Marchex, Inc. (MCHX) Q2 2012 Earnings Report, Transcript and Summary

Good afternoon. My name as Ally, and I will be your conference operator today. At this time, I would like to welcome everyone to the Marchex Second Quarter Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to your host, Mr. Ethan Caldwell, General Counsel and Chief Administrative Officer.

Thank you. Good afternoon, everyone, and welcome to Marchex's Business Update and Second Quarter 2012 Conference Call. Joining us today are Russell Horowitz, Chairman and Chief Executive Officer; and Michael Arends, Chief Financial Officer. During the course of this conference call, we will make forward-looking statements that involve substantial risks and uncertainties. All statements other than statements of historical fact included on this call regarding our strategy, future operations, future financial position, future revenues and other financial guidance, acquisitions, projected costs, prospects, plans and objectives of management are forward-looking statements. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements, and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements we make. There are a number of important factors that could cause Marchex's actual results to differ materially from those indicated by such forward-looking statements as are described in the Risk Factors section of our most recent periodic report and registration statement filed with the Securities and Exchange Commission. All of the information provided on this conference call is as of today's date, and we undertake no duty to update the information provided herein. During the course of this conference call, we will also reference certain non-GAAP measures of financial performance and liquidity, including OIBA, adjusted OIBA, adjusted EBITDA and adjusted non-GAAP EPS. A reconciliation of these non-GAAP financial measures to the comparable GAAP financial measures is contained in today's earnings press release, which is available on the Investor Relations section of our website, and definitions of these measures, as used by us, and the reasons why we believe these measures provide useful information are also contained in today's earnings press release. At this time, I would like to turn the call over to Russell Horowitz.

Thank you, Ethan. On today's call, I'm going to provide a quick business update. Mike will review our financial results, and then we'll open it up for Q&A. During the last 3 years, Marchex has transitioned into a leading call advertising company that's leveraging the explosive growth of mobile and focusing on call-based leads as the ultimate driver of performance. Our transition has been based on the belief that mobile advertising will follow the path of online advertising and eventually evolve to a performance-driven medium where advertisers pay to be connected directly to end market consumers. Through our progress, we have built a growing $100 million-plus annualized call-driven business that we believe is well positioned in the emerging mobile performance advertising market. Our investments have been focused on a call analytics platform, Marchex Call Analytics, and a performance-based call advertising network, the Marchex Digital Call Marketplace. We believe that owning both the call analytics platform that tracks and measures calls, as well the performance-based call advertising network that connects end market consumers to businesses, is a core competitive advantage in driving performance for advertisers. With Marchex Call Analytics, we have created a leading call analytics technology platform that allows advertisers and publishers to leverage pre-, intra- and post-call data in insights that accurately measure performance across all media channels: mobile, online and off-line. In a recent third-party study, The Kelsey Group highlighted that the growth in smartphone adoption will create a surge in call-focused advertising inventory from mobile publishers and suggested that the call analytics market will, in itself, become a billion-dollar industry by 2016, as advertisers will need better tools to accurately measure and track mobile advertising performance. Today, as many of our partners adopt mobile and call advertising for the first time, our call analytics platform provides them with unique insights and actionable intelligence, which help them with increasing call conversions, increasing sales close rates, improved customer service and greater media spend efficiencies. We believe owning this capability and intellectual property is a crucial component to building and sustaining a leadership position in mobile advertising. Our call analytics platform is the foundation of our mobile and call-based advertising products and provides Marchex with a unique understanding of the mobile advertising market as it develops. In addition, we offer call analytics as a standalone product, and it currently supports thousands of customers, including many industry leaders. Examples include Cobalt in the auto category and vertical publishers who are creating their own leads programs, such as Bank Grade in the finance category and Zillow in the real estate category. In the second quarter, we saw record levels of customer growth and usage with our call analytics platform. Through our Digital Call Marketplace, Marchex works with more than 100 different publishing sources, including some of the largest mobile carriers and mobile applications providers, to deliver quality inbound consumer calls to some of the largest advertisers in the country, as well as the hundreds of thousands of small businesses on a pay-per-call performance basis. Customers who participate in our Digital Call Marketplace receive call analytics as part of the service we provide. As a result, Marchex is very well positioned to participate in the projected growth of mobile and the pay-per-call market, which the Kelsey Group recently estimated to be worth $5 billion annually in the U.S. by 2016, up from a nascent market today. In the second quarter, we continued to add new advertisers, including performance-based call advertising entrants, such as Hertz and the University of Phoenix. We're continuing to make progress at increasing our advertiser breadth in many core categories, including auto, cable and satellite, education, financial services, health, home services, local, real estate, retail and travel. We also grew many of our existing relationships as our performance exceeds alternative channels, including search, display and other digital advertising forms. On the supply side, Marchex is growing across mobile sources, including mobile carriers. Mobile sources represent the majority of the calls we drive in our Digital Call Marketplace and continue to be our fastest-growing source. In addition, through our Local Leads advertising platform, Marchex works with some of North America's largest small business resellers to uniquely address the needs of their small business customers. Local Leads is a private label ad platform designed to drive quality phone calls, clicks and other leads to small business advertisers at a lower cost per lead than any other industry alternative. Through this platform, Marchex allows resellers to sell calls as part of their performance-based advertising products, many of which are fulfilled through our Digital Call Marketplace. Recently, we made progress by adding Entravision as the reseller partner focused on the Spanish language market in the United States. We also continue to support existing customers such as Intuit and YP Holdings, formerly AT&T Interactive. I also want to comment on our relationship with YP Holdings. As most of you know, a private equity group recently purchased a majority stake in this business from AT&T. Our ability to drive cost-effective and quality leads to YP's customers at scale, increasingly over the phone, is a competitive differentiator that we believe lays the groundwork for a continued positive relationship with YP going forward. In the meantime, we continue to work hard and execute on this relationship every day, with business as usual. I want to switch gears a bit and discuss our assets. On an asset basis, Marchex owns more than 200,000 domains with commercially and locally relevant content. Over the last few years, we have sold a small portion of our domains for more than $30 million cumulatively, including approximately $3.3 million in the second quarter, which was a record quarter for domain sales. So when we add up the value of our domain assets, cash on our balance sheet and present value tax assets, in addition to our core mobile performance call-driven business, we believe Marchex has built significant but under-recognized value as a company. When weighed against our current valuation, this is one of the reasons why the company has bought back a significant amount of stock and our other executives for purchasing Marchex in the open market. Last quarter, I highlighted ongoing initiatives such as replicating and institutionalizing best practices across our organization and operating in ways that enable our customers and products to succeed. Over the last few months, we took several steps forward in these areas as we reallocated resources to support our growth initiatives and to capitalize on the areas of our business where we're seeing success. In terms of our non-call advertising products, which include our directory and domain assets, pay-per-click and reputation management products, we're continuing our process of exploiting strategic options to realize additional value from these assets. As part of this, we will be increasingly operating these product areas separately from our call advertising organization. This initiative is designed to facilitate our unlocking of further opportunities with these products and assets, as well as enable the resourcing decisions that can help achieve these goals. In summary, overall, we feel our business is making strides forward, and we see evidence that the markets we're focused on, while still very early, are large and transformative. As we move forward, we'll continue to look for ways to maximize value in our business and believe our ongoing progress will do just that. With that, I'll hand the call over to Mike.

Thanks, Russ. Total revenue for the second quarter was $34 million, with call-driven revenues representing $27.3 million. Our call-driven revenues grew sequentially as we continue to make progress in gaining additional budget from existing advertisers, as well as signing up new advertisers. For the second quarter, revenue from non-call advertising products was $6.7 million, which was down $2.3 million from the prior quarter and was the principal reason for the decline in revenues quarter-over-quarter. During the second quarter, we saw weakness from advertising spending in these products, given our decision to concentrate our investments in product development and support for our higher-growth mobile and call advertising products. We've previously communicated that we believe our non-call-driven revenue will decline over time as a result. Excluding stock-based compensation, acquisition costs and amortization of intangible assets, total operating costs were $30.3 million for the second quarter of 2012. Sales and marketing costs, excluding stock-based compensation, were $2.9 million. In the near term, we expect our marketing expense may be consistent or modestly increase from current levels. Longer term, consistent with what we've communicated in prior quarters, we expect to increase sales and marketing expense in support of the continued growth of our sales and customer support teams and the evolution of our products. Adjusted operating income before amortization for the second quarter was $3.7 million. Adjusted EBITDA was $4.6 million. GAAP net income applicable to common stockholders was $330,000 for the second quarter of 2012 or $0.01 per diluted share. This compares to GAAP net income applicable to common stockholders of $80,000 for the same period of 2011 or $0.00 per diluted share. Adjusted non-GAAP income per share, an estimate some Wall Street investors utilize as a supplemental measure of our operating progress, was $0.06 per share. During the second quarter, we generated $8 million in operating cash flow and had more than $33 million in cash on hand as of June 30, 2012. As a reminder, in April, we made a cash payment to the former Jingle shareholders for the scheduled $18 million, net of offsets, as part of our aggregate compensation for the acquisition. During the second quarter, we also acquired 149,000 of our common shares for a total price of $581,000, bringing our total shares acquired under our repurchase program to 11.1 million or 30% of our common shares outstanding. Given the strength and the cash-generating characteristics of the business, including the significant cash generation we received from the sale of domain name assets, we also announce today that we are increasing our quarterly cash dividend from $0.02 to $0.035 per share of Class A and Class B common stock. The indicated annual cash dividend, subject to capital availability, is $0.14 per common share or $5.3 million, up from $0.08 per share previously. For the third quarter, we will pay the incremental $0.015 per share dividends on August 31, 2012 to the holders of record as of the close of business on August 16, 2012. We believe the continued cash-generating characteristics of the business, domain sales and other potential asset sales or divestitures can adequately fund the dividend and ongoing capital needs of the company. Now turning to our outlook for 2012 in the third quarter. First, looking at our revenue guidance for 2012. For the year, we currently anticipate revenue will be between $137 million and $141 million. For the third quarter, we anticipate revenue will be between $33.5 million and $34.5 million. We anticipate call-driven revenue will sequentially increase in the third and fourth quarters of 2012. Next, looking at adjusted OIBA and EBITDA margins for the year. For 2012, we are reiterating our expectation of more than $14.5 million in adjusted operating income before amortization, and more than $19 million in adjusted EBITDA. For the third quarter, we anticipate approximately $3 million to $4 million in adjusted operating income before amortization and approximately $4 million to $5 million in adjusted EBITDA. While we anticipate that we will see growth in demand for our call-driven products as we go through the year, our sales strategy to direct national call advertisers and resellers is still evolving, and we have exposure to period-to-period variability with committed budgets. This can [indiscernible] in our financial performance. As we move forward, we are managing our investment levels such that as we grow, a portion of the incremental contribution will be allocated to support our growth initiatives, including investments in our products, our people and our customers. The rest will flow through to contribute to expanding profit margins. Over the long term, we continue to believe Marchex can deliver healthy annual growth rates and revenue, with EBITDA margins scaling beyond 20%. As we have communicated previously, we are also evaluating potential strategic alternatives for our non-call-driven products and assets, including our domain name assets, in order to further focus on our greatest growth opportunities. We believe our rich asset base is not being properly valued, and whether through select development of these assets, sales or a combination of both, we are more aggressively pursuing how best to realize this value. As part of this process, as Russ mentioned, we will be increasingly operating our non-call advertising products separately in order to create a path to extract additional value from those assets. We expect this process will take time. However, we are currently actively working on it and expect to have updates for you in the coming months. In addition, in the first half of 2012, we sold approximately $5 million of nonstrategic domains. We expect to have more information to share in the upcoming periods. With that, I'll hand the call back to you, Russ.

Thank you, Mike. Given our product strategy and growing competitive position, we believe Marchex is well positioned to emerge as a leading mobile and call advertising company. Though early, we have relationships with market-leading companies across our products and are seeing increasing evidence that the call is emerging as the primary lead form in mobile for performance advertising and customer acquisition programs. We look forward to sharing future progress, including with our strategic initiatives to extract additional value from our non-call-driven products and assets, in the coming months. I want to thank our employees for their continued hard work and dedication, and we look forward to updating you throughout the year. With that, I'll hand the call back to the operator for Q&A.

[Operator Instructions] Your first question comes from Jack McCarthy with Craig-Hallum.

I'm wondering if you can tell me what percent of your call business is coming from mobile today and what number is that likely to become over the next couple of years?

Sure. We're not offering a specific percentage. What I can tell you, it is the majority of calls come from mobile, and it is far and away the fastest-growing source. So it's probably not far out where it's the super majority of calls that we drive through our marketplace.

Are there any signs of a rebound in legacy AT&T spending, and have you been able to reengage that relationship now that, that business has transitioned?

I'm sorry. There was a hiccup in your question. Do you mind asking it again?

Yes, I'm asking if there are any signs of a rebound in the legacy AT&T spending. Have we been able to reengage that relationship now that, that business has transitioned?

Sure. We feel good about where the relationship is. We're not giving specific commentary about spend levels, but we support them on an exclusive basis with multiple products. Our Call Marketplace is, I think, a critical piece of the value proposition that their end customers get. We are the most cost-effective provider of high-quality leads, and so we think there's opportunities for growth in general and with that relationship, particularly, as we think about the balance of the year and beyond.

At this point and given where the stock is trading, what are your current thoughts on how you'll pay the final Jingle earn-out in October?

Thanks for the question, Jack. This is Mike. We have a little over $33 million cash on hand at the end of June, and we are cash-generating, as you know, every quarter from an operating cash flow. We generated actually $8 million in operating cash flow this last quarter. The Jingle payment in October is $18 million, and so by that point in time, we will one have -- continued to increase our cash coffers just from operating cash flow. But in addition to that, we still see a significant interest on the part of different parties out there and some of our domain name assets, and so that would be incremental from a cash perspective, any sales that we have on top of our operating cash flow. So we should have a fairly satisfactory level of cash flow, as well as cash balances, by the October payment date.

Have you made any early traction with Intuit thus far? Should we plan on hearing any more about further reseller partnerships?

Sure. Look, we think it's early with Intuit, and we're supporting them well. We think there are opportunities to grow the program, and we think as we kind of think about the intermediate term and beyond, that's a great partnership to have. We mentioned today as part of our initial part of this call that we've just formalized the relationship with Entravision, which is one of the biggest players in the Spanish language market in the United States, with, I believe, 100-plus television and radio stations. That's focused on the opportunity with -- kind of the digital opportunity with the lead product, and we are going into market with them right now, and we think that's another significant opportunity. And there are examples of new customers that we're winning with the combination of our local leads product. This purchasing platform for advertisers, combined with our Digital Call Marketplace, gives us a unique formula that we think will translate to a [indiscernible] growth for the business overall.

You're working with a lot of the top carriers right now. What are your plans to increase this number? And lastly, do you think we'll see the free 411 app on the iOS platform at any point?

We won't be specific in terms of where we are on product releases. Clearly, when you think about consumer-facing mobile products, you want to be where the users are, so I'll just leave it at that on that one. In the context of growing carrier relationships, it's a two-pronged approach, which is deeper penetration with existing relationships where we can grow volumes. We see no shortage of opportunity for that. And we clearly have a very tangible understanding of which carriers we're a good fit for that we don't work with yet and feel like we've got a clear path to win relationships and grow them there as well.

[Operator Instructions] And sir, there are no further questions at this time.

Look, we appreciate everyone's participation on the call, and we look forward to reporting progress to you as we move through the balance of the year. Thanks again.

Thank you for participating in today's conference call. You may now disconnect.