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

John Campbell - Stephens Inc. Patrick Sholl - Barrington Research Stephen Ju - Credit Suisse.

Good day and welcome to the QuinStreet Third Quarter Fiscal Year 2018 Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Erica Abrams. Please go ahead..

Thank you, Aga. Good morning, ladies and gentlemen. Thank you for joining us today to report QuinStreet's third 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 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 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 filings made on February 5, 2018. 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 website. With that I will turn the call over to Greg, CFO of QuinStreet. Please go ahead..

Thank you, Erica. Hello and thanks to everyone for joining us today. As you know from our press release, we reported an outstanding third quarter highlighted by all-time record revenues, our return to double-digit adjusted EBITDA margin and the continued generation of strong cash flows.

QuinStreet's success continues to be driven by the product and media strategies we have implemented over the past few years. Those strategies provide better matching, transparency and right pricing of media and our recent performance demonstrates that these strategies are working well for consumers, clients and QuinStreet alike.

In the third quarter, revenue grew 49% year-over-year to $117.9 million, our fastest growth rate at anywhere near the scale in QuinStreet's 19-year history. Adjusted EBITDA was $11.2 million or 10% of revenue, an increase of 116% year-over-year. Adjusted net income was $8.5 million or $0.16 per share.

We generated $10.5 million of normalized free cash flow and closed the third quarter with $47.1 million in cash and equivalents and no debt. Moving to revenue by client vertical, our Financial Services client vertical represented 74% of Q3 revenue and grew 79% year-over-year to $87.1 million.

All of our largest businesses in Financial Services had strong growth in the quarter. Clients continue to shift marketing spend to online from offline media.

As a shift is occurring QuinStreet is one of the only providers that delivers measurable, sustainable and cost-effective results for our clients at scale, which allows them sustain more aggressively and predictably in the world's largest shopping channel, the Internet.

Our Education client vertical represented 17% of Q3 revenue and grew 2% year-over-year to $19.6 million. Trends in Education have improved generally over the last several quarters. Approximately 40% of our Education revenue now comes from not-for-profit or international clients. U.S. for-profit Education was just 10% of total company revenue.

Our other client vertical which includes Home Services and B2B technology represented the remaining 9% of Q3 revenue and was flat year-over-year at $11.2 million. Turning to the balance sheet, our balance sheet remained strong and we closed the quarter with $47.1 million in cash and equivalents and no debt.

During the quarter we generated $5.7 million of operating cash flow and spent about $700,000 on CapEx. Normalized free cash flow was $10.5 million or 9% of revenue. Most of our adjusted EBITDA drops to normalized free cash flow due to the low capital requirements of our business model.

Moving to the outlook, we expect positive momentum across our business to continue and once -- we are once again raising our outlook for the full fiscal year, this time to revenue growth of at least 30%. Adjusted EBITDA margin for the full fiscal year is expected to be at least 8%. With that, I'll turn the call over to Doug..

Thank you, Greg. So growth continued to accelerate in the fiscal third quarter and we continued to expand the margins and cash flow. I wanted to spend some time explaining what is driving our business momentum and describing or reminding in some detail how our business model works.

QuinStreet's business momentum is being driven by two main fundamental factors. First, by the shift of marketing dollars to digital media, that's increasingly where the customer prospects are spending their time and beginning their search for a product or service.

Within digital media, due to growing sophistication and digital's inherent measurability, there is a shift to performance marketing and we are a leading, trusted, digital media performance marketing platform. The second fundamental factor driving our renewed business momentum is the success of our new products and media strategies.

The new products increase our ability to optimize performance marketing programs for clients and the media and to do so even more measurably and transparently. They meaningfully strengthen our already formidable technology competitive advantages.

The new media strategies broaden our coverage of digital media sources that contain research and compare consumers. This increases our footprint for growth, diversifies our mix and reduces disruption risks. It is clear from our results that these product and media strategies are working.

Clients are achieving their marketing objectives and growing [spend] with us. Consumers are finding the products and services or solutions they need and engaging, matching and converting into customers for our clients and they are doing so, in our case on a voluntary intent driven and off gain basis.

We serve some of the biggest companies and brands in the world. These big brand name clients are ever more sophisticated and they are capable of and focused on directly measuring marketing results and on monitoring online campaigns and flows.

With all their sophisticated ability and focus and increased scrutiny, these clients are allocating more spend, more confidently to us based on demonstrated measurable performance and compliance.

We continue to be a leader in managing network quality and compliance, an area of significant focus and investment for QuinStreet and an area of competitive advantage for us versus our mostly smaller competitors. These advantages are enhanced and reinforced by our performance marketing and right pricing business model.

I'll say more about that in a moment. So those are the main drivers of our extraordinary business momentum.

Spend increasingly shifting to digital media and performance marketing and spend growing with us due to our ability to deliver measurably effective results consistently, transparently, and compliantly at scale, all greatly enhanced by our new product and media strategies.

Now I want to talk more generally about QuinStreet's business model and to make three points. One, about how we are a pure play in performance marketing; two, about our value proposition to clients and media; and three, about our competitive advantages.

Number one, and perhaps most important to understand about our business model, because it overlays everything else, is that QuinStreet is a pure play in performance marketing. That means that what we get paid is directly tied to and right priced for the actual results we deliver for clients.

And in our world results are pretty simply defined as consumers converting into valuable customers for our clients.

If our information or matching did not work for consumers so should they voluntarily proceeded to our online flows on an opt-in basis or the clients to who we matched consumers did not satisfy their needs as demonstrated by consumers' voluntary conversion into customers, we could not deliver results.

Similarly if the actual results, that is, consumers voluntarily converting into valuable customers did not work measurably for our clients and then they would not spend let alone grow their marketing dollars with us.

We did not exist for 19 years, get to $400 million plus in annual revenue, grow at more than 30% year-over-year and be profitable, if our campaigns did not measurably and sustainably work for both consumers and clients. Number two, regarding our business model. Let me talk about QuinStreet's value proposition to clients and media.

For clients, we provide value in two primary ways. First, the Internet is now essentially the biggest shopping channel in the world for everything. It is where most consumers begin their journey to search for products and services or solutions and for solution providers. It is also an enormously complex and fragmented medium.

Complex and fragmented well beyond most companies' ability to build the expertise and technologies to meaningfully let alone fully harness its potential. Clients work with us, because we do have that expertise and technology.

We have a deep understanding of the channel and of the enumerable types and sources of media where research and compare or high intent consumers can be found and engaged.

We also have deep relationships, integrations and technologies to access, filter, sort and yield that media opportunity and complexity for clients sustainably, consistently, effectively and at scale. And to do so compliantly, we continuously audit our network.

In addition, our network is audited by dozens of client teams and third-party service providers on an ongoing basis and has been for years. Second with regard to our value proposition; we not only harness this large complex fragmented medium. We make it into a productive and economic customer acquisition channel for clients.

We do that by applying our core technologies, expertise and algorithms fed with many years of experience and billions of dollars of media spend. These capabilities allow us to most effectively access and engage consumers in digital media and then match them to the right clients, the ones that can meet their needs.

Matching more consumers in digital media to the right clients for whom they convert into customers, gives us a huge structural media buying power advantage versus other platforms or versus any single client trying to afford to buy the same media.

In general, a single client can only match or serve a very narrow set of consumers in the vastness of digital media, making buy much of the media simply unaffordable without us, even if they have the ability to access its complexity.

This media buying power advantage is the most fundamental advantage of our business model and explains our indispensable role in the channel micro economically.

Clients understand our role and this advantages for them in the channel and they take and get advantaged from our aggregated buying power to access digital media more fully and more affordably. Number three, regarding our business model, QuinStreet has real and deep competitive advantages.

They are networked, experienced and technology-based advantages. The fact that we have real competitive advantages is evident from our success and ability to get to and sustain scale and profitability, and to do so for so many years through so many changes in cycles of competition in our channel.

But let me review the specifics of those competitive advantages with you. They are not branded traffic flows through our own web properties. That is the domain of others, like Lending Tree and HomeAdvisor, both of whom have done a great job with that strategy and both of whom are largely complementary to us in the channel.

Nor does our main competitive advantage lie in building vast amounts of free or organic traffic like say, Bankrate was able to do. That too is the domain of others, many of whom by the way are our media partners.

Our key competitive advantages are in two main areas, one in our networks or marketplaces; and two, in our experience and technologies for making those networks or marketplaces maximally productive from a marketing and media effectiveness point of view.

Regarding our networks or marketplaces, we know of no one that has broader reach and integrations into more types and sources of productive high intent consumer digital media than we do in and across our verticals.

Nor do we know of anyone that combines that vast reach experience and expertise in digital media with large networks of and integrations with clients that can serve the consumers in that media. We combine those networks of digital media sources and the clients that can serve them into highly productive virtual marketplaces.

We do so by applying what we believe are the world's leading technologies, products and platform designed specifically for that purpose. In fact, we are confident that our technologies are our industry's most extensive, advanced, effective and proprietary for doing so.

These technologies, products and platform include merchandizing flows, experience driven matching engines and artificial intelligence algorithms, fed with many years and billions of dollars of actual media buying results. They give us what we believe to be unsurpassed expertise and capability in this model, in this channel.

We apply that expertise and capability to best yield media and to generate strong sustainable revenue streams for our media partners and from our direct media buyers. In turn, we generate predictable, best-in-class at scale marketing results for our clients.

QuinStreet has always focused on technologies, products and platform as key competitive advantages. Over 30% of our employees are in engineering and technical roles and that has pretty much always been the case.

Our investment and expenses in building and making ongoing improvements to our technologies, products and platform have been compounded for 19 years and those quite substantial and still ongoing investments are embedded in the depth of those capabilities and as a significant competitive advantage in our business model.

We previously shared most if not all of what I just described. I hope it was helpful to review how it all fits together and that it helps explain our sustainability and success..

Ladies and gentleman that concludes our prepared remarks for today. Operator, please open the call for questions..

[Operator Instructions] We will go first to John Campbell at Stephens Inc..

Doug, great job going back to the business, I think that's always helpful to kind of refresh guys on that. But if you guys can maybe unpack the growth in Financial Services, Greg, I think you said all the large offerings did well, I'm sure insurance was the primary driver.

But was the -- can you maybe just talk a little bit about the excess growth may be coming out of mortgage and personal loans anything else?.

Yeah, John. Actually all of our businesses grew at pretty similar growth rates around the 79% total Financial Services growth. So there wasn't much variation between verticals. We saw strong growth across all of our businesses actually.

Yeah, insurance grew slightly faster than the overall average for Financial Services, but only slightly faster and we had a couple of businesses that are actually significant business than Financial Services that grew faster than insurance..

That's great.

And then maybe could you -- could you may be decouple how much of that is maybe coming from the new media strategies versus this clients just upping overall spend?.

Hard to separate, but I would say both vectors are working. We are seeing an awful lot of client momentum both naturally because of the need to shift to this channel but also a lot of client momentum driven by the fact that we can accommodate them in this channel and we can get even more better results for them. So it's kind of hard to separate them.

But certainly both are working for us..

And then one more and I will hop back in the queue.

But how much -- not that how much you guys can share at this stage -- but how much was the Progressive lift sequentially and then the remaining lift of insurance how much was that -- was larger clients versus just kind of broader base lift?.

You know John, Progressive itself was probably at a similar percentage of revenue that it has been in prior quarters, I think what you saw is yes a very strong quarter for progressive, but we also saw very strong quarter from a bunch of our other large clients that continued to spend and continued to shift spend to us because we deliver sustainable, measurable marketing results for them and they are working and so we are seeing growth across our entire client base pretty much..

I would add to that, the strong growth across the client base, generally and in insurance, in fact, we had our second largest insurance client which is also a very large client with us, grew significantly faster than Progressive did not just year-over-year but sequentially.

And so we are seeing acceleration in budgets across the board and Progressive continues to be, and I think we have to name them because their size continues to be an incredibly important client for us. But I think it would be a mistake to assume that that's the only driver of our business momentum..

I think there were -- I think may be 23 or so percent of revs last quarter, is that -- are you seeing a similar percent of total revs or similar percent of overall interest revs?.

So that present the total revs..

We will next to Jim Goss at Barrington Research..

Hi this Pat Sholl on for Jim Goss.

You guys eluded to sort of your -- the [indiscernible] your traffic was, wondering if you could walk us in a little bit more detail on how you guys were able to identify if it's sort of maybe not the best quality traffic and how you handle that in terms of ads surveying and just basically highlight a little bit more on that?.

The first and most importantly that gets audited is by the actual results it generates. We and as I emphasized in my opening remarks, we really are a performance marketing company.

So the notion that we would have a lot of traffic on our system that was unproductive for clients is just kind of -- just kind of shows a lack of understanding of how our business model works. We wouldn't get paid for that traffic because what we do for clients is right priced to the results we generate for clients.

So most importantly we see it in results that clients report back to us, including we give clients refunds for traffic that comes from sources that we and they have said we don't want in our system and we have that in our contracts of media and they have that in our contracts with us.

So we would actually have on an ongoing basis when that slips through, which isn't very often, given we give refunds for that. So that's the first and foremost most important way. We also have a lot of algorithms in place that are testing and looking for these kinds of changes in flows and types of flows and changes in performance on an ongoing basis.

That's part of the technology that I talked about in terms of understanding and having an understanding of the channel and we've learned over the years through a lot of fraud detection and qual detection. So even though we could give clients refunds for that traffic, we would rather never give it to them and they never have to deal with it.

And so that technology and those filters have gotten better and better over the years and are part of our ongoing technology solution.

The -- another way as we have third parties that we use and the clients use, they are specifically designed and have been developed over the past five to 10 years to improve the quality and the monitoring and the auditing of traffic networks to ensure compliance with regulatory guidelines, branding guidelines and other considerations.

And we utilize some of those ourselves and clients -- and many, many of our clients utilize those technologies and service providers since they are [crawling] our networks constantly as are we.

We also have a compliance team here and in our offices in India that does manual reviews, particularly when the technologies highlight potential issues in the network. So that's a service and a capability we have built over the past decade plus and have continued to invest in internal technologies and to use third-party technologies.

And I would add, we've gotten awards in our industry for our culture of compliance from a number of these [recognition] and actual awards from -- for these capabilities in our industry, because we do believe and we have proven to clients that it is something important to do. So those are the main ways we do it.

But it is a -- its integrated culturally into everything we do, because it so important to us and to our clients and to sustainability. But I would come back to point one. We get paid for the results that we deliver for clients. So even if we didn't filter it out, it would already be reflected in our revenue.

But we do filter out 99% plus and every time something does slip through we find it, kill it, don't pay the publishers, don't charge the clients. So that we are continuously improving the efficiency for us and for the clients rather than having to get it and then back it, back out again..

And on Education as for-profit and international continue to grow, would you ever sort of split those two up to sort of provide -- and maybe provide a little bit more on the trends within each of those two sub-categories in Education?.

Yes. I think we will as we get -- as particularly as international gets bigger, I think we certainly would. And I think historically we have sometimes given out those numbers separately. We may do that periodically any way. We are not intending to not show anything there.

We have seen good strong growth in our international Education business over the past few years. The period when we haven't seen it in the U.S. for-profit. So we may well do that periodically whether we break it out permanently, separately or not as we have in the past..

But was the international then the primary area of the growth within that sub-sector of Education?.

Actually it has been in past quarters over the past year. So but this quarter, it was not. The enrollment cycle in Brazil was actually out of sync this quarter or this past quarter of last year. And so Brazil, I think was actually down year-over-year….

Slightly..

In Education in the quarter slightly and the growth was actually in the -- driven by the U.S. business this quarter..

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

So I mean obviously insurance has grown in the past for you guys. I think it's one of the lower gross margin businesses for you. But it looks like you are still in pace to grow gross margins about 400 bps or so just this fiscal year.

Can you guys talk a little bit about what's kind of driving that underlying leverage and maybe how we should think about the pace of gross margin lift from here?.

I'm not sure it's completely accurate that insurance is one of our lower margin gross margin -- lower gross margin businesses.

That was the case a couple to few years ago when we were going through the initial implementations of the new products and media strategies, starting in insurance and we did drive down those gross margins pretty significantly in order to get traction and get through that transition as quickly as possible and to make sure we were meeting clients' needs while we were doing it.

But today insurance is actually a pretty strong gross margin business for a couple of reasons. First of all, we've gotten the media margins in insurance, despite the fact that we are growing at such high rates and often media margins lag revenue growth a little bit.

But we've actually been able to continue to bring the media margins up in insurance to just very close to our averages now, within a couple of points actually of our average now. And so that's our biggest component of course, the cost of services which of course would be helpful to gross margin.

The other characteristic of insurance of course it has great scale on a relatively small team, because it is our new product strategy driven primarily much more by technology and with clicks both of which require a lot lower expense level at the -- underneath media costs.

And so the team size in insurance relative to the scale of revenue and media margin profits if you will, is quite small. And so -- and I haven't seen the numbers, we have run the numbers for this year doing the planning cycle going into next year now.

But you know that combination of effects probably suggests that on the media margin -- on a gross margin basis, insurance is in the higher end today given that is pretty close now to our normal media margin and it has so much scale against such a relatively small people cost, which is of course kind of media costs and people costs side.

I would say that -- so that's where that is.

In general on gross margin lift, those are going to -- those themes are the ones to watch for and that is continuing to sustain our media margins, which have we have brought down a little bit over the past few years as we have made the transitions because you do have to do that as we transition these products and technologies.

But we have stabilized at a good level for us over the past three years or so on average and combining that with top line leverage so that as revenue comes in with those media margins that that most of that incremental margin falls to a much slower growing semi-fixed cost base.

And that you will continue to -- we expect to continue to see revenue growth and therefore media margin dollar growth to significantly exceeding semi-fixed costs, so that you get a natural expansion in the adjusted EBITDA or the general profitability lines of the company. And I think that that is what we continue to foresee.

It's not a pure formula, but it's pretty predictable and certainly on medium-term cycles, it's pretty predictable on a gross margin, I mean on media margin times revenue dropping down to semi-fixed costs base growing at a slower rate. I think that's going to be the dominant trend of our financial results as far as we can see for the next few years..

And then obviously media margins, the biggest driver of gross margins for you guys.

Any sense for kind of like what's the breakout of fixed versus variable costs within gross margin [here] today?.

It's probably around 80% variable costs in gross margin..

We'll go next to Stephen Ju at Credit Suisse..

So Doug, stepping back and looking at the bigger picture, it certainly feels like it's been a long road to recovery and it seems like it's pretty much the result of the seeds that you guys have started to sow in the Financial Services vertical, it seems like almost two years ago now.

So you touched on this briefly earlier on the international side, but can you talk about some of your emerging verticals and where you are focused today in perhaps allocating engineering resources, as you think about the next few years of growth for the company? Thanks..

I think that we are actually fairly early still in the full implementation of the new products and technologies across all of our Financial Services verticals. Believe it or not, we're still not fully implemented in insurance.

It's a long process, because it involves all the clients and all the media over time and getting all that right and getting the optimizations built, as we get it right. And then in fact, the job is never done in the optimization. So I would say that we -- in priority -- in terms of priorities we are pretty well implemented in insurance.

But relatively early in most of our other Financial Services verticals and very excited about what we see as the opportunities in those.

We are -- I would say over the next few months, you will see us with enough implementation in our two or three other large Financial Services verticals to begin to I think inflect the performance of those businesses pretty significantly.

And then we have one of our largest market opportunities where we haven't really done -- at the very front end of the curve of the new products and technology.

So I think dramatically, the priorities will continue to be, because of the momentum we're seeing getting the technologies and new products fully implemented across all the Financial Services verticals which represent a big -- our biggest business and a very large footprint of opportunity and continuing to drive scale growth there.

That said, we also have our Home Services business, which represents about half of the market opportunity of all -- of Financial Services for us, in terms of market footprint.

And we again are in the earliest stages of implementing our new products and technologies there, despite, the fact we've been growing that business 15% to 20% a year for the past several years. We're excited there, because we think the opportunity for the new products and technologies are as great or greater there given the competitive set.

I think it is not quite as strong with the exception of course of HomeAdvisor which is actually a good partner of ours and given the early penetration of that vertical. We are in notionally 10 to 12 sub verticals in Home Services. We think they are about 100 we can be in.

So we combined the vectors of getting the new products and technologies implemented with further penetration of the verticals or sub verticals we can be and those sub verticals might be windows, siding, kitchen remodels, home security.

We are pretty excited about the scale growth that can be represented by Home Services, which is about $30 million something new revenue business with us today, but we think can be a very large business. So that would be a very close -- if there's a second, a very close second to Financial Services, but we're working on both at the same time.

In Education, we actually pioneered many of these products and technologies in order to stabilize that business and deal with the extraordinary demands of that industry. So we execute pretty well on the new products and strategies there. That's been more encumbered as you know by changes in the -- in our client's markets.

But we are seeing are a shift in mix of clients to more not-for-profits and international business and more stabilization of the remaining for-profit clients, driven with us at least largely by the implementation of the new products and media strategies.

And so -- and now we are at the early stages of seeing some large clients actually engage in ways that are more like the Financial Services clients that have been successful with us and engage in terms of the full utilization of our new product and media strategies.

And that's pretty exciting for us and I think as I said in last call, [for being] in a position of saying I think on balance Education for us now has got more opportunity to the upside than risk to the downside. And thus I think I said the last call, that was the first time I felt that way in a long time.

And I would say I feel even more strongly that way given the last quarter's progress on that dimension. So that's -- I think that -- I think those are going to be the main drivers that we are still in a product [side] on the B2B business, which is relatively small. We are doing that and by -- while managing that at pretty much breakeven.

We're very excited about the journey to what we do in B2B like we do in consumer but that is even earlier because it's just the way that industry operates.

But we had some real good client wins this past quarter in that business with some very large branded technology company clients that are the kind of milestones you want to see on your way to getting that business in position to better provide scale of growth as well.

So broadly big footprint of market opportunity, lots of opportunity to execute what we know works and to get it implemented so that we can get the results and to drive scale growth..

Thank you..

Thank you, Stephen..

And that does conclude the question-and-answer session and today's conference call. To access the replay for today's call please dial toll free 888-203-1112 and use pass code 5951589 and pin number 5410. The replay will begin at 8:00 AM Pacific Time today and run through May 2, 2018. Thank you for your participation. You may now disconnect..