LookSmart Q3 Earnings Call Transcript

123jump.com Staff
10 Jan, 2009
New York City

LookSmart, an online advertising network reported revenue for the third quarter surged 37% to $15.4 million. Revenues from the advertiser network increased 39% to $13.9 million and revenue per click decreased to 8 cents from 12 cents. Net loss was $1.6 million or $0.10 a share.

LookSmart Ltd. ((LOOK))
Q3 2008 Earnings Call Transcript
November 3, 2008 5:00 P.M. ET

Executives

Laura Foster - Investor Relations
Edward F. West - President and Chief Executive Officer
Stephen Markowski - Chief Financial Officer

Analysts

Eric Martinuzzi - Craig-Hallum Capital Group LLC
Jon Hickman – MDB Capital Group LLC

Presentation

Operator

Good afternoon ladies and gentlemen, thank you for standing by. Welcome to the LookSmart Ltd. third quarter fiscal 2008 earnings conference call. During today’s presentation all parties will be in a listen-only mode. Following the presentation the conference will be open for questions. If you have a question, please press the “*” followed by the “1” on your touch-tone phone. Please press “*0” for operator assistance at any time. For participants using speaker equipment it may be necessary to pick up your handset before making your selection. This conference is being recorded today, November 3, 2008. I would now like to turn the conference over to Laura Foster. Please go ahead ma’am.

Laura Foster

Thank you. Good afternoon everyone and thank you for joining us today to discuss LookSmart’s third quarter 2008 results. On the call today from the Company are Ted West, President and Chief Executive Officer and Steve Markowski, Chief Financial Officer.

Everyone should have access to the press release that went out today at approximately 1:00 p.m., Pacific Time and 4:00 p.m., Eastern Time. If you have not received the release, it’s available on the Investor Relations portion of LookSmart’s website.
Before we begin today, we would like to remind everyone of the Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. The following remarks contain statements that are forward-looking, including statements about our expectations or projections regarding future results and plans for the business. It is important to remember that our actual results may differ materially from our expectations, projections or plans described in the forward-looking statements. A complete list of factors that may affect our business, future operating results and financial condition are on the risk factors and other sections of the SEC filings, including our Form 10-K for the year ended December 31, 2007 and our Form 10-Q for the quarter ended June 30, 2008.

Please note that in addition to discussing the GAAP financial results and outlook for the Company today, the Company will also discuss adjusted EBITDA, a non-GAAP financial measure. An explanation of LookSmart’s use of non-GAAP financial measures in this call and the reconciliation between GAAP and non-GAAP measures are included in the press release issued today.

Now with that, I would like to turn the call over to Ted West.

Edward F. West

Thank you Laura and good afternoon everyone. Thank you for joining us today as we review our third quarter 2008 results. We appreciate your time and continued interest in our Company.

With us today is Steve Markowski, LookSmart’s Chief Financial Officer. Steve joined us in August of this year and brings extensive financial, accounting and mergers and acquisitions experience to LookSmart. Steve is a 17-year veteran of Symantec, the multi-billion dollar security, storage, and systems management solutions company where he most recently served as Vice President of Finance and Chief Accounting Officer. During this time, Steve was instrumental in driving Symantec’s corporate development and growth and shareholder value including executing and integrating the Veritas acquisition.

Steve has spent the past several months at LookSmart ramping quickly into the CFO position. He has already acquired a lot of valuable knowledge about our search advertising network’s business, its policies and practices, our operations and our finances. We are pleased at Steve’s financial and M&A expertise to LookSmart team and we share his enthusiasm for growing LookSmart’s business and value.

Following my remarks, Steve will provide a more detailed review of our third quarter financial results later on this call.

I will start today’s call with a discussion of LookSmart’s decision within the search advertising marketplace, particularly in the context of the current global economic environment. These are serious times as all of you are acutely aware. The current turbulence in our global capital markets and economy has contributed to dramatic reductions in consumer confidence, softened consumer demand, and reduced spending across many, many categories of consumer goods and services. A widespread impact of this recession is already being felt in local and global markets across most industries including the advertising industry and by business organizations and their shareholders, management, employees, and local community. Perhaps the only positive statement that we can make about this market environment is the demand for search advertising where LookSmart has positioned and strictly focused and we believe should remain relatively stable compared to virtually all other forms of advertising including online display advertising.

Search advertising offers advertisers a low-risk means to attract pre-qualified customer leads at highly competitive customer acquisition costs, especially in lean times like these advertisers are highly motivated, in fact they are mandated to drive new customer leads to their businesses. Assuming that consumers will continue to utilize search to query products and businesses, to shop and buy online search advertising should continue to grow, and in fact research analysts at JPMorgan recently projected that search advertising, which has grown 23% in spending during 2008 will continue to grow at double-digit rates or 17% in 2009.

That said, these are uncharted waters for search advertising companies like LookSmart. We cannot easily predict the future of the economy nor the search advertising market. But what we can do and will do is to remain committed to strengthening our competitive position within the search advertising network’s marketplace and to enhancing the value proposition we deliver to search advertisers.

We will remain realistic about our near-term prospects, discipline in our actions, and prudent in our investments.

Turning now to LookSmart’s third quarter results, our results are solid year over year looking back to the third quarter of 2007 but disappointing sequentially compared with the second quarter of 2008. While these results demonstrate that LookSmart is neither immune to the softening economy nor to normal third quarter seasonality, we did deliver year over year double-digit revenue growth for the fourth consecutive quarter.

Total revenues increased 37% to $15.4 million in the third quarter of 2008, up from $11.3 million in the prior year period. Revenues with our advertiser network customers increased 39% t $13.9 million compared to $10 million in the prior year. Similar to the second quarter of this year, LookSmart’s third quarter revenue in the advertiser network were impacted by a reduction in ad spend among a few of our larger volume advertisers. To some degree this was to be expected due both traditionally to a softer seasonal demand in the third quarter as well as to the challenging macro environment. But too, rising industry standards for quality in search queries also impacted these large advertisers and some of our distribution partners within the advertiser network in the third quarter.

Search advertisers are placing increasing importance on the fundamental value relationship between search query quality, paid clicks, customer conversions from those clicks and the price-per-click. They are seeking better performance measure by increased conversion rates at lower costs per click. This is what we would expect of any performance advertising medium in lean economic times like these. Therefore, LookSmart is committed to maintain and enhance the quality and value of our search advertising network.

We continue to focus on adding high quality distribution partners to our ad network here in the US, as well as in international markets including the UK and Australia. We believe it is essential that we meet and exceed these rising standards for search query quality and return on investment for our search advertisers even if it leads us in the short term to volatility in ad revenues with some of those large advertisers. Ultimately, our policy focused on quality will strengthen LookSmart’s competitive position and market share within the search advertising network’s market as the economy and search ad spending recover in the longer term.

Specifically, in our quest for quality assurance across our network we have announced a partnership with Click Forensics, the industry leader in scoring, auditing and improving traffic quality for search advertisers. Through this partnership LookSmart receives third party reports which we leverage to improve speed and flow of feedback from our advertisers on the quality performance and value derived through our advertiser network. We are evaluating other third party tools and reports to improve real-time quality monitoring of our publishers on a network as well.

Revenues from our Publisher Solutions customers increased 15% to $1.5 million during the third quarter of 2008, up from $1.3 million in the prior year. The year-over-year growth primarily reflects the revenue contribution from our IAC, Ask Sponsored Listings or ASL partnership. We are pleased to report that since the restructuring of ASL’s search monetization and internal reorganization during the second quarter, which we had reported previously, had affected our second quarter revenues. The business has been restored to previous levels which have been maintained throughout the third quarter. We plan to continue to work closely with ASL to improve our mutual revenue results and to provide them with platform service and support levels through our contract term on December 31, 2009.

As you will recall from our second quarter report we’ve also undertaken a comprehensive review of our Publisher Solutions customers and we have decided to focus our efforts on growing revenues generated across our licensed AdCenter platform with fewer higher potential AdCenter licensees such as ASL as well as a few additional AdCenter publishers.

In addition to the AdCenter platform license relationships with select publishers LookSmart has innovated a publisher facing business model to market, build, and launch vertical managed networks. Vertical managed networks offer LookSmart the opportunity to leverage our AdCenter technology platform to build and operate private label, syndicated search advertising networks. In this model, we aimed at more value by selling to advertisers and servicing publishers while recognizing the search revenues generated through these vertical syndicated networks.

I am excited to announce that today we have officially launched our first vertical managed network with the brand leader in the entertainment vertical segment. As the network is to be fully branded in the name of our partner, we are under agreement not to disclose that partner by name, but I can report now that we have sold a growing list of advertisers and set up a growing list of syndicated publishers to start driving consumer search queries to advertisers across this vertical network. We do expect this business to ramp over time from here. We are currently prospecting other syndicated networks across high value verticals and geographies and we plan to move prudently to develop and expand with these in 2009.

LookSmart will continue to focus on search advertising networks in its business strategy. We’ll continue to aggregate non-proprietary search queries from a variety of high quality search engine sources and match them with search keywords and advertiser budgets across the LookSmart advertiser network, the ASL and other private label networks and third party branded vertical managed networks utilizing the LookSmart AdCenter platform technology

We estimate that in this third quarter the LookSmart AdCenter search advertising platform operating our own advertiser networks as well as those networks of our Publisher Solutions customers including ASL delivered $338 million on adjusted paid clicks to search advertisers. This represents a doubling of paid-click volume from the third quarter of 2007 and a 5% increase over the second quarter of 2008.

Our third quarter results reflect the expense impacts of several strategic investments that we believe better positions LookSmart’s future growth and market share gains. First, we announced the re-branding of LookSmart, which we unveiled at the 2008 Search Engine Strategies conference in San Jose this August. LookSmart has a strong industry brand and a long operating history and while we are certainly respectful of that history, our new corporate identity energizes our brand as we position LookSmart with a clear focus on search advertising networks and LookSmart’s core proposition to search advertisers of smart choices made easy.

Our new look includes a redesigned logo and website and our new messaging is integrated throughout our media and investor communications materials. We were also surprised and delighted at SES to receive recognition at the conference that our AdCenter platform was recognized as the best search advertising platform in a competitive field of direct competitors in search advertising networks.

Second, as I mentioned we invested during the third quarter in the pre-launch development of our first vertical managed network for syndicated publishers and search advertisers.

And third, we have incurred in the third quarter, one-time costs around the reorganization of LookSmart that we are confident has resulted in a stronger, more focused advertiser networks platform and a more effective structure to the development of our vertical managed network strategy. Taking together these marketing and restructuring investments made during the third quarter and while impacting our current profitability are essential to build a brand for long term and to establish a stronger business platform built for economic recovery and longetivity.

Our net loss from continuing operations for the third quarter was $1.6 million or $0.10 per diluted share, an improvement from $4.3 million or $0.19 in the prior year period but a decline from $40,000 or $0.01 per share diluted in the second quarter of 2008.

We are keenly focused on applying stringent cost controls at LookSmart. However, we are balancing strict control while ensuring that we have the proper infrastructure and resources in place to grow the organization through these challenging times. With this perspective in mind, we are managing LookSmart towards the goal of achieving cash flow breakeven and we believe that given the current environment this approach is both appropriate and most prudent. So with that, I’ll now turn the call over to Steve to provide more detail around our third quarter financial results. Steve.

Stephen Markowski

Thanks Ted and good afternoon everyone. Before getting to the results I would like to express how delighted I am to be part of LookSmart team. This is a very exciting and dynamic time for LookSmart and I look forward to leveraging my financial background and experience to help lead the finance organization. The finance team will be working closely with the rest of the company to maintain tight financial control and employ diligent expense management. In the coming months I also look forward to speaking with many of you in the investment community.

As we discuss our third quarter results, please keep in mind that the results for the current and prior period exclude certain consumer assets that were sold or repaired during 2007 that are now reported as discontinued operations.

Total revenue for the third quarter was $15.4 million, which represents a 37% increase from $11.3 million in the third quarter of 2007 and a 10% decrease from $17.1 million in the second quarter of 2008.

Revenues from the advertiser network increased 39% to $13.9 million from $10.0 million in the third quarter of 2007. Our revenues from the Publisher Solutions business increased 15% to $1.5 million from $1.3 million in the third quarter of 2007 and a 12% increase from $1.3 million in the second quarter of 2008.

Gross margins for the third quarter were 40% versus 44% in the third quarter of 2007 primarily due to higher traffic acquisition costs or TAC. Traffic acquisition costs of 62.5% for Ad Network increased from the 59.0% rate in the third quarter of 2007, and from the 61.9% rate in the second quarter of 2008. During the third quarter we continued to manage TAC slightly higher consistent with our network quality enhancement initiatives and in order to expand the scope and scale of our advertising network.

Paid clicks on our LookSmart advertiser networks were approximately 184 million for the third quarter of 2008, an increase of approximately 122% from 84 million in the third quarter of 2007 and a decrease of approximately 5% from 193 million in the second quarter of 2008.

During the third quarter our ad networks continued to benefit from ongoing sales, distribution partner, and ad network optimization efforts as compared to the prior year.

Revenue per click or RPC for the third quarter of 2008 decreased to approximately $0.08, from $0.12 in the third quarter of 2007, and remained consistent with the second quarter of 2008.

Operating expenses for the third quarter were $8.1 million, which includes approximately $211,000 of severance expense and non-cash, share-based compensation charges of approximately $0.7 million. During the third quarter of 2008 we also incurred costs related to two important initiatives that Ted mentioned previously, namely the corporate branding effort and our vertical managed network strategy. This compares to operating expenses of $8.4 million in the third quarter of 2007, which included approximately $0.2 million of restructuring costs, $0.7 million of severance expense and approximately $0.6 million of non-cash, share-based compensation charges. Operating expenses for the second quarter of 2008 were $7.1 million, which included approximately $0.6 million of non-cash, share-based compensation charges.

The loss from continuing operations for the third quarter was approximately $1.6 million compared to a loss from continuing operations of $2.9 million in the third quarter of 2007. Net loss, which includes discontinued operations, was $1.6 million for the third quarter of 2008 or $0.10 per diluted share compared to a net loss in the third quarter of $4.9 million or $0.19 per share.

Net loss in the second quarter of 2008 was $176,000 or $0.01 per share. Net loss for the second quarter of 2008 included a gain of approximately $220,000 from the sale of the Wise Not domain name approximately $135,000 of lease restructuring credits and impairment charge of $381,000. The EPS amounts, earnings per share amounts are based on 17.1 million, 22.9 million, and 17.1 million weighted average shares outstanding in the quarters ended September 30, 2008, September 30, 2007, and June 30, 2008.

On a non-GAAP basis, for the third quarter of 2008, adjusted EBITDA from continuing operations or earnings before interest, taxes, depreciation and amortization excluding stock based compensation and income or loss from discontinued operations was a loss of $444,000 compared to a loss of $2.3 million in the third quarter of 2007. Please note that these non-GAAP financial measures are not a substitute for GAAP presentation and an explanation of our use of non-GAAP financial measures and their limitations along with the reconciliation between GAAP and non-GAAP where appropriate were included in our earnings release.

Turning to the balance sheet our total cash, cash equivalents and investments were $30 million at the end of the third quarter, a decrease of $4.4 million from $34.4 million in the second quarter of 2008, primarily reflecting the decrease in cash flow from operations and related to the timing of some account receivable collection from a few key customers.

On a per share basis, our total cash, cash equivalents and investment balance was $1.76 as of September 30, 2008. Accounts receivable at September 30 were $9.9 million, a $5.5 million increase from $4.4 million at September 30, 2007. We did collect approximately $3.2 million of our account receivable balance immediately after quarter end. We believe that our existing customer base is healthy and our accounts receivable agent is in a good position.

Our 2008 third quarter capital expenditures including capitalization of internally developed software remained constant with the second quarter of 2008 at $1.2 million, an increase of $0.7 million from $0.5 million in the prior year period.

Depreciation and amortization was $0.8 million in the third quarter of 2008 compared to $1.2 million in the third quarter of 2007.

At the end of the third quarter, LookSmart had approximately 17 million shares of common stock outstanding. Pursuant to the company’s stock repurchase program, the company did not repurchase any additional shares of its common stock during the second and third quarters of 2008 and at 2.2 million available for share repurchases through the open market at prevailing prices or in a privately negotiated transaction. That concludes my remarks. I’d now like to turn it back over to Ted.

Edward F. West

Thanks Steve. As we discussed these are challenging times for any business including those in search advertising and LookSmart is no different. At LookSmart we are focused on operating a disciplined company capable of strengthening its search advertising network’s market position and of conserving its cash resources in order to come out of the market recession as a stronger player positioned for extraordinary growth in our recovery cycle.

Looking ahead to the remainder of 2008 and into 2009 we remain committed to our long-term strategy and growth prospects for LookSmart’s search advertising network’s business and we are confident in our ability to drive value for our shareholders. Our financial position is solid. We have a defined strategy in place and we are appropriately structured and led to execute it.

And with that, I’d like to turn the call over to the operator to take your questions.

Question-and Answer-Session

Operator

Thank you sir. We will now begin the question-and-answer session. As a reminder, if you have a question, please press the “*” followed by the “1” on your touch-tone phone. If you are using a speakerphone today, you’ll need to lift the handset before making your selection. One moment please and our first question comes from the line of Eric Martinuzzi with Craig-Hallum Capital Group. Please go ahead.

Eric Martinuzzi - Craig-Hallum Capital Group LLC

Thank you and welcome to Steve. Congratulations on your new position.

Stephen Markowski

Thank you Eric.

Eric Martinuzzi - Craig-Hallum Capital Group LLC

You talk about – there is consumer issues replaying across the economy and then ultimately to LookSmart. You also mentioned some quality initiatives within the industry and in your customer base. Can you talk about – just focusing first on the consumer issues, and then second on the quality as to when those impacted you in Q3?

Edward F. West

Yes, I think Eric, this is Ted and we’ll share the responses here. The consumer issues that we experienced in Q3 we started to see in July and August attributed to a seasonality, which is pretty normal. We are also very conscious in certain vertical categories of some softening of consumer demand and therefore for consumer queries as we looked into the fall period, typically and seasonally a bounce back period. I think we ran into the teeth of a softening larger picture. So the seasonality bump that we might have projected didn’t materialize at least at the levels that we would have expected from prior experience and we saw the – in fact we saw some increase but not at the levels that we have seen before. So we kind of ran a soft quarter month-to-month-to month for different sets of reasons in the third quarter.

On the quality side, I think we started to see some evidence in the marketplace in the second quarter and then further in the third quarter where some of our large customers who were doing business themselves with large advertiser aggregators were starting to see higher quality demands placed on their products and on their network sources for queries which came back at the margin, came back to impact the LookSmart network where we clearly sourced queries from a wide range of sources and the qualities and blend them to deliver valuable returns for advertisers but in our rising standard field we found ourselves needing to re-look some aspects of our network and to basically replace queries with higher quality queries.

Eric Martinuzzi - Craig-Hallum Capital Group LLC

Okay. What is Click Forensics? I assumed you had this service running for a while, what are you learning from that?

Edward F. West

Well, Click Forensics gives visibility into the advertiser’s experience and not just the advertiser’s experience with our own network but from a variety of different query sources. That visibility comes therefore more broadly, more comprehensively and faster. It allows us to evaluate different sources of search queries in a more systematic way. It adds to the systematic methods that we have been using but because the visibility is not through our own experience but through the experience of many other advertisers it gives us faster visibility.

Eric Martinuzzi - Craig-Hallum Capital Group LLC

Okay and then I know you are not at a point where you are comfortable giving guidance but a year ago, in Q4 of ’07, we were pretty close to break even, I know seasonality is out of the window given the current macro economic issues but what are we looking at for Q4? Do you expect to burn cash from where you sit right now?

Edward F. West

I think broadly speaking Eric the way to answer that question is I want to repeat the words uncharted waters. It’s very difficult without the benefit of history looking at a soft cycle in the business which is going through its first soft cycle to know exactly what the impact of this economic period will be on our business. Historically, we would expect to see fourth quarter seasonal improvements. I have already suggested that we did not see what we have historically seen in September in the third quarter. So, it’s fair to say that all cards are up and we are working through the first soft fourth quarter in our history and in the history of search advertising. Because of that, I will say to answer the second part of your question and I am very proud of the team in this regard we have anticipated a challenging period. We have battened down the hatches, hunkered down if you will from an expense point of view and while we did allow investments that we had planned to make that were of strategic value to us in the third quarter like the marketing re-branding expense investment, like the launch of the first vertical managed network, those expenses are not going to carry forward in this dramatic way in the fourth quarter, in fact quite the contrary, I think we have battened down the hatches to give ourselves the best possible shot at cash neutrality that we can get.

Eric Martinuzzi - Craig-Hallum Capital Group LLC

Thank you.

Operator

Thank you. Our next question comes from the line of Jon Hickman with MDB Capital Group. Please go ahead.

Jon Hickman - MDB Capital Group LLC

Hey Ted. I want to twist your arm one more time there. Out of those investments that you made and you said aren’t going to go forward at the same level, can you give us some kind of number of – like were they $0.5 million because revenue – operating expenses were up a $1 million from the second quarter.

Stephen Markowski

Yes, this is Steve. So, certainly part of it is just straight margin. We also explained and called out severance expense a little over 200,000 and I would say that the investments in vertical managed networks in re-branding were also in that neighborhood and so, what I think Ted is talking about isn’t necessarily specifically about certain buckets of money because if we believe vertical managed networks to be something we want to invest in we will continue to invest in that. I think its reference would be to the entire operating expense levels as something we would not be targeting on a go-forward basis, meaning that we would expect that to be lower.

Jon Hickman - MDB Capital Group LLC

Yes, my question is how much.

Stephen Markowski

And we are not giving guidance. We basically are explaining and calling out what pieces were different about this quarter versus the prior quarters and what we intend to invest in but we are not giving guidance at this time.

Jon Hickman - MDB Capital Group LLC

Okay. Now, I have one more question. You know your new vertical network in the entertainment business, so the company you are now working with does now want their name out there because –

Stephen Markowski

Because of the private label, they are the leader in the industry segment. There is the private label arrangement. The key, and this is going to be the case in many instances in the vertical partnerships, the key to success is that our partner leveraging their business and brand relationships with the community as what we would refer to as advertisers and publishers and we agreed collectively and came to agreement in putting the business contracts together that the most effective way to go to market was effective with (inaudible) pure private label blind basis. We provide the infrastructure and we provide the network management capabilities. We support the sale-to-servicing efforts but under the brand of the partner entirely.

Jon Hickman - MDB Capital Group LLC

So people out there will be able to see this new brand. They just don’t want to know exactly where it’s coming from.

Edward F. West

It’s not a new brand. It’s actually a very familiar brand. It’s familiar within the vertical category.

Jon Hickman - MDB Capital Group LLC

Okay.

Edward F. West

So, you can imagine you can make up your own examples. I don’t want to suggest anything but picking it for examples but imagine a leader within a vertical category with a very strong media brand who has substantial access to both advertisers and publishers bringing a new networking capability, a new community, it’s called a text advertising network capability to the market within its community and generating a fresh lead generation and revenue generation opportunity for its community of interest under its brand. The difficulty is that partner doesn’t know how to build and run a text advertising network, we do. So we provide the infrastructure and the service and the capabilities to help them accomplish that. Some by the way have tried to do this on their own and others have in the display advertising business have actually worked with providers like LookSmart but those who specialize in display advertising to create syndicated branded networks like this as well.

Jon Hickman - MDB Capital Group LLC

Okay. So do you expect revenues from this in the fourth quarter?

Edward F. West

I would tell today that we have been recognizing our first revenues, yes.

Jon Hickman - MDB Capital Group LLC

Okay. Thank you.

Operator

Thank you and at this time we have no further questions. I would like to turn the call back over to Ted West for any closing remarks.

Edward F. West

Okay, very good. Thank you very much and thank you all for joining us today. Before I end the call I would like to invite all of you who are able to do so to experience the new look and feel of LookSmart first hand this week. We are showing at ad:tech in New York at the Hilton Hotel in Manhattan where we are an exhibitor and we are also excited to announce that we will be participating in the NASDAQ Closing Bell Ceremony this coming Friday, November 7th. The ceremony is set to take place a few minutes prior to 4:00 P.M. Eastern Time and can be viewed online at www.nasdaq.com. We are very excited to wave the flag to LookSmart at that occasion. Well, thank you very much again for your interest and we will be in touch with you soon.

Operator

Thank you. Ladies and Gentlemen, this concludes the LookSmart Ltd. third quarter fiscal 2008 conference call. This conference will be available for replay after 4:00 P.M. Pacific Time today through November 17th at midnight. You may access the replay system at any time by dialing 1-800-406-7325 or 303-590-3030 and entering the access code of 3930307. Thank you for your participation. You may now disconnect.