Marchex, Inc. (MCHX) Q3 2012 Earnings Report, Transcript and Summary

Good afternoon. My name is Christian, and I will be your conference operator today. At this time, I would like to welcome everyone to the Marchex Third Quarter Earnings Conference Call. [Operator Instructions] After these speakers' remarks, there will be a question-and-answer session. [Operator Instructions] I'll now turn the call over to our host, Mr. Ethan Caldwell, Chief Administrative Officer and General Counsel. Sir, you may begin.

Thank you. Good afternoon, everyone, and welcome to Marchex's Business Update and Third Quarter 2012 Conference Call. Joining us today are Russell Horowitz, Chairman and Chief Executive Officer; Peter Christothoulou, President; John Keister, Executive Vice Chairman; 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. In addition, there are certain risks and uncertainties related -- relating to our previously announced proposed spinoff transaction, which contemplates a separation of our mobile and call advertising business and our domain and advertising marketplace business including, but not limited to, the impact and possible disruption to our operations and timing and certainty of completing the transaction, the high cost in connection with the spinoff, which we will not be able to recoup if the spinoff is not consummated, the expectation that the spinoff will be tax-free, revenue and growth expectations for the 2 independent companies following the spinoff, unanticipated developments that may delay or negatively impact the spinoff and the ability of each business to operate as an independent entity upon completion of the spinoff. We may not actually achieve the plans, intentions or expectations disclosed on 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, revenue with domain sales, adjusted OIBA and EBITDA with domain sales 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 and spinoff press releases, which is available on the Investor Relations section of our website, and definitions of these measures as used by us and the reasons why believe these measures provide useful information are also contained in today's earnings and spinoff press releases. At this time, I would like to turn the call over to Russell Horowitz.

Thank you, Ethan. Let me begin by saying that we're pleased with our third quarter results as we're seeing validation that supports our early entrance in the mobile performance advertising focused on calls. Our results for the third quarter were driven by our delivering strong performance for our existing call customers, who are expanding their budgets with us and adding new nationally focused customers. These translate to accelerating sequential growth and we believe bode well for growth in 2013. Michael will give additional details later on the call. Now I'd like to share a few thoughts regarding the transformation of mobile advertising into a large and rapidly growing performance marketplace and why we continue to feel good about the opportunity here. First, this is a large growing market driven by a high mobile adoption. According to The Kelsey Group, businesses spend more than $68 billion annually to drive phone calls to their businesses from a variety of sources. With consumers now searching more from their phones or calls or the natural result of those searches, we are well positioned for growth. In fact, The Kelsey Group estimates that consumer calls generated from mobile searches will grow from 18 billion calls in 2012 to 64 billion calls in 2016, which is more than 250% growth over that period. Second, we believe Marchex has a unique technology advantage in measuring, analyzing and driving performance through calls given our investment, intellectual property, technical capabilities and expertise in this category. And third, we believe Marchex has achieved initial scale with both call-focused advertisers and mobile publishers, which creates meaningful growth opportunities and importantly, further dependability. We have been growing advertiser and publisher relationships across the national and local landscape. These relationships are driving increased breadth and depth of ad budgets across more than 15…

Thanks, Russ. Total revenue for the third quarter was $34.8 million, with call-driven revenues representing $29.1 million. Call-driven revenue accelerated to 7% sequential growth. We continue to make progress growing budgets from existing advertisers, as well as adding new advertisers. In the near term, we expect to continue investing in our products and technology to support our ability to provide unique insight into mobile and call advertising. Over time, we believe we can capture additional efficiencies and increase margins in these products as we gain additional scale. For the third quarter, revenue from non-call advertising products was $5.7 million, which was down $1 million from the prior quarter. During the third quarter, we saw decreases in advertiser spending on these products due in part to seasonality and our historical decisions to concentrate our investments in our higher-growth mobile and call advertising products. As today's announcement outlines, our efforts to spin off the non-call assets will create opportunities for these products to take steps forward and grow. We believe with renewed focus and dedicated resources to support the opportunities with these products in assets, Archeo can unlock significant value going forward. Excluding stock-based compensation, acquisition and separation costs and amortization of intangible assets, total operating costs were $31 million for the third quarter of 2012. Sales and marketing costs, excluding stock-based compensation, were $2.5 million. In the near term, we expect our marketing expense may 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 continued growth of our sales and customer support teams and the evolution of our products. Adjusted operating income before amortization for the third quarter was $3.9 million. Adjusted EBITDA was $4.8 million. GAAP net loss applicable to common stockholders was…

Thanks, Mike. Earlier this year, we communicated we're initiating a strategic review process with the goal of achieving greater clarity for all our constituents. We feel good about where this process has taken us and our path forward. I want to thank our employees for their continued hard work and dedication, and we look forward to updating you again soon. With that, I'll hand the call back to you, operator, for our Q&A.

[Operator Instructions] Our first question comes from the line of Dan Salmon with BMO Capital Markets.

Can you first, maybe Mike, just give us a little more background on the diligence that's been put in so far here to suggest that it would be a tax-free spinoff for the new company? And then secondly, I know details are still emerging on how the separation would go, but one thing I did note here is that you do expect to add a management team to the new company. And maybe what expectations for G&A would be there as we start to get a picture of what the 2 split companies would look like?

Thanks for the question, Dan. This is Mike, and I'll take the first part. With regards to the tax-free spinoff, we have done a little bit of work. This is obviously still fairly early in the process, but we've spent a number of days looking at just how we could affect this from a tax-free standpoint. I do think the initial feedback is positive, but it does look like we have a scenario that we can put forth and are going to look to some of the regulators to help provide some comfort over that type of a structure. But we could effectuate a tax-free spinoff that is looking fairly promising at this stage.

Yes. Dan, thanks for the question. As it relates to building a new management team, yes, we think this is going to be a highly entrepreneurial company, Archeo. And we will add some cost to invest in the right folks because we look at this as-- we've got a 9-figure asset base from our estimation, and getting focused in a place that can build the products and intellectual property to invigorate growth, get that recognized and move it forward, clearly looks like the right decision. We don't think it's usually material in the context to Marchex. We factored some of these costs into our guidance, and beyond that, I think it should be pretty clear.

Okay. And then just one follow-up, Russ, is tell us maybe -- then this sort of a big picture question around your vision for how the 2 companies operate after a split, but guide us a little bit more to how being 2 separate companies should help reinvigorate the fundamentals at Archeo and help provide some more momentum for the new Marchex in the call-driven side and the mobile side.

So, let me start with Marchex. Given the focus with Marchex on the mobile marketplace and bringing performance to it through calls, we think more than anything, it's just about execution: more advertisers, more publishers, more scale, understanding our customers, building the relationships that allow us to gain the institutional mind share and be highly strategic. We've done that very well with some great world-class companies, and we think we'll be very relevant to a bunch of other ones. So we think the clarity here will make us that much more attractive to customers, as well as attracting employees that are well-suited for that mission. When you look at the opportunity, we think -- again, bringing quality calls to mobile is what transforms it into a performance marketplace. So we think we're pretty clear. We think the opportunity is pretty interesting and dynamic, and so that kind of hits on where Marchex is. With Archeo, we actually know what's required to move this business forward and grow it. And as we've made the decision over the last few years to try and do one thing right, which is already hard enough, let alone multiple ones, what we saw in terms of an asset-rich opportunity but effectively being somewhat P&L-poor when it came to growth was by being under-resourced and largely neglect. So step #1 is by putting the right people in the right seats, we think we have a pretty clear plan on how we grow that business as it relates to both the domain market -- on domain marketplace opportunity, on driving increased efficiency in sales, driving increased recurring ad revenue on domains, developing domains into vertical sites where we can also generate revenue on lead generation, which we've done successfully in the education vertical as an example and with our premium pay-per-click ad marketplace, and working with leading publishers, whether it's Bank Grade or Morningstar or Inc.com. We see a chance to converge those and leverage premium third-party publishers in combination with our proprietary traffic. And we also have a strong sales force that sells premium advertisers, like Bank of America and Intel and Sony. So we see a lot of chance to proper resourcing and bringing these assets into this framework to higher -- be highly entrepreneurial and reinvigorate growth in ways that we think can create a lot of value, and get a lot of value, we think, that exists today and recognize it.

Our next question comes from the line of Andre Sequin with RBC Capital Markets.

Two areas I'd like to ask about. Last quarter, you also cited a study from The Kelsey Group, and I'm basically trying to frame what sort of an opportunity we might be talking about here. So I don't know if you can give us any color on significant competitors or the competitive landscape out there. How many others are there out there that really offer any analytics around calls? Or to ask it at a different way, how much the call-focused ad market do you currently have? And then secondly, you mentioned Entravision the last time being added as a reseller partner in the Spanish language. Considering the language analytics you do, I was wondering how expandable is this to other languages. Is this an automated process? Or is there some work that needs to be done to adjust what you have in terms of analytics for other languages?

Sure. When you look at our focus on Digital Call Marketplace and pay-per-call and the underlying analytics, this is an emerging market. Most folks now understand that mobile is a high-growth opportunity, but they're still really wrestling with what it looks as a performance marketplace. We know in desktop that kind of -- the impression-based marketplace or display is what was the kind of initial market. But when text links emerged on search, that really came to dominate it as the primary customer acquisition vehicle. And in mobile, we think calls represent to mobile what clicks did to desktop. When you look at the ingredients that are required, we think-- we made a bet early about 3 years ago. As a small company, we knew that we needed to err on the side of being early and hope we weren't too early, and we now see this market coming into prime time based on the validation we're seeing with customers and the acceleration of growth we're seeing in our business. So from a competitor perspective, there are folks out who have some technology that can track calls but haven't necessarily developed analytics that can be applied to kind of broad, diverse sets of advertising campaigns in the mobile space. And as it relates to having performance ad products in mobile, outside of maybe a few companies that are subscale I can't really comment on, we're not really aware of anyone else. Obviously, Google with pay-per-click has extended with click-to-call that helped us with market understanding and adoption. But when you look at operating pay-per-call as a performance product and having the analytics as the platform that can illuminate real performance, we feel we're in a unique position. And it's again a function of, "Can we execute well and scale our business to support the verticals that we think are really call rich?" With Entravision as an example in the Spanish market, it's pretty straightforward for us to extend our analytics to other languages, such as Spanish, and we're doing that.

[Operator Instructions] Our next question comes from Ryan Bergan with Craig-Hallum.

I just want to know if you could talk about the exhaustive process you went through with your strategic evaluation of both trying to sell off the domain assets maybe in more of a bulk method, and then also on the legacy pay-per-click network, what you went through before you finally decided that this was the right move for you.

Good question. Well, we went into this with a-- kind of a really open mind and wanted to develop a variety of options so we could really weigh the pros and cons associated with each. And we had a variety of options. As we went through this and tried to be very, again, self-reflective and understanding what we had and think about what would be best in totality, the simplest way to characterize our learnings would be, we've sold a small number of domains for more than $30 million. And again, when we look at what we think is the real quality of our portfolio in terms of depth and breadth, we haven't even touched it. And so when we looked at some of our short-term opportunities versus what it would mean to properly resource and build this business both with the domain marketplace and the pay-per-click opportunity, we felt that we would be shortchanging our shareholders when you look at the intermediate long-term lens in terms of what the possibilities are and what we think these assets are both worth and can yield as a recurring growth business.

And what about on the pay-per-click side? What process did you go through? Or what did you evaluate as options before you decided on going this route?

We did a strategic analysis of the marketplace, understanding who the alternative providers were, specifically in providing a flexible system that could be delivered on an enterprise basis to premium publishers. We looked at who the potential buyers might be. We looked at how that would play out. We looked at the flexibility of our technology and how it might expand into mobile and new channels. And we looked at kind of what it would mean to reinvigorate and invest in it versus sell it in its current state. And we landed on the investment in growth versus kind of -- take a short-term sale and put it behind us. And it's one network again energized by, and we think that there is a segment in the marketplace that if we can execute well can translate to meaningful growth. The converse of this was through the separation, we gained a lot of clarity on the Marchex side as it relates to really being focused on that mobile and call-driven opportunity, centered on pay-per-call and call analytics.

Then on the call advertising part of the business, what's the overall market demand look like right now? Are you seeing advertisers' budgets hang in there? Or -- and then what do are you thinking about when you look at 2013 for growth from that side of the business? Do you think that there's an opportunity to meaningfully accelerate revenues on call advertising business? I'm not looking for guidance, but just some any commentary you can give on what we can expect perhaps next year.

Sure. Look, this is -- this business -- this mobile and call business has been lot like a start-up for the last couple of years and we're now at a $100 million plus scale. So we feel like we're understanding the rhythms of the business and what success and good execution look like. Last quarter, we were at 3% sequential growth. This quarter, we're at 7% sequential growth. We think the pulse of the business is very good, and we think what that foretells in terms of growth in 2013 is very positive. So these are the rhythms of the business. We think we're understanding kind of what this looks like now. Specifically with advertisers and kind of shifting budgets, right now, with the customers we work with and the customers we're talking to, the key element in procuring budgets, whether it's increases or new budgets, is our ability to prove outperformance. And so long as we continue to prove outperformance in mobile channels focused on calls, we feel there's a lot of budget that we can win. And clearly, that's one of the big catalysts for growth. But we feel pretty good about how we'll be entering 2013 and the underlying pulse metrics of the business and kind of the acceleration from quarter-to-quarter that we've been seeing for the last few quarters.

[Operator Instructions] And there seem to be no further questions at this time.

Look, we appreciate everybody participating in our call today. We know based on the hurricane that today is becoming a very busy reporting day. And so we appreciate you taking the interest in hearing our business update, as well as the great questions you've all asked. We look forward to staying in touch and communicating with you soon. Thank you.

Ladies and gentlemen, this does conclude today's conference call. You may now disconnect.