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Marchex Inc. (MCHX)

Q4 2005 Earnings Conference Call

February 23rd 2006, 5:00 PM.

Executives:

Ethan A. Caldwell, Chief Administrative Officer

Russell Horowitz, Chairman and Chief Executive Officer

John Keister, President and Chief Operating Officer

Michael A. Arends, Chief Financial Officer

Analysts:

Safa Rashtchy, Piper Jaffray

Jordan Rohan, RBC

Sameet Sinha, Kaufman Brothers

Christa Quarles, Thomas Weisel

Stewart Barry, Thinkequity Partners

Bill Morrison, JMP Securities

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Operator

Good afternoon ladies and gentlemen and welcome to the Marchex Fourth Quarter Earnings Conference Call. At this time all participants have been placed on the listen-only mode, then we will open the floor for your questions and comments following the presentation. It is now my pleasure to turn the floor over to your host Ethan Caldwell, Chief Administrative Officer. Sir, the floor is yours.

Ethan A. Caldwell, Chief Administrative Officer

Thank you. Good afternoon everyone and welcome to Marchex's Fourth Quarter 2005 Conference Call. Joining us today are Russell Horowitz, Chairman and Chief Executive Officer, John Keister, President and Chief Operating Officer, Michael Arends, Chief Financial Officer, Peter Christothoulou, Chief Strategy Officer and Cameron Ferroni, Chief Technology Officer.

During the course of this conference call we will make forward-looking statements that involve substantial risks and uncertainties, all statements other than statements of historical facts included on this call regarding our strategy, future operations, future financial position, future revenues, acquisitions, projected costs, prospects, plans and objectives of management are forward-looking statements. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements we make. There are a number of important factors that could cause Marchex's actual results to differ materially from those indicated by such forward-looking statements as are described in the "Risk Factors" section of our most recent periodic report and registration statement filed with the Securities and Exchange Commission. All of the information provided on the conference call is as of today’s date and we undertake no duty to update the information provided herein.

During the course of this conference call, we will also refer certain non-GAAP measures of financial performance and liquidity, including OIBA, Adjusted OIBA, EBITDA and Adjusted non-GAAP EPS. And reconciliation of this non-GAAP financial measures to the comparable GAAP financial measures is contained in today’s earnings press release which is available on the "Investor Relation" section of our website and definitions of these measures as used by us and the reasons why we believe these measures provide useful information to investors will be referenced during this conference call and are also contained in today’s earnings press release.

At this time I would like to turn the call over to Russell Horowitz our Chairman and Chief Executive Officer.

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Russell Horowitz, Chairman and Chief Executive Officer

Thank you Ethan and thank you everyone for joining us in today’s conference call. On today’s call we will discuss four items. One, a summary of Marchex's financial results for the fourth quarter and our operational progress during the course of 2005. Two, a review of recent developments and growth drivers in key business areas during the fourth quarter of 2005. Three, a summary of our areas of focus and investment for 2006. And four, a detail review of our quarterly results and an initial summary of our 2006 financial guidance.

First, the highlight of financial results for the fourth quarter and our operational progress for the year. The fourth quarter was our strongest quarter to date capping a busy year in which we made significant progress across each of our business areas while investing heavily and operational expertise of initiatives that will continue to drive growth in 2006 and beyond. Our financial results for the fourth quarter of 2005 include revenue of $29.8 million, a 97% increase over the prior year period. Adjusted operating income before amortization of $8.2 million which represented a 27% margin compared to a 16% margin in the prior year period.

EBITDA of $9.5 million and GAAP earnings per share of $0.03, and adjusted non-GAAP earnings per share of a $0.11. Continuing the theme of recent quarters the fourth quarter remained a period of significant investment for Marchex as we focused on several products related initiatives including augmenting existing monetization technologies and developing new products for publishers and advertisers such as enhancing our private label contextual product, integrating our services for crop platform deployment such as enabling industry brand listings to be included in our pay-per-click distribution network and continuing to integrate our own merchant listings into our proprietary network of traffic. Testing and launching related to the enhancements to the modernization of our proprietary traffic and accelerating our investment in strong management and personnel to support and drive Marchex’s long-term strategy.

Our progress this past quarter and for all of 2005 was driven by our ability to create more opportunities to deliver targeted online leads to advertisers through both high quality partner and proprietary traffic sources. Michael Arends will touch on this specifics of our financial results in a moment, but I wanted to briefly highlight the strategic and operational process we made this past year by comparing Marchex at beginning of 2005 to the end of 2005.

First, in looking at our search marketing technology and monetization platform we significantly expanded our partner distribution network in 2005 including addition of more than 100 new partners, and samples of these new partnerships include relationships with two of the largest search networks MSN and Ask Jeeves. We also added several of the largest shopping networks such as Shopzilla., MSN Shopping and Become.com and several premium vertical publishers such as Forbes.com, BusinessWeek, Travel and Leisure, Investors Business Daily, Fodors, and USAToday. As a result of this progress, we believe Marchex now have one of the largest, high-quality, third-party distribution networks online, as we have relationships with, and access to top-tier partners in each online customer acquisition channel.

Second, in looking at our progress in local search, we added several new super-aggregator partners in 2005. These partners leverage our search marketing technology and monetization platform to sell local online search packages to their offline and online local merchant customers. The addition of these new local super-aggregator relationships coupled with the growth in the advertiser basis of the existing super-aggregator partners led to a significant increase in the number of local merchant advertisers utilizing our search marketing technology and distribution network. We now have thousands of local merchants utilizing our platform. Additionally we are very pleased with our progress in this channel and to the signup and renewal rates of local merchants utilizing our platform continue to track favorably.

And third, proprietary traffic with some folks preferred to a direct navigation, according to internal log files we had more than 27 million unique visitors in December 2005 accessed our vertical and local websites. Revenue attributable to proprietary traffic sources substantially all arising from our Name Development and Pike Street asset acquisitions with $10.3 million. Further more during the quarter we were successful in increasingly monetizing our own traffic with our direct Marchex advertisers. Prior to 2005 Marchex did not have a proprietary traffic source.

As we have previously stated owning a proprietary source of traffic at critical math coupled with the ability to directly monetize that traffic, that something that very few companies have enabled to accomplish. During 2005 we not only added this component to our business but we believe that within continued focus and execution we will be in a unique position to grow into one of the industries largest vertically and locally focused online networks. While we are pleased with our progress in 2005 we believe that it’s still early in Marchex’s window of opportunity. We fully understand and appreciate that the most significant online leaders have built their positions over a 7 to 10 year period.

Therefore we will remain focused on positioning Marchex as a leader by one, continuing to develop a unique technology platform that allows us to deliver any advertising type into any online environment. Two, enhancing our local outsource platform for super-aggregator partners by introducing product enhancements for local merchants with this call tracking and enhanced reporting. Three, building a vibrant rates of users who frequently access our local and vertical website. Four, growing our proprietary traffic base into one of the largest and most relevant online. And five, building increasingly better content utility on our network of websites which will be a tribute to the growth and activity of our users.

We believe that continued focus and investment against these priorities in terms of product developments, selective potential acquisitions, marketing and people will allow us to continue building a world class company in translate today’s opportunities into tomorrows realities.

Now I would like to touch on the second item, the review of recent developments and growth drivers in key business areas during the fourth quarter of 2005. Starting with our proprietary traffic from our vertical and local websites. As I mentioned earlier according to internal logs our proprietary traffic base grew more than 27 million unique monthly visitors in December up from more than 24 million unique monthly visitors in September of 2005. This growth was primarily due to three factors, the first was due to an incident surrounding the development, testing and launching of our enhanced website and data templates across certain verticals. For example Marchex launched 52 of our 74,000 data ZIP Codes in August 2005 and the remaining ZIP Code data sites in November 2005, prior to their upgrade these ZIP Code Web Sites were directly pages which consisted of search listings related to popular categories, listings that weren't necessarily relevant to the website name or URL. Consistent with our efforts to provide more utility and relevance for users we focused on several technology driven enhancements to these websites that included elements such as targeted advertisements related to the location, integration for from local information services such as weather maps, jobs and related functionality, travel information on a demographics, in an enhanced more intuitive user interface.

Internal data indicates that from September 2005 to December 2005 these enhancements resulted in the following data relative to ZIP Code Web Site specifically. We had more than a 120% increase in unique monthly visitors which we believe is driven primarily by greater relevance for the user and better ranking in algorithmic search engines in response to direct or indirect search queries with specific ZIP Codes. And we had more than a 350% increase in monthly clicks which we believe is driven by greater advertiser relevance on the page. Although we believe we will need to continually evaluate the effectiveness of these and other website enhancements we will be launching we are certainly encouraged by these early results and will continue to test and optimize and deploy new enhancements in the ZIP Code and other verticals.

The second factor underlying our growth of marketing initiatives designed to understand the impact of traffic and conversion characteristics that is sponsored through our channels. We believe a low rated website received diversified traffic through three primary sources. One, direct type in for the website two, algorithmic traffic from search engine or a website that’s highly responsive to a user search query. And three, traffic from sponsor search results. Additionally we believe a website that receives the meaningful amounts of traffic from each of these vertical sources and in many cases achieved very favorable operating margins. An example of a website without a network that received all three forms of traffics is Yellow.com. Yellow.com received direct typing traffic has decided the merge with the leading resource for online yellow page enquiries. Additionally it also receives traffic from algorithmic search engines in response to user search queries and terms related to yellow pages as well as traffic from sponsor search programs for terms related to yellow pages. The combination of these factors made Yellow.com a meaningful contributor to the financial profile with Pike Street which carries incremental operating margins of more than 50%.

We believe that once the website as a proper utility it is relevant to users and maybe appropriate to drive traffic via targeted online marketing in order to extend that site online reach and expose it to new users. As a market leader in providing a variety of search marketing services to merchants like Office Depot, Radisson and REI just to name a few. We believe we are in a position to directly apply our skill set and technology platform for our proprietary websites. In effect overtime we have the potential to leverage our own expertise in expanding the reach of high impact websites to the relevant sources of customer acquisitions across the web therefore we can effectively become our own best customer.

We have started to test various search marketing initiatives for surrounding a limited set of our vertical and local websites. Today we are testing targeted sponsored search programs on less than 1% of our website in order to understand the impact of these campaigns on conversions, repeat visits and incremental profit margins. We will continue to look at sponsored search programs in other strategic marketing initiatives that leverage our existing search marketing knowledge across our network of web properties.

Over the coming quarters we believe that additional testing appropriate to help understand the opportunity and impact. The third factor underlying our strong growth in unique visitors in December with seasonal traffic trends. The fourth quarter is typically the highest traffic rate of the year as many consumers are researching and purchasing products or gifts online. We believe that as our network continues to evolve we will be subject to seasonal trends in advertising spending as well as in consumer internet usage.

In the coming quarters we will continue to make progress toward the 2006 fiscal of the point upgraded enhanced website on the vast majority of our network of more than 200,000 websites. In addition we will also look it at relevant content for enhanced website through new business development relationships. Now moving on to our local search effort in our search marketing and monetization platform initiatives.

Our focus during the fourth quarter wasn’t supporting our local super-aggregative partners to drive more local merchants online. We view the local opportunity as a great growth driver that is relatively early in its lifecycle where we are encouraged with the signup and renewal rates for our existing local aggregator partners. As we now support thousands of local merchant advertisers we believe we are one of the largest providers of search marketing solutions for local merchants.

With the recent addition of The Berry Company into existing partners including AT&T, BellSouth, YellowPages.com and the Houston Chronicle. Marchex believe it supports local super aggregator partners who selectively have more than 3000 direct sales representatives selling local search packages. In total these sales reps have access to potentially more than 2 million local merchants through their various businesses in offline yellow pages, online yellow page directories and newspapers. According to a recent forecast by the Kelsey Group to global online local search market which includes internet yellow pages, local search and wireless that said to grow nearly $13 billion by 2010.

We believe there is a strong need for technology providers to assist local merchants in creating, tracking, fulfilling and maintaining locally focused advertising campaigns, today this channel is vastly underrepresented in online advertising spending. Of this 10 million plus local merchants in the United States we believe that a small fraction or buying pay per click packages on the major search engines. This channel represents a substantial opportunity, so we will be very competitive in the coming years. That said, we believe Marchex’s local solution will be one of the driving forces in accelerating local merchant adoption of online marketing, to the sets we have invested and we will continue to invest significant resources against the local opportunity to support our strategic partners and to set the stage for adding new partners.

Additionally during the fourth quarter we continue to make significant progress toward expanding our base of quality search and product shopping partners as vertical distribution for on sources. For example during the fourth quarter we introduced a search and product shopping distribution deals with Ask Jeeves, MSN, MSN Shopping and Become.com as well as new publisher partnerships with Morningstar and the Chicago Board of Options Exchange. With the addition of Become.com and MSN Shopping Marchex now has relationship to place these merchants in a network that includes 10 of the largest product shopping networks online.

In addition to our new agreement with Ask Jeeves and MSN we now have direct access to place our merchants in the floor of largest search networks online. We believe these relationships combined with the large base of vertical publishers that we added to our partner network during 2005 provide our merchant advertisers with one of the broadest high-quality distribution networks online. This ability to offer advertisers, the opportunity to buy an all major search networks as well as on the top shopping engines and vertical publishers is beginning to translate into better penetration into new direct advertiser account for Marchex. And the advertisers wants the ability to go to one provider for all of their online marketing needs and Marchex is in a stronger position to execute on this need as anyone in the space. We expect this positive trend to continue in 2006.

I would now like to turn the call over to John Keister, our President and Chief Operating Officer

John Keister, President and Chief Operating Officer

Thank you Russ. Now we will turn to a summary of our areas of focus and investment for 2006. In 2006 and beyond we are committed to continuing to build Marchex into a world class company. We intend to accomplish this by one, building a substantial base of traffic for our merchant advertisers across both proprietary and partnered sources and two, continuing to develop our marketing and monetization platform for advertisers, publishers and locally focused super-aggregators. We are very focused on building our base of proprietary traffic beyond its current levels with the goal of making Marchex one of the largest, most targeted vertical networks online.

We are pleased with our ability to grow our traffic base significantly over the last year despite the fact that a majority of the year was occupied with operational efforts such as building infrastructure, adding key personnel, planning various product developments and implementing selected rollouts of early product enhancements in certain verticals.

During 2006 we will continue to invest in our websites and add personnel to evolve our technology platform. In the current year the approach of our proprietary traffic business were revolve around four initiatives. One, to continue to add various technology enhancements such as smart keyword optimization technology, which is designed to improve the keyword relevant to the webpage by rotating and ranking listings. Two, to continue to create, enhance and test various webpage formats and integrations which will allow us to launch appropriate templates across all of our vertical and local categories. Three, to develop strategic relationship with appropriate content partners for integrations across our network of websites. And four, continue to work on integrating more of our own proprietary merchant listings were appropriate.

Today we are currently monetizing an increasing percentage of the inventory on each page of our proprietary network with our direct advertiser relationship. As we progressed throughout the year we plan on extending the value of our proprietary inventory by offering additional advertising formats as well as products to leverage our existing search marketing services platform and large base of advertisers.

Additionally we are intended in growing our partnered traffic footprint and on supporting our existing publisher partners’ monetization efforts. While the market for third-party distribution partners have always been competitive and that trend remains, we believe that Marchex is uniquely positioned become one of the leading providers of vertical and local traffic through our merchant partners. We believe our focus on providing unique product solutions will continue to attract more merchants as well as distribution partners. As an example we believe our contextual site specific products offer unique capabilities with monetization rates that in certain verticals are in excess of the largest networks online.

As a result our distribution continues to grow in several key verticals that we are targeting for expansion. Regarding our technology in monetization platform we will continue to invest in integrating our services and partner services such as call tracking or Pay Per Call options onto one platform. Our goal is to make the merchant choice as seamless as possible in choosing between the various Marchex products and numerous distribution options. Whether merchant is currently accessing our contextual distribution network or pay-per-click network or a proprietary network for traffic, it should be able to quickly and easily take advantage of any advertising unit format and any distribution they need. The combination of these investment efforts we believe will result in Marchex continuing to deliver differential growth and profitability over the long-term. As we continue to build Marchex into a unique online partner that gives merchants of large network of proprietary and partnered vertical and local traffic, we believe we are creating a defensible and scalable business model capable of long-term market leadership.

At this time I would like to hand the call over to our Chief Financial Officer, Michael Arends to discuss our financial progress in more detail.

Michael A. Arends, Chief Financial Officer

Thank you John. Well, 2005 was largely a year of investment those investment set the stage for a largest and strongest quarter today. Our financial highlights for the quarter included revenue of $29.8 million dollars for the fourth quarter a 97% increase over our year ago results of $15.1 million. Total operating cost excluding stock based compensation, amortization of intangible assets and acquisition related retention consideration for the fourth quarter of 2005 were $21.6 million. In the year ago period total operating costs excluding the previously mentioned items were $12.7 million.

This quarter our operating expenses included increased service cost, additional investments in sales and marketing initiatives, as well as increased technology infrastructure cost and certain cost related to becoming a public company compared to last year. In looking at the mix in operating cost for the fourth quarter our service cost decreased largely due to an increase in revenue coming from proprietary traffic sources.

The increase in sales and marketing cost for the quarter were largely due to three factors. One, increased personal cost as we continue to invest in the necessary infrastructure and resources to support our growth and partner development efforts including search engine, product shopping and local super-aggregator relationships. During the quarter incentive base compensation increased, to match the progress our sales and business development teams are making in growing our business and expanding our business development initiatives.

Two tax related to selective marketing of proprietary websites in order to better understand the impact, the impact of traffic from the sponsored search channels on conversion rates in driving repeat traffic and incremental profitability margins prior to additional template rollouts. And three, the impact of a full quarter of IndustryBrains, the IndustryBrains which carried a higher selling cost structure than Marchex.

Adjusted operating income before amortization for the fourth quarter was $8.2 million or a margin of 27% which represented a 234% increase over the $2.4 million or a 16% margin in the year ago period.

Earnings before interest, income taxes, depreciation amortization and stock-based compensation expense or EBITDA for the fourth quarter was $9.5 million which represented a 270% increase over $2.6 million in the comparable period last year. Adjusted operating income before amortization and EBITDA are two of the principle metrics we use to measure the progress of our business liquidity and our ability to generate cash.

Adjusted operating income before amortization includes the reduction for depreciation charges and excludes amortization costs and cost related to our acquisitions as well as other non-recurring charges. GAAP net income applicable to common stockholders for the quarter was $980,000 or $0.03 per share compared to $607,000 or $0.02 per share in the fourth quarter in 2004.

Going forward our GAAP results may be impacted by a number of factors including stock-based compensation charges, increased amortization cost associated with our name development and Pike Street Industries asset acquisitions, our acquisition of industry brands, other potential future acquisitions, our preferred stock dividends, and increased public company cost which will also impact our adjusted operating income before amortization and EBITDA results.

As a note beginning in the first quarter of 2006 due to recent accounting rule changes, we will begin to recognize increased stock compensation charges as a non-cash expense that will impact our GAAP results. Adjusted non-GAAP earnings per share in estimate some Wall Street investors utilize as a supplemental measure of our operating progress was a $0.11 per share for the fourth quarter.

Adjusted non-GAAP earnings per share represents adjusted net income divided by weighted average fully diluted shares outstanding or adjusted non-GAAP earnings per share purposes. Adjusted net income generally captures those items on the statement of operations that has been or ultimately will be settling cash exclusive of certain non-recurring items and represents net income available to common stockholders plus stock base compensation expense, amortization of acquired intangible assets, acquisition related retention considerations, facility relocation expense, gain loss on sale of intangible assets, and other income or expense.

Now turning to the balance-sheet we had approximately $63.1 million cash on hand as of December 31, 2005. During the quarter we used our cash to invest in certain initiatives we believe will strengthen our position within direct navigation and local search marketing. Going forward we anticipate that we will use our cash to continue investing in the long-term gross initiatives including internal product developments and sales initiatives and selected acquisition opportunities.

I would now like to discuss our outlook for 2006. While we continue to invest initiatives that we believe will drive differential growth over the long-term, we believe Marchex will continue to realize current benefits as well. Today we are releasing our first guidance for 2006, for the year we are currently anticipating revenue in the range of $125 million to $133 million. For adjusted operating income before amortization we are currently anticipating a range of $33 million to $38 million. In addition, we are maintaining our long-term target for adjusted operating income before amortization targets of 30% or more as we expect that we will realize benefits from our investments overtime.

As a note, for the first time we are issuing a range of guidance versus a floor this is largely due to the fact that many of our ongoing investments and operational initiatives remain in their early stages. As we execute throughout the year we will continue to provide additional details and updates on our progress in financial outlook.

To summarize our progress, our results in the fourth quarter were driven by investment decisions we made through out 2004 and 2005. Today our 2006 guidance highlights that we are committed to investing against our products and strategic opportunities to position Marchex for a long-term growth. We look forward to sharing our financial progress with you throughout 2006 and beyond. And now I would like to hand the call back over to Russ.

Russell Horowitz, Chairman, Chief Executive Officer and Treasurer

Thanks Mike. We worked aggressively and methodically over just three years to build Marchex into a leader with growth rates and profitability margins, which we believe exceed many of our peers. We have managed to create this strong financial profile while adding components of defensibility to our business. We believe that these components place Marchex among a select group of online leaders. Most importantly we believe 2006 will be our busiest year yet, within this few examples we expect to see new product rollouts, business development relationships with content and monetization partners for our proprietary websites, additional distribution relationships, new aggregator relationships, and other important operational developments related to our technology and monetization platform.

We expect 2006 to be a time of unique opportunity in execution for Marchex as we focus on continuing to build the leader in providing vertical and local online traffic to our merchant partners. As a company we are energized by this opportunity we are already driving hard to report another year of substantial progress in 2006. At this time operator, we like to give the call back to you to take questions from the audience.

Question-and-Answer Session

Operator

Thank you ladies and gentlemen the floor is now opened for questions. Operator’s Instructions. Your first question is coming from Safa Rashtchy. Please announce your affiliation and post your question.

Q - Safa Rashtchy

Hi Safa Rashtchy from Piper Jaffray. Good afternoon Russ and everyone. Congratulations on a great quarter again. Couple of questions if I may, first could you give us a sense of the growth in your own properties of direct navigation excluding Pike Street. And I know you talked about progress you’ve been making in monetizing with your own network. Can you give us some additional color as to how much additional growths were able to generate by both updating the website as well as using your own advertiser base? And I have a quick follow-up.

A - Russell Horowitz

Okay, in terms of looking at direct navigation in the different component, one of the things that we’ve been saying, fairly consistently is Marchex as a whole continue, we just encourage people to look at as an integrated company. And, that’s really highlighted by our focus this quarter on progress and direct navigation being driven by a number of measures including, more monetization with our own advertiser listing. So, we haven’t broken out; we really aren’t focused on segmenting out, specific website in the context of the broader contribution. As we noted, this business contributed $10.3 million in revenue during the quarter and we feel that represented, a very good financial progress, which was driven by a lot of product progress. And so as we look at the contributions of both elements, kind of continuous integration has benefited Marchex as a whole in direct navigation specifically. And at the same time, when you look at the contributions of the underlying direct navigation business, there are some upgrades we’ve made that has impacted the whole business and then there are specific places where we made upgrade that has helped as well. Those aren’t things that were specifically, providing more detail on today beyond that, we did in our press release and in the conference call.

Q - Safa Rashtchy

Okay. Can you – second, give us an idea of the advertisers that you are able to engage especially on the local site and to what degree are you able to migrate them to your owned properties, especially on the direct navigation site and Pike Street?

A - Russell Horowitz

Sure, the way we look at our business there are basically two components to it. One, is advertisers, plays some most effective ads in the most effective places and we do that with our technology monetization platform. The second part is the distribution network, which is comprised of two underlying components, third party relationships and proprietary traffic. And so with merchants of all profiles including local merchant, we bring them in based on the aggressive curtsies we offer in terms of monetization and then we also bring incremental value added by giving them, the broadest opportunity to be played for their relevant. In the course of that analysis we include our own proprietary distribution as an option. And, some folks will take that and some folks may not perhaps. But what we are seeing at the trend is that they increasingly launch that traffic and one of that kind of third party elements I would say it is some weeks ago, WebSideStory which is an online research and analytics company highlighted conversion rate by distribution source and they specifically stated that direct navigation with the highest converting channel online with more than 4% conversion compared to 2% chase for search engine which is also much higher than the next closest one. And so, as advertisers increasingly understand this channel generally and our distribution specifically, we continue to see higher upgrades and for local merchant, that’s been totally consistent as well as across all the other business areas.

Q - Safa Rashtchy

Great, thanks Russ.

Operator

Your next question is coming from Jordan Rohan. Please announce your affiliation and post your question.

Q - Jordan Rohan

It’s Jordan Rohan from RBC here. I was looking you could clarify how much of the revenue in the quarter was from Yahoo specifically. Have you seen, in fact or may be have you seen any major changes from Yahoo in terms of how it’s changing its sponsored search ranking algorithm. If its not, any idea when the beta test for the changes will be conducted or whether your TrafficLeader subsidiary will participate in the beta, thank you.

A - Russell Horowitz

Yeah, thanks for the question Jordan. Yeah, I answer the second part first. With our TrafficLeader subsidiary we tend to be involved pretty rigorously with a lot of the thing said, we are doing with Yahoo, it’s a close and very strategic partner. In the context of looking at Yahoo as a monetization partner for our proprietary traffic, now without being too specific, as I and a number of us are been in the industry for a decade and in working with a lot of different partners, they are constantly kind of changing or tweaking their algorithm. Clearly Yahoo is been working on some significant endeavors in that regard, but at times you will see tweaks that help, you will see evolutions of their (indiscernible) right now, its been business as usual for us. Clearly we expect the Yahoo can make progress in that area, that would be something we would enjoy seeing and we were closely with them to help them understand the areas that we think are most right for increased optimization as their program.

Q - Jordan Rohan

How much of the revenue in the quarter came from Yahoo, I am assuming it’s the 10% contributor?

A - Russell Horowitz

Yeah the specific percentages will be provided in the course of the 10-Q, but again as they have been our wonderful partners that’s above 10%. And we can’t offer those specifics today, but we will offer them shortly in a relatively consistent with what they’ve been in the past.

Q - Jordan Rohan

And primarily when can it actually use Marchex able to switch all the portion of it direct website over to another provider of pay-per-click, if you could give that, that’s beneficial.

A - Russell Horowitz

We have a number of relationship with Yahoo as well as other companies; we have an existing relationship that covers specific areas of our distribution that runs into 2007. And some of that information is available publicly; site to be careful about potentially saying something that’s not. But we would happy supplemental to point you to what is available public that you can look at.

Q - Jordan Rohan

Thank you very much.

A - Russell Horowitz

Thank you.

Operator

The next question is coming from Sameet Sinha. Please announce your affiliation, and then post your question.

Q - Sameet Sinha

Good evening gentlemen, Sameet Sinha from Kaufman Brothers. Going back to your core business, and I know Russ, you don’t like to look at your business in Silos but that again seem to have slipped into low single-digit sequential growth. Could you comment on what happened there?

A - Russell Horowitz

Sure, again all business areas, we both have done did well in Q4 and we continue to feel very good about in Q1. So reason that we’ve been focusing on, kind of the benefit of Marchex as a whole in direct navigation specifically with increased monetization of our own merchant listing is because when you try and break apart the element and I understand why people are trying to – look at these component, since each business area has its own opportunities and a business model characteristic. But its hard to get a super accurate picture, because for us its all inter-company revenue and where it gets counted may in some cases make one business area look like its growing even faster and one other area look like it may not be growing strongly. So to the extent that, direct navigation fulfills proprietary merchant listing with the advertiser with broad end through a search engine marketing part of our business. That’s going to benefit direct navigation’s growth and not necessarily show us in the search engine marketing part. So, that’s why we are trying to encourage people, not discourage them from doing the analysis here, because its an important part of understanding the different components to what we do. But at the same time recognize that those aren’t directly correlated to the progress of those businesses and as why it’s also important to look at progress from Marchex as a whole and at the same time in the context of how our businesses are working together given their increasing integration, the dynamics of the inter-company revenue and where we recognize it. So, we can look at the search engine marketing part, they know that based on our existing customers, increased commitment of dollars, new direct relationships in combination with growth and traffic, and Marchex as a whole had a very good quarter and we set the stage for what we think will be a very promising 2006. And that’s really I think, kind of the best way I could encourage you to look at to different pieces, since we increasingly feel very positive about growth opportunities with each.

Q - Sameet Sinha

Sure, I have two more questions. Can you give list of – you listed your products at least for the next 12 months, can you give us a time table for, how many site do you expect to be deployed across your platform over the next 12 months. And specifically can you target the point that you made about adding content to your site, what are your – what is all the steps you are taking in that direction?

A - Russell Horowitz

It’s what I would describe as a pincer movement, since two components to it, one are universal upgrades, whether that’s, at that point kind of the navigational and layout component in conjunction with contents that maybe relevant to every site we own. And then the second part of it, our individual specific website and individual specific categories. And this is something that we do constantly, we do some product announcement but a lot of them we just simply don’t do. But as we continue to make progress and we think that we have milestones that investors really need to know, we will proactively share that. But just because there haven’t been specific announcements we are doing this stuff everyday and we’ll continue to do this on a weekly, monthly basis throughout the year. And as we feel we have enough data, we’ll share more like we did today with some of the metrics around increased page views and click rates on some of the Zip Code. So, it will be an ongoing initiative and will, and actually increasingly will be aggressive about through this year.

Q - Sameet Sinha

Sure, a final question, your gross margin seem to have increased, improved dramatically, we also heard that on Yahoo’s call that traffic acquisition costs for them was going up. Could you comment of there was a change in revenue splits of payouts or any other trends that you saw there?

A - Russell Horowitz

The trends have been pretty consistent with us in terms of kind of what we saw through the year, and we see happening in 2006, John touched on it. Highly quality third-party distribution, it’s always competitive and; you do a better job, you are going to keep your partners and I think we’ve been doing that. And on the other side of it we clearly benefit as a large and increasingly growing traffic owner, because we know that, the more traffic you have the more control you have of your own destiny. So overall trend feel pretty consistent with what they were and, for us we think that creates a pretty right environment for this year.

Q - Sameet Sinha

Okay. Thank you very much.

A - Russell Horowitz

Thank you.

Operator

Your next question is coming from Christa Quarles. Please announce your affiliation and post your questions.

Q - Christa Quarles

Hi it’s Christa Quarles with Thomas Weisel. First question is just on the local ZIP Codes, you been adding about 3 million net new users a quarter, I was just wondering if that was a big contributor to the 3 million you would add at this quarter. And as well as you look into 2006, the guidance – do you expect a big contribution there i.e. to get to the high-end of the range, the local ZIP Codes need to sort of contribute well to revenue. And then I have a couple of other questions, thanks.

A - John Keister

Yes, the increases in terms of overall user base have been pretty diversified. And so, that’s kind of answers your first question. The second one, when you look at our initial financial guidance, we are looking at contributions from a number of areas of our business, and so, is there kind of one thing in our business that needs to happen to allow us to outperform. There is no one specific thing, we want to execute across all our business areas and we think there are tangible catalysts in these area, that allow us to do that and its our job to want to do better. So that’s not concentrated either in one specific area of ZIP Codes or otherwise. And getting – this --

Q - Christa Quarles

No, so then – a couple of other questions. On the sales and marketing line, Mike you broke out the different pieces. I was wondering if you could give a little bit more specific though specifically related to first IndustryBrains. What sort of percentage sales and marketing of revenue should that business be? And then two, it’s interesting that you are starting to spend on actual paid search. And I was just wondering if you plan to concentrate that among a few of your URLs or that seems to be a broad based plan and does that conflict in anyway with your agreements with Yahoo with respect to, to buy a low price keywords and then you got high price keyword on the site, how does that ultimately work? And then, the other question I have is just, did you spend anything on URL acquisition this quarter? Thanks.

A - Russell Horowitz

I’ll answer the last parts of the questions and then Michael Arends going to answer the first part. We continue to selectively look at the, main acquisitions that are consistent with our overall strategy of generic commercial relevant website. Yeah, in terms of kind of what we’ve been spending in the past, I think it was on the lower-end of the range of what we spent before. The second part getting into kind of the components around selected sponsored search for website, this is an area where there is no one formula that applies to our business and one where we are learning a lot would be initial testing we are doing. And but what we’ve been saying for the last year or more is that when you look at the opportunity, we think the combination of element that could drive revenue growth and incremental profitability are direct site, and search engine referrals and selected marketing opportunities. And then one of the reasons why we like this business areas so much is we had an opportunity to apply, effectively our best-in-class technology in monetization knowledge into effectively a proprietary asset. And so what we are finding there is there are certain websites that has characteristics that naturally may gravitate towards, different combinations of those resources. But there isn’t necessarily a one size fits all approach to it. We give this all as some example because it’s probably is balanced an example as we could offer. But we see somewhere perhaps doing sponsored search or trying to optimize for search engine, doesn’t make any sense. And there may be others that naturally are very well suited to try and build them on the useful way for this search engines in that sense. So there isn’t really a one side fits all and today if our approach is been doing us in a way that it’s strategic, sustainable and appropriate with contribution and I’ll hand it over to Mike to answer the first question in terms of sales and marketing.

A - Michael Arends

Christa, this is Mike. I believe the first part of the question related to IndustryBrains specifically.

Q - Christa Quarles

Right.

A - Michael Arends

And if you look historically at IndustryBrains and some of the sales and marketing initiatives and the spend that they had, it’s ranged in 20% to 30% of what their revenue numbers have historically run at. From our perspective, we continued with some of the growth and the initiatives and the success in the business development areas to add personnel as well as payout increased, incentive based or commission based payments as well.

A - Russell Horowitz

And just a follow-up Chris, the thing I cited before was, referencing a WebSideStory statistic on the conversion rates of direct navigation being at the highest end. Everything that we are focused on is this high quality traffic as the standard and being committed to delivering return on investment for our advertisers that compels them to continue working with us, seeing the value we can deliver to them and embracing online as a medium that deserves more and more of their budget. And so kind of all the initiatives that I described are absolutely consistent with are focus on creating the broadest network with the highest quality traffic to deliver that value to our merchant partners.

Q - Christa Quarles

And do you think that some of your URLs are satisfying to sort of being branded one such that you will be able to drive, they become sort of content players in our own writing, that you will focus or is it – it just going to be, the content that you may either develop or acquire would be pushed out across all of them as appropriate.

A - Russell Horowitz

Yeah, this maybe the shortest answer I ever give -- yeah.

Q - Christa Quarles

Sure, okay. And did you guys – what did you spend on URL acquisitions in the first that – not too different from were at the low end of the range.

A - Russell Horowitz

We are just at the low end.

Q - Christa Quarles

Okay, great thank you.

A - Michael Arends

We having to slow the express but we did to slow some of the EBITDA and operating cash flow characteristics.

Q - Christa Quarles

Sure.

A - Russell Horowitz

We are just at the low end.

A - Michael Arends

We are just the low end.

Q - Christa Quarles

Okay, thank you.

A - Michael Arends

Thank you.

Operator

Your next question is coming from Stewart Barry. Please announce your affiliation and post your question.

Q - Stewart Barry

Yes Stewart Barry, Thinkequity Partners. Could you update us on the progress of your Pay Per Call product and the opportunity there? And then secondly might some of your new product launch include display or rich media advertising. And in general have you been able to attract brand advertisers sort of the same way as some of your larger search peers out?

A - John Keister

Sure, hey this is John Keister, I’ll try to address those. So you may have seen our release, I guess it was couple of months ago with Ingenio that we are going to be doing some Pay Per Call testing on our sites. And that’s targeted to March; we’ll see how those results go when we add some more color for you over the next 60 or 90 days. In terms of graphical ads, I think you are probably referring to what we are doing on our direct navigation network, is that the question?

Q - Stewart Barry

Yes.

A - John Keister

So that again, we are in the very, very early stages of testing that and we think there is some opportunities to do something there on a vertical basis and look at for example advertisers who may be absolutely in the finance category, or advertisers maybe interested in the electronics category and basically give them the opportunity get access to those uses which we know are high quality.

Q - Stewart Barry

Great, thank you very much.

Operator

Your next question is coming from Bill Morrison. Please announce your affiliation and post your question.

Q - William Morrison

Hi, Bill Morrison from JMP Securities. Can you – you mentioned in the release and on the call, similar stuff you guys are doing on the SEO side, applying similar lessons you’ve learned that you’ve been applying to your corporate customers and their websites and have begun applying some of those lessons on your own network. And you’ve seen a dramatic increase in some of the rankings where your sites, the ZIP Code side of the increment up in Google in the last 3 months. Just curious if you could kind of give us an update on where you think you are along the curve and, using SEO to drive the out of -- in the ZIP Code portfolio towards the broader portfolio demand, prior in the algorithmic listings at the major search engines. And specifically we didn’t see much change on Yahoo, and MSN, I am wondering if you are, putting so much of an effort there or to kind of starting on Google and then you are going to move to the other engines and just how hard it is to do, to do SEO across the different platforms now that you are doing with multiple search of different algorithms?

A - Michael Arends

So we are kind of get to the end of it. Everything is hard, nothing is easy, but when it comes to understanding SEO, I sure, as I hope that we are as good as anybody on the planet. And we have the expertise to apply against our own proprietary assets as you would expect, it’s a pretty logical theme and you are going to look at, where is the critical math of market share and prioritize your optimization against both pieces that are largest and potentially most implacable and that’s exactly what we’ve been doing, when we look at kind of where we are in that process. We are pleased with the progress in the direct navigation business and I know lot of people, use meta source of what ending we are in. I really think in that one, we are probably breaking warm up to the first ending. But, and again we’ve gotten enough data and we share it selectively like we did with the ZIP Code. But we have enough data to, I believe really validate that there is a significant opportunity in extending our own expertise across, broader buckets of demand. And in certain cases to kind of a point of previous question very specific individual demand where we think the characteristics of that website in conjunction with the size of the commercial opportunity in its area of focus, merit a lot of intention and increased investment of resource. To urge we determined what we are to be doing and we are doing it. The next step will be to hopefully get a validation that our assumptions were right and start to harvest those benefit, but it’s very early in that process as it relates to what we are doing with SEO. Certainly we are trying to focus on sites that are relevant to our users and at the same time inventory that’s commercially valuable to our merchants.

Q - William Morrison

Okay, a couple of quick follow-ups Russ, you also mentioned on the call that you are – during the quarter monetized a significant percent of your traffic with your own PPC engine enhanced. I was wondering if you could maybe quantify that a little bit more than just significant as within single-digits or you its in the teens and where can that go over, where do you think, you can take that as a percent of your traffic over the next year?

A - Michael Arends

We characterize that, we increase that amount, again we didn’t provide a specific percentage and it was with again, all Marchex advertisers when we look at all the different ways that we acquire advertiser relationship. And so it was an increasing percentage, we think that the best customer experience and the best user experience is going to be driven by effectively having a meta-feed approach of both content and advertising team. And so this is an area that, we believe it make sense to increasingly be in controlled of monetizing our own traffic, but at the same time for the benefit of relevant in user utility, we think it will always be important to have close relationships with other partners as well, either on a general basis or by vertical. And so again this quarter it increased, it was one of the reasons why direct navigation outperformed so nicely, and we are very pleased to see that in the context of specific percentages, it’s not something we broken down at this stage.

Q - William Morrison

And one last question for Mike. Is there any, your business is seasonal in some aspects during where you can provide little bit guidance, so at least on the top line for the quarterly progression of your revenue guidance?

A - Michael Arends

In terms of 2006, I think we should see more of the same just in terms of the context from a seasonal prospective. And we do realize benefit in the later part of the year, particularly as we get into the retail shopping season in September through December timeframe. There are benefits that are attributable from internet search traffic from our proprietary traffic as well as just spend from our advertisers online. So I think that’s the context of how I would put in looking at some of the seasonality in the upcoming year.

A - Russell Horowitz

In the other part which we talk about frequently is, our business is really overlaid with two seasonal trends, search seasonality and retail seasonality. And so understanding both of those, kind of separate from Marchex specific growth initiative, I think and we provide some color as to seasonal impacts on our overall business.

Operator

Gentlemen there are no further questions in queue. Do you have any closing comments you like to finish with?

Company’s speaker

We appreciate everyone’s participation on the call and we look forward to sharing our progress throughout 2006 with you as we progress with the year. Thanks again.

Operator

Thank you ladies and gentlemen. This does conclude today’s conference call. You may disconnect your phone lines at this time and enjoy the rest of your day, thank you for your participation.

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Source: Marchex Inc. Q4 2005 Earnings Conference Call Transcript (MCHX)
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