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QNST > SEC Filings for QNST > Form 10-Q on 7-Feb-2014All Recent SEC Filings

Show all filings for QUINSTREET, INC

Form 10-Q for QUINSTREET, INC


7-Feb-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the fiscal year ended June 30, 2013, filed with the Securities and Exchange Commission ("SEC").

This Quarterly Report on Form 10-Q contains "forward-looking statements" that involve risks and uncertainties, as well as assumptions that, if they do not materialize or if they prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are often identified by the use of words such as, but not limited to, "anticipate," "believe," "can," "continue," "could," "estimate," "expect," "intend," "may," "will," "plan," "project," "seek," "should," "target," "will," "would," and similar expressions or variations intended to identify forward-looking statements. These statements reflect the beliefs and assumptions of our management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified in "Part II -Item 1A. Risk Factors" below, and those discussed in the sections titled "Special Note Regarding Forward-Looking Statements" and "Risk Factors" included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2013, filed with the SEC. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

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 in the form of a 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. References to the delivery of customers means the sale of completed customer transactions (e.g. bound insurance policies or customer appointments with clients). 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.


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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 the three and six months ended December 31, 2013 and 2012. Our DMS business derives 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 45% and 44% of net revenue in the three and six months ended December 31, 2013 and 46% and 45% of net revenue for the three and six months ended December 31, 2012. Our financial services client vertical represented 37% and 39% of net revenue in the three and six months ended December 31, 2013 and 37% and 38% of net revenue for the three and six months ended December 31, 2012. Other DMS client verticals, consisting primarily of business-to-business technology, home services and medical, represented 18% and 17% of net revenue in the three and six months ended December 31, 2013 and 17% of net revenue in both the three and six months ended December 31, 2012.

In addition, we derived less than 1% of our net revenue in both the three and six months ended December 31, 2013, and for the same period last fiscal year, 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.

No client accounted for 10% or more of our net revenue in the three and six months ended December 31, 2013 or 2012.

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 for the remainder of fiscal year 2014 will continue to 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. We are working to offset declines and volatility by diversifying our products, media and markets, including expansion into non-profit and international education markets.

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. We are working to offset declines by diversifying our product base with additions of leads, calls and bound policies.

Acquisitions

Acquisitions in Fiscal Year 2014

During the six months ended December 31, 2013 we acquired the operations of an online publishing business.


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Acquisitions in Fiscal Year 2013

We did not complete any acquisitions in the six months ended December 31, 2012.

Development and Acquisition of Targeted Media

One of the primary challenges of our business is finding 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 find, develop or retain quality targeted media on a cost-effective basis. Consolidation of media sources, changes in search engine algorithms and increased competition for available media has, during some periods, limited and may continue to limit our ability to generate revenue at acceptable margins.

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 our clients adjust their operations as a result of regulatory changes that affect their industries.

One example of a recent regulatory change that may affect our business is the Telephone Consumer Protection Act (the "TCPA"), which the Federal Communications Commission recently amended to, 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 became effective in October 2013. Our efforts to comply with the TCPA has had a relatively small negative effect on traffic conversion rates. Our clients may make business decisions based on their own experiences with the TCPA regardless of our products, and the changes we implemented to comply with the new regulations. Those decisions may negatively affect 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

Our business is composed of two operating segments: DMS and DSS. For further discussion and financial information about our operating segments, see Note 11, Segment Information, to our condensed consolidated financial statements.

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 each of the three and six months ended December 31, 2013 and 2012. 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 website publishers and Internet search companies 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.

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 expect product development expenses to continue to increase in absolute dollars for the remainder of fiscal year 2014 as we believe that continued investment in technology is critical to attaining our strategic objectives.

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 continue to increase in absolute dollars for the remainder of fiscal year 2014 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, 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 for the remainder of fiscal year 2014 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, among other things, 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.

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


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Income Tax (Provision for) Benefit from

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.

Critical Accounting Policies, Estimates and Judgments

In presenting our consolidated financial statements in conformity with U.S. generally accepted accounting principles, or GAAP, we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosures.

Some of the estimates and assumptions we are required to make relate to matters that are inherently uncertain as they pertain to future events. We base these estimates and assumptions on historical experience or on various other factors that we believe to be reasonable and appropriate under the circumstances. On an ongoing basis, we reconsider and evaluate our estimates and assumptions. Actual results may differ significantly from these estimates.

We believe that the critical accounting policies listed below involve our more significant judgments, assumptions and estimates and, therefore, could have the greatest potential impact on our consolidated financial statements.

Revenue recognition;

Valuation of goodwill and intangible assets;

Stock-based compensation;

Income taxes; and

Valuation of long-lived assets.

There have been no material changes to our critical accounting policies, estimates and judgments disclosed in our Annual Report on Form 10-K subsequent to June 30, 2013. For further information on our critical and other significant accounting policies and estimates, see Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the year ended June 30, 2013, filed with the SEC.

Recently Issued Accounting Standards

See Note 2, Summary of Significant Accounting Policies, to our condensed consolidated financial statements.


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Results of Operations

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



                                                 Three Months Ended December 31,                             Six Months Ended December 31,
                                                2013                         2012                          2013                         2012
                                                          (In thousands)                                            (In thousands)
Net revenue                            $  66,145        100.0 %     $  71,751         100.0 %     $ 143,106        100.0 %     $ 150,377        100.0 %
Cost of revenue (1)                       56,116         84.8          61,712          86.0         119,708         83.6         126,902         84.4

Gross profit                              10,029         15.2          10,039          14.0          23,398         16.4          23,475         15.6
Operating expenses: (1)
Product development                        4,776          7.2           4,504           6.3           9,935          6.9           9,397          6.2
Sales and marketing                        3,659          5.5           3,496           4.9           7,815          5.5           7,187          4.8
General and administrative                 4,411          6.7           4,019           5.6           8,545          6.0           7,945          5.3
Impairment of goodwill                        -           0.0          92,350         128.7              -           0.0          92,350         61.4

Operating loss                            (2,817 )       (4.2 )       (94,330 )      (131.5 )        (2,897 )       (2.0 )       (93,404 )      (62.1 )
Interest income                               27          0.0              28           0.0              54          0.0              56          0.0
Interest expense                            (976 )       (1.5 )        (1,354 )        (1.9 )        (2,002 )       (1.4 )        (2,366 )       (1.6 )
Other (expense) income, net                  (29 )       (0.0 )            (4 )         0.0             (48 )       (0.0 )            42          0.0

Loss before income taxes                  (3,795 )       (5.7 )       (95,660 )      (133.3 )        (4,893 )       (3.4 )       (95,672 )      (63.6 )
(Provision for) benefit from taxes       (40,234 )      (60.8 )        32,169          44.8         (40,075 )      (28.0 )        32,044         21.3

Net loss                               $ (44,029 )      (66.5 )%    $ (63,491 )       (88.5 )%    $ (44,968 )      (31.4 )%    $ (63,628 )      (42.3 )%

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

Cost of revenue                            $ 721          1.1 %          $963           1.3 %        $1,595          1.1 %        $1,886          1.3 %
Product development                          610          0.9             698           1.0           1,342          0.9           1,391          0.9
Sales and marketing                          598          0.9             858           1.2           1,368          1.0           1,623          1.1
General and administrative                   697          1.1             510           0.7           1,356          0.9             899          0.6

Net Revenue



                                       Three Months Ended           Six Months Ended           Three             Six
                                          December 31,                December 31,             Months           Months
                                        2013          2012         2013          2012         % Change         % Change
                                                       (in thousands)
Net revenue                          $   66,145     $ 71,751     $ 143,106     $ 150,377             (8 %)            (5 %)
Cost of revenue                          56,116       61,712       119,708       126,902             (9 %)            (6 %)

Gross profit                         $   10,029     $ 10,039     $  23,398     $  23,475             (0 %)            (0 %)

Net revenue decreased $5.6 million, or 8%, for the three months ended December 31, 2013, compared to the three months ended December 31, 2012. Our education client vertical revenue decreased $2.8 million, or 9%, for the three months ended December 31, 2013, compared to the three months ended December 31, 2012, 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 regulatory changes. Our financial services client vertical revenue decreased $2.2 million, or 8%, for the three months ended December 31, 2013, compared to the three months ended December 31, 2012, primarily due to our inability to cost effectively access sufficient high quality media given our current product offerings. Our other client verticals revenue decreased $0.6 million, or 4%, for the three months ended December 31, 2013, compared to the three months ended December 31, 2012, primarily due to volatility in client demand in our medical, home services and business-to-business technology client verticals.

Net revenue decreased $7.3 million, or 5%, for the six months ended December 31, 2013, compared to the six months ended December 31, 2012. Our education client vertical revenue decreased $4.4 million, or 7%, for the six months ended December 31, 2013, compared to the six months ended December 31, 2012, as a result of our education clients' lower budgets, largely due to


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uncertainty surrounding regulations affecting for-profit educational institutions and their operational adjustment to those regulatory changes. Our financial services client vertical revenue decreased $0.7 million, or 1%, for the six months ended December 31, 2013, compared to the six months ended December 31, 2012, primarily due to our inability to cost effectively access sufficient high quality media given our current product offerings. Our other client verticals revenue decreased $2.2 million, or 8%, for the six months ended December 31, 2013, compared to the six months ended December 31, 2012, primarily due to volatility in client demand in our business-to-business technology, medical and home services client verticals.

Cost of Revenue

Cost of revenue decreased $5.6 million, or 9%, for the three months ended December 31, 2013, compared to the three months ended December 31, 2012, driven by decreased amortization of intangible assets of $3.8 million, decreased media costs of $2.5 million and decreased stock-based compensation of $0.2 million, offset by increased personnel costs of $0.4 million, other expenses of $0.3 million and increased depreciation of $0.2 million. The decreased amortization of intangible assets was attributable to an amortization charge associated with certain licensed patents in the three months ended December 31, 2012, assets from historical acquisitions becoming fully amortized and a reduced number of acquisitions in recent periods. The decreased media costs were attributable to lower revenue levels. The increased personnel costs were attributable to an increase in average headcount. Gross margin, which is the difference between net revenue and cost of revenue as a percentage of net revenue, was 15% for the three months ended December 31, 2013 and 14% for the three months ended December 31, 2012.

Cost of revenue decreased $7.2 million, or 6%, for the six months ended December 31, 2013, compared to the six months ended December 31, 2012, driven by decreased amortization of intangible assets of $5.5 million, decreased media costs of $2.0 million and decreased stock-based compensation of $0.3 million offset by increased other expenses of $0.3 million and depreciation of $0.3 million. The decreased amortization of intangible assets was attributable . . .

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