Erica Abrams - IR Douglas Valenti - Chairman and CEO Gregory Wong - SVP and CFO.

John Campbell - Stephens Inc. James Goss - Barrington Research Wallace Wadman - Constitution Research.

Good day, ladies and gentlemen, and welcome to the QuinStreet Second Quarter Fiscal Year 2018 Financial Results Conference Call. Today's conference is being recorded. I would now like to turn the call over to Erica Abrams. Please go ahead, ma'am..

Thank you, Katherine. Good afternoon, ladies and gentlemen. Thank you for joining us today to report QuinStreet's second quarter fiscal year 2018 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 would 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 results to differ materially from those projected by such statements and are not guarantees of future performance.

Factors that may cause the results to differ from our forward-looking statements are discussed in our recent SEC filings, including our most recent 10-Q filing made on November 7, 2017. Forward-looking statements are based on assumptions as of today and the Company undertakes no obligation to update these statements.

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 will turn the call over to Doug, CEO of QuinStreet. Please go ahead..

Thank you, Erica, and thank you all for joining us today. Results were strong again in the fiscal second quarter. Revenue was up 33% year-over-year, and adjusted EBITDA margin was 8%.

The positive momentum in our business continues to be propelled by the roll-out and execution of the QuinStreet product and media strategies developed over the past few years, and by clients shifting more spending to digital media and performance marketing. We expect these general themes to continue.

We are raising our revenue growth outlook for the full fiscal year to approximately 20%, with adjusted EBITDA margin of about 8%. Business momentum is particularly strong in our financial services client vertical, where we are furthest along in the deployment and adoption of the new QuinStreet products and strategies.

We are also seeing continued generally better trends in our education and other client verticals. We acquired certain assets of Katch, LLC, an online performance marketing company, in the quarter. That's Katch with a 'K'. The company was previously known as Vantage Media and had itself acquired BrokersWeb.

We expect the Katch acquisition to be nicely accretive as we have absorbed revenue and media but little fixed cost. The acquisition accounted for about 4% of year-over-year growth in the quarter. Our acquisition model estimates revenues associated with the Katch acquisition will be approximately $4 million per quarter going forward.

With that, I'll turn the call over to Greg to discuss the financials in more detail..

Thanks Doug. Hello and thanks to everyone for joining us today. Our second quarter financial results were strong, with our highest revenue growth in over eight years, continued margin expansion, and strong cash flow generation.

We are excited about the success of QuinStreet product and media strategies that allow more effective online marketing spend and better media yields. In the second quarter, revenue grew 33% year-over-year to $87.5 million. Revenue related to the acquired Katch business was approximately $3 million or 4% of year-over-year growth in the quarter.

Adjusted EBITDA was $6.6 million or 8% of revenue, and adjusted net income was $3.7 million or $0.07 per share. We generated $5.6 million of normalized free cash flow and closed the second quarter with $42.4 million in cash and equivalents.

Moving to revenue by client vertical, our financial services client vertical represented 71% of Q2 revenue and grew 57% year-over-year to $62.3 million. All of our largest businesses in financial services had strong growth in the quarter.

Clients continue to shift marketing spend to online media and QuinStreet delivers measurable, sustainable and cost-effective results for them at scale. Our education client vertical represented 18% of Q2 revenue, and declined 5% year-over-year to $15.4 million. Trends in education have generally improved over the last several quarters.

Over 30% of our education revenue now comes from not-for-profit or international clients. U.S. for-profit education was 12% of total revenue. Our other client verticals represented the remaining 11% of Q2 revenue and grew 2% year-over-year to $9.8 million.

Turning to the balance sheet, we closed the quarter with $42.4 million in cash and equivalents and no debt. During the quarter we generated $7.3 million in operating cash flow and spent $14 million for the acquisition of Katch. Normalized free cash flow was $5.6 million or 6% 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, Q2 was a very good quarter for QuinStreet where we delivered our highest year-over-year revenue growth in over eight years, continued margin expansion, strong cash flow generation, and maintained a strong balance sheet. The momentum in our business is strong. We are raising our outlook for full-year revenue growth to approximately 20%.

We look forward to reporting more progress to you over the coming quarters. With that, I'll turn the call over to the operator for Q&A..

[Operator Instructions] We'll go to John Campbell with Stephens..

Congrats on a super quarter. On the gross profit, I mean that was it looks like 3x higher than last year on 30% revenue growth. That's a really good result.

Were you guys expecting that degree of lift or is there anything that's kind of not sustainable there, any kind of one-time lift there, or is that kind of a new go-forward run rate?.

No, it's nothing that's unsustainable, John. That's kind of what we were expecting to be on the quarter at this revenue level and I would expect that to continue..

Okay, that's helpful.

And then on Katch, congrats on that deal, when did that close, did you say kind of early in the quarter?.

It closed about mid-quarter. In November was the close. We had a couple of months of revenue from that in the quarter, John..

Okay. And then I think you said $4 million or so in rev per quarter going forward.

Anything around seasonality there, and also if you could maybe help us with the margin profile, any kind of EBITDA contributions?.

No real seasonality effect. That's going to be pretty close to that as best we can estimate it. There will be some puts and takes on that business as we figure out what we're able to keep and grow and what we might need to take out.

But we think that's going to be pretty close to the average, more driven by those details of the business than by seasonality. In terms of margin profile, very similar to our margin profile in terms of media margins, a little lower than ours but once you put it into our mix, we pretty much lift it up to ours. So, it won't change margin profile.

It's still got – you know, we've said that incremental revenue tends to come in about 30 points of margin and that is what we would expect with the Katch revenue as well..

Okay. And then I'm going to miss this, but it sounds like you guys bought the assets of Katch.

Was it pieced out, were there pieces that were going elsewhere?.

There were pieces that went elsewhere. We only bought the auto, home, mortgage – auto and home insurance, and mortgage assets, and then the technology platform assets. There were health and life business assets that went elsewhere and I think they had some other pieces that I'm not as familiar with.

But the two big chunks were the piece we bought, which were auto/home insurance and mortgage, which we wanted, and we wanted the tech platform out of the space basically. And then the other piece we understand went to another company in this space.

We looked at all of it, we got what we wanted, and we got it at really the price we wanted to pay for it..

Yes, it looks like you guys got it at a fantastic price. Congrats..

We'll now go to Jim Goss with Barrington Research..

I was wondering how much of the gain you recorded in the second quarter might have come out of the third and fourth quarter, so did it pulled it forward a little bit or are those quarters really not affected by the strength?.

We don't think any was pulled out of future quarters, Jim. It would not be, not something that we would expect at all. I'm trying to think if there's anything that came through in that way and I'm coming up with nothing. So, no, this was just a good strong quarter in the quarter..

Okay. And with Katch, I think you said it closed in the mid-quarter and contributed about $3 million and you're looking for about $4 million per quarter from it.

So, did it just have a strong end of the quarter or – because it seemed like it was more than a half of the quarter, if you got $3 million and set the $4 million run rate?.

Yes, I was not being overly precise with the mid-quarter thing. It was in November. So, I wouldn't read anything into that. It's generally proportionate with the time we owned it in the quarter..

Okay. And if you looked – and you said there would be an 8% EBITDA margin you expect for the year now.

That's part of the new guidance?.

We're still saying about 8% for the yearly EBITDA margin guidance, that's correct..

If you looked over the next two or three years, is there a certain gross margin and/or EBITDA margin target you think can be a realistic goal to improve from?.

We think that the general trend over the next couple of years should be that we'll add EBITDA margin or grow EBITDA margin as we add revenue, because we will grow fixed and semi-fixed costs significantly slower than we expect to add revenue.

And so that revenue, and it's approximately 30% of contribution it comes with before fixed and semi-fixed costs, should drop disproportionately into EBITDA.

So, in terms of the actual number, other than that general model, I would say that our intention is to continue to expand EBITDA margin through that top line leverage, but I don't have a specific number for you. We aspire to get into the double digits again as soon as we can and we aspire to keep pushing it from there..

Okay. And you had indicated you were going to grow more from organic means than from acquisitions. This was just an opportunistic acquisition I presume.

Are there any other such acquisitions you might have your eye on that you think could contribute over and above the organic growth?.

This was absolutely opportunistic. We look at potential acquisitions almost continuously, but there are none that I would say right now we are particularly excited about. That being said, we are pretty good platform for adding companies in our space, if they fit our criteria. So we will continue to review that.

I don't expect that that's going to be a big part of our growth story or strategy going forward. That said, we will continue to be responsive and engaged and certainly opportunistic..

All right, thanks for answering the questions. Thanks very much..

We'll go to John Campbell with Stephens..

I just wanted to follow-up on the insurance spend.

I know that you guys see that kind of having somewhat of a whipsaw at times, and just coming in relation to that the hurricane activity, are you guys see any kind of change in spend or is there any kind of change in mood or behavior?.

We are not. That said, a lot of the carriers still haven't come back to the market strongly after last year's loss ratio issues. They haven't completely gotten their product where they wanted to in order to go out and spend aggressively in marketing.

But we are not hearing from the carriers that are spending with us anything about loss ratio effects from the hurricane season and from the losses associated with that..

Okay.

And then last one for me, on education, do you guys feel like you're kind of bottoming out there or is it just give or take 5% growth here and there, any kind of thoughts there?.

The general trends continue to look better, as we've said. It's hard for us to call the bottom because it's been such a difficult period in education and you still have a lot of companies who are not fully adapted to the new model.

But as you've heard me say before, most of the companies that were the most exposed in a negative way to the new regulations are either gone or have dramatically downsized.

Most of the companies that are left have or at least a few years into adapting to the new operating environment, and as a proportion of our business, for-profit education now only represents 12% of total revenue. So, it can only hurt us so much. So, I think we kind of look at it like that.

I don't mean to make it sound like we're not engaged and hopeful for education, because we are.

I think if you were to twist my arm right now, I'd tell you that I think there may be more upside potential versus expectations in education over the next few years than more downside, and that's a pretty profound shift versus where we've been in that business vertical or that client vertical over the past five years or so..

Sure. I lied. I have one more. As far as capital allocation, it doesn't sound like M&A is much of a use. You don't have any debt to pay down.

What could we be thinking about cash from here?.

We're still going to focus on keeping that cash on the balance sheet for the most part. Number one priority will be finding opportunities like Katch or like [AWO] [ph], the [AWO] [ph] partnership, to deploy the cash in a way that gives us strong leverage and strong return in terms of the business impact.

A distant second will be, we have in the past and we will continue to review whether or not it makes sense to buy back stock.

And when we see a – we feel like we have an excess, if you ever have that of cash and there's a big difference between what we think we're worth and where the stock is trading, we'll continue I'm sure as a Board to review and discuss that option.

But I think first and foremost we're going to keep a strong balance sheet to make sure we have plenty of flexibility and resilience as we continue to put in place the elements it takes to have a strong growing business for a lot of years to come. Second would be, are there Katch and [AWO] [ph] type opportunities out there.

And then third is, we've done over the past few years, we will periodically review whether or not it makes sense to maybe buy back stock.

That's something that we have had a plan in place for and we'll continue to have plans in place for if and as it makes sense and if and as the stock is trading at levels that we think are well out of line with the value that we think that actually has..

Okay, that's helpful. Thanks guys..

We'll take a question from Wally Wadman with Constitution Research..

Just a quick technical question, and then one follow-up on the education market.

I know it doesn't impact you until next fiscal year, but can you give us some guidance, some color on 606 accounting changes and also whether you get any impact or benefit from the new tax bill?.

From a 606 standpoint, Wally, our initial assessment is really it's more of a disclosure issue for us the way our business operates. So I don't expect it to have any real impact on the business.

From a tax perspective, given the fact that we are under full valuation allowance and we're primarily domestic-based, I don't expect that to have a big impact on us as we are not going to be a taxpayer for quite a while. What it will do is it affects your gross down, your deferred tax assets, but your NOLs won't change from that standpoint.

So I don't expect either of those to have a big impact on our business..

And on the education, when you were referring to new regulations and people taking a couple of years [indiscernible], I assume you were talking about actually now older regulations from the Obama administration, and I thought that the [private] [ph] education had proposed some easing up on the for-profit regulations, I don't know if those have been enacted yet, and whether that would help in the outlook for for-profit companies?.

You're right, Wally. The new regulations are not so new anymore, and I was referring to those that were promulgated in the Obama administration. You're also right that the new administration has proposed loosening a number of those regulations and perhaps even eliminating the gainful employment provision.

That hasn't been approved yet or promulgated yet, but certainly the environment is better when it comes to regulations because the Department of Education in this administration is at least less proactive in their efforts to control or regulate or otherwise affect for-profit education than the previous one.

So, I would say that – but that all said, most of the companies in this space are assuming, and I think this is prudent, are assuming that the new regulations won't go away, and that even if the regulations are loosened in the current administration, there's not insignificant risk that the next administration could be democratic again and it could be right back where we started.

So, I think they are for the most part operating as if they're going to have to live with these regulations forever..

Ladies and gentlemen, that does conclude today's conference. Thank you all, again, for your participation. A replay will be available after 6.30 PM Central Time today through February 7, 2018 at 6.30 PM. To access the replay, you may dial 888-203-1112 and enter confirmation code 6111712.

Again, for replay information, dial 888-203-1112, enter confirmation code 6111712. You may now disconnect..