Erica Abrams - Investor Relations Doug Valenti - CEO Greg Wong - CFO.

John Campbell - Stephens Inc. Yuri Korolev - Credit Suisse.

Good day, and welcome to the QuinStreet Third Quarter Fiscal 2016 Financial Results Conference Call. Today's conference is being recorded. At this time, I’d like to turn the conference over to Ms. Erica Abrams. Please go ahead, ma'am..

Thank you, Jessica. Good afternoon, ladies and gentleman. Thank you for joining us today to report QuinStreet's Third Quarter 2016 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 Web site at www.quinstreet.com.

Before we get started, I’d like to remind you that the following discussion contains forward-looking statements. These statements involve a number of risks and uncertainties that could cause actual result to differ materially.

Factors that could cause the results to differ from our forward-looking statements are discussed in our SEC filings including our most recent 10-Q filing with the SEC. Forward-looking statements are based on assumptions as of today and the Company undertakes no duty to update these statements as a result of new information.

Today, we will be discussing both, GAAP and non-GAAP measures. A reconciliation of GAAP to non-GAAP financial measures are included in today's earnings press release, which is available on our Investor Relations Web site. Now, I’ll turn the call over to Doug, CEO of QuinStreet. Please go ahead..

Thank you, Erica. Hello, everyone. Thank you for joining us today. Our strategy to invest in new product and media initiatives that reestablish topline growth and re-expand adjusted EBITDA margin is working.

We grew 10% year-over-year in the March quarter excluding one-time item, delivering over $80 million in quarterly revenue for the first time since 2012. Adjusted EBITDA margin re-expanded to over 4%, the highest adjusted EBITDA margin since 2014, again excluding the one-time item. Growth was driven by continued strength in financial services.

Our largest client vertical now approaching 60% of total company revenue. Financial services revenue growth accelerated to about 50% year-over-year on the success of new products and media partnerships.

We delivered strong double-digit revenue growth in insurance, mortgage, and credit cards, our three largest businesses in financial services, even excluding the effects of the All Web Leads partnership. We are pleased with the progress of the All Web Leads partnership.

While its ramp has been somewhat slower than they or we expected due to difficulties and complexities associated with the integration of their acquired InsuranceQuotes business, it is already contributing significant new revenue and creating new opportunities for both companies to better serve clients and grow revenue together.

Our enthusiasm and expectations for the partnerships potential are stronger than ever. We also continue to make good progress with initiatives to diversify and transform our education client vertical. Revenue from not-for-profit schools and international markets has grown at a compound annual rate of 46% over the past two years.

New products also continue to grow as a percentage of revenue and represented almost 50% of total education revenue in the quarter.

Our exposure to U.S for-profit education continues to decline and represented less than 20% of company revenue in Q3, down from almost 40% just two years ago, even as total company revenue has grown this year and is now growing at an accelerated rate.

Our strategy has been and continues to be to invest in successful new product and media initiatives, in big markets, where we already have considerable scale and competitive advantage. And in so doing, one, diversify our business and offset challenges in U.S for-profit education.

Two, reestablish sustainable topline growth, and three re-expand adjusted EBITDA margin, all while maintaining positive cash flow and a strong balance sheet. The strategy is working.

Our revenue excluding U.S for-profit education has grown at a compound annual rate of about 17% over the past two years, and we just delivered 10% total company revenue growth and the highest adjusted EBITDA margin in two years, despite significant declines in U.S for-profit education.

Turning to our outlook, we expect the effects of our strategy to accelerate with revenue and adjusted EBITDA margin momentum continuing through the fourth quarter and into fiscal 2017. Specifically, Q4 revenue is expected to grow 15% to 16% year-over-year, beating historical sequential seasonality with adjusted EBITDA margin at or above Q3 levels.

We also expect to continue to expand EBITDA margin with topline leverage going forward. With that, I’ll turn the call over to Greg, who will discuss the financials in more detail..

Thanks, Doug. Hello, and thanks to everyone for joining us today. We are pleased with our results for the third quarter, which marked an important inflection point in our business. Topline growth has accelerated, while we’ve begun to expand EBITDA margin. From here, we expect positive trends to continue in Q4.

For the third quarter of fiscal 2016, we reported $81.2 million revenue and grew 8% compared to the same quarter last year and 25% sequentially. Revenue grew 10% year-over-year in the quarter excluding a one-time benefit associated with the collection of historical receivable in the same period one year ago.

Adjusted net income for fiscal Q3 was $1.2 million or $0.03 per share on a fully diluted basis. Adjusted EBITDA was $3.5 million or 4% margin. Turning to revenue by client vertical, our financial services client vertical represented 56% of Q3 revenue and grew almost 50% compared to the year-ago quarter to $45.6 million.

We saw strong performance pretty much across the board. Our insurance business grew 49% year-over-year and now represents 42% of total company revenue. Our mortgage business grew 55% year-over-year and our credit cards business grew 196% year-over-year in the quarter.

During the quarter, we successfully integrated with All Web Leads and are already seeing significant revenue and new opportunities from grow -- for growth from the partnership. We expect growth in financial services to accelerate in Q4 as strategic partnerships like AWL ramp and as mortgage and credit cards continue to scale.

Our education client vertical represented 28% of Q3 revenue or $22.7 million. The year-over-year decline was due primarily to the exit from the channel by large U.S for-profit education client as previously discussed.

The decline is also related to the comparison against a one-time benefit of $1.6 million associated with the collection of a historical receivable in the year-ago quarter. Revenue from U.S for-profit education was less than 20% of total company revenue in the third quarter.

Revenue from not-for-profit schools and international market is growing at 46% over the past two years and is expected to total approximately $30 million in revenue in fiscal 2016. We believe the not-for-profit and international markets represent big long-term opportunities for QuinStreet.

Revenue from our other client verticals represented the remaining 16% of Q3 revenue or $13 million. In these verticals, our performance marketing products grew 6% year-over-year. Display revenue in our B2B technology business was down year-over-year, primarily due to budget shifts to programmatic buying.

B2B technology is the only client vertical where we’ve significant display revenue and even there could represent a small share of revenue. Moving on to EBITDA, adjusted EBITDA was $3.5 million or 4% margin. Excluding the one-time item in the year-ago quarter, this was our highest quarter of adjusted EBITDA since March of 2014.

We expect adjusted EBITDA to expand primarily due to topline leverage in future periods. Turning to the balance sheet, cash and cash equivalents at quarter end were $55 million. Total debt was $15 million and our net cash position grew by $4 million in the quarter to $40 million.

Normalized free cash flow was $2.3 million in the quarter or 3% of revenue. Most of our adjusted EBITDA drops to normalized free cash flow due to the low capital requirements of our business model.

In summary, we delivered results in the quarter that validate the turn in our business with accelerated revenue growth and re-expansion of adjusted EBITDA margin. Excluding one-time item, we grew 10% year-over-year in the quarter and delivered our best quarter of adjusted EBITDA since March of 2014.

Importantly, we expect positive momentum to continue in Q4. For the fourth quarter of fiscal 2016, we expect to post revenue growth of 15% to 16% year-over-year. We also expect adjusted EBITDA margin in Q4 to be at or above Q3 levels and that EBITDA margin will continue to expand with topline leverage going forward.

With that, I’ll turn the call over to the operator to open-up Q&A..

Thank you. [Operator Instructions] And we will go first to John Campbell with Stephens Incorporated..

Hey, guys. Good afternoon..

Hey, John..

Hey, John..

Doug, you mentioned that AWL ramp was a little bit slower.

I think you said due to some of the complexities of some of their acquired businesses, but so first can you just dive into a little bit more and explain what’s going on there? And then secondly, how beneficial just roughly was AWL in the quarter and then how much under perform your original expectation?.

Sure. John, the complexity of the difficulties of relative two expectations, the AWL partnership was really solely related to the acquired InsuranceQuotes business. That business AWL has -- had to be more aggressive in rationalizing that business than they or we expected.

I think in so doing, they’re really setting it up to be much more successful going forward and setting it out for good strong sustainable future growth. But they have had to be much more aggressive in that rationalization then they and therefore of course we expected them.

It’s really related to the fact that the industry itself as you’ve heard us say over and over again, in all of these verticals there was a major shift going from lower quality blended pricing to much higher quality and right pricing.

And that’s where the AWL has taken their business and that's why they were growing when the acquired business was not and they’re really repositioning the acquired business to be able to good on that same track. But that’s that is requiring a lot more change again then and rationalization and either was expected.

Our expectations over time are every bit as big as they ever were. In fact, some ways bigger, because we’ve actually discovered a lot more ways to work together. We and AWL have been -- were anticipated in the original partnership and we are super excited about those things.

In terms of the effect on the quarter, I’d say that the difference as if you look at our current guidance, it puts us in the mid-to high single digits for growth for the year and the difference between that whether we end up at 6%, 7%, or 8%, which is the most likely range of year-over-year growth between that and the 10% that we were expecting a few months ago.

Its pretty much 100% associated with the Delta from the acquired InsuranceQuotes business with AWOL..

Okay. That is helpful. And so I guess you guys have had another month and half or so to see that the rev ramp with AWL.

So just in that mid-teens rev growth guidance for next quarter, I guess are you assuming a bit of a sequential jump in AWL going into next quarter?.

Some. Certainly, we didn't. We had partial ramp in the third quarter, because we didn't really integrate with the acquired business until early February. And so you’ve got the effects of that working for you.

What you have working against us a little bit is that the --- is the more aggressive rationalization that AWL has done and again in order and I think very pragmatically and in the interest of the clients which is in the interest of long-term growth.

So -- but yes, we expect more this quarter than we did last quarter and we expect more next quarter than we will get this quarter. So the business is on a very good ramp.

Its already delivering tens of millions of dollars in revenue to us and in doing so it in a way that's a strong return on the investment we made there, but it's the slope -- I’d say that our view of the size of the opportunity is as big or bigger than it ever was given particularly the added business opportunities that we now have.

But the slope is definitely a little bit lower given that the changes that they’ve needed to make and have decided to make have been a lot more aggressive and significant than they expected..

Okay. That is helpful. Just one more for me and I will hop back in the queue.

If you guys think about the positive, the cash flow generation, and you guys look like you are on a good path to continue to grow your net cash position, I get you guys want to be flexible for any kind of partnership opportunities in the future, like AWL, but why not buyback shares here?.

It’s a question and it’s something that we discussed periodically. I think that our view in the near-term is that we’ve had to undertake a lot of changes in the business and we had to face down and address a lot of challenges in the business, particularly in the -- due to for-profit -- in for-profit education.

Our commitment has been to aggressively pursue those changes, because we see great market opportunity in front of us which as you’ve heard would, we believe we’re delivering on, but for the for-profit education on the phenomena that we are growing away out of.

During that period, we just don't think it's prudent to do anything other than maintain a very conservative posture when it comes to our cash position, our cash flow and our balance sheet, because we certainly don't want to add to that mix of complexity the downside risk of either, best case not having enough cash to pursue further opportunities like AWL or worst-case, no running short of cash generally, obviously we’re a long, long way from that with $40 million of net cash, but we don't want to blend in financial risk with these significant operating risk and challenges and opportunities that we've been facing.

So, it will be something we will continue to discuss. We’ve had vigorous discussions already. I’d say that our position may or may not change on that as we continue to grow and to expand EBITDA margin start generating significant cash again.

And as you know we just don't have much other than deals like AWL or historically acquisitions and we don't see -- that we really don't see any acquisitions we’re very interested in at this point in front of us.

We don’t really have many other uses of cash and we are not a cash using business or our capital requirements for the basic business model or insignificant relative to our size.

So it's an absolutely right question, but one that we as a Board continue to discuss vigorously and right now the thinking that I outlined is really what’s governing our decision..

Okay. That’s helpful. Thanks guys..

Thanks, John..

We will now take a question from Stephen Ju with Credit Suisse..

Hey, guys. It’s Yuri on for Stephen. So a couple of questions, if I may. The first is on Google, specifically with what has happened recently with fourth link on desktop and some of the changes in the overall, both mobile and desktop news feed and adds there.

I’m curious if there is any impact there to your business? And then, I guess, secondly, I’m curious on the AWL kind of amortization of that initial upfront cost.

Are you changing how you are amortizing that at all as a function of like the ramp or the slower than expected ramp with that? And thirdly, any change in your outlook in terms of gross margins, especially around as you guys are another quarter into ramping the financials business and seeing what you guys are doing in for-profit versus non-profit?.

Sure. As far as the Google question we have actually not seen any meaningful effects from the changes in the paid listings positioning. I’d say that it’s been more positive than negative, which was a little surprising to us, but certainly great news.

But our pay per click as a source of media for us continues to be very strong and just as strong and effective as it was prior to those changes. So that’s been very good -- a very good news and because again nobody really knew exactly what those -- what the effect would be.

It’s not surprising, I guess to me, we had the hypothesis that we probably do fine, because we are able to be pretty aggressive on the highest ranking terms and the effects should've been primarily on lower ranking terms. But the good news is that has played out -- has played out that way.

In terms of amortization, it’s a straight line amortization; $1 million a year over 10 years which is the term of the deal and it’s really a $1 million per year..

It’s an exclusivity fee..

Exclusivity fee..

So it doesn’t. The way we amortize it through the P&L does not change by volume..

Got it..

So, we’re just treating it straight line $1 million a year and we do include that in adjusted EBITDA. It is not adjusted out. We interpret it to be a part of cost of services so that payment is included in cost services for calculation of adjusted EBITDA. As far as gross margin, gross margin outlook remains pretty similar to what it has been.

If you look a year-ago to now, if you adjust out the one-time effects of the $1.6 million payment we received from a receivable, there is about a one-point difference between last year and this year. We lost some -- on some of the media margins, because of the mix shift in the business, but we regained most of that to topline leverage.

About a third of our cost of services is associated with semi-fixed costs and so as we scale those that gross margin actually benefits from that scaling. So we still expect that to be in effect and of course the expenses below the gross margin line are also primarily semi-fixed and will scale, continue to scale with revenue growth as well..

Got it. Thanks a lot guys..

[Operator Instructions] We will go next to John Campbell with Stephens Incorporated..

Hey, guys. Just Greg, if you can go back through a little bit more color on why you expect margin to naturally expand with -- if you guys were able to get some of topline growth you are looking for.

If you could maybe just start off with an update on the, I guess, the current cost structure, variable versus fixed costs, and then maybe just if you could drill down within COGS and operating expense?.

So John, I think what we see I think as discussed the biggest portion of our semi-fixed costs is headcount. We carry the same headcount that we did at or similar headcount that we did at over $400 million of revenue.

So, although we will continue to remix the headcount to point our resources at the most -- the biggest growth opportunities, we don’t need to expand headcount to drive the topline.

So, as we drive the topline up, the bulk of that media margin will drop to EBITDA, and so that’s where we will start seeing expansion, both on the gross margin and EBITDA line..

Yes, that’s the gross effect.

If you want to get slightly more detail, its really what we were describing before, which is about a third of cost of services is semi-fixed cost and so you actually get the -- if you want to divide it up slightly, you actually get gross margin benefit from the revenue scaling, because that component of cost of services will remain fixed, while the media margin and the media margin shouldn't change much from here.

It’s changed quite a bit lately, because of the mix shift over to more click based products, particularly in auto insurance and the good news about click based products is that while they tend to have a lower media margin so therefore lower gross margin.

They tend to have equivalent EBITDA margins even at a lower gross margin, because they have a lot fewer costs below the media costs or the gross margin line and that's because quite simply when you sell a click, the click goes to the clients Web site.

When you sell a lead, the traffic goes to our own Web sites and we have to maintain those Web sites and those technologies and that eventually shift that that prospect over to the client.

So you take out a whole chunk of the cost structure when you sell a click and it’s primarily you see that below the gross margin line, but you see some of into the gross margin lines.

So, again that -- so the main effects are to Greg's point, revenue coming in at media margin, dropping through the same total fixed cost structure, the gross margin operating margin components of that are about a third of gross margin is headcount or semi-fixed cost which will not grow generally and quite specifically over the past couple of years and we don’t expect to over the next year too with revenue, so you get a scaling of gross margin with revenue growth for the same reason that we get overall the other semi-fixed costs.

And then you have the -- of course in the other operating costs you have the topline leverage, you’ve media margin drop into a fixed cost base and then again the other way to look at it is as I said before is that that just the fixed and variable component of overall costs.

So, does that make sense to you? That’s the way we look at the business, and that’s how it’s actually working and that’s how you continue to see it working..

That makes sense. It sounds like education is probably, I guess, just the exact opposite with a little bit better gross margin but higher OpEx. So, it does sound like I guess ….

That’s right..

… if you continue to grow your insurance that we might see some pressure on gross margin, but overall adjusted EBITDA is probably all set with lower OpEx, that’s fair to say?.

That’s fair to say, and that’s exactly how we ran the business before, back in four, five years ago before we hit both the product cycle and the auto insurance education, those two businesses have gotten to the point where they’re about the same size.

And they had almost the exact same EBITDA margin structure, but auto insurance and the click business of that did that on a media margin base, which was about 33% lower than education, but did not carry the other operating costs associated with maintaining all the Web sites and lead gen technologies, because again that click goes straight to the client, the client's Web site.

So that's -- it's both -- it’s the way the business is structured, it’s the way we've seen them operate in the past and it is the way we expect to operate it going forward.

So as you see the mix shift away from leads which is the dominant product in education and two clicks which is the dominant product in auto insurance, you will see what looks like pressure on the gross margin line, but really is not at any -- and we’re getting to the scale already where it’s the case is not -- there is not similar pressure and in fact the pressures is offset over time with scale on the EBITDA line..

Okay. Thanks, guys..

Thank you..

And that concludes today's question-and-answer session. A replay of this call will be available at 6 PM Central time starting today May 10, until 6 PM Central May 17 at 6 PM Central time also by calling 1-888-203-1112. This concludes today's call. Thank you for your participation. You may now disconnect..