Local Corporation (NASDAQ:LOCM)
Q3 2012 Earnings Call
November 8, 2012 5:00 PM ET
Janine Zanelli - IR
Heath Clarke - Chairman and CEO
Ken Cragun - CFO
Good afternoon, my name is Matty and I will be your conference operator today. At this time, I would like to welcome everyone to the Third Quarter Financial Result Conference Call for Local Corporation. 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. Ms. Janine Zanelli, you may begin your conference.
Thank you. Welcome to Local Corporation’s third 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 third quarter 2012 results and updated guidance for the full year 2012. We’ll then open the line 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 statements. These risks and uncertainties will be outlined at the end of this conference call and are detailed in Local Corporation’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 third 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.
Thanks, Janine. We are pleased to report that third quarter revenue and adjusted net income came in slightly above prior guidance. We are working hard to build a defensible business by growing organic traffic to at least 50% of total traffic and growing organic ad revenues to at least 50% of total revenue.
As detailed in our release today, we are at or near record levels for both of these high gross margin revenues sources during the third quarter and we expect continued momentum in this fourth quarter. We have also made progress in expanding our mobile footprint, achieving record mobile traffic during Q3.
We released Launch by Local, our digital media suite for small businesses during the third quarter and expanded our direct sales force by 50%. We now have nearly 1,000 direct small business subscribers on our premium products and over 10,000 additional subscribers from our private label, channel and affiliate partners.
We have made good progress, since we launched our SMB product and will be maintaining our sales force of about 45 people through year-end. During this quarter, we plan to invest further in our sales force analytics and reporting systems in order to ready to ramp our sales force and customer acquisitions starting January 2013.
Local search continues to go mobile and we are aligning our business strategies to take advantage of this emerging market opportunity. The third quarter saw record mobile traffic and the release of our mobile app. We expect mobile to be a growing portion of overall traffic and continue to develop our mobile strategy to take advantage of this industry shift.
Regarding the Rovion Sale, we closed the Rovion transaction for about $4 million after acquiring it for about $2.7 million a little over a year ago. We executed two licensing agreements. The first is our license of the Rovion platform in our SMB suite and the second is the PointRoll license of our Krillion Local product data feed to Rovion.
We think this was a win-win for us and PointRoll and it added $3.5 million to our balance sheet early in the fourth quarter. We are seeing stronger momentum in our key growth areas in the fourth quarter offset by monetization reductions in a portion of our owned and operated business due to recent policy changes and pricing challenges by our major partners. While we are disappointed with the impact on our owner business, these changes have no impact on the strategic areas we’ve been focused on long term, organic traffic and organic ad revenues. Macro pay-per-click rate challenges are affecting the entire industry that we expect to adapt to market conditions this quarter along with everyone else.
We remain convinced we’re a beneficiary of the secular trend towards local online advertising, which provides us with long term tailwinds. While partner policy changes result in new term monetization dislocation, once again, we think that in the long term they make sense because they tend to drive a better user experience and we believe this will create new monetization opportunities for the company.
Our updated guidance reflects this lower yield for our O&O business and we’re projecting 27% year-over-year revenue growth with $750,000 in adjusted net income. We fully expect top and bottom line revenue growth in future days.
Our company operates in a rapidly changing fragmented ecosystem where billions of dollars are moving from print to online and from within Digital to Local. Desktop is moving to tablet and everyone is moving to smartphones. Tablets and smartphones have new and changing devices and operating systems. Everything is in flux and everyone from the largest companies to the smallest products must adapt.
We’re still at the beginning of most of this and there are enormous opportunities in this sector. As with all businesses, only the agile will thrive and we’ve proven our ability to thrive by delivering nearly 40% compound annual growth for the past six years. We remained focused on building long term value creators in our business, traffic, technology and advertisers with a primary focus on organic traffic and organic revenues.
We have proven that we are agile and we are able to adapt quickly to the changing digital and mobile landscape, while making long term investments in our business, so we can continue our long term growth trend. We want to build a big and profitable business and that’s our focus.
Quarterly guidance tends to focus us all on the next quarter instead of the long terms opportunities we’re focused on. Starting in 2013, we will move to annual guidance only and will plan to update our outlook as the year progresses.
We remain committed to pursuing our long term objectives of traffic, technology and advertising growth and to maintain our business at about breakeven while invested for the future. We expect revenue and adjusted net income to increase incrementally in future periods.
Now, I would like to handle the call over to our CFO; Ken Cragun.
Thank you, Heath. As Heath mentioned we exceeded our top and bottom line guidance in the third quarter and reported third quarter year-over-year revenue growth of 20%. We achieved record levels of overall traffic with over 101 million monthly unique visitors to our site and network and solid monetization of that traffic, with our Local.com site reporting revenue per 1000 visitors of $276.
I would like to discuss some recent developments, our third quarter results and fourth quarter guidance. On October 19th, we sold all assets relating to the Rovion business. The sales price totaled $3.9 million with $3.5 million paid in cash at closing. We expected to close the sale by the end of the third quarter but closed early in the fourth quarter. Therefore the cash proceeds will appear in the fourth quarter balance sheet. I’m pleased with the boost to liquidity.
As a reminder, Rovion appears as assets held for sale on the September 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.
Comparing our COGS and operating expenses to the prior quarter, Q3 cost of revenue was $18.5 million and decreased $1.5 million, primarily related to lower traffic acquisition costs, as we optimized our paid search campaigns to the seasonally lower monetization during the third quarter.
As a percent of revenue, cost of revenue increased slightly from last quarter, lowering our gross margin percentage less than 1%. The lower gross margins were offset by cost savings and other operating expenses.
Q3 sales and marketing expense of $4.2 million decreased about $0.5 million from the prior quarter related to lower personnel related costs, partially offset by higher advertising and marketing expense. Q3 G&A expense of $2.5 million decreased about 10% from Q2, also due to lower personnel related costs.
Q3 R&D costs of $1.2 million were down slightly from the prior quarter. Q3 amortization expense increased by $1 million from the prior quarter, due to accelerated amortization of intangible assets related to the legacy let subscribers that will be discontinued by the end of the year.
During Q3 we had a GAAP net loss of $3.8 million or $0.17 per share on $22.1 million shares. This compares to a Q2 GAAP net loss of $9.3 million or $0.42 per share on 22.1 million shares. During Q3, we had adjusted net income of $152,000; down from the Q2 adjusted net income of $468,000.
As for cash and liquidity, we ended the third quarter with cash of $3.7 million. About $800,000 were used in the quarter for capital expenditures and about $400,000 were used to pay down the line of credit with $2.2 million used in operating activities. In the fourth quarter, the company will recognize the proceeds from the Rovion sale of $3.5 million, which will strengthen the balance sheet.
On to our updated financial guidance, as Heath mentioned our fourth quarter results will be sequentially lower than the third quarter, due to the impact of recent policy changes and pricing challenges by our major partners. Based on this, we expect fourth quarter revenue to be in the range of $22 million to $23 million, a mid-point decrease of 11% from the year ago period, adjusted net income at breakeven with $23 million weighted shares outstanding.
For full year 2012, we expect revenue to be in the range of $99 million to $100 million, representing mid-point growth of 27% over 2011 with adjusted net income of $750,000 or $0.03 per share, assuming 23 million diluted weighted average shares.
I’d now like to open the call up to Q&A. Moderator?
(Operator Instruction) Your first question comes from the line of Jon Hickman.
Heath, can you elaborate on what these policy changes are?
Yes. So there’s two changes in particular from one of the major search machines and one of them relates to how we advertise our advertising format. In other words, how our ads read on their site and we have about 11 million key words that we advertise. So it’s been a lot of heavy lifting for us to make sure those comply with the new guidelines. That's actually a little impact on that. These are changes that help ads to be more relevant to the keyword search term that’s used on that search engine. That's one of the changes.
The other change is what the page looks like when the consumer clicks on that ad and comes to our site. And they are intended to basically enable the consumer to have a better user experience, so that they don’t have to continually click through to get to relevant results.
And there are also guidelines around content versus ads or organic content versus ad content on the page and we've been compliant with these all the way through. These changes actually happen fairly frequently. In this case, there’s a couple that have happened at the same time but one of them is a more significant change in the past.
We think that overall, this helps to drive a better user experience on our search results page for consumers. We’ve actually seeing page views per visitor increase as a result of these changes. So we think long term the changes really apply across the industry. So we think the long term it creates opportunity to engage the consumer more fully.
We have good relationships with all of our ad partners, so we've been able to work with them to make sure we are in compliance. It actually potentially lowers the search engine marketing cost price overtime, that's TVD (ph) and so that’s basically the principle of the changes, one is how we advertise.
Heath, you're not explaining why it's cutting your revenues?
Well, fine. If the question is why is it cutting the revenue, as I mentioned its content and ad inventory on the page. So it’s less ad inventory on the page. So therefore that cuts the yield or the revenue per thousand visitors on that page. So perhaps the ad yield for that portion of the traffic, that’s on that piece of the side.
So they are controlling what your page looks like once I’ve clicked through?
The guideline do that yes. Not in control per se but they’ve got guidelines for how much ad inventory you can show. Let me give you an example. If I do a search for Dennis and Irvine and my ad pops up and says for Dennis and Irvine go to local.com, you want to see a list of Dennis and Irvine and we’d show that today. We’ve always shown that. That’s one of the things that we do well.
What they want to do though is to want to make sure that some of those organic listings that we have, up here above the fall versus below the fall. So a consumer wouldn’t have to scroll down to see them. So those are the kinds of changes that we’ve had to make and those directly impact our ability to monetize the traffic and our business model in terms of, if you distil it down, its traffic times monetization equals revenues.
So in this case, the traffic hasn’t been impacted but on the one side the monetization has been impacted on the other side but that also does impact our ability to buy traffic through search engine marketing. We’re obviously not going buy traffic through search engine marketing where the campaigns went negative as result of these changes. So it’s kind of double impact for us in this quarter, whereby we’ll have less traffic and we’ll monetize at a lower rate.
The flipside is as we adapt to this, we’ll have double positive on the other side. As we adapt to this and optimize, which we’ve already started to do, tested a couple of dozen pages already, we’ve seen a pretty significant increase in monetization off of that testing and we expect to continue to grow that. That allows us to turn those campaigns back on, but our guidance reflects kind of where we’re right now.
When did this monetization change hit?
It’s a standard release. So it kicked in officially October 15th and it rolls through December 2nd. Like I said, we think we’re in compliance. We’re talking with the teams all over both organizations and ours and theirs and we’re talking daily. So we feel that we’re in compliance. We don’t think that there is another chute to drop, but it’s a policy that’s being rolled out across a multi-week timeframe.
We think we’re well ahead of the rollout and the final kind of, they click this off on December 2nd, in terms of this rollout. And just to be clear, it’s not that they’re layering across different changes. The guidelines are already in place. We believe we’re compliant with them. Those who are not in compliance may see impact that would roll through to December 2nd.
So you knew this would come?
On October 15th we did, yes. We did get a heads up little bit before that. These policy changes come from time to time. We certainly didn't know what the exact change was, not until right before October 15.
This didn't affect your organic traffic at all.
Not at all. No it doesn't affect organic traffic; it doesn't affect traffic from other sources, the other places that we search engine market to. It's just one source only and that's it. It only affects that. So it's not even all of our O&O business. Remember our Owned and Operated business is the largest revenue source that was going to have the maximum impact, it’s also our thinnest margin which is why we're able to maintain the business at breakeven despite taking that revenue hit, but it only impacts that one thread of traffic through as large as it is, on that one side. It doesn't affect anything on any of the other pieces of our business.
But you're cutting your revenue forecast by like $5 million.
It's a big impact to me.
Yes. I'm not saying it's not a big impact. I'm just saying it's limited to that particular source of traffic and where we monetize that traffic on our site. So that is the
So when you say you're going to grow in future periods, can you elaborate?
Yes. We expect to grow. We're continuing to grow organic traffic and organic ad revenues so that we continue to grow in to Q3 to Q4, we grew in Q3, we expect it to grow in to Q4 and again in Q1. In Q4, we're optimizing against these policy guidelines and we're doing the normal optimization that we would do, so we do anticipate there to be upside as we enter in to Q1 or typically we get a lot of traffic volume. And so we expect the top line to increase in Q1 over Q4 and we expect the bottom line to improve as well. Basically, if you kind of go back to our Q3 outlook, we're expecting a higher adjusted net income in Q4 than incremental increases, so it's taking a step down from that based on this, but the underlying story is the same, we still expect incremental increases and that we do anticipate in Q1, Q2 next year as well.
Your next question comes from the line of Ed Woo.
I had a question on overall traffic; you've mentioned that this policy change hasn't affected your traffic. You think that this is going to continue going forward?
Well, there’s two pieces to the traffic mix. One is, does their policy change affect our ability to advertise, the answer is no. So it’s not affecting it from that standpoint that’s one piece of it. The second piece is, we’re monetizing at a lower rate than we were before, so that being the case, some of the campaigns that we would maintain as active are not profitable for us, so we are not going to keep those on, at least not until such time as we've optimized against the fees and brought the monetization back up again.
And so that will happen during this quarter, it’s already happening as we speak. So, for our business traffic times monetization equals revenue, so if monetization drops we will turn off campaigns that aren’t productive for us. As monetization increases, then we’ll turn those back on. So, we get a double negative on the way down. We've had this in previous periods where traffic’s lower because monetization is lower, it’s kind of a double hit, but on the way up, it’s a double positive, monetization goes up because we do think and the marketplace may be has some seasonality and then traffic volumes go up as well. So, it’s a double positive.
But what we are seeing right now or what we’re forecasting in Q4 is that double negative, we see monetization go down on that piece of our business, offset by higher margins on our organic revenues and organic traffic on the other side of our business and we’re seeing volumes go down from SEM campaigns only. Organic traffic is at record level.
In terms of traffic, how much of that is organic and intend you guys have plans to drive much higher organic traffic?
Yes. Our organic traffic’s about 40% of total traffic approximately. We've grown that from couple of percent a few years back and our long term target is to get to 50% of all traffic being organic. And so how we grow that as we continue to expand our syndication network, it’s over 1,000 sites today and we've grown that from few hundred sites in 2007 to over 1,000, today, well, over 1,000. And we want to increase the rate at which we drive traffic per site and that’s all through the search engine optimization. We have a business directory product right across that network of sites due to the Krillion acquisition; we’re launching a product directory in this quarter and then rolling that out through 2013, starting to roll that out this quarter.
And that’s kind of, our goal with that is to be able to tap into in the kinds of queries that consumers are doing in mobile, and desktop, which is not just looking for an electronics retailer, but looking for a specific flat screen TV as an example. So those are a couple of the things that we’re doing to increase organic traffic. As well, some of the user experience oriented guidelines that are being implemented, it has the potential for driving organic usage, just repeat usage as well as better SEO with a slightly lighter ad writing on the page. We think overall those pages are going to SEO better, and that’s going to drive organic traffic to local.com itself.
Great. I have one last question, as your mobile becomes a bigger piece of your business, do you anticipate discussion in terms of much less lower monetization on mobile. Do you think that’s going to have a greater impact going forward?
Yes. I think it’s going to have an impact as far as our business goes. Mobile at this point isn’t taking away from our desktop business. It’s an addition to it. So if our desktop business is transferring the mobile at a much more significant rate, and it was our users that were going there, that would be one thing. That would be negative. That’s not what we've seeing today.
We are active in the mobile marketplace so that’s kind of new for us. It’s additional to us. The monetization is definitely lower. But we’re working with ad partners and you know the whole industry is kind of working on this to figure out, how do we monetize mobile in a more effective way. There are certain verticals that are better. We are going to be focusing those verticals.
But overall it’s not cannibalizing the rest of our business. We don’t see that occurring at any point, in the near future anyway. Everything is going mobile, so we have to be in the mobile space and really we’re building our mobile ecosystem and our mobile footprint so we can build the kinds of partnerships that we have in the desktop space, we’ll extend the partnerships that we have in the desktop space into the mobile space. And work with the rest of the industry to figure out what’s the best way to monetize mobile. But for now it’s a whole new revenue stream.
Your next questions comes from the line of Christopher (inaudible).
This maybe in the queue, I don’t recall but, can you detail what the SEM cost were in the quarter? And then secondly you talked about, Heath talked about how some of these costs will come down in tandem with these changes, these policy changes if you will, that you’ve discussed. Can you talk about what sort of magnitude and will it be in tandem with the revenue or how will that works exactly, can you give a little color there?
Yes, a little bit of color, we do have some disclosures of what we spend with some specific traffic partners because they are material and you will find that in the 10-Q. But broadly speaking on an operated traffic, on operated revenue it’s generally about a 20% margin business. Historically, it’s being about a 20% margin business for us. And so that will give you an idea of the bulk of the cost associated with that revenue are from our online marketing, our search engine marketing.
An opportunity, as we will maintain the positive margin on that business. It will be less because we have lower monetization on each page view and so we’ll optimize our traffic and advertising in to how the page will monetize. One opportunity potentially it could be, if there are advertisers out there right now, people advertising online that are competitors to us, if they have difficulty adapting to this policy, their ability to advertise could be hampered, they might be cut off for example, which there is less competition for those same keywords, we may see a lower cost per quick on our buy side. So that’s one potential. And then we think we’ll have balance between our organic network business and the search engine marketing on an operated side. As we get that balance, we’ll have a higher margin percentage. So we do anticipate gross margin percentage being incrementally better from Q3 to Q4 but it will be at lower revenue.
Okay. And since you’re no longer will be providing a quarterly guidance, just yearly guidance, does that reflect that going forward you are going to have less visibility into what the top and bottom line will be or is that more reflective of, you know you’ve had a couple of quarters here where you had to reduce the forward guidance and it’s just more on your part a reluctance to provide that number?
Actually, this is Heath. We've considered and weighed the value given quarterly guidance probably for about three years now and we’re about to get as much visibility as is possible and that’s why we’ve continued to give quarterly guidance. But we’re a small business and still we’ve got $100 million year business and as I kind of talked about it in the prepared part of my comments, even a very change oriented environment and so there is a lot of stuff going on a lot of the time and even big companies are impacted by some of these changes and whether they can foresee.
And despite this, we’ve delivered a six year bottom left to top right revenue growth chart, we’ve had some great quarters and some not so great quarters. But directionally we’re building a more defensible business, we got more revenues that are own revenues and direct revenues in our history. We've got more traffic that’s our own traffic or non-SEM based traffic in our history.
So, we think, we’re focused on the right long term things. And so, we feel it’s better to just kind of orient the street towards, we think revenues are going to be about this much and our bottom lines is going to be about that much for the next 12 months and we’ll update, that allows us to make the near term adjustments that we will have to make being a smaller player in this very dynamic marketplace.
We want to be able to make those, we want to be able to make the right decisions for that long term financial targets and the long term benefit of the business for that being, already concerned about the near term impact and the volatility that comes with that. We want to be able to make the long term decisions. So, in weighing this for the past three years, the board is weighed, management is weighed and on a number of occasions we decided to finally make that call and simple go to annual guidance.
There are no further questions at this time. I will now turn the call over to Mr. Ken Cragun.
Thank you. I appreciate all of that who joined us on call today. Now I’d like to turn the call back over to Janine for our final disclosures.
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, project, 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 purchase advertising form third parties to drive users to our sites, 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, 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 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 general 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 related 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 and thank you for your interest in Local Corporation.
Ladies and gentlemen, this does conclude today’s conference call. You may now disconnect.