Following the Q1 earnings release, I feel it is appropriate for me to update my position on YuMe (NYSE:YUME). In my last article I speculated that YuMe guided conservatively and would beat the Q1 revenue estimates. They did this and by a nice margin. Sales came in at $37.3M compared to estimates of $35.36M for the quarter. That's the good news. The bad news is that Q2 revenue estimates are $40M-$42M with analysts expecting $44M. Although the company never provided previous Q2 guidance, analysts will have to lower expectations for the current quarter. However, the FY2014 guidance of $190M-$200M and the EBITDA of $2M-$8M is unchanged. Given that this full year guidance was pretty aggressive when intiated by the company in the Q4 2013 release, I'm happy to see it reaffirmed.
CEO Jayant Kadambi acknowledged the fact that predicting YuMe sales on a quarter by quarter basis rather than annualized is a difficult task. During the Q&A period on the earnings call in response to a question from Needham's Kerry Rice he notes:
As I had said before, our business is lumpier than all of you would like from a percentage basis and given the numbers we are talking about $30 million, $40 million, $50 million, a $1 million move of a campaign affect the percentage points a lot more from a sort of - if you just eyeball lid perspective then I wouldn't read too much into it.
Also notable is that CFO Tim Laehy stepped down to pursue an opportunity with an early-stage growth company, which pretty much sums up his career and should come as no surprise to anybody who follows this company. Laehy has never spent more than two or three years with any company, normally leaving following a liquidity event, in this case the successful IPO in 2013. I did speculate in my last article about YuMe that given Leahy's history of acquisitions that there is a strong probability that the company's sale is imminent. So while I now have to cross this theory off my list in the very short term, the actual departure is a relative non-event, and any fear based selloff (which is common when a CFO leaves) should be bought.
Let me clarify that this is not a vote of non-confidence in the company and I highly doubt that Laehy was asked to leave. In fact, his three year tenure with YuMe was about the longest he has ever stayed with a company. Since becoming a CFO in 1997 he has worked for five different companies. He left two following acquisitions and left another two companies following successful IPOs. One company he worked for simply failed to attract a takeover bid and he naturally left following that. Overall, he has had a very impressive career and I suspect we will see Laehy shortly in a new gig taking the next YuMe public, albeit in an unrelated industry as he stated on the call.
Moving on, the quarter over quarter customer metrics are sharp and exceeded my expectations. One big complaint about the Q4 2013 numbers was that the average spend per customer decreased by 14% over the previous period a year prior. In Q1 the spending reversed and actually increased 3% on an ARPU basis. Due to the rapid growth in customer acquisitions, in this case 37% YOY, the ARPU is challenged because customers ease in to spending over time. So when the customer growth rate is high the ARPU growth rate will naturally be low or negative. Here is how Kadambi described the growth paradox that the company finds itself in:
I think our average revenue per advertising customer was still somewhere around $100,000 specifically, $104,000 and it increased 3% from Q1 of 2013 when it was just over $100,000. So, it's a 3%, 4% increase. Similar to the question from Kerry, I think the growth in advertising customers is overshadowing the ability for these customers to move into large spending and it's too early. So that's the trend you are seeing.
This is a good problem to have when you are looking long term, but at a casual glance to an uninformed investor it may not make sense. That is why I am explaining it. Also, I was also impressed with the strong cash and cash equivalents position at the end of Q1. Cash strengthened on a quarter over quarter sequential basis almost 20% to nearly $2 per share or $58.7M. With zero debt and positive EBITDA, this leaves YuMe in an extremely comfortable position to see out their long term growth and profitability plan of 18%-22% EBITDA margins without ever having to worry about taking on debt or selling equity to raise capital.
The biggest catalyst that is not baked in to FY2014 guidance is Video Reach, YuMe's programmatic offering. In response to Piper Jaffray analyst Gene Munster on the call, Kadambi stated that he feels that this new product will be a new source of revenue but he is being conservative by not factoring it in at all in to the current guidance. He expects to offer additional guidance based on its performance in late this year. Additionally, at the Deutsch Bank Internet Conference in March, Kadambi stated that programmatic will not pressure profit margins. This is owning to the strength of the proprietary YuMe PQI algorithm, which led to an impressive 600 basis point margin expansion for the quarter over the same period last year.
Another big advantage that YuMe has over the competition is their R&D efficiencies. While at a cursory glance it appears that R&D is on the decline, that is simply not the case. It is just getting more efficient. The reason YuMe is able to be so efficient is that their R&D department is located in low cost India, where there is no shortage of highly skilled technical help. In response to Citi's Mark May, Kadambi said that they hired 20 new technical people in India in Q1 and expect that to accelerate through Q2 and Q3. This is despite an overall drop in R&D spend on both a sequential quarterly and YOY basis. So the technical headcount is rising but the spend is dropping. This is great efficiency as YuMe moves its technology department headfirst in to low cost India from high cost Silicon Valley, giving the company a very unique competitive advantage.
While overall operating expenses as a percentage of revenue were roughly in-line compared to the same period last year, it is worth noting that sales and marketing spend as a percentage of revenues increased. Specifically it was up about 50% over the same period last year, which outpaced the 40% revenue growth. This is a key metric that analysts always have their eyes on. As expected the question was presented as to what is the reasoning for this increase and when can we expect the trend to reverse? The reasoning that Kadambi provided was that the company is in the right place at the right time eyeing many International opportunities that it feels it has a unique opportunity to capitalize on in the market. He states:
So, we continue to aggressively invest overseas in sales and marketing. We think that the timing is good now to continue to grow and while as you've seen, we've maintained pretty decent fiscal discipline throughout our growth.
I think from a timeframe perspective, I think it will be into 2015 before you see us temp down on sales growth, because there is a few markets that we need to get into. I'd say you'll see that trend continue through Q3, Q4 before it - at the very least before it starts to normalize.
Lets not forget that this is a company with nearly 30% YOY sales growth (40.1% in Q1), a positive EBITDA, high gross margins of 46%-48% and is on the cusp of a fundamental shift to monetize TV ad dollars online. For all of those reasons and more, YuMe continues to be one of the most attractive long term investment opportunities in the market for those with patience and a minimum 12 month outlook. Despite day to day volatility that is common among small cap tech stocks, it will not get much cheaper due to the strong balance sheet and relative performance compared to its peers. Any weakness on these already historically depressed levels makes it a no-brainer buy and hold.
Disclosure: I am long YUME. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.