New Product Adoption Boosts Revenues and Margins for Constant Contact

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CTCT
Constant Contact

Digital marketing services provider Constant Contact (NASDAQ:CTCT) posted a strong set of second quarter results. Q2FY14 revenues kept pace with the accelerated year-on-year growth rate of 16% posted in Q1FY14. The company has delivered on both revenue drivers, namely customer additions and average revenue per user (ARPU). In terms of customer additions, Constant Contact has been able to add 10,000 unique new customers onto its marketing platform every quarter for the last 6 quarters. Year-on-year growth in ARPU accelerated to 8% in H1FY14 from 4% in FY13, driven by upselling and bundling of services.

The strong top-line performance resulted in a 38% jump in quarterly adjusted EBITDA for the company. Operating profit for the quarter crossed $3 million, compared to a loss of approximately $98,000 in Q2FY13. Having invested significantly into Research and Development (R&D) activities such as its newest offering, Toolkit, for the last three quarters prior to Q2FY14, Constant Contact eased on R&D investments this quarter. As a proportion of revenues, quarterly R&D expenses declined to 15.8% compared to 17.1% in Q2FY13. However, sales and marketing expenses in Q2FY14 have increased by 1.15 percentage ponts on a year-on-year basis to support adoption of the new product offering from customers.

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Strong Operational Performance Prompts Share Repurchase Program

In the Q2FY14 earnings conference call, Constant Contact CEO Gail Goodman announced a $30 million share repurchase program to distribute some of the cash that the company has on its books. Its net cash reserve has expanded nearly 75%, from $81.9 million in June 2012 to $141.4 million now. These net cash reserves include cash and cash equivalents, marketable securities and restricted cash and excludes debt.

The company had a similar excess cash position of approximately $143.7 million on its books in March 2012, which it utilized to acquire SinglePlatform in June 2012. However, its intention to return the excess cash to shareholders this time could mean that the management views the stock as relatively undervalued for future growth. The company looks to be testing different metrics to find the right long-term balance between ARPU growth and customer additions for new product offerings such as Toolkit and SinglePlatform. In Q2FY14, SinglePlatform added 11 large enterprise deals, each with more than 100 individual locations. As these products continue building scale, revenue growth rate and adjusted EBITDA margins are bound to trend higher, leading to higher valuations.

Margins Expected to Surge Ahead of Revenue Growth in Q3FY14

In the near term, management expects a healthy growth in gross and EBITDA margins. Guidance for Q3FY13 indicates adjusted EBITDA margin between 21-21.5% on a revenue base range of $83.4-$83.7 million. Comparatively, adjusted EBITDA for Q3FY13 stood at approximately 20.4%. Quarterly net income is expected to arrive between $4.3-$4.6 million for Q3FY14. This translates into 13-14 cents of earnings/share. However, any progress on the share repurchase program could boost EPS for the quarter.

Moreover, sales and marketing dollars spent in Q2FY14 are expected to be the high point of operating expenses in absolute terms for full fiscal 2014. This relieves downward pressure on EBITDA margins, particularly because sales and marketing expenses account for nearly 40% of revenues. Additionally, with the kind of EBITDA margin expansion observed in Q2FY14, driven by strong adoption of its new product offerings, there is a strong chance that Constant Contact might exceed its guided Q3FY14 statistics handsomely.

We are revising our Trefis price estimate of $31 for Constant Contact to incorporate trends from the recent Q2FY14 earnings.

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