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CNET Networks, Inc. (NASDAQ:CNET)

Q1 2008 Earnings Call Transcript

April 24, 2008 5:00 pm ET

Executives

Todd Friedman – IR, The Blueshirt Group

Neil Ashe – CEO

Zander Lurie – CFO

Analysts

Mark Mahaney – Citigroup

Youssef Squali – Jeffries & Company

Heath Terry – Credit Suisse

Gene Munster – Piper Jaffray

Lloyd Walmsley – Thomas Weisel Partners

Brian Fitzgerald – Banc of America Securities

Jennifer Watson – Goldman Sachs

William Morrison – ThinkEquity Partners

Steve Weinstein – Pacific Crest

Mark May – Needham & Company

Kit Spring – Stifel Nicolaus

Clay Moran – Stanford Group

Ross Sandler – RBC

Operator

Ladies and gentlemen, thank you for standing by and welcome to the CNET Networks first quarter 2008 financial results call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator instructions)

Thank you. I would now turn the conference over to Mr. Friedman. You may begin your conference.

Todd Friedman

Thank you, Operator. Good afternoon everybody. Before we get started I would like to remind you that call is being webcast. The webcast can be accessed in the CNET Network's investor relations website at ir.cnetnetworks.com. A replay will also be available shortly after the conclusion of the call.

I would also like to remind you that in the financial news announcement released today and also on the call, CNET Networks is providing specific forward-looking statements including guidance related to expectations, our future financial performance, the cost savings from our recent restructuring and the benefits of our new partnership with Yahoo!.

Any forward-looking statements made as part of our news today are subject to risks and uncertainties that could cause actual or productive results to differ materially. These risks are outlined in our first quarter news announcement as well in the Company's Security and Exchange Commission filings include its 10K for the year 2007 which can be obtained from the SEC's Web site or directly from our Investor Relations Web site. All information discussed in this call is as of today, April 24, 2008 and CNET Networks undertakes no duty to update this information.

Last, but not least, you can find a reconciliation of the non-GAAP financial measures that we use in our news release and on this call to GAAP financial from the last pages of today's news announcement.

Participating on this call are Neil Ashe, CNET Networks Chief Executive Officer; and Zander Lurie, our Chief Financial Officer. Following the prepared remarks, we will host a brief question-and-answer session. To facilitate the question and answer session, we will be muting the line following each question and we'll take follow-up questions if time allowed.

Now, let me turn the call over to Neil.

Neil Ashe

Thanks Todd and thank you all for joining us. I would like to focus my comments today on a few key topics. First, I will review the quarter, which saw strong progress on business model changes and good traffic growth at our key brands, but had its challenges in terms of financial performance. Second, I'll talk about today's exciting announcement with Yahoo! And third, I'll talk about our perspective on the industry and our strategic focus for the rest of this year and beyond.

Before beginning though, I'd like to quickly address the whitepaper that JANA issued a few weeks ago. We have reviewed the whitepaper and we will address our response as we get closer to the proxy process. Today, I would like to keep my comments and our discussion focused on our business and therefore we will not discuss their proposals on this call.

Last quarter, we outlined our specific strategic priorities for the year which are; one, to focus on key category defining brands, CNET, BNET, GameSpot, TV.com and CHOW; two, to improve our financial performance through revenue growth and margin expansion; and three, to maximize our opportunity in China. During the quarter, we made significant progress against these goals.

On the first priority, we were very pleased with the growth of our leading brands. We have built the portfolio of premium properties that collectively make CNET Networks the tenth largest Internet network in the world. The number of people and the time that they spend on our sites continues to grow.

During the first quarter, CNET Networks properties reached 161 million monthly unique users, up 9% sequentially from the fourth quarter. Our users consumed approximately 90 million pages per day, up 13% sequentially from the fourth quarter. CNET, BNET, GameSpot, TV.com and CHOW each had record traffic months in the first quarter.

That said our financial performance did not mirror this traffic growth. Revenues for the quarter were $91.4 million, up 3% from last year within our guidance albeit at the low end. Display advertising revenue increased 6%. Cash operating expenses before stock compensation expense, depreciation, amortization of tangible assets, restructuring charges, stock order proposal, and stock option investigation and related costs were $89.7 million, which was flat with Q4 2007. And non-GAAP operating income was $1.7 million, which was below our guidance. The changes that we made during the first quarter will continue to create value for our users, for our customers, our employees and our shareholders.

The most important changes we made in the quarter were to our business model. On our last call, we talked about taking aggressive steps to accelerate revenue growth including exploring third party sale partnerships. I am excited today announce that we have signed a broad multi-year partnership with Yahoo! that encompasses advertising, content and search marketing.

Under the partnership, CNET.com will become Yahoo!'s partner for technology and consumer electronics content, powering sites like Yahoo! Tech, Yahoo! News and other Yahoo! properties. CNET Networks will sell advertising against our own audience on Yahoo! properties, giving our marketing partners the ability to efficiently and effectively scale their marketing programs across both CNET Networks and Yahoo!

Yahoo! will sell advertising inventory across CNET Networks brands, which will be key components of Yahoo's publishers network. And finally, Yahoo! will broadly distribute its search tool bar products and services through a newly constructed program at cnetdownload.com.

With this relationship, we have dramatically expanded the reach of our most important brand, we have optimized our undersold inventory with a premium ad platform, and we have created the largest vertical technology ad network for our sales force to sell. We expect this partnership to deliver over $100 million of profitable revenue growth over the next three years.

We also made progress on the cost side of our business. We made the difficult but right decision to reduce our U.S. workforce by 10%, which will reduce our quarterly operating expenses by approximately $4 million beginning in the second quarter. The changes we made were designed to maintain our investment in our core properties.

We reduced our investment at central operations while at the same time creating centers of excellence around key initiatives such as our Open API technology architecture. We're confident that these changes will improve our operations while at the same time reducing our operating costs.

Taken together, the Yahoo! partnership and the workforce realignment mitigate risk this year against an uncertain U.S. economy and position us for profitable growth next year and beyond. We remain on track for our 25% non-GAAP operating income margin goal for 2009.

Now, turning back to the market and our strategy, it is important to look at the environment in which CNET Networks competes and the underlying strength of our competitive position both with users and with marketers. There has been a dramatic shift in where people spend their time online. According to the Online Publishers Association, in February, 42% of a person's time spent online is with content sites, more than people spend with communications or commerce or search which for example represents 5% of their time.

This is what we do. We build content destinations where people stop and spend time. Our ability to create these leading brands has allowed us to build significant reach with audience that marketers covet. This has allowed us to develop strong relationships with advertisers across technology, consumer electronics and gaming categories, as well as developing relationships in new categories like automotive, finance and media.

In addition, our ability to export this content presents unique opportunities for us to partner with other media companies to extend the reach of our brands like we have done today with Yahoo! And we are one of the only U.S. media companies that has been able to translate this success online into new countries and build significant presence in growing markets like China.

During the quarter, we focused on new product developments that improve both the appeal and accessibility of our sites and partnerships that make it easier for more people to find our content.

Let me share a few highlights from CNET and BNET. We are committed to creating great user experiences on our sites and we are also committed to opening up our properties, to getting our content out into other environments, and to integrating more third party content on our sites.

To make CNET content even more accessible to more people, CNET launched its own channel on YouTube featuring CNET's original shows such as The Buzz Report, Loaded and Top Five. We are also proud to launch CNET TV 2.0, featuring closed captioning of the site's popular video content, making us one of the few Web sites today with video content that is accessible to the deaf and hard-of-hearing communities. An added benefit of closed captioning is that it improves our SEO efforts by making our videos easier to be indexed by search engines.

Finally, to further expand the brand's presence with new demographics, CNET announced a partnership with the largest Spanish language brand in the country, Univision, to launch a new Spanish language technology mini site on Univision.com. Hosted by Univision and branded CNET, the site features CNET news, reviews and videos all translated into Spanish.

The Spanish speaking population is the fastest growing demographic in the U.S. and the Univision Web site and broadcast operations reach over 90% of approximately 44 million Hispanics in the U.S. today. With very limited incremental investment, we were able to partner with Univision to reach this important and growing group of consumers.

CNETnews.com continues to thrive under the new leadership of Dan Farber. The site is aggressively establishing itself as a leader in the blogging community. In fact, according to an analysis recently done by Tech Crunch, CNETnews.com has 16 of the top 100 tech bloggers, more than any other organization, with some of the industries most vocal pundits such as Caroline McCarthy and Tom Krazit, Ina Fried, and Dan himself leading the charge on blog coverage.

This continued commitment to the highest quality content combined with important distribution arrangements like our deal with Yahoo! ensures that more and more people have turned to CNET as their prime destination for their digital lifestyle.

BNET, our newest property, continues to attract business professionals looking for resources to help them succeed at work. In addition to our original content, the site offers access to more than 11 million resource articles from over 3,000 leading independent publishers. It is currently the fastest growing business Web site reaching more than nine million unique users per month in the United States, up 29% sequentially from Q4 according to (inaudible).

During the first quarter, we launched BNET Industries. BNET Industries combines original reporting with information on more than 9,000 public companies, helping managers stay up to speed on the industries in which they work and compete. At launch, BNET Industries covers 11 industries including automotive, media, financial services, advertising and technology with more to be added in the future. BNET's success continues to attract new advertisers including American Express, AT&T, MasterCard, Visa and WebEx.

Outside the U.S., our business in China is dynamic and growing with leadership positions in online and technology, autos and a developing position in women's lifestyle. Last quarter, we announced the acquisition of Cheshi, a leading Beijing-based automotive Web site. Together with our other automotive sites, XCar and Gocar, we now have both leading content and lead environments. These sites are attracting advertisers including Honda, Nissan, Toyota, Ford and Audi.

As we have discussed, we are in the process of evaluating investments by local partners in order to scale this business more rapidly. We are on track to make a decision about this in the second quarter. In our other international markets, we continue to have attractive revenue growth but remain focused on margin expansion. We will continue to evaluate the growth and profitability in all of our international operations.

As we look ahead to this quarter and beyond, our strategic priorities remain the same; focus on our key brands with exciting product development, continue to improve our business model to revenue growth and margin expansion initiatives including the launch of our Yahoo! relationship later this year, and maximize our opportunity in China.

With that, let me turn it over to Zander.

Zander Lurie

Thank you, Neil. I am happy to be here with you on my first call today as CFO. I have had the opportunity to speak with a number of our large and small investors in the past and I look forward to meeting more of you on the road and at conferences this quarter.

When I took the role of CFO last quarter, my primarily objective was to begin implementing the operational and strategic initiatives that would drive financial results in line with the performance of our brands. While millions of new people engage with our leading properties every quarter, our business model not yet enjoyed comparable traction in recent quarters at least. Our near and long term efforts are focused on driving shareholder value and our recent reorganization and the Yahoo! partnership that Neil highlighted marks significant progress against that goal.

As we talk about these changes and our projections, I am committed to working closely with the Street to ensure that we are providing you with the right information to help you understand and model our business. My comments today will focus on our performance for the first quarter before concluding with our guidance for the second quarter and full year 2008. Keep in mind that some of my comments will refer to non-GAAP financial measures and you can find a reconciliation of our GAAP to non-GAAP measures in our press release.

Now to Q1 revenue, total revenue for the first quarter of 2008 was $91.4 million, a 3% increase from $89.1 million last year. While this revenue is within the guidance we provided last quarter, we are not satisfied with 3% year-over-year growth. The quarter was not without its operational highlights, as our international business continues to enjoy strong growth up 26% year-over-year. U.S. revenue declined 3% primarily due to declines in marketing services revenues and to a lesser extent display revenues. U.S. display ad revenues were affected by a decline in media and entertainment revenues, partially offset by increases in consumer electronics and technology.

As we indicated on the Q4 call, we anticipated a difficult year-over-year comparison in search revenues, because our current revenue sharing relationship beginning on the first day of this year is on less favorable terms than prior years. In paid listings, the declines were solely the result of light volume not pricing, which we believe reflect softer macroeconomic conditions for consumers.

Licensing fee and user revenues increased 17% to $12.1 million during the first quarter, driven largely by a growth in our channel data licensing business and the addition of TechTracker, which we acquired in the third quarter of last year.

International revenue as I mentioned increased 26% to $22.4 million during the first quarter. The growth there was driven by increases in display revenue from both our existing properties and recent acquisitions. Adjusted for foreign exchange, international growth would have grown 18% from the first quarter of last year.

In the first quarter, we saw particularly strength from our China operations. We continue to experience the high renewal rate from our top advertisers as 93% of our top 100 U.S. customers that did business with us in the fourth quarter came back and renewed in the first quarter.

Total cash operating expenses before stock compensation expense, depreciation, amortization of intangible assets, restructuring charges, stockholder proposals and stock option investigation and related costs during the first quarter were $89.7 million, an increase of 15% from $78 million last year.

Nearly $7 million of the $11.7 million year-over-year increase is related to investments in our core domestic brands such as CNET and BNET, specifically in the acquisitions of TechTracker and FindArticles. The balance of the increase can be attributed to international investments, mostly associated with newly acquired properties in China and France. Other charges in the quarter included a $5.1 million charge associated with our Q1 organizational restructuring.

Our statement of operations also reflects $100,000 of net expense related to stockholder proposals and stock option investigation costs. This amount consists of $2 million of expenses related to the ongoing shareholder proposals and $200,000 of fees related to our shareholder litigations, offset by a $2.2 million insurance recovery related to expenses previously incurred on our stock-option investigation.

Non-GAAP operating income, which excludes depreciation, amortization, stock compensation expense, restructuring cost, shareholder proposals and stock related to our stock option investigation was $1.7 million, which is an operating margin of 2% compared to $11 million or 12% in 2007. The lower margin is a result of revenue coming in at the lower end of our guidance combined with our higher first quarter 2000 expense base.

In Q1, we recorded an income tax benefit of $10.8 million. On a GAAP basis, we currently expect to record income tax expense at an estimated rate of approximately 80% for 2008. However, on a cash tax basis, it should be noted that due to the size of net operating losses and other deferred tax assets, we'll continue to pay minimum cash taxes for a number of years.

In the first quarter of 2008, we have determined that we over-estimated a portion of the tax evaluation allowance which we released in Q4 2007. To correct this item, we have adjusted downward the value of our deferred tax assets and stockholders equity on our December 31, 2007 financial statements by approximately $4.8 million.

Cash provided by operations during the first quarter was $15.9 million, a $4.9 million increase over last year. Capital expenditures during the quarter were $7.7 million and primarily reflected investment in hardware and software to support our U.S. media and international businesses. Excluding the insurance recovery relating to our stock option investigation and offsetting cost related to shareholder proposals, free cash flow was $8.3 million in both the first quarters of 2008 and 2007.

Before turning to guidance, I'll give you more color on the two significant events that influence our business model that Neil highlighted upfront. Starting with Yahoo!, today's announcement represents a key component of our business model shift. The scope and structure of this relationship will generate significant high margin revenue over the next three years. Not only will our yield optimization improve, but the relationship will expand the overall inventory in specific areas of CNET, where we have the highest interest for marketers.

Aligning our monetization capabilities with our traffic growth is a key focus for me as we transform CNET Networks to a faster growing, more profitable company. We estimate the deal would generate over $100 million in incremental revenue for the next three years, as well as provide numerous strategic benefits which we are happy to discuss in the Q&A. The relationship is scheduled to commence in Q3 with revenue growth through the life of the contract. It should be noted the revenue growth scaled significantly in years two and three of the deal.

In terms of our cost structure reductions, the total workforce reduction was approximately 120 people, which will result in annualized cost savings of approximately $16 million or $4 million per quarter going forward. The cost savings will be recognized across all operating lines.

When viewed in context with our other strategic initiatives, you can see that we've been active in repositioning the company to return to faster and more profitable growth. We addressed a major revenue growth need with the Yahoo! agreement and have addressed our operating margin structure with the restructuring. We continue to target the 2009 non-GAAP operating margin goal of 25% and I am confident we can achieve that target.

Now, I would like to provide you with CNET Networks financial guidance for Q2 and full year 2008. For the second quarter of 2008, we expect the following. Second quarter revenue is expected to be within the range of $100 million to $104 million, representing a 6% to 10% growth over Q2 last year and 10% to 14% sequential growth over first quarter of 2008.

Non-GAAP operating income is expected to be between $15 million and $17 million for the second quarter. The $86 million in cash operating expenses implied by the midpoint of our guidance represents a $3.7 million decrease from the first quarter of 2008. Additionally, we expect to incur approximately $2 million of legal and financial advisory fees in the second quarter associated with the ongoing activist stockholder proposals, which is not reflected in our non-GAAP operating income guidance or earning per share guidance.

Second quarter earnings per share is expected to be approximately break-even. This estimate reflects a full GAAP tax rate of approximately 80%. We estimate that stock compensation expense will be approximately $4.5 million or $0.01 per share net of tax.

Now, to full year, as a result of our business model changes we've highlighted, we are maintaining our guidance for revenue and non-GAAP operating income for the full year. For 2008, we expect revenue to be within the range of $440 million to $460 million, which represents growth of 8% to 13% over 2007. We are forecasting non-GAAP operating income to be between $88 million and $96 million for the year, representing a 10% to 20% increase over 2007.

Earnings per share is expected to be within the range of $0.03 to $0.04. This estimate reflects a full GAAP tax rate of approximately 80%. Our estimated GAAP tax rate is higher than you would normally experience due to estimated tax operating losses from certain foreign entities, for which we will receive no tax benefit.

We estimate the stock compensation expense will be approximately $19 million or $0.06 per share net of tax. We also expect to invest approximately $25 million to $30 million in capital projects throughout the year. Investments and content development business expansions and enterprise infrastructure are currently planned.

Non-GAAP operating income and earnings per share guidance does not consider costs related to the stockholder proposals or the stock option investigation and related matters.

With that, I would like to turn the call back over to Neil.

Neil Ashe

Thanks Zander. Despite challenging operating results, we were pleased with the progress we made this quarter against our long term strategic priorities to build category defining brands, to accelerate revenue growth, to right size our cost structure and to realize the full potential of our China assets. There is more to do and we are doing it.

We understand the long term potential of this company and we are making the strategic and operational changes necessary to realize it. CNET Networks is a great company made up of many talented people whose efforts produce outstanding Web properties that tens of millions of people visit every day.

That wraps up our formal comments and we would like to turn it over to the operator so we can open up for your questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Mark Mahaney with Citi.

Mark Mahaney – Citigroup

Thanks. Two questions please. As part of the Yahoo! agreement, do you have to have some sort of change of control provision in there? And I only ask that in the context of WebMD did something of a similar deal with Yahoo! and expressed some uncertainty of what that could look like in the event that Yahoo! is acquired by Microsoft. And then secondly, could you just talk about progress again in terms of non-endemic advertisers, the ability to continue to expand the advertising base beyond the core CNET brand advertising base? Thank you.

Zander Lurie

Sure. Mark, on the Yahoo! deal, we're not going to go into specifics of change of control. I understand your question and obviously all of the key provisions were thoughtfully considered but we are not going to disclose that in the public.

Neil Ashe

As it relates to the expansion of our other category advertisers, as we talked about, we created a program called our partner sales account strategy where we have created sales people within our organization who have the ability to go represent the entire collection of sites to important advertisers. The most important areas where we have contraction there are autos, both Asian autos and developing in Detroit. We see a significant amount of interest at properties like BNET from financial services companies and others, so yes we have made progress on that. I think our growth rate reflects the fact that we want to be making more progress. I think we can make a lot more progress. I'd say we are still -- we still believe that that's a big opportunity that has not yet been realized.

Operator

Your next question comes from the line of Youssef Squali with Jeffries & Company.

Youssef Squali – Jeffries & Company

-- seem to include search. Can you just update us on your negotiations with Google? Is that still going month to month? And then on the Yahoo! relationship, just help us understand a little bit how the money flows. So, I guess it has three components; contents, advertising and tool bar. Is there -- for on the tool bar for instance, is that on a bounty basis that you get paid from Yahoo? And on content, is there -- do you get paid as you supply your own content to Yahoo!, or is it pretty much just a pure advertising driven kind of rev share relationship?

Neil Ashe

So first question on search, we maintain our relationship with Google on search. We've been partners with Google on search monetization for a long time. I think it's been a very productive relationship for both of us and we look forward to continuing that.

As it relates to the money flow on the Yahoo! deal, this is obviously a very expansive deal, which is why we are so excited about it. First on the content side, we put the CNET content in front of a number of additional consumers that didn't have access to that before. The Yahoo! sales force has the ability to sell some of our undersold inventory which would obviously be revenue to us.

We have the ability to sell our users on Yahoo! Properties which would be revenue from us to them, and the tool bar relationship is a -- is one which we hope will be the center of an ecosystem program for the independent vendors at download.com, which is consistent with other programs like that in the space. So it's a complicated transaction to summarize, but the net of it is that we dramatically expanded our advertising opportunities.

We've introduced a premium advertising network to our undersold inventory across our own properties and we have created dramatic technology -- vertical technology advertising network through the ISVs at download.com and through our sales of the Yahoo! inventory with our sales force.

Operator

Your next question comes from the line of Heath Terry with Credit Suisse.

Heath Terry – Credit Suisse

You actually touched on this a little bit when you mentioned Yahoo! potentially repping [ph] some of your inventory. We've talked before about the opportunity that exists to some of the CNET inventory within the growing kind of premium ad networks that are out there. Does this relationship with Yahoo! include usage of their ad network whether it's the right media or is it purely just their ad sales force that can sell the inventory? And then, has there been any progress in your discussions with those other premium ad networks for -- in order to utilize -- not the right term, but the remnant inventory that you have on the site?

Zander Lurie

Sure. This is Zander. Let me take a crack here. It's a great question. I think we really sat down with Yahoo! and achieved a win-win here after a pretty critical evaluation of the entire landscape and where is that win-win. We are giving Yahoo! a good chunk of inventory across our properties seasonally in ways to help us kind of optimize yield across our network, which they will be able to sell in vertical channels. And so, we are not going to have the kind of sales channel conflict that would otherwise be highlighted if you had two organizations selling against each other.

So our properties will be sold in vertical channels with others and really starting to utilize behavioral targeting on the CNET sales component of the deal. So, we will be able to offer our marketers increased reach across the Yahoo! Property by CNET users, the Yahoo! Sports or Yahoo! Mail by capitalizing on that technology. So it's really enabling Yahoo! to sell in channels some of our great brands which help their overall offering to marketers and then using behavioral targeting on the CNET side.

And in essence, we are creating as Neil said our own vertical ad mailer except it's a vertical ad network of more of just the best technology pages on the Web at CNET. So we're going to be able to create significantly more inventory at our highest premium sites across their network.

Neil Ashe

I'll add just a little bit to that, Zander, which is that we've been saying for a long time that not all ad networks are created equal and there's been a lot of press over the last little bit about the fact that many of these ad networks are selling all of the same inventory. We evaluated every opportunity to maximize our yield and we chose to partner with the most productive partner that we came across in Yahoo! and we created the opportunity for us to scale that significantly over time. So, we evaluated the entire landscape and its optimization process and this is the right deal for CNET Networks and for Yahoo!

Operator

Your next question comes from the line of Gene Munster with Piper Jaffray.

Gene Munster – Piper Jaffray

Good afternoon. Neil, you talked obviously about the international side and the growth potential and last quarter you a lot talked about China and realized that you guys have been dominating that segment in China. If we look at international as a total, if I'm not mistaken, it's basically hovered around 25%. Should we expect -- is there a reason why it's been in that range and should we expect that to begin to trend upward going forward?

Neil Ashe

Gene, yes, thanks. As we've said, and we covered this in our prepared remarks, we continue to identify ways to scale in China, scale more quickly, which may entail us taking on some investment there. As you look at the rest of our international business, we focus on realizing the power of the brands that are important to us in geographies that matter. So over time you'll see a scale larger in the -- in those core markets and probably invest less or maybe even exit markets where we don't see the future margin potential. So, yes, you'll continue to see the growth that we've demonstrated out of international, the 20% plus revenue growth, but potentially offset by us focusing on exiting some markets like we did Korea last year and focusing on those where we think we really can make some hay and have a much larger and profitable business.

Operator

Your next question comes from the line of Lloyd Walmsley with Thomas Weisel Partners.

Lloyd Walmsley – Thomas Weisel Partners

I was wondering if you could just tell us if you are getting any of the inventory on Yahoo! Tech that isn't associated with CNET content? So for example will you be actively selling vertical -- tech vertical inventory that isn't your own there?

Neil Ashe

No. We are going to be selling CNET video across Yahoo! which they are pretty excited about given the power of some of our personalities and franchises at CNET TV. So we look to that to be a pretty exciting program, as the kind of increased penetration of video streams and pretty significant demand for marketers, we'll be able to sell what may be a lot of video into Yahoo! Tech, but we will not be selling display media at Yahoo! Tech, rather driving a lot more traffic back to CNET, in the particular areas of CNET where we are particularly productive. So that's the – the vertical ad network we see selling our users on Yahoo!, but also just creating a lot more pages at CNET through that relationship with Yahoo!.

Operator

Your next question comes from the line of Brian Fitzgerald with Banc of America Securities.

Brian Fitzgerald – Banc of America Securities

In terms of lettering the Yahoo! arrangement starting in Q3, Q3 and Q4 haven't been factored into guidance yet, but there will be some impact this year we assume. Second thing I wanted to confirm Google is still less than 10% revenue partner.

Neil Ashe

Google in Q1 was about a 12% revenue partner. On your question of Yahoo!, Brian, I think you were cut off for the first half, but I think I got the gist of your question. We are -- we have a broad launch of this program on July 1, as we highlighted it, it's really a multi-prong program that has a number of different initiatives, some that will get cranking sooner than others. The significant impact on incremental revenue as I mentioned will generate the second and third year of this deal. So I think for the first quarters we will see some revenue and that has been factored into our guidance, when we think about the overall economic picture and some of the business model actions we have taken that put us back in line with both guidance on revenue and EBITDA.

Operator

Your next question comes from the line of Jennifer Watson with Goldman.

Jennifer Watson – Goldman Sachs

Great, thank you. The user metrics that you reported were quite strong. Can you discuss what you believe drove the strength this quarter and why you think that advertising revenue growth is below that of the usage trends? Do you feel it is CPMs or fall-through rates?

Neil Ashe

We did have a strong traffic growth from a user perspective. As I mentioned, in CNET, BNET, GamePlay, TV.com and CHOW, each had a month that's four to five for March, and one was January their highest users in the first quarter. That was driven largely by repeat users coming back to our site so people who come directly to our sites. As we've discussed with many of you, for the last couple of years, we've been focused on search engine optimization where we've been pretty successful with those efforts. Our SEO starts in Google are up 65% year-over-year.

So, we continue to drive that traffic. And we focus there -- our focus is once we have that person, let's get them to come back because a person who comes directly to our properties engages with significantly more content, two to three to four times as much content as somebody who comes from a search engine. So that's where you see the scaling of the traffic and obviously BNET is a big winner in that quarter as well.

Our monetization model, Jen, as you know is not a search model. So a search model of monetization is effectively you have a piggyback and you pull against that piggyback of presold inventory based on your traffic. Ours is a combination of multiple revenue streams, so our display advertising is sold on campaigns based on marketers needs and we frankly had a light first quarter.

As Zander indicated, the business model changes, now we've started to layer in additional part of our business now in our display revenue which like our leads business or like our Google relationship are more kind of on-demand revenue as search is described by taking a swap of the inventory with this Yahoo! relationship and making it a more predictable revenue stream.

So, we continue to build on the foundational pieces of our inventory, but the principal thing that we are focused on again is to build these category defining brands, get more and more people to come back even more often and generate inventory. We'll find a way to monetize as much inventory as we can generate.

Zander Lurie

And Jen, just to pile on there, one area where the sell-through is going to get a lot better in this Yahoo! deal, where there are few endemic advertisers and where we generate a lot of page views, specifically in some of our entertainment properties, that's where Yahoo!'s reach and scale as an ad sales force can potentially be more productive when we do have these kind of big page turning quarters of some of those entertainment properties. So, we do look for a significant uplift in a good portion of undersold inventory there.

Operator

Your next question comes from the line of William Morrison with ThinkEquity.

William Morrison – ThinkEquity Partners

Thank you. A couple of questions and I apologize, I joined the call late, so if this is repetitive --

Neil Ashe

You missed all the good stuff.

William Morrison – ThinkEquity Partners

I caught most of it. The $100 million -- I think you said $100 million you are expecting from the Yahoo! deal, I just wanted to clarify that. And if you could clarify, it sounds like you are saying most of that comes in year two and three. So, does that mean we should assume kind of $40 million or $50 million in years two and three? Is there a contingency? Is the $100 million an estimate or is it a guaranteed gone either or both ways? And what is the incremental margin on that revenue?

Neil Ashe

A lot of good questions there. It's fair to say the revenue scaled significant in years two and three, so it does not look straight line. We are not ready to break out specific line items or quarterly revenue projections yet, but it's fair to say it's a line that goes up into the right significantly.

On the different components, there are significant guarantees from Yahoo! to CNET associated with sale of some of our undersold inventory and there are multiple performance components associated with the partnerships specifically at download and our ability to sell CNET users on their network.

So, $100 million is our prudent guess of what the total value of this deal will be over the three years. It will be significantly higher margin revenue than our current operating income margin, it's fair to say, but there will be a range on this revenue and it will be contingent upon performance and there is other buffers of area where we can continue to work together in a higher fashion to the extent we see success across the program.

Operator

Your next question comes from the line of Steve Weinstein with Pacific Crest.

Steve Weinstein – Pacific Crest

I just want to clarify one point on the Yahoo! relationship. Are you getting paid anything directly just for the distribution of your content or just for the right to have your content, or is it all based on different rev shares from ad sales?

Zander Lurie

We've always licensed our content and we do it with other parties. I'd call that part of this broader relationship. Obviously this is a strategic relationship for both us that has multiple tentacles, so the answer is we are ultimately being very fairly compensated for our content there.

Neil Ashe

Yahoo! reminded us of that a number of times in the discussion.

Operator

Your next question comes from the line of Mark May with Needham & Company.

Mark May – Needham & Company

Thanks for taking my question. A little big bigger picture, one of the issues that has been raised in the past is about CNET's monetization. And I am wondering if you could talk a little bit more broadly about what you are doing to improve monetization at the owned and operated sites? So outside of things you are doing to build out your network or things you are doing with partners like Yahoo! to help maybe monetize some inventory that's not endemic or not core, what are you doing sort of internally within your owned and operated to improve yield? I've noticed that average ad RPM in the quarter was down 9% year-over-year. I think you talked about what happened in the quarter, but I'm thinking just a bigger picture longer term.

Neil Ashe

Sure. I'll piggyback on the answer that I gave to Jen's question earlier to talk about kind of our monetization strategy, which is that ideally we would like to continue to have more and more predictable revenue streams and have our sales force target those opportunities which are large and meaningful and can be differentiators for us. So, as you see a relationship like the Yahoo! relationship, which is -- and we've been careful to draw this distinction before, yield management is others selling our inventory and ad network would be us selling other people's inventory. This deal is both of those.

We significantly improve the yield on undersold inventory, as Zander said. So we created a swap of our inventory which is a predictable relationship, outsourced sales relationship with Yahoo! and we create an ad network for us to expand. Our sales force then can go focus on those large opportunities around our endemic categories and Ad Age 100 advertisers where we can build integrated and deep relationships.

We are increasingly seeing the desire and need for the association with stand-out brands, so whether it's CNET or BNET or GameSpot, et cetera, as we go to market, we can create integrated programs for large advertisers. You cannot buy an integrated program from a generic ad network. It just doesn't happen. So, we are -- the special sauce for us is that relationship. So, for longer term and bigger picture, our ad sales strategy is to have these multiple lines of revenue, so whether that is search or outsourced sale, and develop these core relationships with endemics and large advertisers where we can build important custom programs for them to scale our relationship and become a very important partner to them both tomorrow and beyond.

Finally I think you asked a question about RPM. Obviously RPM is kind of a little bit a -- is a trailing statistic. So that's -- the more we grow traffic, the more RPM goes down. So, as I've said many times in the past, though you will not see a direct -- always a direct correlation between our traffic growth and our revenue, as in some cases our inventory outpaces our growth in some cases in revenue, and in some cases our growth in revenue outpaces our growth in inventory.

Operator

Your next question comes from the line of Kit Spring with Stifel Nicolaus.

Kit Spring – Stifel Nicolaus

On the Yahoo! deal, do you expect that the $100 million might cannibalize some of the existing revenues from CNET? Is there a risk that people start going to Yahoo! instead of CNET? Are you replacing any other content like PC World or are you just purely new content? And then my other question to Zander would be, in 2Q it looks like about 10% year-over-year revenue growth in these. How do you get there from 3Q in the first quarter -- or 3% in the first quarter? Thanks.

Zander Lurie

Sure, Kit. Let me take your first question first on cannibalization of remnant. Good question really. All inventory is sold just matters what price level it is sold at. So we did a thoughtful analysis of what we were cannibalizing. And I think Neil said it best earlier, maybe it wasn't on the call, but we are really levering to the upside here and leaning to our biggest brands and the relationship those sales forces have with the industry. And in areas where we've got great brands and great traffic but the reach is more difficult, that's where Yahoo!'s going to play a big role for us. And as you know, when you are undersold in some of those lower CPM categories, the RPMs associated with those pages are more difficult. So the remnant that we are giving up here is de minimis compared to what we are getting in return.

On the content side, obviously you can imagine, the relationship here for CNET is an important one featuring their content on Yahoo! Tech and there was significant discussion about the depth of our content and the placement of our content and the treatment of our content, and we take our distributors of our content, we take those relationships very seriously.

So, we think we've done what we needed to do to protect our ability to maintain kind of number one in the technology media category, but also avail ourselves to millions if not tens of millions of new consumers across Yahoo! as they promote our content. And then, on the first quarter as we mentioned, the search year-over-year tough comparable was a significant component of what kept our Q1 revenue growth under what we think it would be in Q2.

As also some specific items associated with the entertainment industry, for instance the writer's strike, the effect of TV.com, the push out of GameSpot or Grand Theft Auto Four to second quarter took some revenue out of Q1. So, a number of specific issues remained at CNET Networks that we think will not be there in Q2 and that is why you see a bigger number for revenue growth in the second quarter.

Operator

Your next question comes from the line of Clay Moran of Stanford Group.

Clay Moran – Stanford Group

Thank you. You've mentioned $16 million in expense cuts, increased user traffic and the addition of the Yahoo! deal, but at the same time, your revenue and EBITDA guidance haven't changed. I don't really have a good sense yet of what is offsetting those positive impacts. Can you sort of explain where the weakness is and what is driving it?

Neil Ashe

Sure, Clay. As I mentioned upfront, we are making some pretty significant business model shifts and our business model shifts are ahead of our operational execution on the monetization side right now. So, the health of the brand is really strong highlighted by kind of all-time highs in traffic at our five category defining brands. But monetization whether it's through macroeconomic conditions or industry specific conditions, obviously our Q1 revenue performance was not something we are particularly proud of. So, we've taken operational cuts to (inaudible) business faster, more profitable growth and taken into some macroeconomic conditions that are more pronounced than they were on February 5. So, all things being equal, the revenue from the Yahoo! deal is not nearly as significant in the back half of this year as it will be in full quarters of '09 and 2010, and some lighter revenue across macroeconomic conditions, which -- that's what gives us the prudent view of staying within our guidance both for revenue and EBITDA.

Operator

Your next question comes from the line of Ross Sandler with RBC.

Ross Sandler – RBC

Thanks, guys. A couple of questions and I apologize kind of hopping off on and of off the call. And I think this is a follow-on from a prior question, but how much of the 11% page growth was organic versus acquired? And if you look at your comments on display of 6%, can you bring us back to what pricing and sell-through looked like in the quarter? And then I have got a follow-up. Thanks.

Neil Ashe

So the first question on traffic growth organic versus acquired, I don't have a break out in front of me to give you an accurate answer on that. I'd say the dramatic increases were -- or where we saw strong growth was at CNET which big brand nothing really happened from a page view change there. BNET obviously is a big grower that includes some traffic from FindArticles, but we've gone that traffic about 50%. So that's largely organic.

As it relates to your second question, the display, the -- I'd say we saw seasonal weakness year-over-year in the -- traditional seasonal weakness from fourth quarter to first quarter which reduced our total revenue number. You remember piling on the last question that Zander answered, the second quarter, we had a challenge last year where we had some big tech accounts that rolled out that were advertisers in the first quarter. So that's where you see some of the difference in the first quarter. And that will obviously drive sell-through down and yield. So I think we saw a little bit of both sell through and CPMs in the first quarter, but largely driven by the absolute opportunity -- absolute revenue opportunity that we saw out there.

Ross Sandler – RBC

Okay. And as it relates to the Yahoo! deal, the $100 million contribution over three years to CNET, is that a gross number or a net number? And is the Yahoo! contribution for year one factored -- was it factored in back when you gave guidance in February or is it incremental today, are there any areas that are kind of below trend line versus where you were three months ago? And that's it, thanks.

Zander Lurie

I don't want to bore some of your colleagues on the phone. I think we hit that one a little earlier. The Q3 and Q4 revenue associated with Yahoo! will offset some of the weakness that we've seen in other areas that have developed over the last three months. On your first question …

Neil Ashe

As we've said, this has been a strategic priority for the year. So we have in the back of our minds that we were going to do this. As it relates to what sell -- the first question about the $100 million of revenue, that's our estimate. As we've described, this is a broad multi-faceted relationship which is strategic for both of us. It is a gross revenue number, but it is an estimate. So, we could expect that number to be higher.

Zander Lurie

And we'll work with you if that revenue line item needs to develop into a tack line item. For instance, if we are selling significant inventory across Yahoo, there's a different kind of relationship there than just selling your O&O, so we'll think critically over the next few months on how we share that number.

Operator

You do have a follow-up question from Mr. Gene Munster with Piper Jaffray.

Gene Munster – Piper Jaffray

This is a quick one. Did you guys break out growth rate in China?

Neil Ashe

We have not broken that number out, so -- but it's a -- think of it as our fastest growing international market. It's growing faster than the rest of the international market, which grew 26% this quarter.

Zander Lurie

And its traffic is growing significantly as well.

Neil Ashe

Operator, we will take another question if there is interest.

Operator

Yes, you have a follow-up question from the line of Youssef Squali from Jeffries & Company.

Neil Ashe

Youssef, your last name changed.

Youssef Squali – Jeffries & Company

I know, it keeps changing there. So, just a quick -- two follow ups. One, Zander, the 25% in '09 non-GAAP operating income margin, can you just clarify that? That assumes no further trimming in the cost base; I'm talking about the employee base. And second, can you just speak a little bit about the pricing environment? WebMD on their call discussed how advertisers were going for fuller term commitments and they kind of blame that on what they were seeing in the economy. Can you tell us if you are seeing the same thing?

Zander Lurie

Yes. Neil walks by my office every day and reminds me of the 25% target that we are going to hit in 2009. No, that does not model any future cost reductions in the employee base. We took the business model change we think is necessary to position us for profitable growth. And as I mentioned we do feel levered to the upside here and that we are going to be driving more inventory to our most premium areas. Pricing in the market, we didn't see price erosion. We've maintained the integrity of our rate cards and we are being creative around packaging and different horizontal rotation so we can deliver on expectation to marketers.

Neil Ashe

And we don't currently get very much pharma revenue, so it's tough for us to compare ourselves to WebMD.

Zander Lurie

Although, if there are any pharma advertisers on the phone, we'd be happy to take ads.

Operator

Your next question comes from the line of William Morrison with ThinkEquity.

William Morrison – ThinkEquity Partners

Yes, two quick follow-ups. One, I'm just curious, will you be building or will Yahoo! be building, or does Yahoo! already have an existing infrastructure to manage this relationship? Is this a part of their you-sell/we-sell platform? I'm just kind of curious about the technology that will implement it. And then secondary or derivative to that would be, do you have control over what ads they put on your sites in the remnant spots? I think CNET has been well known for not just having quality content but quality brands up against your content. And I'm curious if you are going to be relaxing the standards in terms of what kind of remnant ads are going to be on your property. Should we expect for instance lower my bills and NetFlix ads next year coming? If you could just talk about that?

And then secondly, you've mentioned a few times now you have -- it sounds at least like you've seen some economic business in your business which is being offset by Yahoo! I was wondering if you could just talk a little bit more about that and exactly how much economic weakness you've factored into your guidance in both the second quarter and for the full year. Thanks.

Zander Lurie

Bill, I'm not going to get specific on the nature of the offset in incremental Yahoo! revenue against economic weakness, but fair to say, staying in our revenue range. There are pockets of lightness in specific categories, as we highlighted the media and entertainment category. Maybe more lightness there germane to specific conditions like the games release or the writer strike and then macro economy, but we did see health in key consumer areas like consumer electronics and technology. So we will continue to monitor macroeconomic conditions and provide new guidance if necessary.

On the display ads that Yahoo! will be showing on our -- if you are asking if we are going to have any dancing monkeys next to our premier content ad technology, I do not foresee that happening. That said, we do not have control over which ads Yahoo is going to be displaying, but this is within the you-sell/we-sell program, and it is a pretty impressive platform that we have put together to work with them. And obviously, our ads in the platform will be key to delivering ads both on CNET Networks properties but as well as how we work with Yahoo! on delivering with the (inaudible) targeted technology to reach our users on their network.

Operator

There are no further questions at this time. I would now turn the call back over to Mr. Ashe for any closing remarks.

Neil Ashe

Thank you all for spending some time with us to talk about Q1 and this exciting relationship with Yahoo! and what our special company can do going forward. So, thank you for your interest in our company and we look forward to talking to you again soon. Thanks.

Operator

This concludes today's conference call. You may now disconnect.

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Source: CNET Networks, Inc. Q1 2008 Earnings Call Transcript
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