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InfoSpace,Inc. (INSP)

Q32007 Earnings Call

November 1, 2007 5:00 pm ET

Executives

StacyYbarra - Director, Investor Relations

JamesF. Voelker - Chairman of the Board, President, Chief Executive Officer

AllenM. Hsieh - Chief Financial Officer, Chief Accounting Officer

Analysts

ScottSutherland - Wedbush Morgan Securities

DerekWood - Pacific Growth Equities

Presentation

Operator

Welcometo the Infospace Incorporated third quarter 2007 earnings conference call.Today’s program is being recorded. For opening remarks, I would like to turnthe call to Miss Stacy Ybarra. Please go ahead ma’am.

Stacy Ybarra

Goodafternoon and welcome to Infospace’s third quarter 2007 earnings conferencecall. I am Stacy Ybarra, Director of Investor Relations. With me on the calltoday is Jim Voelker, Chairman and CEO, and Allen Hsieh, Chief FinancialOfficer.

Beforewe get started I want to remind you of three things: first, this is an investorcall; accordingly, we will only be taking questions from the investmentcommunity. Second, this conference call contains forward-looking statementsrelating to the development of the company’s products and services, thedevelopment and future of the company’s business, strategic transactions beingpursued by the company, and anticipated future operating results.

Thesestatements are subject to certain risks and uncertainties that could causeactual results to differ materially from those projected. Factors that couldaffect the company’s actual results of operations include, but are not limitedto, the progress and costs related to the development of our products andservices; the timing and market acceptance of those products and services; ourdependence on companies to distribute our product and services; the performanceof our systems; the effectiveness of the development and implementation of ourstrategy; possible changes to that strategy, and the ability to retain keycontracts and personnel.

Amore detailed description of the certain factors that could affect actualresults of operations is contained in the company’s most recent annual reporton form 10-K and quarterly report on report 10-Q as filed from time to timewith the Securities and Exchange Commission in the section entitled “RiskFactors.”

Listenersare cautioned not to rely on forward-looking statements which speak only as ofthe date of this conference call. The company undertakes no obligation toupdate publicly forward-looking statements due to new information, events orcircumstances after the date of this conference call, or to reflect theoccurrence of unanticipated events.

Third,please note that on this call we will provide you with non-GAAP financialinformation; these items together with the corresponding GAAP numbers and areconciliation to GAAP are contained in today’s earnings release, which we haveposted on our website at www.infospaceinc.com,and filed with the FCC on form 8-K.

Wewill also discuss historical financial and other statistical informationregarding our business and operation. Some of this information is included inthe press release, and the remainder of the information will be available in areported version of this call on our website.

Now,I’ll turn the call over to Jim; following his comments, Allen will review thethird quarter results and fourth quarter outlook. Then we will open up the callto your questions.

James F. Voelker

ThanksStacy. Welcome to the call today. It’s been a very eventful fall. On anoperating basis, we’ve exceeded GAAP guidance in both revenue and adjustedEBITDA, and we unlocked significant value for shareholders by executingdefinitive agreements to sell our online directory and mobile service units fora combined total of $360 million in cash.

I’mpleased to announce that the directory sale to Idearc for $225 million in cashclosed yesterday and we expect the mobile transaction will close in the nearfuture. We also anticipate distributing a significant portion of these proceedsto shareholders in early January.

I’llstart by sharing some details on the transactions and the positive outcome forshareholders, and then I’ll discuss the ongoing search business.

Earlierthis year the board and the management began to evaluate alternatives forclosing what was a significant gap between our market valuation and thecompany’s asset value. We focused on a strategy in which we would sell certainassets to unlock value, and still retain a majority of our revenue and segmentincome.

Weconsistently believed that the aggregate value of our assets – search,directory, mobile and our $1 billion NOLs – had not been recognized in thestock price, and in fact, the proceeds from these transactions alone are almostdouble the enterprise value in mid-September. Our enterprise value beingdefined as market capitalization less cash.

Therecent announcements validate our strategy. As the $360 million proceeds arerealized, we expect that this will be shielded from substantially all cashtaxes at the corporate level by the application of our NOLs, and that ouroverall cash position will be in the range of $550 million or over $16.50 pershare in cash. In addition, we’ll maintain our highly scalable search business,which we believe is our most valuable asset. Based on our results for the firsthalf of 2007, we retain over 60% of our core revenue and the vast majority ofour segment income.

Nowsome details on the divested assets: over 90% of the revenue in the directoryunit was generated from the switchboard.com business, acquired in 2004 for $103million. In the first half of 2007, directory represented approximately $17million in revenue and $11 million segment income. While this business is veryprofitable, growth has been stagnant, therefore an implied multiple of morethan ten times segment income, this was an attractive transaction.

Onthe mobile side, we experienced good revenue growth from our mobile servicesbusiness this year. Up over 50% from the third quarter last year, and webelieve the unit will be in break-even in the fourth quarter. But it’s an early-stage business, and as acomponent of our businesses, we did not believe it was garnering appropriatemarket value. At 2 ½ times our annual revenue guidance, we believe thistransaction delivers full value for our shareholders.

Nowonto our search business: upon the completion of these transactions, Infospacewill be a focused online search company, well positioned for growth andsuccess. As we move toward next year, we will further align our cost structurewith the expected revenue from search. And while we will share more details inthe near future, our financial objectives are for gross profit margins to be inthe range of 55-60% and adjusted EBITDA to be 15% plus in 2008.

Thisrefined focus will benefit our business and our shareholders. The opportunityfor search continues to be significant. Among our assets, a highly scalable,proven business model; a J.D. Powers certified highest satisfaction product twoyears running; strong and unique monotization relationships with Google, Yahoo,Live Ask and many others; a broad distribution network of over 100 partners;new opportunities in portal and DNS monotization; and positive market trends aswell. The latest market developments in vertical and human-powered search serveto enhance our metasearch value proposition, and search frequency andadvertising rates continue to rise year-over-year.

Postingthese transactions and the return of capital to shareholders will maintain astrong balance sheet and increase our cash generation. Personally, I’m excitedfor the prospect of full-focus on one business.

Thishas been a very positive year for Infospace shareholders. In May, we paid a$208 million or $6.30 per share dividend and in the past few months wecompleted or entered into definitive agreements to unlock substantial value viathe sales of our directory and mobile businesses. In addition, by utilizing ourNOL assets, we expect to maximize the proceeds available for distribution, andwe retained the majority of our revenue and segment income in a dynamic growingmarket. Over the past five years, we have generated over a 6 ½ times return forinvestors and we look forward to the next chapter.

Andspeaking of next chapters, in connection with these transactions, BrianMcManus, Executive Vice President of our online division will leave the companyby the end of the year. Brian’s been a strong leader and he’s chieflyresponsible for the success we’ve had in our search and directory business forthe past four and half years. We thank him for his considerable contributionsand we wish him the best in his future endeavors.

Withthat I’ll turn the call over to Allen for more details and guidance. Allen?

Allen M. Hsieh

ThanksJim. I will start with a review of our third quarter results and then discussour outlook for the fourth quarter. Please keep in the mind that for the thirdquarter of 2007 and all prior periods, the operating results of the directorybusiness has been presented as discontinued operations in our GAAP financialstatements.

Revenuesfrom continued operations for third quarter of 2007, which include onlinesearch and our mobile businesses, were $48.7 million, compared to $88.3 millionin the third quarter of 2006. As expected, total revenues decreased compared toprior year, primarily as a result of exiting the mobile media business.

Directoryrevenues of $8.7 million in the third quarter of 2007 are now treated as discontinuedoperations. Had directory remained partof our continuing operations, revenues would have been $57.5 million for thethird quarter of 2007, which significantly exceeded our expectations.

Thirdquarter 2007 adjusted EBITDA from continuing operations, which includeadjustments to our restructuring reserve, was approximately $400 thousand,compared to a negative $56.2 million in the third quarter of 2006. Had weincluded the segment income from our directory business, adjusted EBITDA wouldhave been $3.8 million, which also exceeded our expectations.

Netloss in the third quarter was $12.3 million, or $0.37 per share, compared tothird quarter 2006 net loss of $46.7 million. Weighted average sharesoutstanding were $33.2 million for the third quarter of 2007.

Turningto our segments, in the third quarter of 2007, online search revenues were$33.9 million, sequentially up 7% compared to second quarter 2007 revenues of$31.8 million. In the third quarter of 2007, approximately 40% of revenues werederived from our own sites and distribution search revenues were approximately6%. As expected, revenue growth in the third quarter of 2007 was attributableto our search distribution network.

Wesaw revenue growth from both organic and our FCM distribution partners. Segmentincome was $10.1 million in the third quarter of 2007, a decrease of 6%compared to second quarter of 2007 of $10.8 million.

Movingon to mobile, revenues in the third quarter were $14.9 million, comprised of$13.9 million in mobile services revenues and $1 million from our media contentbusiness. Mobile services revenues increased by 4% from the secondquarter 2007 revenues of $13.3 million. We had a segment loss of $2.4 million in the third quarter of 2007 – amore than 30% improvement to the second quarter 2007 segment loss of $3.6million. Our mobile business is on-track to be break-even by the end of theyear.

Regardingthe balance sheet, we ended the quarter with $214.8 million in cash andmarketable investments and had no debt. With the addition of $225 million thatwe collected yesterday from the Idearc sale, our cash balance is approximately$440 million.

Turningto our outlook, beginning in the fourth quarter of 2007, the company willpresent directory and mobile as discontinued operations and we will only beproviding guidance for our online search business. Our guidance excludes thedirectory and mobile discontinued operations; gains from those sales of thosetwo businesses, and any other non-recurring charges.

Forthe fourth quarter of 2007, the company expects search revenue to be between$34-35 million. Additionally, the company expects adjusted EBITDA fromcontinued operations to be approximately $1 million, and GAAP net loss fromcontinued operations to be between $7.5-8.5 million or $0.22-0.25 per share.

Aswe move forward, we are organizing around our online search business, and wewill align our costs appropriately. Our financial objectives are for grossprofit margins to be in the range of 55-60% and adjusted EBITDA margins to bein the 15% plus range.

Withthat, I will now turn the call over to the operator, and we will be happy totake your questions.

Question & Answer Session

Operator

Thankyou. (Operator Instructions) We’ll go first to Scott Sutherland with WedbushMorgan Securities.

Scott Sutherland - Wedbush MorganSecurities

Goodafternoon and good job managing through all the moving parts. First, sincesearch is going to be your stand-alone business I want to focus a little bitthere. You mentioned some SCM growth and growth in the core business; so this SCMstuff’s been kind of lumpy and you have been guiding it generally down over thelong-term, so how do you see this playing out now?

James F. Voelker

WellI think SCM is going to have some volatility in it; although the legitimateportions of SCM, and I’ll characterize that, are really getting stronglydefined now. And so that operators, SCM and marketing kinds of companies areseeing the exact parameters in which they can operate in. Basically what that means is they have toenhance the content on their websites and the landing pages, and they have toprovide a high-quality user experience that then translates into high-qualityand high-converting traffic. Likeanything else, as the enforcements come, people come along to that and figureways to do it. I think we’re going to see it still remain volatile for awhilebut it is narrowing down into an area where people know what they can and can’tdo and how it’s going to monotize.

Scott Sutherland - Wedbush MorganSecurities

Yousaw a kind of sequential growth in the online unit, but you saw sequentialdecline on the segment income; did you invest here or did something else movearound on the online unit?

Allen M. Hsieh

Wedid invest in some initiatives in the third quarter and these are opportunitiesthat we see in the future in the online search business.

Scott Sutherland - Wedbush MorganSecurities

Ona year-over-year the online search was down about $7 million was that all SCMor could you say whether you had organic growth in the non-SCM business?

Allen M. Hsieh

Year-over-yearit went from third quarter 2007 to third quarter 2006 we had a combination, andthe primary drivers were the declines in the SCM but we had enough in theorganic piece of our business.

Scott Sutherland - Wedbush MorganSecurities

Justa couple of more questions here and I’ll be out of your way. You’ve guided $1million EBITDA next quarter but you got about $400 thousand this quarter andthe mobile impact would be about $2.5 million so you’re implying you’re doing$3 million EBITDA and you’re also guiding revenue up, so is there some othertype of investment going in Q4 that’s going to keep EBITDA down for thequarter?

James F. Voelker

Yeswe are going to make some other investments and look at trying to draw in moredistribution partner revenue growth.

Scott Sutherland - Wedbush MorganSecurities

Okay.The last question I had if you dividend out most of the cash but you’re goingto keep some of the cash on top of the x million you had before, do you seeplans for that cash; I mean is more buy-backs or would be more strategicM&A would be the first priority of business?

James F. Voelker

Tobe clear we haven’t determined exactly how much cash we’re going to retain inthe company, but we’re a smaller entity now so our cash needs that we’ve seenprevious to be at a level to be around $200 that may not need to be that kindof a number for going forward. But we haven’t made that decision yet. Andobviously what we’re looking for is to see are there other opportunities herefor some kind of M&A that’s really right on top, and basically what we’reinterested in is anything that would drive or provide quality search traffic.We’re not looking to spread out into any other kinds of businesses; we’ve takenthat class here on the mini-conglomerate but we’d definitely be interested inacquiring quality search traffic, so that’s what we’d be looking at.

Scott Sutherland - Wedbush MorganSecurities

Okay,great, thanks a lot guys.

Operator

Andwe’ll go next to Derek Wood with Pacific Growth Equities.

Derek Wood - Pacific Growth Equities

Hithanks. Just wanted to clarify on thedividends, as an investor to they get taxed on the dividends or are you somehowable to use your NOLs to make that a tax-free dividend?

Allen M. Hsieh

Derek,the NOLs that we have are really the company’s NOLs so it cannot be applied, orpushed down if you will to the shareholders. And the amount of the dividendsthat is taxable to shareholders depends on a number of factors including howmuch accumulated earnings and profits and current profits we have. It is anannual type measure.

Derek Wood - Pacific Growth Equities

Okay,and now that you’ve carved out some of your NOLs what’s kind of the current NOLstanding right now?

Allen M. Hsieh

IfI look at this on a broad-stroke basis, we had about $1 billion NOL to beginwith, we just recently, between the two transactions roughly $360 million grossproceeds, as you can tell there’s not a lot of, if you will, bases in thoseassets so let’s call it $300 million of those will probably be in the gainrange, so you’re looking at between $600-700 million in NOLs.

Derek Wood - Pacific Growth Equities

That’swhat’s remaining?

Allen M. Hsieh

It’llbe between $600-700 million,

Derek Wood - Pacific Growth Equities

Okay.And then, how many diluted shares outstanding do you have if you didn’t have ananti-diluted situation right now?

Allen M. Hsieh

Youmean included all the outstanding RSUs and options?

Derek Wood - Pacific Growth Equities

Wellyes, if you were reporting profitability what would be the total diluted sharesoutstanding?

Allen M. Hsieh

Idon’t have that right off hand Scott; one thing we’ll have in our 10-Q it’ll beon file and that should be out early next week.

Derek Wood - Pacific Growth Equities

Okayand then on the EBITDA margins getting to 15%, is there a timeline; obviouslyit’s not going to happen next quarter given your guidance; can you get to thatnumber fairly quickly, how are you thinking in terms of cost reductions, andhow long that’s going to take?

James F. Voelker

Wethink the cost reductions will be effected relatively quickly, however, there’salways transitional; and even in these deals that we’ve done, thesetransactions we have some transitional issues to deal with. We’ve taken threebusinesses and split them off and so we’ll have some issues to deal with interms of small amounts of real estate, and some other issues that will carrythrough a little bit into next year, but we’re looking at that number as anannual number for 2008.

Derek Wood - Pacific Growth Equities

Okaythen if you could just drill down a little bit on, without mobile where are yougoing to see most of the savings in the operating and expense line? And thenactually moving up above that, you did about $5.5 million in systems andnetwork operation costs, is there any room for reduction there? Thanks.

James F. Voelker

That’sa real long and complicated answer and I think at this point we’ll put thosedetails off until the next time we have a chance to chat.

Derek Wood - Pacific Growth Equities

Okaywell thanks for the update.

Operator

(OperatorInstructions) And we appear to have no further questions. I’ll turn the conference back to our speakersfor any closing remarks.

Stacy Ybarra

Thankseveryone for joining.

Operator

Thatconcludes the Infospace Incorporated conference call. You may now disconnectand have a good day.

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