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QNST > SEC Filings for QNST > Form 10-K on 20-Aug-2013All Recent SEC Filings

Show all filings for QUINSTREET, INC

Form 10-K for QUINSTREET, INC


20-Aug-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion of our financial condition and results of operations in conjunction with the consolidated financial statements and the notes thereto included elsewhere in this report. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this report, particularly in the sections titled "Special Note Regarding Forward-Looking Statements" and "Risk Factors".

Management Overview

QuinStreet is a leader in performance marketing online. We have built a strong set of capabilities to engage Internet visitors with targeted media and to connect our marketing clients with their potential customers online. We focus on serving clients in large, information-intensive industry verticals where relevant, targeted media and offerings help visitors make informed choices, find the products that match their needs, and thus become qualified customer prospects for our clients.

We deliver cost-effective marketing results to our clients most typically in the form of a qualified lead or inquiry, in the form of a qualified click, or call. Leads, clicks or calls can then convert into a customer or sale for clients at a rate that results in an acceptable marketing cost to them. We are typically paid by clients when we deliver qualified leads, clicks, calls or customers as defined by our agreements with them. Because we bear the costs of media, our programs must deliver value to our clients and provide for a media yield, or generation of an acceptable margin on our media costs, that provides a sound financial outcome for us. To deliver leads, clicks, calls, and customers to our clients, generally we:

own or access targeted media;

run advertisements or other forms of marketing messages and programs in that media to create visitor responses in the form most typically of leads (visitor generated contact information and requests), clicks (to further qualification or matching steps, or to online client applications or offerings), or calls (to our owned and operated call centers or that of our clients or their agents);

match these leads, clicks, calls, or customers to client offerings or brands that we believe can meet visitor interests or needs, converting visitors into qualified leads, clicks, calls, or customers for our clients; and

optimize client matches and media yield such that we achieve desired results for clients and a sound financial outcome for us.

Our primary financial objective has been and remains creating revenue growth from sustainable sources, at target levels of profitability. Our primary financial objective is not to maximize profits, but rather to achieve target levels of profitability while investing in various growth initiatives, as we continue to believe we are in the early stages of a large, long-term market.

Our Direct Marketing Services ("DMS"), business accounted for substantially all of our net revenue in fiscal years 2013, 2012 and 2011. Our DMS business derives its net revenue from fees earned through the delivery of qualified leads, clicks, calls or customers and, to a lesser extent, display advertisements, or impressions. Through a vertical focus, targeted media presence and our technology platform, we are able to deliver targeted, measurable marketing results to our clients.

Our two largest client verticals within our DMS business are education and financial services. Our education client vertical represented 44%, 42% and 44% of net revenue in fiscal years 2013, 2012 and 2011. Our financial services client vertical represented 40%, 42% and 45% of net revenue in fiscal years 2013, 2012 and 2011. Other DMS client verticals, consisting primarily of business-to-business technology, home services and medical, represented 16%, 16% and 11% of net revenue in fiscal years 2013, 2012 and 2011.


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In addition, we derived less than 1% of our net revenue in fiscal years 2013, 2012 and 2011 from the provision of a hosted solution and related services for clients in the direct selling industry, also referred to as our Direct Selling Services ("DSS") business.

We generated substantially all of our revenue from sales to clients in the United States.

Trends Affecting our Business

Client Verticals

To date, we have generated the majority of our revenue from clients in our education and financial services client verticals. We expect that a majority of our revenue in fiscal year 2014 will be generated from clients in these two client verticals.

Our education client vertical has been significantly affected by the adoption of regulations affecting for-profit educational institutions over the past several years. The regulations have affected and are expected to continue to affect our clients' businesses and marketing practices, including an overall decrease in our clients' external marketing expenditures. The effect of these regulations or any future regulations may continue to result in fluctuations in the volume and mix of our business with these clients.

Our financial services client vertical continued to be negatively affected due to reduced availability of high quality media at acceptable margins caused by changes in search engine algorithms, acquisition of media sources by competitors and increased competition for quality media. These effects may continue to impact our business in the near future.

Acquisitions

Acquisitions in Fiscal Year 2013

We did not complete any acquisitions during fiscal year 2013.

Acquisitions in Fiscal Year 2012

In February 2012, we acquired certain assets of Ziff Davis Enterprise from Enterprise Media Group, Inc., a New York-based online media and marketing company in the business-to-business technology market, in exchange for $17.3 million in cash, to broaden our registered user database and brand name in the business-to-business technology market. In August 2011, we acquired 100% of the outstanding equity interests of NarrowCast Group, LLC, or IT BusinessEdge, a Kentucky-based Internet media company in the business-to-business technology market, in exchange for $24.0 million in cash, to broaden our registered user database and media access in the business-to-business technology market. During fiscal year 2012, in addition to certain assets of Ziff Davis Enterprise and all of the equity interests of IT BusinessEdge, we acquired eleven other online publishing businesses.

Acquisitions in Fiscal Year 2011

In November 2010, we acquired 100% of the outstanding shares of Car Insurance.com, Inc., or CarInsurance.com, a Florida-based online insurance business, and certain of its affiliated companies, in exchange for $49.7 million in cash, for its capacity to generate online visitors in the financial services market. In July 2010, we acquired the website business Insurance.com from Insurance.com Group, Inc., an Ohio-based online insurance business, in exchange for $33.0 million in cash and the issuance of a $2.6 million non-interest-bearing, unsecured promissory note, for its capacity to generate online visitors in the financial services market. During fiscal year 2011, in addition to the acquisitions of CarInsurance.com and Insurance.com, we acquired 13 other online publishing businesses.


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Development, Acquisition and Retention of Targeted Media

One of the primary challenges of our business is acquiring or creating media that is high quality and targeted enough to attract prospects for our clients at costs that work for our business model. In order to grow our business, we must be able to develop or acquire and retain quality targeted media on a cost-effective basis. Changes in search engine algorithms, our ability to develop or acquire and retain high quality targeted media and increased competition on available media has, during some periods, limited and may continue to limit our ability to generate revenue.

Seasonality

Our results are subject to significant fluctuation as a result of seasonality. In particular, our quarters ending December 31 (our second fiscal quarter) are typically characterized by seasonal weakness. In our second fiscal quarters, there is lower availability of lead supply from some forms of media during the holiday period on a cost effective basis and some of our clients have lower budgets. In our quarters ending March 31 (our third fiscal quarter), this trend generally reverses with better lead availability and often new budgets at the beginning of the year for our clients with fiscal years ending December 31.

Regulations

Our revenue has fluctuated as a result of newly-adopted or amended regulations and the increased enforcement of existing regulations. Our business is affected directly because we operate websites and conduct telemarketing and email marketing, and indirectly as clients in our education and financial services client verticals adjust their operations as a result of regulatory changes that affect their industries.

One example of recent regulatory change that may affect our business is the TCPA, which the Federal Communications Commission recently amended, among other things, impose heightened consent and opt-out requirements that companies conducting telemarketing must follow. Certain provisions of the regulations became effective in July 2012, and additional regulations requiring prior express written consent for telemarketing calls to wireless numbers become effective in October 2013. We generate a significant amount of revenue from calls made by our internal call centers as well as by third party call centers. Our efforts to comply with the new regulations may negatively affect media conversion rates and, thus, our revenue or profitability.

In addition, our education client vertical has been significantly affected by the adoption of regulations affecting for-profit educational institutions over the past several years, and a higher level of legislative scrutiny is expected to continue. Clients in our financial services vertical have increasingly been affected by laws and regulations as a result of the adoption of new regulations under The Dodd-Frank Wall Street Reform and Consumer Protection Act and the increased enforcement of new and pre-existing laws and regulations. The effect of these regulations, or any future regulations, may continue to result in fluctuations in the volume and mix of our business with these clients.

Basis of Presentation

General

We operate in two segments: DMS and DSS. See Note 14, Segment Information, to our consolidated financial statements for further discussion and financial information regarding our reporting segments.

Net Revenue

DMS. Our DMS business generates revenue from fees earned through the delivery of qualified leads, clicks, calls, customers and, to a lesser extent, display advertisements, or impressions. We deliver targeted and measurable results through a vertical focus that we classify into the following client verticals:
education, financial services and "other" (which includes business-to-business technology, home services and medical).


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DSS. Our DSS business generated less than 1% of net revenue in fiscal years 2013, 2012 and 2011. We expect DSS to continue to represent an immaterial portion of our business.

Cost of Revenue

Cost of revenue consists primarily of media costs, personnel costs, amortization of intangible assets, depreciation expense and amortization of internal software development costs relating to revenue-producing technologies. Media costs consist primarily of fees paid to website publishers that are directly related to a revenue-generating event and pay-per-click, or PPC, ad purchases from Internet search companies. We pay these Internet search companies and website publishers on a revenue-share, a cost-per-lead, or CPL, cost-per-click, or CPC, and cost-per-thousand-impressions, or CPM, basis. Personnel costs include salaries, stock-based compensation expense, bonuses and employee benefit costs. Personnel costs are primarily related to individuals associated with maintaining our servers and websites, our editorial staff, client management, creative team, content, compliance group and media purchasing analysts. Costs associated with software incurred in the development phase or obtained for internal use are capitalized and amortized in cost of revenue over the software's estimated useful life. We anticipate that our cost of revenue will increase more than our revenue in the near term as we invest in opportunities we see in the financial services client vertical.

Operating Expenses

We classify our operating expenses into three categories: product development, sales and marketing, and general and administrative. Our operating expenses consist primarily of personnel costs and, to a lesser extent, professional services fees, rent and other costs. Personnel costs for each category of operating expenses generally include salaries, stock-based compensation expense, bonuses, commissions and employee benefit costs.

Product Development. Product development expenses consist primarily of personnel costs and professional services fees associated with the development and maintenance of our technology platforms, development and launching of our websites, product-based quality assurance and testing. In the current period of business challenges, we are constraining expenses generally to the extent practicable. However, we believe that continued investment in technology is critical to attaining our strategic objectives and, as a result, we expect product development expenses to increase in absolute dollars in the future.

Sales and Marketing. Sales and marketing expenses consist primarily of personnel costs and, to a lesser extent, professional services fees, travel costs and advertising. In the current period of business challenges, we are constraining expenses generally to the extent practicable. However, we expect sales and marketing expenses to increase in absolute dollars as we hire additional personnel in sales and marketing to support our offerings.

General and Administrative. General and administrative expenses consist primarily of personnel costs of our executive, finance, legal, corporate and business development, employee benefits and compliance, technical support and other administrative personnel, as well as accounting and legal professional services fees, and insurance. In the current period of business challenges, we are constraining expenses generally to the extent practicable. However, we expect general and administrative expenses, including increased legal and accounting costs to increase in absolute dollars in future periods as we continue to invest in corporate infrastructure and expand our business internationally.

Interest and Other Income (Expense), Net

Interest and other income (expense), net, consists primarily of interest expense, other income and expense, net and interest income. Interest expense is related to our credit facility, including the related interest rate swap and promissory notes issued in connection with our acquisitions, and includes imputed interest on non-interest bearing notes. Borrowings under our credit facility, the aggregate principal amount of outstanding promissory notes and related interest expense could increase if we make additional acquisitions through debt financing. Interest income represents interest earned on our cash, cash equivalents and marketable securities, which may increase or decrease depending on market interest rates and the amounts invested.


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Other income (expense), net, includes foreign currency exchange gains and losses and other non-operating items.

Income Tax Benefit from (Provision for)

We are subject to tax in the United States as well as other tax jurisdictions or countries in which we conduct business. Earnings from our limited non-U.S. activities are subject to local country income tax and may be subject to U.S. income tax.

Results of Operations

The following table sets forth our consolidated statement of operations for the periods indicated:

                                                               Fiscal Year Ended June 30,
                                              2013                         2012                        2011
                                                                     (In thousands)
Net revenue                          $ 305,101        100.0 %     $ 370,468        100.0 %    $ 403,021        100.0 %
Cost of revenue (1)                    251,591         82.5         283,466         76.5        291,991         72.5

Gross profit                            53,510         17.5          87,002         23.5        111,030         27.5
Operating expenses: (1)
Product development                     19,048          6.2          21,051          5.7         24,163          6.0
Sales and marketing                     14,705          4.8          14,074          3.8         17,382          4.3
General and administrative              16,226          5.3          23,375          6.3         20,396          5.0
Impairment of goodwill                  92,350         30.3              -            -              -            -

Operating (loss) income                (88,819 )      (29.1 )        28,502          7.7         49,089         12.2
Interest income                            115          0.0             134          0.0            169          0.0
Interest expense                        (5,200 )       (1.7 )        (4,462 )       (1.2 )       (4,213 )       (1.0 )
Other (expense) income, net                (69 )       (0.0 )           (42 )       (0.0 )           56          0.0

(Loss) income before income taxes      (93,973 )      (30.8 )        24,132          6.5         45,101         11.2
Benefit from (provision for) taxes      26,601          8.7         (11,131 )       (3.0 )      (17,887 )       (4.4 )

Net (loss) income                    $ (67,372 )      (22.1 )%    $  13,001          3.5 %    $  27,214          6.8 %

(1) Cost of revenue and operating expenses include stock-based compensation expense as follows:

    Cost of revenue              $ 3,930       1.3 %    $ 4,293       1.2 %    $ 4,506       1.1 %
    Product development            2,765       0.9        2,570       0.7        2,705       0.7
    Sales and marketing            3,264       1.1        3,096       0.8        3,747       0.9
    General and administrative     2,057       0.7        3,037       0.8        2,992       0.7

Net Revenue



                        Fiscal Year Ended June 30,            2013 - 2012         2012 - 2011
                     2013          2012          2011          % Change            % Change
                              (In thousands)
 Net revenue       $ 305,101     $ 370,468     $ 403,021               (18 %)               (8 %)
 Cost of revenue     251,591       283,466       291,991               (11 %)               (3 %)

 Gross profit      $  53,510     $  87,002     $ 111,030               (38 %)              (22 %)


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Net revenue decreased $65.4 million, or 18%, in fiscal year 2013 compared to fiscal year 2012. Our financial services client vertical revenue decreased $35.4 million, or 23%, primarily due to reduced availability of quality publisher media as a result of search engine algorithm changes, acquisitions of media sources by competitors and increased competition for quality media. Our education client vertical revenue decreased $19.6 million, or 13%, primarily as a result of our education clients' lower budgets, largely due to uncertainty surrounding regulations affecting for-profit educational institutions and their operational adjustment to those regulation changes. Revenue from other client verticals decreased $10.3 million, or 17%, primarily due to decreased client demand in our home services and business-to-business technology client verticals.

Net revenue decreased $32.6 million, or 8%, in fiscal year 2012 compared to fiscal year 2011. This was primarily due to a decrease in revenue from our financial services and education client verticals, which was partially offset by growth in revenue in our other client verticals. Our financial services client vertical revenue decreased $26.2 million, or 14%, due to lower volumes resulting from reduced availability of quality publisher media and, to a lesser degree, lower click prices as compared to fiscal year 2011. Pricing in our financial services client vertical was relatively stable throughout fiscal year 2012. Our education client vertical revenue decreased $20.4 million, or 12%, as a result of our education clients purchasing fewer inquiries due to uncertainty surrounding new regulations affecting for-profit educational institutions. Lower inquiry volumes were marginally offset by higher prices. Revenue from other client verticals increased $14.1 million, or 31%, primarily due to the acquisition of IT BusinessEdge and certain assets of Ziff Davis Enterprise in the business-to-business technology client vertical and, to a lesser extent, higher lead volumes in our home services client vertical.

Cost of Revenue

Cost of revenue decreased $31.9 million, or 11%, in fiscal year 2013 compared to fiscal year 2012, driven by decreased media costs of $26.1 million due to lower lead and click volumes, decreased personnel costs of $4.9 million and other decreases of $1.7 million, partially offset by increased amortization of intangible assets and depreciation of $1.2 million. The decreased personnel costs were attributable to a reduction in average headcount. Gross margin, which is the difference between net revenue and cost of revenue as a percentage of net revenue was 18% in fiscal year 2013 compared to 23% in fiscal year 2012, driven primarily by an increase as a percent of net revenue in media cost, amortization expense, personnel and other fixed costs on a lower revenue base.

Cost of revenue decreased $8.5 million, or 3%, in fiscal year 2012 compared to fiscal year 2011, driven by decreased media costs of $12.6 million due to lower click volumes and decreased personnel costs of $2.0 million, partially offset by increased amortization of acquisition-related intangible assets of $4.1 million, professional service fees of $1.0 million and a one-time offline marketing event expense of $0.8 million related to an acquisition. The decreased personnel costs were attributable to a reduction in average headcount. Gross margin, which is the difference between net revenue and cost of revenue as a percentage of net revenue was 23% in fiscal year 2012 compared to 28% in fiscal year 2011, primarily due to a lower mix of traffic from owned and operated media, lower margins from publisher arrangements and higher amortization expenses, partially offset by decreased personnel costs.

Operating Expenses



                                         Fiscal Year Ended June 30,               2013 - 2012           2012 - 2011
                                     2013            2012           2011           % Change              % Change
                                               (In thousands)
Product development                $  19,048       $ 21,051       $ 24,163                 (10 %)                (13 %)
Sales and marketing                   14,705         14,074         17,382                   4 %                 (19 %)
General and administrative            16,226         23,375         20,396                 (31 %)                 15 %
Impairment of goodwill                92,350             -              -                  100 %                   0 %

Operating expenses                 $ 142,329       $ 58,500       $ 61,941                 143 %                  (6 %)


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Product Development Expenses

Product development expenses decreased $2.0 million, or 10%, in fiscal year 2013 compared to fiscal year 2012, primarily due to decreased personnel costs of $1.5 million resulting from a reduction in average headcount and other decreases in various product development expenses.

Product development expenses decreased $3.1 million, or 13%, in fiscal year 2012 compared to fiscal year 2011, primarily due to decreased personnel costs of $1.7 million resulting from a reduction in average headcount, increased capitalized software expenses of $0.6 million and decreased professional services of $0.4 million.

Sales and Marketing Expenses

Sales and marketing expenses increased $0.6 million, or 4%, in fiscal year 2013 compared to fiscal year 2012, primarily due to increased personnel costs of $0.8 million and increased stock-based compensation expense of $0.2 million partially offset by decreased advertising cost of $0.2 million.

Sales and marketing expenses decreased $3.3 million, or 19%, in fiscal year 2012 compared to fiscal year 2011, primarily due to decreased personnel costs of $2.3 million resulting from decreased performance bonus expenses and decreased stock-based compensation expense of $0.7 million.

General and Administrative Expenses

General and administrative expenses decreased $7.1 million, or 31%, in fiscal year 2013 compared to fiscal year 2012. This was due to a $2.5 million payment to the attorneys general of multiple states in connection with a settlement related to online marketing for education companies in the prior year and additional decreased legal costs of $1.9 million related primarily to litigation expense, decreased bad debt expense of $1.4 million resulting from the insolvency of an advertising agency of record of one of our clients in the prior year, and decreased stock-based compensation expense of $1.0 million related to the departure of one of our directors and reduction in average headcount.

General and administrative expenses increased $3.0 million, or 15%, in fiscal year 2012 compared to fiscal year 2011. This was due to a $2.5 million payment to the attorneys general of multiple states in connection with a settlement related to online marketing for education companies, increased bad debt expense of $1.4 million resulting from the insolvency of an advertising agency of record of one of our clients, partially offset by decreased personnel costs of $1.4 million attributable to a reduction in average headcount.

Interest and Other Income (Expense), Net



                                             Fiscal Year Ended June 30,                2013 - 2012           2012 - 2011
                                        2013            2012            2011            % Change              % Change
                                                   (In thousands)
Interest income                       $    115        $    134        $    169                  (14 %)                (21 %)
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