Marchex Inc (MCHX) 2006 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Marchex, Incorporated sponsored second quarter earnings conference call.

At this time, all participants have been placed on a listen-only mode and we open the floor for your questions and comments on the presentation.

It is now my pleasure to turn the floor over to your host, Ethan Caldwell, General Council and Chief Administrative Officer.

Sir, the floor is yours.

Thank you.

Good afternoon, everyone, and welcome to Marchex's second quarter 2006 conference call.

Joining us today are Russell Horowitz, Chairman and Chief Executive Officer;

John Keister, President and Chief Operating Officer;

Michael Arends, Chief Financial Officer;

Peter Christothoulou, Chief Strategy Officer; and Cameron Ferroni, Chief Technology Officer.

During the course of this conference call, we will make forward-looking statements that involve substantial risks and uncertainties.

All statements other than statements of historical fact, including on this call regarding our strategy, future operations, future financial position, future revenues, acquisitions, projected costs, prospects, plans and objectives of management are forward-looking statements.

We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements, and you should not place undue reliance on our forward-looking statements.

Actual results or events could differ materially from the plans, intentions, and expectations disclosed in the forward-looking statements we make.

There are a number of important factors that could cause Marchex's actual results to differ materially from those indicated by such forward-looking statements as they're described in the risk factors section of our most recent periodic report and registration statement filed with the Securities and Exchange Commission.

All of the information provided on this conference call is as of today's date, and we undertake no duty to update the information provided herein.

During the course of this conference call, we will also reference certain non-GAAP measures of financial performance and liquidity, including OIBA, adjusted OIBA, adjusted EBITDA, and adjusted non-GAAP EPS.

A reconciliation of these non-GAAP financial measures to the comparable GAAP financial measures is contained in today's earning press release which is available on the investor relations section of our Web site and definitions of these measures as used by us and the reasons why we believe these measures provide useful information to investors will be referenced during this conference call and are also contained in today's earnings press release.

At this time, I would like to turn the call over to Russell Horowitz, our Chairman and Chief Executive Officer.

Thank you, Ethan, and thank you, everyone, for joining us for today's conference call.

On today's call we will primarily discuss our progress during the second quarter, and our focus going into the back half of 2006, and also review or quarterly financial results.

Prior to discussing these topics, however, I'd like to spend a few moments commenting on Marchex's overall development.

Marchex was founded on the premise that there was an opportunity to create an integrated vertically focussed search and media company that leveraged technology to develop and monetize its assets.

Additionally, we believe that Marchex's success would primarily be driven by our ability to have direct control over two assets.

One, a sustainable critical mass of high quality online traffic; and two, an advertiser platform that provides efficient access to that traffic.

To date, only a few companies in our industry have been able to successfully own, develop and integrate these important elements and Marchex's goal is to be counted as one of these few.

While focusing on the vertical categories in the most dynamic growth segment of the online market, we have made significant progress in building an integrated technology-driven search and media business that is characterized by these important elements.

For example, in looking at traffic, we have a significant base of proprietary online traffic driven by consumers accessing our vertical and local Web sites.

Our focus is to gradually and consistently build an increasingly useful and relevant consumer experience on these sites by leveraging our search technology platform, Open List, to dynamically populate our Web sites with targeted content.

We are able to build improved relevancy by effectively treating the domain name of each Web site as a search key word and prepopulating the home page and underlying sub pages with specific, relevant content and information.

As a result of this approach, based on initial internal data from a limited number of Web sites, we have seen what we believe represents an increase in overall utility, which has driven increased usage and monetization.

This approach to building our local and vertical Web sites is also the most scalable approach from a business model perspective.

Next, in looking at advertisers, we have a proprietary advertiser network driven by our Pay-Per-Click and contextual search marketing platforms that allows advertisers to place text-based advertisements on our Web sites choosing either specific keywords or categories as a targeting mechanism.

Owning an advertiser platform allows us to directly monetize our Web sites and directly participate in the upside of our network over time.

Over the last few months, we have increase our advertiser exposure to our proprietary network as we believe more exposure to quality traffic sources increases overall advertisement conversion rates and, therefore, typically increases monetization rates or revenue per click rates.

With its increased exposure to quality traffic, we saw average revenue per click rates for Marchex's proprietary advertisers accessing our proprietary base of traffic increase by 17% in the second quarter of 2006 as compared to the first quarter of 2006.

The combination of these traffic, technology and advertiser assets have resulted in Marchex's delivering pro forma organic revenue growth in the second quarter of 2006 of more than 30% versus the prior-year period and an adjusted EBITDA margin of 31%.

We believe this organic growth rate and EBITDA margin places Marchex in the upper tier of our industry in terms of financial performance despite the fact that we believe we are in a relatively early stage in our history, and at an early stage of internal product integration and development.

We believe that the continued integration and development of our assets can provide meaningful revenue growth and profit margin expansion over the coming quarters and years.

As a result, we are focussed on continuing to execute against our traffic and advertiser growth strategy and extending our reach as a technology-based search and media company.

Now, moving on to an update on our progress during the second quarter and our focus going into the second half of 2006.

The second quarter represented continued execution and product development.

While there were many points of progress during the quarter, I will highlight just a few.

First, we augmented the utility of our Web sites by beginning to extend our Open List search technology to our Web sites.

In addition to enhancing the user interface on many of our Web sites, we added increased Web site functionality by adding modules such as local search and local mapping.

The initial results from this product enhancement and technology integration show significant traffic and monetization improvement in addition to a dramatic increase in overall usage which in this context we define as page views.

Second, we increased the advertising inventory for our Pay-Per-Click and contextual search marketing advertisers on our Web sites, which resulted in increased Pay-Per-Click rates as advertisers benefited from what we believe are relatively high conversion rates from incremental quality traffic.

Third, we increased the footprint of our premium partner distribution network with the addition of new relationships, including Briefing.com, Open System Publishers, ZDNET, TechRepublic and BNET, and we also renewed key partners such as The Motley Fool.

And lastly, we internally developed and introduced a new graphical advertising product that is unique to the market in providing an auction-based cost-per-thousand-impression, or CPM marketplace.

We now offer advertisers the ability to purchase graphical advertisement placements on a vertical category basis from a premium roster of our partner distribution such as BusinessWeek Online, PC World, and Morning Star.

These initiatives have been a significant source of our investment this year, and while we believe executing on these initiatives is a multi-year strategy, we have already made tremendous progress by hitting important internal milestones thus far.

Now, turning to the traffic side of our business, our proprietary traffic base was approximately 28 million unique visitors in June 2006, according to our internal logs.

Trends on our proprietary network during the second quarter of 2006 were consistent with our expectations and similar to the seasonal trends we have seen in prior-year periods.

Examples include a seasonal decrease in traffic in June versus the month of April and May and generally lower advertiser budgets in June versus the months of April and May.

Given our understanding of industry-wide seasonal traffic trends from prior years, analyzing current data from specific product initiatives currently underway, and monitoring current year trends, we are confident in our belief that our proprietary base of traffic will continue to grow over time and anticipate that revenue contributions from our proprietary traffic sources will be increasing in the back half of 2006 and into 2007.

Now, let's turn for a moment to discuss our content and monetization strategy for our network of Web sites.

We believe that improving the consumer experience on our Web sites through better relevance and utility is an important part of increasing Marchex's online footprint and financial performance.

While the goal of improving the utility of our Web sites is not simple to execute, we believe that we are well-positioned to accelerate our Web site product development progress, thanks to the substantial work we have done in building the infrastructure for publishing, monetizing and reporting, and also due to our Open List asset acquisition which is proving to be a very efficient search and content publishing platform.

The combination and integration of our Web site network infrastructure and Open List has put us in a position to accelerate our content publishing processes with efficiency and relevance.

To be more specific, the strategy to develop our proprietary network is to extend our content and search technology platform to our Web sites, and essentially treat each Web site as a search query against our database.

Additionally, we intend to create subpages for each Web site by applying the same methodology; that is, related search queries will be used to create additional relevant web pages for given sites.

For example, this approach will allow us to take a site we own like FrenchRestaurants.com and over time build sub pages like Seattle.FrenchRestaurants.com or NewYork.FrenchRestaurants.com.

This strategy and approach allows to us take each Web site and with very little incremental cost, create multiple subpages which not only enhances the user experience with supplementary-related content, but also increases the available inventory we can offer to our advertisers.

It is through this strategy that Marchex is increasingly delivering utility and relevance to users while expanding monetization opportunities and serving as a valuable participant in the growth of the online ecosystem.

Early tests and data indicate that the integration of Open List into our Web sites will result in greater usage and greater monetization.

For example, let's take a look at some of the data we delivered in our press release today about our local and vertical beta sites.

On May 30th, we announced a Web site beta launch which consisted of our search technology and content aggregation platform integrated across a select number of Web sites.

These enhanced Web sites included various improvements over prior versions such as an improved user interface, category search capability, multidimensional local search refinements based on personal relevance, local mapping, related Web site suggestions, expert third-party reviews, user-generated reviews, awards, detailed descriptions, and feature summaries, as well as other items.

Selected results and trends from the beta Web sites are as follows and represent internal data for the full month of July 2006 versus data for the average of the months of March, April, and May 2006, which were the three months prior to the launch.

The 29 local and vertical Web sites included in the test data provide us some very positive indications on how to build out the balance of our Web sites going forward, as we attack various other categories of Web sites within our owned and operated network.

First, page use increased more than 175% for the month of July 2006 over the average number of page use for the months of March, April and May.

Second, revenue increased more than 75% for the month of July 2006 over the average revenue for the months of March, April and May 2006.

Third, many of the beta Web sites were picked up and indexed by algorithmic search engines, which we believe was due to their deep, highly-targeted content that specifically relates to the Web site.

For example, delis.com, which provides online users with comprehensive reviews and ratings of local delis throughout the United States, is listed in the algorithmic search results of multiple major search engines in response to a user query of delis.

And lastly, even when the beta sites were not indexed by algorithmic search engines, users who directly navigate to the Web site, we believe, found them more useful and subsequently interacted more with the site.

This is supported by data that highlights an increase of more than 50% in both monthly page views and revenue across many such sites over the prior monthly averages.

Given some of these early trends and results, we now have a better understanding of how to integrate our content platform on the major categories of Web sites within our network.

The good news is that this data helps us focus our strategy to address the majority of our network in the coming months.

Therefore, our goal is to continue to launch these enhanced sites in a methodical fashion, knowing that the impact can significantly and meaningfully impact revenue growth and profit margin expansion for Marchex.

Some of these categories and individual Web sites will be launched soon based on their fit within our existing search and content publishing engine.

As evidence of our now improved capabilities to launch enhanced Web sites, today we announced that we launched new versions of more than 100 local and travel-related Web sites, including the Web sites that we initially released on May 30th with improved user interfaces and functionality.

Our goal with today's launch is to continue to collect information, and now we can do so from a larger data set.

Once additional data is collected, we will continue to extend our technology to the appropriate Web sites within our network.

Yesterday we announced the launch of updated implementations of our more than 75,000 ZIP code Web sites, as well as the launch of MyZIP.com, which is designed to be a destination Web site that covers city and ZIP code locations across the United States.

MyZIP.com will also serve as the umbrella brand and gateway into our ZIP code Web sites and the associated city and local content.

All of these ZIP code Web sites now offer robust hotel, restaurant, travel, local attraction information, and reviews targeted to individual locations or ZIP codes in the United States.

Our initial category coverages included the travel vertical and its underlying segments such as hotels, restaurants, and attractions.

As we extend our search technology and content aggregation platform into additional verticals in the coming months, we will see benefits in two ways.

One, we'll be able to augment existing updated Web sites with proprietary content through adding subpages or tabs, and two, we'll be able to extend targeted information to additional Marchex Web sites in new categories and transform them into rich and highly relevant destinations.

At scale, when we have extended our search technology to cover all of the major commercially relevant categories, we believe the significant majority of our Web sites will benefit.

At that point we will have taken more than 200,000 individual Web sites, and created millions of pages of targeted content with highly relevant user experience and valuable advertising inventory.

Now I'd like to turn the call over to John Keister, our President and Chief Operating Officer.

Thanks, Russ.

Now we will turn to our search marketing and local business areas.

Over the last few months, our advertisers have increased their exposure to our proprietary network due to the relatively high conversion rates we believe they experienced.

This belief is grounded in the conversion data we have received from advertisers which suggests that traffic from our proprietary network of Web sites is delivering a relatively high return on investment.

As the exposure to our proprietary network has increased for our advertisers, we have seen their average revenue per click rates increase 17% sequentially in the second quarter of 2006, over the first quarter of 2006.

One year ago, we were not able to directly monetize our sites with our advertisers, and, therefore, not able to offer this source of traffic to our customers.

Today, however, our advertiser listings cover an increasing percentage of the available click-based advertising positions within our proprietary Web site network.

Over time our goal is to monetize more of the available inventory with our own advertisers.

Today, we offer advertisers the ability to buy our inventory based on either categories or keywords, and we will continue to offer more flexibility to advertisers to buy in both of these ways.

To that end, during the second quarter, we launched our locally targeted advertising center on Open List, allowing advertisers to bid for placements, based on specific categories and locations.

With the integration of Marchex's advertising center, advertisers now have the ability to sign up directly on Open List to place locally targeted ads on the Open List site via a self-serve account management system.

This system enables advertisers to purchase advertising on the following pages -- One, local pages, such as New York-related pages; two, category pages, such as hotel-related pages; and three, hybrid local and category pages, such as New York hotel-related pages.

This initial implementation of the contextual advertising platform allows advertisers to bid on run of site local inventory as well as several local and category-specific pages covering major cities in the United States, such as New York, Los Angeles and Las Vegas.

In addition, advertisers can bid on selected international geographies, such as Europe and Mexico.

We are early in the process of selling advertising placements on Open List, but we have already seen an increase in average revenue per click rates an expect continued growth over time.

One of the important parts of our advertiser growth plan for the back half of 2006 will be to, one, increase the depth of the opportunities for advertisers to buy on a local or category basis across our network; and two, integrate these advertising units that now exist on Open List across other areas of our proprietary Web sites.

As we are able to accomplish this, we believe that advertisers will increasingly see Marchex as an important entry point to purchase a high volume of quality local and vertical traffic.

Next, turning to the local market.

We believe that the majority of the growth in the market for paid search will be generated from locally targeted paid search advertisements over the next four years.

As such, we believe the companies with quality local traffic sources and direct local advertiser relationships will be the primary beneficiaries of this growth.

Fortunately, Marchex has a tremendous amount of proprietary locally-focussed traffic given the composition of our Web sites as more than half are locally targeted.

Additionally, we have chosen to invest heavily supporting large local aggregators of advertisers such as YellowPages.com to assist them in their fulfillment of search marketing packages sold to local merchant customers.

While we are still investing heavily in our local platform and in resources supporting these initiatives, we believe that our super-aggregator partners are gaining traction and pushing the adoption of search marketing packages for local merchants, evidenced by the fact that we continue to add new local merchants to our system each quarter.

As mentioned previously, we believe that Marchex is uniquely positioned to be one of the prime benefactors in the growth -- in the growth of local search, and that in 2007, we will see an increased industry focus on local advertising spend acceleration.

At this time, I'd like to hand the call over to our Chief Financial Officer, Mike Arends, to discuss our quarterly financial results and a summary of our 2006 financial guidance.

Thank you, John.

Our second quarter represented continued financial progress as we drove strong revenue growth while increasing the cash generation capabilities of our business on a year-over-year basis.

Furthermore, as Russ highlighted, our continued product progress is evidence that we are starting to realize the benefits of the product investment decisions we have made over the past 12 months.

While some of these investments are ongoing and long-term in nature, we believe we are in a strong and unique position to realize long-term differential growth.

Looking at the second quarter as an indication that we continue to make strong progress on a year-over-year basis, revenue for the second quarter was $31.7 million, which represents a 50% increase over our year-ago results of $21.2 million.

Total operating costs, excluding stock-based compensation, amortization of intangible assets for the second quarter of 2006, were $23.4 million.

In the year-ago period, total operating costs, excluding the previously mentioned items, were $15 million.

In looking at the mix and operating costs for the second quarter, our service costs, excluding stock-based compensation, decreased as a percentage of revenue on a year-over-year basis, largely due to an increase in revenue coming from proprietary traffic sources.

The increase in sales and marketing costs on a year-over-year basis were largely due to increased personnel costs, the integration of IndustryBrains, and marketing of proprietary Web sites.

Other operating costs included additional investment in personnel, product development, as well as increased technology infrastructure costs and certain costs related to being a public company compared to last year.

Adjusted operating income before amortization for the second quarter was $8.3 million, which represented a 36% increase over the $6.1 million in the year-ago period.

Adjusted earnings before interest, income taxes, depreciation, amortization, stock-based compensation expense, and gains and losses on sales of intangible assets, or adjusted EBITDA for the second quarter was $9.7 million, which represented a 35% increase over $7.2 million in the comparable period last year.

Adjusted operating income before amortization and adjusted EBITDA are two of the principal metrics we use to measure the progress of our business, liquidity, and our ability to generate cash.

Adjusted operating income before amortization includes a reduction for depreciation charges, and excludes amortization costs and costs related to or acquisitions as well as other nonrecurring charges.

One item of note, beginning in the first quarter of 2006, due to recent accounting rule changes, we, like all other public companies, began to recognize increased stock compensation charges as a non-cash expense that will impact our GAAP results.

Stock-based compensation expense for the second quarter was $3.4 million, compared to $497,000 in the same period in 2005.

GAAP net loss applicable to common stockholders for the quarter was $612,000 or $0.02 per share compared to net income of $107,000 or $0.00 per share in the second quarter of 2005.

Going forward, our GAAP results may be impacted by a number of factors including stock-based compensation charges, increased the amortization costs associated with our acquisitions, other potential future acquisitions, our preferred stock dividends, and increased public company costs, which will also impact our adjusted operating income before amortization and adjusted EBITDA results.

Adjusted non-GAAP earnings per share, an estimate some Wall Street investors utilize as a supplemental measure of our operating progress, was $0.12 for the second quarter.

Adjusted non-GAAP EPS represents adjusted net income divided by weighted average fully diluted shares outstanding for adjusted non-GAAP EPS purposes.

Adjusted net income generally captures those items on the statement of operations that have been our ultimately will be settled in cash, exclusive of certain non-recurring items and represents net income available to common shareholders, plus stock-based compensation expense, amortization of acquired intangible assets, gain-loss on the sale of intangible assets, and other income or expense.

Turning to the balance sheet, we had approximately $60 million cash on hand as of June 30th, 2006.

During the second quarter, we continued to generate significant cash flow from our operations.

Going forward, we anticipate that we will use our cash principally to continue investing in long-term growth initiatives, including internal product development and sales initiatives, and selected acquisition opportunities.

I would now like to discuss our outlook for 2006.

As Russ mentioned, we continue to focus on broadening the reach and depth of our unique base of proprietary and third-party traffic sources, as well as increasing our direct monetization capabilities.

Today, we are raising the top end of our guidance range from the previously announced range on May 30th and are now anticipating revenue for the year in the range of 130 to $136 million as compared to a range of $130 million to $134 million.

Likewise, we are raising the top end of our adjusted operating income before amortization guidance to a range of 33 to $38 million from our previously stated range of 33 to $37 million.

Thus far in 2006, we have made and continue to make investments in product development initiatives, as well as in strategic initiatives which we believe give Marchex an increasingly unique and defensible footprint of locally and vertically focussed traffic.

I would note that we are highly focussed on recouping the investment we are making in our business over time, and are, therefore, reiterating our long-term adjusted operating income before amortization margin -- margin guidance of 30% or more, which is a level few companies online have been able to attain.

I would now like to hand the call back over to Russ.

Thanks, Mike.

Marchex's opportunity is greater now than it's ever been.

We believe our unique assets, our focus on vertical and local leadership, and our approach to leveraging technology provide us with the opportunity to build leadership in the most highly commercial areas within search.

Our investments in product development and strategic initiatives are designed to add components of defensibility to Marchex's model and to help ensure that we're in a position to outgrow our peers over the next several years while continuing to deliver adjusted EBITDA margins in excess of 30%.

The Internet search and media business is as competitive as it's ever been.

There are new ideas and new companies coming into this space every day.

In this type of environment, you have to be very decisive and hold fast to your long-term goals.

Marchex has done a very good job in focusing and executing on its core strategy in the past 12 months.

First, we've continued to build out our proprietary network by investing in the technology and people that will fuel future growth; and second, we have continued to integrate and simplify our advertiser facing business as we share advertisers between our business areas and deliver better tools to our customers.

By continuing to focus on our core strategy, we believe Marchex will be in a position to continue to deliver strong differential growth and substantial profitability for years to come.

At this time, Operator, we'd like to give the call back to you to take questions from the audience.

[OPERATOR INSTRUCTIONS].

Christa Sober Quarles.

Hi, a couple questions.

First, I guess I was pretty positively surprised by the revenue per click increase sequentially, and I was just wondering if you could highlight the specific categories of ads that you guys are serving, what percentage of Marchex's proprietary network is served versus using Yahoo!, and then whether you guys will consider CPA or CPL-type ads and then I have a follow-up.

Thanks.

Sure, John Keister's going to take the first passage of your question.

I would -- I guess I would just start by saying that we -- from a proprietary advertising perspective, we're covering all the major commercially relevant categories.

So we're not specifically focussed on just finance or just entertainment advertisers, for example.

We're across the board, and we've got under our own -- under our own proprietary advertiser base, we're well north of 10,000 advertisers on a direct basis.

So when we look at kind of our opportunity to integrate and take more of the inventory, we've got good breadth and depth across the board and then there are verticals where we're stronger.

Finance is an area we're particularly strong, technology we're particularly strong, travel and health are also areas where we see a lot of strength and momentum in pricing and what we found is the more of our proprietary inventory we're able to get to the advertisers, they tend to vote with their bid rates and their budgets, so we think it's a very encouraging sign.

We're clearly focussed on the longer term opportunity of being the kind of predominant monetizer of our own traffic base.

And so we have very positive third-party relationships to supplement that strategy, but each of these metrics just gives us affirmation that the approach we're taking is the right one and will deliver us the best balance of growth and defensibility.

And I guess if you're not willing to state sort of what percentage of Marchex's network is served from its own ad network versus other partners, I guess -- I mean, could you give some indication as to the growth rate anyway of what you guys are serving on your own?

To give you a ballpark estimate, I'd say going back a quarter, plus or minus we had about 20% of the admin inventory on our proprietary sites, and now it's up to about 30%.

That's very helpful.

And then, just the other question that I had was just seeing the revenue up 175 on the -- on the beta sites, I was wondering, were those 100% paid content sites before?

Because I'm surprised given that usually when you shift to an editorial paid mix, I would expect revenues at least near term to go down, so I was just wondering if you could characterize that and then sort of what you expect to see over the sort of medium to longer term?

We clearly believe in our strategy but we were surprised, too.

So the tradeoff, and a lot of folks understand is that when you go from a page that 100% paid listings and change the mix to some content that's unpaid and some content that is paid, you could potentially see usage increase and monetization decrease.

And the thing that we found, both for those sites that were indexed by search engines and those that weren't, is the users found a compelling enough proposition to just want to use them more and interact with them more and that meant more pages and more paid clicks.

So we were very encouraged with the initial results that came back, and we think some of the underlying data gives us a greater focus in terms of the road map on how to really scale this now.

So from a formulaic basis, it is encouraging and while the data set was small, these weren't minor increases.

They were meaningful.

That's why we're pretty excited about what the impact can be as we scale the strategy and extend our search publishing system to more and more verticals.

Got you.

That's helpful.

Thanks.

Thank you.

Clay Moran.

Thank you.

Can you talk about how far you are in the process of enhancing the different travel-related sites, and then also possibly what the next categories will be for integrating Open Lists into your Web sites?

Sure.

What -- what we've been looking at is we had this initial launch of about 30 sites that we did at the end of May and we reported on some of that data.

Today we've also announced that we're extending that to more than 100 sites, and yesterday announced that we've launched upgraded implementations on more than 75,000 ZIP code sites.

And so kind of our ability to scale this to support a whole lot of sites is pretty evident and so now the next step is going to be sequencing which -- sites of which profiles get the next kind of version 2.0 as we roll through and add categories to our search publishing system.

Right now, this latest launch of going to 100 will accomplish a couple of things for us in defining those next steps.

One, it will give us more data, which we think will help us refine our focus as we roll it out further.

And two, as the makeup of those hundred sites, we've really launched even more variety of the types of templates that are supported.

So we can look for themes in terms of increased usage and monetization across a broader profile of Web sites, and so that's an important component.

And once we have that data -- and I think the ZIP codes are very illustrative, if there's a template that supports a certain type of Web site, whether you launch one of them or 70,000 of them, is a similar process for us given the way our technology works.

So it's more about sites of different profiles and how best to deliver utility and monetization, versus the numbers game of how many sites we can support and how many millions of pages we can serve underlying them.

In terms of next steps on categories, we have not disclosed which ones we're building currently.

Although it's not a secret that we're big believers that more locally targetable inventory and more vertical inventory in what are the most monetizable verticals are areas that we're trying to attain and build leadership.

So if you follow the dollars of where we think the growth is and best monetization opportunities, you'll be able to figure out where the verticals are that we're building.

Okay.

On a different subject, can you just address the -- what was essentially a flat quarter on the proprietary sites?

Was that essentially seasonal or is there something else impacting those results?

Thanks.

There were really three factors that came into play.

One, seasonality.

Q2 is the slowest quarter of the year.

Second, we did see an increase in monetization from our proprietary advertisers which was a positive.

And third, we saw a net decrease in monetization from third party advertisers during the quarter.

And on a net basis, that translated to flat contribution in a quarter that is the seasonally slowest.

And as we said in the call, we feel very good about where that business is, expect growth to accelerate in that business area, and for contributions from proprietary traffic to be increasing through the balance of the year.

So the traffic was essentially flat but the margins are -- and the click rates are lower because it's your proprietary ad network but the margins are better?

The trade-off is if we add our own advertisers and we're seeing those increased rates which we think is the right thing to do in the long term, we do dislodge third-party placements but at the same time, again, those third parties, the monetization was a little bit lower.

We think seasonally they'll get stronger, and we already see the trends in our proprietary advertiser listings where we saw rate increases during the seasonally slowest time.

So we think we're in a pretty good place when we look at catalysts for growth in that area in Q3 and Q4.

Thank you.

Safa Rashtchy.

Thank you.

A couple of questions.

One, could you give us a sense of the percentage of your proprietary Web sites that are more locally oriented and what progress have you made in making those that are not more locally oriented?

And I have a follow-up.

Sure.

About 50% of our sites, just based on their name characteristics, have a local orientation.

The other part is, even where you have a local site, we know we can verticalize it, kind of where you can look at taking something like a Beijing.com and verticalize it with Hotels.Beijing.com or Restaurants.Beijing.com and with the local sites we can -- we can verticalize those and we gave the example before of French restaurants being categorizable with Seattle.FrenchRestaurants.com or SanFrancisco.FrenchRestaurants.com.

So we have the ability to theoretically create as much inventory as we want, but at a top level, which is how we're drawing users, about 50% are local in nature and we think that gives us a great foundation of undeveloped real estate to leverage at this stage.

Great.

And a second question is regarding Google's quality score.

Have you seen any impact on that -- from that initiative that Google has on your Web sites and how you get listed in the organic results, as well as maybe paid results and what are your expectations based on that?

Well, Google clearly has an ongoing initiative to evolve their algorithms, both in their algorithmic and paid areas, and that's something we need to understand based on the breadth and depth of our proprietary network and based on fact that we support thousands and thousands of third party advertisers who use us to handle their search marketing through sources that include Google.

And so for us, as they continue to evolve, it's largely business as usual.

But when we look at our Web site launches and even the data we provided today, about half of those 30 -- of those 29 sites were indexed by the algorithmic search engines and obviously Google's the largest of those, where we saw very good uptake rates.

And so when we look at the utility of the sites we're building, both in the context of user interaction and we look at how relevant it's deemed by search engines including Google, we think it bodes very well in the context of our ability to grow traffic and increase our relevance in the overall kind of online ecosystem.

So even as Google evolves, as we -- to the extent we build useful sites, the job of a search engine is to find relevant, useful sites in response to user queries.

And if we're doing a good job of that, we'll continue to be benefactors.

And the data to date has proven we are doing a good job of that.

Malindi Davies.

Hi.

Thanks.

I have a question regarding the long-term impact of Yahoo!'s Project Panama, and what impact do you think their changes could have on your business?

And do you think there could be an impact on your monetization rates, either short term when they turn on the switch there, or longer term?

We're no different from anyone else.

If we can get more money without having to do anything, we'd love to see that.

But -- and clearly one of the big focuses of the Panama initiative for Yahoo! has been to increase relevance and monetization in how their ad system works.

We -- when we've been asked this question in the past since Yahoo! is a strategic partner, the answer we've given is the same one which is it's not something we've counted on, it's not something we've built into forecasting our business.

We hope Yahoo!'s able to do it, both for their own sake and for ours, and if and when that happens we'll happily take it.

So we're optimistic, but it's not something we're building into our forecast, both -- either internally or externally.

And if we're pleasantly surprised, we'll happily take it.

And just one quick question on the local sites that you've had up.

Where are those sponsored links coming from?

At first glance, it looks like they're all coming from Yahoo!, but it sounded on your call like you were talking about them coming from the -- from your proprietary network.

Yes.

If you go to -- using an example like Open List and doing a local query, all those ads are coming from Marchex advertisers.

Okay.

Thank you.

Stewart Barry.

Thank you.

Just a few questions.

First, is can you update us on IndustryBrains and the initiatives you've got going on that front?

And then secondly, Russ, how do you see Marchex's position in mobile local search?

It's a market that hasn't yet been really developed but an important one down the road.

Sure.

IndustryBrains brought us the contextual infrastructure and we've continued to leverage that as we integrate more and more into a common ad center that could support paid listing across search and vertical Web site, both proprietary and partnered.

And so bringing us high-quality third-party relationships and infrastructure to support contextual has been a key part of what IndustryBrains has done.

In addition, we leveraged that as part of our product initiative to be able to support an auction system for graphical inventory, and so it continues to be a positive part of Marchex's overall development of both adding third-party distribution partners, and at the same time extending our infrastructure in terms of ad serving.

And so it's been a very positive contributor.

We've got very good people out there leading this as part of our integration process when we look at the opportunities with our proprietary network.

And so those are important components.

When we look at, again, mobile search, our primary focus has been in looking at added utility to our locally focussed Web sites, and we think we've made tremendous progress and have set the stage for even more progress going forward.

We all know mobile's a big market and that mobile local search will be important, we think it's still relatively early.

But the good news is, is when you look at the infrastructure for content publishing, and monetization, we have it, and to the extent that it becomes something that we feel is going to be more tangible, we think we're in a good position to be able to leverage it given we already would have created the content and advertiser relationships that are naturally extensible.

In the short term, and intermediate term, we continue to focus on leadership in local and vertical traffic and monetization.

And when mobile as a distribution technique becomes more relevant to us, we feel well-positioned to extend our infrastructure in that direction.

But that's not something that I would say is at the top of our '06 priority list.

Ross Sandler.

Yes.

It's actually Jordan Rohan for Ross Sandler.

Several questions.

First is, there have been several questions on this call surrounding the flattish sequential performance out of the owned and operated proprietary sites, whatever you want to call then.

One way to think about this is that you have a very small percentage of your traffic still coming from those or -- and specifically, you put a lot of effort into the ZIP code site, and there's certainly -- those sites are much improved, but those are still a very small percentage of your total uniques.

Do I get this right, are ZIP codes still less than a couple million uniques a month out of that 28 million that you have in total?

Thank you.

We -- we don't -- we haven't segmented out the traffic, but the ZIP codes at this stage are a minority of the traffic.

So I think you're -- you're in the right place.

When you look at the combination of what we think is kind of the existing local traffic today, we believe Marchex is amongst the largest owners of local traffic online, but it -- overall it's still a minority of the aggregate traffic we have.

Although it is a rapidly growing minority within our overall network and one that clearly we have a lot of focus around.

But I think your analysis is sound.

All right.

Can you comment on a trend basis whether you spent less on driving traffic through paid search this quarter than you did last quarter?

Look, we do a variety of testing which includes marketing on proprietary domains.

It can vary from quarter to quarter.

In the second quarter, it was a little bit lower, and I think you can see that in our search and marketing line.

Sameet Sinha.

Yes.

Thank you.

In terms of the incremental additions you were making on the product development and business development side, are you done with those head count additions and have we see the full quarter's impact?

Or do you think this line item will increase going into the third quarter?

And just -- as you're talking about the -- could you talk about additional investments that you could potentially make in your search technology as you continue to modify the Open List algorithm?

Sure.

To kind of go off on a few tangents and hope we come back and answer your question directly.

We're in a environment where we've got one of the highest growth segments in one of the highest growth industries when you look at the search market, and you've got folks like Google and Microsoft spending billions of dollars -- literally, billions of dollars to try and defend and enhance their positions.

And so we've taken the position that as a young company that's growing at organic growth rates of 30% plus, we feel as we look out at 2007 and beyond, we've got catalysts to see growth accelerate, and in the meantime, we've got EBITDA margins north of 30% that we ought to be investing too, given that a lot of the markets we focus on are very early and high growth and leaders always get a premium.

And so we made the choice to invest some of that incremental margin as we grow our business in more people and systems and capital spending to support our initiatives, so that if anything, when we look out -- or look back a year from now on where we are and where we are in terms of our scale and industry position and opportunity, we didn't make a mistake of underspending against that given that we know our business model works and that we've got a growth profile and profitability profile that positions us in the very upper tiers of our industry.

And so we have continued to invest some of the that incremental margin into people and systems, and while we've done a fair bit of that, I don't think it's over.

It is something that's discretionary to us, but we are in a window where we think it makes sense to continue to add high quality people that can help us fulfill against that opportunity and apply those EBITDA margins to a revenue line that's hopefully seeing acceleration in its growth rate.

And so we'll manage that balance as we grow on how much of that incremental margin can show up on the bottom line versus reinvesting into people and systems.

Okay.

My next question is, in terms of ZIP code sites, now that you launched the version 2.0, that's obviously going to benefit your third quarter numbers, could you share the data -- you shared data with us on the 29 beta sites, do you have similar data there on the ZIP code sites as well which you could share so that we could see what sort of monetization and revenue potential you have in the third quarter?

That may be some data we can share subsequently.

It's a launch we just did in the last few days and announced yesterday, and clearly our goal is to try and give investors as much information about Marchex as possible so they can make a determination whether or not we're relevant to them as an investment.

We're excited about what we're doing.

We think as we have opportunities to provide more data it's a good thing and we ought to do it, and so as we make progress with the ZIP codes sites, if there's some data we think is relevant to investors we will share it.

Bill Morrison.

Yes, hi.

Russ, you said, I think, that you guys are now serving about 30% of ads from your proprietary network and that's up 1000 basis points from last quarter.

I was wondering if you could just set -- set expectations for where we can expect that to go, let's say, a year from now.

And then, secondly, I wanted to just get your -- your thoughts on another type investment you could make.

With your stock down as significantly as it is, could you talk about your -- how you view stock buybacks?

Thanks.

Sure.

We have increased the percentage of inventory we're monetizing with our direct advertiser relationships.

And I'll say what I have in the past, which is over time, our goal is for Marchex to be the biggest monetizer of our own inventory.

And that continues to be the focus.

We have not given a specific time line on that.

But that's our goal.

Clearly, a company like Microsoft is investing billions of dollars around trying to build systems that allow them to do that.

And we feel we're very well along in that process, and again, each step we take just gives us affirmation that it's the right strategic approach when we look at opportunity and defensibility.

So those are key components.

In the context of looking at share buybacks, as we generate more cash and we look at the opportunity to grow our Company and invest in internal processes or our own stock, it's clearly something we've got to look at and consider, and so that's an area that I would say it's something that gets talked about and to the extent that we feel it makes sense, may act against.

Thank you very much.

Gentlemen, there appear to be no further questions in queue.

Do you have any closing comments you'd like to finish with?

We appreciate everyone's involvement in today's call and the questions, and we look forward to sharing our progress with you in the balance of the year.

Thank you very much, ladies and gentlemen, this does conclude your conference.

You may disconnect your lines and have a wonderful day.