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Executives

Stacy Ybarra - Sr. Director, IV

David Binder - CFO

Will Lansing - President and CEO

Analysts

Clay Moran - Benchmark

Scott Kessler - Standard & Poor's Equity

Eric Martinuzzi - Craig-Hallum

Rich Tullo - Albert Fried and Company

InfoSpace Inc. (INSP) Q2 2010 Earnings Call August 2, 2010 5:00 PM ET

Operator

Good day ladies and gentlemen, and welcome to the second quarter 2010 InfoSpace earnings conference call. My name is Alicia and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be conducting a question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's conference, Stacy Ybarra. Please proceed.

Stacy Ybarra

Good afternoon, and welcome to InfoSpace's second quarter 2010 earnings conference call. I'm Stacy Ybarra, Senior Director of Investor Relations. On the call today are Will Lansing, President and Chief Executive Officer; and David Binder, Chief Financial Officer.

During the course of this call, InfoSpace representatives will make forward-looking statements, including but not limited to use statements regarding InfoSpace's expectations about its products and services, outlook for the future of our business and growth initiatives, acquisition strategy, and anticipated financial performance for the third quarter of 2010. Other statements that refer to our belief, plans, expectations or intentions, which may be made in response to questions, are also forward-looking statements for purposes of the Safe Harbor provided by the Private Securities Litigation Reform Act. Because these statements pertain to future events, they are subject to various risks and uncertainties, and actual results could differ materially from our current expectations and beliefs. Factors that could cause or contribute to such differences include, but are not limited to the risks and other factors discussed in InfoSpace's most recent quarterly report on Form 10-Q on file with the Securities and Exchange Commission. InfoSpace assumes no obligation to update any forward-looking statements, which speaks only as of the date the statement is made.

In addition, during this call our management will discuss GAAP and non-GAAP financial measures. In the press release, which has been posted on our website, and filed with the SEC on Form 8-K, will present GAAP and non-GAAP results along with reconciliation tables and the reasons for our presentation of non-GAAP information.

Now I will turn the call over to Will Lansing, following his comments David will review second quarter results and third quarter outlook. And then we will open up the call to your questions.

Will Lansing

Thanks Stacy, and good afternoon. I am pleased to report that InfoSpace had another solid quarter. Revenue was $59.4 million up 36% from the prior year, and adjusted EBITDA was strong at $10.9 million. Both our core search business and the newly purchased eCommerce business grew compared to the same period last year. Before I turn the call over to David to discuss the quarter in detail, I would like to give you a quick update on our businesses and reiterate our strategy for growth through acquisitions.

First, our businesses the biggest piece of our core business is distribution. As expected, our distribution business has stabilized and is showing signs of growth after the declines we saw in the first and second quarters. We are pleased with the quality of traffic in the network and believe we have a strong value proposition for our customers. In the second quarter we signed six new distribution partners, and have deals in the pipeline for the second half of the year.

Regarding our eCommerce segment, we recognize that Mercantila is not at the scale or profitability that we are looking for in a transformational acquisition. That said, we are extremely pleased with the assets, the team and the growth prospects of the business that we purchased. Our eCommerce segment is performing much better than expected on the top line. We are seeing growth rates at over 50% compared to last year. We are investing in the business, and are currently focused on platform development to improve margins as well as category extensions.

We believe there is a tipping point where we have enough scale that we recognize that we start to optimize margins and maintain our strong growth rate. While we are pleased with the growth in both of our business segments, we believe the real value is going to be created on the acquisition front. We remain committed to our strategy of deploying the roughly $223 million in cash to buy a business or businesses that lets us use the $800 million in NOLs faster.

What we look for, are businesses with high profitability and good growth profiles. Ideally, not heavily dependent on Google or any other particular player, but with the success for the business lies largely within our own control. We continue to have a wide aperture for the types of deals we might consider. Of course eCommerce is one area for expansion, but we continue to look beyond eCommerce.

With that I'll turn the call over to David to share with you the quarter’s financial details.

David Binder

Thanks Will and good afternoon. As Will mentioned, we completed the purchase of Mercantila's eCommerce business in the second quarter. Because of this transaction, we revised our presentation of the financial results and now report in two segments. The first segment is our core InfoSpace business, which includes our search services as well as our new initiatives such as Haggle and WebPosition. The second segment is eCommerce, which includes the newly acquired Mercantila business.

I'll start today with a review of our financial results in the quarter for the entire business, and then give greater details on the performance of each of the segments, or end my comments with guidance for the third quarter.

Total revenue in the first quarter was $59.4 million; this represents an increase versus the same quarter last year of 36% and a decrease from the prior quarter of 4%. Growth from the prior year was driven by better performance of our search business as well as the acquisition of Mercantila. Versus the prior quarter, declines in our core segment were partially offset by the revenue generated by Mercantila in our eCommerce segment.

Adjusted EBITDA in the quarter was $10.6 million; nearly double the performance from the same quarter last year and higher than the first quarter of 2010 by 68%. These positive trends were primarily driven by our acquisition of assets from our distribution partner, Make The Web Better.

Net income in the second quarter was $670,000 equal to $0.02 per diluted share. This result includes the charge of $3.5 million associated with the acquisition of Make The Web Better. This charge reflects our current expectation that the performance of these assets will be better than was expected when we first completed the acquisition. The expectation of greater revenue and cash flow also leads to higher earn out payments which is reflected in this charge.

We ended the quarter with $223.4 million in cash and short-term investments equal to $6,000.21 per share, and we continue to hold no debt. The fully diluted share account in the quarter was $37.4 million and we ended the quarter with $35.9 million basic shares outstanding.

Now turning to the details of our two segments, I’ll start with our core segment, which includes our search services as well as our new initiatives, such as Haggle and WebPosition. In the quarter, our core segment generated $52.4 million in revenue, representing a 20% increase versus the second quarter of 2009, and a decrease of 15% versus the prior quarter. Growth versus the prior year was driven by better performance in both our owned and operated and distribution products, with the lion share of growth coming from our owned and operated properties. Versus the first quarter of 2010, we saw an increase in revenue from owned and operated, however this was more than offset by a decrease in distribution.

In the second quarter our owned and operated sites represented 35% of our core segment revenue, up from 29% in the second quarter of 2009 and up from 19% in the first quarter of 2010. This increase is driven by the addition of Make The Web Better as one of our owned and operated websites. These acquired assets generated $7.4 million in the quarter, equal to 14% of our total core revenue.

In comparison our distribution business equaled 62% of the core segment revenue, down from 71% in the second quarter last year and from 78% in the first quarter of 2010. This decrease is driven by removing Make The Web Better as one of our distribution partners in the second quarter this year. In the second quarter of last year, this partner represented 7% of the total core revenue and equaled 15% of total core revenue in the first quarter of 2010. Excluding the effects of Make The Web Better, our distribution business grew by 16% versus the second quarter last year and decreased by 16% versus the first quarter of 2010.

Gross margin from our core segment in the second quarter equaled $25.7 million or 49% of revenue, versus the second quarter of last year this is an increase of $6.3 million and versus the first quarter of this year an increase of $5.1 million. The increase in gross margin in dollars is driven by the acquisition of Make The Web Better, which represented approximately $7.2 million of gross margin versus $500,000 in the second quarter of 2009 and $600,000 in the first quarter of 2010.

Income from our core segment equaled to $11.3 million or 22% of core revenue. This is an increase in income versus the second quarter of 2009 of $5.9 million, and versus the prior quarter of $5 million. Again, it’s important to note the positive impact of the acquisition of Make The Web Better which drove $7.1 million of core income in the second quarter.

Now turning to the performance of our eCommerce segment, in the second quarter we generated $7 million in revenue between the closing date of our Mercantila acquisition on May 10, through the end of the second quarter. Normalized for the full quarter, this would have equaled approximately $12 million of revenue. We are pleased with the growth in top line performance with this business, with volumes growing at a rate greater than 50% compared to the same period last year.

Gross margin for our eCommerce segment equaled to $1.1 million or 15% of eCommerce revenue. Included in this amount is revenue less the cost of product, shipping and credit card fees. The eCommerce segment lost $700,000 in the quarter in line with our expectations when we purchase the assets.

Now for our outlook, in third quarter of 2010 we expect revenue to be between $61 million and $65 million, adjusted EBITDA between $7 million and $8 million and net income between $500,000 and $1.5 million, or $0.01 to $0.04 per diluted share. Our guidance reflects an expectation of lower revenue from our owned and operated search services due to the continued attrition of Make The Web Better assets. In contrast, we are seeing growth in our distribution services versus the second quarter which will partially offset that decline. Additionally, we expect continued growth in revenue from our eCommerce segment, however as we are investing in infrastructure and personnel to support the long-term opportunity, we expect a loss from the segment between $1 million and $2 million in the quarter.

With that, I will turn the call over to the operator and take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Clay Moran from Benchmark. Please proceed.

Clay Moran - Benchmark

Thanks good afternoon, couple of questions, I guess I will give them all to you upfront. First, just curious you said distribution was trending a little better this quarter, just wondering if you’ve basically removed the distribution partners that you had planned to and if that process is done for the time being? Second question, is there anything more you can give us to help us to get a recurring EBITDA number given the seasonal aspects of the business? And then lastly, Mercantila can you remind us if there is a significant seasonality to that business, and if so, do you think you are at the scale where in the fourth quarter that could actually be profitable? Thanks.

Will Lansing

With respect to the distribution yes we are pretty happy with the quality of our traffic today, and we feel like we’ve done the work we need to do on the partner side. We are happy with where we are for now. I’ll let David take the recurring EBITDA question and I’ll just speak to the Mercantila point on seasonality. It is a seasonal business, it’s a fourth quarter seasonal business, and we also are benefited by tremendous upward trajectory on trend. So, the combination of seasonality and the overall growth trend bode pretty well for the fourth quarter. I don’t want to represent that we will be profitable in the fourth quarter, but we are feeling good about that outlook.

David Binder

On the seasonality of the core business, second and third quarter tend to be a little rough from us in terms of user use of the search services, and we would expect third quarter to reflect that. Fourth quarter usually bounces back with more volume and greater revenue per click.

Revenue per click. I think that for our business, we will see some of that in the underlying trends. One thing to keep in mind now is that the Make The Web Better business that we purchased generated $7.1 million of revenue in the second quarter and as we expected that business is in a natural state of attrition, I think those revenues will continue to come down through third and the fourth quarter, that will partially offset some positive trend that we might otherwise see in the core business segment.

Clay Moran - Benchmark

Yes, David I know the question you may not be able to answer, but what I was trying to get is sort of is there a level of recurring EBITDA meaning excluding Make The Web Better that you can sort of share with us a little bit given all the recent changes, all the puts and takes we have had, it’s a little bit more difficult to discern maybe what recurring EBITDA is on an annualized basis, is that something you can sort of give us some color on?

David Binder

One thing that I will provide is that we have a core segment income that we reported this quarter and we also try to break out the impact, the total performance from the Make The Web Better business. If you normalize the total income, lest Make The Web Better, that’s a little bit lower than we think is achievable from the core business today.

I would reiterate that we are hopeful that the distribution business is at a footing now, where we will begin to grow again. So looking at that math for the second quarter, we will hopefully start to expand.

Operator

Your next question comes from the line of Scott Kessler from Standard & Poor's Equity.

Scott Kessler - Standard & Poor's Equity

I have two questions, the first is obviously your business model is becoming more complicated as was alluded to not only in the question but in your prepared remarks. I'm wondering what kind of benchmarks we should be looking for from you in terms of how you are managing these new businesses and also maybe give us a better way to think about what types of acquisition activity we can look for from the company.

My sense would be maybe on the smaller size to kind of help round out some of the businesses that you have been talking about. But any related details as to how these will kind of grow overtime either through internal investment or of course acquisition.

And then the second quick question is, can you give us an update on stock repurchase activity if you have authorized shares, when it may expire and plans you might be considering along those lines.

Will Lansing

I think we are very much interested in building organically and building through small acquisitions and potentially bigger acquisitions, our eCommerce segment. So, we are constantly looking at things that make sense, either from the standpoint of technology or from the standpoint of category extension or completely new categories.

So, I think that part of the question and statement is accurate, we are interested in rounding out, augmenting, building on the eCommerce segment. That said, I would not rollout either a bigger acquisition in eCommerce or a bigger acquisition outside eCommerce because our real strategic goal in terms of doing M&A is to deploy the cash in a way that helps us to monetize the NOLs more rapidly and to build as much value as we can over the longer term.

And in order to do that we are looking for businesses that are growing nicely, that are profitable and can be more profitable, that good growth trajectories we are looking for attractive margins, we are looking for businesses that turn on our own skill set as opposed to being a dependent and reliant as our search businesses on Google and Yahoo for example.

So that’ our goal and that may or not may not take place around the eCommerce. That could easily be an acquisition beyond eCommerce, I wouldn’t want you to think that we are just focused on eCommerce.

We are committed to making that space successful and we are looking at things in this space.

Scott Kessler - Standard & Poor's Equity

Because if I could just interject, I think a lot of folks at least myself believe that for a long time, even prior to your arrival, the thought was there was this considerable amount of cash right building and there really wasn’t a lot of activity around M&A.

Now it seems like you’ve done a couple of deals, you have identified areas of focus and it would seem that you already kind of have a template in place, in terms of what you are looking to do. You’ve done some of theses things before. You’ve brought in additional staff at expertise in this area. So I think most people would argue that they expect more of the same from you guys and are encouraged by that because at this point how much is the cash earning from our term perspective?

Will Lansing

Not as much as we would like. Good point Scott, we actually agree and we are really focused on M&A as the biggest tool to unlocking value and we recognize that the NOLs are undervalued by the market today because we don’t have as clear path as we’d like to have for monetizing them quickly.

So deploying the cash is absolutely the way to go and we are very focused on and your point about building the team to support that is absolutely correct. We bought in Stephen Hawthornthwaite as a managing director from Savvian came in to run our corporate development efforts. He is very strong and helpful there and so yes, we have a good pipeline and we are pretty excited about the prospects there.

Scott Kessler - Standard & Poor's Equity

If you can just provide an update on your thoughts not related to another use of cash buyback, that would be great.

Will Lansing

I think in the absence of our goals of monetizing the NOLs, the buybacks would make a lot of sense because it’s hard to imagine buying profits more cheaply than the two times EBITDA that our search business goes for today and so start buyback from that standpoint make some kind of economic sense.

The challenge for us is if we buyback stock, it shrinks the shares outstanding and in so doing it, it constraints our ability to do as much acquisition as we would like to do to book by using up cash and also by shrinking the denominators and the number of shares for equity for us to do the M&A that we would like to do. And so I think what it does, what it really does is it pinches our ability to monetize the NOLs as quickly as we’d like to. So I would say that well one should never say never, it’s not in the immediate horizon.

David Binder

The first part of your question is around on metrics and how we look at it (inaudible). Obviously the business has become more complicated as we are now looking at two different segments and we think about metrics for success distinctly across those two segments.

With our core segment, we are looking at that cash flow number or the income number, $11.3 million and we think in the short run that’s coming down because of the addition of Make The Web Better, it’s a naturally attriting business, but eventually we want to stabilize that and get it back to a growth position. So it’s stabilizing and expanding that income. On the eCommerce segment, we are very excited about the growth opportunities, so maintaining the growth rate which we are currently seeing at about 50% year-over-year and then getting it first to our breakeven on an income basis and then getting into a good margin given the eCommerce segment. So maintaining growth first, but then getting it to a positive income position is how we think about the key metrics.

Operator

Your next question comes from Eric Martinuzzi from Craig-Hallum.

Eric Martinuzzi - Craig-Hallum

My question is on that growth. Based on your commentary I presume $12 million run rate even though it only got $7 million because of the stub period, but that $12 million run rate, that implies we were roughly $8 million a year ago, is that correct?

David Binder

Yes, that is a good way to look at it. Now keep it in mind that, we are not reporting prior year revenue, so that’s a good proxy.

Eric Martinuzzi - Craig-Hallum

Okay so given that growth rate and your desire to get the business to breakeven, are you investing on the cost side for the Mercantila, for the eCommerce platform such that if we just took a ruler out and took that growth rate and backed into a number from the gross margins of the business. I am trying to figure out when this thing becomes profitable, if there is other investments, obviously it pushes it out further.

Will Lansing

We’re definitely not investing at the same rate the revenue’s growing. So those two lines will cross and we think that will pass in 2011

David Binder

And we think that we are reporting at 15% gross margin percentage. There is some upside to that metric as well and as well as growing together to scale profitability.

Eric Martinuzzi - Craig-Hallum

And for dealing with the eCommerce now, you are seeing the good growth there, can you report on which products, which segments are most responsible for that?

Will Lansing

There is a little bit of seasonality in it and it varies, in the earlier part of the year you get a good fitness business and as you know we are in treadmills and ellipticals and things like that. We had a pretty attractive business in Trampolines recently. And then we expect that the business is going to shift, the product mix will shift in the fall with seasonal, with where the consumer goes.

Eric Martinuzzi - Craig-Hallum

So more, maybe furniture and less fitness, that sort of thing?

Will Lansing

A little bit, although we are growing nicely on all fronts, so I hesitate to say anything is pulling off, but the mix will shift a little.

Eric Martinuzzi - Craig-Hallum

And then your current headcount, where is it today, where do you expect to be at year-end?

Will Lansing

Were around 170 heads right now. We are going to go up a little bit as part of that investment in Mercantila. But we won’t be over 200 people with both businesses combined, we will be under that.

David Binder

A less that 200 on December 31.

Operator

(Operator Instructions). Your next question comes from line of Rich Tullo from Albert Fried and Company.

Rich Tullo - Albert Fried and Company

Did you say that there was a $3.5 million charge in relation to the acquisition of Make The Web Better because they were earning that at a higher rate?

David Binder

That’s correct. When we first acquired the business, there was an earnout in the consideration. We had to estimate the value of that earnout and the initial charge was low given how the business has performed since we first closed. And so that $3.5 million charge equals the incremental payments we expect to make over the life of the [it].

Rich Tullo - Albert Fried and Company

And was that number included in the guidance you previously gave for the quarter?

David Binder

That was not.

Operator

There are no further questions at this time. This concludes the question-and-answer portion of the call.

Will Lansing

Thank you.

David Binder

Thank you.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation, have a great day.

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Source: InfoSpace Inc. Q2 2010 Earnings Call Transcript
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