QuinStreet, Inc. (QNST) Q3 2014 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to QuinStreet Third Quarter 2014 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to Ms. Erica Abrams. Ma'am, you may begin.

Thank you, Sayeed, and good afternoon, ladies and gentlemen. Thank you for joining us today to report QuinStreet's third quarter fiscal 2014 financial results. Joining me on the call today are Doug Valenti, CEO; and Greg Wong, CFO of QuinStreet. This call is being simultaneously webcast on the Investor Relations section of our website at www.quinstreet.com. Before we get started, I would like to remind you that the following discussion contains forward-looking statements. These are statements that relate to future events or financial performance and involve risks and uncertainties. QuinStreet's actual results may vary materially from those discussed here. Factors that may cause the results to differ from our forward-looking statements are discussed in our most recent 10-K filing with the SEC, completed on August 20, 2013. Forward-looking statements are based on current expectations, and the company does not intend to and undertakes no duty to update this information to reflect future events or circumstances. Now I'll turn the call over to Doug, CEO of QuinStreet. Please go ahead.

Thank you, Erica. Hello, everyone, and thank you for joining us today. Revenue in the quarter was $71.9 million, at the top of the outlook range we provided last quarter. Adjusted EBITDA was 9% of revenue. Normalized free cash flow was $5 million. We closed the quarter with $120 million in cash and $39 million of net cash. We continue to spend aggressively on initiatives to return to growth with good progress. This has been especially true in auto insurance, our largest market where we successfully launched our full range of complementary new policy, lead and click products in the quarter, as committed in our last earnings call. The launch of these products is an important milestone for QuinStreet. They significantly increase our revenue opportunity and competitive advantages in auto insurance and we are now more fully shifting from investment in product to investment in revenue. We believe that this is the most direct path to returning the company to revenue growth and stronger margins. We are particularly excited about the new version of our policy or rate comparison product and brand, Insurance.com. It has new technology that allows more effective optimization and monetization. Its new design is more consumer-friendly and is driving stronger engagement. With these important features now in place, we have begun direct-to-consumer advertising. This one form rate comparison product represents a revolutionary and compelling consumer proposition for auto insurance shopping in the United States, one already proven in Europe, and we believe that Insurance.com has the most complete and capable assets for successfully delivering and thriving on this enormous long-term opportunity. We expect the new policy, lead and click products to add to auto insurance revenue in the current quarter, and to do so at an accelerating rate in future quarters. We now project that auto insurance revenue will grow next fiscal year, which begins July 1 as we continue to ramp the new products. Progress in auto insurance will be offset somewhat in our Financial Services numbers in the near-term by a drop in health insurance revenue now that the surge from the Affordable Care Act is over, and by cyclical softness in mortgage. These are relatively short-term phenomena. We feel very good about the progress, performance and potential of our health insurance and mortgage businesses overall. Our Education client vertical remains challenging due to regulatory effects on the for-profit postsecondary segment and resulted changes in client growth and budgets. We continue to work to gain share in that market by focusing on quality and compliance for our clients. We also continue to focus efforts on new growth areas in Education, including click and call products, not-for-profit clients and Brazil, with good progress and revenue growth in all of those areas. Our Other client vertical is picking up, with year-over-year growth last quarter and B2B technology and Home Services, the 2 largest of the 3 businesses in that segment. We expect growth there again in the current quarter. The progress is a result of new initiatives and organization changes now bearing fruit. For the current quarter, we expect revenue to be approximately $67 million, consistent with typical sequential seasonality. We expect auto insurance revenue to buck seasonal trends and to be approximately flat sequentially. Based on the significant market potential we see for the new auto insurance products and our desire to fully capitalize on those opportunities, we are increasing our media and marketing spending ahead of revenue, impacting margins in near-term quarters. EBITDA margin for the next few quarters will therefore be in the single digits. Now before I turn the call over to Greg to discuss the financials in more detail, I want to recap where we are in auto insurance. This is exciting stuff, at least to us. We've talked for the past couple of years about the range of challenges we have been addressing in that important market and about the progress we have been making. Most of that progress has been incremental and largely defensive given the narrow footprint of the SureHits product, the need to rebuild and update the complex policy product from acquired assets and the competitive environment. By contrast, the launch of the 3 new products this past quarter represents a dramatic -- represents dramatic progress and a step-function increase in our adjustable market. The products put us in position to turn back to offense. We are excited to be at the point where we can now confidently spend aggressively in marketing and media to grow those products in that business. I believe this is a major turning point for us in auto insurance and as a company. Revenue growth is key to increasing shareholder value and to returning to margins and cash flows more in line with historic levels. With that, I will now turn the call over to Greg to discuss the financials in more detail.

Thanks, Doug. Hello, and thanks again for joining us today. For our third quarter of fiscal 2014, we posted $71.9 million of revenue, a 9% decline compared to the same quarter last year. Adjusted net income for fiscal Q3 was $2 million or $0.04 per share on a fully-diluted basis. Adjusted EBITDA was $6.3 million or 9% margin. We delivered results at the top end of the revenue outlook we provided last quarter and we're pleased with the accelerated progress we made around our primary growth initiatives, particularly our product launches in auto insurance. We believe the growth of these new products is our path forward to returning the company to year-over-year revenue growth and stronger margins. So with that overall context, I'll now discuss the details of our fiscal Q3 results. Please see the supplemental data sheets available for download on the Investor Relations page of our corporate website. They provide essentially all of the figures that I will now walk you through. For revenue by client vertical, our Education client vertical represented 43% in Q3 revenue or $30.7 million. The year-over-year decline of 13% was driven by the continuing challenges in the for-profit postsecondary Education market. To offset the for-profit industry headwinds, we're making good progress with our initiatives to diversify our products, markets and media. Those initiatives include broadening our product set from our traditional lead business, inviting clicks and calls to our product mix. While we work hard to diversify our product set, we have a continued focus on optimizing the quality and monetization of our traditional lead business. We are also broadening our market footprint with our efforts with not-for-profit schools and our international expansion in Brazil, both of which are not subject to the radiance or dynamics of the for-profit Education market. Although these are early markets for performance marketing line, they represent a huge opportunity for QuinStreet over the longer term. As a reminder, our Education client vertical is a solid profitable client vertical for QuinStreet. We believe we are the leader in this space in terms of revenue, market expertise and competitive assets. This is a great long-term business for us. Our Financial Services client vertical represented 40% of Q3 revenue or $28.7 million, a decline of 11% compared to the year ago quarter. We are excited to have launched our full range of complementary new policy, lead and click products in auto insurance this past quarter, as we committed to do on the last call. With the products in place, we are now more fully shifting our focus from investment in product, to investment in revenue growth, where we believe the increased monetization and greater media reach of these products will eventually lead us to return to strong year-over-year growth and good margins. Client marketing budgets in auto insurance are substantial and this represents the largest addressable market for the company. Revenue from Other client verticals, which include B2B technology, Home Services and Medical represented 17% of Q3 revenue and grew 8% compared to the year-ago quarter to $12.5 million. Increased revenue in our B2B technology client vertical, primarily drove the growth. Moving to a discussion of EBITDA. For adjusted EBITDA, we delivered $6.3 million or 9% margin. EBITDA margin last quarter reflects our continued investment in growth initiatives across all client verticals, including our expanded product set auto insurance, as well as diversifying and growing high-quality media sources throughout the business. With our products in auto insurance now launched, we will begin to accelerate our investment in marketing and media spending. We believe once those products are ramped and optimized, they will result in meaningful revenue growth and good margins over time. For the near term, we expect that investment in marketing and media spending to outpace revenue, impacting margins for a period of time. But to be clear, we plan to continue to remain EBITDA positive throughout this period of investment. Moving to the tax front, our rate, as we are close to breakeven on a tax basis, is not meaningful. For your modeling purposes, we expect our ongoing rate to be approximately 40%. Going to the balance sheet, our cash, marketable securities balance at quarter end was $120 million. You can see the details in the cash flow statement in our earnings release, but the largest items were the generation of $3 million of cash flow from operations, capital expenditures of $1.3 million and payments on debt of $4.1 million. Total debt decreased to $81 million from $85 million in the previous quarter due to repayments, and we had no new borrowings. Our net cash position is a positive $39 million. Normalized free cash flow was $5 million or 7% of revenue. As always, we look to normalize free cash flow as our primary cash flow metric as it removes the effects of current quarter working capital account fluctuations to drive the underlying cash flow characteristics of our model after minimal capital expenditures. To summarize, we launched our full range of complementary products in auto insurance this past quarter. We are now in a position to invest in brand awareness, consumer adoption and market share in the coming quarters, as we believe the growth of these products will be the catalyst to driving long-term, sustainable growth and good margins for the company. We believe now is the time to aggressively go after these markets as we believe we have the best competitive assets and combined monetization capabilities to be able to capitalize on these enormous opportunities. While we work to return to growth, we will continue to be financially-disciplined and maintain a strong balance sheet. With that, I'll turn the call over to the operator to open up Q&A.

[Operator Instructions] I am showing no questions at this time. And ladies and gentlemen, this concludes our Q&A session for today's conference call. A replay will be available starting May 6, 2014 at 8:00 p.m. Eastern Time until May 13, 2014 at 11:59 p.m. Eastern Time by dialing 1 (800) 585-8367 and entering conference ID 30843970. Thank you for participating in today's conference call. You may all disconnect and have a wonderful day.