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March 2, 2006

5:00 p.m. EST

Executives

Mollie O'Brien - Director, IR

Mike Long - CEO

Lew Belote - CFO

Analysts

Mark Argento - Craig-Hallum Capital

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the fourth-quarter and full-year 2005 Homestore, Inc. earnings conference call. My name is Letisha, and I will be your coordinator for today. (Operator instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Ms. Mollie O'Brien, Director of Investor Relations. Please proceed, ma'am.

Mollie O'Brien

Thank you, operator. Good afternoon, and welcome to our call today. On the call today are Mike Long, our Chief Executive Officer, and Lew Belote, our Chief Financial Officer.

Today's call is being webcast from the Investor Relations section of our website, and will be available for replay shortly after we conclude. A copy of our press release issued earlier this afternoon is also available on the Investor Relations section of our website.

Please be advised that some of the comments that will be made today constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act, that involve potential risks and uncertainties concerning Homestore's expected financial performance, as well as Homestore's strategic and operational plans. These potential risks and uncertainties include, among others, decreases or delays in advertising spending and market acceptance of new product and services. Additional factors are discussed in the Company's annual and quarterly reports, which are filed with the SEC and available on our website.

All information discussed on this call is as of March 2, 2006 and Homestore undertakes no duty to update this information. Results projected on the call today may differ materially from actual results, and should not be considered as a guarantee of future performance. I will now turn the call over to Mike Long.

Mike Long

Thanks, Mollie and good afternoon, everyone. Thank you for joining us as we review our fourth quarter and full year financial results. 2005 was a very important year in the development of our Company. During the year, we:

  • achieved revenue growth of 16%, the first double-digit growth in four years;
  • significantly improved profitability, delivering the first GAAP-profitable quarters and full year in the history of the Company;
  • fortified our balance sheet through positive cash flow, as well as a $100 million strategic investment from Elevation Partners;
  • resolved most of our remaining legacy legal issues with the distribution of proceeds related to the class-action settlement, and the negotiation of a cap on our exposure to the legal defense costs of two former officers; and,
  • finally, and perhaps most importantly, through a successful investment program, launched new corporate and product strategies intended to extend our leadership position in the online real estate categories, which we were excited to communicate to you last week.

The focus of the Company is on creating the best possible consumer experience around the moving cycle. That means before, during and after a move providing them with access to all the real estate and move-related services they need to have a successful move. We will be able to offer advertisers the premier venue for reaching these consumers.

For those of you who did not see our announcements last week, or were unable to listen to our conference call, let me provide a brief summary. We're changing the Company's name to Move, Inc. Move will have three compelling consumer offerings -- Realtor.com, Move.com, and Welcome Wagon. In the second quarter, we will be launching a new website, Move.com, a comprehensive real estate listing search engine, which will replace Homestore.com, HomeBuilder.com, and RentNet.

Our new homes and rentals business models will change to adopt many elements of the highly successful Realtor.com business model, in addition to cost-per-click products that scale efficiently with traffic levels. Realtor.com will expand to include many features that focus on community and user-generated content, as well as the introduction of new products to further enhance the monetization of our traffic. Welcome Wagon will be integrated with Realtor.com to better leverage our existing audience. And finally, we acquired the assets of moving.com, a best-in-class provider of moving-related tools.

We are encouraged by the early reaction from customers to our strategic plans to capitalize on the large market opportunity available to us. With the advantages of our strong balance sheet, large consumer audience, and content leadership positions in the online real estate segment, we are able to focus on managing the execution risks and opportunities of our implementation plans.

Before I ask Lew to review our financial and operating results, I would like to comment on the status of the real estate market and the implications for our business. I am sure our investors, like many homeowners in U.S., are trying to sort out facts from speculation as home sales cool a bit from the torrid pace of the last few years. We have known for some time that the pace of sales in certain markets around the country was slowing down. We know this because of the steady increase in inventory on our home-listing sites, beginning around the middle of last year. Overall, this is not surprising, since many markets have not experienced a down real estate cycle in almost 12 years. Purging excess from any rapid market expansion is inevitable.

But the scope of the slowdown varies widely depending on where you live. House and home values have changed very differently, whether you live in Denver or Indianapolis, which have not been hot markets; or, you live in South Florida or Phoenix, where there has been substantial investor speculation in homes.

We agree with the Chief Economist of our partners at the National Association of Realtors and the National Association of Homebuilders that nationwide, home sales will recede to the levels of a few years ago, which were record high years at the time.

Now let me share how we think these changes in the housing markets affect us. First of all, we believe that it confirms our strategy of offering real estate advertisers several different marketing alternatives for different market conditions. We are committed to offering both performance-based and subscription-based marketing solutions. Pay-per-lead products will always be hugely popular and profitable in strong housing markets because of an abundance of home buyers and sellers. Fixed-price leads in expanding markets are attractive to suppliers and purchasers.

However, in slowing markets, the number of qualified leads declines, and many agents whose businesses rely on lead generators are disadvantaged relative to agents and brokers who have strong brand awareness and networks in local communities, causing a shakeout of lower performers.

Subscription advertising products, on the other hand, tend to represent longer-term commitments with predictable, recurring revenues for us, and are generally preferred by top-producing agents and brokers because of their brand-building features. Top producers, possessing an abundance of listings, are able to contextually attach their advertising to their listing inventory, increasing their prominence on our website.

In slowing markets, these subscription products, given their long-term commitment, tend to have high persistency. However, during rapid market expansions, these subscription-based advertising products with their fixed costs tend to deliver value for which a supplier is not fully compensated -- in other words, significant increased value in qualified leads and traffic that the agent or broker might otherwise be willing to pay for if they were priced on a per-lead or a per-click basis. We are confident that providing both types of solutions is the right strategy for our Company.

Second, the adage that a rising tide raises all boats is very true in real estate sales. During periods of rapid growth, the industry supports many more agents and brokers who can make a decent living. Actually, marketing and selling the homes becomes less of an issue than pricing it correctly, one of the primary reasons home sellers need professional help from realtors.

As markets tighten, home sellers become more anxious about their prospects, and invariably turn to established agents and brokers who have the marketing expertise to merchandise and differentiate their clients' homes from the competition. In these markets, top producers actually experience market share expansion. We believe our focus on securing relationships with top-producing agents and brokers will serve us well during shifting markets.

Third, we believe that diversifying our sources of revenue, while serving a common audience of consumers who are moving, makes good sense. For example, when home sales are strong, the rental markets tend to be weak, and vice versa. We have learned a lot from our rental customers who had to manage through a market where extremely low interest rates made buying cheaper than renting. Also, focusing on both real estate advertisers and move-related advertisers, all trying to get their message to the same audience of movers, broadens our market opportunity and spreads our revenue dependencies across a larger group of advertisers.

Fourth, although it has been awhile since most U.S. housing markets experienced a slowdown, there is no historical correlation between slowing housing markets and significant declines in advertising spend. In fact, there is a greater need to effectively market a home and differentiate it from its competition to a smaller pool of buyers. When markets are hot, there is less incentive for agents and brokers to advertise homes aggressively, because they seem to sell, regardless of the marketing effort.

We believe this downturn will be remembered for changing advertising habits, as real estate professionals scrutinize their off-line advertising spend relative to the efficacy of online advertising. We believe we are positioned to benefit from this rationalization of advertising spending by real estate professionals.

Fifth, the online real estate advertising market is nascent, and is not yet particularly susceptible to market swings common to more mature online categories or the overall Internet advertising space. The vast majority of real estate and move-related advertising is in the off-line world today. For companies like us that offer diversified online marketing solutions, the primary issue today is convincing advertisers to shift their off-line advertising spend to a more efficient online spend.

For now, stimulating and benefiting from this shift is a more important factor than even competing with other online providers. After significant advertising dollars have shifted online, competition and market cycles will become more important.

We like our position in the market and our strategies for strengthening our market position. So in 2006, the risks and challenges we are most concerned about are successfully transitioning our customers to new products and business models that, if not managed extremely well, could create fluctuations in our growth and profitability ambitions. Lew, would you please review the financial and operating performance of our business units with our investors?

Lew Belote

Thanks, Mike. Revenue for the fourth quarter was $66.6 million, an increase of 23% over the fourth quarter of 2004. Revenue for the full year of $252.6 million represents 16.5% growth over 2004, the first time the Company has generated double-digit revenue growth that wasn't aided by acquisitions. This growth is significant, considering we have three major businesses that were not contributing, as we have shared with you on previous calls.

Our financial results for the fourth quarter were impacted by two litigation settlements we recently reached. The quarter includes a $1.75 million litigation settlement charge related to the Pentawave lawsuit and legal expense related to a settlement to cap our obligation to pay the defense costs of a former officer, Peter Tafeen. The settlement with Mr. Tafeen of $11.85 million is similar to the one we reached in the third quarter with Stuart Wolff, and in return for the cap, we have given up any right to recover from Peter Tafeen in the event he is ultimately found not eligible for indemnification. As a result of the settlement, we are taking a charge of $5.9 million in the fourth quarter for those fees not already accrued as of September 30th.

The Tafeen and Wolff settlements should eliminate future material charges for indemnification and advancement costs for former officers. However, the combination of the Pentawave and Tafeen settlements resulted in a net loss for the fourth quarter. The net loss for the quarter was $4.6 million, but factoring out the impact of legal charges and the gain from discontinued operations, we would have had net income in the quarter of $2.2 million. For the full year, our net income was $234,000.

Income from operations, excluding restructuring charges and certain other non-cash and non-recurring items -- principally stock-based charges, depreciation and amortization, or EBITDA -- was a loss of $2.8 million for the fourth quarter. However, without the impact of the Tafeen settlement, we would have had EBITDA income of $3.1 million.

Our fourth quarter EBITDA calculation excludes the effect of $1.3 million in revenue, similar to the last two quarters, related to a legacy virtual tour contract with Cendant that we consider non-recurring in nature, as we were prepaid for these services in 2000 and 2001. The fourth quarter is the last quarter that will be affected by this revenue. Our EBITDA for the full year was $5.4 million. Without the legal accruals related to the former officers' defense costs, which totaled $15.6 million for the year, our 2005 EBITDA would have been $21 million.

Our 2005 financials reflect the execution of the investment plan that we outlined a year ago, involving our RentNet, HomeBuilder and Welcome Wagon businesses. The product initiatives that resulted from these investments were announced last week. While we continue to incur costs related to launching these initiatives, most of the investment dollars are already reflected in our ongoing operating results.

As a result of the strategy we discussed last week, we have realigned our reporting to better reflect the way we manage and evaluate our business. Starting with the fourth quarter, we have organized into two reporting segments based on customer type.

The Real Estate Services segment includes Realtor.com, Top Producer, RentNet, and HomeBuilder. Next quarter, RentNet and HomeBuilder will be replaced by Move.com. The Move-Related Services segment includes Welcome Wagon, Retail Advertising, and our Plans and Publications business. In the first quarter of 2006, this segment will also include the moving.com business we've recently acquired.

To make it easier for those investors who have been tracking our Company over the past few years, we have provided tables with our earnings press release that show our financial results for the quarter and the year, in both the old and new segment presentations. However, when we file our 10-K, it will show our new segments for all years presented, and will only report those segments going forward. For purposes of this call, we will review the results of the business based on the new segments.

The Real Estate Services segment reported improved revenue growth and higher profitability for both the quarter and the year. Revenue for the quarter of $48.7 million represented 29% growth over the fourth quarter of 2004, and the operating margin increased to 31% from 22%. Operating margin improvements were driven by better performance in Realtor.com and Top Producer, although the fourth quarter dropped slightly on a sequential basis due to increased traffic costs and our investments in the HomeBuilder and RentNet businesses. On a full year basis, revenue grew 22% and the operating margins improved to 30% from 18%.

The segment performance was driven by Realtor.com, which makes up just over 60% of the segment. Under the able leadership of Allan Dalton, Realtor.com revenue grew 43% in the fourth quarter compared to the fourth quarter of 2004, and 34% for the full year. Excluding the impact of non-recurring revenue resulting from our virtual tour contracts with Cendant, revenue growth was 36% for the quarter and 29% for the full year.

We continue to see strong adoption of our showcase listing enhancements as well as the featured home display products. We are also looking forward to launching the new products and features we announced last week. Later this year, Realtor.com will be adding featured listings to its search results, which will be available on a cost-per-click basis, as well as a feature comparative market analysis product to generate CMA leads for realtors.

In the second quarter of 2006, we will also be adding new community pages to the Realtor.com site. These community pages are designed to enable customers to promote their local communities, and to interact with consumers online. Together with Realtor.com's leading position in audience size and listing content, this new user-generated content will allow us to create the best online consumer real estate experience available. On the marketing front, our real estate marketing expos were a significant contributor to the success of Realtor.com. We held close to 40 events in 2005, and will be continuing this program in 2006.

Turning to our software business for real estate agents, Top Producer was also a strong financial performer for the quarter and the full year. Revenue growth was 37% in the fourth quarter compared to 2004, and 40% for the full year. The 7i Web-based solution now represents more than 90% of Top Producer's revenue. The operating income, while much higher than last year's level, still reflects the impact of development costs related to new product initiatives, including the Top Marketer leads product. Top Marketer provides consumers with information regarding recent residential real estate sales and facilitates a connection with a participating realtor.

Last week, we officially launched the product by offering leads at prices ranging from $20 to $35 per lead depending on the geographic region. This offering will be made available to all interested Top Producer 7i subscribers. Top Marketer will generate leads from one of our new web sites, HomeInsight.com, as well as from our existing traffic partners. Participation will be on a month-to-month basis, with consumers setting the limit on the number of leads they would like to receive.

Partially due to the strong product endorsements we received from many real estate franchises including Cendant, Keller Williams, GMAC, and Re/Max, the number of Top Producer 7i subscribers grew over 60% during 2005, and recently passed through the 60,000 mark.

Turning to our new homes and apartment businesses, HomeBuilder and RentNet were recipients of major investments in 2005. As a result of the early investment in sales and marketing, we were able to stem revenue declines and, in the case of RentNet, we had modest revenue growth in the third and fourth quarters.

Last week, we unveiled the content and project strategy for our new homes and rental businesses that we've been working on for many months. Our new real estate vertical search site, Move.com, will significantly improve our consumer experience. Move.com will display basic property listings for free, and will offer a showcase listing product for customers who want to enhance their properties. In addition, home builders and rental owners will have the opportunity to purchase prioritized featured listings, as well as traditional text advertisements on a cost-per-click basis. We believe the new products will provide more flexibility for customers' marketing needs, and the revenue models will allow us to more effectively monetize our traffic.

The changes to our HomeBuilder and RentNet business models should position us for long-term growth and profitability. Initial signs from consumers and customers are quite positive. But these changes may have an adverse effect on the quarterly revenue trends of HomeBuilder and RentNet, particularly in the second and third quarters.

We are taking prudent steps to ensure that the transition of our HomeBuilder and rental customers from a paid inclusion to a free inclusion model will go smoothly. But there are some short-term risks that some of the customers might require more time to adopt the new model. Because we're confident the new models will better position these businesses for long-term success, we are more focused on how these businesses exit the year then their near-term financial performance. This is not unlike the transition previously made in the Realtor.com and Top Producer businesses.

Our Move-Related Services segment's fourth quarter revenue of $17.8 million represents 7.5% growth over the fourth quarter of 2004. As expected, the profitability of the segment declined compared to the third quarter and the prior year due to the investments being made in Welcome Wagon. Revenue in this segment for the full year grew 4%, and the operating margins declined from a $3.8 million profit to a $1.3 million loss. We anticipate the margins will continue to be under pressure into the first half of 2006, as we continue our investments.

We made progress with our investments in 2005, as evidenced by Welcome Wagon's fourth quarter revenue growth of 15.5% over the fourth quarter of 2004, the highest since it was acquired in 2001. Typically, the fourth quarter is a slower-revenue quarter for Welcome Wagon, due to the fact that we recognize revenue as we ship our gift product to new movers, and fewer customers move during fourth quarter. However, as a result of the launch of the new and improved off-line products, revenue for the fourth quarter of 2005 was higher than the third quarter.

In August, we started shipping significantly redesigned new mover gift books. In October, we began shipping books which, for the first time, included national advertisers in addition to local merchants. Our goal is to double the number of gift books we send annually from 2 million to 4 million.

There are two types of gift books -- those which include both local merchant and national advertisers, and those that include national advertisers only. The gift books that include only national advertisers currently have a lower margin attached to them until we add additional advertisers. Over the next year, we expect to continue to enhance the product and the value proposition for our national advertisers, and thus improve the margins on those gift books.

Beginning next quarter, realtors will be able to order the Welcome Wagon new mover book as a gift for their customers. By offering realtors a co-branded gift book, we will enable them to further extend their personal touch with clients. And these co-branded mover gifts will allow us to collect the critical information about a mover far earlier in the move process, resulting in substantially more value for our advertising partners. As a result of our new product initiatives and the integration with Realtor.com, we expect Welcome Wagon to reach our revenue growth target of 20% for 2006. While we are expecting improvements in profitability, we don't expect Welcome Wagon to reach our long-term target of 20% EBITDA margins during the coming year.

Our retail advertising business includes revenue generated from graphical display ads that run across the network, as well as sponsorships and directory inclusion in our home finance, moving, and home and garden content areas. Revenue for the fourth quarter grew almost 9% compared to the fourth quarter of 2004, while the revenue for the full year grew 7% over last year. A significant portion of the revenue in retail advertising is tied to traffic levels. Because the fourth quarter is our lowest traffic quarter, as expected, the fourth quarter revenue was down sequentially from last quarter.

Retail ad inventory will be reduced when we launch Move.com, as the current graphical ads at rental search page results on HomeBuilder and RentNet will be replaced by cost-per-click text links. Although we expect the cost-per-click text links to generate more revenue for the Company, the revenue associated with these links will be reflected in the Real Estate Services segment. As a result, we do not anticipate retail advertising's revenue to reach our long-term growth target of 20% in 2006.

Our Plans and Publications business had a disappointing fourth quarter. As opposed to our other businesses, which we believe should benefit from a slowing market, our home plans business is more negatively impacted as housing slows and interest rates increase. We've appointed a new general manager for the business, and are looking at strategies to improve the performance of the business.

Last week, the Company announced the acquisition of Moving.com. Moving.com provides consumers with offers from qualified movers, truck rental and self-storage providers, as well as access to a sophisticated lender directory. Moving.com's move-related tools including their lender directory, will be integrated to improve the consumer experience on Move.com, Realtor.com, and Welcome Wagon. We expect the Moving.com acquisition to contribute 2% to 3% revenue growth this year, with an EBITDA margins near our target levels of 20%.

Our unallocated or corporate expense for the fourth quarter of $19.4 million increased from $10.3 million from the fourth quarter of the prior year, due to two legal settlements we discussed totaling $7.7 million as well as higher infrastructure costs. For the year, our corporate expenses increased to $56.6 million from $48 million.

Excluding the non-recurring legal costs in each year, $17.4 million in 2005 and $9.4 million in 2004, and restructuring charges, our costs increased approximately 9% or $3.3 million, which reflects investments in our ERP system and data center moves.

Turning to our income statement, our gross margins in the fourth quarter declined slightly from earlier quarters, mostly as a result of the lower margins associated with the new national mover gift books and our Welcome Wagon business. Gross margin was 76% in the quarter, and 78% for the full year. Going forward, we expect our gross margins in 2006 will be similar to 2005 levels, particularly as we improve the margins on the national gift books throughout the year.

Taking our expenses line by line, sales and marketing expense in the fourth quarter of $23.6 million, was $3.6 million higher than the same period in 2004, reflecting the impact of our investment plans and increased distribution costs.

We expect sales and marketing expense as a percentage of revenue to increase during 2006 as we introduce and promote our brands to consumers. Our intent is to integrate off-line marketing activities gradually, rather than pursuing an aggressive advertising campaign, and to concentrate our activities on those that are tied to revenue.

Prior development expense continued to ramp in the fourth quarter, as we invested in the business, including our soon-to-launch vertical search engine, Move.com. Prior development expense during the fourth quarter was $6.8 million, compared to $3.8 million last year and $5.8 million in the third quarter. While we don't expect comparable increases in 2006, we expect prior development expense to approximate 10% of our revenue as the Company grows.

General and administrative expense of $24.3 million for the fourth quarter was significantly higher than the year before, mostly because of the $5.9 million legal accrual and higher consulting fees associated with our data center move and our ERP implementation. We will continue to work to lower our G&A expenses, and expect G&A expense as a percentage of revenue in 2006 to be lower than the fourth quarter, after removing the impact of legal costs.

Our cash and short-term investments as of December 31st were $152.3 million, which reflects the issuance of our convertible preferred stock. We expect our cash position to decline slightly in the first quarter due to payment of our previously announced legal settlements and the acquisition of moving.com for approximately $9 million.

Our sources of cash during the quarter were as follows: $94.1 million from the issuance of preferred stock, $2 million from the exercise of stock options, $3.6 million due to an increase in working capital, and $850,000 released from escrow related to the prior sale of Wildfire. These were offset by a $2.8 million EBITDA loss, $3.5 million in capital expenditures, $1 million in payments of restructuring charges, and $400,000 in payments on capital leases. Capital expenditures, which totaled $11.2 million in 2005, will likely be higher this year as we relocate and upgrade our data center.

Finally, keep in mind that beginning in the first quarter of 2006, we will begin recognizing the impact of FAS 123R that requires us to record compensation expense in our income statement for the granting of stock options. This is likely to prevent us from being GAAP profitable in the first half of the year, and may preclude GAAP profitability for the full year. We're still in the process of determining the impact of 123R on our financial statements. Whatever the impact, it will be excluded from our EBITDA calculation so that you will have a consistent basis of comparison to prior periods.

At this point, I'd like to turn the call back over to Mike for final comments. Mike.

Mike Long

Thanks, Lew. As many of you know, given the amount of extraordinary non-recurring expenses associated with the turnaround of our Company, and the scope of investments and business model changes we have been making to our businesses, we have provided only limited financial guidance.

For those businesses that were early beneficiaries of our investment program, mainly Realtor.com and Top Producer, the predictability of their financial outcomes is improving markedly. Further, with the recently announced legal settlements, the frequency and amount of extraordinary charges related to the Company's legacy issues should be significantly reduced going forward.

However, the new strategy and products we announced last week also represent major business model changes to businesses representing a meaningful part of our Company's revenue. While we are very excited about these changes, these new business models are unproven. Until their financial outcomes become more predictable, we will continue to provide limited guidance.

With that said, we expect our Realtor.com and Top Producer businesses to operate at or above our long-term revenue growth target of 20% this year and now believe Welcome Wagon can achieve that performance this year as well. The revenue challenges for us will be how effectively we manage the transition of RentNet and HomeBuilder.com's new revenue models, and how successfully we integrate Moving.com. Taking these factors into account, we believe we can achieve full year revenue growth above 15%.

On the profitability side, despite continuing investments in our new products and infrastructure and increasing consumer marketing spending, we expect to modestly improve our EBITDA margin for the full year, excluding this year's legal defense cost. We remain optimistic that we are pursuing the right strategies to better serve consumers and customers while creating a valuable business for our shareholders.

We are very interested in your questions. Operator, please open the phone lines for questions.

Question-and-Answer Session

Operator

Your first question comes from Mark Argento with Craig-Hallum Capital.

Mark Argento - Craig-Hallum Capital

Thank you. In terms of the segment operating margins under the old way you guys were reporting the numbers, should we look for those to tick back up after some of these expenses that you guys have been putting into the model over the last couple of quarters? Should we return to the run rate levels that we saw in Q3? In particular, on some of these when you look at it on a segment-by-segment basis? I know you had made some comments in terms of traffic costs; can you talk little bit more and elaborate on that a little bit? Thanks.

Lew Belote

Hey, Mark, its Lew. First of all, I guess we haven't looked on the old segment basis. We have done some looking forward as we build the forecast on the new basis. To help you understand historically, we've given as attachments to the press release, the old method as well as the new method.

Within the Real Estate Services segment that we call it now, which includes Top Producer but doesn't include retail, obviously, you've still got a big impact of the investment from the HomeBuilder and RentNet businesses. I think you'll see those investment dollars -- and as we said, most of those are showing up in product development. The product development should continue at roughly 10% of revenues on a company-wide basis. Most of that investment right now is showing up in those two businesses and in Welcome Wagon.

Now, I'm not sure if that helps you understand -- we've said because of the revenue issues related to HomeBuilder and RentNet, which will take some transition in the second and third quarter, the margins themselves could also suffer during those periods. But we believe that overall for the year, as we move through the end of the year, that those businesses will be much stronger, both on the revenue line and the operating and profit lines.

Mark Argento - Craig-Hallum Capital

So product development cost in the quarter was about 10%. So going forward, you anticipate 10% of revenues -- that's kind of the run rate that we should expect going forward?

Lew Belote

Yes, our expectations are it will continue at about 10%.

Mike Long

Mark, this is Mike; I will take your traffic question. Some of the major changes we're making to the business model is to better monetize our traffic, and to draw sort of a correlation between the cost of that traffic and our ability to generate revenues.

So by the introduction of, for example, cost-per-click, CPC products really throughout our network, as well as maintaining our subscription-based products, we think we're going to be able to go out and aggressively compete for substantially more traffic and be able to match those costs up with increased revenues and, of course, margins associated with that revenues. So that's clearly one of our goals for 2006, and we are pretty optimistic about it.

Mark Argento - Craig-Hallum Capital

Does that impact the gross margin in the quarter -- this quarter in particular, Q4?

Mike Long

As far as additional traffic costs, no, it was not a real material part of our fourth quarter results.

Lew Belote

It doesn't affect the margins. It's in sales and marketing, primarily. What affected the margin for the quarter was the investment and the actual cost of the Welcome Wagon book relative to the revenue. As we said during the call, as we add additional advertisers in that national book, the margins will improve there.

Operator

(Operator instructions) There are no more questions at this time. I will now turn the call over to Mr. Long for closing remarks.

Mike Long

Yes, thank you. We do appreciate your participating with us this afternoon in our fourth quarter and full year 2005 financial results. We appreciate your continued support and interest in our Company, and we look forward to future conversations with you as we communicate the results of our new strategies. Thank you.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may all disconnect. Have a good day.

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