MARCHEX INC annual report, FY2011

Marchex, Inc. Form 10-K Summary

Business context and reporting period

Marchex is a digital call advertising and small-business marketing company offering pay-for-call, call analytics, pay-per-click, cost-per-action, small-business solutions and proprietary local-information websites. The filing covers the fiscal year ended December 31, 2011. The fourth quarter ended December 31, 2011 generated revenue of $39.0 million and net income of $1.0 million.

Marchex operates as a single segment, primarily in domestic markets. AT&T was the largest customer and reseller partner, contributing 31% of 2011 revenue. The five largest customers represented approximately 50% of revenue.

Financial performance and key metrics

Metric	2011	2010	Change
Revenue	$146.7 million	$97.6 million	Up 50%
Income from operations	$6.0 million	$(3.8) million	Improved by $9.8 million
Net income	$3.0 million	$(3.0) million	Improved by $6.0 million
Net income applicable to common stockholders	$2.7 million	$(3.2) million	Improved by $5.9 million
Basic and diluted EPS	$0.08	$(0.10)	Improved by $0.18
Cash flow from operations	$16.8 million	$9.4 million	Up $7.4 million

Operating margin was approximately 4.1% in 2011 versus negative 3.9% in 2010. Net margin was approximately 2.0% versus negative 3.1%. Fourth-quarter revenue was $39.0 million, operating income was $2.0 million and net income was $1.0 million.

Partner and other revenue increased from $71.5 million to $126.2 million, driven primarily by call advertising, small-business solutions and the Jingle acquisition.
Proprietary website revenue declined from $26.0 million to $20.5 million and represented approximately 14% of total revenue in 2011, versus 27% in 2010.
Service costs were $81.8 million, or 56% of revenue, compared with 59% in 2010.
Sales and marketing expense was $15.4 million, or 11% of revenue; product development expense was $22.8 million, or 16%; and general and administrative expense was $22.7 million, or 15%.
Stock-based compensation increased to $15.1 million from $10.8 million.
Gain on sales and disposals of intangible assets was $9.4 million, compared with $6.8 million in 2010.

Balance sheet, liquidity and capital resources

Cash and cash equivalents were $37.4 million at December 31, 2011, substantially unchanged from $37.3 million at year-end 2010.
Working capital was $16.2 million, down from $47.3 million, primarily because of $35.2 million of current deferred acquisition payment liabilities related to Jingle.
Total assets increased to $220.1 million from $159.7 million, largely reflecting the Jingle acquisition and resulting goodwill.
Total liabilities increased to $61.1 million from $20.0 million. Stockholders’ equity increased to $159.0 million from $139.7 million.
Marchex had no borrowings under its $30 million senior secured revolving credit facility and had the full $30 million available at year-end. The facility matures April 1, 2014 and is subject to customary covenants.
Contractual obligations totaled $56.8 million, including $35.6 million of deferred Jingle consideration and $14.0 million of operating lease obligations. Future Jingle payments may be settled in cash, Class B common stock or a combination, at Marchex’s option; stock settlement increases the shares issued by 5%.
Operating cash flow was $16.8 million. Investing cash flow was negative $10.4 million, principally because of the Jingle acquisition and capital expenditures, partly offset by proceeds from intangible-asset sales. Financing cash flow was negative $6.3 million, including $6.2 million of share repurchases and $2.9 million of dividends.
The company paid a quarterly dividend of $0.02 per share, or $0.08 annually, and stated that it expected the annual dividend to remain approximately $0.08 per share subject to capital availability, with no assurance of continuation.

Material changes versus the prior comparable period

Marchex acquired Jingle Networks on April 7, 2011 for approximately $16.6 million in cash, $7.6 million in Class B stock and $34.7 million of discounted future consideration. Jingle contributed approximately $17.0 million of indirectly attributable revenue from pre-existing customers during 2011.
Goodwill increased by approximately $47.3 million to $82.6 million, and acquired intangible assets increased to $8.1 million from $1.6 million.
Operating results moved from losses in 2010 to profitability in 2011, supported by revenue growth, the Jingle acquisition and higher gains on intangible-asset sales.
Acquisition-related costs of $1.9 million and higher amortization of acquired intangibles reduced 2011 earnings.
Accounts receivable increased to $30.6 million from $20.2 million. AT&T accounted for $11.3 million, or 37%, of year-end accounts receivable.
Marchex repurchased approximately 883,000 Class B shares for $6.2 million in 2011 and increased the authorized repurchase program to 12 million shares in aggregate, less prior repurchases.

Guidance, outlook, management commentary, risks and unusual items

Management expects near-term sales and marketing, product development and general and administrative expenses to remain relatively stable in absolute dollars, while longer-term spending may increase with platform investment, personnel growth and expansion.
Management expects distribution-partner payments and service costs to rise in the near term as partner-network revenue and network investment increase. More favorable margins may result if proprietary website revenue represents a larger share of operations, although management expects that source to remain under pressure in the near term.
The company stated that existing cash, operating cash flow and credit availability should fund operations for at least twelve months, but additional financing may be needed for acquisitions, long-term obligations or strategic initiatives.
Marchex was evaluating strategic alternatives for certain pay-per-click products and websites, including potential divestitures. The filing does not provide a definitive transaction or proceeds estimate.
Key risks include customer and reseller concentration, dependence on AT&T and other distribution partners, pricing pressure, seasonality, economic sensitivity of advertising budgets, mobile-market adoption, traffic quality and fraud, technology or hosting outages, data-security breaches, intellectual-property claims, telecommunications and privacy regulation, and potential impairment of goodwill or other intangible assets.
The company reported an accumulated deficit of $137.8 million despite 2011 profitability and has historically incurred significant net losses.
Net deferred tax assets were approximately $49.1 million at year-end, including a $4.6 million valuation allowance for certain state, city and foreign tax attributes. Future changes in projected taxable income could affect realizability.
The Jingle purchase-price allocation remained preliminary, including limitations on acquired net operating loss carryforwards. No goodwill or intangible-asset impairment was identified in 2011.
KPMG issued unqualified opinions on the financial statements and internal control over financial reporting. Management concluded that disclosure controls and internal controls were effective as of December 31, 2011.

Most important facts for investors to verify

Whether revenue growth following the Jingle acquisition is sustainable and how much is attributable to acquired versus organic operations.
The renewal terms, economics and concentration risk of the AT&T relationship and other major customer and distribution-partner arrangements.
How the $35.6 million of deferred Jingle consideration will be funded and whether settlement in stock could dilute existing holders.
Accounts-receivable collectability, particularly the $11.3 million owed by AT&T and exposure to financially stressed advertising partners.
Whether gains from sales of intangible assets are recurring or nonrecurring and the underlying profitability excluding those gains.
The realizability of approximately $49.1 million of net deferred tax assets and the impact of future tax-attribute limitations.
Potential goodwill or intangible-asset impairment, given goodwill of $82.6 million and the acquired intangible assets’ relatively short amortization lives.
Continuation of the $0.08 annual dividend and share-repurchase program in light of acquisition obligations, operating needs and capital availability.