted by top line, and I'm happy to talk a little bit more about the details on auto media investment.

Gregory Wong

Yes. So Bo, to give you a little color on that, what we're saying is it's primarily a fixed cost issue over smaller top line. So no structural change to our margin structure. It's primarily just a seasonal loss of top line leverage over a fixed cost base of your operating expenses, if that helps.

Bo Nam - JP Morgan Chase & Co, Research Division

Okay. I mean, by specific -- so then by specific OpEx line, there's not going to give any particular standout increase in cost?

Gregory Wong


Bo Nam - JP Morgan Chase & Co, Research Division


Douglas Valenti

So you just have the seasonal loss of that top line, and it just drops right down to the EBITDA line. Given that we're not going to reduce our cost structure for our one quarter seasonal trend, you just get a natural drop in EBITDA. So I guess the main point is nothing structurally different about our EBITDA approach this quarter that we're in versus last quarter, which probably leads to your other question, which is talk a little bit more about the investments in media on the auto insurance side. As you know, we've been talking for a while now about our investment in the product expansion in auto insurance going from just clicks to policies, calls and leads. In addition to the click product, and we've talked primarily about it for a while, we talked about the acquisitions and then the implementations and the assets, and now we've been talking about adding clients. So we're getting to the point where we have enough client coverage that we can begin to grow our media footprint. We don't yet have enough client coverage that we can be fully efficient in media, but we have enough that in order to satisfy the clients that have already committed and to begin to work our way up the monetization curve or the optimization curves, we need to get going. And so we are doing that primarily around the policy product as we ramp the call center and seek to make sure we're providing enough policies to hold budget and interest to the clients we already have signed, while we build out more client coverage, which is coming quite nicely, by the way. We're doing that in some other forms of media, including pay-per-click, where we have not been that active in Financial Services or auto insurance historically but is now one of the largest drivers of revenue for our -- in fact, it's now the largest driver of revenue for our new products. And we have made great progress there in both building on our presence in those campaigns, building out volume and optimizing the margin curve. But it does, as you probably know, take quite an investment to do that as you buy into those campaigns, buy into those accounts and earn your quality score and pricing with Google. And that's probably one of the bigger devours of kind of new media investment. While at the same time, we're continuing to fight for publishers in our -- in the historical traditional business and make sure we're fighting where it makes sense strategically, where we believe we can over time and continue to improve monetization for them and us and hold those at margins that we might not choose to hold if we did not see the growth in monetization coming from the expanded product set. So those are the things we're doing, which I think are -- I would depict as necessary and on track and promising.


Our next question comes from Lauren Slabaugh with Stephens.

Unknown Analyst

This is James Rutherford [ph] in for Lauren. My question was just about the Education business and specifically the non-for-profit. I know there's been some growth in there recently. But I was hoping to get some color about your ideas of the total market possibilities out there, as well as sort of the long-term perspective on where that's going.

Douglas Valenti

Sure. The total market opportunity, we think, over the medium- to long-term is quite substantial. As you probably know, nonprofits represent about 85% of the Education secondary market versus for-profits at about 15%. Of course, the for-profits have historically been, by far and away, the largest marketing spenders. And that's why we have such a high dependence historically and still on those for-profit clients for our budgets. And that has, of course, been a problem as that industry has declined and it continued to adapt and I think getting certainly closer to its point of stability, and we're anxious to see that and to continue to serve and work with them through that. And we think we've gained share there. But they've been the biggest part of the market. The good news is that the nonprofits, while still relatively small, and as you can hear in our numbers, are growing very rapidly in terms of their marketing budgets and their presence in the ecosystem. And that's driven by a couple of things. One is the advent of online programs and the relatively easy low-cost access to technologies that allow you to put your programs online, combined with the desire for nonprofit schools to expand their footprint, their market, and very importantly, their income, partly to offset declines in funding elsewhere. And the second thing that's a big driver of the budgets for nonprofits is the advent of third parties that serve those nonprofits of various shapes and sizes. But they are third-party companies that will very often provide marketing services in student enrollment for the online programs, and in some cases, even also provide the curriculum management and technology for the online programs. So those third parties are profit-driven, ambitious, and then quite a number of them have raised a lot of capital in pursuit of what they and their investors see as a very big market opportunity that's really still very early. So that's driving the market as well, and it's a very good thing for us because we seek to be a provider of Internet marketing services to those companies, either directly or through the third parties. Very importantly, we already have their students in our media. We convert a very small percentage of the traffic that we engage, not because we're not really good at it, I'd say we probably do it better than anybody, ethically -- that does it ethically. But there are only so many folks in the media that qualify for or are willing to attend a for-profit school and there are some real defined segments where it makes great sense for them. So I think they're being rational. But a heck of a lot of the folks in our flows are qualified for and would prefer to attend a nonprofit school. So the leverage we get by making sure that we -- by getting those budgets and matching traffic, we already have 2 at, over time is going to be -- is going to be and is shown the potentially to be quite a lever on our margins, as well as on our top line. So we're quite excited about that. So the other point I might make is that similarly, as we expand our products to clicks and calls, we're picking up folks again that are already in the traffic we're paying for that would never have filled out a lead form even if they were a good fit for, for-profits, let alone nonprofits. So the product expansion, as well as the client expansion, particularly in the nonprofits, gives us a combination of, we think, great long-term -- medium- to long-term top line leverage, and you're starting to see -- we're starting to see real meaningful numbers now and growth with numbers that matter, as well as great bottom line leverage given that media, as you know, is a -- is by far and away the largest component of cost of goods or cost of services for us.


[Operator Instructions] Our next question comes from Nat Schindler with Bank of America.

Nathaniel H. Schindler - BofA Merrill Lynch, Research Division

Doug, I'm just wondering, longer term, when these market corrections end and you get back to where you think you should be with your new product, is there a path to your old standard 20% EBITDA margin that you had? Or is something structurally changed in the business that will keep it from ever getting back to those levels?

Douglas Valenti

Yes, great question, Nat. And we think quite adamantly that there's absolutely a path to 20%. I'm, quite frankly, a little surprised that we can do on a non-December quarter 12% or 13%, given that we're running auto insurance really at a negative contribution. 47% of our auto insurance is not itself, but Financial Services is 47% of our business. Auto insurance is probably 30-something percent of our business. We're doing that because if you look at the rest of the business, structurally, we're generating way more than we need to, to generate 20% EBITDA margins. And in auto insurance, we are super early in the ramping and rollout of what we are seeing to be and predicted would be much stronger monetization capabilities so that we'll be able to not only afford more media, but we'll be able to make a lot more money on the media we have. So yes, we think that over the medium- to long-term, there's a quite predictable path back to our 20%.


[Operator Instructions] And this will end our Q&A session for today. Ladies and gentlemen, thanks for participating in today's program. This concludes the program. A replay will be available 2 hours after this call and can be accessed dialing the following: 1 (800) 585-8367, 1 (855) 859-2056 and (404) 537-3406, using the code 83621517. Thank you for participating. You may all disconnect.

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