MARCHEX INC quarterly report, Q1 FY2013

Marchex, Inc. Form 10-Q Summary

Reporting period: Three months ended March 31, 2013, with comparative results for the three months ended March 31, 2012. Financial statements are unaudited. Marchex operated mobile performance and call advertising, call analytics, local leads, pay-per-click advertising, and proprietary website traffic businesses. The company was pursuing a proposed tax-free separation of its Call-driven business and Archeo domain and click-based advertising business.

Key Financial Metrics

Metric	Q1 2012	Q1 2013	Change
Revenue	$35.5 million	$36.2 million	2% increase
Operating income (loss)	$(0.6) million	$0.2 million	Improved
Income (loss) before taxes	$(0.8) million	$0.2 million	Improved
Net income (loss)	$(0.7) million	$0.1 million	Turned profitable
Net income (loss) applicable to common stockholders	$(0.8) million	$0.1 million	Turned profitable
Basic and diluted EPS	$(0.02)	$0.00	Improved
Cash flow from operations	$4.0 million	$2.1 million	46% decrease

Revenue mix: Partner and other revenue increased from $31.4 million to $34.3 million, primarily from call advertising. Proprietary website traffic revenue declined from $4.0 million to $1.9 million, primarily due to lower cost-per-action and pay-per-click activity.

Margins and expenses: Service costs increased 7% to $21.4 million and rose to 59% of revenue from 56%. Product development increased 14% to $6.9 million, or 19% of revenue. Sales and marketing declined 26% to $2.8 million, and general and administrative expense declined 22% to $4.8 million. Total operating expenses declined slightly to $37.3 million, or 103% of revenue, from $37.5 million, or 106%.

Other items: The company recognized a $1.4 million gain on sales and disposals of intangible assets. Amortization of acquired intangibles declined to $1.1 million from $1.5 million. Stock-based compensation declined to $1.9 million from $3.9 million. Acquisition and separation-related costs were $0.3 million compared with a $0.1 million benefit in the prior-year quarter.

Balance Sheet, Liquidity and Debt

Cash and cash equivalents were $17.1 million at March 31, 2013, up from $15.9 million at December 31, 2012.
Accounts receivable increased to $28.6 million from $26.0 million.
Total assets were $152.4 million and total liabilities were $27.6 million at March 31, 2013.
Stockholders’ equity was $124.8 million; accumulated deficit was $172.9 million.
The company had no borrowings under its $30 million senior secured revolving credit facility and reported $30 million of availability. The facility matures April 1, 2014.
Contractual obligations totaled $16.0 million, including $11.4 million of facility leases and $4.6 million of other contractual obligations. Tax contingencies of $0.3 million were excluded from this schedule.
Management stated that existing cash, credit availability, and operating cash flow should fund operations for at least twelve months, although additional financing may be required for acquisitions, long-term obligations, or the proposed separation.

Cash Flow and Capital Allocation

Operating cash flow was $2.1 million, compared with $4.0 million in Q1 2012. The decline reflected higher accounts receivable and lower non-cash adjustments.
Investing activities provided $0.5 million, including $1.4 million of proceeds from intangible asset sales offset by $0.8 million of capital expenditures.
Financing activities used $1.5 million, primarily for $1.4 million of tax withholding related to vested restricted stock awards and $0.1 million of Class B share repurchases.
The company repurchased approximately 31,000 Class B shares for $119,000 during the quarter. The repurchase program authorized up to 13 million shares in aggregate, subject to conditions.
All four 2013 quarterly dividends had been accelerated and paid in December 2012. The company stated that future dividends were not assured and were expected to transition to Archeo if the separation occurred.

Material Changes Versus Q1 2012

Call-driven revenue increased from $26.7 million to $31.1 million, while Archeo revenue declined from $8.8 million to $5.1 million.
Revenue growth was driven by higher national advertiser budgets and additional small-business accounts using call analytics, partly offset by lower pay-per-click spending and fewer advertisers.
Profitability improved primarily because of revenue growth, lower sales and marketing expense, lower general and administrative expense, reduced stock-based compensation, and lower amortization.
Operating cash generation weakened despite the return to profitability, largely because accounts receivable increased by $2.9 million during the quarter.
Management changed segment reporting in late 2012 to reflect the planned separation into Call-driven and Archeo segments.

Guidance, Outlook, Risks and Unusual Items

Management expected proprietary website traffic revenue to remain modestly lower to similar in the near term and expected partner revenue and distribution-related service costs to increase as a proportion of revenue.
Product development expense was expected to remain relatively stable in the near term, while sales and marketing and general and administrative expenses were expected to be stable or modestly higher or lower, respectively.
The proposed separation was expected during 2013 but remained subject to board approval, regulatory approvals, favorable tax rulings or opinions, further diligence, and effective SEC filings. Completion, timing, and terms were not assured. Additional separation costs were expected.
Customer and partner concentration is significant. YP represented 25% of Q1 2013 revenue and ADT represented 12%; the five largest customers represented approximately 57% of revenue. YP and ADT represented 33% and 15% of accounts receivable, respectively.
The company had $17.8 million of net receivables from YP, certain other reseller partners, and ADT, representing a significant portion of total receivables. Changes in YP’s ownership or spending could materially affect revenue and liquidity.
Goodwill totaled $65.8 million, including $63.3 million in Call-driven and $2.5 million in Archeo. The company recorded a $16.7 million Archeo goodwill impairment charge in Q4 2012 and warned that additional impairment charges could result from weaker performance, cash flows, market conditions, or stock-price declines.
Net deferred tax assets were $28.5 million, offset by a $22.2 million valuation allowance. Changes in projected taxable income could require additional valuation allowances and tax expense.
Key risks include dependence on distribution partners and major advertisers, seasonality, advertising-budget reductions, invalid traffic and advertiser credits, competition from larger platforms, telecommunications and privacy regulation, intellectual-property claims, technology outages and security breaches, and the need for additional financing.
The company reported no material legal proceedings and stated that disclosure controls and procedures were effective as of the evaluation date.

Investor Verification Points

Verify whether the proposed Marchex-Archeo separation was completed, delayed, or modified and quantify associated costs.
Monitor YP and ADT revenue, receivable balances, contract terms, and payment performance given the concentration risk.
Assess whether call-advertising growth can offset continuing declines in proprietary website and pay-per-click revenue.
Reconcile operating cash flow with net income and track accounts receivable, collections, advertiser credits, and working-capital requirements.
Review the April 1, 2014 credit-facility maturity, covenant compliance, and the company’s need for refinancing or additional capital.
Evaluate potential goodwill, intangible-asset, and deferred-tax-asset impairment or valuation-allowance charges.
Confirm future dividend policy, particularly in connection with the proposed separation and the company’s cash needs.