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Conversant Inc. (NASDAQ:CNVR)

Q2 2014 Earnings Conference Call

August 6, 2014, 04:30 PM ET

Executives

Erik Randerson – Investor Relations

John Giuliani – Chief Executive Officer and President

John Pitstick – Chief Financial Officer

Analysts

Kerry Rice – Needham & Company

Brian Fitzgerald – Jefferies & Co.

Colin Sebastian – Robert W. Baird

Tom White – Macquarie

Youssef Squali – Cantor Fitzgerald

Eric Martinuzzi – Lake Street Capital Markets

Deb Schwartz – Goldman Sachs.

Shyam Patil – Wedbush Securities

Peter Stabler – Wells Fargo Securities.

Mitch Bartlett – Craig-Hallum & Co

Sumit Sinha – B. Riley & Co.

Operator

Please standby. We are about to begin. Good day everyone, and welcome to the Conversant Second Quarter 2014 Earnings Call. At this time, all participants are in a listen-only mode. Later we will conduct and question and answer session. As a reminder this call is being recorded. At this time, I would like to turn the call over to Erik Randerson, Vice President of Investor Relations. Please go ahead.

Erik Randerson

Thank you. Good afternoon, and welcome to Conversant's Second Quarter 2014 Financial Results Conference Call. Joining me on the call today are John Giuliani, Chief Executive Officer; and John Pitstick, Chief Financial Officer. This call contains forward-looking statements that involve risks and uncertainties. Actual results may differ materially from the results predicted, and reported results should not be considered as an indication of future performance.

Important factors that could cause actual results to differ materially from those expressed or implied in the forward-looking statements are detailed under risk factors and elsewhere in filings with the Securities and Exchange Commission made from time-to-time by Conversant. These documents include, but are not limited to our Annual Report on Form 10-K filed on March 3rd of 2014, recent quarterly reports on Form 10-Q, and other current reports on Form 8-K. Conversant undertakes no obligation to release publicly any revisions to any forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

I'd now like to turn the call over to John Giuliani, Chief Executive Officer of Conversant. John?

John Giuliani

Thank you, Eric and good afternoon everyone. Thanks for joining us today on our second quarter conference call. I will provide a brief overview of Q2 results and an update on our progress on key initiatives. Then I’ll turn the call back over to John Pitstick, who will provide a more detailed review of the numbers and our guidance for.

So, let’s go into Q2, first of all, Q2 was a solid quarter with strong execution against many of our strategic priorities. Our financial results were generally consistent with the outlook provided last quarter. We still remain capable and we believe we are capable of delivering higher revenue growth over time and that continues to be our focus. The market continues to change and we are investing and integrating to improve our positioning for where the market is headed.

With that in mind, I am confident we are making the right investments to get there. For example, we continue to invest and hire aggressively. We’ve added significant talent in the areas of technology operations, sales and analytics among others.

In May, we brought in a strong leader in HR. Last month, we brought in another strong leader to head up our Media product development. It’s gratifying to witness the impressive caliber of candidates who believe in the Conversant’s vision of personalization.

Our recent success in attracting top talent is strongly edified and underscores our successful rebrannding efforts. So, let’s talk about some of the things we’ve done in Q2 and in the past we talked about a common ID and what the common ID does it allows us to link up throughout our many businesses so we can identify devices people at the same person.

So, last quarter we talked about after that common ID was put together, that our online presence or reach was second only to Google. This quarter, as we look to what we process in a single month, we processed over a trillion bid requests through our real-time bidding.

We also monitored over 1 billion clicks in a month and we handled 2 billion actual customer transactions. So bid numbers that helps us to run our business and brand with scale and have better understanding of the consumer. So that common ID links to something and what it links to is a common attribute store. And so, in Q2 we completed our common attribute store. It will be operational in Q3 and what that does is that it allows us to take the common attributes we find, put it against common IDs so that we can treat them similarly throughout the marketplace.

If you think about our SET acquisition and the integration of SET into our media front-end campaign manager which is currently underway as well as our video ad server, we now can attach them to that common attribute store. What that does for them is it allows them to have access to our more custom audiences it also leads to more inventory for them, better targeting and increased margins.

But also, the common attribute store then benefits from all the video categorization that SET uniquely that and with that then we are now able to better understand consumers interest and tailor advertising to them.

As we speak of video, video remains an area of investment focus for us it represented a significant share of our hiring in Q2. We anticipate that will continue in the future as well.

Other Q2 initiatives. We built a new European datacenter in June. It went operational in July which enables high volume RTB inventory in Europe where in the past we’ve had none. That will be both for European and US customers. This datacenter allows for RTB ad serving and profile building. It also paves the way for product expansion later in Q4 this year as well as Q1 2015 coinciding with our rebranding in Europe.

But short-term, right now, it enhances delivery quality and access to inventory. So significant initiatives gained in Q2 that should have both immediate and long-term business impacts.

In the area of sort of matching/consumer recognition, unique inventory and quality inventory have three things I want to talk to you about. First, we again, built – in June, we’ve built a new high speed PDUP data store and if someone wants some help on PDUP I’ll do it with some technical conversations later. It allows for continuous matching from device to ID to household. So what this means is, with very little latency, we are constantly matching to IDs before there is any attrition which should lead to expanded matching and increased recognition.

And it also within about 10 minutes of that match, 10 minutes or so latency, it’s sent over and could be immediately used for real-time bidding. Second under the quality and viewability, we’ve always been a performance-based situation with our media. So, if media doesn’t perform, we’ve developed techniques to sell select non-performing sites, publishers and inventory, because we are very aligned with our advertisers. If we can’t make that perform, we don’t get paid.

Recently, viewability has been a more common theme in the industry and we’ve developed our own proprietary viewability measurement technology to evaluate different publishers’ inventory and impressions and we met with great success. We are now expanding that by the end of Q3, we should have that on all capable browsers that allow.

And some of the things that it actually looks at are the actual device, the screen size as well as the bandwidth that will come through to make sure the ad ha s the shot to be viewable. So, significant improvement. We would be doing that and as we have as we’ve been growing this out on a proactive basis.

It leads to higher quality, higher quality inventory for everybody will also allow us to manage cost because we won’t be buying this up it doesn’t work as well. Lastly, I want to leave you initiative is, we’ve established our internal private exchange with direct publishers and so what that does is, it allows RTB and our programmatic valuation evolve with the inventory that’s coming through our direct publishers.

It enhances the quality of what we are getting for overall a customer mix it adds unique three users or scale and increases performance because we are able to add the elements of programmatic in there as well. Roughly, it’s approaching about 20% of our inventory.

We hope to build that or we would expect to build that about a third or half and expand that number. So, big accomplishments in Q2. So let me take a brief moment and discuss our two operating segments.

First, affiliate marketing. We had another solid quarter with double-digit revenue growth and strong profitability with affiliates. Looking forward, comparisons get a little tougher as Q2 marks the one-year anniversary of Google Shine On’s affiliate network. In the past year our team has been very focused on successfully integrating, ramping up those new clients with that now behind us.

What we found some of those new clients we had to go resell because they had a urgent need last year. Our team has been very diligent about doing that and keeping those folks moving forward and now we refocus our effort though on new business development outside of that initiatives.

In addition, I am excited about a new initiative in affiliate that leverages our media segment’s CRM capabilities. We’ve established a first-party data integrations for pilots with multi-channel retailer clients we have.

Using their data, to help them understand how customer profitability metrics compare across various marketing channels. So for example, we will enable these retailers to compare the average order value, the total life time value of consumers in the affiliate channel to other channels which will further demonstrate the ROI of our solution for our clients. So nice break through. We will be back when we find more in the pilot, but excitement around that.

Turning over to the media segment real quickly before I turn it back to John or turn it over to John, we are increasingly integrating our traditional display in mobile and video audience to offer cross-device campaigns for our clients.

Marketers and agencies understand the connecting and audience of individual consumers across their digital devices, delivers superior results. I am going to close at the end with some initiatives around that but tie-in all these to the same audience we think is a strong differentiator for us. We are seeing value and recognition in the marketplace.

Another key benefit of that is, campaign efficiency, our cross-device campaigns eliminate ways by controlling the number of impressions delivered to any individual consumer. We can now – we can frequency cap at the individual level versus the device level so we more – app to match up what the desires of our advertisers are with the actual delivery because of our persistent consumer profiles allow us to identify this consumers better than anybody else across the different digital devices.

In summary, we continue to make considerable progress executing the One Conversant integration station which further strengthens the differentiation within a highly competitive market.

This progress is evident in the higher media segment growth that John will discuss along with the other financial data; key driver in these expectations is Q3 video revenue. We expect that revenue shortly whether it’s Q3 or shortly beyond there to exceed our entire last year.

In addition, as I look at Q3, we are looking at a midpoint of really delivering our best growth in six quarters. Our best growth in median six quarters and at the midpoint we are looking at double-digit.

But I think the range includes double-digit overall for the quarter and again, we are not there yet but the things what we’ve done to position ourselves for the future and the changing market and the differentiated products that we have we are very proud of but at the same time we’re improving our overall performance in the short-haul. We’ve been comfortable with the trade-off of profitability to invest into this growth profile and we think that growth profile is there in the future to garner for us.

So, with that, I am going to turn it over to John P and let John give you the specifics.

John Pitstick

Great, thanks. John. Good afternoon everybody. So Q2 revenue was $137.4 million near the midpoint of our guidance range and an increase of 7% from Q2 2013.

Affiliate Marketing revenue increased 11% to $40.6 million and came in at the high end of our guidance. After four quarters of solid double-digit growth in Affiliates, we expect Q3 Affiliate Marketing revenue to decelerate a bit due to the stronger and tougher comps from the GAN wins last Q3.

In Media, our segment revenue there increased 6% to $96.7 million right in line with our guidance range with the segment and existing growth with the past couple of quarters.

More importantly, with some of the traction we are seeing in our investments that John alluded to we are forecasting a return to double-digit revenue growth for Media at the midpoint of our Q3 guidance. Further improvement in our traditional display business and continuing strong revenue growth attributable to video are driving the improved outlook for media in Q3.

And we think we are just beginning to scratch the surface on the video opportunity in particular. One area where we had a couple of mis-steps and in otherwise, solid Q2 was our media segment gross margin which was down 300 basis points from Q2 last year.

Most of this change was expected and built into our guidance due t revenue mix. However about a 100 basis points of the lower margin due to integration issues for certain campaign management and optimization tools as we brought some of those processes and functions together.

We’ve isolated those and are addressing these issues in Q3 and we should see a bit of recovery in the media gross margin relative to Q2. Keep in mind however that mix will still drive a year-over-year decline in gross margin and the media segment. But some of those one-time issues will be behind us.

In terms of operating expenses, our investments this year drove a higher OpEx in the quarter of roughly $10 million compared to Q2 of 2013 which is consistent with the numbers we discussed on last quarter’s call. And most notably, we continue to make up ground on hiring and we’ve added 9% to our headcount in the last two quarters.

We’ve also maintained higher expenditures on marketing and thought leadership programs following the domestic rebrand campaign and to support our growing sales force and telling the new differentiated story to the market.

We’ve also scaled our investment in SET media to accelerate growth in video, while these investments have meaningful impact at our EBITDA margins in Q2 and Q3 prior to any significant revenue contribution which drags will be less impactful in Q4 and we expect our video business to be profitable in 2015.

EBITDA in Q2 was $41.8 million, just below our guidance for the quarter due to the media gross margin I mentioned earlier. Despite the year-over-year decrease from the year ago period resulting from these investments, our free cash flow grew to $89 million for the six months ended June 30, which is an increase of 21% compared to the year ago period. And we will continue to invest out capital to enhance shareholder value.

We repurchased 2.6 million shares in Q2 representing nearly 4% of total shares outstanding. In the last four quarters we repurchased roughly 15% of our total shares. Since the inception of our buyback program we have now reached more than $1 billion of capital to shareholders at an average cost of around $12.

Significant discount to our current stock price demonstrates the value, our capital allocation decisions, and have generated for shareholders over the long-term. And our Board recently authorized $150 million increase in our stock repurchase program, and we have plenty of capacity to our continued strong cash flow and our balance sheet to execute on this authorization.

Despite this investment spending and $62 million of stock repurchases, we’ve maintained a net positive cash position of nearly $20 million and we have $335 million available on our credit facility as of June 30.

Moving on to the Q3 guidance, we expect revenue to be in the range of $142 million to $148 million representing 8% year-over-year growth at the midpoint. We expect Q3 adjusted EBITDA to be in the range of $44 million to $47 million, a margin of 31.4% sequentially.

As we’ve discussed on previous calls, we do not view the current margin profile to be reflective of the new normal. In fact, assuming normal sequential revenue trends through the end of the year, I expect our EBITDA margin to approach 40% in our seasonally strong Q4 which would bring our overall margins for the full year in the 34% range.

Given some of the one-time corporate rebrand costs in the SET Media operating loss that we have in 2014m we see a clear path for EBITDA margins to expand from these levels as we look into 2015. So with that, I will turn it back to John for some closing comments. John?

John Giuliani

Thanks, John. Clearly, we are continuing to make significant investments in our business that we expect will drive stronger growth through 2015 and beyond, we’ve given careful consideration to our investment spending in 2014 investing our capital prudently is in our company’s DNA and it always has been. And as John mentioned, we expect our EBITDA margin to return to more normalized levels in 2015.

I think as we do that, I really want to highlight a couple of things for you though that are coming out of all those product integration and we are excited about how our product development lead person who will be bringing all this to ahead. I think you will see in the fourth quarter, we’ll come out with an integrated suite of video products that combines what we’ve acquired with SET with what we have with our current video product along with the utilization of our audience and data that we think will be a suite that is unparallel in the marketplace.

Second, we’ve been – we’ve talked about this a little but you will see more in the fourth quarter. We’ve got pilots running now with a handful of customers on our personal calibration engine that prior that initiative we might add one more client to that which is really about decisioning and helping clients understand by the data consumer level how to make decisions and where to spend their money.

And we think it opens up a different potential model for the future for us that might be more in line with what customers want and wanting them to have more control of the decisioning process as well as portability of the data profile. Exciting stuff that we are actually doing in making – not making money on but getting money for which means we are vested with the customers doing that.

And the third thing is, when we bring video display and mobile against the same audience. From a delivery standpoint, that’s really a big advantage in the marketplace. We’ve also got a technology in our tracking and – our ad serving and tracking and reporting technology that formerly called Mediaplex that is expert in this.

And it’s in part of what we are doing going forward, is to track, report and analyze at the audience delivery level. We think from a marketer’s perspective the old outages of advertising like an airplane taken off and never known where it’s landing. We’ve got the tools set and the data set to provide marketers with where it’s landing exactly at least from a digital individually addressable standpoint.

So you’ll see us pursue that as well. And lastly, I’ll leave you from a product standpoint; we’ve talked a little bit about this in the past. There have been some recent transactions in this space in the matching area.

That is a strength of Conversant. We are doubling down on that strength as we’ve looked at the matching with throughout the industry and we think there is a – we are in conversations with a lot of the folks in the industry that have been using some of the other match players.

But we think that is a real strength of our organization. It also opens up potentially a way for us to evolve our business and be open minded to how we do business and participate in the more sophisticated part of media delivery and decisioning itself. Great stuff coming in, in the future.

So I just want to leave it for – really our three key constituents, our customers, we are out there building a differentiated model to help you win your battles in the marketing side and drive efficiency. As you see with our employees, we’ve been attracting more folks we provide a great environment.

Those folks are doing fantastic stuff. A little insight based off from my employees. We are getting our fly well going and I’ve got a really dedicated sales management staff that is getting excited about the stuff we are doing. And for our investors, who I know, a lot of you get a little uncomfortable because we are making big investments.

Keep in mind, I am a 4% shareholder and I have invested my money very long with it and I believe it’s paying out and it’s going to pay out for us even more in the future. And lastly, I’ll leave you with those bet against us. We’ve been building up demand and we are – we’ve got product coming out, we’ve got systems improving, our integration is paying off.

So, it may not be today, it may be next week, it maybe the week after, it’s going to pop and when it pops it’s going to go fast. So if you bet against us, whatever level you are, I just want to give you fair warning. So in summary, I truly believe we are executing well on many of the initiatives. We are building a great company for employees, for clients, and for shareholders in the long term and with that I thank you and we’ll see out there in the show.

Erik Randerson

Great. We’ll take your questions now.

Question-and-Answer Session

Operator

(Operator Instructions) And we will take our first question from Kerry Rice with Needham. Please go ahead.

Kerry Rice – Needham & Company

Thanks a lot guys, couple quick questions. Could you give a little more detail around the private exchange that you are developing? And maybe talk about – I don’t know if you can talk about who any of those publishers are but I’d be curious kind of the mechanism this is kind of a built off the previous publisher network that you had or is this kind of a new set of publishers that you are building?

And then could you give us a little bit of update. In Q2, around the CRM business, you had a couple retailers that had fallen on some challenges, one bankruptcy, one was reorging, particularly to the reorg have you seen them come back or have you talked to them to see if they were coming back and just one follow-up here on M&A.

You are buying back a lot of shares but I was curious if that means that there is nothing really out there that you feel could be complementary to your product set or maybe valuation isn’t where you wanted to be so, you’d rather buy back shares and do the M&A? Thanks.

John Giuliani

Yes, so, first of all the publisher network, it is a build off of our prior publisher relationships not exclusively. And so, we are adding new ones, but as well- but it is definitely that – from that stance. What it does for us is, particularly for some of the business – for the CRM business.

It offers new inventory for them and because we are putting it through the same programmatic standpoint for bidding and evaluation, we are seeing improved quality, because we know the value of that all. So, we think it’s a great thing to those publishers as well because rather than an open market they can get the value on the private exchange before they have to put it somewhere else.

So, that’s – I think that will be a growing position. We think that’s a really strong position for us and we are unique to be able to do that because it really adds for sure scale and scale is a differentiator in this market particularly from a third-party group. Secondly, you talked about the…

John Pitstick

About the CRM business in terms of some of the clients we talked about last quarter. I think?

Kerry Rice – Needham & Company

Right.

John Pitstick

With that takeaway there is no real change relative to expectations. So Q2 played out where we expected with those diminished budgets from the one particular client and that’s fairly status quo in terms of the Q3 outlook. So, none of the increased performance in Q3 relative to Q2 that we are seeing and expecting, that’s not based upon a particular customer coming back so we are still engaged with discussions and hope to bring those bigger budgets back to those – that’s not in the sort of current Q3 guidance.

John Giuliani

Just one clarification we say bring it back to the level, there is still – we are still working the brand business I then want to leave with the impression that they are going on.

John Pitstick

It’s just the budgets are smaller.

John Giuliani

And then

(Multiple Speakers)

Kerry Rice – Needham & Company

Yes.

John Giuliani

Yes, so I think if you look at our history, we’ve been able to do all these things, whether it’s buybacks, whether it’s M&A and whether it’s investing in the business and I think…

John Pitstick

`Q1 was a good example with the SET acquisition. So we don’t really look at those as mutually exclusive. So the fact that we are doing in buybacks doesn’t necessarily close the door, close the window for us in terms of looking at M&A. As you know, the cash flow profile, the line of credit which has got capacity to sort of look at different things but I think as a takeaway we are probably more internally focused in terms of getting through some of these final integration steps versus looking at M&A in the very short term.

John Giuliani

Operator next question please?

Operator

We go next to Brian Fitzgerald with Jefferies.

Brian Fitzgerald – Jefferies & Co.

Thanks guys. A couple questions. You mentioned integrating SET into the campaign manager and video servers; I think you said that would be done in Q3. Once that’s plugged into you is that a gradual roll or is it kind of a stair step? What to do you expect the usage trajectory to be? And then the second question maybe, we saw some companies lose its ability due to panda changes, so wanted to ask what you saw with respect to your publishers and your partners in both the affiliate and media businesses? Thanks.

John Giuliani

Yes, so I’ll talk about the SET. Yes, the integration for SET, when that gets completed, and it’s in the process right now. So it will be operational shortly. First and foremost, yes, we will roll their video and in the inventory coming out of our system that will get our buying power and the inventory. If they are not that big yet, so it’s not like it’s a big rollover kind of thing.

We will expose them to a lot. I think secondly is and more importantly, as we get to the fall here, the latter part of Q3, I think the products that are getting them to attached to some of the custom audiences we have really we think enables them to create the set what we call the SET suite of product, a broadened product portfolio that we think will be differentiated. Conversant people all including in the current SET people will all be selling that, so.

John Pitstick

And then, on the panda question and visibility, I think, from media that really has no impacts in that part of our business. When you think about the affiliate marketing business and our relationship there so, it’s a clearly publishers in that ecosystem some win, some lose when there is algorithm changes from Google.

I think and where we stand there was we tend to sort of drive those out because it’s if one particular publisher is down maybe another publisher is up and it sort of evens out over time. So it doesn’t necessarily severely impact our visibility into the business or our expectations in the short-term.

We, kind of have the ability to roster with that and clearly that would having the – owned and operated businesses, we used to have – those would have some sort of impact when there is algorithm changes, but obviously and that’s not part of the mix anymore.

Brian Fitzgerald – Jefferies & Co.

Right, great. Thanks guys.

John Giuliani

Operator next question please?

Operator

We will go next to Colin Sebastian with Robert W. Baird. Please go ahead.

Colin Sebastian – Robert W. Baird

Great, thanks. John G., I’ll ask you for the PDUP teaching but maybe we’ll set that for another day.

John Giuliani

Thank you.

Colin Sebastian – Robert W. Baird

My question is on some of the cross-device challenges and the common ID and hoping you can help me understand a little better how you are providing or mapping consumer across these devices and how that distinguishes you from some of the other digital marketing alternatives that have or report to have similar capabilities? And then secondly, is this focused primarily on retail and e-commerce, or can this be used to – or could be implemented across a number of different verticals? Thanks.

John Giuliani

Yes, so I think probably to start is our – we match to – we match- even though we have anonymous profiles the way we match which is somewhat proprietary. It does match to physical name and address offline. Now that’s done through a very intricate process of that it strips PII for us but what it does is it matches devices back to a home base if you think about it.

And so when we see these we can attach it to something. We can attach the IDs with the device back to a permanent ID that starts with a home base of a physical name and address. Then, through some – and I won’t do this just as, because I was just kidding about my ability to do with – or anything else technically.

We can make connections through – basically through triangulating different devices against an ID so we tend to get faster matches, better matches and then because of our persistency, which tend to have a more durable ID and so we don’t have say – and so what that’s to is we typically have a broader audience to address, they are more likely to be persistent, so we can capture more of the value and if there are times when they do a trip, we are able to refresh them back and have the full set of data.

So, there is probably a lot more than to that. But my guides have been cautioned to me not keep talking to all. So, because there is not a part of the question I thought you might handle.

John Pitstick

Yes, Colin, I’m sorry, what was the second question?

Colin Sebastian – Robert W. Baird

Yes, now just understanding if this is targeted specifically towards retail or is it an e-commerce or this is probably applied across verticals?

John Pitstick

No, it’s – I am sorry, I was talking about something else, John, no it really, the datasets coming in might be more applicable one or the other but actually as we kind of address those out, this is audience and the audiences has applicability to really any vertical. There may be more or less data attributed to them. But from an execution and tracking standpoint it’s the same.

Colin Sebastian – Robert W. Baird

Got it. Okay, very helpful. Thank you.

Operator

Thank you. We’ll take our next question from Tom White with Macquarie. Please go ahead.

Tom White – Macquarie

Great, thanks for taking my questions. On the Affiliate Marketing guide, I realize that you guys are facing a tough comp there, but, I guess, I am just curious, I remember at one point we used to think about sort of overall e-commerce growth in the markets you operated in and it’s kind of the target growth rate for that business.

So, just wondering kind of what opportunities or new initiatives you guys might be able to in affiliate marketing to get the growth rate to narrow versus overall industry e-commerce? And then John P I was hoping maybe just on t he sort of one-time media segment gross margin pressure, can you just provide a little bit more color on exactly what that was? Thanks.

John Pitstick

Sure, on the affiliate marketing growth, one of the challenges we have in terms of forecasting and it seems play out the last couple of quarters as with the new subset of customers that came in from GAM. We don’t have a lot of the monthly and seasonal history in terms of being able to really have a lot of confidence with how we forecast come of that.

So, as we construction guidance in any particular quarter in the recent quarters as we kind of look at what we know and what see, for the month, that we have behind us when we provide the forecast and I think if you look at Q1 and Q2, we come back and down little bit better than some of those trends that we’re able to confidently rely.

So, when we think about mid single-digit growth in affiliates, it doesn’t, that’s reflective of what we see as long-term growth opportunity there. And we’ll see how the quarter plays out and how some of those customers trend throughout the quarter.

So whether it’s mid single-digits, high single-digits, I think Affiliates just continue to be a healthy growth business. We just kind of looked at it as not sort of a main growth driver as we look out the next one to two, three years, media segment really – should be the main growth driver with Affiliates providing a nice base having solid growth but not at sustained levels.

So, not just to disconnect overall e-commerce which I think the datapoints there are sort of low double-digits and I think that’s something that we are hard to get back to but, I don’t think it will be there for Q3. I don’t know if that sort of addresses that?

Tom White – Macquarie

In terms of what the media margins?

John Pitstick

Yes, and then in terms of media margin, as we bring these systems together, so each of the different operating systems that we have for managed campaigns to optimize to make sure we are efficient with the media spend as we bring teams together and technology some of the tools that we use to identify when things are running where they should be or whether we are getting underwater on a certain campaign, we’ve identified areas where we have lost sight at some of those controls as we brought these together.

So, there are several specific areas that come to mind as I think about the research we’ve done on the quarter and those are addressable. We’ll get more through those in those fixed and again that was a part of the margin decline year-over-year that the bigger part was the mix which has been a pretty consistent thing that we talked about. But the other one will get fixed and behind us.

Tom White – Macquarie

Okay and just a quick follow-up on that. In terms of the mix, safe to assume that it’s kind of the video business if it’s kind of growing more quickly is maybe structurally a little bit lower gross margin than some of the other businesses is that kind of the main mixed dynamic or is there something else there?

John Giuliani

Yes, I’d put mobile in that category. So mobile and video, when you look at those businesses they are in line with sort of our traditional display business and others that you see out there sort of competing. So something in sort of mid to high 40s those products. The flip side is the highest gross margin product that we have is the ad selling business, John, alluded to in some of his comments that’s been a relatively flat business, so as some of these other things grow that mix it’s a bit exacerbated. So, you got sort of a barbell effect of some of the still healthy margins, but just lower relative margin businesses growing faster. And it’s the highest business sort of volume steady.

Operator next question please.

Operator

And we will take our next question from Youssef Squali with Cantor Fitzgerald. Please go ahead.

Youssef Squali – Cantor Fitzgerald

Thank you very much. Just on the margin question, so, there is a 300 basis point hit to media gross margins, if I am looking at this correctly, it looks like on the operating on the media segment margin, the hit was more like 500 or 600 basis points, what’s driving that, how – where is the pressure coming from?

And as – I guess a follow-up to that, John G I think you talked about Q4, I know, you are not guiding to it but you think that EBITDA margins in Q4 could hit the 40% range which is a dramatic increase from here. Where are the levers or what levers will those improvements be the result of? Thank you.

John Giuliani

Yes, I think, this is John G. Just taken the last question on the Q4, actually John P probably did that because he has long been projecting the numbers. But, I think, it’s the seasonality we get with revenue growth in Q4 all that investments that we’ve had so far, if you think about it we lever up in Q4 with an increased revenue against that.

And so, we are typically going to make more money in Q4. I think it’s within historical guidelines as well sort of with these nowadays. So, I think it doesn’t feel like it’s too far out from what we’ve been doing in the past. If John wants to give a little bit more color he can.

John Pitstick

Yes, I mean, if you go back the last couple of years, it goes, starts back in 2012 in Q3 to Q4 about 800 basis points of expansion into Q4 last year it’s not quite as much as still healthy expansion, so, some of the things that we had in the margin, in Q2 and Q3.

That are sort of been exacerbated those will be diminished and some of the seasonal trends will kick in. And keep in mind, we did 42.5% or so EBITDA margin in last Q4. So we are still be a bit below that but, certainly we’ll see expansion from Q3 to Q4 with those seasonal trends and some of the leverage in the business.

In terms of the question on the media margins, I just want to distinguish the first comment about the 300 basis points, how was the gross margin? But I think the other number you mentioned was probably the overall operating margin which is it had the impact of all the investments in video and some of the operating losses there that we are absorbing as we scale that business. So, I think that’s where the disconnect was.

Youssef Squali – Cantor Fitzgerald

Right, and the 500 to 600 basis points that the media segment margins, can you maybe identify non-recurring or these kind of investments that are going to go away that will impact on that line item?

John Pitstick

Well, a lot of that keep in mind, it is the investment in the video people then and we have taken the burn of the expense on right now without much revenues. And so, as that starts to scale little bit in Q3 and more on Q4 and on, that will start to be normalized because, it’s almost pure investment in Q2 and we expanded both the – what we had internally on video folks but certainly absorbing SET but then expanding SET’s profile with particularly in sales and engineering, all that’s hitting that line.

Youssef Squali – Cantor Fitzgerald

Okay, that’s helpful. Thank you.

John Pitstick

I wouldn’t really call out any one-time sort of OpEx items in Q2 or Q3. Q3 was a little bit with our European rebrand but that’s more noise level sort of dollars.

Youssef Squali – Cantor Fitzgerald

Okay, thanks.

Operator

We will take our next question from Eric Martinuzzi with Lake Street Capital Markets. Please go ahead.

Eric Martinuzzi – Lake Street Capital Markets

Yes, question on the buyback. It looks like you were purchasing again in July. The intent to pursue and you beefed up the plan to $150 million. Is the intent that you would take on, you would depend on the revolver to continue apace similar to Q2 or is it going to be more opportunistic?

John Pitstick

Well, I think we – historically we have just end of the revolver at times to fund buybacks when we thought that was the right thing to do. I wouldn’t guide today, to say we are going to do at the same level. I think our history sort of speaks for – absolutely being focused on that over time, but we do that in Q3 or Q4 over the course of the next several quarters, that remains to be seen, but clearly there is an ongoing commitment to that program.

Eric Martinuzzi – Lake Street Capital Markets

Okay, and then again on the cash flow, the seasonality, typically, Q2 is a nice strong one and it was again for you this year and then you had the benefit of – sales yielding some of your profits. Remind us of what seasonality or I guess, maybe educate me on the seasonality for Q3 and Q4 on free cash flow?

John Pitstick

Yes, I’d say it’s roughly in the same range, I’d say the first half of the year, if you kind of look at first half versus second half, maybe bit more headwinds, we’ll pay more in cash taxes in the second half of the year than we did in the first half, but, looking at the first half of the year is sort of a good starting point.

Eric Martinuzzi – Lake Street Capital Markets

Okay, thanks.

Operator

We go next to Deb Schwartz, with Goldman Sachs. Please go ahead.

Deb Schwartz – Goldman Sachs.

Hey, great, thank you. So two questions on the media segment. First, can you just go into little bit more specificity? I know you mentioned some of the products that you are seeing traction but more specificity on why you feel comfortable with the reacceleration in revenue growth from the media segment and then two, just sort of longer term, how do you think about sort of the trade-off of revenue growth in the media segment versus gross margin?

John Giuliani

So, I’ll take the last one first this is John G. So, my basic philosophy is always been gross margin over long-term is a reflection of the value created and so, I think one of the things you are seeing in the industry with the easy access to inventory is you see some pricing in industry go down you see some gross margins for folks that they have to kind of keep selling stuff.

But where you are really getting to that – that’s the wrong ingredient and so you have to be able to discern the differences between your – of our ingredients and you have to be able to add value. And so, we think sort of data and technology and understanding with the consumer and then blending those together is an added value.

So at time-to-time, because we have to be efficient for our – relentlessly efficient for our customers but we have to be more relentless about adding more value because there is a fair trade-off and so that’s what our focus is. So, I think we will get our margins from time-to-time if that helps to accelerate an area, certainly bottom-line margin like we are doing now which I think it’s probably a break from what people thought we would is part of an really investing heavily into these new areas.

I am talking more on OpEx standpoint. From a gross margin though, we know we recognize there are different mix of businesses and some are like a mobile or – that are going to have the same with some other ones. And so we are comfortable making that trade-off.

I think more so that we were – we want to make sure we add enough value that clearly good to do business with us and we’ve got a thought that our customer has to get more value than what they pay for it and as we accrue more value, most of it has to – as we build more value, most of it has to accrue to the customer.

So, over time, maybe that would have some slight margin hits, but I don’t think it has to if you are driving more value and that’s clearly what we try to do and that’s why we think about the decisioning part of things and the tracking. Things that other people can’t do that has enormous value to someone. So, hopefully, that answers and I’ll turn the first part over to John.

John Pitstick

Sure, so, I think the first part was, sort of the media guidance and color around what’s driving that and specificity, I think like any quarter, it’s a combination of looking at what we’ve seen so far in the first month of the quarter from commitments that we have in those parts of the business like CRM or you sort of have a bit more visibility and more long-term planning.

The CRM business I think we look Q2 to Q3 is a source of source of some of the sequential lift. So, better visibility into that and some of the – driven parts of the business, but I think we have constructed the guidance like what – any other quarter in terms of combining what we know for July, what we see in terms of those commitments as well as what’s in the pipeline and how we see with that sales force productivity. So, it’s all those things sort of finding up the way we do with any other quarter.

John Giuliani

Operator, next question please?

Operator

We go next to Shyam Patil with Wedbush Securities. Please go ahead,

Shyam Patil – Wedbush Securities

Hi, thank you. John G, before the end of your prepared remarks, you talked about, demand – you emphasized that demand is building and when you look at to next year, would you be disappointed as media is not growing double-digits and if you are back at that growth, would you expect to see margin leverage or do you think we would see additional investments?

John Giuliani

Well, so, I am disappointed this year that we don’t have double-digits. So, definitely will be next year, but, and again I am not supposed to guide anything, but yes absolutely, and I think when you get the growth on that, you get the productivity and so I would guess that both bottom-line margin for sure if you are hitting that hazard.

But I think also you tend to – when you are growing at a predictable and you are not behind a little bit – you tend to run things more efficiently and that’s where – there is a lot of areas that control that will hit the margin not just the selling price, but how efficiently you run and how you run your programs, because that’s how you don’t waste money or – you run it efficiently.

So, I would definitely expect that if we are doing that we would have some upward margin leverage.

Shyam Patil – Wedbush Securities

And then on the exchange you talked about the private exchange, that you are working on, what are your thoughts on eventually expanding that into the open exchange and operating on both the demand side and the supply side of that as we’ve seen some other players in the space too. Is that’s something that you see is possible or likely in your roadmap?

John Giuliani

I wouldn’t say likely, I think, it definitely is possible. I think in any of these businesses that we have just an enormous amount of opportunities to be in the businesses and the question is, is that a good thing long-term for us or not, such as, I talked about the matching earlier.

There is definitely a business to sell matching. We’ve taken data in from competitors’ customers and we’ve seen the data matching efficacy with than we do. And we know there is a business there. The question us, do we want to – is that a business that we want to commit to, is it worth investing in, does it has the margin profile we want, does it has the growth profile we want and then what are the unintended consequences. What did we let of this table that’s proprietary?

Who do we now start competing with that we really weren’t and we don’t want to and so there is a lot to that? So, the potential to do what you say is absolutely there. I couldn’t say if it’s likely because I don’t think we’ve made that evaluation and we have to go through that evaluations and make sure it was the right thing long-term for us.

Shyam Patil – Wedbush Securities

Great, thank you.

John Giuliani

You are welcome. Operator next question please?

Operator

We’ll go next to Peter Stabler with Wells Fargo Securities.

Peter Stabler – Wells Fargo Securities.

Good afternoon. Thanks for taking the questions. Couple quick ones. John P. I think you talked a bit about mix shift to mobile having a bit of impact or contributing in any way to media gross margins. Wondering if you could talk about the impact of the mobile shift on the Affiliate business plus minus otherwise and then John G, in your prepared remarks, I missed something; you were talking about matching companies and M&A in the space where you referring to D&Ps or if not could you clarify? Thank you.

John Pitstick

Yes, this is John P. On the mobile impacts on affiliate. So no impacts in terms of margins given the net revenue of accounting there. I think as we think about mobile’s impact on affiliate we are seeing somewhat in the mid-teens range of overall transactional volume in the affiliate channel is through mobile devices.

I think there is still is somewhat a leakage in terms of tracking and crediting the full credit for transactions through mobile and that’s something that we are focused on sort of closing the gap, but currently it’s about in the mid-teens percentage of the mix of overall transactions and I think us and the rest of the industry is sort of saying, hey, there is probably some leakage there that we need to figure out.

John Giuliani

Yes, this is John G. As far as I did say matching and I was referring to some without want to name names, but sort of some recent transactions, but marching partners that are designed basically to link devices with cookies for folks so that they can run their advertising and the point I was making is we do that as a natural course. We do it very efficiently and we do it to improve the advocacy and the attribution for our customers.

Ad we do it well and what I point to is, when you look – there is a value ascribed to a transaction there, we do it naturally as part of our business and so, as we continue to look at our assets going forward, I continue to invest in things like that and those are areas that have great value in the industry.

And so we are building that. We are supporting those within our organization, the reason I bring those up is because we are sort of really focused on those things that are unique and as you go to the long haul and you really look at what the changes in the marketplace and you think about who is positioning themselves to compete in the future.

That’s part of the reason I am sort of trying to point folks to some of the things that we are doing that we may or may not be making money everyday built more importantly why we are investing in those and this is really to my investors, so then he know we are strengthening our portfolio for the future to sustained growth rate profitability that they are used to.

But that’s why I talk about that. Hopefully that helps you.

Peter Stabler – Wells Fargo Securities.

Attribution states. Got it, thank you.

Operator

And then we go next to Mitch Bartlett with Craig-Hallum & Co. Please go ahead.

Mitch Bartlett – Craig-Hallum & Co

Sure, my question maybe a little bit redundant, but just back to the video assets and the negative drag that they’ve had this year are turning into a positive contribution. Have you ever detailed kind of the size of the investment in video through SET or whatever as far as the drag this year and what it might look like next year? And do you get revenues in the fourth quarter? Are you planning revenues in the fourth quarter?

John Pitstick

Yes, Mitch, so, yes, we do. We have talked about the drag in terms of sort of the net loss from that part of the business; put those numbers at about $2 million in the quarter here in Q2 and probably roughly the same range in Q3. So there is revenue coming out of that part of the business, it’s nascent; it’s beginning to grow and to be part of the mix.

But on a net basis, as we increase those investments, the net loss quarter-on-quarter would still be about the same. As we see and expect revenue growth to continue to scale there into Q4 start to get closer to more of a breakeven from that business and then as you look into 2015, on a full year basis that should turn to profitability. Whether it will be overall profitability and that sort of has our company average, probably not, but it will be a positive contributor versus the bigger drag like it had been this year.

Mitch Bartlett – Craig-Hallum & Co

That’s helpful. Thank you.

Operator

We will go next to Sumit Sinha – B. Riley please go ahead.

Sumit Sinha – B. Riley & Co.

Yes, thank you. Couple of questions. So, John. G, a question for you, I mean, in terms of I am thinking about your last analyst day and you spoke about all the products that you are working on. I know that some of them got delayed but lately conversation has been more about it seems like tools, you are talking about campaign management or viewability or matching. Can you talk about some of the products that you spoken about the combination of great marketing with CRM at an enterprise level?

The second is, if you kind of help me understand the private exchange and how CRM will have access to it, just want to think about the financials there. Are there any gross margins benefit – I don’t want to use the term, but just colloquially speaking it seems like you could potentially be double dipping there in the tool businesses. So I am going to leave it at that then I have a follow-up. Thank you.

John Giuliani

Yes, I am going to have to talk to you about the double-dipping – I wasn’t sure about doing that, but we are not aware of that, but I think it’s really – I don’t think – I think it’s a way of giving more inventory. So, I really look at as, the private exchanges have to get unique reach, better quality of inventory which we think is a critical component particularly in display, but display and video right now.

And really it’s all about – but we are seeing a lot of issues around quality or questions in display and video and so the high quality, unique reach and better performance, that’s what I was really gauging on. I don’t think it’s really about for us accessing for price, it’s more of differentiating ourselves around that and allowing our publisher side some advantage to some of the systems we have.

So, that’s a real big one and just – because it wasn’t plugged into that, the CRM never didn’t enjoy that access to that inventory as we – and we are increasing the quality and the amount of that inventory. So that’s the first one.

Second one, that the tools versus products, well, so, what I’ve realized along the way is, the integration we do is not very not – , if you are putting things together you are making things work, you are spending time smoothing those things out versus create new utility.

But, when you put and that’s what I tried to look at when I say the common ID, the common attribute store, when you start to build those things together, it starts to open up the product possibilities. So by bringing SET into – I think your question was about SET, the SET inventory or tool sets of campaign manager, by getting them, frankly, getting all of our – which is really a intermediate term for us, is getting all of our media properties to have the same campaign management tool.

Why is that important, because, I get leverage on my camp management staff meaning they can do more and do it easier and they don’t have to do thing redundantly on different systems. So last year we put the mobile business that had their own ad server into the, what we call cobalt, which was the ad server that we have in the traditionally on our media side. And that mean that you could run campaigns against the same data, the same targets.

And so as we are building these common attribute stores and common ID and leveraging our data against a persistent ID that opens up what I would call product is custom audiences. And when I create a custom audience, if I’ve got a similar campaign management tool which is I understand doesn’t sound very exciting and it’s internally focused. It is because I care about my camp management’s productivity and their job satisfaction all that I want them to be able to do that.

But now, I can access an audience that’s custom and if it’s custom for somebody and they are interested in there they have the same interest on venues they do on display and they do on mobile, I now can build that campaign and build these three different channels together. What I also can do then is, I can report on that, I can track on that, I can analyze.

So, that all becomes part of the product. And so, that’s certainly, when I talk about personal calibration or what I am really satisfied is the ability to track on these audiences for reporting in the analysis from the ad serving technology, I think is a phenomenal product orientation. But until I put all these things together, then I don’t have that opportunity.

And so, that’s how we think about it. But I think the other part of that is when we hired a (Inaudible) who – I guess I didn’t get his name, but our Head of Products. Now I have the organizational infrastructure building to go make those assets working into a formulated integrated product strategy. That’s how we kind of think about it, I hope that helps Sumit there is probably more I can talk about but I’ll leave it at that.

Sumit Sinha – B. Riley & Co.

Sure, definitely, very helpful. One final question. I guess, you gave us a kind of a sense of how CRM is growing. You probably saw some back-to-school wins and those are going to be interaction in the third quarter. Can you just touch on the legacy display business? How is the growth there? As – is it being helped the kind of rebranding campaign that it is in Q1 and continues into Q2?

John Giuliani

Yes, the business definitely has stabilized. It’s, we think – benefiting from the overall – not just the rebranding but in product portfolios how are these integrated and as John alluded to. If you sort of try to isolate that down to a specific product I think when you look at the Q3 expectations that sort of traditional display with that for modest growth.

It’s consistent with sort of how we’ve talked about the longer-term growth opportunities across the various businesses where traditional display as part of that mix will probably not be the main growth driver but it’s really – layered in the video and the mobile and the CRM things that we do are going to drive that, but, To answer your question, I guess, shortly it should be back to growth here.

Sumit Sinha – B. Riley & Co.

Thank you.

John Pitstick

Operator, next question please.

Operator

And our final question today will come from John Campbell with Stephens. Please go ahead.

John Campbell – Stephens Inc.

Hey guys. Thanks for taking our questions. John G, you talked a little bit about the new initiatives in affiliates that’s going to leverage off that Media data and I know you guys are in the early stages of that pilot, but do you see that as something, is that being something like an incremental growth driver? Is that more of a free type service you are willing to offer your affiliate customers?

John Giuliani

Yes, so, just – I was going to make sure I am consistent. What we are doing is using the technology and our infrastructure on that we’ve done on CRM side to apply it to the data that an affiliate customer would have. So, they would give us that – they provide that data that we can help them figure it all out through our existing systems. But, I think it’s more of it in growth driving. I think in affiliate marketing we are a leader in there. I think we need to one of the questions earlier was about how do we match up to e-commerce growth.

I think that’s also thing that we’ve got to do to get more out of the channel for our customers and I think of it in terms of broadening the impact and increasing the growth rate and adding value to it and I think where we went on that is, where I am getting my growth is by getting more out of what they do and making the channel more substantial because as you know affiliate marketing – it’s a sub-segment of a huge online media and a sub-segment of performance and there is a lot s of substitutes.

So we got to continue to make that channel help our customers through data understand the value and then proportionally increase the value. Where I can win on that is by increasing the overall of what we get and then by either getting new customers by taking share or expanding the affiliate marketing footprint in the industry. And I don’t think there is a need to prove this out to raise prices or something like that, I don’t see that. I see it more helping our customers get more out of the channel.

John Campbell – Stephens Inc.

Got it. That makes sense and then just a second question here is, I think, John P, you might be able to answer this on, but, I think you mentioned the headcount increase over the first half of about 9% and I mean, I guess that implies that the pace of hiring slowed a bit in 2Q.

So could you just talk to us a little bit about anticipated hiring maybe in the back half of the year? And then, I know, I mean, this probably tells like decades away but any thoughts to share on 2015? Just curious if you guys have a definitive headcount target you are kind of managing to?

John Pitstick

Yes, so, I’d say modest slowdown in Q2 relative to Q1. Keep in mind that was a Q1 event in terms of bringing that team into the organization. So, in terms of our recurring efforts and our internal focus on new hires, similar pace in the second quarter. I don’t think that second half will be as robust as the first half.

We’ve added, I think 120 or so people in the first half, I don’t think it will be that high in the second half and then for 2015, it’s a bit early we haven’t gone through the formal budgeting for that. But, I do think there as we talked about some catch-up investments we’ve made this year, so I wouldn’t expect the pace of hiring to be at the same level as we look into 2015 and that’s where some of the leverage comes back to the model.

John Giuliani

But for some of our executives listening in, bigger forecast, and larger revenue commitments could lead to higher (inaudible)

John Campbell – Stephens Inc.

That makes sense. Thanks guys.

John Giuliani

Yes.

Operator

At this time, I’d like to turn the conference back over to management for any additional or closing comments.

John Giuliani

Great, well, thank you so much for your time and then we look forward to talking to you on the road and after the call.

Operator

Thank you for participating in today’s Conversant second quarter 2014 conference call. A replay of today’s conference will be available beginning at 4:30 PM Pacific Time today by dialing 1-888-203-1112 or 1-719-457-0820. The access code for the replay is 2825301. The replay will be available through 4:30 PM Pacific Time on August 13, 2014. Thereafter, the replay can be accessed on Conversant’s Investor Relations website at www.conversantmedia.com.

This does conclude today’s conference. We thank you for your participation.

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