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Ancestry.com, Inc (NASDAQ:ACOM)

Q2 2014 Earnings Conference Call

July 23, 2014 17:00 ET

Executives

Heather Erickson - Head of Global Communications

Tim Sullivan - CEO

Howard Hochhauser - CFO & COO

Analysts

Adam Spielman - PPM America

Jeff Harlib - Barclays

Operator

Welcome to the Ancestry.com Second Quarter Earnings Conference Call. (Operator Instructions). I will now introduce your host for today’s conference, Heather Erickson you may begin.

Heather Erickson

Thank you. Before our CEO Tim Sullivan begins the discussion, I'd like to take care of a few housekeeping items. In our remarks today, we will include statements that are considered forward-looking within the meanings of the securities laws. Forward-looking statements are based on current knowledge and expectations and are subject to certain risks and uncertainties that may cause actual results to differ from the forward-looking statements.

A detailed discussion of such risks and uncertainties is contained in our quarterly report on Form 10-K for the period ended December 31, 2014 which was filed with the Securities and Exchange Commission on May 7, 2014 and in discussions and other of our Securities and Exchange Commission filings. The company undertakes no obligation to update any forward-looking statements. We will also refer to certain non-GAAP measures, which, in combination with GAAP results, provide additional analytic tools to understand our operations.

You can find a reconciliation of these non-GAAP measures to the GAAP results included in our press release. A reconciliation is also posted on the company's IR website found at ir.ancestry.com, a rebroadcast of this call will be made available on our website after 6:00 p.m. Mountain Time today.

And now, I'll turn the call over to Tim.

Tim Sullivan

Thank you Heather and thanks to everyone for joining us today. I’m just going to make a few brief comments and then I’m going to hand it over to Howard, talk to our financial results. So what we would certainly say that we had a disappointing quarter from a subscriber growth perspective and this is something Howard that is going to cover a bit more deeply. Our revenue growth of 13.3% was just 50 basis points behind our Q1 rate. Our business remains healthy and we remain quite enthusiastic about the investments we’re making to expand our total addressable market and position us for continued long term growth. It's also worth noting that some of the gap between our revenue and subscriber growth in the second quarter is related to the pricing, packaging and offer page optimization strategies that we implemented around this time last year.

As you may recall about a year ago we successfully raised price on some of our longer term packages that’s both for new and existing subscribers and also guided more of our new subscribers into higher ARPU month to month subscriptions at the expense of our longer term packages which are priced at a material discount to those monthly packages.

We remain comfortable with the way these price optimization changes have unfolded but there will continue to be some downward pressure on subscriber growth relative to revenue growth in the next few quarters. Our adjusted EBITDA was up slightly over the year ago period by about 5% after adjusting for one-time items as we continue to execute on our investment plans for the business. Overall we think these results underscore that our core business remains a great high margin, high cash flow model and that we have real opportunity to continue to fund the key investments we’re making in new content, the core product and technology, new services like AncestryDNA and our international activities. DNA continues to be a particularly bright spot for us. Our data base of genotyped members is now approximately 500,000. This milestone coming roughly two years after launching this business, we’re excited about the trajectory we’re on and we think the business is supporting our thesis around TAM expansion.

In fact about 25% of our DNA customers taking the test are new to Ancestry.com. On the content side we have added more than 700 million records in the quarter included the final sets of a digitized collections made available to our collaboration with family search. These include a number of international collections in countries such as the Philippines, The Netherlands and the Czech Republic. In addition to investments in the core product we also continue to improve other key areas of the Ancestry.com network including Archives.com, our value price service with more than 4.6 billion records and more recently acquired Find A Grave which is approaching 120 million grave memorials and 96 million uploaded photos.

These services as well as smaller properties like Newspapers.com and Fold3 help us provide an array of offerings that reach consumers with varying family history research needs, very specific needs that fill in important gaps in their family stories.

Collectively offering these services helps us further broaden our TAM and also strengthen our overall market leadership. Before wrapping up I want to mention that the new season of Who Do You Think You Are? debuts tonight on TLC and we’re as excited as ever about the celebrity line-up for this season. We’re also delighted to see Who Do You Think You Are? nominated for an Emmy for two consecutive seasons and we really continue to be very proud of our association with this program and are looking forward to another successful run on TLC.

In summary our performance in the quarter we think underscores the strengthen of our financial model even in a period of somewhat softer subscriber activity. In the big picture this business is healthy. We maintain a strong market leadership position and we have continued to invest in widening that competitive mode. We think we’re very well positioned for the long term and with that I’m going to turn it over to Howard.

Howard Hochhauser

Thank you Tim. Let me summarize the quarter quickly. Financially we generated double digit revenue growth led by our DNA business. As Tim mentioned from a subscriber growth perspective it was a disappointing quarter and I will spend some time on that in a minute. Revenue for the quarter rose 13% on a non-GAAP basis to a 156 million. Revenue growth reflected 7% growth in subscription revenue driven in part by the offer page optimization Tim spoke about which had the effect of increasing revenue per subscriber but slowing sub growth.

Product revenue nearly doubled to 18 million led by our growing AncestryDNA business and FX had a negligible impact on our revenue this quarter. Turning to EBITDA, EBITDA of 55.4 million includes onetime cost of about 2.6 million relating to our appraisal litigation.

Excluding these costs EBITDA was up about 5% in the prior year period as we continue to invest across the business. Marketing spend in particular is higher by 6.6 million, about half of which was attributable to activity supporting our DNA business. Total subscribers on Ancestry.com stood at 2.109 million and in the quarter down 52,000 for March 31 or down from Q1.

The primary reason for the decrease is softness of new subscriber acquisition. We believe a few factors will play here including the DDoS attack with clearly effective sign-ups during the period’s impact including while the site was down obviously.

But the main issue in our view is marketing related. Recent several trends we have observed, we’re currently adjusting our media mix with the focus on TV in particular. Adjusting the cable networks emphasizing to best reach our targeted demos, we’re also preparing to launch for fresh TV creative later this year. These efforts will take some time to seed to generate the desired results overtime.

Another factor in the quarter in sub count are cancellations that were anticipated as part of our collaboration with the LDS Church. As part of the broad collaboration of content announced earlier this year we agreed to provide free subscription to LDS Church members.

A number of these members were existing subscribers at Ancestry.com and as we expected they have been migrating their accounts to the free offering. I want to be clear this trend is on plan with what we had expected when we initially entered into the deal.

As we work through this period our primary goal is protecting the strong financial characteristics of our model. Well we have no plans to temper our growth investment activities this year as we discussed in our last call we will remain focused on management core business performance with an eye on EBITDA and cash flow.

I want to be really clear the headline for us is that the core business is healthy meaning retention rates are solid but we did have softness in new GSA growth. To our focus on managing the EBITDA and cash flow while also fully supporting the necessary investments that position us for sustained long term growth. That concludes the prepared remarks. Why don’t we hand it back to the operator for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Adam Spielman of PPM America. Your line is now open.

Adam Spielman - PPM America

I might have missed it. Could you guys just talk a little -- can you just repeat a little bit what you were saying about optimization strategies for effective price increases and the drivers behind the losses.

Tim Sullivan

I was referencing some changes we made as we said really about a year that effectively really changed I guess the default package or guided people at a greater rate into one of our month to month subscriptions previous to this we were seeing a significant majority of our gross subscriber additions coming in to one of the long term packages. For a lot of subscribers that’s exactly the right package, we want them to come into but for some subscribers that’s a big ticket purchase if you’re not familiar with family history. So after really a significant battery of testing in the first half of last year we made that change.

And the impact the metric is really just as we experience a gradual shift from some of these longer term tenures to month to month subscribers, it sort of has a natural drag on some of the subscriber growth as you anniversary periods where you had more of those long term subs.

Adam Spielman - PPM America

Basically is it effectively higher churn as people move into monthly packages?

Tim Sullivan

Well it's higher churn if you were calculating that across all of our different subscriber packages. Importantly it's not higher churn when you’re looking at monthly subscribers year-on-year or six month subscribers year-over-year. So it's -- I guess you could call it a structurally higher rate of churn.

Howard Hochhauser

Let me jump in, I want to make a few additional points. So we made the changes Tim spoke about which directed people more towards monthly packages and a reminder monthly -- when you pay month to month price that’s higher than discounted annual price, so that contribute to an increase in average price per subscriber. At the same time we also increased price in our semi and annual up about 27% and 20% respectively. While we increased our prices so really no degradation in the long term renewal behavior and further as a reminder long term packages today, long term is defined as semi and annual are still north of -- its roughly 60ish percent of our base. So still a significant majority of our base is in long duration packages.

So our retention rates or survival rates are generally pretty consistent by package monthly, semi and annual. Did that answer your question?

Adam Spielman - PPM America

Yes can you just say, just maybe repeat the comment again I think Tim made about this will continue, what did you say about this continuing for more quarters or through the year?

Howard Hochhauser

Well look I don’t want to get into specific guidance but just structurally as we have, if we were to continue to have sort of a same ratio of new subscriber additions come in the various 10 year packages you might continue to see revenue growth ahead of subscriber growth in the next couple of periods. And I’m not providing specific guidance on how many periods but it's just sort of structurally something that you might see in the metrics.

Adam Spielman - PPM America

All right. And then final one for me can you just talk again, again this maybe a repeat Howard. Can you just say what you said about the trend, the higher marketing spend is that something that you think is paying off right now and should we expect continue to see that trend?

Howard Hochhauser

So one of the changes we made was to migrate some of our cable networks that we’re targeting specifically move to target some more of our traditional older demos. So we’re in that move now and the early results were actually positive. It's acquiring subscribers that are right within our sweet spot and we know that the subscribers are typically are more valuable, have a higher LTV. So it's early but the initial results look good. Further to the marketing point we’re launching new creative back half of this quarter and had caution that new creative you know initially may actually produce adverse results until it's season [ph] to the market but we haven't refreshed the U.S. creative with creative specifically designed for U.S. market in a long time. So it's due course time. So we’re excited about that as well.

Operator

Thank you our next question comes from the line of Jeff Harlib of Barclays. Your line is now open.

Jeff Harlib - Barclays

Just following up on the last question, can you just clarify what you said on the shift in marketing from cable to what network or?

Tim Sullivan

It's a shift in network so we’re still cable. it's instead of targeting network XYZ towards a specific demographic. We’re targeting FOX News so it's a demographic switch not a strategy shift.

Jeff Harlib - Barclays

And just again you said that you don’t think you have had an increase in churn in your longer term subscribers after throwing those price increases, it's more just attracting fewer new subs that are coming into with monthly packages is that?

Howard Hochhauser

Yes so today our mix is more monthly so a year ago we had roughly a quarter of our base was monthly. Today, it's north of 30, it's close to 34% for monthlies. So that’s what Tim was referring to. So we have more monthlies as a percentage of the base today. Definitely our new acquisition, or grow subscription additions, new people come into the system that’s where the disappointment was. So trying to be real clear that the core business is really consistent and we have talked for a while about. We have a large majority of core subscribers, being with us two plus years and there was about 45% of our base has been with us two plus years. Though the core business is solid, we’re saying the new growth was soft.

Jeff Harlib - Barclays

And can you just update the international initiatives Germany, Mexico, other geographies?

Howard Hochhauser

Yes, we see all as good as we did a year ago if not better. Things are certainly marching our plan -- I want to just remind everybody these things take time. The benefit of the business is once you’re successfully have this great mode [ph] because there is a lot of capital and time invested – our bet is it takes a lot of capital and time. So, we’re very much on plan. We’re digitizing content as we speak that’s really the spike in CapEx that you’re seeing is digitizing international content. We’re actually soft launching in Mexico this quarter. You should expect to see some activity in the back half of this year, early next year again more in the sort of beta soft launch department but really good about the progress we’re making.

Jeff Harlib - Barclays

Okay and in Germany?

Howard Hochhauser

Sure that was a comment that pertained to both markets.

Jeff Harlib - Barclays

Okay and how are you looking at CapEx, just update on CapEx spending for this year and how much of that is for the LDS Church initiative and also just an update on cash taxes as well.

Howard Hochhauser

Yes so our CapEx this year, it will be roughly 60 maybe slightly north of 60 million about 40 million of that is on content and off that 40 about 15 is related to these new investments. New international expansion investments if you will. Sorry, and your next question was about cash taxes. So that number this year will likely be single digit millions of dollars to give you a ball park range, it's a mid-single digit millions of dollars but that is still moving around and will expect it to move dramatically either direction.

Jeff Harlib - Barclays

Okay. Should that change very much looking out further?

Howard Hochhauser

I don’t want to look into the future. Our effective cash tax rate is roughly 25%. But it's on a base of, you actually have to take operating income, add back EO-related amortization and then you can tax effective.

Operator

Thank you. (Operator Instructions). Our next question comes from the line of (indiscernible). Your line is now open.

Unidentified Analyst

Couple of questions for you, can we start with the product gross margins? I missed the very beginning of your prepared comments but if we just looked at the last couple of quarters, you’re trending down with your expansion of the DNA product. Obviously this quarter we had a jump up, was that related to what you have been able to do at the cost of that product or is there something else starting that change?

Tim Sullivan

We had a catch up adjustments over onetime benefit related to our DNA business in the quarter, it's really catch-up that pertains to both Q1 and Q2. But on an on-going basis we’re actually lower the unitary cost of that business.

Unidentified Analyst

Okay. Can you give any more guidance around this? So if I look at the 40% gross margin should I think of that as high? Stable? Or should be lower given the adjustment that you guys made, the catch up?

Tim Sullivan

I appreciate the question but I really don’t want to give our guidance especially to the business. That’s sort of doubling in terms of revenue growth in one which we’re investing in. This price benefit is sort or sustainable benefit, it's not just a onetime benefit.

Unidentified Analyst

Also on DNA, and prepared release that said -- it looked like you had about a 100,000 DNA sales units from April 30 to, I’m not sure, was it June 30th or July 23rd?

Tim Sullivan

Yes that’s about right. I mean we’re specifically referring to, yes it's sales. It's the number of people that have completed the test, the test has been processed and then they are in the database but you’re right that was about a 100,000.

Unidentified Analyst

Okay and I was just curious would you be able to give any guidance, was that to the July 23rd or June 30th? Like in kind of single -- per day [ph] rough math?

Howard Hochhauser

We had our last earnings call, each of the database was roughly 400,000. Today we’re saying database is roughly 500,000. That’s as of actually today. It's not as of the end of the quarter but those are approximate numbers and to Tim’s point that’s actually data base which is obviously a darn good proxy for sales but that’s database. People have had to have return their kit and that’s processed and give them the results. We counted it in the database, it was actually higher.

Unidentified Analyst

Corporate expenses up 2 million quarter-over-quarter, was there anything specific that you’re spending actual money on there in the quarter. Is that the Mexico expansion or something else I should think about that?

Howard Hochhauser

Litigation. It's a onetime cost I referenced in my speech.

Unidentified Analyst

And then you talked about it a little bit on in terms of the marketing cost given that you guys have the TV shows, should I expect the natural outcome to be upward directly in terms of marketing spend in the back half of the year or was it just going to be shifting between different channels?

Tim Sullivan

It's a good and accurate question. We don’t want to give guidance but we have seen in the past the show. We love the show but there are costs associated with the show and marketing does tick up when the show is airing. And that’s to be cleared for a few reasons, one, we’re dealing [ph] the work and sponsoring the show but we also up weigh our media spend in and around the show.

Unidentified Analyst

Which makes sense, you should as (indiscernible). And then also you commented on previous question you’re little disappointed with the acquisition portion that your marketing spend in last quarter. Could you give any more specifics around channels that better or worse than expected?

Tim Sullivan

Okay, TV would be the channel that was disappointing if you will. You know (indiscernible) obviously is highly measurable but TV was the one that was disappointing and obviously the DDoS attack had an impact beyond just the day that we were out. We really didn’t throttle up our marketing initiatives for several days after the website was back up. I really want to make sure the site was stable and performing well for our current customers before we throttle up the marketing initiatives. So that frankly was like a 4 to 5 day pain point for us

Unidentified Analyst

And then also I had a question about DDoS attacks, just in general has that created any changes in terms of spending on security runs?

Tim Sullivan

Yes that’s a fair question. It has sparked a debate about disaster recovery business continuity. There is nothing to announce today but it's certainly has brought that, your question, more into focus.

Unidentified Analyst

Just another follow-up to someone else’s question. You guys talked a little bit about the duration impact of the subs and how they are rolling off. Could you just give a couple of data points to help us understand that better? I think what would be really helpful is if you could give us duration by segment of the subs that you added to 2Q, 13? You have given the annual information of the current subs out but to just understand what the new additions were 2Q last year. That would kind of help us in some context around how we should think about that.

Howard Hochhauser

Right. I think -- we don’t give out packaged mix by GSA but we do give out is the current subscriber inventory and that will be in our 10-Q. We could actually model that out and see how that has changed over the past few quarters that’s why again today in (indiscernible) about 26% relative -- as compared to a 34% a year ago. We could try invert of that 34% today as compared to 26%. You could track that -- get back to our Qs and our Ks and see how we trended overtime.

Unidentified Analyst

Okay. And then just to confirm your other comment was that although the duration mix has changed the cohorts of the durations, the lifetime where the attrition rates that you’ve seen you haven't really any changes in those numbers despite pricing changes.

Howard Hochhauser

I was talking specifically about our semis and annuals. We have really seen no change good or bad, it's been pretty consistent. I should say no material change good or bad. It's generally been pretty consistent in the semi and annual.

Unidentified Analyst

And the monthly, you hadn’t had the pricing change but also no change there?

Howard Hochhauser

Monthly is actually, there is just a lot more data in there. It's now -- one of the benefits of the price change, one of the dynamics it brought a lot more people in, 1995, automatically tracks the different audience than 2295 does. So you’ve seen in some cases depending upon the renewal period and actually worsening retention rate while in others you see the improvement to retention rate. So it's frankly a lot of noise in the monthly.

Operator

Thank you. I’m showing no further questions at this time. Ladies and gentlemen thank you for participating in today’s conference. This does conclude today’s program. You may all disconnect. Have a great day everyone.

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Source: Ancestry.com's (ACOM) CEO Tim Sullivan on Q2 2014 Results Earnings Call Transcript

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