Avantax Inc (AVTA) 2006 Q1 法說會逐字稿

Good day, everyone, and welcome to the InfoSpace Q1 2006 earnings release conference call.

Today's call is being recorded.

At this time for opening remarks and introductions I would like the turn the call over to Ms. Stacy Ybarra. Please go ahead, ma'am.

Thanks. Good afternoon and welcome to InfoSpace's first quarter 2006 earnings conference call. I'm Stacy Ybarra, Investor Relations for InfoSpace. With me on the call today is Jim Voelker, Chairman and CEO, and Allen Hseih, Interim CFO.

Before we get started, I want to remind you of two things. First, this is an investor conference call. Accordingly, we will only be taking questions from the investment community.

Second, this conference call contains forward-looking statements relating to the development of the Company's products and services and anticipated future operating results. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected.

Factors that could affect the Company's actual results of operations include but are not limited to the progress and costs related to the development of our products and services, the timing of market acceptance of those products and services, our dependence on companies to distribute our products and services, the performance of our systems, the effectiveness of the development and implementation of our strategy, possible changes to that strategy, the ability to retain key contracts and personnel and the ability to successfully integrate acquired businesses.

A more detailed description of certain factors that could affect actual results of operations is contained in the Company's most recent Annual Report on Form 10-K and quarterly reports on Form 10-Q as filed from the time with the Securities and Exchange Commission in the section entitled, "Factors Affecting Our Operating Results, Business Prospects and Market Price of Stock."

Listeners are cautioned not to rely on these forward-looking statements which speak to the Company's prospects only as of the date of this conference call. The Company undertakes no obligation to update publicly any forward-looking statements due to new information, events or circumstances after the date of this conference call or to reflect the occurrence of unanticipated events.

Now I'll turn the call over to Jim. Following his comments Allen will review the first quarter financial results and then we'll open up the call to your questions.

Thanks, Stacy. Welcome to the call today.

We're pleased to report another strong quarter at InfoSpace. We posted record revenues and solid EBITDA, and just as important, we achieved several milestones towards our long-term goal of solidifying our leadership position in mobile search, personalization and entertainment.

First the financial results. Revenue for the first quarter was 90.3 million, up 4% over the seasonally strong fourth quarter with a 14% adjusted EBITDA margin. This was driven by strength in mobile media downloads and online volume increases.

Mobile revenue was 44 million and our Online segment posted revenues of 46 million. We further strengthened our balance sheet adding 20 million to end the quarter with $396 million, or more than $12 per share in cash.

These results underscore the strong position we're building in mobile media where a massive new market is developing right before our eyes. Mobile devices have transformed from voice communications to text communication to media consumption in a very short time.

In North America we're beginning to experience the effects of broadband speed as Verizon, Sprint Nextel and Cingluar complete their high speed networks. Broadband will have the same effect on mobility as it did on the Net, a larger audience yielding more use with richer content and applications delivering better experiences.

For consumers this is an exciting time as they begin to realize the capabilities of this evolving device. And for InfoSpace it's a time of unprecedented opportunity as we are front and center for most of the critical activities that bring users and content together. We have the broadest mobile distribution platform in North America.

Let me give you some data to illustrate that fact. We lead the industry in portal services. We've developed and powered a mobile Web for Cingluar's MEdiaNet, T-Mobile's T-Zones and Verizon's portal, Verizon Today among a host of others. These carriers comprise over 60% of the market.

We lead the industry in mobile media downloads. Last year we delivered over 150 million mobile content downloads through our carrier relationships, comprising an estimated 45% of the market.

In this quarter we firmly established leadership in mobile search, a critical position to occupy.

All of the substantial value created on the Web at Amazon, eBay, Expedia, Yahoo and Google has centered on discovery, and we believe that mobile search will soon be the starting point for most mobile media consumption. More on this in a moment.

Our goal is to continue to build a large and diverse mobile audience that accesses personalization, entertainment and information content through our portals, our applications and our content relationships. And we are doing just that.

We estimate that more than 25 million mobile users access our content or utilized our applications in the first quarter. This is up by more than 40% year-over-year and represents approximately 13% of all mobile users in North America.

Last quarter we discussed our strategy for growth and the three pillars we are building upon, technology, content and distribution. Aligned with those themes we announced three key initiatives for 2006, mobile search, content acquisition, and a direct to consumer offering. I'd like to take a moment to update you on these initiatives and share some of our progress to date.

I'll begin with mobile search. In the first quarter we deployed two new search products. Along with our fourth quarter MEdiaNet launch with Cingluar, we now have search applications enabled on three of the four major U.S. carriers. Carriers are choosing InfoSpace because we offer the industry's most comprehensive and customizable mobile search platform.

Two of our deployments are geared towards searching for mobile content and local information through the carrier portals and it resulted in an instantaneous lift in content sales. Users know what to do when they encounter a search box, and the number of queries are substantial and growing.

At Sprint Nextel our InfoSpace Find It! product is a downloadable application focused on mobile local search categories, including dining, shopping and movies to give users quick and easy access to highly relevant information, direction and maps all in one integrated package. It features an important additional element, location-based technology, leveraging the user's exact location to center the search.

For years now pundits have speculated on the power of location as an added element for mobile applications, and InfoSpace and Sprint Nextel have combined to make it real. In each of these deployments users now have an intuitive tool that provides easier to access to the content and information they desire. Providing this discovery mechanism is a very important role to occupy and InfoSpace is leading the mobile industry.

Discovery alone does not yield much without content behind it which leads me to our second initiative. Mobile content takes several forms, information, personalization, and entertainment being our focus and we gained significant ground in all three areas in the first quarter.

Regarding information, we're extending our online expert, content expertise and relationships to mobile. One of the keys to our success in mobile search has been the extensive search information we've developed through our online properties such as Switchboard and InfoSpace.com. We search over 30 resources to yield the best user experience in the market. And now with the addition of location information we refine the results even further.

And the same monetization relationships we enjoy on the Web with SuperPages, Yellowpages.com, DEX, City Search, Ticketmaster and many more, are being leveraged for our mobile services. We're the leading provider and publisher of mobile content in North America. We have licensed and had acquired a deeply library of mobile content and music, graphics, games and a variety of other personalization and entertainment products.

In the quarter we closed approximately 20 new licensing deals to bring us to more than 600 licensing agreements and over 2.5 million items in our content catalog. We partnered with Cingluar Wireless and FOX to offer Live Idol ring tones from the songs performed on the number one rated TV show, "American Idol." The Live Idol ring tones are made available hours after the songs have been performed on the show, a breakthrough in terms of turnaround time.

We also announced a partnership with Cingluar and the popular social networking portal, MySpace, to create Cingluar's mobile music studio. The studio is a first of its kind platform that allows emerging artists on MySpace to create and market their music as ring tones.

We improved our games catalog by launching QBIS, Skeeball for Prizes, Marble Galaxy and many others through multiple carriers including Cingluar and Verizon.

Now, at the end of the first quarter label tones accounted for approximately 80% of our total content sales, and the resulting margin compression will only be offset by driving sales of a broader set of content. To that end, we're building on our leadership position by securing an extensive range of content that appeals to a much wider mobile audience.

We will continue to expand our demographics and focus around five key verticals, faith, family, Latino, action sports and urban. In addition, our video-based application will launch with a major carrier in the third quarter.

Finally to distribution. Over the past few years our growth has been fueled by our more than 40 mobile carrier relationships and our 100 plus online distribution partners. We continue to deepen our carrier penetration as evidenced by the search launch on Sprint Nextel and the content initiatives at Cingluar. Online we added strong partners such as RCN, Alltel and Teen Talk.

Our private label capabilities have been extended further with the launch of the Fuse TV mobile content portal earlier this month, and more and more we're seeing the value in the combination of online and mobile capabilities as brands and carriers look across platforms for access to consumers.

And speaking of consumers, our direct to consumer offering is on track to launch this quarter. We've invested in significant research to craft the consumer-friendly, value oriented set of offerings that will feature our unique applications and a variety of content.

We plan to launch on all four major carriers with what we believe will be the broadest and deepest content catalog in North America. Our skills in content acquisition and delivery and our close working relationships with the carriers gives us an advantage in developing this off deck channel.

This has been a very eventful start to the year with a number of important product deployments. As we move forward we will continue to invest in initiatives that facilitate bringing our search capabilities to mobile, expand our content portfolio and support our direct to consumer offering. This is an incredibly exciting time in the industry, and particularly here at InfoSpace because we are truly defining the future of mobile media.

Before I turn the call over, I'm pleased that Allen Hseih has agreed to step up and serve as Interim CFO. Allen's done a terrific job here over the last three years as Chief Accounting Officer, and his deep understanding of the business will help to ensure a smooth transition.

With that, I'll turn the call over to Allen.

Thanks, Jim, and welcome to our call today. I will start with a review of our first quarter results and then turn to our second quarter outlook. We are pleased with our revenue growth from the seasonally strong fourth quarter. Our revenues for the first quarter were 90.3 million, an increase of 3.3 million from the first quarter of '05 and sequentially up 3.7 million from the fourth quarter. For the first quarter of '06 our adjusted EBITDA was 12.7 million, or 14%.

We are investing significant resources in our three major growth initiatives, mobile search, content acquisition, and a direct to consumer offering. As previously discussed in our last call, we had targeted to spend 5 million on those initiatives in the first quarter. However, due to timing our spend was just over 3 million.

The timing of our initiative spend, combined with the strength in our revenues, [segment] gross profit, resulted in adjusted EBITDA being ahead of plan. On a comparative basis first quarter adjusted EBITDA decreased 9.2 million compared to the first quarter '05 and was also sequentially down by 3 million from the fourth quarter.

Net income for the first quarter of '06 was 3 million, or $0.09 per share. Please keep in mind when comparing our 2006 net income results to '05, starting in the first quarter '06 we adopted FAS 123R and began expensing stock compensation costs. We also started to report full GAAP income taxes. Additionally, in 2005 we recognized a significant gain from a litigation settlement.

Excluding the stock compensation of 4.1 million and the related taxes, net income in the first quarter of '06 was 5.3 million compared with the first quarter net income of 16.6 million after excluding the net gain from the litigation settlement of 77.3 million. Weighted average fully diluted shares were 32.9 million for the first quarter of '06.

Now, let me turn to our segments.

As we discussed in the last earnings call, in early January we combined the operations of our two businesses, Mobile and Search and Directory. We will continue to break out revenues as we have done in the past, however, starting this quarter we will also break out segment gross profit which represents Mobile and Online revenues net of content and distribution costs.

For comparative purposes, included as an attachment to the earnings release you will find a table showing our segment gross profit in prior quarters.

Starting with Mobile, revenues in the first quarter of '06 were 44.1 million, up 5.1 million from the first quarter of '05 and up 1.9 million from the seasonally strong fourth quarter.

Segment gross profit was 18.8 million, or 43%, a decrease of 2.8 million compared to the first quarter of '05. Sequentially gross profit decreased by 1.5 million compared to the fourth quarter.

As Jim mentioned, approximately 80% of our total media sales are label tones. Consistent with the trend over the last several quarters, our segment gross margin has been impacted by this as well as increases in our content costs. Additionally, a portion of the decline is the result of an expiration of a legacy professional services agreement at the end of '05.

Turning to Online, in the first quarter of '06 revenues were 46.1 million, down 1.8 million from the first quarter of '05 and up 1.8 million sequentially from the seasonally strong fourth quarter.

Segment gross profit was 29.9 million, or 65%. Gross profit decreased by 700,000 from the first quarter of '05 and sequentially gross profit was up by 1.6 million compared to the fourth quarter.

We are pleased that our segment gross profit increased and our margin remained in line sequentially, reflecting the progress we made during the second half of '05 towards improving the quality of our distribution traffic network. In the first quarter of '06 search distribution revenues in North America continue to account for approximately 60% of the portion of our Online revenues coming from search.

Now I will go into detail on some of our other expenses. Other operating expenses of 47.1 million increased by 11 million from the first quarter of '05 and increased 7.7 million sequentially. In 2005 we did not report stock compensation costs and starting in the first quarter of '06 we recorded stock compensation costs of 4.1 million.

Also in the first quarter of '06 we started to report full GAAP income taxes which amounted to 2.4 million representing an estimated tax rate of 45%. However, it is important to remember that the majority of our income tax expense is non-cash in terms of our significant net operating loss carry forward, and for the first quarter of '06 our cash taxes were less than 400,000.

The amount of income tax expense we recognize in any particular quarter is driven by our estimates for the year which are sensitive to a mix of earnings and different tax jurisdictions. Our effective tax rate is also impacted by the recording of stock compensation expense. These estimates are complex and adjusted from time to time.

Looking at the balance sheet we ended the quarter with cash and marketable investments of 395.6 million, up 20.2 million from the end of '05, and we have zero debt. As you may recall, we are authorized to spend up to 100 million on our stock repurchase program. To date we've spent 70.2 million and repurchased 2.6 million shares of common stock.

Now let me turn to our second quarter outlook. The second quarter has historically been a slower quarter for online search due to decreased Internet usage going into the summer months. On the mobile side last year we saw the effects of a seasonal decline starting in the middle of the first quarter continuing into the second quarter, however, this year we are not seeing that same pattern.

As a result, we are cautiously optimistic entering into the second quarter. Therefore, we expect revenues to be in line with our first quarter ranging between 90 and 92 million. We expect adjusted EBITDA to be between 5 million and 6 million in the second quarter.

This is a very important year for us. The mobile market is a very fast growing and evolving business opportunity and we plan to continue investing significant resources in our three major growth initiatives. These initiatives will account for approximately 6 to 7 million of operating expenses in the second quarter.

We expect a net loss between 2 million and 3 million, or $0.06 to $0.10 per share in the second quarter. This will include approximately 6.5 million in stock compensation expense and it reflects an estimated income tax rate of 45%.

This concludes our prepared remarks. I will now turn the call over to the Operator and we'll be happy to take your questions.

[OPERATOR INSTRUCTIONS]

Okay. Thanks, Operator. If we have no calls then --

We do have some questions in the queue. I was just giving them time. We'll take our first question from Mark May with Needham & Company.

Okay. Thanks for taking my question. I apologize I was not able to listen -- Hello.

Hello.

Okay. I wasn't able to listen in to the entire call. I apologize.

You have announced a number of very interesting new initiatives and partnerships, and I'm just wondering is there any way you can sort of frame the size of how big some of these things could be for you from MEdiaNet to MySpace, et cetera, maybe frame just how big these opportunities could be for you over the next twelve to twenty-four months. Thanks.

Well, Mark, this is Jim. You know, I wish we could frame some of this. It is a brand new market. We're trying some interesting things. I think you highlighted a couple of them.

MEdiaNet, we know that the, there's two ways that that can benefit us. One is just in adding users and users are steadily added there. But the big lift comes off really in this early stage over the time period you're talking about, at least the twelve months, is what kind of lifts do we see on content sales through the search there, and so that's been, it's probably what's happened for us.

As Allen mentioned, we did not see a drop-off this year in the middle, kind of towards the end of the first quarter that we saw last year, and we think we attribute quite a bit of that probably to the advent of having search and getting deeper into the catalogs, so in that case with MySpace, I've got to tell you it's, we just don't know. We'll see what the participation will be from bands.

We'll see how much interest people on MySpace have in buying material, and I guess we'll find out how many MySpace users are actually Cingluar users, too.

We'll now go to Gordon Hodge with Thomas Weisel Partners.

Good afternoon.

Change the name of your company there?

No, no. I got a new accent. Still at the same place.

Anyway, just curious as you think about, I don't know what more you can tell us about the direct to consumer strategy, but if I heard right, you'll incur 6 to 7 million more expenses. I gather that will be in marketing initiative or is it going to be in something -- some other form and I assume there'll be a brand launch and so forth. Any chance you can tell us when we can look forward to that?

Gordon, a couple of things there. One is, the 6 to 7 million, that's really across three initiatives. It's across the direct to consumer, it's across mobile search and as well it covers some of the content acquisition, so it's across all three of those, and the direct to consumer will go out this quarter.

We're already at the end of April, so, and it hasn't happened yet so it won't be, and it's not going to be the next couple of weeks, so that will be also a factor of how much of that money gets spent there. In terms of giving you any more color on that, obviously we want to be a little circumspect about this so that we can have some power around the launch, but we've been working real hard.

I think some of the key things for you to take away here is we've been working very hard although making sure we have an expansive catalog, that large catalog we talked about in the call, that that's applicable in getting that licensed across this platform as well. That's been key for us.

The second has been to get arrangements with all four carriers and some of that is just fortunate timing for us that now Verizon is finally joining on and Sprint are joining on to allow some off deck, but we're going to be timed across, basically, I guess 80 to 85% of the users out there. So that's positive for us.

In terms of the kind of marketing we're going to do in the beginning, you know, we'll do the launch here but we do not anticipate doing television or anything quite like that until we've been out there for awhile, understanding, let's just call it the operational mechanics of the business, and getting a feel for what it's going to really be like in that business and tweaking some things. We'll utilize, obviously, leverage our search capabilities to drive traffic to the site and we're excited about it.

Great. Any early read on usage on Find It! on Sprint?

It's too early to tell, and hopefully we'll know more next quarter.

Okay. Terrific. Thanks.

Thank you.

Now we'll here from Imran Kahn with JPMorgan.

How are you doing?

Sounds like you're doing okay there, Imran.

I'm doing okay. A couple of questions.

First, you talked about the seasonality leading the business that you're cautiously optimistic about Q2, so I was wondering if you could give some more color what you saw in terms that giving you the confidence or making more cautiously optimistic about the seasonality, and in terms of the seasonality are you seeing in both improved seasonality in search and mobile both areas or just on the mobile? And then I have a follow-up.

What we're referring to there really was the mobile side of the business. I think we've been in the search business long enough now to feel fairly good about the forecasting capability on the search side absent some unusual things that could happen, but we feel pretty confident about how that runs, that cycle runs.

As you recall last year, we saw, really, as I said before, kind of in the late part of the first quarter we saw some drop-offs and we thought that was seasonal at the time. We thought it might be related to music sales, to phone sales, I'm sure it does have some -- there is some impact on the spike, from the spike in phone sales at Christmas, that carries through in part of the quarter, and that kind of thing, but as Allen said earlier, Imran, we just haven't seen that kind of an adjustment this year.

So we feel cautiously optimistic that we're going to be able to have a, relatively a better quarter in the second quarter this year than we did in the second quarter last year.

And as to some of the issues around that, once again it's kind of the, I'd call it two-and-a-half years of experience on this so you don't have a lot of experience, but we do know that the search -- we do know search lifts the boat. There's no doubt about that. We saw improvements in carriers as soon as we launched search that people can get into the catalog much quicker and deeper.

The second thing is I think that all of the systems, delivery systems, whether it's us or some of the billing players or even some of the gateway issues that the carriers have and had last year, are getting smoothed out of the process so the process is better, and we just have a much larger core group of users out there than we did a year ago.

I mentioned the number here that we had in the quarter, about 25 million unique users, and that's up about 40% year-over-year. So we have a bigger core of people using the products, and I think those are the factors.

And last question is in terms of the $6 million marketing expenses for three marketing areas, I was wondering if that's more of a one-time nature, what should we think our second half of the year? I know you're not giving guidance but just to get a sense like if we should expect any kind of major marketing initiatives in the second half of this year?

Imran, this is Allen Hsieh. In terms of it, it's 6 or 7 million we're expecting in the second quarter, it's not all just marketing costs. It's going to be attributable to a number of our initiatives that we have here as well as the fact it includes our own resources from a head count standpoint, so I think it's safe to say that that amount is not going to be a one-time item, and it depends on how fast we grow parts of our initiatives here.

Okay. Thank you. [OPERATOR INSTRUCTIONS]

We will now here from Richard Fetyko with Merriman Curhan Ford.

Thanks for taking my questions, guys. Just curious about the state of the business on the search and directory side that still represents 50% of the revenues and close to 70% of the operating profits. You haven't spent much time talking about it.

Just curious what the trends are on the proprietary search side in terms of traffic growth and also on the distribution side your efforts to clean up the, or I guess, groomed it at the distribution network, where are you at in that process? And then I have a follow-up question on the search side, I mean on the mobile side.

Sure, Richard. Well, I guess I'll start with the second one first. We went through a process last year with ourselves and our partners, specifically Google and Yahoo, all of us basically to try and make sure that we, that our distribution network is bringing the kind of quality converting -- let me start again, the quality traffic that really converts well for advertisers, and I think we've made a tremendous amount of progress there. Not just in the fact of eliminating some partners who were, let's just call it, operating at the edge of the envelope out there.

This is a very lucrative business, and so there's people that are willing to push the limits to try and capitalize on these businesses, but the thing that we really improved on is kind of on the other side of it, the up-front side in terms of vetting partners much better and managing that in concert with our partners, so I think we made a tremendous amount of success, had a tremendous amount of success with it, and I would think if you ask the question to Google and Yahoo, they would echo that and feel very confident about the position that all of us are in in that space. That's gone very, very well.

In terms of growth on the O&O side, this is a difficult market to grow in. But our own sites have stayed pretty flat. Actually, we have had user growth on the directory side of the business on Switchboard.com in particular, but pretty flat in terms of number of users year-over-year on the O&O side. That's kind of what we think we can expect.

We can expect to grow there slightly perhaps, but we want to just kind of hold our own in that space and hope to find growth in directory and then of course moving those advertisers eventually to mobile.

So you don't feel like you have another sort of cleaning up swoop to do on the, sweeping to do the distribution side? You feel like you've done all you needed to do and it's more of a continued focus on quality as you bring on more partners?

It's a quality. It is a continuous focus, and again, it definitely was an issue for us last year, but it's been an issue for the industry, and I think, again, I think the industry working as closely as we do with Google and Yahoo we manage to put processes in place now that people aren't, quite bluntly, able to put -- slip stuff past us as they may have been able to do in the past, so we do feel very confident about that, and I think you can see the kind of distribution partners we talked about here are Alltel, RCN, Teen Talk, these are high quality.

This is not the kind of issue -- you're not going to have any issue with those kinds of partners, and that's the vast majority of our partners.

On the mobile side just curious about what the margin profile of the direct to consumer business you would expect to be? Relative to your current mobile margins perhaps or any color on that?

I think it's still too early to tell right now. We haven't launched yet, and that's something that we'll see in the future. We're going to do the measured approach, and in looking at try to drive revenue and profit on there. Again, it's too early to tell.

Thanks.

Thank you.

Our next question comes from Safa Rashtchy with Piper Jaffray.

Good afternoon and congratulations, great quarter. How are you doing, Jim?

I'm doing well. Thanks.

Can you give us your assessment of the competitive landscape on the mobile area both in terms of kind of your direct competitors, private companies, others that might be there, but also what you see from the major companies, major portals, for instance Google as we see is a fairly visible player now on the MEdiaNet on Cingluar, so I'm wondering if you see any traffic patterns that tell you how things are going and also beyond it in terms of partnerships what you see from others in the form of partnerships with the carriers. And I have a quick follow-up.

I think two separate things there. If you talk about the major players, the Yahoos and Googles and clearly both of these guys are going to have a presence in the mobile world. There's no question about that.

I think as we talked before, Safa, the carriers have a -- this is a different -- this is not the Internet this is a closed network. It's a closed device. The carrier both pays for the network and in a large part pays for the device it gives you. So they have a tremendous amount of influence. In fact, they have all the influence, quite bluntly, on what appears on that device and how it appears there, and clearly Google and Yahoo will have a presence on that device.

However, heretofore and what we were seeing in the pattern and what we hear from the carriers is the carriers want to make sure that they are front and center here. So when you open the page at Cingluar, it's something that's a Cingluar product and it has a Cingluar search box on it, the same with some of the other carriers, and it will be across the board we think, and that's the place where we'll play.

We want to support, do the private label support that we're doing and we're on -- we have that exact kind of arrangement with two of the four major carriers now and then we have the specialized product that we put on Sprint Nextel, the Find It! product.

In terms of some of the smaller private guys, as you know, there's a whole list of people that are out there in small companies, in different kinds of niches in this business, but really, there's nobody we see that goes across the kind of platform that we do when we talk about portal, and again, I just -- you give me a good opportunity to quote this again, but in portal we have better than 60% of the market. In downloads last year due to the carriers we had around 45% of the market.

In search right now we've got three of the four major carriers. So there's some niche players out there and there's some good ones, you have some interesting things, but right now we feel like we're pretty broad, we're pretty deep.

Thanks. And, Jim, I don't know if you talked about this, I might have missed it, but can you give us an update on how you're doing with games, the Java games and other mobile games? And also kind of maybe related to that, I think this is maybe related to the question that was asked earlier, too, can you give us some sort of even broad categorization or quantification of the initiatives you have over the next two or three quarters?

Where should we expect the majority of growth in mobile area to come from? You have the, you're obviously, you're working on your private label, and you have the search and find product with Sprint, and you work on a number of other initiatives.

You're growing beyond the label ring tones, so it seems to me that your product mix is changing quite noticeably. So I'm trying to see if you can give us a sense of where the growth will come from in the next year or so?

It's all -- I think you named all the areas.

I was afraid to.

I think you have all the areas named there and how to quantify those, that's the trick for us as well as we sit here. I mean it's a brand new market, and we're trying to move a lot of things through the channel.

I think that what makes us optimistic is that we continue to see more and more users adapt and start to, or adopt, I'm sorry, and start to use things on the phones. We know that the 3G is quite helpful in terms of just like it was on the Internet, just the speed of response and the quickness you can get a screen to refresh and back and have people utilize a search function.

If you haven't been able to use our Find It! product on Sprint yet, you'd be, I will tell you, you'd be very, very impressed with the speed at which the results come back. I mean it's very quick. It's not, you know, it's not high speed at your desk but it's not far away.

And so we're encouraged by those kinds of things, and by the advent of search in the fact that one thing that we're seeing that I haven't talked about, I'll talk a little bit about is, the kinds of queries we're seeing go into the search box are really different than the kinds of content that we sell through our merchandising. Largely we've been selling to, call it the hip hop audience, through our merchandising, and yet the queries that we see coming through the search box reflect a much broader interest in different kinds of content, so we feel positive about that.

In terms of the spending and the dollars and I think you were asking about on the initiatives, it's as Allen detailed here a minute ago, it's going to be 6 to 7 million in this quarter. I would say I don't expect us to, and we certainly wouldn't without notification, go launch a $20 million a quarter television ad campaign here any time soon. We're going to take a measured approach to this.

We think we know some ways to drive traffic through search engines, and we think we know a little bit about that and so that we can drive some good traffic and test the waters on our D to C this year, and then we'll kind of take it from there.

And Jim, I'm sorry, anything on games?

Oh, sorry about that. The game business is going to be in line kind of with where we've been before, about around that 5, 7, 8% of the overall business, and that's something, again, that needs a boost from higher speeds so that we can get more of the interactive stuff happening and higher resolution screens, things of that nature. We're waiting, I think, for the second level, if you will, of technology capability to really start to see some significant growth in games, and that's just not here yet.

Okay. Thanks, Jim. Great quarter.

Thank you, Safa. Good to talk to you.

Our next question will come from Wil Power with Robert Baird.

Thanks and good afternoon. I guess a couple questions. First, on Mobile gross margins, I guess it's 43% in the quarter, I know there's been a trend in label tones which has impacted that. Do you sense that margins should start to stabilize around this level or do you think there's still further pressure there?

And then secondly, I know you've had success, you talked about with regard to mobile search with some of the margin U.S. carriers, how are you thinking about the international opportunity there? What does that opportunity look like? Thanks.

I'll take the second part, Wil, and then we'll let Allen chat about the first part. Yeah, you know, we're working in Western Europe pretty hard, and we definitely think there's an opportunity for the search products over there. We just haven't had anything to announce yet, but we definitely think there's an opportunity there for us. Carriers there have the same issues that they have over here.

There are no deeply embedded -- there are no, really, anybody who's embedded at all in terms of competition over there in Europe. I think one thing that we have in this country still is an inferiority complex when it comes to where our mobile business is in terms of where the European mobile business is when you talk about the data businesses, and we're involved in Europe all the time. They're no further ahead in most areas at all really, and in fact in some areas they're behind.

They don't have a preponderance of 3G phones in the market either yet. We don't either. We're pretty much aligned on that. Search over there has not really been started yet, either, so it's pretty much a green field. We have work to do to get a couple of carriers on board over there and then spread from there. Allen?

Well, in terms of the mobile margins, yes, it's declined, and we are experiencing a lot of shifting here in our product mix to higher cost content, and also experienced pricing pressure on that front, so that's why Jim had talked about earlier the fact that we need to bring in a new set of content here, and we are on that path as part of one of our initiatives for this year is to create and grow our own content here. So you will continue to see some of that shift mix and pricing pressure, but that's one of our initiatives we're focusing on the rest of this year.

And I would just say kind of that maybe lay some more color on that, it's been -- the ring tone business is great, and the volumes are terrific, and continue to improve, and that's fine. It's not, you know, the margins are not and we never expected them to be what they were in the early stages of this business when it was polyphonic.

We're kind of at a period where, as we said before, 80% of what we're selling is label tones. I think if we look out a couple of years, it's not going to be anywhere near that kind of percentage because we're going to have video capability, we're going to have, again, much faster and more intricate gaming capabilities on the phone and deeper applications that we can do to integrate video and other kinds of things that the devices aren't there yet. They're coming, but they're not there yet.

This is just a period that we'll go through. But we are at 80% penetration already and so it won't go too much further down that line, and music is the one type of entertainment content where there is an oligopoly in place. You essentially have three companies that control it, control the price, et cetera. The other ones aren't like that and so we're anxious to see a broadening of content consumption out there. There's no question about that.

Okay. Thanks. Thank you.

[OPERATOR INSTRUCTIONS] Scott Sutherland with Wedbush Morgan Securities has our next question.

Great. Thank you. Good afternoon. A couple questions. First, I didn't see or I didn't hear that you had any search query numbers or pricing on that. Can you talk about any trends you saw there in the first quarter?

Well, we didn't give any numbers but they're up.

Okay. On the Verizon you announced that today and I believe you mentioned before you got it earlier in the quarter. It was 4.5 million when you guys lost it per quarter or approximately that. How much did you get back and did you get them for the full quarter or is that more of a Q2 impact?

Actually it started end of last year, right?

It actually started December of last year, and so we have a full quarter impact, but it's a longer term arrangement.

Okay.

It's not at the level it was before.

That's a good point. It's not at the level it was before.

Great. A couple questions on the mobile side. As you go and look at your D to C launch, do you think there could be any more delays from Verizon? Would that look back to direct to consumer launch this quarter?

Could there be a delay from Verizon, yeah, you know, sure, there could be. We don't control what they do but right now everything's on track. But it wouldn't delay our launch. We'd be happy to go with three out of four if we had to. So far so good.

Okay. And some of the bigger media companies are coming out there in the direct to consumer definitely seen some marketing on their television stations and they definitely have much bigger budgets. So it seems like you're trying to ride a fine line of not paying too much but how much do you have to spend to compete effectively with those guys?

That's a good question. I think that there's different ways to compete and one is to have a pretty robust and superior offering.

I think the kinds of things we can do with applications, and you've seen the Find It! happen, it's pretty unique, and believe me, that's just the structure that we can build a lot of interesting things off of that are not necessarily related to finding restaurants, et cetera, they're much more related to media, so we think we have some really interesting things that we can do that will attract consumers.

But this is a long-term game, Scott, for us, and so what we're saying this year is we're going to learn what it's like to be in that D to C business on a day-to-day business, and we're going to develop the skills, the internal skills and operational sets in order to do this, to do a really good job for both our carrier partners, our content partners and the consumers that we get in.

We don't want to have a run way up and then crash way down scenario in this market. We want to grow this business steadily and long-term, so we'll see. What you say it's a genuinely good question. We're going to have to feel that out and find out. We do look at it as a long-term business.

And lastly, I've seen at last in some of the music services, sometimes the content providers decide to go direct, paying the net-net fee to the guys in the middle. Do you see any of that in your business where you might get a net fee that's higher margin but lower revenue? And also, what happened with the buyback in the quarter? I didn't see anything on the cash flow statement there.

Well, we have some -- we're involved in agreements right now that are direct and so those are possible. It just kind of depends on how the carrier views this and what kinds of services they want us to perform versus others, and carriers have different opinions on those kinds of things. The labels have one opinion but the carriers are the ones that make the decisions. I think not much has changed in that for us over the last year when we've been hearing this question.

In terms of the buyback, we had authorized of 100 million. We've spent or invested, if you will, 70 million. Over the course of this quarter, we didn't purchase much stock, and we'll just see. In fact, that reminds me, we didn't purchase any stock in this quarter. We'll see what we do going forward.

Okay. Great. Thank you.

Thank you.

Operator, I think we have time for one last question.

Very good. Our last question will come from Jeff Shelton with Bleichroeder.

Thanks. I was hoping you could talk a bit about the economic model around mobile search. Are you getting a cut of subscriptions and I'm sure the carriers want a revenue share. Is the revenue share on the same terms? Should we be thinking about as your online affiliates?

I think the answer is kind of yes and a qualified yes on the second one. On subscription fees, as Find It! is structured, it's a revenue share on that, and on the other kinds of things as we see going forward and I think you're kind referring to [attack B], I think that will be the similar kind of the structure that we see developing. That's fine with us.

Our main issue here is to develop enough eyeballs, if you will, enough people searching, et cetera. Remember, this is a little bit different market in the sense that it's not really a, people are not really looking in large part for Web links, right? They're looking for specific, mainly from what the queries are telling us is as we analyze the queries that we're getting in and, again, the numbers are big enough to be a real sample here.

What we're seeing primarily are people looking for content they can consume right now on this device and looking for things that are local in nature, if you will. A restaurant, directions, something like that, a phone number. Things of that nature. That's a large part. It's much, much different, a much, much different kind of query profile than what we see on the Web everyday.

But it seems to be very scalable?

Oh, yeah, it's tremendously scalable, and it's like it was in the early days of search here, it's a matter of getting people acclimated to using a tool, making the tool really intuitive and easy and simple for people to use and driving the number of queries, and queries will, the number of queries will define how many advertisers you can bring to the party, but we're obviously very bullish on this. Have 200 million users out there in North America alone. And so it's a huge opportunity.

Thanks. And the second question I have back to the Mobile gross margins, I believe you said in the fourth quarter you were about 75% label tones, first quarter you're about 80% and the gross margins went down 500 -- 550 basis points. If you go from 80 to 85, should we expect a similar compression?

You also mentioned something about a legacy contract rolling off, so I was wondering how much that contributed to the first quarter?

Unfortunately, I don't want to get too into specifics of the details for competitive reasons, but it's not that linear relationship you have seen because we did the legacy contribution -- it was fairly significant in the fourth quarter. It's not linear, it's going to be within a range if you will, but nothing more than what you see in the quarter-over-quarter on a sequential basis.

Although your questions are important to us, our time is limited for questions at the moment. I'll turn the call back over to our host for any closing remarks or comments.

Thanks for joining us for our call today. Bye.

That does conclude our conference call. Thank you, everyone, for your participation. We wish you a great day.