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InfoSpace, Inc. (INSP)

Q3 2007 Earnings Call

November 1, 2007 5:00 pm ET

Executives

Stacy Ybarra - Director, Investor Relations

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

Allen M. Hsieh - Chief Financial Officer, Chief Accounting Officer

Analysts

Scott Sutherland - Wedbush Morgan Securities

Derek Wood - Pacific Growth Equities

Presentation

Operator

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

Stacy Ybarra

Good afternoon and welcome to Infospace’s third quarter 2007 earnings conference call. I am Stacy Ybarra, Director of Investor Relations. With me on the call today is Jim Voelker, Chairman and CEO, and Allen Hsieh, Chief Financial Officer.

Before we get started I want to remind you of three things: first, this is an investor call; accordingly, we will only be taking questions from the investment community. Second, this conference call contains forward-looking statements relating to the development of the company’s products and services, the development and future of the company’s business, strategic transactions being pursued by the company, and anticipated future operating results.

These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. Factors that could affect the company’s actual results of operations include, but are not limited to, the progress and costs related to the development of our products and services; the timing and market acceptance of those products and services; our dependence on companies to distribute our product and services; the performance of our systems; the effectiveness of the development and implementation of our strategy; possible changes to that strategy, and the ability to retain key contracts and personnel.

A more detailed description of the certain factors that could affect actual results of operations is contained in the company’s most recent annual report on form 10-K and quarterly report on report 10-Q as filed from time to time with the Securities and Exchange Commission in the section entitled “Risk Factors.”

Listeners are cautioned not to rely on forward-looking statements which speak only as of the date of this conference call. The company undertakes no obligation to update publicly forward-looking statements due to new information, events or circumstances after the date of this conference call, or to reflect the occurrence of unanticipated events.

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

We will also discuss historical financial and other statistical information regarding our business and operation. Some of this information is included in the press release, and the remainder of the information will be available in a reported version of this call on our website.

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

James F. Voelker

Thanks Stacy. Welcome to the call today. It’s been a very eventful fall. On an operating basis, we’ve exceeded GAAP guidance in both revenue and adjusted EBITDA, and we unlocked significant value for shareholders by executing definitive agreements to sell our online directory and mobile service units for a combined total of $360 million in cash.

I’m pleased to announce that the directory sale to Idearc for $225 million in cash closed yesterday and we expect the mobile transaction will close in the near future. We also anticipate distributing a significant portion of these proceeds to shareholders in early January.

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

Earlier this year the board and the management began to evaluate alternatives for closing what was a significant gap between our market valuation and the company’s asset value. We focused on a strategy in which we would sell certain assets to unlock value, and still retain a majority of our revenue and segment income.

We consistently believed that the aggregate value of our assets – search, directory, mobile and our $1 billion NOLs – had not been recognized in the stock price, and in fact, the proceeds from these transactions alone are almost double the enterprise value in mid-September. Our enterprise value being defined as market capitalization less cash.

The recent announcements validate our strategy. As the $360 million proceeds are realized, we expect that this will be shielded from substantially all cash taxes at the corporate level by the application of our NOLs, and that our overall cash position will be in the range of $550 million or over $16.50 per share 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 first half of 2007, we retain over 60% of our core revenue and the vast majority of our segment income.

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

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

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

This refined focus will benefit our business and our shareholders. The opportunity for search continues to be significant. Among our assets, a highly scalable, proven business model; a J.D. Powers certified highest satisfaction product two years 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 as well. The latest market developments in vertical and human-powered search serve to enhance our metasearch value proposition, and search frequency and advertising rates continue to rise year-over-year.

Posting these transactions and the return of capital to shareholders will maintain a strong balance sheet and increase our cash generation. Personally, I’m excited for the prospect of full-focus on one business.

This has 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 we completed or entered into definitive agreements to unlock substantial value via the sales of our directory and mobile businesses. In addition, by utilizing our NOL assets, we expect to maximize the proceeds available for distribution, and we retained the majority of our revenue and segment income in a dynamic growing market. Over the past five years, we have generated over a 6 ½ times return for investors and we look forward to the next chapter.

And speaking of next chapters, in connection with these transactions, Brian McManus, Executive Vice President of our online division will leave the company by the end of the year. Brian’s been a strong leader and he’s chiefly responsible for the success we’ve had in our search and directory business for the past four and half years. We thank him for his considerable contributions and we wish him the best in his future endeavors.

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

Allen M. Hsieh

Thanks Jim. I will start with a review of our third quarter results and then discuss our outlook for the fourth quarter. Please keep in the mind that for the third quarter of 2007 and all prior periods, the operating results of the directory business has been presented as discontinued operations in our GAAP financial statements.

Revenues from continued operations for third quarter of 2007, which include online search and our mobile businesses, were $48.7 million, compared to $88.3 million in the third quarter of 2006. As expected, total revenues decreased compared to prior year, primarily as a result of exiting the mobile media business.

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

Third quarter 2007 adjusted EBITDA from continuing operations, which include adjustments to our restructuring reserve, was approximately $400 thousand, compared to a negative $56.2 million in the third quarter of 2006. Had we included the segment income from our directory business, adjusted EBITDA would have been $3.8 million, which also exceeded our expectations.

Net loss in the third quarter was $12.3 million, or $0.37 per share, compared to third quarter 2006 net loss of $46.7 million. Weighted average shares outstanding were $33.2 million for the third quarter of 2007.

Turning to 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 were derived from our own sites and distribution search revenues were approximately 6%. As expected, revenue growth in the third quarter of 2007 was attributable to our search distribution network.

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

Moving on 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 content business. Mobile services revenues increased by 4% from the second quarter 2007 revenues of $13.3 million. We had a segment loss of $2.4 million in the third quarter of 2007 – a more than 30% improvement to the second quarter 2007 segment loss of $3.6 million. Our mobile business is on-track to be break-even by the end of the year.

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

Turning to our outlook, beginning in the fourth quarter of 2007, the company will present directory and mobile as discontinued operations and we will only be providing guidance for our online search business. Our guidance excludes the directory and mobile discontinued operations; gains from those sales of those two businesses, and any other non-recurring charges.

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

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

With that, I will now turn the call over to the operator, and we will be happy to take your questions.

Question & Answer Session

Operator

Thank you. (Operator Instructions) We’ll go first to Scott Sutherland with Wedbush Morgan Securities.

Scott Sutherland - Wedbush Morgan Securities

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

James F. Voelker

Well I think SCM is going to have some volatility in it; although the legitimate portions of SCM, and I’ll characterize that, are really getting strongly defined now. And so that operators, SCM and marketing kinds of companies are seeing the exact parameters in which they can operate in. Basically what that means is they have to enhance the content on their websites and the landing pages, and they have to provide a high-quality user experience that then translates into high-quality and high-converting traffic. Like anything else, as the enforcements come, people come along to that and figure ways to do it. I think we’re going to see it still remain volatile for awhile but it is narrowing down into an area where people know what they can and can’t do and how it’s going to monotize.

Scott Sutherland - Wedbush Morgan Securities

You saw a kind of sequential growth in the online unit, but you saw sequential decline on the segment income; did you invest here or did something else move around on the online unit?

Allen M. Hsieh

We did invest in some initiatives in the third quarter and these are opportunities that we see in the future in the online search business.

Scott Sutherland - Wedbush Morgan Securities

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

Allen M. Hsieh

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

Scott Sutherland - Wedbush Morgan Securities

Just a couple of more questions here and I’ll be out of your way. You’ve guided $1 million EBITDA next quarter but you got about $400 thousand this quarter and the 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 other type of investment going in Q4 that’s going to keep EBITDA down for the quarter?

James F. Voelker

Yes we are going to make some other investments and look at trying to draw in more distribution partner revenue growth.

Scott Sutherland - Wedbush Morgan Securities

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

James F. Voelker

To be clear we haven’t determined exactly how much cash we’re going to retain in the company, but we’re a smaller entity now so our cash needs that we’ve seen previous to be at a level to be around $200 that may not need to be that kind of a number for going forward. But we haven’t made that decision yet. And obviously what we’re looking for is to see are there other opportunities here for some kind of M&A that’s really right on top, and basically what we’re interested 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 taken that class here on the mini-conglomerate but we’d definitely be interested in acquiring quality search traffic, so that’s what we’d be looking at.

Scott Sutherland - Wedbush Morgan Securities

Okay, great, thanks a lot guys.

Operator

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

Derek Wood - Pacific Growth Equities

Hi thanks. Just wanted to clarify on the dividends, as an investor to they get taxed on the dividends or are you somehow able 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, or pushed down if you will to the shareholders. And the amount of the dividends that is taxable to shareholders depends on a number of factors including how much accumulated earnings and profits and current profits we have. It is an annual 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 NOL standing right now?

Allen M. Hsieh

If I look at this on a broad-stroke basis, we had about $1 billion NOL to begin with, we just recently, between the two transactions roughly $360 million gross proceeds, as you can tell there’s not a lot of, if you will, bases in those assets so let’s call it $300 million of those will probably be in the gain range, so you’re looking at between $600-700 million in NOLs.

Derek Wood - Pacific Growth Equities

That’s what’s remaining?

Allen M. Hsieh

It’ll be 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 an anti-diluted situation right now?

Allen M. Hsieh

You mean included all the outstanding RSUs and options?

Derek Wood - Pacific Growth Equities

Well yes, if you were reporting profitability what would be the total diluted shares outstanding?

Allen M. Hsieh

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

Derek Wood - Pacific Growth Equities

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

James F. Voelker

We think the cost reductions will be effected relatively quickly, however, there’s always transitional; and even in these deals that we’ve done, these transactions we have some transitional issues to deal with. We’ve taken three businesses and split them off and so we’ll have some issues to deal with in terms of small amounts of real estate, and some other issues that will carry through a little bit into next year, but we’re looking at that number as an annual number for 2008.

Derek Wood - Pacific Growth Equities

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

James F. Voelker

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

Derek Wood - Pacific Growth Equities

Okay well thanks for the update.

Operator

(Operator Instructions) And we appear to have no further questions. I’ll turn the conference back to our speakers for any closing remarks.

Stacy Ybarra

Thanks everyone for joining.

Operator

That concludes the Infospace Incorporated conference call. You may now disconnect and have a good day.

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