Ancestry.Com's (ACOM) CEO Tim Sullivan on Q4 2015 Results - Earnings Call Transcript

| About: Ancestry.com Inc. (ACOM)

Ancestry.Com LLC (NASDAQ:ACOM)

Q4 2015 Earnings Conference Call

February 17, 2016, 05:00 PM ET

Executives

Melissa Garrett - Corporate Communications

Tim Sullivan - CEO

Howard Hochhauser - CFO and COO

Analysts

Jeff Harlib - Barclays

Ilya Voytov - Vector Capital

Akbar Causer - DDJ Capital

Operator

Good day, ladies and gentlemen, and welcome to the Ancestry.com Fourth Quarter 2015 Earnings Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions]

I would now like to introduce your host for today's conference, Ms. Melissa Garrett, Corporate Communications. Ma'am, you may begin.

Melissa Garrett

Thank you. I have our CEO Tim Sullivan and CFO and COO Howard Hochhauser here with me today. After Tim and Howard make some brief prepared remarks, we will get to your questions. Before getting underway I would like to take care of a few housekeeping items. In our remarks today we will include statements that are considered forward-looking within the meaning 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-Q for the period ended September 30, 2015, which was filed with the Securities and Exchange Commission on October 30th, 2015, and in discussions in our other 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. We've combined the 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 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, Melissa, and hello to everyone today. 2015 was a terrific year for Ancestry, both financially and strategically. We performed well and also executed on a number of initiatives that we think meaningfully improved the overall long-term growth profile for the Company. And we capped off a very good year with a great fourth quarter, led by 17% revenue growth on a constant-currency basis and a year-on-year revenue acceleration in each of the four quarters of the year.

We added about a 150,000 new net subscribers to Ancestry sites in 2015 while also growing ARPU and our DNA business ended an already great year with really a fantastic fourth quarter, in which we more than doubled kit sales over last year's fourth quarter, bringing our full year kit volumes almost 1 million units for the year. AncestryDNA was a popular holiday gift with a 200% increase in year-on-year sales during the Black Friday-Cyber Monday weekend. We have over 1.5 million DNA samples in our database, making us the worlds' largest consumer genomics database.

This was a great year performance wise, but also an important one strategically. We accomplished a lot this year, headlined by the launch of our new core website customer experience which has now fully rolled out to a 100% of all of our Ancestry users. We introduced one of our largest content launches ever, the U.S. wills and probate's collection and we made significant progress in new international markets, and we executed on new growth opportunities in emerging businesses. The results of all these efforts is a stronger, more diverse company with exciting opportunities to create additional growth and value.

So looking more closely at our core business, our subscriber count is healthy and growing. We continue to be pleased with overall customer feedback on the new user experience and the narrative driven features we build into this new Ancestry, as well as by another strong year of creative marketing and great execution. We also introduced another 1.7 billion records to our collections, including the wills and probates projects, new Mexican records and an exciting collaboration with media company Gannett digitized over 80 of their newspaper titles.

Beyond our prudent PlayBook for attracting and engaging subscribers, we're also starting to see a nice core business tailwind from the ramp of AncestryDNA. DNA is clearly adding to our subscriber TAM. Today we're seeing approximately 20% of non-subscriber DNA kit sales translate to an incremental Ancestry subscriber.

Moreover, these customers are showing higher engagement and lifetime revenue characteristics. So while we’re really excited about DNA as a standalone profitable proposition, it’s also having a meaningful and better than anticipated impact on the subscriber business as a negative cost marketing channel producing high quality Ancestry subscribers.

Clearly 2015 was a breakthrough year for our DNA business, and the strong momentum continues entering the New Year. Consumer awareness for DNA is growing here in the U.S. and we're starting to see it grow in the international markets where we’ve launched as well. We’re also excited to be collaborating on the new TLC network show, long lost family, debuting in the United States on March 6th. This new series leverages DNA testing to unite family members who have been separated throughout their lives. We think it’s potentially a great vehicle for continuing to drive awareness for DNA testing and our brand in particular.

While subscriber business and DNA will remain the anchors of our growth and performance, we’re also beginning to drive incremental contributions from or other portfolio or emerging businesses, Brands like Newspapers.com and our Progenealogist research service, help extend a competitive mode and create the opportunity to leverage the strength and scale for the Ancestry brand to profitable new growth opportunities for the Company, through better cross pollination of content as well as cross-selling and up-selling the services.

One example is our all access bundle, which we launched at the end of 2013 to provide Ancestry subscribers with bundled access to our important non- Ancestry brands, specifically Newspapers.com and [indiscernible]. While it's still early, all access revenue more than doubled in 2015 and we’re taking the initiatives to our international markets this year as well.

Another great example our powered by Newspapers.com initiative launched in 2015. Here we collaborate publishers, digitizing and making available the papers archived additions through the publishers' website under a revenue share model. We have over a dozens of these sites running now and dozens more in various stages of implementation and contract discussion.

Wrapping up, I'll say again 2015 was really one of the best years in our Company’s history. We’ve enjoyed real momentum in multiple parts of the business and we’re emerging as a stronger and more diverse company with multiple avenues for growth. To our healthy growing and higher free cash flow generating subscription business, we've added a powerful opportunity in DNA, which is both a great standalone profitable business, and an accelerant to growth for the core business as well.

We’re also executing on strategic initiatives, including targeted international expansion and positioning our portfolio businesses to generate incremental and synergistic growth. In 2016, we're aiming to continue this momentum and to maintain high levels of execution while also investing in a very focused way on future opportunities. Opportunities including DNA, international and importantly also in our technology and support of new business initiatives.

I want to take this moment to again thank our teams across the company and across the world for their really outstanding efforts and contributions to really just a terrific 2015. I’d like to thank our members and also to thank everyone else on this call for your continued support. So we turn it over to Howard to cover our results.

Howard Hochhauser

Thank you, Tim, and thank you everyone for joining the call today. Tim gave briefly a perspective on our accomplishments and underlying momentum in the business. And frankly I can't help but to pile on a bit. 2015 was really an outstanding year on every level. We improved the core products experience, made the right long-term investments in the business, and accelerated growth of the core subscription products.

Again, it was really a solid year and 2016 has gotten off to a really strong start. So let me jump in with a review of Q4. Q4 year-over-year revenue growth was 14%. On a constant currency basis, revenue grew almost 17%, and we exited the year with accelerating revenue growth in the core subscription business. Our subscriber metrics remain strong, our retention and engagement metrics remain healthy and our DNA business is frankly on fire. The acceleration in business performance is allowing us to incrementally ramp up hiring to further improve the product experience, invest in new content and launch in new markets, all of which is intended to expand the total addressable market for our products while retaining our core audience.

Digging a little deeper into subscriber activity in the period, we exited the year with 2.26 million subscribers across the Ancestry website, up almost 150,000 subscribers from the prior year-end, from 2014 year-end. Q4 bumped the normal end of year seasonality trend with net adds of just over 20,000 new subscribers. Marketing execution has been solid and we’re also benefiting from DNA cross-sells as Tim mentioned in his prepared remarks.

Year-over-year adjusted EBITDA growth was 6% for the quarter. In addition to an increasing mix of lower gross margin DNA sales and the impact of investments and personnel during Q4, we've also modified an accounting estimate in the DNA business. That estimate resulted in deferring $2 million of revenue into future periods. As I mentioned, we expect to ramp up our hiring in 2016 in an effort to further improve the project experience.

Looking into 2016, we entered the year with a lot of momentum and we're also planning for a busy year strategically. We should continue to see revenue growth rates improve into 2016 over a full year 2015 with slower growth in EBITDA as we ramp our engineering and product award [ph], as well as the impact of the revenue mix shift with DNA having a lower gross margin than the subscription business.

Overall margins are expected to remain very healthy. From a CapEx perspective we're budgeting content investment of approximately $30 million and a PP&E budget of approximately $25 million to $30 million, which includes about $12 million to $13 million related to our new headquarters office in Lehi, Utah. It's important to note that with the transition of Family Tree Maker, approximately 85% of our revenue -- of our service related revenue rather going forward will be attributable to the DNA business. So while exiting the SCM [ph] business will be a modest headwind to the revenue growth, it will also give you a cleaner look at the underlying trends in the DNA business.

To summarize we had a terrific 2015 and the momentum we are seeing across the Company suggests another year of solid growth. We're in a position of great strength and we're capitalizing on it by investing in the long-term opportunities we see for the Company. At the same time, we're also super focused on execution, performance and growth in the near term.

That concludes my remarks. So, again like Tim I want to thank everybody for their support over the past year. And with that we want to turn it over for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And our first question comes from Jeff Harlib of Barclays. Your line is open, please go ahead.

Jeff Harlib

Just the commentary on growth improving in 2016 versus '15 which was a solid growth year. Can you just talk about some of the key contributors -- talk about DNA, your core Ancestry.com business as well as maybe some color on the international expansion?

Tim Sullivan

Sure Jeff, this is Tim and I'll start. Howard can jump in. Starting with the last part of your question, not a lot of this was driven by international expansion. Our existing international businesses continue to grow more or less in parallel and at the same rate to our U.S. business. I'd say the real drivers of success this year were and we've said this many times before is very solid execution across the board, in marketing, great content -- improvement to that core product experience, which we think has been effective at satisfying the vast majority of our long time subscribers while also A, being a new site that's a lot more appealing and accessible to a new audience.

And then on top of that of course you have DNA, which really is a double positive. It obviously is a fast growing and profitable revenue line, but as we've said and as we've repeated many times, the cross sell dynamic is really creating a very important dynamic with respect to new subscriber acquisition and the cost of subscriber acquisition of that core business. Since a growing percentage of our GSA's in any period are coming to us expectedly for free or at a profit from this DNA channel, it really has provided a nice tailwind to that core business.

Howard Hochhauser

Jeff, let me just add on to that to put some numbers around it. So, Tim talked about the cross sell. So last year roughly we sold 1 million units. Importantly the growth rate of that accelerated in each quarter. We started the year in Q1, our growth rate was 30%. Q4 that growth rate was a 150%. So the cross sell as Tim mentioned is just 20% of non-subscribers end up becoming Ancestry subscribers and those subscribers have great characteristics in terms of higher engagement, higher life time revenue. So, what's that done for the core business is you see an acceleration in that revenue growth. In Q1 our revenue growth for the core business was around 3%. We exited the year doubling that rate of growth, closer to 7%, again on the yield of the cross sell that Tim talked about.

Tim had his remarks with the bundle. We launched a bundled offering which has packaged in a few of our products into one premium price service, which frankly is a real benefit for our customers. If it gets down for them, if they had to buy it separately and that provided another layer of incremental pricing growth on the core service.

Jeff Harlib

So, are you saying a 1 million, 20% -- you saw a benefit of around 200,000 ads from your DNA business.

Howard Hochhauser

No, to be clear, the $1 million is the total units sold, something to 20% is of those kits that were sold to non-subscribers. It was roughly around, call it between 5% and 7% of our U.S. subscribers came to us from the DNA, up from frankly zero a couple of years ago in the U.S.

Jeff Harlib

Okay, okay. And are you seeing those lower term from those subscribers that have come over from DNA?

Howard Hochhauser

Yes. Again the folks that come over from DNA tend to take a higher value package, both in terms of longer duration and more premium, and as a relates to monthly subscribers have an initial higher monthly renewal rate. But more importantly they engage more with the service. They're not just signing up. There're signing up and diving in and engaging with the content and their trees.

Jeff Harlib

Okay, okay, good. And just for ’16 the commentary, I think you said that your growth rate is expected to improve over 2015. I don’t know if you meant that the year-on-year growth rate will improve. But either way, what are some of the other contributors to that and how does international expansion factor into your revenue growth prospects?

Howard Hochhauser

Yes. Just to be clear, we’re talking about aggressive revenue acceleration, and its really continuation of the momentum that we’ve seen throughout the year. Again with the core business starting out growing 3%, exiting 7% year-on-year revenue growth. So we expect that upper trend to continue as we progress through 2016 and not to be redundant. But that acceleration is coming on really direct result on the DNA cross-sell. EBITDA however to be really clear, we want to make the right long-term investment and capitalize on its acceleration and revenue growth and put let some of that incremental revenue back into the business in terms of an acceleration in hiring and our product and engineering organizations.

Jeff Harlib

Okay, okay. And just maybe lastly, just what about deployment of free cash flow? You built up a good cash cushion. Are you looking at other acquisitions, deleveraging, et cetera?

Howard Hochhauser

Yes. So today we have January, roughly in February, we have about $140 million in cash. Our use of that cash -- we'd love if there were some relevant acquisitions to make. We look at some smaller assets from time-to-time. Should they become available, we'd be interested in acquiring them. There's nothing that is a must require to execute on our strategy. There are things that would be nice to have. So for now frankly that cash is going to build up as a credit markets, as you know probably better than me were a bit frozen for our cost structure.

Operator

Thank you. [Operator Instructions] And our next question comes from the line of Ilya Voytov of Vector Capital. Your line is now open. Please go ahead.

Ilya Voytov

Hi, thanks for taking the question. Congrats on the solid quarter and a great year. I wanted to ask about the size of your key basket today, and whether your free cash flow suite prepayments have synced and becoming up into one?

Howard Hochhauser

So the governor RFP today is where we pick notes thickness. At the end of Q1 number, that’s going to be around 40-ish million. We finished the year at around $20 million and we expect that to grow as the year progresses.

Ilya Voytov

And the free cash flow sweep.

Tim Sullivan

There is no free cash flow sweep. We did away with that when we did the refinancing over the summer. Next year is a first year of the free cash flow sweep.

Ilya Voytov

Got it. And…

Tim Sullivan

Go ahead.

Ilya Voytov

What is [indiscernible] optical levels?

Howard Hochhauser

I’ll give you the year-end numbers going through the cap structure. The bank debt is always around numbers $55 million. The bond is at $16 million and the pick it $20 million.

Operator

Thank you. And our next question comes from the line of Josh Brolin of [indiscernible]. Your line is now open. Please go ahead.

Unidentified Analyst

Just had -- first a couple of questions about the subscriber in the base in the context of DNA growth. You guys need to breakout gross subscriber adds and churn. I'd love to hear how those have trended over the last few years as you had the benefit from DNA?

Tim Sullivan

Yes. Again, I'll dial back to what I said to adjust our survival rates -- retentions rates over subscriber. If you look at that for annual, monthly, semi-annual, have been just really consistent and durable over time. And we look back to see how we performed, even the last recession and again the survival rates by package, by duration were all very consistent. As…

Unidentified Analyst

Can you guys give us the specific numbers? It would just be great to see those, especially if they are improving?

Tim Sullivan

Yes. They are constant over time and there is no specific number. We have three different packages, right and we look at retention rates just like a cable company or phone company look at retention rates.

Unidentified Analyst

So it’s churn like lower than maybe 4%. There was -- last time you broke it out, 2010-11 or it higher or?

Tim Sullivan

Churn is an output, it’s a mix of how many annuals, monthlies and semi-annuals you have in the mix at any one-time. That’s disclosed in our financials, how the mix has moved, up or down. What I can say is, we're thrilled with the performance of a subscriber base. Retention has remained rock solid and DNA has just served to help retention rates, especially in the monthly cohort.

Unidentified Analyst

And then have you guys -- I guess I think one thing top of my new search was there was a change in the -- I think it was like Family Tree Maker software that you guys had and there was a bunch of complaints of kind of older users it seemed like. Has there been any hit in retention from core users, non-DNA users in the first quarter? Has there been something that's done to address that [indiscernible]. It seemed like people were kind of upset about that. I don’t know how big that is in the context of the overall business or not?

Tim Sullivan

Yes, we made a decision late last year that we would not ourselves continue to support a desktop software program. Family Tree Maker had a reasonable -- reasonably sized install base. We announced we would continue support through this year. And since that announcement we -- we did get a lot of frankly feedback from our members, which we welcome, and that led us to look at other options for moving forward, which ultimately led us to finding somebody to take over further development of Family Tree Maker, so essentially selling that asset, while Ancestry will continue to be integrated into that. And then we also are going to be integrated into the other very large market share, our -- desktop software is probably called Roots Manager.

Unidentified Analyst

So was there any fallout from that or no fallout from that?

Tim Sullivan

Yes. There was -- I guess what I can say is no measurable or really noticeable impact on resignation metrics. We are one of those brands that has a real challenge and we have a real responsibility to people that have been long-term, long-time subscribers. And we also want to continue to evolve that product, to make it relevant and accessible for more people. So that's a constant mini stress, and I think we continue to take that very seriously.

Unidentified Analyst

And then just one last question. I've just been curious. As you guys are out marketing the DNA product and given the fact that you've collected now the largest database of DNA information in the world, has that created any change in the extent to what you're seen cyber-attacks or attempts to capture patient information, and just talk a little bit about your strategy around that in terms of protecting that information?

Operator

Ladies and gentlemen please stand-by, your conference will resume momentarily. Your line is now open.

Tim Sullivan

Great, well let me, I don't -- we kind of got cut off on that last question. I think it was a question around are we seeing greater security requirements around our DNA business or greater number of cyber-attacks. Look, we're not going to comment specifically on that. I would say that we have taken great care to pay attention to the things that we have to, frankly really focus on with this new business. We've always been -- really sought to protect our users' private information. We now have significantly more sensitive information and we have made the right investments we think in security and attention to consumer privacy and trust. So it's a very, very important part of future challenge we will have as we continue to become larger and more relevant in the consumer genomics business.

Operator

[Operator Instructions] And our next question comes from Akbar Causer of DDJ Capital. Your line is now open. Please go ahead.

Akbar Causer

Hi guys congrats on the strong 2015. Just a few questions from my end. In your comment on just the status of expansion into Germany, Mexico just the international focus?

Howard Hochhauser

Yes, I’ll take that. It's Howard. So we launched in Germany in October and frankly it’s very early. I would double that underlying vary. But it’s been good. We lunched. We’re on TV now. We have an active campaign there, launched with some PR. We have great content hitting the site. And the headline is that the market is responding and traffic is ramping, obviously work to do in terms of optimizing our conversion funnel and really tuning in our message to that audience. But I would say out of the gate we feel good, but again durable [ph] underlying very early.

Akbar Causer

And on Mexico.

Howard Hochhauser

Mexico, we haven’t launched as much as we have -- to the same centers we have in Germany. So right now we're focused on getting Germany out there and learning from Germany. We are going to rollout frankly in 29 countries imminently here the DNA product. So it would effectively English version of the DNA product, but launched and available for sale in 29 countries around the world. And there too, it's sort of a beta launch, use it to learn, acquire samples, test and marketing initiatives, and course correct and learn as we’re in market.

Akbar Causer

Okay, great. And just on the subscriber base. It doesn’t seem like it was reflected in the number, which is good, but the new credit card; did that have any impact on your renewal rate or do you see any issues there?

Howard Hochhauser

Yes. The times we’ve seen issues with renewal rates, the Target breach, the Home Depot breach, and then the third one that we saw was when they starting circulating or resending out cards that included chips. But we have a good payments program in place, that we optimize to get the new credit card number even with this chip change. So we saw some initial impact, but frankly through systems implementations and just staying ahead of it, we didn’t see any dramatic impact to the business.

Akbar Causer

Okay. And then just last one in, Howard, you had mentioned with the sort of -- the way that markets are right now, with the freeze, little cash maybe spend on M&A. I know you brought back some of the whole Co [ph] bonds in the past. Are you going to re-entertain that and hoping [indiscernible] and the cash you have?

Howard Hochhauser

It’s a fair question frankly. There are not terribly liquid. So we're a bit constrained as to our ability step into the market and buy those back. So theoretically the answer is yes. In practicality as the non-call in the bonds expires in December. So our focus is really on optimizing around that date.

Operator

Thank you. And I’m showing no further questions at this time. I would now like to turn the call over to Mr. Tim Sullivan, CEO for closing remarks.

Tim Sullivan

I want to thank everybody again for joining us today. And look forward to doing it again. Thank you to our team and to all of you.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This concludes today’s program. You may all disconnect. Everyone have a great day.

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