InfoSpace Q3 2006 Earnings Call Transcript

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InfoSpace, Inc. (INSP)

Q3 2006 Earnings Call

November 1, 2006 5:00 pm ET


Stacy Ybarra - Director, Investor Relations

James F. Voelker - Chairman and Chief Executive Officer

Allen M. Hsieh - Chief Financial Officer, Chief Accounting Officer


Joe Cobrayan - JP Morgan

Gordon Hodge - Thomas Weisel Partners

Jeff Shelton

Clayton Moran - Stanford Financial Group

Derrick Wood - Pacific Growth Equities

Paul Bieber - Piper Jaffray


Good day, everyone, and welcome to the InfoSpace Q3 2006 earnings release conference call. Today’s call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Stacy Ybarra, Director of Investor Relations for InfoSpace. Please go ahead, Stacy.

Stacy Ybarra

Good afternoon, and welcome to InfoSpace's third quarter 2006 earnings conference call. I am Stacy Ybarra, director of Investor Relations. With me on the call today is Jim Voelker, Chairman and CEO, and Allen Hsieh, Chief Financial Officer.

Before we get started, I want to remind you of two things. First, this is an investor call. Accordingly, we will only be taking questions from the investment community.

Second, this conference call contains forward-looking statements relating to the development of the company’s products and services and anticipated future operating results. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected.

Factors that could affect the company’s actual results of operations include, but are not limited to, the progress and costs related to the development of the products and services, the timing of the market acceptance of those products and services, our dependence on companies to distribute our products and services, the performance of our systems, the effectiveness of the development and implementation of our strategy, possible changes to that strategy, the ability to retain key contracts and personnel, and the ability to successfully integrate acquired businesses.

A more detailed description of certain factors that could affect actual results of operations is contained in the company’s most recent annual report on Form 10-K and quarterly report on Form 10-Q, as filed from time to time with the Securities and Exchange Commission in the section entitled “Factors Affecting Our Operating Results, Business Prospects, and Market Price”.

Listeners are cautioned not to rely on these forward-looking statements which speak to the company’s prospects only as of the date of this conference call. The company undertakes no obligation to update publicly any forward-looking statements due to new information, events, or circumstances after the date of this conference call, or to reflect the occurrence of unanticipated events.

Now, I will turn the call over to Jim. Following his comments, Allen will review the third quarter financial results and fourth quarter outlook. Then we will open up the call to your questions.

James F. Voelker

Thank you, Stacy, and welcome to the call today. While third quarter results were in line with our projections, the main development of the quarter was the pending loss of significant revenue from one of our carrier partners, and our consequent restructuring efforts.

Over the last three years, our mobile strategy has focused on driving growth through the licensing, production, programming, and delivery of content, the development of mobile applications and discovery tools, and the development and hosting of portals and store-fronts for our carrier partners.

The goal has been to create an end-to-end ecosystem that served both carriers and content owners, and to build a substantial audience for content and, further out, for advertising.

This yielded a business model that allowed us to grow in a linear fashion with our partners, as the audience and content types expanded.

Since 2003, this model worked quite well, delivering a five-fold increase in revenues and substantial margins along the way. That success encouraged us to invest in a broader set of content in anticipation of higher speed networks and more capable devices, and a direct-to-consumer portal that leveraged the scale of our mobile content business with the carriers.

However, rather than broadening, content sales consolidated around label tones. When we were informed by our largest carrier partner that they intend to form direct relationships with the major record labels beginning in early 2007, we determined that our content business would quickly become sub-scale and support scant investment going forward.

Therefore, we have made the decision to align costs with expected revenues as quickly as possible. During the quarter, we announced plans to reduce headcount by approximately 250, or roughly 30% of our workforce, to absorb the impact of the revenue loss in 2007.

As part of the restructuring, we have also suspended investment in Moviso, our direct-to-consumer site, as well as new content initiatives.

Our remaining media business is expected to generate positive cash flow. We intend to fulfill all of our contractual obligations and maintain and update our current catalog of ringtones and graphics in the ordinary course of business.

As a result of these cost-cutting measures, in the third quarter, we incurred a $58 million restructuring charge, of which $45 million are non-cash charges. This was a very difficult decision, but an important one in our effort to achieve long-term profitability. Entering the fourth quarter, we are focused on completing the restructuring and transitioning this portion of our carrier relationship as seamlessly as possible. Our mobile portal, store-front, and search services are largely unaffected by this restructuring.

Now, to our results. Despite the challenges we faced during the quarter, we posted strong revenues. Revenue in the third quarter was $96.3 million, up 16% year over year, driven by strength in both our online and mobile segments. We added $4 million to our balance sheet to end the quarter with $411 million, or more than $13 per share of cash.

Our first task now is to execute through the transition and continue to build upon the strength and success of our mobile technology and online discovery products. Our online business continues to generate strong cash flow. Dogpile, our signature meta-search site, was recently ranked highest in overall customer satisfaction among search engines, according to a survey by J.D. Powers and Associates. This recognition illustrates the value of our meta-search technology.

Our online directory capabilities have been extended to mobile via InfoSpace Find It, where we added spoken turn by turn directions and integrated performance based advertising, along with 15 million points of interest to enhance the search experience.

InfoSpace is the first to integrate performance-based advertising to a mobile local search product, providing increased exposure to thousands of businesses.

Our mobile services are in high demand and growing as well. We currently provide portal and/or search services to three of the top four carriers in the U.S., and we recently signed Virgin Mobile U.K. to a long-term contract.

More than 15 million users accessed our portal and search services in the third quarter, and that is an increase of over 60% from one year ago.

Going forward, we remain on solid financial ground, with a strong balance sheet and a profitable business.

As search and advertising move to mobile devices, we are well-positioned to capture value in the chain. Our goal is to continue providing the best tools and technologies to help users discover and enjoy content and information, whether on a mobile device or online.

We will achieve these goals by sharpening our focus on search and mobile infrastructure services, and putting the right cost structure in place for future growth.

With that, I will turn the call over to Allen to give you more details on our quarterly financial results and outlook. Allen.

Allen M. Hsieh

Thanks, Jim, and welcome to our call today. I will start with a review of our third quarter results, and then turn to our fourth quarter outlook.

Revenues for the third quarter of ’06 were $96.3 million, an increase of $13.1 million from the third quarter of ’05, and sequentially up by $452,000 from the second quarter. As we previously discussed, as a result of the loss of pending revenue from label tone business with a major carrier partner, we recorded a restructuring charge of $57.8 million in the third quarter, which I will discuss in greater detail later.

As a result, for the third quarter of ’06, our adjusted EBITDA was a negative $51.3 million. Excluding restructuring costs, our adjusted EBITDA was $6.5 million. On a comparative basis, third quarter adjusted EBITDA, excluding the restructuring charge, decreased $7.5 million compared to third quarter ’05, and was sequentially down by $2.4 million from the second quarter.

We had a net loss of $46.7 million for the third quarter of ’06, or $1.49 per share. In addition to the restructuring charge, please keep in mind that starting in 2006, we record stock compensation costs and also provide for GAAP income taxes. Excluding the restructuring charge and stock compensation costs of $4.8 million, and the related income taxes, net income in the third quarter of ’06 would have been $3.4 million, compared with third quarter ’05 net income of $11.3 million.

Weighted average fully diluted shares were $31.3 million for the third quarter of ’06.

Now, let me turn to our segments. Starting with mobile, revenues in the third quarter of ’06 were $47.7 million, up $8.7 million from the third quarter of ’05, and up $2.3 million from the second quarter. Our gross profit was $18.2 million, a decrease of $617,000 from the third quarter of ’05, and an increase of $770,000 from the second quarter.

Our gross profit margin was 38%, down compared to third quarter ’05 gross profit margin of 48%, but in line with our second quarter gross profit margin.

Turning to online, in the third quarter of ’06, revenues were $48.6 million, up $4.4 million from the third quarter of ’05 and down $1.8 million sequentially from the second quarter. Segment gross profit was $30.4 million. Gross profit increased by $3.7 million from the third quarter of ’05, and was down by $1.9 million sequentially from the second quarter. Our gross profit margin was 62%, up compared to the third quarter ’05 gross profit margin of 60%, and down 2% sequentially.

In the third quarter of ’06, search distribution revenues continued to account for approximately 60% of the portion of our online revenues coming from search.

Now, I will provide more detail on our restructuring charges. We implemented a restructuring to align our cost structure in anticipation of the loss of revenue from label tone sales starting in the first quarter of ’07. As a result, we recorded a restructuring charge of $57.8 million.

The cash portion of the restructuring charge totals $13.3 million, which includes severance related costs of $6.3 million, charges related to certain content agreements of $5.6 million, and lease termination charges related to excess facilities of $1.4 million. The non-cash portion of the restructuring charge includes a write-off of $44.5 million of intangible assets, which includes good will.

In addition to the charge recognized in the third quarter of ’06, we expect to record additional charges in the future, ranging from $3 million to $4 million for severance stock compensation and lease termination costs as we exit certain excess facilities.

Looking to the balance sheet, we ended the quarter with cash and marketable investments of $411 million, up $4 million from the end of the second quarter, and we have zero debt.

In May, we renewed our stock repurchase program and authorized a spend up to $100 million. To date, we have not purchased any shares under this renewed program.

Now, turning to the fourth quarter outlook, given our restructuring plans and the uncertainty surrounding the short-term effects of that plan -- for example, timing of employee departures -- we are only providing revenue guidance for the fourth quarter.

We are currently experiencing reduced activity and monetization trends in both mobile and online businesses. As a result, we expect revenues in the fourth quarter to be down compared to the third quarter, and range between $91 million and $93 million.

This concludes our prepared remarks. I will now turn the call over to the operator and we will be happy to take your questions.

Question-and-Answer Session


(Operator Instructions)

We will take our first question from Imran Khan with JP Morgan.

Joe Cobrayan - JP Morgan

This is Joe [Cobrayan] for Imran. He is multi-tasking right now on another call. I had a question about your search distribution business. I wanted to know, first off, if you are adding more distribution partners than you are losing on a year-over-year basis, or a quarter over quarter. I also want to know how the renewal process goes for those. Are you seeing pressure on TAC? Are you happening to be more aggressive in those deals? Just some color there.

James F. Voelker

I will take the last part of that first, on TAC. You know, TAC has been relatively very stable across the last three years -- and Allen, if you disagree, you can say so -- but it has been very, very stable. TAC depends on volume, so there are some situations when you are re-upping with a customer, and by the way, our numbers have been very, very good in that regard. We have over 100-some partners. We have had less than five that have not renewed, so very, very good on renewals.

If someone’s volume has grown substantially through the period, you would see some adjustment there, but it is more volume-related rather than kind of market-related and market shifts.

We do continue to add partners and, as I said, our renewal rate has been very, very high. We add them at a much stronger clip than we lose them.

Joe Cobrayan - JP Morgan

One quick follow-up, if I may. What is the key driver behind the wins that you guys do get in your distribution partners versus a competitor’s product out there?

James F. Voelker

We monetize extremely well. I mean, the fact of the matter is that we have such great -- our meta-search technology has just gotten better and better and better over the last few years, and for a variety of reasons. As we look at the different search engines, whether you are talking about algorithmic results or paid results, there is a real divergence in the types of results that we get from different search engines, and so the overlap is very, very small on any given query between a Google, a Yahoo!, an Ask, or an, or an MSN.

Having, frankly, from a monetization point of view, where that comes into play is just having the breadth of advertisers we have. We have a much higher chance of returning a really good, relevant add result than any other engine because we have a much broader set of advertisers to draw from.

That, and really our monetization scheme in terms of the way we rank and display paid results, that yields the highest click-through rates, frankly and the highest monetization rates of the industry. That is how we win.


We will take our next question from Gordon Hodge with Thomas Weisel Partners.

Gordon Hodge - Thomas Weisel Partners

Good afternoon. Just a couple of questions. You mentioned that monetization has dropped a little bit in the fourth quarter. Could you just comment on that? Is it pricing or is it click-through, or clicks? Maybe give a little color there.

I guess a bigger question is, you have $411 million of cash and it sounds like you are not inclined in the near-term to invest heavily in the mobile business. Just curious what kind of things you might be mulling over for the use of that cash. Thank you.

Allen M. Hsieh

In terms of the sequential decline in the fourth quarter, just to be clear, it really is the transactions are going down or have been suppressed both in the mobile media business and in our search distribution, and so really it is a function of a lower activity that we have seen in both the media and our mobile distribution partners -- I am sorry, the mobile media products and our search distribution partners exiting the third quarter going into the fourth quarter.

James F. Voelker

In terms of the cash situation, it certainly is one of the substantial assets that the company has, and one of the things the Board and the management are always cognizant of is how to use our assets and the best way to enhance value. That being said, we do not comment on any specific kinds of transactions we would be looking at.

I would not cross mobile totally off the page yet. Remember, we still have a really good, thriving services business here in mobile, so it is possible there will be things out there that could enhance it, but if you are thinking about the mobile content side, Gordon, you are right. It is highly unlikely we would be investing there.

Gordon Hodge - Thomas Weisel Partners

In terms of investing in your content, would you consider getting back to a level of scale by looking at acquisitions, or is that not --

James F. Voelker

I really would not comment on that at this time.

Gordon Hodge - Thomas Weisel Partners

A question on your non-ring tone business. How should we think about margins there? It looks like they are substantially higher on the ring tones. Obviously if you lose most of the ring tone business next year, and then you have some costs, obviously -- what should we be looking at in terms of run-rate revenues?

Allen M. Hsieh

Gordon, one of the things that you look at here is that, just to give you some insight, as we mentioned before, 80% of our mobile revenues come from the mobile media business, so the inference is that the other 20% comes from our portal and services business.

In terms of the gross profit margin with respect of that, that type of cost, when you go down a line, most of the content distribution costs that we have for that particular business really relates to the ring tones download business. That does have a higher profit margin, a much higher profit margin, because it has very little variable cost from a third-party standpoint.

Gordon Hodge - Thomas Weisel Partners

Thank you.


Our next question will come from Jeff Shelton with [inaudible].

Jeff Shelton

Thank you. Jim, you have about $1.2 billion of NOLs. Is there any way you can realize value from them in the near-term, either through the acquisition of a tax-paying entity or otherwise?

Allen M. Hsieh

The utilization of an NOL is highly dependent upon obviously by being a profitable company. It is hard to imagine something very near-term to utilize the entire $1.2 billion of NOLs in the near-term.

James F. Voelker

The options are kind of as you outline them there, Jeff. One is create your own profit. We are doing that, but to Allen’s point, at the rate, we are profitable no matter what here, the size of our company, basically. It would take quite a while to do that. There are other options, but nothing that we would comment on.

Jeff Shelton

Secondly, could you provide an update on distribution for your mobile search product?

James F. Voelker

Sure. There is a variety of them. Let’s see. You might be thinking about InfoSpace Find It, which is the mobile local search product. Distribution there, we have it on Sprint right now, and we have just released the 1.2 version of that, and so excited about that. Growth there has been slower than we would like, but still steady, and we continue to get subscribers.

I think for us in that product, it has been quite a learning experience in terms of how you manage to deliver a downloadable app. It is the first downloadable app we have done, and how do you manage to get that placed in the right spots on the decks of the phone and get the marketing materials associated, et cetera, but I would say that the users who have downloaded it continue to use it and the usage has been good there.

We have a WAP version out there as well, of InfoSpace We have not put substantial marketing dollars behind that as of yet, as we are continuing to perfect the product. When we think it is ready for primetime, we will do it.

We also have some other search products in place that are more a portal search, if you will, or a little bit broader. We are in place on Cingular there, and happy with the results as well.

I would say that this is a very hot topic across almost every carrier between here and Western Europe, and we are actively in on just every pitch there is out there. I think over the course of the next six months or so, you will start to see carriers choose directions there and we think we are very well-positioned and have done a good job in the early ones that we have been implemented on.


We will take our next question from Clay Moran with Stanford Group.

Clayton Moran - Stanford Financial Group

Hi, this is James filling in for Clay. I have two questions. I guess first, I am trying to get an understanding behind the idea to stop the Moviso investment. My understanding was that was not really carrier related. Also, the online assets, it seems like they have not had a tremendous amount of growth in the last year. What is the resurgence in confidence in those assets? Thank you.

James F. Voelker

I will take the first one first. Moviso was, you are right, it was not directly related to carriers in the sense that it was its own independent distribution channel, but for us, it was a matter of scale overall of the business that we have. Having the carrier channel produce well over $100 million a year of revenue on media gave us a scale, an operational scale, that we could invest in Moviso with incremental dollars, if you will.

Once that business became sub-scale, that advantage was no longer there, and so, at least at this point in time, we have suspended the work on that. I think that kind of sums it up. We had always felt that was something we could build off of, the advantage of scale. When that advantage went away, it became sub-scale.

In terms of the online business, the online business has several different kinds of revenue generators within there, and we have been really pleased with the growth in our O&O business -- that is our owned and operated. We have seen again, in some levels of our distribution, a really strong growth and in some levels of our distribution, not growth at all. In fact, it declined.

That has been something that we have seen over the last number of years, just in terms of particularly on the distribution around, you might call it opportunistic kinds of search applications out there that kind of come in, do pretty well, and then move away.

If we look at the vast majority of our traffic, about 40% of our search traffic is our owned and operated sites. That is solid. We do not grow users a great deal. We do manage to grow queries from the users we have, pretty solidly, and rates continue to grow and all those accrue very well for us.

Much of our distribution traffic, and I kind of look at it as contributing to gross margin, all but about 15% of our total gross margin we think is very solid traffic, and that just continues to grow pretty well, too. But you do have these opportunistic things that come and go. That happens for all of us -- for us, for Google, and for Yahoo!. It just has a slightly more noticeable impact with us.


(Operator Instructions)

Next, we will go to Derrick Wood with Pacific Growth Equities.

Derrick Wood - Pacific Growth Equities

I was hoping to get a little more color on your exit of the mobile content business, and where the contracts are at. Could you give us a sense of the linearity in the step-down of the mobile content revenues? You did indicate that one customer was going to terminate the contract at the beginning of next year. What about the other contracts with some of the other carriers?

James F. Voelker

What we reported was that it would be a substantial amount of our revenue, and I am not sure if we put it into a percentage at that time, but the number we reported was around $55 million for the first half of the year, so a pretty substantial amount.

That one customer was a significant amount of that business. As we said, it is going to start in the beginning of the year and then it is going to transition off. We have been notified by that customer that that transition time should take around six months, but we do not know the firm start date yet, so that is what makes it a little bit foggy for us to do, but again, this is a substantial amount of revenue.

In terms of the other customers, it does not really have a huge effect on the other customers, and so we will continue to be, to maintain our contractual obligations there, or we intend to do that. We just kind of, to some degree, have to play this out by ear as we go and see how this transition works.

Derrick Wood - Pacific Growth Equities

So you are going to continue to have some sort of infrastructure for the ring-tone business for the foreseeable future? That is not going to go away?

James F. Voelker

That is correct.

Derrick Wood - Pacific Growth Equities

What about the mobile games? Could we get an update on what your strategic --

James F. Voelker

We will maintain the structure with games and with graphics as well.

Derrick Wood - Pacific Growth Equities

A little bit more color on the guidance for Q4. First of all, should we expect a decline in ring-tone because of the changes that are going on? What is the historic seasonality of the online business in Q4? I had thought that it was up sequentially. Is there something going on in the industry for you to believe that transaction volumes are going to be down in Q4? Could you just give me a little more color on that?

Allen M. Hsieh

First, on the mobile media side, the decrease in activity is not the result of the whole label tone business. It is just that we have seen this decline here exiting the third quarter, entering the fourth quarter, very similar to last year. There are a number of different factors out there, none of which are in our control -- new song releases, new handset releases, carrier promotions.

We are not exactly sure, the pinpoint exact reason why the decline, but there is that decline that we have seen right now, and that is why we are providing lower guidance for the fourth quarter.

In terms of the search side of the business, or the online side of the business, it really is related to some of the decreases in our search distribution partners. Our owned and operated sites, which Jim mentioned earlier, are doing well and have the same increase and same seasonal up-lift. It is just that some of the activities from a few of our distribution partners is going down, that we saw exiting the third quarter and entering the fourth quarter.

Derrick Wood - Pacific Growth Equities

One final question -- obviously the mobile content media business was a big part of your revenue and a big part of your growth initiatives going forward. This is the first time you have talked publicly about the change in the business strategy. Is there anything you could give us in terms of what is your next, new strategic growth focus that was different from before? Are you going to put more emphasis on search? Could there be new technologies or areas that you could purchase and plug in and leverage your relationships with the carriers? How else could you leverage your mobile position going forward?

James F. Voelker

Well, that is the question in front of us. At this point, we have been very focused on getting through this transition. As you might imagine, it has been not only difficult but time-consuming. Even though these things are not pleasant, there are good ways to do them and bad ways to do them. We have been focused on trying to do this in as good a way as possible for our employees and our shareholders and for our customers. Our focus has been there.

Our focus right now is to really continue to execute on the businesses we are in. Again, we are in a great cash position here, so we do have assets to work with. We create cash. We will be looking to see what kinds of things we can add on to these businesses to generate more growth.

Your earlier point is correct. This was a lot of our plan around growth and around growing audience. I mentioned that number of audience of about 15 million people who used our portal services and search services on the mobile side. There was pretty close to an equal amount, or maybe even larger, that used it on the download side. We just did not talk about it because it will not be ongoing.

We were building a substantial audience there, and now we have to back off and say okay, how do we take it from here?

Stacy Ybarra

Operator, I think we have time for one last question.


Your final question will come from Safa Rashtchy with Piper Jaffray.

Paul Bieber - Piper Jaffray

This is Paul Bieber for Safa. Most of my questions have been answered, but could you just give some color on the monetization trends? I think you spoke a bit about the volume, but I might have missed what you said about the monetization trends. Secondly, just a housekeeping question. I did not see the pro forma net income number in the press release. What was that number?

Allen M. Hsieh

Let me start back on the last question on the net income. Just going back, if you exclude the restructuring charge and the stock compensation charge that we took, it was roughly around $3.4 million.

In terms of the monetization comment, that really actually feeds in on both the reduction in activity. As a result, we have lower monetization. In particular, on the search distribution side, we have tiers going on there, so what happens is with lower monetization, we do not get some of the same volume rates that we usually get.


At this time, we have no further questions coming in. That does conclude our conference for today. On behalf of InfoSpace, we would like to thank you all for your participation and we hope you enjoy the rest of your day.

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