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Don't Panic Over RetailMeNot's Second-Quarter Results

RetailMeNot (NASDAQ: SALE  ) reported second-quarter results on Aug. 4. The market wasn't pleased with the results and has since pushed the stock down more than 25%. However, the sell-off may be overdone. Let's take a closer look.

Quarterly highlights
Total sales for the quarter increased 37% year over year to $59.5 million. Excluding sales from businesses acquired over the past year, organic sales increased 34% year over year. Net sales from international markets increased 57% year over year to $13.5 million, making up 23% of total sales as a whole.

RetailMeNot continues its strong growth in mobile, with mobile revenue increasing 114% year over year to $10.7 million. Mobile revenue made up 18% of overall sales, signifying just how much room there is to run in this quickly growing segment. Total visits to RetailMeNot's digital platform increased 27% year over year to 154.2 million.

Net income for the quarter decreased 16% year over year to $4.3 million ($0.08 per share), caused primarily by higher expenses relating to product development, sales and marketing, and stock-based compensation. Compared with the second quarter of 2013, product development expenses increased 87%, sales and marketing expenses rose 36.3%, and stock-based compensation shot up 175%. Adjusted EBITDA grew 25% year over year to $19.7 million.

I don't mind investments into R&D -- such expenses are common with young and innovative companies disrupting their respective industries -- but the drastic increase in stock-based compensation has the potential to be harmful to shareholders should it continue to progress at these levels in the coming years. (Stock-based compensation for employees and executives can lead to dilution of shares outstanding, thereby diluting earnings per share.)

Operating cash flow saw a strong year-over-year increase of 128% to $18.2 million, with free cash flow (including cash acquisitions) increasing 151.5% to $17 million. This strong free cash flow production helps validate the strength of RetailMeNot's core business right now, despite some short-term operational hiccups. 

So why the market hate?
A few things about this quarter peeved Wall Street analysts. First, RetailMeNot's revenue and sales fell short of the $60.2 million (actual sales were $59.5 million) and $0.17 in earnings per share (versus actual EPS of $0.08) the analysts were expecting on average. An approximate 1% revenue miss for a company growing as quickly as RetailMeNot is hardly a reason to panic, but investors should watch closely to ensure that the company's investments into product development and sales and marketing begin to drive growth.

RetailMeNot's search engine traffic was indeed affected by Google's algorithm change in May -- which caused RetailMeNot shares to drop 20% at the time -- and RetailMeNot's search engine traffic still hasn't recovered to the levels it reached before the change. There is thus some pressure on RetailMeNot's growth in the remainder of 2014, with management estimating a 5% impact on projected revenue in 2014 as a whole because of the algorithm change. On the conference call, management was quick to point out that the change didn't affect the company as significantly as some had been speculating it would in May, but it did disrupt and reduce RetailMeNot's page rankings, search traffic, and monetization levels.

For the upcoming third quarter of 2014, RetailMeNot management anticipates revenue to increase year over year approximately 16% to between $53 million and $57 million. For 2014 as a whole, management now projects the company to bring in total sales of $262 million to $270 million -- levels that would represent an increase of 25% to 29% from 2013. 

RetailMeNot's guidance for 2014 as a whole is exactly the same guidance management provided in the fourth-quarter conference call this February. Unfortunately, management raised guidance in May after reporting first-quarter results, thus leading to a nasty reaction this time around when guidance was reduced to initial levels. Rookie mistake for a company that's been public for just over one year. (I wish more companies would follow Warren Buffett's lead and provide no guidance to Wall Street.)

In short, RetailMeNot's 2014 expectations are right back to where they were in February of this year. The long-term outlook for RetailMeNot is really unchanged. 

Looking ahead
"While our top-line growth outlooks reflects some near-term headwinds," says CFO Douglas Jeffries, "we believe the long-term outlook for our business remains unchanged. Accordingly, we are continuing to invest against the long-term opportunities."

Going forward, RetailMeNot must diversify its operations to lessen its dependence on search engines to drive traffic and sales. While management claims it regained roughly two-thirds of the traffic lost by the Google algorithm change within one month, clearly the change dinged the company's shorter-term operations, focus, and outlook. RetailMeNot has certainly dealt with algorithm changes before, so I'm not concerned that this particular change will result in any significant lasting damage.

A survey from Gartner released this April found that digital marketing budgets are expected to increase 10% in 2014. Companies are allocating more of their marketing resources to digital and mobile venues, which still make up only a third of overall marketing budgets on average. RetailMeNot stands to benefit from these trends thanks to its wide audience of digital and mobile users. As RetailMeNot continues to reinvest in product development, the company is poised to generate solid sales growth over the next three to five years.

Foolish bottom line
Remember that RetailMeNot has $213.9 million in cash with only $22.8 million in debt. These numbers, coupled with RetailMeNot's steadily increasing free cash flow, serve as ammunition for the company to make acquisitions, invest in product development, and provide a cushion in tough times. 

Few of RetailMeNot's fundamentals have changed since May, yet the stock has been pushed down more than 40% in that timeframe. Overdone? I think so, but what really counts is how the company performs in the remaining quarters of 2014 and beyond. Investors should be watching closely to see whether RetailMeNot's growth strategy remains intact.

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David Kretzmann

David started investing in stocks when he was 12 years old and has been a Fool ever since. He is a graduate of Berea College and the Motley Fool's Analyst Development Program, serving as an analyst in Rule Breakers and Supernova. Follow David on Twitter @David_Kretzmann.

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8/28/2015 4:00 PM
SALE $9.14 Up +0.46 +5.30%
RetailMeNot CAPS Rating: *****