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Local Corporation (NASDAQ:LOCM)

Q2 2012 Earnings Call

August 9, 2012; 05:00 pm ET

Executives

Heath Clarke - Chairman & Chief Executive Officer

Ken Cragun - Chief Financial Officer

Janine Zanelli - Investor Relations

Analysts

Jon Hickman - Ladenburg

Ed Woo - Ascendiant Capital

Operator

Good afternoon. My name is Sabrina and I will be your conference operator today. At this time I would like to welcome everyone to the second quarter financial results conference 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 like to turn the conference over Janine Zanelli. Please go ahead ma’am.

Janine Zanelli

Welcome to Local Corporation’s second quarter 2012 conference call. With me are Local’s Chairman and CEO, Heath Clarke; and our Chief Financial Officer, Ken Cragun. Heath and Ken will discuss our second quarter 2012 results and updated guidance for the full year 2012. We’ll then open the lines for questions.

Today’s discussion includes forward-looking statements that are subject to risks and uncertainties that can cause actual results to differ materially from those expressed in the forward-looking statement. These risks and uncertainties will be outlined at the end of this conference call and are detailed in Local.com’s SEC filings. Any forward-looking statements are only made as of the date of this conference call and we undertake no obligation to update such statements to reflect subsequent events or circumstances.

We use non-GAAP financial measures in evaluating our financial performance. Please refer to the press release we issued today for how we define such non-GAAP measures and our reasons for using them, as well as a detailed review of our first quarter 2012 results, including the corresponding GAAP financial measures and a reconciliation of our non-GAAP to GAAP financial measures.

This conference call is publicly available via audio webcast through our website and a replay of the call will be available for the next 90 days.

I’d now like to turn the call over to our CEO, Heath Clarke.

Heath Clarke

Thanks Janine. We continue to make great progress exceeding prior guidance and increasing our adjusted net income guidance for the year. As I’ve mentioned in the past, we have a multi year approach to building traffic, technology and advertisers.

We’ve built a leading local search site and network. We did that by aggregating locally relevant data like business information, activities, events and more and publishing that data across a network of over 1,000 regional media sites. The major search engines index that content, which drives traffic into our ecosystem and we monetize that traffic with ads from our direct advertisers plus ads from various partners.

Our revenue model is surprisingly simple. Traffic times monetization equals revenue. To grow our business we need to grow traffic and increase monetization. Lets look at our momentum in each of these areas.

When it comes to traffic we consistently set new records. We achieved a major milestone in the second quarter reaching over 100 million monthly unique visitors or MUVs across our ecosystem, up nearly 22% against the year ago period. Organic traffic was a record 39 million MUVs in the second quarter, up over 25% from the year ago period and was nearly 40% of total traffic.

Mobile traffic results are up sharply reaching 19 million MUVs during the second quarter, up 60% from the first quarter and over 350% from the year ago period. We’ve grown our network from 700 sites to over 1,200 sites over the past few years and we expect that to continue into the future. We clearly have momentum on the traffic side of the equation.

Turning to monetization, we see great momentum here also. As many of you know we suffered monetization challenges about 18 months ago, which we addressed by contracting with a leading ad supplier a year ago. Largely due to this partnership, second quarter 2012 monetization was near record levels at $300 per 1,000 visitors, up nearly 72% from the year ago period.

Our visibility in the third quarter this year was limited as we didn’t have a full year’s worth of data from our current blend of ad partners and this blend drives the majority of our monetization. As a result of that we’re softer on revenue and margin guidance and we expect it to be for the third quarter, but we feel confident in our visibility post Labor Day. We fully expect to gain monetization momentum in our seasonally strong fourth quarter period.

Overall, momentum is strong in both traffic and monetization and to grow from here, we need to grow both traffic and monetization. Our long-term goals will get to 50% of our traffic organically and 50% of our revenue is from direct customers. Right now we are at about 40% organic traffic and we expect to end the year with a 25% direct revenues.

To grow organic traffic we need to do three things. First, grow the number of partners using our private label solutions; second, increase the traffic on each site by a better SEO and content syndication; and third, increase the number of products each partner uses. Today we have a single product reach partner.

We acquired Krillion in the second quarter last year and they will be powering our new product directory, which we expect to begin installing on our network starting in the fourth quarter. These instillations are forecasted to provide particularly high gross margin revenues to us.

On the mobile front we developed a great new local app design to engage our users in a mobile environment and we expect that will be approved for the iPhone and Adroid OS this quarter.

To grow monetization requires two things; one, optimized ads on our ecosystem and two, sell our own ad products directly to small and medium sized businesses or SMBs. I am very excited about our small business products; single debut and all in one bundle for SMBs, which is a $249 per month subscription product.

We’ve been test selling this for over two months and have been very encouraged by the feedback from our SMB customers and by the considerably lower churn. We plan to steadily ramp up the size of our teller sales force by about five people per month through the year end, ending with about 60 teller sales staff here at our Irvine facility. Growth in direct subscribers build a recurring and defensible revenue stream with very high gross margins.

Underpinning all of this is our great technology. We received another patent during the second quarter and now have nine patents issued covering a variety of our business methods and technologies. Our technology platform underpins our proprietary SMB solutions, which when coupled with our large eco system of consumers searching for products and services locally, we believe provides us with long term competitive advantages against others who sell digital products and services to SMBs.

Moving now to Rovion. We acquired Rovion about a year ago to enhance the display ad capabilities of our platform and today its fully integrated. The Rovion platform itself is very powerful and quite frankly, it does more than we need to do with our SMB customers.

As a result and based on strategic interest in the platform for multiple parties, we felt that made sense to explore a sale of Rovion, so long as we could retain our license fees and technology. We are actively in discussions and will update you as we make progress in this regard.

As a corporation we’ve adapted to significant challenges over the past two years and we’ve overcome them. We met or beat guidance for four consecutive quarters and we believe will end this year with record revenues and a return of profitability, yielding about $0.07 per share in adjusted net income for the fourth quarter alone; a very strong end to the year and ample reason to remain confident about our future.

Now, I’d like to turn the call over to our CFO, Ken Cragun.

Ken Cragun

Thank you Heath. As Heath mentioned, we had strong second quarter results. Our second quarter revenue grew 75% from the prior year period. We achieved record levels of overall traffic and strong monetization in that traffic; two key performance indicators of our business.

I’d like to point out a few second quarter items noted in our earnings release, discuss our second quarter results and comment on trends we are seeing as we enter into the second half of 2012.

During the second quarter we recorded an impairment charge of $6.5 million related to good will and intangible assets of our Spreebird business. We saw two indicators of impairment during the quarter, lower revenues from this business unit and a significant decline in the market capitalization of public companies in the daily deal space.

During the second quarter, as Heath mentioned, we began exploring the divestiture of our Rovion business. Given these activities, we are required to show the Rovion assets as assets held for sale on the balance sheet and as a result Rovion’s revenue and results of operations are excluded from net income from continuing operations in all periods presented.

During the quarter we took actions to reduce our operating expenses and incurred severance cost of $514,000 or $0.02 per share. Comparing our cogs and operating expense to the prior quarter, Q2 cost of revenue increased to $2.6 million, primarily related to cost incurred to grow traffic and expand our revenue.

As a percent of revenue, cost of revenue increased about 4.5 points from last quarter, lowering our gross margin, in part due to a shift in revenue mix, more heavily weighted to O&O revenue in the quarter, which has lower gross margin percentage than our other business units. The lower gross margins were offset by cost savings in sales and marketing.

Q2 sales and marketing expense decreased over $1 million from the prior quarter related to lower personnel related costs and a reduction in advertising and marketing expense. Q2 GNA expense increased about $400,000 from Q1 due to higher personnel related costs including severance costs.

Q2 R&D costs were fairly flat from the prior quarter, up about $90,000. Q2 amortization expense was fairly flat from the prior quarter, down about $100,000. During Q2 we had a GAAP net loss of $9.3 million or $0.42 per share on 22.1 million shares, including a $6.5 million or $0.29 per share non-cash charge for impairment of good will and intangible assets. This compares to a Q1 GAAP net loss of $3.2 million or $0.14 per share on 22.1 million shares.

During Q2 we had adjusted net income of $468,000 up from the Q1 adjusted net income of $139,000 taking into account exclusion of the adjusted net loss from the Rovion assets held for sale in all periods.

As for cash and liquidity, we ended the second quarter with cash of $7.1 million. During the second quarter, we generated cash from operating activities of $1.1 million and had capital expenditures of about $800,000. We expect a modest burn of cash during the third quarter of about $1 million, mostly for capital expenditures, primarily capitalized development cost and we expect to have cash balance improvements in the fourth quarter of 2012.

Looking to the second half of 2012, as Heath mentioned, we expect the third quarter to monetize at a lower level than the second quarter with less traffic. However based on trends we experienced last year, we expect the fourth quarter to return to near record levels of both traffic and monetization.

Regarding leg billing, certain of our legacy customers are billed on their phone bill, also known as leg billing. We’ve been notified that two of the carriers will no longer accept leg billings beginning in August of 2012 and expect the other carriers to seize leg billing by the end of the year. Due to this change, we expect a reduction in the second half revenue of about $700,000 and a reduction of net income of about $600,000.

On to our updated financial guidance, we expect third quarter revenue to be $24.5 million, up 18% from the year ago period, with adjusted net income at breakeven with $22.5 million weighted shares outstanding. For full year 2012 we expect revenue of $106 million, which represents growth of 35% from 2011, with adjusted net income of $2.2 million or $0.10 per share, assuming $23 million diluted weighted average shares.

Note that our updated revenue guidance excludes approximately $800,000 of revenue from the Rovion assets held for sale and $700,000 of leg subscriber revenue, both of which were included in our prior guidance.

I’d now like to open the call up to Q&A. Moderator.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Jon Hickman with Ladenburg.

Jon Hickman – Ladenburg

Hi, can you hear me?

Heath Clarke

Yes, hi Jon.

Jon Hickman – Ladenburg

So I think I understood everything you said, except, could you go over the comments about Krillion again?

Heath Clarke

Yes, so Krillion is the real time product search company that we brought last year and how we plan to use that on our network is – let me tell you what we do today on our network. We have over 1200 sites that have a private label version of local.com on it, a very much striped down version and basically what we are doing is publishing business information on the sites, on this regional media sties and the major search engines index that and that drives traffic to those sections of those websites and we monotize that with ads.

So Krillion allows us to do that with product level search and the way that it would work, if somebody typed in plasma TV in Irvine, California on Google, Yahoo! or Bing, hopefully they would see our plasma TV listing in our Local Regional Media publisher in the directory that we installed there.

So its basically kind of similar to a business directory, but its really a product level directory that we hope to install in as many sites as possible, but we got that installed customer base. You have the relationship and what we are looking to do really is to lever the relationship and install a new product directory into each of those sites.

And how we make money off that is the listing themselves typically generate pay per click revenues and they are very high revenues per click, because its very targeted traffic, geographically and by topic and we think that the clicks right on those will be very high compared to the directory of the product that we have today. So we think that that’s overall our directory product today is a high margin product for us. We think this is even higher.

Jon Hickman – Ladenburg

So it’s integrated in your directory product now?

Heath Clarke

No, the integration hasn’t happened. We will be launching the first directory actually on krillian.com during the third quarter, so that will happen this quarter according to our plans and then once that’s done or while that’s being done we are working on our directory publishing network and we are looking to basically modify contract to allow for the installation of the product directory on the same partner and that installation process will begin in the beginning of Q4 and that will probably push into, I’d say by the end of Q1 we’d have good progress there.

Jon Hickman – Ladenburg

Okay, model question. Cold you give us some idea of what we expect gross margins to be in Q3.

Ken Cragun

We are going to see. As we mentioned the revenue per 1000 visitors is going to drop down and so we will see margins probably in the mid-teens, coming down from where it’s been in the last couple of quarter. We think the fourth quarter will come back stronger than we’ve experienced in the last couple of quarters.

Jon Hickman – Ladenburg

Okay, so this monetization drop off that you are seeing for the, I guess July, August period, can you comment further on that. Like the second quarter seemed to be pretty strong and then all of a sudden, what people stopped using their computers in the summer?

Heath Clarke

No, so versus a year ago period, certainly there’s seasonality. I mean people do stop using their computers as much, because they are outside and that’s a marked seasonality. We haven’t seen that in the past though to be clear.

We haven’t had the same blend of ad partners as we have in the past. Our major ad partner previously was fairly consistent across the summer, but we do have a new ad partner blend and so we hadn’t had a full year’s worth of data from that new blend and we would have anticipate, we did anticipate that the monetization overall is pretty steady through the summer as it has been in the past for us, but that blend does behave differently than it did before.

Frankly we get a lot more strength out of that in the fourth quarter but there is a little bit more seasonality than we would have anticipated in the third quarter. But we do, its very delineated; we can see where it now. Now that we’ve got a full year’s worth of data we can see where it begins and where it ends and that’s why we said Labor Day, we see a big jump up in Labor Day and that should, that monetization increase should go right through to Christmas, and its material.

Jon Hickman – Ladenburg

Okay. So, okay, and the sales, the reduction in sales in market expenses, was it due to personnel. Is that because you are going to use a channel partner or can you explain that a little bit?

Ken Cragun

Yes, one of the more significant drops there was as we reassess our offerings on the Spreebird Daily Deals business, we look to kind of right size the team there and how we approach the markets.

We found good success with product offerings, some national offerings and certain recurring local deals that have worked really well for us, and we have been able to have decent margins on that lower level of revenue, without having to necessarily slug it out market by market, going door to door.

So as a result we have gone, we reduced headcount of the Spreebird business, but continued to assess that and try to staff it appropriately for the level of revenue we have right now.

Jon Hickman – Ladenburg

And then just one more question, the 8-K that you filed yesterday about the Yahoo relationship, in fact I thought the Yahoo relationship terminated last year.

Heath Clarke

No, no we have been partnered with Yahoo all the way through. We did terminate it last year in its current form and we re-implemented it last year as well, taking out some of the provisions of it. Basically every year we renew, there’s usually a change to it or several changes. So we did renew it last year with several changes.

This year we actually just extended it for 60-days to give the party, us and Yahoo an opportunity to make sure we got the right people in the room and negotiate it. So it’s really an extension of the Yahoo contact and we fully expect that that will be renewed again.

Jon Hickman – Ladenburg

Okay, so do you just further time to negotiate -- okay.

Heath Clarke

Yes.

Jon Hickman – Ladenburg

Thank you.

Heath Clarke

Thanks John.

Ken Cragun

Thanks John.

Operator

Your next question comes from Ed Woo with Ascendiant Capital.

Ed Woo - Ascendiant Capital

Hi. I had a question about your Spreebird business. How much of the slowdown or lower revenue that you had expected, do you think its maybe due from your competitors increasing competition of how much of it do you think it maybe possible slowing overall industry trends.

Ken Cragun

We think that there is more of a slowing industry trend and not to say that its not high right, but what we found a nuance of this business is we found what we call internally yield capacity by consumers. So what that means is, when you have a consumer that may have bough several deals, they love seeing the deals, they love purchasing the deals. But if they bought several deals and they haven’t actually used them yet, they don’t buy any more details till they’ve used up the old ones.

And so we are seeing that, at least with our base. That’s something that’s going to slow the efficiency. So when you send out a deal to a certain number of subscribers you expect it to performer is a certain rate. So that’s something that we’ve uncovered as a nuance of the daily deal space.

I think overall the daily deal space is still trying to find its feet, you know in certain verticals where its going to orient very well too, after serving in terms of an ad product and that’s why we want the daily deal product in our portfolio and its actually how we are using this Spreebird business going forward. We have the presence in the Southern California market, but we incorporating that into our small business product suite.

Also in the Spreebird platform we build our Local rewards, which is our loyalty and rewards program, which is a very powerful loyalty rewards program that we are able to utilize in our small business product suite as well.

So the Spreebird platform is integral to kind of where we want to go as a corporation serving small business customers and we are leveraging that fully in our S&B product suite, which is really a big part of our growth strategy. But in terms of an individual daily deals entity, it’s not going to be a significant help and I think that you have seen that right across the board as an industry.

Ed Woo - Ascendiant Capital

Okay, thank you and then the other question I have is, you mentioned customers loyalty and it seems to be a pretty big growth area these days. Do you have any plans or what’s your view on how its been perceived by the consumers?

Heath Clarke

Did you say, I’m sorry, you were a little choppy there. So did you say customer loyalty?

Ed Woo - Ascendiant Capital

Yes.

Heath Clarke

You mean like the loyalty and rewards program.

Ed Woo - Ascendiant Capital

Yes.

Heath Clarke

Okay. Yes, well we are seeing kind of obviously a lot of interest right across the board and loyalty rewards you got companies of that group on looking at this. Obviously there’s many others looking at this and so we think it’s a very important instrument that we view it as a part of our small business product suite. One of the big industry issues for digital media products is what we call the on-line, off-line gap, which is to say that a small business can buy a digital media solution, but they often have a hard time understanding how that translates into customers coming to their door.

And so you can use your wallet as a way to sell for that, that has a lot of challenges. But loyalty rewards program is another way to solve for that. And so we view it as an important way for a small business to reward their own customers and for us it serves as a way to validate the value of their online advertising with us. It also allows you us to build the database of our small business customers and that increases a switching cost of our S&B product suite. So we view it as a churn reduction strategy as well.

But it’s a very powerful tool. We have been approved on the nationwide to use our loyalty rewards program on the visa, mastercard route. So ours is a world-class loyalty rewards program. But we are deploying it for the small business owner and when they sign up for our S&B solution, again, we will be launching that pretty soon here, they will actually, once that piece of our program which will come in the fourth quarter is fully integrated, when they sign up they will actually receive a welcome package with a book of maybe 50 credit card sized Local rewards card that they can hand out to their best customers and start rewarding them on the spot.

So we think it’s a pretty compelling area and we are just glad that we are built that off our platform, because we do see a lot of competition arising. But again, we think we’ve got a big advantage in the market place with many of these smaller companies and they are interesting companies that they start up. They don’t have 30 million units a month looking for product and services. That’s a distinct advantage we have in the market place. So we think we are going to – we have to level that more effectively than many others.

Ed Woo - Ascendiant Capital

Great. Well, thank you and good luck.

Heath Clarke

That’s Ed.

Ken Cragun

Thank you Ed.

Operator

At this time there are no further questions.

Heath Clarke

Thanks for being on today’s call. I’d now like to turn the call back over to Janine for final disclosures.

Janine Zanelli

This conference call contains certain forward-looking statements within the meaning of section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Words or expressions such as anticipate, believe, estimate, plans, expect, intend, projects, forecast, potential, feel and similar expressions and phrases are intended to identify such forward-looking statements.

Any forward-looking statements are based on the beliefs of our management, as well as assumptions made by and information currently available to our management. Actual results could differ materially from those contemplated by the forward-looking statements as a result of certain factors, including, but not limited to our advertising partners paying less revenue per click and revenues to us for our search results.

Our ability to adapt our business following the shifts in our monetization partners, our ability to monetize the Local.com domain, including at a profit, our ability to retain a monetization partner for the Local.com domain and other web properties under our management that allows us to operate profitably.

Our ability to develop, market and operate our local-search technologies, our ability to market the Local.com domain as a destination for consumers seeking local-search results, our ability to grow our business by enhancing our local-search services, including through businesses we acquire, the integration and future performance of our Spreebird business and our Krillion business, the possibility that the information and estimates used to predict anticipated revenues and expenses associated with the businesses we acquire are not accurate.

Difficulties executing integration strategies or achieving planned synergies, the possibility that integration costs and go-forward costs associated with the businesses we acquire will be higher than anticipated, our ability to divest the assets of our Rovion business, our ability to successfully expand our sales channels for new and existing products and services, our ability to increase the number of businesses that purchase our advertising products, our ability to successfully bill our monthly subscription customers.

Our ability to expand our advertiser and distribution networks, our ability to integrate and effectively utilize our acquisitions technologies, our ability to develop our products and sales, marketing, finance and administrative functions and successfully integrate our expanded infrastructure, as well as our dependence on major advertisers, competitive factors and pricing pressures, changes in legal and regulatory requirements and generic economic conditions.

Any forward-looking statements reflect our current views with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this paragraph. Unless otherwise stated, all site traffic and usage statistics are from third-party service providers engaged by the company.

This concludes our call for today. Thank you for your interest in Local Corporation.

Operator

This does concluded today’s conference call. You may now disconnect.

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