Erica Abrams - IR, The Blueshirt Group Doug Valenti - CEO Greg Wong - CFO.

John Campbell - Stephens, Inc..

Good day and welcome to QuinStreet Second Quarter 2015 Earnings Conference Call. Today's conference is being recorded. At this time I would like to turn the conference over to Ms. Erica Abrams. Please go ahead..

Thank you, Randy [ph]. Good afternoon, ladies and gentlemen. Thank you for joining us today to report QuinStreet's second quarter fiscal 2015 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 statements 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 filed on September 12th, 2014.

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. Today we will be discussing both GAAP and non-GAAP financial measures.

A reconciliation of GAAP to non-GAAP measures are included in today's earnings press release and also available on our Investor Relations website. We are doing this because we believe that our non-GAAP results presents a good representation of our ongoing operating results. Now I will turn the call to Doug, CEO of QuinStreet. Please go ahead..

Thank you, Erica. Hello everyone and thank you for joining us today as we report financial results for the second quarter of our fiscal year. We reported revenue of $66.7 million, exceeding the outlook we provided last quarter and delivering year-over-year revenue growth for the first time in three years.

The improved year-over-year results were driven by renewed strength in our financial services client vertical, particularly auto insurance, as well as increasing contributions from new products and markets in education, and continued growth in other client verticals. Revenue from businesses other than traditional lead generation for U.S.

for-profit education clients totaled $53.8 million in the quarter and grew 27% year over year. Revenue from traditional lead generation for U.S. for-profit education clients, our historic business in education, totaled $12.9 million and declined 45% year over year in the quarter. We are breaking out revenue from traditional lead generation for U.S.

for-profit education clients for you because it remains the drag on our overall top-line results. Breaking it out also allows us to better highlight strong progress in performance in the rest of the business. Summary themes in the business include, one, strong growth in businesses other than traditional lead generation for U.S.

for-profit education clients. Growth is being driven primarily by innovation and diversification.

Two, a return to year-over-year growth in financial services -- in the financial services client vertical, driven by auto insurance where we have developed and launched a range of new products that dramatically expand and diversify our footprint and addressable market, increase valued clients and media partners, and strengthen competitive advantages.

Three, rapid growth in new products and markets in the education client vertical. These new products and markets represented 45% of revenue in our education client vertical last quarter, or $10.6 million, and grew 69% year over year.

We believe revenue from these new products and markets can continue to grow and lead to stabilization of the education business as they offset more and more the headwinds from traditional lead generation for U.S. for-profit education clients. Four, attractive positive contribution margins from businesses other than auto insurance.

We continue to invest aggressively in auto insurance to further develop and ramp new products and media, a growth program that is working in what we believe is our largest addressable market. Five, an ability to expand adjusted EBITDA margin to top-line leverage on what we believe to be reasonable assumptions of revenue growth.

And six, a strong balance sheet, maintained throughout this period of unprecedented change and challenge to the business. We have funded our aggressive innovation program with internal cash flows and still have $46 million of net cash.

We expect these themes to generally continue in coming quarters, and as a result, that we will continue a successful transition back to overall revenue growth and margin reexpansion.

As mentioned on our last call, we have resumed meetings with investors because we believe we are nearing the end of our turnaround process and transitioning to renewed year-over-year growth. For the March quarter, we expect revenue to be generally flat to up 3% from a year ago.

The exact outcome will depend more on the precise timing of customer budgets and orders than on any change in the key themes just described. More importantly, we continue to believe that the trajectory from here is generally up and to the right.

Adjusted EBITDA margin next quarter will remain in the low single digits as we continue to invest and focus on revenue growth. Now I will turn the call over to Greg who'll discuss the financials in more detail..

Thanks, Doug. Hello and thanks again for joining us today. For second quarter of fiscal 2015 we posted $66.7 million of revenue and grew 1% compared to the same quarter last year. Adjusted net income for fiscal Q2 was $231,000 or $0.01 per share on a fully diluted basis. Adjusted EBITDA was $2.1 million or a 3% margin.

Q2 was a solid quarter for QuinStreet. We delivered results above the revenue outlook we provided last quarter, and importantly, delivered year-over-year revenue growth, the first time in over three years. This is a big deal and has been a long time coming.

The progress we've made with our product, market and media expansion strategies is paying off and outweighed challenges in U.S. for-profit education during the quarter. Excluding revenue from traditional lead generation for U.S. for-profit education clients, we grew 27% year over year in the second quarter.

So with that overall context, I'll now discuss the details of the fiscal Q2 results. Please see the supplemental data sheets available for download on the Investor Relations page of our corporate website. They provide essentially all the figures that I'm going to walk you through.

Revenue by client vertical, our education client vertical represented 35% of Q2 revenue, or $23.4 million, a decline of 21% compared to the year-ago quarter. Revenue from traditional lead generation for U.S. for-profit schools represented 55% of our overall education client vertical, and declined 45% compared to the year-ago quarter, to $12.9 million.

We are breaking out this component for you because it remains the drag on our top-line results, but also allows us to have a progress with our growth initiatives. Revenue from new products and markets in education represented 45% of our overall education client vertical, and grew 69% year over year to $10.6 million.

We believe that over time, continued diversification in our education product mix and growth from non-for-profit schools and international markets will eventually return our overall education business to year-over-year revenue growth. Education is a solid, profitable client vertical for QuinStreet. We believe this is a great long-term business for us.

Our financial services client vertical represented 44% of Q2 revenue and grew 21% compared to the year-ago quarter, to $29.5 million. We are excited to return the financial services business to year-over-year revenue growth.

Specifically in auto insurance, our recently launched suite of complementary products has generated a renewed enthusiasm and momentum to this business. We are pleased with the client adoption, engagement and ramp of these products, and we expect that trend to continue.

Client marketing budgets in auto insurance are substantial and we believe this represents our largest addressable market. Also in financial services, our life and health insurance, credit cards and deposits business all experienced double-digit year-over-year revenue growth in the quarter.

Our investments in growth initiatives are clearly paying off, and we are excited to turn the corner in this important client vertical. Revenue from other client verticals represented 21% of Q2 revenue and grew 15% compared to the year-ago quarter, to $13.8 million.

Continued solid execution from our B2B technology and home services client verticals drove the growth. Both of these businesses experienced solid year-over-year revenue growth in the second quarter, and we expect those businesses to grow again in Q3.

Moving to a discussion of EBITDA, for adjusted EBITDA, we delivered $2.1 million or a 3% margin, consistent with our expectations and the outlook provided last quarter. We will continue to invest aggressively in our growth and diversification initiatives as these investments are working.

We expect that adjusted EBITDA margin will begin to re-extend gradually over time with top-line leverage, and as we move from the period of heavy investment and growth, to optimization. Turning to the balance sheet. Our cash and marketable securities balance at quarter-end was $116 million.

Total debt decreased to $70 million from $73 million in the previous quarter, due to repayments, and we had no new borrowings. Our net cash position is a positive $46 million. Normalized free cash flow was $1 million in the quarter. This is a testament to our strong business model.

Despite aggressive investments and growth initiatives throughout the business, we still generated positive normalized free cash flow in the quarter.

As always, we look to normalized free cash flow as our primary cash flow metric, as it removes the effects of current quarter working capital fluctuations to drive the underlying cash flow characteristics of our model after minimal capital requirements. To summarize, three primary points.

One, we delivered results in the quarter that demonstrated real momentum with our growth initiatives. Growth in financial services, other client verticals, and from new product and market diversification initiatives in education outweighed challenges with traditional lead generation from U.S. for-profit schools in our overall results.

Two, we have a fundamentally strong business model, which allows us to invest aggressively in new growth initiatives, while at the same time maintaining a healthy balance sheet. And three, QuinStreet is a leader in online performance marketing, and we operate in large, attractive addressable markets.

With a 15-year track record, we believe we have the market expertise and the best competitive assets to capitalize on enormous market opportunity ahead. With that, I'll turn the call over to the operator to open up Q&A..

Thank you. [Operator Instructions] And we'll now take our first question from John Campbell from Stephens, Incorporated..

Hi guys. Good afternoon. Congrats on a great quarter..

Thank you, John..

Thanks, John..

Could you guys maybe just walk through just some of the drivers of the financial services growth? I mean obviously that was good coming off last few quarters of declines.

And maybe just, I don't know if you could specifically break it out, but just trying to get an idea between kind of the newer offerings, like interest leads and clicks -- or the click-to-call business, or is it more of a rebound in that kind of traditional click business?.

\ Yeah, the financial services growth was really driven by the fact that all of the verticals there had a pretty good quarter. But auto insurance went from being down in the teens the previous few quarters year over year, to being up about 24% year over year in the December quarter. And that was driven primarily, John, by the new click product.

As you recall, we launched four products, four new versions in some cases, and brand-new products in others back in the March timeframe. One was a brand-new click product platform that we worked very closely with our clients to develop and launch.

And that -- and most of the growth in the auto insurance business this past quarter and ongoing is being driven by that product which is -- so it's a combination of the two things. Really it's a new product but it's a new product that's driving rebound in our click business.

We did see and continue to see good strong growth with calls year over year, and with leads year over year, and continue to see good progress in the policy product. But the bulk of the turn was driven by the new click product..

Got it. Thanks for that. And then just on the click-to-call, it seems like that's a pretty good opportunity.

Is that growth more driven by, you know, is it kind of same customer growth or is it -- are there new clients there?.

It's mostly existing clients, and then some new clients.

But there's a -- we think that's an enormous opportunity as well, and it is driven by a combination of the clients want the calls and we have some great technologies for delivering very well-qualified and targeted and matched calls, which is building a lot of enthusiasm and excitement amongst the clients.

And there's a market there already that we're able to enter into and really substitute for or add to products that have not been nearly as effective in terms of its qualification matching. And then the third thing that's really an able driver of that click-to-call product is mobile.

From a mobile experience standpoint, as we see more and more traffic coming in on mobile devices, it is -- a call is a much stronger product offering and conversion tool than is a click on that platform. So, calls are also being driven, have a lot of tailwind from that as well.

So we are exceptionally excited about the opportunity in clicks and about our technology and our product there, which we believe is unique, and clients tell us the same thing, and about again how it matches up with both social and mobile. And the reason I say social and mobile is that most social traffic now comes in on the mobile device as well..

Got it, thanks.

And last question for me, I know you guys don't give guidance outside the next quarter, but not looking for anything specific here, but just generally speaking, look out two-plus years, if you guys can continue kind of, I don't know, call it low-single-digit or kind of mid-single-digit revenue growth, if we assume some of the investments spend kind of taper and we get some leverage in the gross margin line, could you guys give us an idea, just maybe a neighborhood, where you think margins can head? I mean we're kind of low single digits now, you guys have done kind of low 20% or so in the past.

Could you guys maybe just kind of frame that up for us?.

Yeah, I think the main answer there is, you know, kind of a simple top-line leverage analysis.

If you look at a simple top-line leverage analysis, and I say simple by saying, take some simplifying assumptions like current gross margins or current, say, media margins, which as you know we primarily focus on, John, but current media margins, which we think actually is conservative because we believe that the media margins at auto insurance are depressed right now versus where we will be able to walk then, because we continue to invest in taking on media and then optimizing up to margin.

But if you just assume that we keep current media margin averages and current headcount, and our headcount today is actually bigger on a total FTE basis than it was when we did over $400 million in revenue, and we're doing that on purpose to enable us to invest and roll out these growth initiatives, so if you take those two assumptions and then roll out revenue, the -- at about $300 million you get to 5% or 6% of adjusted EBITDA margin.

AT $350 million you get to around 9% of adjusted EBITDA margin. And at $400 million you're back up to about 15% to 16%..

It's about 13% to 14%..

Right, 13% to 14%, thank you, Greg, of adjusted EBITDA margins. And so that's what the potential is. I don't think that's unrealistic. We may or may not decide to capture all of that as adjusted EBITDA margin depending on what we see as opportunities to continue to invest aggressively.

But certainly that, you know, that gives you some good -- a good structural insight into the leverage in the business model.

And I would add that if you look at the strong growth we're seeing in all of the business but for that traditional for-profit education lead product, we just don't think it's crazy to think about where the good growth rates on average over the next couple of years.

And we need to ramp to those because we still have those headwinds to overcome, and we're just, you know, believe we're just crossing over that line. But again, the business -- the bulk of the business grew 27% year over year last quarter. For-profit education -- traditional lead generation of for-profit education clients was down 45%.

That's a heck of a headwind, but it's now down to only $13 million a quarter.

So those lines, at these rates, and we may not be able to sustain that rate consistently with -- I think we can go up from here, I think we'll come down from here, but I think generally, as I said up into the right [ph], you can see growth now coming as we keep working our way across to overcome that for-profit education headwind, and then you can see the kind of leverage that the business model gives us, even with existing headcounts and media margins which obviously the headcount thing gets fixed with volume, but the fact is, on the media margins side, we're operating now on one of our largest businesses in areas that we probably will be able to and have shown internally we can expand beyond once we get to the point where we're ready to, again as Greg said, optimize rather than invest heavily.

And so we're, you know, I think that's how I would think about the evolution of the business from here forward..

Excellent. That's great color. Thanks guys..

Thank you, John..

[Operator Instructions] And we'll take our next question from Yanni Edgarn [ph]. Please go ahead..

Hey guys. Congrats on the quarter..

Thank you, Yanni [ph]..

Thank you, Yanni [ph]..

So I guess kind of a follow-up to the last question. As you kind of try to think about top-line leverage on the gross margin line, particularly around COGS, so you're kind of -- we're kind of looking at like, okay, you guys have -- the amortization is going to kind of flow through over the next year or two.

Do you guys look at the point with your having a high revenue based on that? And like you mentioned, you have -- is it the number of people who would think this volume will be able -- will kind of be able to allow you to see more and more dollars flow through the bottom line.

But it seems like the media costs within -- around the auto insurance and financials business, as well as in terms of the click-to-call business, how much of that is like do you think of as variable and how much -- and are you seeing more efficiencies in that as you guys get to higher revenue volume, whether it's in terms of like how much your media costs will cost you as you guys get better at bidding or buying and converting leads? Or should we think of it as more of a variable base for the media costs that won't really expand a lot, but just having it fixed cost based on amortization and headcount?.

We think it'll be both. There's certainly the natural factor of the headcount leveraged against the bigger top line.

But we -- the main area of investment currently in the business besides having a lot of heads that are on ours to grow to a much more significant revenue number without having to add to those operating costs are -- is media cost in auto insurance.

We continue to be in investment mode in auto insurance, which means we are taking on media at margins that we don't believe, particularly initially, at margins that we would not necessarily consider acceptable or attractive for the long term, and then we optimize and allow the clients to price that media appropriately as we work to optimize it, and then we get that media up to what we do consider acceptable margins, and then we go off and grab another chunk of media and bring it to low margin, but then work it -- integrate it with a new product and allow the combination of optimization of client bidding to bring that back up to margin, and then we go grab another piece of media.

So that's -- that process eventually winds itself down to the point where we're able to focus more on optimization and less on heavy investment.

The goods news from our perspective is we still have a lot of areas of heavy investment, which means there's a lot of media out there that we still know we can go take and turn into productive, you know, to a productive source and channel for our clients.

But over time as we get to do more and more, that you're going to see the balance shift from that heavy investment chunk of media to more and more it's in optimization mode, and we expect our media margins in auto insurance, which is going to be a bigger and bigger part of the business, to run up nicely.

And we've seen it happen over and over again already over the past six months, six to nine months, on pieces of media. So we're quite confident in that ramp. But again you'll see that balance shift to optimization. As that happens, we'll get a lot of media leverage.

And the new products allow us -- the most important thing about the new products is that they allow us to get more out of the media for the clients, which allows the clients to pay more, which allows us to pay more, take more margin.

And so that's the virtuous cycle being created thematically across all of our new products, particularly of course in the auto insurance business..

Got it. And one follow-on question to that if I may.

For those clients within the auto insurance, so you guys are offering these products, are you seeing capped budgets or is it more along the lines of they're telling you that, listen, we want leads, see how many you could get us, as long as then effectively ROI-positive, price we are willing to pay up?.

It's a combination of some clients are essentially uncapped if we can hit certain performance metrics, which is how a lot of our business works. Some clients are capped in the short term because they just have budget constraints that they have to, you know, and budget planning that they have to work around.

In the longer run, almost all of our clients are essentially uncapped as we perform. To the extent we're capped to the short term, it's usually because of course they've set an operating budget and then an operating plan and they have to adhere to it.

But we have more clients than you might expect that are essentially uncapped against certain performance metrics. And then -- and that's how our business has always worked. And we tend to get more budget if we perform better, and better pricing, as clients -- as we perform better as well..

Great. Congrats again guys. Thanks..

Thank you, Yanni [ph]..

Thanks..

[Operator Instructions] And with no further questions, this does conclude today's call. If you would like to ask the recording of -- this recording, it will be available for seven days starting February 10th at 7:00 p.m. at phone number 888-203-1112. And when prompted for a code, you can use the code 2215690. Thank you and have a good day..