Earnings Call Transcript
ZIFF DAVIS, INC. (ZD)
Earnings Call Transcript - ZD Q1 2020
Operator, Operator
Greetings and welcome to j2 Global’s First Quarter 2020 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Scott Turicchi, President and CFO. Thank you, sir. You may begin.
Scott Turicchi, President and CFO
Thank you. Good morning, ladies and gentlemen and welcome to the j2 Global investor conference call for Q1 2020. As the operator mentioned, I am Scott Turicchi, President and CFO of j2 Global and I am joined by our CEO, Vivek Shah. A presentation is available for today’s call. A copy of the presentation is available at our website. When you launch the webcast, there is a button on the viewer on the right hand side, which will allow you to expand the slides. If you have not received a copy of our press release, you may access it through our corporate website at www.j2global.com. In addition, you will be able to access the webcast from this site. After completing the formal presentation, we will be conducting a Q&A session. The operator will instruct you at that time regarding the procedures for asking a question. However, you may e-mail us questions at any time at investor@j2global.com. Before we begin our prepared remarks, allow me to read the Safe Harbor language. As you know, this call and the webcast will include forward-looking statements. Such statements may involve risks and uncertainties that would cause actual results to differ materially from the anticipated results. Some of these risks and uncertainties include, but are not limited to the risk factors that we have disclosed in our various SEC filings, including our 10-K filings, recent 10-Q filings, various proxy statements and 8-K filings as well as additional risk factors that we have included as part of the slideshow for the webcast. We refer you to discussions in those documents regarding Safe Harbor language as well as forward-looking statements. Now, let me turn the call over to Vivek for his opening remarks.
Vivek Shah, Chief Executive Officer
Thank you, Scott and good morning. I hope everyone joining us today is doing well and are safe and healthy. I want to start by thanking all of j2’s employees worldwide for their dedication and determination. I continue to be inspired by our organization’s response to this crisis and impressed by the tremendous resilience shown by our people and businesses. We were early in our embrace of social distancing. We began shifting our entire workforce, which is more than 4,000 people in over 60 locations, to remote work on March 10, which is well ahead of local orders. We are very thankful that our workforce remains healthy. Our ability to move everyone to remote work as seamlessly as we did is a tremendous tribute to our technology organization and the preparation and investments the company has made over the past couple of years. We have always believed that being a company that produces and delivers nearly all of its products and services digitally is an advantage, even more so in this environment. We are pleased with our Q1 results, which were in line with our expectations. We are closely monitoring every part of the portfolio to evaluate the impact the pandemic is having on our businesses. Our March revenues were up 9.2% year-over-year, which was a tick under the first two months of the quarter, but in no way represents the kind of revenue drop many of our peers are reporting in March. Our April revenues are also relatively healthy, coming in flat year-over-year. As we stated in the business outlook section of last night’s press release, we anticipate Q2 2020 revenue to be slightly down and adjusted EBITDA and adjusted non-GAAP EPS to be down single-digit percentages versus Q2 2019 based on current performance. It’s important to understand that our decision to withdraw our full-year financial guidance in no way reflects a lack of confidence in our business. Quite the contrary, we feel our portfolio is demonstrating remarkable resilience; rather it reflects a reluctance to engage in pure guesswork as to what the world is going to look like starting in July. It might be helpful, however, for me to share some of the broad market trends that were observed. Let’s start on the advertising side of our business. In any downturn, the first expense cuts happen within the marketing and advertising budgets of companies. It’s the easiest thing to turn off as there are few long-term non-cancellable contracts. There are few penalties or costs associated with cancelling. And the revenue impact is felt in future periods. In this particular market, we have another factor, which is the explosion of ad inventory based on significant increases in media consumption that are causing compression on advertising rates. As a result of all of these trends, a number of the largest sellers of advertising in the world have reported significant, sudden and steep declines in revenue. At j2, however, we are cautiously optimistic that our $510 million annual ad business can perform better in relative terms. First, our advertising business has little local retail exposure in terms of customers. We have roughly 1,100 advertisers who are mostly big companies, while many of the social media companies have millions of advertisers, a good number of them local businesses that have been hit hardest by the pandemic. Second, we have little exposure to the hardest hit ad categories so far: travel, retail, food and auto. In fact, roughly 40% of our ad revenues fall into the health category, where we are seeing growth from pharma marketers. As a point of reference, through April, Everyday Health has seen organic ad revenue growth of 5%. Third, the last marketing dollar cut is usually the best performing dollar, and as you know, about half of our ad business is performance-based meaning cost per click, cost per lead or cost per acquisition, and the other half, which is impression-based display, is usually measured and optimized on performance outcomes. We are hopeful moreover these are mitigating factors for us in a punishing environment for ad sales. On the subscription side of our business, which is about $850 million annually, we are closely following subscription acquisition and cancellation trends. We have not yet seen any appreciable slowdown in our subscriber adds. We are stable in the near-term, we believe, for a few reasons. For starters, our services are viewed as more essential in a work-from-home environment. In fact, over the past six weeks, we have seen that net adds for eFax in North America running about 50% ahead of plan and a rapid shift to remote work spurred orders, but we expect that will likely return to normal levels. Our voice businesses, which offer soft phone services, are relevant at a time like this and we are seeing meaningful increases in email send volumes with our MarTech services. Security and privacy are as important now as at any time. Also, much of our subscription revenue employs a lighter touch sales model meaning web and phone-based customer acquisition, which have been less disrupted by the pandemic. Finally, our lower ACVs likely make purchasing much easier than larger ticket items. Where we have seen customer acquisition impact is where field sales and/or physical contact are necessary. Larger cloud fax deployments, which require in-person sales efforts, and Ekahau, which sells tools for commercial Wi-Fi deployments, have seen slowdowns. We have also seen meaningful reductions in corporate fax page volumes from healthcare customers who have suspended elective surgeries and therefore have lesser movement of medical records. On the cancel side, we have not yet observed higher rates of cancellations evidenced by a slight decline in Q1 cancel rate from Q4 2019. But if past recessions are any indication, we would expect to see increasing cancels as credit card statements and accounts payable ledgers all around the world get even greater scrutiny. Another headwind we have on subscription side is Forex, which has already cost us $1.5 million in the first four months of the year. All taken together, we are cautiously optimistic that the headwinds and tailwinds will cancel each other out, but much depends on the broader environment. Across the entire company, we have developed contingency plans to manage expenses, including pauses on hiring, delays on salary increases, delays on certain development projects, reducing less productive marketing spend, renegotiations with vendors and suppliers and reductions in our real estate footprint. At the same time, we have not had to resort to the more draconian measures that we are observing by many in the industries in which we operate. And we are also funding some key growth initiatives of the company given our very strong balance sheet and free cash flow. In the category of longer-term themes that we believe will emerge out of this crisis, we have identified four that are important to j2. The first is our belief that healthcare will finally embrace digital transformation. There are two areas in which we believe we can benefit. The first is in our cloud fax business. As we said in the past, we estimate that the vast majority of healthcare faxes are done with machines and servers. This crisis underscores the need to move from on-prem to cloud solutions. Furthermore, we recently launched a new platform called Consensus, which combines an improved enterprise cloud fax solution with secure direct messaging and patient record query capabilities. We believe that this will be an important platform as healthcare moves to the cloud. To learn more about it, please visit consensus.com. The second area where we see opportunities is what’s referred to as detailing in the pharmacy industry. Historically, that’s meant sending sales reps in to see doctors. We believe that will be replaced almost entirely by e-detailing, which is reaching doctors digitally through websites, email and webinars. Everyday Health Pro is in this business and our flagship site, MedPage Today, saw a 33% increase in its physician promo revenues in Q1. The second theme is the rise of remote working. In Cloud Services, we are focusing our product development, marketing and sales at our security, privacy and voice businesses on work-from-home needs. What might have taken months of development is now being rolled out in weeks. A prime example of that is the eVoice Meet product, which is a fully encrypted videoconferencing solution for our customers; you can try the beta for yourself at meet.evoice.com. The third theme is our belief that video game play will only grow and establish itself as a leading form of entertainment. The spikes in consumption are evident and our ambition at Humble Publishing to be the leading indie game publisher is as promising as ever. We expect to launch 19 games this year and another 60 games are in development for the future. The fourth theme is our belief that e-commerce will become the dominant form of retail. Prior to the pandemic, e-commerce represented only 11% of all retail sales. Now, the entire public is growing accustomed to shopping online. As you know, we have long focused on being a driver of qualified traffic to online retailers, to our editorial sites such as PCMag, IGN and Mashable as well as our deal sites like Offers.com and our Black Friday sites. Now, a few words about M&A: we are pleased to have consummated two transactions in Q1. While small, it’s nice to see us get our first cloud fax deal done in a few years as well as add a condition-specific site to the Everyday Health portfolio. During this pandemic, we are very reluctant to close on transactions without visiting companies. Right now, we are planting a ton of seeds and when the clouds lift, we think we are going to be very well-positioned strategically and financially to act on some very interesting opportunities. We are also very focused on building our cash balance through ongoing free cash flow from our operations. Before I hand the call back to Scott, let me reiterate my utmost confidence in j2 and its prospects. I personally bought $1 million worth of shares during our open window in March. The resilience and strength we are showing convinced even our biggest doubters that j2’s portfolio, operating discipline and capital allocation are special. Scott?
Scott Turicchi, President and CFO
Thanks, Vivek. I will provide a succinct overview with Q1 results on Slides 4 to 6 to ensure that we have ample time for Q&A. We ended the quarter with approximately $625 million of cash and investments after spending approximately $75 million in the quarter on acquisitions and share repurchases. Now, let’s review the summary quarterly financial results beginning on Slide 4. As Vivek mentioned in his opening remarks, we had a solid Q1, which was in line with our expectations and saw 11% growth in revenues to $332.4 million, up from approximately $300 million in the year-ago quarter. EBITDA grew 2.6% to $166.8 million. The slower EBITDA growth, which was anticipated, was due to lower margin revenue contribution from BabyCenter and Spiceworks coupled with the timing of certain Humble Bundle payments in 2019 that shifted out of Q1 2019 and into Q2. Earnings per share was flat at $1.40 aided by the higher operating income and lower share count offset by higher interest expense due to the 1.75% convertible notes issued last November as well as a modestly higher tax rate. We completed two tuck-in acquisitions during the quarter and have repurchased 1 million shares of our stock since the beginning of this year. Turning to Slide 5, in Q1, we generated $95.2 million of free cash flow which was an 8.7% decrease from Q1 2019. The decrease was due to receivable collections anticipated in March that shifted to April, approximately $5 million, and higher CapEx of approximately $14 million versus Q1 2019 that has been funding a variety of projects over the last year as well as the implementation of various corporate systems. Now, let’s turn to our two segments, Cloud and Digital Media, for Q1 as outlined on Slide 6. The Cloud business grew revenue 11.5% to $169.8 million with EBITDA growing 4.3% to $78.4 million after corporate allocations. The Digital Media segment saw growth of 10.1% to $162.6 million with a slight decline in EBITDA of 2.1% to approximately $40 million due to the shifting of timing of the Humble Bundle payments referenced earlier. I would note that absent corporate allocations, the Digital Media segment had a slight increase in EBITDA over Q1 2019. Finally, before going to our question-and-answer session, I would like to turn your attention to our business outlook on Slide 7. As noted in the press release, we are withdrawing our previously issued financial guidance due to COVID-19 and the uncertainty of the macroeconomic environment. However, based on our current performance and expectations, we expect Q2 2020 results to be slightly down for revenues and adjusted EBITDA and non-GAAP EPS to be down single-digit percentages from Q2 2019. I would note that Q2 2020 will benefit from acquisitions that are not contributory to Q2 2019 financial results. The revenue contribution from those acquisitions represents approximately 6 percentage points of year-over-year growth in the quarter. Given the nature of this macroeconomic environment and the need to evaluate operations on a short-term basis, we have limited visibility at this time into Q3 and Q4 financial expectations. Following our business outlook slide are various metrics and reconciliation statements for the various non-GAAP measures and the nearest GAAP equivalent. I would now ask the operator to rejoin us to instruct you on how to queue for questions.
Operator, Operator
Thank you. Our first question comes from the line of Cory Carpenter with JPMorgan. Please proceed with your question.
Cory Carpenter, Analyst (JPMorgan)
Great, thanks for the questions. Hope everyone is doing well. Maybe one and then a follow-up if I could. Vivek and Scott, appreciate the color on the margin April trends. Very, very helpful. I guess my question is any signs of stability you are seeing in the first few weeks of May from a trend perspective and then maybe kind of pulling it all together, could you talk about Digital Media and Cloud services, maybe the revenue and EBITDA assumptions embedded within your Q2 guide? Thank you.
Vivek Shah, Chief Executive Officer
Hi, good morning, Cory. Thanks for the question. So, with respect to May, I mean, we are only 12 days in, but May looks just like April does, so essentially flat across the board. I do want to point out what Scott said in his prepared remarks, which is adjusting for M&A that contributes to this year that was not present last year, that’s about six points. So on an organic basis, trending about six points down in April and May and that’s our expectation for Q2. And look, I think considering the environment in which we are operating, where essentially every business is feeling the negative impacts of the virus, particularly media businesses and ad-based businesses, we think that’s really outstanding and then it reflects the strength of the portfolio and it reflects the strength of these brands. And so, I think at this stage, and as I said and as Scott reiterated, really the reason why we are not going to really speak beyond Q2 is we have no idea what the operating environment is going to be. It has nothing really to do with our businesses. Our businesses are showing, I think, a fair amount of strength and resilience in this period, but it’s really, as I said, pure guesswork to figure out what’s going to happen starting in July and for the rest of the year. I keep seeing all forms of different recovery notions; I think this morning was the swoosh recovery. So again, I think everyone is trying to understand what’s happening in the marketplace, not just us.
Scott Turicchi, President and CFO
And I would just follow-up on that, Cory, that in terms of the two segments, they look similar in their operating performance in the first five or six weeks of Q2 meaning flattishness on both. But as Vivek just mentioned, the media business does benefit from some M&A in Q2 that was not present in Q2 of 2019 where that’s not the case for the cloud business to any material degree.
Cory Carpenter, Analyst (JPMorgan)
Okay, thank you. Very helpful. And then just one follow-up and you touched on this on the call as well, but just hoping you could expand some — on your Q4 call, you did lay out some investment areas in 2020. Could you speak to how the current environment changes your plans if at all, maybe where you continue or plan to continue investing or even lead in, any areas where you may pull back?
Vivek Shah, Chief Executive Officer
No. So, I don’t think it changes our investment themes and where we would like to put capital to work. I think it changes our timing and I think it changes valuations. And so from a timing point of view, as I said, we are holding back right now and it is us holding back thinking that we would prefer to be in an environment where we can actually visit companies before we transact. And so that’s something that we will see for how long that’s going to be our reality, but that’s the timing issue; it’s not about availability of ideas and availability of opportunities per se. And then in terms of valuation, I think that particularly in the media world and in the digital media world, I think seller expectations have come down appreciably and not surprising. And so we think we are going to benefit from being patient here. In the meanwhile, we are going to continue to add to our balance sheet and continue to add to our buying power, but I think when the time comes for us to transact, I think we are going to see some very, very interesting opportunities.
Operator, Operator
Thank you. Our next question comes from the line of Saket Kalia with Barclays. Please proceed with your question.
Saket Kalia, Analyst (Barclays)
Okay, great. Hey, thanks for taking my questions, guys, and thanks for having me on the call here.
Scott Turicchi, President and CFO
Absolutely. Good morning.
Saket Kalia, Analyst (Barclays)
Absolutely. Good morning. Hey, Vivek, maybe just to start with you, understanding to your point, it’s really hard to think about the back half of the year here in terms of the pace of recovery, etc. So definitely not looking for any sort of quantitative forecast here, but maybe the question is what are you hearing from advertisers here for the latter part of the year and what are some of the leading indicators that are informing your thought around how the back half of the year would sort of transpire for your advertising business. Does that make sense?
Vivek Shah, Chief Executive Officer
Yes, it does. I mean, look, I think it’s category dependent. So if you look at the categories in which we operate, you have different things going on and you have different ideas amongst our advertising clients. So, let’s start with pharma. Pharma, as I pointed out in my prepared remarks, continues to grow and it grows both on the direct consumer side, but even more so on the direct provider side. So pharma advertisers have historically had messages for patients and messages for providers. And so we are seeing some pretty healthy trends, particularly on the provider side. I think part of that has to do with this notion that physical detailing — sales reps going to see a physician — essentially isn’t happening right now and I think this will affect a permanent shift. There are some exceptions. So if there is a drug that has any concerns about a negative interaction between that drug and the virus, they have gone dark. So, we have seen a few drugs go dark from a marketing point of view, which I think is understandable. In the gaming area, we have something entirely different going on. Prior to COVID-19, I believe I mentioned this at the Analyst Day in early March, we were anticipating that many gaming advertisers and publishers were going to hold their spend to support the next generation of consoles both Sony and Microsoft’s consoles that are coming out during the holiday season in 2020. And so we saw that already happening and then after that demand for gameplay is so high. There is probably a notion amongst some of the publishers that they don't really need to advertise right now, because the demand is coming in. But again I think with the console cycle, if it still comes in the fall, I think we are going to see some budgets release. And then on the tax side again, it depends. If you are direct-to-consumer, you are trying to feed online sales where we are well positioned. If you are enterprise-oriented right now, you may not value leads that you can’t follow up on and have an in-person call. So it really is that there isn’t one answer across the categories in which we operate and I don't know if it's we're lucky or we are good, but the thing is we're not dealing with travel and auto which are the most affected categories and we have fewer long-tail local advertisers. We have mostly enterprise buyers of advertising. We are unpacking the situation based on each of these different categories.
Saket Kalia, Analyst (Barclays)
Got it. That makes a ton of sense and is super helpful. Maybe for my follow-up for you, Scott, just maybe digging into the digital media business a little bit more: how do you think about the subscription component of that business? I think that includes parts of businesses like parts of measurement, maybe some components of healthcare as well. I think that was down sequentially; how do you think about that sort of seasonally in a typical year?
Scott Turicchi, President and CFO
Yes, I think that’s an interesting point, because our subscriptions in digital media do behave differently than the typical subscriptions in the cloud business, which is very sequential in nature. For those of you who are newer to j2, if you go back to Q4 of 2018 and Q1 of 2019 you'll also see a sequential dip in subscription revenues in digital media as they're heavily weighted into the Ziff Davis business unit into the first two categories you mentioned, which are our Humble Bundle on the game side and Ookla in the broadband division, and each behaves somewhat differently. But let's take the games piece: we tend to see a surge of activity later in the year in the second half, particularly in Q4, which was evident in Q4 of 2019 where we outperformed by about 10% versus our own expectation. Now the interesting thing about Humble Bundle is people are allowed to pause their subscription, which is very common as we go into Q1, so we actually expect to see sequential declines in Humble Bundle subscribers in early quarters. Then as the year goes on we tend to see that recover and even grow. Ookla is a little bit different in that it tends to have a very small number of subscribers who are very chunky. So the timing of when they subscribe and for what they subscribe tends to influence the total revenue we book. Those two also seem to be weighted from Q2 to Q4 versus Q1 and it’s also a function of the package they buy. Some are very short-term in contract duration, maybe measured in a matter of a few months, and some come at higher value levels than others — a lot of it has to do with the types of data they are subscribing to. So I think if you look at our total subscription revenues on a year-over-year basis for Q1, they are up 12.5%. If you look at the run-rate the way we look out of the business — once again with some degree of caution as we look at the back half of the year — we think that’s tracking to about 10% year-over-year growth.
Saket Kalia, Analyst (Barclays)
Got it. Very helpful. I will get back in queue. Thanks, guys.
Scott Turicchi, President and CFO
Alright. Thanks, Saket.
Vivek Shah, Chief Executive Officer
Thank you.
Operator, Operator
Thank you. Our next question comes from the line of Daniel Ives with Wedbush Securities. Please proceed with your question.
Daniel Ives, Analyst (Wedbush Securities)
Yes, thanks. So, when you talk about Q2 and obviously being down so far and it’s been flat, can you just maybe talk about assumptions in some of the businesses from a high level as you think about the quarter?
Vivek Shah, Chief Executive Officer
Yes. So, I think I will start and then Scott can jump in. But again when we are looking at it at the segment level, we look at Cloud being essentially flat to slightly down with really no M&A in that mix. And remember against last year, you have a full quarter of ownership for our IPVanish business. And then within that, if you just look within the areas that we talked about at the Analyst Day, security and privacy and corporate fax continue to be very strong and strong organic growers, offsetting a little bit of decline on the web fax side and a little bit of decline on the backup side. In the Digital Media segment, again, we are saying revenues on a reported basis will be flat year-over-year, but it benefits in the advertising portion from BabyCenter and Spiceworks on the revenue side being in our Q2 2020 numbers and not in our Q2 2019 numbers. So, on that basis, really those six points of M&A really all fall within the Digital Media segment. And so as a segment, the organic decline in the Digital Media segment is roughly six points.
Daniel Ives, Analyst (Wedbush Securities)
Got it. Could you — and maybe Scott get on the expense areas, but for me from a media perspective, can you just talk about day-to-day what you are doing in terms of just navigating all the businesses? Obviously, all the different businesses are almost running their own businesses, but just maybe talk specifically in digital media, what you are doing on day-to-day with clients, with the business to kind of navigate this storm? Thanks.
Vivek Shah, Chief Executive Officer
Yes, it’s a great question. I think we are staying in constant contact with all of our clients. It’s interesting in this remote work environment, there almost seems to be more of a willingness for clients to engage; I think everyone finds themselves with more working hours and less travel and commuting hours and an interest in having these discussions. So I think the quality of the engagement between us and our clients is very strong, lots of discussions about future plans. So, I do think it’s very healthy that way. From an operating point of view — and I will say this for all of j2 and I said this in my prepared remarks — it is remarkable to me how quickly and early we were able to get into this new environment. I think the productivity levels in the company have been higher, and I am pretty amazed at the product development work that’s going on. I mentioned a couple of the things that we rolled out in the first quarter, but the pipeline is very strong and the product roadmap is very strong. That is a mindset that the company has right now, which is: you can’t control the external environment, but we can certainly control our pace of development and our pace of innovation. That shows up a little bit in the expenses. I will be the first to tell you that the driver of expenses year-over-year is compensation and that has to do with the organization that we’ve built to pursue the opportunity that we see in front of us, and those aren’t changed. So we have not engaged in any sort of large-scale reductions in force or layoffs and we don’t believe that our businesses are anywhere close to feeling the effects that other businesses in our industry are feeling and have gone to those measures. We feel very fortunate at this point that we can keep this team in place and pursue all of the things that we are pursuing. Whether it’s the Everyday Health Group, Ziff Davis or Cloud, each one of those divisions and inside each of those business units have pretty ambitious projects on their plates.
Operator, Operator
Thank you. Our next question comes from the line of Shyam Patil with Susquehanna. Please proceed with your question.
Shyam Patil, Analyst (Susquehanna)
Hey guys. Good morning.
Vivek Shah, Chief Executive Officer
Good morning, Shyam.
Shyam Patil, Analyst (Susquehanna)
Vivek, at your Analyst Day, you talked about having some larger deals in the middle of the funnel; it sounds like there could be somewhat of a pause now given the travel restrictions, but can you just talk about how you feel about those deals coming out of this and if you expect M&A to be weighted more towards larger deals during the recovery? If you could just talk about that?
Vivek Shah, Chief Executive Officer
Yes, Shyam, always hard to predict, but I will tell you that what might have been larger a couple of months ago just got smaller on the very same target potentially. So we recognize that and we are making sure that we understand the right price on pre-existing assets we have been working on, and then new assets start to come into view. We do have those dynamics going on. But I will give you the answer I always give, because it is the truth: it really isn’t about size, it’s about putting capital to work to get maximum returns. We are built to do a series of small things or even larger things. To me it’s going to come down to finding the best available opportunity when we are in a position to transact. The key unknown is when we are going to be in a position to feel comfortable to transact and whether we will ever get comfortable transacting without physically seeing a company. Right now my view is I think that’s a hard thing to do, but again depending on how long this reality is in place it’s something that will at least have a healthy debate about it.
Shyam Patil, Analyst (Susquehanna)
Okay, great. And then just a quick follow up for Scott. In terms of gross margins overall and by segment and the OpEx by the bucket, any color you can give us in terms of how you think about those for Q2 and perceptually how you're thinking about those for the rest of the year?
Scott Turicchi, President and CFO
Yes. I will limit my comments to Q2 given the uncertainty of the macroeconomic outlook for the balance of the year, although I think some of these trends have a likelihood of persisting in terms of the cost structure. That’s more about probable revenue questions. In Q2 specifically, I would say that the gross margins are not moving around a whole lot within each of the two segments. I think the trends you saw in Q1 are likely to continue into Q2 in terms of the EBITDA margins. I would expect that our EBITDA margins to be somewhere between where we were in Q1, which was a 35% EBITDA margin, and where we were in Q2 of last year, which was 39%; you can use the midpoint of that just so as a guardrail. A lot of where the margin comes in Q2 would be a function of a couple of things as Vivek mentioned: this is very much a week-to-week analysis primarily on the top line, so incremental revenues that come in or don't come in relative to our current expectation will generally have a very high flow-through to EBITDA. Most of that's going to come because there's not a lot of OpEx associated with that incremental revenue — there might be 15 to 20 points of COGS, that's about it. And then the second thing is that a number of the initiatives that Vivek outlined at the beginning of his call are really a timing issue. So we're tracking, independent of the revenues, where all of the savings are coming in from things like lack of T&E, although I wouldn't say that it's absolutely zero. Things like elimination of certain costs that we previously thought were necessary and have deemed now to be more of the luxury. Those things are coming in during Q2. I think the good news is they will more than offset certain headwinds in the near term. Just to make it clear to everybody I am looking at our interest expense net assuming no currency translation adjustments or other income of $16.3 million for Q2. I think that’s likely to sustain itself in each of the following quarters and our non-GAAP depreciation is right around $15 million. As you saw in Q1, our tax rate came in consistent with our budget which is right around 22%. One last thing: our share buybacks technically spilled into the second quarter but as a practical matter we actually executed all the trades in Q1. But we paid for about 250,000 of those shares in Q2. So that’s why I referenced earlier we repurchased a million shares; there was a partial benefit of that in the effective share counts for Q1. That will be fully realized in Q2. If you look at the EPS the effective share count in Q4 last year was 40.5 million; in Q1 of this year it was 48.1. We are expecting it to be in Q2 around 47.2 million to 47.3 million.
Operator, Operator
Thank you. Our next question comes from the line of Nick Jones with Citi. Please proceed with your question.
Nick Jones, Analyst (Citi)
Great. Thank you for taking my questions. Could you dive in a little bit on the cost services side and what you are hearing from the SMBs? I think you have a pretty broad coverage there of the types of users; any additional color there would be helpful. Thanks.
Vivek Shah, Chief Executive Officer
Hi, Nick, thanks. So again, the question that everyone’s asking really is on the cancel side: are you seeing the kind of cancellations that others that are SMB-focused are experiencing? The answer to this point is no; we have not seen cancellations. As I mentioned in my remarks, we have an improvement over Q4 and in the early goings of Q2. We yet haven’t seen any indication of a material increase in cancels, but Scott does remind me that in past recessions we had seen increasing cancels. We are in a very different product portfolio now; we are largely not just web fax. It will be interesting to see how the non-web fax portion, which is larger than the web fax portion within cloud, will behave. A couple of things: one, we are not selling very high price-point products. The products we sell, if you are a going concern in business, are somewhat essential to what you are doing. When you look at our email marketing business, I was surprised that send volumes are even bigger. That's because if you are a retailer and you are trying to drive online sales, you are going to use email marketing as a cost-effective, quick-to-turn-on tool. On the ad side, because most of our customer acquisition is done on the phone or on the web, those have been less affected — in some cases more effective in this environment than other forms of customer acquisition. Where we are seeing challenges, as I mentioned, is we are seeing significant page-volume decreases. It’s not a huge portion of overall revenue, but we are seeing fewer sends among healthcare enterprise customers where we do get an incremental amount of revenue on volume. We think that will return when elective surgeries and non-COVID care resume across our customer base. The only other thing: on the healthcare piece, because healthcare is a huge part of the cloud customer world, I really do believe that this event is going to trigger a lot of change, and I think that change will be helpful to us. I encourage you to spend some time on Consensus because I think you will appreciate the interoperability solution we're building. So I am bullish about that, although I can’t tell you when healthcare will return to some form of normalcy. But I do believe the solutions we are building here are important, and in many ways these healthcare solutions are a big part of the cloud business.
Scott Turicchi, President and CFO
And what I wanted to follow up on, Nick, was that when Vivek said the product mix is substantially evolved from the Great Recession of '08/'09, I'll be a little more definitive on that: back in late '08/early '09, the business we called the web fax business was heavily SOHO-weighted at the time, not even what we now call SMB. So the mix between SOHO, SMB and enterprise is substantially different today than it was back in '08/'09. Just to give you a benchmark going into the Great Recession in terms of the peak, the cancel rate increased about 50 basis points per month; it started at a higher rate — it was about 3% versus the current 2.3% to 2.4% — and it peaked to 3.5%.
Operator, Operator
Thank you. Our next question comes from the line of James Fish with Piper Sandler. Please proceed with your question.
James Fish, Analyst (Piper Sandler)
Hey guys. Thanks for the question. You guys actually answered most of mine but just one for you: one thing that was not addressed at the Analyst Day was the prior cross-sell programs that I think are important in the cloud business that didn't work out in the past cycle when you tried it under the old management team. What are the differences this time and how are the early cloud cross-sell programs going in this environment?
Vivek Shah, Chief Executive Officer
Yes, thanks Jim, appreciate that question. We're doing a few things. We started to bundle SugarSync and IPVanish; that really is a retention play, same price, both products together, and it's early because we're not in that many renewal cycles yet. Month-to-month looks good but we haven’t yet seen an annual cycle, but from a retention point of view that seems to be working and we're seeing some good early positive signs. We have also bundled VPN with VIPRE; VIPRE is our endpoint product and then we created a VIPRE VPN. We're leveraging our white-label VPN technology inside of the security and privacy business and there we are trying to drive more average revenue per user and we are seeing some good progress in solid double-digit growth in revenues on that bundle. Then we've got Speedtest VPN which is a Digital Media and Cloud Services collaboration where we're leveraging the footprint of the native Speedtest application and a white-label Speedtest VPN. Initially it was free with some data limits and now we've added the monetization layer; early results are good, where if you hit the usage cap you have to convert to a paid subscriber. Another cloud-digital media bundle we actually used was Humble Bundle; Humble Bundle did a work-from-home bundle that had non-j2 and j2 products. I think we had Encrypt.me, which is our remote access VPN product, in that bundle and we drove some good orders. For the most part, natural bundling has happened — mostly in security plus privacy coming together — and we are now exploring more on the SMB enablement side which is: do our MarTech customers want our soft phone services, do our soft phone services want our MarTech? That's the next wave of exploration in terms of ways in which we can cross-sell.
James Fish, Analyst (Piper Sandler)
Thanks for the color and good luck this quarter.
Vivek Shah, Chief Executive Officer
Thank you.
Operator, Operator
Thank you. Our next question comes from the line of James Breen with William Blair and Company. Please proceed with your question.
James Breen, Analyst (William Blair)
Thanks for taking the question. Just a couple. One, I think Vivek just talked a little bit about Ookla. What have you seen as a trend there? It seems like people working from home, a lot of people are checking their speed to make sure they get the bandwidth remotely. And then two, just from an M&A perspective, obviously not a lot happening when you are face to face — what is sort of net capitalized operating perspective your ability to do multiple deals in a single quarter? If things were to open up a bit and you do a bunch of stuff at one time, to what extent can you do that across your different operating segments and different general managers? Thanks.
Vivek Shah, Chief Executive Officer
So on the Speedtest side we've seen testing volume increase 25% year-over-year really for the reasons you just described. That doesn't necessarily immediately translate into revenue; remember the foundation of the business is subscription and licensing of data. Certainly having more data helps improve that product; it's not something we would necessarily charge more for — it certainly cements our position in measurement and broadband measurement. So we will take it and it’s good — it’s not a traffic lift that equates dollar-for-dollar to revenue. In terms of the second question, given our general manager structure and as long as the deals are spread generally across the various general managers, we can do a fair number at once. We did a lot at once before. We get deals done at the general manager level, at the divisional level and at the corporate level. When you look across the number of sponsors that you have inside the company — it's close to 20 individual sponsors — having that many sponsors allows us to integrate and to acquire a fair number at the same time if that's what ends up happening.
Operator, Operator
Thank you. Our next question comes from the line of Shweta Khajuria with RBC Capital Markets. Please proceed with your question.
Shweta Khajuria, Analyst (RBC Capital Markets)
Great. Thank you. Could you please, Scott, talk about how you are thinking about marketing spend overall across the business, how we should think about it as maybe traffic on some properties increase and you may want to lean into it if pricing is attractive versus not on some other businesses? How should we think about marketing spend in Q2 and for the rest of the year? Thank you.
Vivek Shah, Chief Executive Officer
Go ahead, Scott.
Scott Turicchi, President and CFO
Sure. Through the first four months of the year, we have actually increased our marketing spend year-over-year slightly, largely due to what we have just described. We think there are some interesting buying opportunities from a customer acquisition point of view. This is entirely on the Cloud side; on the Media side we don’t do much in the way of traffic acquisition — it’s mostly organic. But on the Cloud side we spend marketing to acquire subscribers. As I think Vivek mentioned, on the web fax side we have seen a nice uptick in customer adds. We want to lean in because where others may pare back, there is some interesting prime real estate available for us. So we are going to do that. Having said that, we have cut other spends that we didn’t think held the same kind of returns as some of this new incremental spend, so our ability is to manage the marketing budget so that it is slightly up while getting far more yield out of it. That is what we are attempting to do. In general, this will be monitored day-by-day and week-by-week. If the spend is producing good yields, particularly in the cloud areas Vivek mentioned, we will continue to spend the money.
Shweta Khajuria, Analyst (RBC Capital Markets)
Okay. Thank you, Vivek. Thank you, Scott.
Operator, Operator
Thank you. Our next question comes from the line of Will Power with Robert W. Baird & Company. Please proceed with your question.
Will Power, Analyst (Robert W. Baird)
Great. Thanks. Yes. A couple do. I guess maybe just to come back or follow-up on some of the SMB commentary, obviously encouraging thus far not to be seeing an increase in cancel rates, but I wonder if there is anything else you are seeing with respect to deferred payments, any higher bad debt, anything along those lines that gives you early signs of caution there?
Vivek Shah, Chief Executive Officer
No, nothing meaningful or appreciable. Again it’s early and possibly one thing to think about is because our price points are relatively low, as people start to study their expenses whether it's appearing on a credit card or on the payable ledger, we could see some impact, but that has not been meaningful to date. Also remember our customer base tends to be more healthcare, legal, financial services — industries that seem to be doing better than some others. It’s important to draw the distinction between local retail businesses which have shuttered on Main Street and that’s not our primary customer base. But again it’s early — only two months into this.
Will Power, Analyst (Robert W. Baird)
Yes, okay. That's helpful color. And then I wonder if you can just touch on VPN? It turns out moving into that business was probably timely given the demand for work from home and whatnot, so I know you touched on some of the cross selling. Could you speak to broader trends there and growth rates if possible?
Vivek Shah, Chief Executive Officer
Yes, we continue to grow organically on the personal VPN side with nice growth rates. Stay-at-home orders have helped. We think the business is even more relevant now. We also have Encrypt.me which is a remote access VPN — think of VPN both as a privacy tunnel and as a remote access platform. We're more of the former but have technology and ambition on the latter, which we think is a very interesting opportunity for us, though we have some product development and marketing work to do there. We also have a white-label VPN business used internally with Speedtest and VIPRE and with other partners; we license that and that is also picking up. We're happy to be in that business and find it timely and relevant.
Will Power, Analyst (Robert W. Baird)
Right. Thank you.
Operator, Operator
Thank you. Our next question comes from the line of Rishi Jaluria with D.A. Davidson. Please proceed with your question.
Rishi Jaluria, Analyst (D.A. Davidson)
Hi Vivek and Scott. Thanks so much for taking my questions. Glad you are all staying safe out there. Just wanted to ask about two of the different businesses. First, on the Everyday Health side, Vivek, I appreciate your commentary that advertising revenues were up 5% in April; just what are you seeing out there in terms of traffic patterns there especially with the flagship Everyday Health property? And then Scott on BabyCenter, you did mention that it’s a lower margin business which hit a little bit of the EBITDA growth in Q1 — can you just remind us on BabyCenter what the EBITDA profile right now looks like and what kind of work needs to be done to get those margins more in line with the rest of the media business and the rest of the healthcare business? Thanks.
Vivek Shah, Chief Executive Officer
I will start on Everyday Health traffic: our consumer-facing property is Everyday Health. We have seen low double-digit increases in traffic as more individuals go online to search for COVID-related information. Where we're seeing a very significant amount of traffic is on the provider side with MedPage Today where traffic has increased 100%. That's where more of the monetization opportunities exist — more focus on direct provider advertising versus direct-to-consumer advertising. MedPage Today’s coverage of COVID-19 has been strong and we're seeing the provider community come in; we are also seeing consumers who want deeper medically driven and scientific answers, so that is driving traffic growth. Regarding BabyCenter: BabyCenter was a Q3 2019 transaction and integration is ongoing. We are seeing improvements as those assets are integrated. I would say there is probably 7 to 10 percentage points of margin pickup yet to be realized as BabyCenter is integrated into Everyday Health. There is some seasonality in that business as well. The integration is very much on track and we expect to continue to pick up those points over the balance of the next several months as the integration completes.
Operator, Operator
Thank you. We have reached the end of our question-and-answer session. I'd like to turn the call back over to Mr. Turicchi for any closing remarks.
Scott Turicchi, President and CFO
Thank you very much. We did receive one question via e-mail. I would like to address that before we actually close up the call. We were talking earlier about the first six weeks of Q2; the question came in whether we were speaking about this relative to Q1 or Q2 of 2019. Particularly for Digital Media, year-over-year comparisons matter, so sequential really is not what we look at in Digital Media. You can look at that in Cloud. In the case of Cloud, I would say both year-over-year and sequential comparisons are appropriate. In the case of Digital Media, we're speaking about year-over-year comparisons. There was also a question in terms of the mix of our revenues in Q1 of 2020 versus Q1 2019 in our media business. I do actually want to note this: in Q1 of 2020 performance-based marketing slightly eclipsed display. Display was 35% of revenues, performance marketing was 36%, and subscriptions were about 28%. If we look at the year-ago period, Q1 of 2019, that would have been 37% display, 34% performance and 27% subscription. As we talked about throughout this call, the goal has been to move more and more of that advertising revenue into the performance category and we are seeing some shifts in the proportional relationships. As the operator mentioned, this concludes our earnings call for Q1. Normally I would say we will be out there meeting you at a variety of conferences; I think they’ve all converted into virtual formats through mid-June so we do have a number of those. We have a press release out already talking about the two we will participate in in May including one tomorrow, and then there are also early June conferences. We look forward to participating in one-on-one meetings and fireside chats, and we would look to announce our Q2 results as we normally do in the first 10 days of August. Thank you very much.
Operator, Operator
Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.