Full Transcript of 24/7 Real Media’s 3Q05 Conference Call — Q&A (TFSM)

Here’s the entire text of the Q&A from 24/7 Real Media’s (ticker: TFSM) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and we’ll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha.

Q&A

Operator

Operator Instructions. And your first question comes from Joe Maxa with Dougherty & Co. please go ahead.

Q - Joe Maxa

Hi good morning gentlemen, congrats nice quarter. A question on the Search margins. They have come down significantly over the last year. Can you kind of go through the dynamics related to that?

A - Jonathan Hsu

Thanks for the question, Joe. As you can see, we continued to see stellar growth in our Search division during Q3. Regarding Search, the blended gross margins in the segment did decrease as we experienced a significant out performance in our lower margin full-service SEM business. As we have stated previously, gross margins in the segment will mathematically be lower if our search engine marketing business performs better than expected as it did during Q3. And as you can see over the overall performance of the Company, we did outperform both on the top and bottom line. So overall I think we were quite happy with how the overall business performed.

Q - Joe Maxa

So going forward, we should see this as long as Search continues to do well, should continue to drip down to a certain level. And where should we see that level out? Is there a point where you are comfortable where it would not drop below?

A - Jonathan Hsu

Well, going forward right now we expect gross margins in the segment to be stable, unless we once again experience better than expected growth in our lower margin full-service SEM business.

Q - Joe Maxa

Okay. And then just lastly with the Dentsu coming up, you are saying those margins should be consistent, but being that that's the lower margin business, that could also negatively impact margins because they don't have the they have got over to 100% feed?

A - Jonathan Hsu

I think it will be consistent with our current gross margins that we're reporting currently for the business.

Q - Joe Maxa

Okay thank you all I will be back in queue.

A - Jonathan Hsu

Okay, thank you.

Operator

Thank you our next question comes from Stewart Barry, with ThinkEquity Partners. Please go ahead.

Q - Stewart Barry

Good morning and congratulations on a nice quarter. Jonathan what was your organic growth rate this quarter, and what percentage of revenues were international? And then kind of moving forward, what is your implied organic growth rate for the fourth quarter and next year? As I look at the fourth-quarter guidance, it looks like -- maybe I'm wrong, but it looks like the Media segment -- the implied growth rate is close to 10% year-over-year.

A - Jonathan Hsu

Thanks for the question Steve and we once again appreciate your observation that it was a strong quarter. Our organic growth rate for Q3 was 59% year-on-year. As everyone remembers, we acquired Decide Interactive in mid-August 2004. Going forward since Decide was acquired in Q3 of 2004, all our guidance for Q4, as well as 2006, incorporates this into it and will represent organic growth. In terms of international operations for the quarter, once again they did edge up. So international operations during Q3 represented 56.3% of total revenue and U.S. operations represented 43.7%. Once again, this is significantly different than most other competitors in our space and represents what we believe is quite a strategic leverage going forward in the years to come.

Q - Stewart Barry

Is there any particular market internationally that is I know you are both in Asia and Europe showing stronger?

A - Jonathan Hsu

Sure. Within the quarter, we did see strength across the board, but particular strength from Continental Europe. And I think that when you look forward, our international operations will continue being a very important driver for growth for this Company.

Q - Stewart Barry

And then one final question. What do you consider as your Search line becomes more of an agency business, just reporting that net revenue I know you have some elements in there that are reported net and some gross. And so it could be a little bit it sounds to me a little confusing as the gross margin moves around, but if you reported at all net, then there would be more clarity there. Would you consider doing something like that?

A - Jonathan Hsu

Currently everything on the table, the issue is that based on GAAP we are required to represent business growth.

Q - Stewart Barry

I got you. I understand. Okay. Thanks.

Operator

Thank you and your next question comes from George Mihalos, with Gilford Securities. Please go ahead.

Q - George Mihalos

Hi guys congratulations on a nice quarter. Jon, I was hoping you can break out the CapEx for the quarter and perhaps give us some guidance looking into '06?

A - Jonathan Hsu

Sure. Thanks for the comment, George. CapEx for the quarter was $1 million, and as we cited, we did frontload CapEx during 2005. So it did trail off from what was a run-rate of about 2 million a quarter in Q1 and Q2. Cash flow from operations, as I stated, was 4.9 million, which netted a positive $3.9 million in cash, net cash per operations for the Company, strengthening our balance sheet. Going forward CapEx should remain at this level, and we feel that we have the systems and infrastructure in place to support our growth.

Q - George Mihalos

Okay. You certainly have a lot of strength now with your Search product and a comprehensible offering between Technology and Media. Are there any other areas that you might look to expand your services into? And do you -- can you consider a scenario where you would be interested in acquiring proprietary traffic for your business?

A - David Moore

At this stage of the game, we have not looked at acquiring any proprietary traffic. We see our niche as essentially being neutral, particularly in Search and Technology, and then, of course, in online advertising we represent all of our sites equally. We are still in the market for acquisitions. We always are. But we will focus on acquisitions that are technology driven. We are not going to be spending money to buy people and customers.

Q - George Mihalos

Okay. Thank you.

A - David Moore

Okay thanks George

Operator

Your next question from Aaron Kessler, with Piper Jaffray. Please go ahead.

Q - Aaron Kessler

Congratulations on a good quarter. A couple of questions. One, can you give us an indication as we enter 2006 how much of the Search growth do you expect to draw from new versus existing clients? And as to the Dentsu relationship, should we be expecting additional agency relationships as we head into next year?

A - David Moore

Thanks for the question Aaron. Regarding our '06 growth in Search, I think what you will see is a good blend, say, half/half of growth from existing clients and the wins from new clients. Regarding our Dentsu relationship, which is a very important strategic objective that we achieved for the Company, Dentsu is one of the largest dominant advertising agencies globally and they are obviously the dominant advertising agency in the Asia-Pacific marketplace, which itself will experience phenomenal growth over the years to come. Our first priority is to work with Dentsu on a number of different projects, which we have a good relationship with Dentsu, and we're continuing to execute for them. And obviously as the entire market evolves, that additional global advertising agencies will look to leading technology and services providers in the Internet advertising market like 24/7 Real Media for partnerships and other solutions.

Q - Aaron Kessler

Great. Thank you.

Operator

And your next question comes from Sameet Sinha, with Kaufman Brothers. Please go ahead.

Q - Sameet Sinha

Good morning gentlemen thank you for taking my question. A quick question on the Media and Technology side. CPMs obviously slipped during the quarter, even year-over-year. Growth rates were much lower. Can you comment on that and how do you see that -- do you see that coming back up, or if not, what sort of declines should we be expecting?

A - Jonathan Hsu

Thanks for your question. Our Media and Technology divisions performed very well during Q3. Media revenues year-on-year were up 29%, and Technology revenues year-on-year were actually increasing and were up 26%, and both of those significantly outpaced the overall growth of the sub segment. Impressions on both the Media and Technology side greatly increased during Q3. Therefore, as we ramp up those impressions, CPMs did decrease a little bit. But net our revenues on both Media and Technology increased significantly, and we anticipate that to continue going forward.

Q - Sameet Sinha

So we should expect CPMs to kind of trend the way they have been over the last three quarters?

A - Jonathan Hsu

They should be around where they are for the last three in Q3.

Q - Sameet Sinha

Okay and a question on your operating margin. Now that Search has -- obviously margins have declined, are you still sticking to your operating model of 30% incremental gross margins in Media and Search?

A - Jonathan Hsu

Well, our target operating model, which is reflected within our financial guidance for 2006 which we just raised today, does incorporate and is consistent with what we believe will be the case for Media, Search and Technology. I would also like to just say that when you look at our overall business model right now and the overall robust streams of the advertising marketplace, you definitely see a case where there are the haves and have-nots within the overall marketplace. And companies like 24/7 Real Media, which has this diversified business model, is capturing fully the robust growth and the secular shift to the Internet advertising business we are seeing in the market. So I think that we are in the right place at the right time with the right model.

Q - Sameet Sinha

Okay. One quick question. When do you expect GAAP profitability? Is that something we can expect next quarter or maybe the first quarter of '06?

A - Jonathan Hsu

Regarding profitability and metrics, obviously we believe that pro forma operating income per share is the right way to look at the business, and it reflects very accurately the cash costs and performance of the overall business. Regarding GAAP, we have not provided any guidance regarding GAAP income per share. That will be influenced by a number of variable factors, including the final regulations regarding expensing of stock options.

Operator

Thank you and your next question is a follow up from Joe Maxa. Please go ahead.

Q - Joe Maxa

Yes thanks. Regarding the competition in the search engine marketing space, can you go into that a little bit, and is that potentially a reason why some of the margins were down?

A - David Moore

The competition, of course, is fierce, particularly in the United States. However, I think as we have indicated earlier the different types of business that we do with our search engine marketing business have different margins and not as a result of the competition, but as a result of the type of search business that we have a decline in the margin overall, which, of course, is offset by a much better performance from a revenue perspective. Over in the Continental Europe Pan market, the competition varies on a country by country basis. It is considerably less. And, of course, over in Asia, we see a Greenfield marketplace. So to sum it up, competition did not affect the margin overall. It is the type of business that we chose to accept, but it is no question about it a competitive marketplace, particularly in the U.S.

A - Jonathan Hsu

And, Joe, when we take a look at the future of Internet advertising and particularly in Search, more and more so advertisers will look for global provider of these types of services. And based on our footprint today with 19 offices in 12 countries throughout the three major regions, we are the only provider right now that can address some of the largest advertisers globally. So I would think that when you look forward to the next several years it will be more and more global deals being put in place, and there are not any providers aside from 24/7 Real Media that can accomplish those types of deals. Most recently, in Dentsu, you could see that we were the only choice to provide a double-byte enabled technology platform for Search within the Japanese market.

Q - Joe Maxa

Okay. Could you give us like how many new searches and marketing customers you signed in the quarter, and would you classify these guys as all Enterprise customers?

A - Jonathan Hsu

We don't break out the number of clients that we won in the quarter. Obviously the pace of wins continues to be brisk for us as evidenced by our more than tripling of Search revenue in the quarter. In terms of the types of clients that we are attracting, we are paying to attract those who provide us their entire search budget, and we put those search budgets to work for them either on a regional or a global basis currently.

Q - Joe Maxa

Okay. Thank you.

Operator

Our next question comes from Jeff Osher, with JMP Securities. Please go ahead.

Q - Jeff Osher

Hi Jonathan, not to beat a dead horse here on the Search margin, but I guess just coming to the quality or type of business you're accepting, I don't know if I ever seen a situation where revenues increased by 18% and gross profits actually go down. I mean that would suggest even if decide is adding customers, your organic business is rolling customers off, and you're having to accept new business at much lower gross profits. Can you just kind of help me reconcile how gross profits could be down 100,000 on a $2 million increase in revenues?

A - Jonathan Hsu

Thanks for your question, Jeff. As we stated, our gross margins in this business are affected by the types of lower margin full-service SEM business that we except. And, as you saw in the quarter, our overall revenue for Search did increase explosively by over 234%. Anytime you have that type of explosive growth there will be some short-term variability in the gross margins as we ramp up customers and drive to optimize their campaign. So even within the one quarter, and I encourage everyone to take a longer holistic view of this, you know we are experiencing explosive growth here in the Search business, and within it we're winning larger and larger clients that we are serving globally.

Q - Jeff Osher

Well, if I just look sequentially and I think everyone appreciates the explosive growth, if I just look sequentially, you guys saw a $2 million plus jump in revenues. And I cannot remember who asked before, but the net versus gross reporting, your net revenues actually declined by 100,000. Isn't that a better way to look at it given the fact that you are reporting gross on the top line and that is what you're referring to as explosive when your net revenues are actually declining?

A - Jonathan Hsu

I think that when you take a look at the year-long trend and what you'll see in the fourth quarter and beyond is continued step-up in gross margin, as well as increased growth on the top line for Search. So once you stretch this out a few additional quarters, obviously baked into our guidance will be increased revenue and gross margin across our three business segments.

A - David Moore

And you have to remember that when we secure a client on our search platform and we achieve their return on investment goals within a couple of months of that client being on the platform, we have got that client for the life of that particular product lifecycle. So that while we may suffer in the short-term a little bit by securing that client, over the long-term we're able to build up the business, the spend, as well as the margin in a manner that makes that client very profitable.

Q - Jeff Osher

Okay. So would that suggest these new clients come on in the first quarter at a gross profit loss?

A - Jonathan Hsu

They never come on at a gross profit loss.

Q - Jeff Osher

Then how could revenues go up by 2 million and gross profits go down?. Do you know what I mean? I am having a hard time reconciling that, guys.

A - Jonathan Hsu

The existing clients that we have optimized roll off their campaign, and then we bring on new clients that replace them and more. But during the ramp-up phases, they are at a lower gross profit margin, but they ramp up over time ago. That is how it mathematically would work out.

Q - Jeff Osher

Well, why would you have such a big roll-off in existing clients?

A - Jonathan Hsu

That is just the timing of the campaign.

Q - Jeff Osher

Okay. What is the typical lifecycle of the campaign?

A - David Moore

It depends on the product.

Q - Jeff Osher

Okay. Thanks, guys.

Operator

Operator Instructions

David Moore, Chairman and Chief Executive Officer

Okay. Well, thank you for joining us this morning. 2005 has been a breakout year for 24/7 Real Media. As we exit this year and enter 2006, everyone at the Company is optimistic about our prospects. We will continue to deliver results for our clients, partners and shareholders. I look forward to speaking with you again during our next call. Thanks for joining us.

Operator

Thank you. Ladies and gentlemen, that does conclude today's teleconference. If you would like to listen to a replay of today's conference, you may dial in at 303-590-3000 or 1-800-405-2236 and then followed by the access code of 11041517 and the follow-up at the #. Once again those numbers are 303-590-3000 or 1-800-405-2236 followed by the access code of 11041517 and the follow-up at the #. Once again, thank you for your participation in today's conference, and at this time you may disconnect.

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