Welcome to j2 Global's second quarter earnings call. I am Donna, and I'll be the operator assisting you today. At this time, all participants are on a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. I will now turn the call over to Scott Turicchi, President and CFO of j2 Global. Please go ahead, sir.
Thank you. Good morning, welcome to the j2 Global Investor Conference Call for Q2 2018. As the operator mentioned, I'm Scott Turicchi, President and CFO of j2 Global. Joining me today is our CEO, Vivek Shah. We're very pleased with the second quarter and first half performance of j2, most notably the strong free cash flow generation, improving margins, and better than expected EPS, notwithstanding some revenue softness. The board has approved an increase in the quarterly dividend by $0.01 to $0.425 per share. We will use the presentation as a roadmap 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've not received a copy of the press release, you may access it through our corporate website at j2global.com/press. You will be able to access the webcast from this site. After we complete the formal presentation, we'll conduct a Q&A session. The operator will instruct you at that time regarding the procedures for asking a question. You may email 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 the risks and uncertainties include, but are not limited to, the risk factors that we have disclosed in our 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. Let me turn the call over to Vivek for his comments.
Thank you, Scott Turicchi. Good morning, everyone. We're pleased to report record revenues, adjusted EBITDA, and EPS for the second quarter. We'll get into more details about our results shortly. As I've done on our last two calls, and what I'll look to continue to do in future calls, is to focus my remarks on larger themes across the j2 Global portfolio. Today, I'd like to cover three topics. First, I'll share some of the dynamics we're seeing inside of our advertising revenue stream in the digital media segment. Second, I'll talk about how our Mosaik transaction relates to our larger vision for Ookla. Finally, I'll describe a bit more about how our new leadership team is taking shape and why we're so excited about the talent we're bringing into the company. While a record, our revenues were a bit soft in the quarter.
Pretty much all of that softness was within our advertising revenues. As a result, we basically gave back the revenue surplus we enjoyed in Q1. Through the first half of the year, we're essentially on target. As many of you know, there are two components to our advertising revenues, the display and video business and the performance marketing business. Our display and video revenues consist mostly of banner and video ads that we sell on a CPM, cost per thousand impressions basis. Over the last 12 months, display and video represented about $250 million in revenue across our tech, gaming, and health properties. We have sales forces who pitch programs and respond to requests for proposals from advertisers and their agencies. When we're successful, we receive insertion orders for ad programs directly from agencies.
We also generate display and video revenues through programmatic selling of ads, where it's an automated process. On the performance marketing side, we generate revenues by receiving commissions on e-commerce transactions that result from users clicking on Buy Now buttons on our sites and then directed to the merchant's site to conclude the transaction. We also receive revenues for leads that we generate for enterprise vendors. In some instances, we get paid to drive clicks to client sites. Over the last 12 months, performance marketing represented about $200 million in revenue. Our performance marketing business is what really distinguishes us from many digital publishers. Some time ago, we understood the shifts taking place in the CPM-based market and focused our evolution towards being able to deliver ROI-based solutions. That's the key distinguishing factor between display and performance marketing. The latter is entirely about outcomes.
You're often driving discrete sales and transactions. The display and video business, however, often has a branding, awareness, or favorability goal attached to it. Also, another difference is that the display and video business is often pretty lumpy. You can see some pretty large fluctuations quarter to quarter. There are some timing issues at play. We also believe, and it's something we've talked about, that the display market has some headwinds. First, the move to programmatic has created some pricing pressure, as programmatic CPMs are generally lower. Second, the social platforms have created a lot of inventory that eats up large portions of advertiser budgets. While we're vertical publishers and therefore have some strong endemic books of business, we're not entirely immune to the emerging oligopoly in the advertising market.
Third, clients are demanding measurable performance and ROI, which is why we embarked on a major transition in our digital media business to be able to deliver on those market needs. Finally, we still haven't seen a rebound in the pharma ad market, Everyday Health represents nearly half of all the display revenues in the digital media segment. This is all to say that near term, we view our overall advertising business as a mid to high single-digit grower, with performance marketing driving all of the growth. Of course, any improvement in the pharma category would represent upside, as would any swing of the pendulum back to premium vertical sites. We're not relying on it and see our growth in performance marketing and digital media segment subscriptions, which we discussed at length last quarter, driving overall digital media segment growth along with our M&A program.
The media subscription businesses are right now on a run rate of $130 million in annual revenues, which is remarkable. Now let me shift to Ookla. As you know, we're very bullish on our Ookla business and have a vision for being the single source of truth, the global standard in the broadband industry, which includes mobile carriers, ISPs, device makers, tower companies, governments, ASPs, and content providers. We receive 10 million global tests per day across all of our speed test platforms, our website, mobile apps, browser plugins, and smart TVs, which we translate into vital research and analytics for our enterprise clients so they can better understand the state of their networks. These real-world tests are at the core of our value proposition, we recently acquired Mosaik to enhance our offering by providing visualization and mapping solutions that we lacked.
What Mosaik has done is use public data sources and client-provided data to populate its mapping solutions and geospatial analysis engine. What we can now do is leverage our speed test data with their mapping solutions to provide our enterprise clients more value and new products to attach to their contracts. Lastly, Mosaik has also developed some early expertise in 5G, Internet of Things, and smart city analytics, which we think will figure prominently down the road as we see a greater variety of wireless connected devices worldwide. We have a nice pipeline of acquisitions that we believe should allow us to expand our capabilities and product portfolio. Today, Ookla largely services the performance market. That is data and insight related to the quality of fixed and mobile networks.
We believe we have a ton of runway in that market, we also have ambition to penetrate the coverage market, which is why Mosaik made sense for us, as well as the roaming and tower markets, application metrics and customer experience, and other areas in high-speed internet. Now let me talk about our leadership organization. Much has changed since the beginning of the year. As you know, we promoted two of our top executives, Harmeet Singh and Steve Horowitz, into divisional President roles overseeing Cloud Services and Ziff Davis respectively. We also hired Dan Stone in April to be the President of Everyday Health. All of our portfolio businesses report into Harmeet, Steve, or Dan. While we've had general managers in charge of our media units, the Cloud Services side has not always had business unit general managers.
All five of our Cloud Services businesses, digital Fax, backup, voice, email marketing, and security, have general managers at the helm. With that, we now have strong leaders with full P&L responsibility and oversight of their products, strategy, engineering, and development. It makes all of the difference to have that kind of focus and accountability. John Neuberger, who has an incredible healthcare background, having held senior roles at Demandforce, Alliant Health, Zynx Health, and Allscripts, has hit the ground running in the Fax unit. He's taken all the great work that was done in Q1 to enhance our position in the healthcare market and accelerated development, marketing, and sales. We closed 42 enterprise healthcare deals in the quarter, deployed a new RESTful API, which integrates into healthcare EMR and EHRs, and grew the overall digital Fax business by 4.5%, a good portion of which was organic.
This was probably the best organic growth quarter for Cloud Fax in a very, very long time. On the voice side, Ron Burr, having been CEO of CallFire, Layer2, and a founder of NetZero, immediately identified the opportunity to acquire Line2 to fundamentally improve our eVoice offering. The second line business allows small businesses and sole proprietors to add a second phone number to their mobile device, as well as place and receive phone calls from a laptop. There's no hardware. It allows these small businesses to cost-effectively and conveniently juggle personal and business phones and text messages. With Line2, we're now transitioning eVoice off of a legacy platform to a modern one that allows for advanced mobile features. Line2 also brings a stronger mobile app and app development skills to match well with eVoice's web-based product.
Before Ron, our voice business was frankly an orphan that was essentially housed inside of our digital Fax unit. It deserved real leadership. It's a $65 million run rate business. We believe Ron will continue to drive smart thinking and strategy that will translate into growth. Several weeks ago, we were pleased to welcome Tim Smith to the company, who is overseeing our cloud backup unit. Tim has spent the last 15 years at Dell EMC and Western Digital, and before that was in the tech investment banking group at CSFB. He has the perfect background and skill set to tackle the situation at backup. Finally, we promoted one of our brightest and most dynamic executives, Seamus Egan, into the general manager role in our email marketing unit. We're excited for the business and its potential under Seamus' leadership. Let me pass the call on to Scott.
Thanks, Vivek. Q2 2018 set a variety of financial records for j2, including revenue, EBITDA, and free cash flow for a second fiscal quarter. These results were driven by several areas of strength in our portfolio of companies, notably the digital Fax business, performance-based marketing, and our media subscription businesses, as well as sequential improvement in our EBITDA margins. We ended the quarter with approximately $428 million in cash and investments. Let's review the summary financial results beginning on slide four. For Q2 2018, j2 saw a 5.4% increase in revenue from Q2 2017 to $288 million, even after taking into account the ASC 606 revenue recognition rules, which impacted us by $2.8 million in the quarter, as well as the divestiture of assets later in 2017 that were present in Q2 2017 of approximately $11.8 million. Adjusted for these, revenue growth would have been 11.2%.
Gross profit margin, which is a function of the relative mix of our 12 business units, remained strong at 83.7%, up from 83.1% in Q1 2018. We also saw EBITDA grow by 3% to $113.5 million. I would note that the ASC 606 impact of $2.8 million also reduces EBITDA dollar for dollar and penalizes our EBITDA margin by approximately one percentage point. Finally, adjusted EPS was $1.50 per share versus $1.33 per share for Q2 2017, positively impacted by lower domestic tax rates, partially offset by higher interest expense of the 6% notes issued last July and a higher share count. I would note that after further study of the Tax Cuts and Jobs Act of 2017, we now believe that our tax rate for the year will be between 20%-22%, reduced from the original estimation of 23%-25%.
At the midpoint of our guidance range, this has an impact of approximately $0.21 per share, as a result, we are raising our non-GAAP EPS range by a like amount. Let's take a closer look at the EBITDA margin profile in Q2 2018. The EBITDA margin in Q2 2018 was 39.4%, ahead of our budget, and about one percentage point lower than Q2 2017. ASC 606, as I just mentioned, accounted for almost all the differential in margin this quarter versus Q2 2017. In addition, as we discussed last quarter, two newer acquisitions, VIPRE and Mashable, continue to be in the process of integration and also produce a slight drag on our overall EBITDA margin. As you know, a core tenet of our business model is the conversion of EBITDA to free cash flow.
Turning to slide five, you can see we had a record free cash flow in a second fiscal quarter, producing $87 million, up 22.4% from Q2 2017. While there can be influences on any given quarter due to the timing of tax payments, collection of receivables, spend on CapEx, and timing of payables, it is helpful to look at the trailing 12-month free cash flow, which was $309.9 million, and a conversion of 66% of the trailing 12-month EBITDA. As Vivek mentioned in his opening remarks, subscription revenues, especially in our digital media business, remain an ongoing focus. Our total subscription revenue, as detailed in Slide 6, hit an all-time quarterly high in Q2 at $181.5 million. Of this amount, $31.3 million of subscription revenue was from our media group and is on approximately a $130 million run rate.
Total subscription revenue represented 63% of j2 Global's total revenue for the quarter. Our digital media business saw a more than doubling in subscription revenue from Q2 2017, despite the impact of ASC 606 on our Ookla subscription revenue. Now let's turn to the two segments as outlined on Slide 7. The Cloud Services business grew 3.9% to $150.3 million. We saw real strength in the Fax business, which grew 4.5% year-over-year, a good chunk of it organic, driven by our healthcare initiative. I can't remember a quarter of organic growth this strong for Fax. It's been many years. EBITDA declined slightly on a reported basis to $75.6 million from $77 million in Q2 2017. However, as we noted last quarter, we've done a reclassification of certain corporate expenses to conform with our audited financials for the Cloud Services business, which we furnish to our 6% note holders.
The impact of these adjustments is $1.2 million in Q2 2018, resulting in a pro forma EBITDA of $76.9 million, approximately flat with last year. In addition, current quarter results of both revenue and EBITDA were also impacted by the loss of patent licensing revenue due to ASC 606 of approximately $800,000. EBITDA margins expanded by two percentage points from Q1 2018 to 51.4% from 49.4%. Our media business grew revenue 7.1% to $137.6 million, or 16.6% after taking into account the divestiture of Cambridge and Tea Leaves, and produced $39.8 million of EBITDA and 8% growth. The EBITDA margin for the quarter was 29% and was impacted by approximately one percentage point for ASC 606, or $2 million, and slightly less than one percentage point for reclassification from j2 of certain corporate expenses of $1.2 million.
Slide eight presents our financial data in tabular format, showing the year-over-year change for the various results. Finally, we reaffirm our annual guidance of revenues, EBITDA, and raise our adjusted non-GAAP EPS due primarily to our lower expected tax rate. As a reminder, we estimate our 2018 revenues to be between $1.2 billion and $1.25 billion, EBITDA to be between $480 million and $505 million, and are increasing our adjusted non-GAAP EPS range to between $6.16 a share and $6.46 a share. Following our guidance slide are various metrics and reconciliation statements for the various non-GAAP measures to their nearest GAAP equivalent. I would now ask the operator to rejoin us to instruct you on how to queue for questions.
Thank you. The floor is now open for questions. If you would like to ask a question, please press star one on your telephone keypad at this time. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Once again, that is star one to register questions at this time. Our first question is coming from James Breen of William Blair. Please go ahead.
The mature margins will be in the media space as you get through some of these synergies, going forward. How you anticipate-
Jim.
Sorry, then how you anticipate some of the revenue mix in the media group, going forward as well. Thanks.
Jim, we missed the first part of your question. You weren't live for some reason. Can you restate the first part of your question?
Just where you think margins go in media as you get through some of this integration with some of the things you've bought, and where the margins could be there longer term. Then what the advertising revenue mix or subscription and advertising revenue mix will be in media. Thanks.
I think we're real pleased with where the margins are going in digital media. As you know, through the process of integration of Everyday Health, they came in a little bit last year. We have a target margin of approximately 35% EBITDA for the digital media business consolidated. As you know, Q4 is seasonally rich and Q1 is seasonally light. We're tracking on the margins we are for the first two quarters of the year, and I'm pleased to say that Everyday Health in particular is showing very strong improvement in its EBITDA margin of 27% year-over-year. I think on the margins, you should look at mid-30s. We might be a tick under that this year. As you know, we have Mashable and VIPRE on the cloud side, which is different question, but that are still in the process of being integrated.
I think if you look out a year or so, about 35% EBITDA margin. In terms of the mix of the business, right now in digital media, it's roughly 40% display and video, 40% performance-based marketing, and about 20% subscription. I expect there to be some moderation in that over time with the rate at which subscription is growing. It probably becomes a slightly larger percentage, as does performance-based marketing, because those are both demonstrating double-digit growth. I think if we look out a year, and obviously this is all qualified by what we may buy in the future and what its revenue streams may be, but if you took the current book of business and just rolled it forward, you're going to see that subscription piece creep up and the performance piece creep up and display go down a little bit as a percentage of the totality.
Great, thanks. Then just to follow up on the cash flow, very strong this quarter. Anything in particular that's leading to that? Then, how do you see that trending as we move through the back half of the year? Thanks.
It helps having a lower tax rate, means we have less estimated tax payments and less tax payments due. Doing the deeper dive on the Tax Reform Act and being able to look at some of the nuances there that ended up accruing to our benefit helps, not only this year but going forward. As I mentioned in the prepared remarks, there are timing differences related to things like collection of receivables and payables. I would not look at the 76%-77% flow through of EBITDA to free cash flow as normative. I think the trailing 12-month is more representative in the 65%-66% range. I would expect a lower dollar amount of free cash flow in Q3 because it is also the quarter in which we make our bond payments.
We have both the interest on the convertible securities as well as the 6% notes. We have an interest payment coming up in Q3, so that will knock down the Q3 free cash flow somewhat. It should begin to pick up in Q4 and then accelerate into Q1 of 2019. Look at the trailing 12, look at that $310 million. As you recall, even though we don't formally guide the free cash flow, the midpoint of our range in guidance implies a $310 million number. We're already there on a trailing basis with upside as we look to the back half of the year. I expect us to do better than the $310 million for full year 2018.
Great. Thanks.
Thank you. Our next question is coming from Shyam Patil of SIG. Please go ahead.
Thanks, guys. Good morning. I have a few questions. The first one, Vivek, just on the media business. The pressures you outlined, I guess, have been in the space for a while. Just curious why you think they're impacting the business now, and how do you think about the playbook to deal with these pressures going forward?
Yeah, look, those aren't new. I thought it was just helpful to reiterate them. Those are things we've been dealing with for a while. Look, I've been around the CPM ad business for 24 years, I've kind of grown accustomed to the choppiness and fluctuations that are inherent in the ad business, I don't view this any differently. It doesn't really alarm me. I think in many ways, what we've been doing over the last five years, building our performance marketing business, and now more recently building our subscription business, has always been in the context of understanding some of these headwinds in the display and video marketplace. I kind of look at Q2 a little bit as some combination of just kind of giving back the lead we had in the first quarter.
Getting back to where we want to be and where we need to be and watching these trends. Look, we think long term, we've said this before, we don't view the display portion of the business as the driver of growth for digital media. It really is the performance marketing and subscription parts of the business. Not a surprise for us. We've known these issues. I don't think they manifest differently in Q2 per se. I just think we've seen some choppiness. At this level of dollars, it's not uncommon for a couple of campaigns to either start early or start late. The other thing I'll just point out is half of the display business is Everyday Health, and the comps for Everyday Health are different relative to last year.
As Scott pointed out, we've been in our shrink to grow with Everyday Health. The EBITDA margins are up 27% year-over-year, even though the display revenues are down.
Got it. Thank you. To follow up, Scott, you reiterated the guidance, and you talked about kind of the range for EPS. Just in terms of revenue and EBITDA, how are you kind of thinking about the annual range at this point? Are you still comfortable with the midpoint, or would you direct us in any particular direction within the range?
Yeah. Let me make a couple comments. First, I'm very comfortable on all three of the ranges, meaning revenues, EBITDA, and non-GAAP earnings per share, we're comfortably within the range. I think that coming out of Q1, if you'd have asked, I would've said, look, we're tracking ahead of the midpoint of the range for all three. I tend to be a little bit cautious as a CFO, so while I think there's some good momentum in the back half of the year, if you press me today, I'd say on the revenues, I'd probably be a little bit under the midpoint. EBITDA, I think very close, if not at the midpoint, in terms of EPS, probably above the midpoint, even of the revised range.
Great. Thank you guys.
Thank you.
Thank you. Our next question is coming from Will Power of Robert W. Baird. Please go ahead.
Great. Thank you. Yeah, just a couple of quick questions. Vivek, I think you indicated you expected digital media to continue to grow mid to high single digits, and I guess I just wanted to confirm, is that the organic expectation? Just trying to understand the key drivers of that, given the weaker results here in Q2 and what I think is probably organic growth kind of below that level. Given the display challenges you're facing, what gets you back to that kind of higher single-digit range?
No, I think we're more, I would say to your point, I think we're more in the mid-single-digit organic growth, right? I think, again, what drives that piece is really strong double-digit growth in the performance marketing business, organic, as well as in the subscription business and not expecting a lot out of display. Again, if you unpack display, we do view the Ziff Davis set of properties, the tech and gaming properties, as being sort of a lower single-digit display growers, whereas the Everyday Health piece really, again, because of the comps, but also we haven't yet seen a return of the pharma ad market. We think we will, but we haven't seen that on the consumer side, on the DTC side. We're going to continue to stay conservative there.
I would just amend the statement and say where we might have been mid-to-high single digits, I think right now we're more comfortable in sort of the mid-single-digit range.
Yep. Okay. I guess the other related question, as you see this shift within digital media from display to performance marketing, how does that impact margins? What does the margin profile display look like versus the other two growth areas?
Yeah. No, there's a fair consistency amongst them. The high incremental flow through that you would see, there is no traffic acquisition costs associated with either really display or performance marketing. Those have sort of reasonable characteristics. The subscription side is showing the same sort of margins. We often think about, are there points where we would invest more in marketing to accelerate subscriber growth? It's something we think about and just it's something we're going to watch where if we think we can get great ROI, we'll do that. Right now, everything is sort of narrowing to this same band of EBITDA margins across the different pieces of the media business.
Okay. Great. Thank you.
Thank you. Our next question is coming from Walter Pritchard of Citi. Please go ahead.
Hi. I guess, Vivek, following up on the question from earlier in the year or from earlier in the call here. It feels like these headwinds have been there. It seems like you've sort of skirted the headwinds, acknowledging some of the issues in the healthcare market. Why do you think now it's impacting your revenue on the DM side? And then just had a follow-up for Scott.
Yeah. Look, again, Walter, I think it's hard to tease out how much of this is the manifestation of the pressures that have been there now for a while, and how much of this is simply just seasonality and choppiness. Where, remember, in the insertion order piece of the display business, which is a large chunk of our display business, it's order by order. So if orders get delayed or if they get canceled and if there are shifts, you can see those kinds of impacts. Again, when we look at it in total, sometimes it's hard with display advertising to measure it by quarter. Right?
I think we're looking at it from a first half point of view and say, "Okay, we're sort of even." Really, and as you know, it's the second half that matters a lot for this business and how the holiday season's going to shake out in Q4. Again, I wouldn't say this is the direct manifestation. I do think, though, it's what keeps it from being the kind of grower that we see performance marketing and subscriptions being.
Great. Then, I'm not sure who to direct this one to, but either one of you. On the M&A front, it seems like you have, to some degree, all of your GMs in place at this point, and your ability to kind of discreetly do M&A in those categories is maybe improved. I'm wondering if that logic is valid and how we should think about M&A, I guess, especially on the Cloud side, relative to having these GMs now very well aligned.
You're absolutely right. I think having a dozen general managers in place across our portfolio is going to directly translate into more M&A activity, and we're seeing it in the pipeline. We closed three deals in this quarter. We're now five deals, I think, in the last
45 days
45 days. They're smaller. Again, I think they each do different things. I talked about Mosaik and I talked about Line2. They're very important, I think, in the context of where we want to take these businesses. We are seeing pretty much a lot of interesting opportunities in every one of our segments. In every one of our business units. The only two that we're not seeing attractive deals are Backup and in Fax.
Fax. Okay.
As Scott pointed out, and as I pointed out, the organic characteristics of Cloud Fax are pretty compelling, and our focus on the healthcare industry is clearly paying off, and it's still early. We look at the strength of that and saying, "Okay, the absence of M&A in the Cloud Fax space we can deal with because we see a fair amount of organic opportunity." No, we're very bullish. I think you're going to see some interesting activity from us in the second half of the year.
Great. Thanks a lot.
Thank you. Our next question is coming from Rishi Jaluria of D.A. Davidson. Please go ahead.
Hey, guys. Thanks for taking my questions. Vivek, I wanted to start with you. Can you expand a little bit on your commentary in terms of weaker pharma ad sales? Is this a macro issue related to budgets and drug pricing? Or is it a matter of missing out on pharma advertising budgets?
I think it's the former. There's probably some measure of the latter as we've gone through some organizational changes, changed our sales leadership, and some of our key marketing folks. I think what's happening in pharma still is that the industry, because of self-imposed drug caps, is just pulling back on the kind of marketing spending that they're doing. It affects everyone in the space, and we certainly hear that in the marketplace. I do think that the drug pipeline is interesting over the next 12 months-24 months, that I think will unlock dollars. I do think there is a beginning of a movement in the DTC pharma world to shift from traditional venues, television, print, which still accounts for a vast majority of pharma spend, into digital.
We do believe from a secular point of view, from sort of a high-level long-term point of view, that pharma advertising spend will return and will start to shift from traditional to digital platforms. It's also one of the spaces that we like because the social media properties don't really compete for pharma. From a regulatory point of view, you can't run pharma advertising inside a user-generated content. It's the one ad category that is somewhat protected from the oligopoly, that's an interesting dynamic. Right now, I do think it's market and probably some measure of some of the sales force changes that we've made. We'll have a better sense, I think, in this quarter as we go through what are upfront. In the pharma business, a fair amount of stuff gets done upfront.
The upfronts will, I think, be telling for us on a go-forward basis.
Okay, thanks. Vivek, just to be clear, you're not expecting that rebound this year. It's more of kind of over time you expect the things to kind of shake up. That's correct on that trend. Okay. Okay, perfect. That's right. Scott, I wanted to touch on the digital media margins. I know you talked a little bit about this in the prepared remarks, but EBITDA margins on the media side were relatively flat. Op margins were down. Can you just help us understand the moving parts here? I understand Mashable is a little bit more dilutive.
Correct.
Also Q2 last year did include Tea Leaves, which was a money-losing business. Maybe what sort of impact the 606 has had there? One more follow-up, and I'll jump off.
Sure. I think you actually hit all the pieces. If you look at this year, we have the benefit of removing the low-margin businesses of Cambridge and Tea Leaves. To some extent, that's replaced by Mashable, which is still in the process of integration and is still a drag on our overall media margins. On top of that, you have in the quarter about $2 million primarily affecting the Ookla business in digital media that relates to ASC 606. That's $2 million hit to revenue and to EBITDA, it flows through at 100%. I think when you put those pieces together, you'll see that the margins, we look more at EBITDA margins than the operating income, because, as you know, there's a fair amount that flows through in depreciation and amortization.
I'd say on the core depreciation, meaning not the amort of intangibles, we have had in the last couple of years, some higher CapEx in digital media. That is flowing through in what I'd call the hard depreciation component as opposed to the soft component. I would say it's mostly the ASC 606 and Mashable in terms of normalizing the margins.
Got it. That's helpful.
Also remember, I don't know if you're looking at it pre or post-allocation, because if you look at it year-over-year, remember, we've conformed this year the accounting where we're pushing down from the parent certain costs to both the Cloud and the media segment. In the quarter, that was roughly $1.2 million for each. When you look at the prior year, there's nothing being pushed down.
Right.
It's an apples to oranges comparison.
Margins are up year-over-year.
Right. EBITDA margins are up. Okay?
Got it.
Just keep that. There's three moving pieces, allocations, which you can choose to pro forma in or not, ASC 606, and Mashable.
Okay, perfect. Just on the topic of ASC 606, can you remind us which specific businesses are impacted on the rev rec side? I know you've mentioned Ookla subscription. In the past, you've mentioned the licensing and IP income. Are there any other segments impacted from 606 on the rev rec side?
No.
Are there any changes when it comes to operating expenses?
No, you hit the revs correctly. Just to review in the quarter, $2 million for digital media, all of that coming out of Ookla. On the cloud side, about $800,000, all of that coming out of what we used to call patent licensing revenue. No material change or benefit in terms of ASC 606 as it relates to expenses.
Okay, perfect.
ASC 606 for us is punitive in that it's taking away revenue that was very high margin.
That makes sense. I guess last, was there any currency impact in the quarter, or should we be thinking about currency for the back half of the year?
No. In fact, we looked at it. FX was really immaterial. We look at Q2 2017, Q2 2018. As you know, that mostly impacts the cloud business, given its diversity of revenue streams overseas in currencies. Most of which are still tethered to the U.K. pound, the euro, then it kind of falls off the Canadian dollar, the Aussie dollar, and there's a few other currencies in there. No, I don't think FX is going to be a big issue one way or the other.
Got it. All right. Thanks.
Thank you. Our next question is coming from Greg McDowell of JMP Securities. Please go ahead.
Oh, hi guys. It's Pete Lowry in for Greg.
Hey.
Can you give me some color on the M&A landscape, just in terms of what you're seeing in terms of valuations, or valuations on the small side being impacted as much as some of the heightened valuations we're seeing in large tech companies? Then just the second part to that question, can you remind us about how you think about investing in up and down markets and maintaining discipline? Thanks.
Sure. As we've talked about before, I think that you see a lot of headline deals out there. We could name some names. Publicly traded companies that are in the midst of trading, you see the multiples at which they're trading at. I would say that for anything that is of size, meaning hundreds of millions of dollars in revenue, certainly those that are publicly traded, what you see going on in the marketplace, either equity valuation-wise or actual trades that have taken place for M&A, those tend to be elevated. We have participated in varying degrees to some of these deals that have cleared the market, and it is not uncommon that we are 20, 30, even 40% lower than where the deal actually clears. As you know, we don't premise j2 on doing large transactions.
We want to be in that deal flow every now and again, an Everyday Health comes along. For the most part, whether the multiples are frothy valuations or not, that's generally not where our focus is. It is the case that as you start to move downstream, there's less correlation with the market dynamics and the multiples that we pay. I would say that for the most part, when we do the tuck-in deals I wouldn't say they're completely immune, but I would say they are more or less immune from the market dynamics because often there are other drivers that are influencing the sale of the asset. There's intangible benefits that the sellers want beyond just the economic $. It may be an asset in a portfolio that isn't performing to the PE or VC's liking.
For them to be able to get it out of their portfolio, stop allocating time and money to it is a real benefit beyond just what's the highest bid. We've won deals like that where we're not necessarily the highest bidder, we're certainly not paying market multiples, but we are bringing an intangible value to the equity owners.
I think that's an important point that Scott makes. We're seeing more volumes of deals where we think we're uniquely positioned to extract value. Where we've got a platform, we've got an existing business, we've got an approach that is unique and allows us to view this asset differently than the marketplace. We're seeing more of those, and that's frankly.
That's correct
our sweet spot. The businesses that are rocket ships in and of themselves, that are demonstrating growth and consistent growth and improving margins, those are harder, right? Because those are the ones that have attached to them very premium multiples. We're staying away from that, and that's what I think Scott's referring to. We're seeing more of that former category where we believe we've got an approach that is unique to us to create value on the revenue side, on the cost side. Those are increasing. I think part of it.
Yes
back to Walter's point is having this 12 general managers, each with a vision and a mindset and approach to it, consistent generally.
Yes
Each bringing that focus. Line2 is a great example of that, right? We wouldn't have even thought of that if it weren't for Ron. Right? You're going to see more of that.
I think it's correct. To sort of wrap it all up, the key and I think really the goal, and this is the function of our structure of the parent, is to message that discipline to the presidents and the general managers and their various M&A people within the two segments, and to act as that check and balance. This is not about, in any given timeframe, doing X or Y amount of deals or spending Z amount of capital. It's really over an extended period of time putting, like we did in the last five years, another billion and a half dollars to work. Sometimes we have to be patient because things that we're looking at that we like are just not the right valuation.
I think as Vivek just mentioned, we're looking at the M&A a little bit differently maybe than we did in the past, where we are looking into portfolios where we can bring unique and differentiated value to the table, either as it relates to the seller and/or as it relates to how we integrate it within our existing business units. We can extract value that is unique to us. We're not paying a bad multiple from the seller's perspective. It's just we're synergizing it down to that 5x EBITDA multiple when the work is done. I feel very good that even in these markets, we will deploy a significant amount of capital this year. It's about $100 million in the six months. I think it's going to be a larger amount in the back half of the year.
I don't know why, it seems like the last few years we've had more spend and deal flow in the back half of the year than the front half of the year. I think that's going to be true again this year.
Okay, that's great. Thank you. Just quickly, on the new eVoice platform and the functionality you've added to Fax on the healthcare vertical, it seems like there's momentum in Cloud Communications and Cloud Productivity Suites. Has that landscape changed, do you see sort of the interest there as a potential headwind because of more interest or a tailwind in that you're seeing more customer interest in those types of solutions?
Look, I think on the Cloud Fax side, the real driver is our approach to these verticals and healthcare being at the top end of that. We are solving a real problem in that industry. You can't go a week without people sort of complaining about the paper-based approach of healthcare. We bring that digital interoperability that they're all looking for, our market share still is small because healthcare takes a while to adjust. We're now trying to force that issue through product development, through sales, through marketing, and not waiting for the phone to ring for a hospital system, for instance, to switch to our Cloud Fax solution. For us to get in there and convince them of that and to handhold them through that, right? I think that's what you're seeing there, and I think we're uniquely positioned in that marketplace.
I don't think there's quite anyone like us that can do this in healthcare. I think on the voice side, the part of the business that is most of the business is the second-line business that I referred to, which I actually think from a market point of view, as people talk about the gig economy, and you talk about more and more people being independent and freelance in orientation. They often view their laptop and their phone. They don't want to carry two phones, and they don't necessarily need a second set of hardware to be able to provide a professional face to their business. We like it. We think it's a good space to be in. We think the market's growing. We think we're one of the larger providers.
There are some smaller providers in this space, we think that they would be natural roll-up candidates because we do think now between eVoice and Line2, we've got the best of breed in second line. We like the space, and it's one where we think there's some good cross-selling opportunities. That is something that we are now exploring in earnest within Cloud, which is trying to push these services. It's not something that's been talked about, I think, in the past, and I don't think a lot's been done, and the general managers are forcing that agenda, too. I think they're both spaces where we're not running into real competition.
Great. Thank you.
Thank you. Our next question is coming from Jonathan Tanwanteng of CJS Securities. Please go ahead.
Vivek, you've mentioned a lot of ongoing trends in display and video in the CPMs. Was there any impact, or do you see anything coming down the road on the privacy front with GDPR and Facebook? Either headwinds or tailwinds. I think you addressed it last quarter, but now that we're here, have you seen anything further?
Yeah. It's still early. Again, I think long term, there's a thesis that says, "Hey, data-driven targeting will diminish and contextual-based targeting will grow." We certainly didn't see that in the quarter. Then interestingly, if you look in the M&A marketplace, there have been a lot of data-oriented ad tech businesses that have traded at big multiples. It's a little bit of a interesting discussion in the marketplace, which is a lot of these businesses were probably at the top of people's lists in terms of people who would be negatively impacted by GDPR and the California ballot initiative that's now turned into the California law relating to privacy, and yet that hasn't played out. I think it's very early days, and it is worth mentioning the California legislation. It is not quite GDPR. It's being negotiated right now.
While the law is passed, it doesn't go into effect for a little while, and I think there's some work being done to sort of refine it. I don't think the issue of privacy goes away. The impact of privacy on the advertising market is still unclear. Could there have been some very near-term-- when I talk about lumpiness and choppiness, could advertisers have said, "Before we spend more right now, let's understand the implications of these laws, and let's hold back a little bit of our spend?" Possibly. Again, that you would think would happen more in Europe, and our European ad business is like 5% for the ads business. I'm not sure that was there, but that's a possibility, and it's something we talked about internally. Again, I think it's early.
I think it's early to really understand what the impact of this privacy legislation is going to have in the ad market generally.
Got it. That's helpful. Scott, can you just break out a little bit more how Backups did in the quarter if it contributed to the year-over-year EBITDA decline in Cloud? Maybe second, how do you see the near and longer-term trends for the business, both on how the business trend is going and how you stand on a portfolio perspective?
Yeah. Similar to the first quarter, a couple million dollar decline year-over-year from Q2 of 2017 to Q2 of 2018. We did a little bit better. As you'll recall, in Q1, we talked about that hitting EBITDA dollar for dollar. As we said in the Q1 call, our goal was to manage that business for margin. This was pending Tim Smith's hiring. We didn't lose dollar for dollar in Q2 of the revenues lost to EBITDA. I think it was about $0.80 on the dollar. That was good. I think the general trends in the marketplace are not substantially different from what we talked about previously, which is very aggressive sales and marketing, a lot of which we think is, we question the economics behind it.
M&A valuations elevated, although I would say we've started to see a few things on the tuck-in side that may not quite mirror that. They might be attainable. A lot of this now, we're really pleased to have Tim on board because he will take over this. He's digesting where we're at and what the opportunities are to really give us the view of the right answer for the Backup Business going forward. I think in the near term, the way we've continued to forecast it for the balance of the year, we're not assuming any change in anything we've said previously. A continued, somewhat slow erosion of the top line with some cost mitigation, but still a substantial hit to EBITDA for revenue dollars lost. With Tim getting up to speed, I think, a better answer as we go into 2019.
Great. Thank you very much.
Thank you. Our next question is coming from Gregory Burns of Sidoti & Company. Please go ahead.
Good morning. What's the split of media subscription revenue between Ookla and Humble Bundle, and what are the relative growth rates of those two businesses?
We gave you some little hints last quarter about Humble Bundle. We talked about the two of them being on $130 million run rate, and there's actually some other subscription elements that go into it, although it is dominated by Ookla and Humble Bundle. I think we've decided that it's not prudent for us, and I say us collectively, shareholders and others, to really split that out because in both cases, Ookla and Humble Bundle, there are both competitive reasons and situations that we're involved in negotiation-wise where I don't think that that split makes sense. You can go back to last quarter. As I said, we gave some information. You can tease it out. What I will tell you is Humble Bundle did grow sequentially from Q1 to Q2.
Those numbers we gave you last quarter are higher on both an actual and a run rate basis. We don't intend to break those out.
Vivek, earlier you talked about some of your initiatives to move Ookla beyond the broadband test market, but in terms of Humble Bundle, are there any kind of strategic initiatives you might want to highlight in terms of revenue enhancement or margin transformation for that business? Thanks.
Yeah, look, we're doing some interesting things. I think I might have mentioned this in the past. If I haven't, I'll mention it now. We're trying to enhance the subscription itself and what you get as a subscriber. For instance, now annual subscribers to Humble Bundle get VIPRE, which is our antivirus endpoint solution. That now is close to a $100 value that is built into what is close to $100 or more than a $100 annual subscription. We're looking for things within the company that are relevant to the subscriber base to give them more value for their subscriptions.
Additionally, I think I mentioned this in the last call, we are financing games where we provide the finishing funds, which will allow us some control over those games and participate in economics for those games in their release windows and have the ability to include them in our bundle at attractive economics. That will continue, and we're ramping up our finishing funds activity relating to indie development of games. I think I've mentioned this, but also continuing to find ways in which IGN and Humble can help accelerate each other's paths within the gaming universe. We've started to move into some tech bundles. We've done some things in the tech space, software space. We actually did a security bundle, and VIPRE was in that security bundle.
There are a bunch of things like that that I think fit in sort of the collaboration across j2 category, but also fit into how do we enhance this membership and continue to add value to it. I think that's very important.
Okay, thank you.
Thank you. At this time, I would like to turn the floor back over to management for closing comments.
Thank you. Before we do that, we did receive one question via email, and the question was about the amount of revenue from the assets we divested throughout 2017 that are not in our 2018 numbers. Just as a quick review, on the digital media side, in two separate transactions last year, we divested Cambridge and Tea Leaves. They accounted for about $10.5 million of revenue in Q2 of 2017 and zero, of course, in 2018. On the cloud side, we divested Web24, which was our small web hosting business in Australia that had about $1.3 million in revenues in Q2 of 2017. Combined for the company as a whole, about $11.8 million of revenues from the divested assets were present in Q2 of 2017 and not in 2018.
Finally, with no other questions via email, we thank you for joining us on this Q2 earnings call. There are several conferences that we'll be participating in right after Labor Day. Look for a press release shortly to announce those the first week of September, there will be other follow-on conferences between now and when we announce Q3 results, which we would look to do in early November. Thank you.
Thank you.
Ladies and gentlemen, thank you for your participation. This concludes today's conference. You may disconnect your lines at this time, and have a wonderful day.