ZW Data Action Technologies Inc.
Q1 2006 Earnings Call Transcript

Published: 25 Apr 2006

[Operator:]

Good afternoon. I would like to welcome everyone to the CNET Networks first quarter 2006 financial results conference call. (Operator Instructions). Mr. McLaughlin, you may begin your conference.

[Cameron McLaughlin:]

Thank you and good afternoon. Before we begin our formal comments, I would like to remind you that in the financial news announcement released today and also on this call, CNET Networks is providing specific forward-looking statements, including guidance related our expectations of future financial performance. Any forward-looking statements made as part of our news today are subject to risks and uncertainties that could cause actual or predicted results to differ materially. These risks are outlined in our first quarter news announcement, as well as in the Company's Securities and Exchange Commission filings, including its 10-K for the year 2005 which can be obtained from the SEC's website or directly from our investor relations website. All information discussed on this call is as of today, April 24, 2006, and CNET Networks undertakes no duty to update this information. Last but not least, you can find a reconciliation of the non-GAAP measures that we use in our news release and on this call to GAAP financials, on the last page of today's news announcement, as well as in the slide presentation that accompanies this call, located on our investor relations web site ir.cnetnetworks.com. Hosting today's call are Shelby Bonnie, CNET Networks' Chairman and Chief Executive Officer; and George Mazzotta, our Chief Financial Officer. Neil Ashe, Executive Vice President, will also be available during the Q&A session. Now let me turn the call over to Shelby.

[Shelby Bonnie:]

Thanks, Cameron and thanks everyone for joining us. During the quarter, we continued to expand our audience and product offering, securing our leadership in the categories we currently serve and moving to launch into a new category, further positioning ourselves for growth. As we start off 2006, we're pleased with the overall health of the business and believe that our long-term prospects only continue to improve. At the same time, it is a less robust first half of the year than we saw last year and we are adjusting our expectations accordingly. Though we have gone a long way in broadening our customer base and expanding our business, there are important transitions occurring simultaneously in the PC and video game industries this year that are impacting us. I will talk further about them later in this call. Let me quickly review some of the highlights of our first quarter performance. Total revenues were $83.4 million, up 17% from the first quarter of 2005. Given the sale of Computer Shopper Magazine, all year-over-year comparisons exclude that business' results. Profit margins continued to expand during the quarter. Operating income before depreciation, amortization and stock compensation expense was $9.2 million and margins increased to 11% during the quarter. Excluding the stock compensation expense and gain on sale of investments, net income was $2.3 million, or $0.02 per diluted share. The opportunity ahead of us is large and we're continuing our investment in the expansion of our current brands and the development and launch of new ones. Now let me turn it over to George to cover financial highlights in more detail and after that, I will provide more insight into the operating results and outlook.

[George Mazzotta:]

Thank you, Shelby. We are pleased report continued growth across all key financial and operating metrics during the first quarter. We generated $83.4 million of total revenue in the first quarter, which was 17% above last year. Total revenue was driven by growth in our interactive business, partially offset by a decline in our international publishing business. Supporting our total revenue growth is a stable and expanding advertiser base. Across the entire network, our 100 largest customers represented 53% of total revenue which is similar to previous quarters. We continue to experience a very high renewal rate from our top advertisers. In fact, 96% of our top 100 advertisers in the fourth quarter renewed with us in the first quarter. During the first quarter, we finalized the sale of our Computer Shopper Magazine and have determined that the appropriate accounting treatment of this transaction is the discontinued operation. As a result, we have excluded the performance of this business from our financial statements for all comparable periods. Accordingly, all year-over-year comparisons discussed on this call and presented in our financial statements exclude Computer Shopper Magazine. With the sale of Computer Shopper Magazine, our publishing revenues are not expected to be a material portion of our total revenues this year. Therefore, we will no longer report publishing revenue as a separate line item on our financial statements. Consequently, we have included advertising revenue generated by our international publishing business in marketing services revenue; and the subscription revenue in licensing fee and user revenue. This information is provided to you on the statistical highlights page that accompanies our press release issued this afternoon. Marketing services revenue increased 19% to $70.9 million during the first quarter. Our marketing services revenue was driven by growth across all interactive businesses with significant growth in display media. Growth in marketing services revenue was partially offset by a decline in international print advertising revenue. Licensing fee and user revenue increased 7% to $12.4 million during the first quarter. Growth in licensing fee and user revenue was primarily driven by our CNET Channel beta licensing business and Webshots subscription revenue. Our international interactive revenues grew significantly during the first quarter. Over the past several quarters, our international growth rates have fluctuated. This is the result of pursuing a plan to change the composition of our international business. We expect our future international growth rates to be varied as we continue to acquire new properties and exit existing businesses. Search revenue from our Google partnership represented approximately 10% of total revenue for the first quarter. This is a function of the elimination of Computer Shopper publishing revenue which makes all other accounts proportionately larger. Total cash operating expenses of $74.2 million in the first quarter increased 14% from last year. This increase is a function of personnel investments we made within our fastest-growing businesses during the second half of 2005 as well as continued investments in the first quarter. Profit margins continued to expand during the quarter. Our first quarter operating income before depreciation, amortization and stock compensation expense of $9.2 million increased 47% from $6.2 million last year. Margins reached 11% of revenue compared to 9% last year and as a result, we achieved a 24% incremental margin for the quarter. This level of incremental margin is consistent with the seasonality of our revenues and we expect that incremental margins will expand as our operating leverage increases throughout the year. During the first quarter of 2006, we reported approximately $4.7 million of stock option compensation expense which had a $0.03 negative impact on diluted EPS. Additionally, we reported approximately $1.3 million of investment gains

[Shelby Bonnie:]

Thanks, George. Overall, the opportunity in online advertising only continues to strengthen. Having said that, it is an unusual year for us with two important industries both in transition simultaneously. As you know, in March Microsoft delayed the release of Vista to 2007. While there is not a lot of immediate impact on sales, it does alter the marketing and product development plans at Microsoft and of the ecosystem of companies that rely upon it. You have seen companies like Intel cite weaker PC demand during the first quarter and research firms like IDC adjusting expectations for PC shipments following the Vista delay. Additionally, a transition is occurring in the games industry as both Sony and Nintendo are expected to launch new platforms toward the end of 2006. However, as we saw in the first quarter, those dates have been changing. Transition cycles in the video game market caused a slowdown in game sales as game publishers wait for new platform availability to launch new titles. Fewer game titles launching this year due to the platform changes lead to less marketing spend and less sales dollars. Our position in the games industry this year has never been stronger and we continue to outgrow the market and increase our market share among game-related marketing spend. We're also gaining more general consumer marketing dollars in these demographically attractive properties. The net effect is continued growth, albeit not quite at the robust pace that we have seen in the last several years. We went into 2006 believing that the impact during the first half from these two transitions would be less than what we have seen. We saw the uncertainty lead to more conservatism than we expected from our marketers. While the first quarter has always been the weakest from a seasonality perspective, in the past we would see trends begin to pick up towards the end of the quarter with a slower January and February leading to a much stronger March. We did not see as much momentum in March as is typical. The uncertainty in some of our core endemic categories translated into some budgets being cut or delayed which we felt in March and continue to see as we look through to the second quarter. While these platforms' transitions occurring simultaneously are having impact thus far in 2006, they should translate into stronger opportunity as we look forward to 2007. We continue to see strong growth in the brand building and demand generation activities on our properties and our early efforts to broaden our customer base have been promising. We are just not far enough along in those efforts to counteract what we were seeing in our endemic categories. In the first quarter, we added new consumer advertisers such as Sara Lee, BMW and Victoria's Secret to the network. Not only are we able to attract consumer advertisers, but we have proven the ability to keep advertisers spending with us. Approximately 80% of the Ad Age top 100 customers that did business with us in 2005 have already spent with us thus far in 2006. We continue to have very high renewal rates, confirming the value we deliver to our marketing partners. Our challenge is to increase the visibility of our brands in the marketing communities. At this point, our brands do not have the broader recognition among both clients and agencies that more established media companies have. General and consumer advertising will be a growth engine for us; it will just take time. While we are seeing nice growth on the branding side of the business, our market-leading users tend to be more sensitive to industry transitions and trends. Thus, we saw less transactional activity translating into some weakness and leads to merchants. The overall dynamics and health of our business remains very strong as evidenced in our growing audience and strong advertiser relationships. We continue to grow the size of our audience and their usage of our sites during the first quarter. We ended the quarter reaching 117 million monthly unique users, turning over 98 million pages per day, reflecting 10% and 4% year-over-year growth, respectively. Traffic growth continues across all of our non-Webshots properties during the quarter 18% and we feel very comfortable with our progress in increasing usage. While we have grown Webshots significantly and it is one of the largest photo sharing sites, it was impacted by increasing competition, including the launch of photo sharing by The Facebook during the fourth quarter. We are proud of the improvements that we have made thus far on Webshots and of its growth. We continue to see very strong metrics around our ability to satisfy the needs of our customers. Our advertiser renewal rates remained very strong with 96% of our top 100 advertisers from Q4 renewing with us in Q1. While it's clear to us that our audience and marketers continued to recognize the value of our properties as evidenced in the continued growth of our user base and high advertiser renewal rates, more and more outside sources are also recognizing our best-in-class brands. Avenue A/Razorfish released its second annual Digital Media Outlook Report with a new section titled Best of the Web. In this report, CNET Networks was named Publisher of the Year in the Western region and our CNET brand was named Publisher of the Year in the technology category. Now let me take a moment to go through some of the key initiatives in each of our categories. During the quarter, our CNET-branded properties continued to scale, adding more features and services. CNET recently announced CNET TV, a new video-on-demand service that produces and packages CNET content for distribution on television and online. For those of you who have known us for awhile, this is a bit of back to our roots. As we see the blurring lines between different mediums and the growing penetration of broadband users, video is becoming increasingly important. CNET TV will launch across the CNET-branded properties later this year, adding even more original video content and features that allow users to further personalize the viewing experience as well as access video content across all of the CNET-branded sites, including news.com and download.com. Also as part of the initiative, Cox Communications and TiVo have signed on as initial launch partners, providing an opportunity to distribute custom CNET-branded original video content to millions of television viewers. While we are seeing strong interest in this initiative from a variety of distribution partners, advertiser interest has also been high. We have already signed on Best Buy as a charter sponsor. Let me turns to our games and entertainment category. We continue to see very strong momentum at TV.com with strong user trends and advertiser traction. Just last week, we had a record page view day at TV.com and our ability to attract television, studio and DVD marketing dollars continues to expand. We also look forward to this coming E3 in May and anticipate that GameSpot will once again have a leadership presence, providing users with an in-depth view of what is going on at the show. Similar to what we have been seeing at CNET in terms of strong demand for original video programming, GameSpot recently entered into an agreement with VOOM Networks to produce two original series for their new gaming channel. Our business category grew in the first quarter with strong usage of our properties, strong marketing from our traditional marketing partners, as well as the addition of new advertisers. At ZDNet, we continue to see good user interest from our growing blog network initiative. The site now has over 50 bloggers, taking the brand standards of ZDNet and welcoming the voices of other professionals and talent to provide insight on trends and other important topics. Turning to the community group, we are seeing strong product development and we're beginning to see the benefits of our branded sales effort. The first quarter marked the completion of our large investment in the core technical infrastructure at Webshots and we're now focused on feature development. A recent example is the launch of CollegeLive, a section of Webshots that we developed specifically for the college market. CollegeLive provides students from over 4,100 schools a single place to manage their social activity with party and event-planning tools, message boards, enhanced user profiles and popularity rankings, all integrated into a community-based photo sharing experience. While this is an interesting service for the college market, it is an even more interesting opportunity when applied to other substantial markets that Webshots serves including families, travelers and hobbyists. Expected to see more in this area over the coming quarters. You will also see us launching a number of additional product enhancements and features throughout the remainder of this year. Although this is a very competitive category, we believe that between our new product initiatives and its already significant audience size, Webshots is in a position to continue to be a leader in the community category. On the sales side, while Webshots is still largely monetized via ad networks, we continue to make good strides in terms of our direct sales effort. These efforts are on track with our expectations and will lead to increased monetization later this year and beyond. Our international business continues to scale and grow, particularly in markets like China and the UK. We saw very strong growth from our online businesses internationally but continue to see a slowdown in our international publishing business. This is consistent with the trends we have been seeing over the last few quarters. While our focus historically has been more on the IT professional market, we have increasingly stepped up our effort to bring more consumer-focused content to key markets. Just today, we launched GameSpot in the UK, leveraging the GameSpot US site with content catered to the UK market. In addition, our online properties in China continue to show strong momentum with user and usage trends at Zol and PCHome continuing to scale, albeit off a small base. We're seeing strong growth at these properties. We are focused on extending our brands beyond the categories we are in

[Operator:]

(Operator Instructions). Our first question comes from Anthony Noto, Goldman Sachs.

[Anthony Noto:]

Thank you very much. Shelby, I actually had two questions. One is on page view growth and the second is on incremental EBITDA margins. On page view growth, you had mentioned 4% year-over-year page view growth, and then you broke out Webshots and said it was 82% without Webshots, given the competitive impact of Facebook. Do you think that pages views for Webshots come back, or should we use that sort of base level ex-Webshots? If it does come back, what do you have to do drive it? Is it your college initiative or something else? The second question is on incremental EBITDA margins. The comment was made that 24% was consistent with seasonal trends. If I go back in time, not just from 2005, but before that, you really haven't had an incremental EBITDA margin that was less than 30% since you became profitable on the EBITDA line. So I was trying to understand (1) what is the big drop there? And then (2) do you really think you can still get to 40 to 45%? Because that would imply that the back half of the year would be significant on an incremental EBITDA basis. Given the competitive environment you just outlined and potentially you are seeing softness in platform delays, et cetera, it just doesn't seem logical. Thanks.

[Shelby Bonnie:]

To the first question on the page view growth side, one of the blessings with Webshots is after we had bought it, we have seen significant growth on a page view standpoint. And as we have said publicly, we've spent a lot of time on getting the infrastructure right so that it could scale. We had to go through the process of parsing the database into multiple services, and so we've done a lot of work on it. I think we feel very comfortable with where we are at right now. We went through a period where frankly due to our focus on infrastructure, we were a little behind on some of the feature development side. We have a lot of good stuff that you will see us launching over the next three quarters, so I think we feel very comfortable. The truth is that both at Webshots and also network-wide, over the last three years we have been very aggressive at growing the page views and growing users. So we have plenty of inventory overall. So I don't think we're constrained in any way from an inventory standpoint. I think we feel very comfortable at where we're at. Yes, the market on the photo sharing side has gotten more competitive, but I think we have one of the leading products. I think you will see a lot of really good innovation coming from us as you go forward. Let me speak quickly to part of the second question and I will let George maybe chime in. If you look at trends overall from a cost standpoint, we added infrastructure -- lots of it in the sales and marketing area in the second half of last year, and against some of our higher growth product areas. You see that cascading from a leverage standpoint throughout this year. The thing that we are unwavering on is we absolutely continue to have as much confident in the overall size of the opportunity and the necessity for us to continue to both grow our opportunity and to further diversify our audience and our brand. So you see us continuing to do that. I think we feel very good, as you see the leverage translating in the business, to be able to translate into the overall range that we provided from an incremental margin standpoint for the second half of the year. I would also say just as a note to what we have seen in the first half, the industry transitions and I think where we've been a bit surprised is as there's been uncertainty, they've translated into less confidence. And the less confidence, marketers are holding a little tighter, at least in our categories. That has kind of rippled through everyone within each one of those respective ecosystems. I think though, you will see uncertainly coming down as people get more comfortable with where the business is at. I think we feel very good that, though it's still early, I think we feel good we can have a really good second half of the year and that's reflected in our guidance.

[Operator:]

Our next question comes from Mark Mahaney, Citigroup.

[Mark Mahaney:]

Great, thank you. Two questions. First, Shelby, you mentioned the need to generate broader brand awareness. You're seeing it amongst agencies and that's something that would develop over time; it already clearly has to some extent. What can you do to accelerate that? The second one is a broader question. I think you had mentioned earlier on in your comments that you're seeing general strength in brand advertising. To what extent are you seeing any at all shift in ad buying away from ad or display formats towards search formats? Clearly, that's something has been going on for awhile. Could there have been something this quarter that may have accelerated or tipped that a little bit more than perhaps you had expected? Thank you very much.

[Shelby Bonnie:]

To the agency awareness standpoint, and you see this reflected in what we have done, we need to put more effort behind our sales and marketing effort. You need to see us do more things. It's just getting out all of us, from me on down, need to continue to focus on what things we can do just to get in front of more people and make more people aware of who we are. The good news is, when you look at our numbers, when people advertise with us, they stay with us. They have very good experiences. You see that in the awards we win, you see that in renewal rates. So we're very comfortable that when we have the opportunity to have someone test us that we can do a very good job and show them really good results. I think that you see that consistently. We just need to be known by more people, and we still struggle. A lot of people, when you say you're from CNET Networks, they say yeah, I bought a digital camera there or I read a review on a digital camera, and they don't necessarily recognize the broader portfolio that we have and the diversity of brands we have; and the ability for us to address more audiences than what would be addressed just by the Red Ball brand. So it's just going to take time. Clearly, we would like to always see it go faster as everyone would, but I think it's going at a good rate. I think we're seeing really good progress in it. It's just unfortunately for this year, it's kind of a strange year with what is happening in our endemic categories, and it just wasn't far enough along to be able to make up for what we saw in the uncertainty around core categories. In the shift in ad buying, you suggest that we might be seeing a shift in ad buying. If anything I continue to hear more and better momentum around kind of core brand advertising. But as we have said publicly, it's going to take time and we were the first to say, when you looked at examples like Ford, that it's not that easy. The people, they don't necessarily know where they can put money to work, they don't necessarily have the infrastructure, and all of us need to do more to make that better. So I think it's going the right way. I think there's nothing in kind of the core general consumer advertising area that gives us pause and makes us think that we're not going to see that being a really long term attractive growth area. It just takes time.

[Mark Mahaney:]

Thank you.

[Operator:]

Our next question comes from Imran Khan, JP Morgan.

[Imran Khan:]

Good afternoon, Shelby and George. In terms of vertical weakness that you saw in your expectation, can you talk about like which brand of your site had the weakness most? Or was it across the board at CNET.com or GameSpot? Recently you mentioned that CNET brand now represents less than 50% of your revenue. Could you just comment on which brand you are most excited about in '06 and '07?

[Shelby Bonnie:]

Okay, great. That's like having us talk about what children we like more. When you look at vertical weakness, we said on the call after the fourth quarter results that the CNET brand now comprises less than 50% of overall revenue. But you also know and I think people that have followed us know that the games area has been a really important growth engine for us. So in some respects, we probably could have handled uncertainty in one of them; when you saw uncertainty in both of them, even though the games area is growing, we just didn't see the hyper growth that we saw last year. It's one of those kind of unfortunate things when you look at the overall category side in terms of to where we are in the development and our ability to bring in general and consumer advertisers. I think all of these, as you look forward out of 2006 and you see that these cycles begin to turn the other direction in our favor, I think we will probably benefit on the flipside of it. I think overall though we continue the process of diversifying, we need to continue to do more of it. With respect to things that we think are more attractive, I'd say we're blessed and we have some really good categories. I think the opportunity when you look at the CNET side, that is a brand that has been around for 10 years. So clearly, the technology area is going to be slightly more mature. I think we have great opportunity in the consumer branding area around that brand and I think we're really beginning to see some good traction. I think that team has done a fantastic job in terms of how you bring all of the pieces together. We continue to be very excited about the games and entertainment area. TV.com continues to show a lot of momentum and I think that market only continues to get more and more interesting. I think one of the sleepers, in fact, going forward might be the business area. I think there's stuff we can do, this product we've done around ZDNet with a blogger network is a really interesting development. We have taken under the ZDNet brand and we now have over 50 people blogging for us within that brand where we sell on their behalf and make them part of our overall service. I think it has worked very well for the people that participate in the network. It's creating a real richness and fabric to that product and it's something that I think the question is going to be, why stop at 50? So when you look forward and you begin to look at brands like BNET I think that can be really interesting in terms of our ability to do more. The other thing, when you look at the community side, Webshots, I think that's seeing more competition. There's going to be some really exciting product stuff happening there later this year. It's a new area for us, but I think the food area is going to be really interesting. If you go try to use Chow Hound, the comment right now would be it's a very difficult site to use, yet the most passionate people in the food area use it. So we're excited out our ability -- the same thing we did with TV.com -- launch it in a more robust site with better functionality, better UI, better tools for the participants within the community; layer in the Chow Magazine team and then the relaunch of Chow, I think that could be a really interesting area for us. I think the first half of the year is not a perfect half for us, but I think nobody really questions the overall size of the opportunity. I think we have a unique skill which is that ability to continue to launch and build new brands. We're going to continue to do that this year.

[Operator:]

Our next question comes from Gordon Hodge, Thomas Weisel Partners.

[Gordon Hodge:]

Just a couple of things. I think Shelby you mentioned that the Vista push out didn't have much of a chance to affect the first quarter. I'm wondering, is that why you're anticipating some slowing in the Q2 as it ripples through the industry? As it relates to the first quarter on the core CNET branded sites, I think technology or the core endemics had been accelerating as we went through last year. Is it flattening out, or is it actually down year-over-year? Maybe just give a sense for that. On GameSpot, I'm just curious if you're seeing a diminution in page view growth there, or is it principally just a transition as it related to ad spend? I think that site has typically been bought forward quite a ways out, just given the demand in the category. I'm wondering if you're seeing much towards the second half of the year? Thanks.

[Shelby Bonnie:]

I think overall when you look at the transitions, I think Vista is an example of this. The truth is that things like Vista don't necessarily have a dramatic impact on overall sales in the PC category. What they do do is they create a lot of uncertainty for kind of marketers and all of these things because everyone builds to cycles. The degree to which people back off or pause or get conservative and the like, I just need to hold my budget a little bit more, that's really where we see it, and I think we saw that in March, we see that in the second quarter. Now you know, having been at this for awhile, we also recognize that people get comfortable and you move out of those positions even before the product launches. So I think it is one of those we were a little bit in a pause area. I think the same thing you would say in the gaming area, which is, we're very sensitive to game launches. That's really where marketers really spend money against them. So what happens is, in a time -- and you've seen this reflected in all of the game publishers' numbers -- even the hard-core gamers, and remember our audience, both on the technology side and on the gaming side, they're the people that know. A lot of consumers look out there and probably don't even know what Vista is. Our audience does. Our audience does know what is happening and sits down and says gosh, I want to wait until PlayStation 3 comes out or the Nintendo device. So I think we see it, marketers get probably more cautious, and I think that is just natural. With respect to the core CNET sites, we still in a good way I think we continue to see growth. This isn't a case where when you look overall that these products are falling out of bed, it's just we saw some slowing. The unfortunate thing is, in some instances over the last years, we would have slowing in one revenue stream or area, and we would have growth in others that made up for it. We just didn't this quarter with two things happening, they are relatively material, we just saw what we saw. Given that the brand stuff still looks good and I think we're seeing growth on all our properties in the branding area, it's an area we continue to get excited about. We're just frustrated it's not bigger this point. On the third question, I'd say the overall games and entertainment area has seen really nice page view growth. Ironically, if you look at the products, they continue to improve the products. We're doing a lot of really interesting stuff. When you look at GameSpot, they're doing a lot of event-based things, where we're doing tournaments. When a new game came out, we had one editor play it live for 12 straight hours. We had all of these people that tuned into watch this via broadband live. As one user said, he wrote a thing in the message board that said, it really wasn't that good, I stopped watching after six hours. So there's some good stuff happening there. TV.com, as we mentioned, just had one of its biggest page view days or its biggest page view day last week. So I think overall, really good trends. What gives us confidence right now is it seems when you look at growth on a page view size growth on the user side; what we see that we have in the pipeline in terms of product development in new product launches like Chow; we feel pretty damn comfortable with where the business is at.

[Gordon Hodge:]

Great, thanks.

[Operator:]

Our next question comes from Kit Spring, Stifel Nicolaus.

[Kit Spring:]

Talk a little bit about specifically what you think the implications of Fox acquiring IGN has had at GameSpot, if any? Then maybe talk about whether you plan to get more aggressively into streaming video or audio on the TV.com or your MP3 sites. Thanks.

[Shelby Bonnie:]

To the first on the Fox IGN side, we have not seen a lot of impact. I'm sure that will -- I assume they will do more together over the next year, 1.5 years, but we really have not seen a lot of impact. IGN and GameSpot have been traditionally two very different properties. IGN is focused more in a lifestyle area and has done a lot of stuff out of the games area. GameSpot traditionally has stayed very hard core in the games area and really I think is unmatched in what it does in terms of game coverage. We have not seen a lot of changes and I think it's clearly on our radar screen. We pay a lot of attention to it. I think we feel very good about the competitive position that GameSpot's in. On the video and audio side with respect to both TV.com and MP3.com, we're clearly, you'll see us do a lot more in that area, not just at those properties, but network-wide. Both video and audio are becoming more important. It has happened as broadband usage has increased. We saw last year our video streams went up by 100%. So we're seeing really good growth there. You see us doing more stuff around podcasts and other things. I think we're very encouraged. That's why you see us doing things like launch CNET TV, but you'll also see more stuff in the TV area. One of the things, if there is a piece of the kind of games and entertainment upside that I think is really interesting right now; one of the areas that I think has a lot more room to go is TV.com. We are seeing really good interesting things happen in that industry with the leadership of people like Disney and what they have done with some of their video products, but you also see people like CBS who I think are doing a lot of forward-thinking work. So for someone like us who grow up very much on the interactive side, we look at this and look at what a lot of these traditional media companies are doing in terms of big steps they are taking into this medium and I think this bodes very exciting for the categories. It also has a lot of really interesting implications for TV.com. So it's an area where we will continue to focus on and grow and believe it can be a much more significant important player within that realm.

[Kit Spring:]

Okay.

[Operator:]

Our next question comes from Scott Kessler, Standard & Poor's Equity Research.

[Scott Kessler:]

Thanks. I have two quick questions. The first is, if you could comment a little bit more on the competition in the photo sharing area. Were there any other developments beyond Facebook that perhaps negatively impacted Webshots? My second question is, do you have any thoughts on how you could perhaps better cross-promote your properties? Right now, my sense is that they are largely siloed, but things like CNET.com, TV information on TV.com, or I've noticed that Yahoo over the past several months has increasingly employed Flickr across many of its properties. I was wondering if you had any thoughts on perhaps doing something similar with Webshots. Thanks a lot.

[Neil Ashe:]

This is Neil, I will take the Webshots and then also the cross-promotion question. First on Webshots. As we first started looking at this property two years ago, Webshots, Yahoo and AOL were by far and away the three largest sites. If you look at comp scores for February on the photo sharing sites, the Facebook photo sharing was the number one property, which did not even exist when we acquired Webshots. The largest photo sharing sites now are Facebook, are Photo Bucket and are our property, which is up 50% since we acquired it. So in the face of three large new competitors, we're really proud of how Webshots has grown. So yes, as Shelby indicated in his remarks, this is a much more competitive marketplace. But Webshots has growing significantly in the context of that more competitive environment. And then on the cross-promotion of our properties, it's something that we're spending increasingly focused efforts on. We find that as we increase editorial integration across our properties, we drive cross-promotion and we're doing more of that. I think for as long as we're at this business, that will always be an opportunity which we can figure out how to do more and better of. But clearly, with a network of 120 million monthly unique users, which is one of the largest in the world, we are and will continue to be focused on figuring out better ways to cross-promote.

[Scott Kessler:]

If I could follow up, my sense perhaps is that from a mix perspective obviously, you're not going to go into details as to the revenues generated from your two main categories that saw some softness in the quarter. But my sense is, if there was greater cross-promotion, that you maybe would not have seen that kind of drop off necessarily. I was wondering if generally you had some thoughts on that, and if maybe the impetus of the first quarter is going to cause you to rethink the fact that there has not been as much cross-promotion among the properties as some other companies employed?

[Shelby Bonnie:]

I would say if you look at overall kind of user and usage numbers, they were very good in the quarter. As we look at cross-promotion, it's really, how do we do more to grow users and usage within our property? As I think Neil mentioned, look, I think we have done an okay job at it. We could continue to do more. And part of the magic of getting these properties right is really having kind of these passionate audiences who believe that that brand and that product is there for them and it's a special community and it's really unique. We have found that when you get those things right, that the right users find you. I think cross-promotion is something that I think is an opportunity. I don't think in any respect that it is a silver bullet. Having said that, when you look, that really is more kind of the inventory side. The good news is, we've done a really good job over the last couple of years growing inventory. In terms of what we saw in the first half of the year, this had more to do with the demand side for advertising versus demand from users. So it's just uncertainty against the categories and how that kind of rippled through, especially as we got into March where we just didn't see the lift in March that we normally would have seen in our business. That is not a function of anything happening on the user side. I think if anything, we've continued to show that even in an area where there is some question in the industry, we've been powering through and growing both users and usage.

[Operator:]

Our next question comes from Safa Rashtchy, Piper Jaffray.

[Aaron Kessler:]

Hi, it's Aaron Kessler for Safa. A couple of quick questions. One, on demographics, can you tell us where you see maybe the strongest or the weakest demographic trends to the various sites? Also, in terms of video adoption, are you seeing any of that? Can you remind us, Webshots seems like a very different site than Facebook, unless I'm wrong, but it seems like a very different value proposition to the consumer, and that's it. Thanks.

[Shelby Bonnie:]

On the demo side, the good news is we are fortunate and we personally would say we have the best audiences in the business. When you look at the demographic against each of the specific brands, whether it's CNET against one demographic, GameSpot against another or TV.com or ZDNet or Webshots, each of them are different, so they have different kind of age characteristics. They tend to all be educated. They tend to skew towards higher income, but they have different things from both a psychographic and a demographic standpoint. And so I think it's one of the really good things and it's why when we get advertisers, advertisers are very happy with the experience because we deliver what I think are the best, highest quality audiences in the business. I think we do it extraordinarily well. On the video ad side, video continues to be a more important driver. I think for all of us in the industry, there's still not enough overall inventory within the video side. So we're still kind of taking steps as to how we get used to it and how we think about scaling issues and measurement issues and all of that kind of stuff. I think it could be as we look forward to early 2007, it can be a more important part of our business. You saw the announcement of CNET TV, you saw the announcement of Best Buy coming in as a charter sponsor on that. So this is something that plays really well within that overall category. I will let Neil pick up on the Webshots versus Facebook side.

[Neil Ashe:]

We would agree that they're very different properties and very different user propositions. The reality is that the launch of photos on Facebook has exploded their traffic around photos. But the great part about Webshots is that it has always been a community site for the 10 years of its existence, focused on the sharing of user experiences and the creation of social theater. That applies to a much broader audience than the Facebook does. So while we have been and will continue to be very competitive with Facebook and those 10 million or so people that are in college in the United States, Webshots has a large and continually strong opportunity with all of the rest of the people in the world. So we remain very excited about Webshots and where it is; it's just going through a couple of months of changing user demand, and we see that in the comp score ranking.

[Aaron Kessler:]

Thank you.

[Operator:]

Our next question comes from Mark May, Needham & Co.

[Mark May:]

Thanks for taking my question. The first question has to do with the guidance for the full year. Shelby, your explanations with regard to Microsoft and the video game space make a lot of sense on the revenue side, but I am seeing the EBITDA guidance coming down more so, more than the revenue guidance, and that's actually in the face of the first quarter where it looks like EBITDA came in a million above the low end of the guidance, while revenue was at the low end of the guidance. So it looks like I understand what's going on on the revenue side -- or your expectations at least -- but it looks like something also is happening on the cost side. So I was just hoping you could run through that a little bit. The second question, Shelby, in your prepared remarks, you said something about a change in composition in the international markets will cause results to vary, and I was hoping you could just flush that out a little bit? Thanks.

[Shelby Bonnie:]

On the first one, essentially what we have done is, we had originally had a guidance range on the incremental margin side of kind of between 45% and 50%. We've taken that to 40% to 45%. It's just a recognition of as we have said over the last three years that we're going to continue to invest and grow this business. You look at of the tools to do it and our ability to launch new things, whether it's chow.com or the relaunch of chowhound.com, we're going to continue to invest in and grow new brands and new properties. I think from an overall when you look on a return on invested capital standpoint, it's a very good, high-value use of our dollars. So as opposed to going out into what is a relatively pricey acquisition market, it is another tool to grow the market. So we have done a mix of being able to buy small things, rebuild them, reposition them, redesign them, relaunch them. It clearly puts more pressure in terms of flow-through from the income statement. I think we all agree right now, if you looked at the overall what is going on in this space, there is a dearth of really good brands and good products. There's very few companies of any size who have shown any ability to build anything. We are one of few ones. So if you look at what we've been able to do with a TV.com or an MP3.com or other things, we have a unique ability to build brands and assets. So we think as a way to deliver value ultimately to our shareholders, if we can do that and build into this dearth good brands and good properties, we will do it. Yes, I think from an overall results standpoint, what we saw in the first half of the year isn't exactly what we would have liked, but at the same time, we remain as excited about the overall opportunity; we remain as confident as we have been in our ability to build new things and create new things and we're going to keep doing that this year and going forward.

[Mark May:]

I'm not sure if you can hear me, but just along those lines, would you consider this year to be more of a year of taking some of these smaller acquisitions you have done and really trying to kick-start them? And as a result maybe slowing down the acquisition pace a little bit? What is the view, in terms of further acquisitions this year?

[Shelby Bonnie:]

I think if you look at our track record in acquisitions, we tend to do a lot of really small ones that we think are ingredient acquisitions. If we can find larger ones that would fit kind of our economic criteria, we would certainly look at them. So I wouldn't put that out of the question. But I think we've found an ability to take small things and really do very interesting things with them, and I think we will continue to do that. The good news is, we're producing cash and we have an ability to take the cash that we produce and reinvest it. We will continue to do that as long as we think we can do it in a way where both we have an ability to execute it and do it in a way that we think is appropriate from a results standpoint, and too, that they are able to fit our overall return criteria.

[Mark May:]

And in terms of the international business?

[Neil Ashe:]

I will take the international. As we have said, we're in the midst of transforming the international business to more closely align with the online opportunity. So as we shuffle assets there, you will see some lumpiness in the growth based on historical quarters and projected quarters. I will give you some examples. For example, in the fourth quarter of last year we shut down a magazine in Australia which would obviously affect the comparable. In addition to that and probably most notably, we continue to transform our Chinese operations which are attractive and growing from almost entirely a print-based operation to an online operation. As we start to discontinue product lines, and in some cases, even properties, that make the comparables very different. But the net output is that we end up with a very attractive higher growth online asset like we have and like we're the process of doing in China. So you will see a little bit of lumpiness during the transition, but we're confident that what pops out the other side is a higher quality online growing business.

[Operator:]

Our next question comes from Youssef Squali, Jefferies & Co.

[Hagit Reindel:]

Thank you, this is Hagit Reindel for Youssef. Following up a little on the international, you mentioned that growth will be varied. How about profitability? This quarter, we have seen revenue levels that produced breakeven in the past. So how should we think about that? A second question about pricing. Obviously when we look at RPMs, we see the effect of maybe lower sell-through because of the delayed spending from your advertisers. So could you just comment on how you're seeing pricing evolve and what are the trends there? Thanks.

[Neil Ashe:]

Again, it's Neil. I will start with the international. We do expect it to be profitable going forward. The first quarter in our international business is our hardest quarter due to seasonality, and specifically the Chinese new year which impacts us relatively dramatically. The international business, however, is on a path of improvement. It's a couple of years behind American business and we expect it to continue to grow in its profitability.

[Shelby Bonnie:]

With respect to the RPM side, as we have said before, RPM really is an output, rather than an input for us. So as we have shown an ability to grow pages and to grow revenue, I think you have seen that number stabilize over time and I think you saw little bit of growth in that business. I think it just once again points out that we have done a good job overall from a monetization standpoint, and I think you see it with respect to advertiser retention rates and other things. We have continued work as we go to diversify and expand and grow our ability to monetize our inventory over time.

[Cameron McLaughlin:]

We have time for one more question.

[Operator:]

Our last question comes from Bill Morrison, JMP Securities.

[Bill Morrison:]

Thanks. A couple of quick questions. One, George, it looks like the sales and marketing expense kind of grew significantly quarter-over-quarter, and that did not happen in the year-ago comparison. I was just wondering if you could explain what was going on there? Secondly Shelby, you noted that you guys are obviously generating cash and you plan to invest. I was curious if you could comment about CapEx guidance for the year. I think you were talking somewhere in the $35 million to $40 million range last quarter. Is that still a good number, or do you expect to invest more or less? Thanks.

[George Mazzotta:]

Sure. The underlying growth in our sales and marketing expense is a result of us investing in key personnel for those businesses. We've build our infrastructure there both in the back half of 2005, investing in quite a bit of talent and also continue to invest in Q1. The thing you should be careful of is to back out the stock compensation expense, which drives that expense line up 29% over last year. Without the expense, the growth is 24%. Then on the capital question, we believe that our capital plan is consistent with our strategic expansion plan. Just to break this down again as we talked about on the fourth quarter call, probably half of this capital investment is to support growing business. It is the hardware capital we need for both U.S. and international revenue. The remaining half, the majority of it is in our infrastructure, our network systems and our business services systems. These are strategic capital investments we believe are very important to support our growth. The remainder is in facilities, and this is just the expansion of our U.S. facility, our headquarters office building in particular. We just build out one floor of this building. So we believe generally that our capital investment plan is very consistent with our strategic growth plan.

[Shelby Bonnie:]

Well that was the last question. We appreciate everyone taking the time to tune in for our call and participate. We look forward to talking with you next quarter. Thank you.

[Operator:]

This concludes today's conference call. You may now disconnect