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ReachLocal (NASDAQ:RLOC)

Q4 2012 Earnings Call

February 12, 2013 5:00 pm ET

Executives

Alex Wellins - Co-Founder and Managing Director

Zorik Gordon - Co-Founder, Chief Executive Officer and Director

Ross G. Landsbaum - Chief Financial Officer

Analysts

Kerry K. Rice - Needham & Company, LLC, Research Division

Charles Eugene Munster - Piper Jaffray Companies, Research Division

Brandon Pickett

George F. Sutton - Craig-Hallum Capital Group LLC, Research Division

Neil A. Doshi - Citigroup Inc, Research Division

Yun S. Kim - Janney Montgomery Scott LLC, Research Division

Nathaniel H. Schindler - BofA Merrill Lynch, Research Division

Operator

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the ReachLocal Fourth Quarter and Fiscal Year 2012 Earnings Conference Call. [Operator Instructions] This conference is being recorded today, Tuesday, February 12, 2013.

And now I'd like to turn the conference over to Alex Wellins of The BlueShirt Group. Please go ahead, sir.

Alex Wellins

Thank you for joining us on today's call. This call is being broadcast live over the web and can be accessed at the Investor Relations Page of ReachLocal's website at reachlocal.com.

With me on today's call are ReachLocal's CEO, Zorik Gordon; and CFO, Ross Landsbaum.

During the course of this conference call, management may make projections or other forward-looking statements, which are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve risks and uncertainties that could cause actual results to differ significantly from those projected. You are cautioned not to place undue reliance on the forward-looking statements, which speak only as to the date of this call.

A detailed discussion of the material factors that may cause results to differ from the statements made can be found, for example, in the Risk Factors section of ReachLocal's filings with the SEC, including its annual report on Form 10-K, ReachLocal's updates in its quarterly reports on Form 10-Q and current reports on Form 8-K, including the Form 8-K and attached press release filed today.

Certain supplemental financial measures we will use on this call, such as adjusted EBITDA, Underclassmen Expense, non-GAAP net income and non-GAAP net income per share are expressed on a non-GAAP basis. In addition, Underclassmen Expense is a financial measure that we have developed internally. It is not directly comparable with any financial measure recognized under GAAP and represents an estimate that requires management's judgment.

Definitions and calculations of these financial measures and in the case of adjusted EBITDA and non-GAAP net income, a GAAP to non-GAAP reconciliation can be found in our earnings release. These financial measures are not intended to replace any GAAP financial measure. You should rely primarily on our GAAP results and consider adjusted EBITDA, Underclassmen Expense, non-GAAP net income and non-GAAP net income per share only as a supplement to our GAAP results.

With that said, I'll turn the call over to ReachLocal's CEO, Zorik Gordon. Zorik?

Zorik Gordon

Thanks, Alex. And I'd like to welcome everyone to our fiscal year-end 2012 call. I'm pleased to report that 2012 was another strong year for ReachLocal, both operationally and in terms of our financial results. Throughout the year, we continued to capitalize on the massive opportunities presented by Local Commerce and specifically online local marketing. We also made significant progress relative to our global distribution network and our industry-leading suite of online and mobile products for SMBs around the world.

In terms of financial results, revenue in the quarter increased to $120.2 million, a 20% increase over Q4 of last year. For the full year, revenue increased to $455.4 million or a 21% year-over-year growth. We were pleased with our North American revenue growth in 2012. North America grew 13% during the year, above the high single-digit growth outlook we had going into 2012. Our National Brands and Resellers, or NBAR channel, showed strong gains during 2012, posting growth of 14% for the year. While Direct Local is and will continue to be the key driver of our business, the renewed focus and investment we made in our NBAR channel during 2012 reversed the negative trend we experienced in 2011.

International continued to be the fastest-growing part of our business, up 47% year-over-year in Q4 to $36.1 million, and up 49% to $127.8 million in the year. In Q4, International represented almost 30% of our business, up from just 25% a year ago. For fiscal 2012, International was 28% of our business, up from 23% in fiscal 2011. And I'm pleased to say that we are right on plan to reach our stated goal of 40% of our revenue coming from our International operations by 2015.

Adjusted EBITDA was $6.4 million for the quarter and $23.6 million for the year, up 49% increase for the year. We are pleased to have been able to deliver these strong top and bottom line financial results in the face of continued unstable macroeconomic conditions throughout the year.

Even if this is our year-end call, I'd like to review the significant progress we made during 2012, as well as give you some highlights from Q4. I'll then lay out strategic priorities and plans for 2013 including saving space for some exciting announcements that we're going to make at our upcoming Analyst and Investor Day in New York on February 21.

On the sales front, we grew our IMC ranks to 824 with 419 of these IMCs Upperclassmen. In Q4, for the first time, the majority of IMCs in the company were all important Upperclassmen. And for the first time in 2012, we hired more IMCs internationally than in North America. We also continued our geographic expansion and launched operations inside new countries. These efforts were highlighted by our direct entry into 2 new continents, Asia and South America, with new offices in Tokyo, Japan and São Paulo, Brazil. We also announced our first ever franchise agreement with Oxata that further expands our footprint by opening 3 new countries for us in Eastern Europe. As we ended in 2012, ReachLocal is operating across 12 countries in 5 continents. However, we believe that we are still in the early days of our international expansion efforts. To put things in context, even with the extensive international expansion we've had in the last few years, we are still well over 100 cities with million-plus populations within the countries and regions we've already entered.

To that end, our focus in 2013 will be on growing our presence in our already established ReachLocal markets. For example, we will be driving scale in Japan and expanding our presence there by leveraging the infrastructure we've already built in Tokyo. Similarly, we will continue to leverage the shared service centers we built in Europe to continue to penetrate recently launched European countries, including Germany, as well as to enter new European countries.

ReachLocal has built a very large global digital sales force. And we strongly believe that our feet-on-the-street IMC sales force is a major competitive advantage for our business.

In terms of IMC productivity metrics, international IMCs continued to lead the way. Specifically, in 2012, international IMCs were on average more than 90% more productive than North America IMCs over the first 2 years of employment with ReachLocal. We were pleased with our overall IMC productivity. As in Q4, this figure increased to an annualized rate of $466,000 per average IMC, up 17% from $390,000 a year earlier. Major drivers of increased overall IMC productivity are the continued uptick in the number of Upperclassmen, which increased 30% over the prior-year period, as well as the increased maturity of our Upperclassmen. Upperclassmen tenure at the end of 2012 continued to increase and it's just over 3 years on average. IMC productivity hence increase as the tenure of the IMC forces increases.

In 2012, we rolled out significant programs designed to optimize our sales force in North America. One in particular, our inside sales program, which is designed to extend our reach into smaller Tier 2 and 3 markets across North America produced strong results. Our inside sales reps were able to acquire clients at the same or better rate as our IMCs and at a lower cost of acquisition. To that end, we have made a decision to take it out of beta mode, make further investments in term of hiring and formally launch the program in 2013.

As we continue to optimize and leverage our sales platform, in 2013 we will be focusing on 2 additional sales pilots: sales 2.0 and verticalization. I won't go into the specifics on this call but Josh Claman, our Chief Revenue Officer, will be discussing these 2 exciting initiatives in much greater detail during our Analyst and Investor Day on February 21.

I'll now shift the discussion to product. During 2012, we continued to enhance our core product suite while adding a set of new products for our IMCs sales force to cross- and up-sell to our SMB customers. While lead generations search-focused campaigns still represent the lion's share of our revenue, especially new market, multi-product uptick continued during Q4. Major new products and tools launched during the year, including ReachRetargeting and our ReachLocal Mobile App. ReachRetargeting is off to a solid start. It allows SMBs to build awareness with consumers who did not convert immediately via search and leverages our display network that today reaches more than 90% full of unique visitors in the U.S. We're also getting a strong response to the ReachLocal Mobile App that puts the power of ReachLocal's campaigns in the palms of our customers' hands. We are quickly finding that giving our advertisers real-time campaign updates, alerts, leads and the ability to follow up on calls on the go more closely ties them to our solutions and greatly increases ReachLocal's mine shares and level of interactivity with our platform.

Client engagement is much higher than mobile app with sessions per user as well as rate of lead up over 4x over our desktop users. Furthermore, we believe that Mobile App will drive our IMCs' ability to roll out new products more quickly as it'll become a powerful method of introducing our slate of upcoming new products to our customer base.

Speaking of new products, in 2013, we intend to release more new products than we ever have in the history of the company. On lead generation and conversion front, in 2013, we will look to add both an integrated website solution as well as extended SEO capabilities. As well, we look to expand our product offering beyond lead generation products to include a brand new staff lead conversion platform based on our RealPractice acquisition. Finally, you will see ReachLocal extend even further and move into powering our customers' transactions with a brand new staff looking and buying platform. We will be introducing and showcasing these new products and more at our upcoming Analyst and Investor Day.

In closing, we delivered strong results in 2012 and today, we've laid out a solid operational plan and guidance for 2013. We're incredibly excited about our future and believe strongly that the sound investments we continue to make will deliver results in 2013 and beyond. The management team and I look forward to seeing many of you at our upcoming Analyst and Investor Day on February 21.

And now, I'll ask Ross to review our financials and guidance before taking your questions.

Ross G. Landsbaum

Thanks, Zorik. Let's turn to our financial results for the quarter and year. I'll start with fourth quarter results and then the full-year comparisons where appropriate.

Revenue for the fourth quarter of 2012 was $120.2 million, up 20% over Q4 of last year. For the year, revenue grew to $455.4 million, up 21%. Q4 Direct Local revenue of $96 million increased 23%. And for the full-year Direct Local revenue was up 23% as well. As a percentage of total revenue, Direct Local represents 79% of our 2012 revenue versus 78% for 2011. Revenue for the NBAR channel was up 13% for the quarter and 14% for the full year. Revenue from the National Brands portions of the channel grew by 8% for the quarter and 16% for the full year. While the agency and reseller portion of the channel grew by 17% in the quarter and 13% for the full year.

As we discussed last quarter, Q4 is typically a seasonally weak quarter for NBAR and this year's Q4 drop was exaggerated by the tougher quarter-over-quarter comp versus the previous year. International revenue was up 47% for the quarter and 49% for the year. Overall, while representing 30% of revenue, our combined international sales operations delivered 56% of our dollar growth in Q4 and 20% of total revenue and 52% of dollar revenue growth for the full year.

Moving on to key revenue metrics. At the end of each year, we provide a cohort analysis on advertiser maturity. As a reminder, we group advertisers in 3 buckets: the trial period from 0 to 4 months, and 1-year post-trial and long-term clients that have been with us over 16 months. Our 2012 trends are positive with regards to longer-term advertiser retention as 47% of our revenue in 2012 came from advertisers at least 1 year after their trial period with us, up 41% in 2011. Moreover, 78% of revenue came from our combined post-trial and long-term advertiser versus 76% in 2011. We ended Q4 with 32,500 Active Campaigns and 22,000 Active Advertisers, up 18% and 15% respectively. We did see a slight decline over the third quarter in these metrics due primarily to a higher number of holidays falling on weekdays during the end of December.

Finally, the number of campaigns per an advertiser was 1.48 and the average revenue per an advertiser was $5,453, both up over the prior year's quarter. Cost of revenue totaled $59.8 million or 49.7% of revenue compared to 49.3% of revenue in Q4 of last year, reflecting net changes in our product and service mix including the continuing growth of ReachSearch in our international market partially offset by an increase in vendor retakes to 4.7% in the fourth quarter of 2012.

Sales and marketing expense was $44.8 million or 37.3% of revenue as compared to 36.5% of revenue. We saw sales and marketing costs in our established markets and channels as a percent of revenue drop over 250 basis points versus the prior year's quarter, offset by investments in our international and other market expansion programs, including our recent launch in Brazil. Commissioning expenses as a percent of revenue was relatively flat at 10.7%. For the year, sales and marketing was 36.8% of revenue compared with 37.3% in 2011, reflecting the scaling we are seeing in our established market.

Underclassmen Expense accounted for $11.4 million of total sales and marketing expense in Q4, a decrease of $0.3 million driven by the lower number and percentage of Underclassmen in North America, partially offset by the increased number of Underclassmen in our international markets. For 2012, we invested a total of $45.3 million of Underclassmen Expense and more than 50% of this investment was in our international markets. Product and technology expenses were $5.6 million or 4.7% of revenue and our net of $2.6 million of costs capitalized. This compares to $4.8 million or 4.8% of revenue, which was net of $1.1 million of costs capitalized in Q4 of 2011. The dollar increase is principally driven by an increase in headcount driving our product development around the RL platform and new initiatives including our July acquisition of RealPractice.

General and administrative expenses totaled $10.2 million or 8.5% of revenue as compared to $9 million or 9% of revenue. The increase in absolute dollars is primarily due to increased headcount, facilities and related costs associated with our growth, partially offset by a decrease in professional fees during the period. G&A for the year was $40.5 million or 8.9% of revenue and flat relative to 2011. In 2012, our provision for taxes was $1.2 million, up from $0.7 million in 2011 covering our obligations to the state, local and foreign jurisdictions as we continue to scale in various jurisdictions and reflecting the current benefits we continue to receive from operating loss carryforwards in such territories. You should note that with the expected continued growing profitability in our established markets, we are expecting our tax provision in 2013 to increase to approximately $6 million. After the provision for taxes, our loss from continuing operations was $0.4 million, or $0.01 per diluted share, versus income from continuing operations of $0.2 million or $0.01 per diluted share in Q4 2011.

GAAP net income reflects the continued growth in the operating performance of the business in the quarter, offset by increased noncash depreciation and amortization, due to international and product expansion and stock-based compensation expenses including the impact of the RealPractice acquisition which closed in July. Loss from continuing operations for the year was $0.2 million, improved from $4.1 million in 2011. Q4 net loss was $0.4 million, or $0.01 per diluted share, versus a loss of $1.3 million or $0.05 per diluted share. Net loss for the year was $0.2 million or $0.01 per diluted share versus a loss of $10.3 million or $0.36 per diluted share.

Non-GAAP net income for the quarter was $3.2 million, or $0.11 per diluted share, versus non-GAAP net income of $3.5 million, or $0.12 per diluted share. Our operating gains were offset by increased depreciation and amortization expense from our continued and international expansion and product releases versus the prior-year quarter and which are ahead of related operating performance from those markets and products.

Adjusted EBITDA in Q4 was $6.4 million, or 5.4% of revenue, up from $5.2 million or 5.3% of revenue. The increase over the prior year reflects continued operating gains in our established markets partially offset by the significant investments in new international markets, new sales channels and continued product innovation. For the year, adjusted EBITDA grew to $23.6 million up from $15.9 million. We are very pleased with our demonstrated ability to grow adjusted EBITDA, reflecting the scale we are accomplishing in our established markets while continuing to make significant investments and product distribution and new initiatives.

We continue to generate strong cash flows based on the strength of our business model. Net cash from continuing operating activities during Q4 was $11 million compared to $1 million, reflecting our operating gains and the timing of publisher rebates with some offset from the unfavorable impact of FX. Operating cash flow was $42.6 million in 2012. Before the cash impact of our stock repurchase program, stock option proceeds and our M&A activity, the business generated free cash flow of $26.3 million in 2012. During the quarter, we repurchased 480,000 shares of our stock using $5.6 million of the company's $26 million repurchase program. Since inception of our stock repurchase program, the company has acquired a total of 1,985,000 shares for a total of $17.1 million. During Q4, we added another $6 million to the previously authorized $20 million program. We ended the fourth quarter with 28,154,000 shares outstanding, which is a decrease of 398,000 shares from the end of last year.

We finished the quarter with cash and cash equivalents and short-term investments totaling $95 million. Our net cash and investment position grew approximately $10 million year-over-year even with our stock buyback and investment activity.

Now turning to our outlook. We are providing revenue and profitability guidance for 2013 that shows we expect to continue to balance gains on the top and bottom line and reflecting a broad range of substantial ongoing investment and continuing international expansion, distribution, optimization and new products. Despite some improvements in the economy, economic indicators remain mixed. Our guidance reflects the realistic expectation of ongoing volatility in world markets and slow economic growth in North America. Specifically, for Q1 2013, we expect revenue in the range of $121.5 million to $123.5 million, adjusted EBITDA in the range of $5.4 million to $6.4 million, ending Upperclassmen headcount in the range of 410 to 430, ending Underclassmen headcount in the range of 395 to 415, and ending total IMC headcount in the range of 805 to 845.

For fiscal 2013, we expect revenue in the range of $530 million to $540 million, adjusted EBITDA in the range of $29.5 million to $31.5 million, ending Upperclassmen headcount in the range of 470 to 510, ending Underclassmen headcount in the range of 300 to 340, and ending total IMC headcount in the range of 770 to 850. Moreover, for the near term, we currently expect to maintain revenue growth and annual margin expansion at levels equal to or better than our current expectation for 2013.

Before turning it over to the operator, I want to remind everyone of our Analyst and Investor Day to be held on February 21 at the NASDAQ Marketsite in Times Square. The program begins at 8 a.m. and we will be doing a deep dive into our business and cover a number of sales and product initiatives. As a reminder, due to NASDAQ security rules, you must preregister to attend the meeting.

With that, let's turn the call over to the operator and start the Q&A session. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Kerry Rice with Needham & Company.

Kerry K. Rice - Needham & Company, LLC, Research Division

Just a couple of questions. As you highlighted on the call, Zorik, that for the first time there are more Upperclassmen than lowerclassmen and more international IMCs higher than domestic. Can you talk a little bit about if there's a shift in strategy there? Is this kind of normally what you would have expected, that over time Upperclassmen would begin to kind of outweigh lowerclassmen or is there some other kind of strategy that has shifted there? And then the next question is campaigns or essentially products per advertiser ticked down slightly sequentially. Again, was that related to the holiday, just kind of the number of holiday days in the quarter? And then just a housekeeping, how impactful was Google rebates in Q4?

Zorik Gordon

Sure, Kerry. This is Zorik. I'll start with the first part of your question and then Ross will jump in and answer the other 2 parts. So in terms of Upperclassmen, the milestone passing Underclassmen, I think that was always part of our thesis. I mean, as we invested in Underclassmen over the years, clearly, the maturity of these Underclassmen into Upperclassmen, the real revenue and profitably came as they became Upperclassmen. So for us, the fact that we now have more Upperclassmen than Underclassmen is something that we've actually been pointing to as a key milestone in our model for many years. Remember going back to the IPO roadshow, it was of the bigger questions and I think the fact that we've gotten there is part of the way that we've strategically built the business and to have a base of highly profitable mature Upperclassmen. We still continue good levels of Underclassmen investment. That investment has been geared somewhat much more towards international because of the higher productivity that we're seeing. I think you're going to continue to see that. I think in North America, we're also shifting some of our Underclassmen investment into inside sales to expand penetration in our addressable market into markets where we're not in today. So I would classify where we are from an IMC perspective is what we want to be. I think it's good for the model and the model is maturing the way we thought it would be, and I think it's actually very positive milestone for the business to have that level of Upperclassmen.

Kerry K. Rice - Needham & Company, LLC, Research Division

Can I ask just one quick follow-up on that? Should we think about 370 or what your guidance was for the full year of 2013 for the Underclassmen, is that kind of maybe a thing, a way to think about those levels kind of ongoing each year? Maybe you keep the Underclassmen at about the same level annually but obviously, some graduate up to Upperclassmen, is that a fair way to think about maybe where you expect to retain Underclassmen levels?

Ross G. Landsbaum

Kerry, this is Ross. And I think if you look -- so we guided between 300 and 340 for Underclassmen at the end of the year. Keep in mind that we always fall off at the end of the year because we hire much less in that quarter. I think it is likely as our base are the established countries and established Upperclassmen and our market continues to grow that we will continue to invest in processes and personnel to help them leverage those skills there. And as we move into other markets where we're under-penetrated, we'll obviously hire Underclassmen to go there. So I suspect that it will move around some. And I think we kind of have a range between where we're looking where we think next year will be and where we were last year. And I suspect it will probably move around in that regard.

Kerry K. Rice - Needham & Company, LLC, Research Division

Okay. And then the part about the products per advertiser?

Ross G. Landsbaum

So I think your first -- I think there was definitely an impact of the number of holidays that came in at the end of the year. I mean from a practical perspective, the fourth quarter is always our lowest gross quarter of the year and North America is essentially flat and has been -- it was this year and it was last year as well. And so if you take that into account with the exacerbated seasonality from the tougher comp on NBAR and the incremental holidays, that all really led to the slight decrease in sequential advertisers and campaigns.

Kerry K. Rice - Needham & Company, LLC, Research Division

Okay. And then the Google rebate impact?

Ross G. Landsbaum

So rebates in total would -- came in at the 4.7% that we spoke to, and obviously Google is a large part of that percent of revenue. And just to go back, obviously, on the campaign and advertisers, obviously, as we're forecasting revenue growth for both the quarter and the year, we saw a normal resumption in the advertisers after the end of the year and we're obviously expecting advertiser and campaign growth during the year based upon our revenue expectations.

Operator

Our next question comes from the line of Gene Munster with Piper Jaffray.

Charles Eugene Munster - Piper Jaffray Companies, Research Division

Zorik, if you can kind of take a step back and I know you ran through some of those new product areas in 2013, could you recap which those areas are, and can you talk a little bit about how you decided this? Is this something you're hearing from your clients that they want these products and then the last piece is what the potential margin impact. I mean, could we see some of these new products create margin lift in 2013, 2014?

Zorik Gordon

Well, okay, Gene. At the start of the question, in terms of the products, I really again would, as I mentioned several times on the call, highly recommend -- I know you're going to be attending -- everybody to attend Analyst Day. We're going to get into some level of depth here on this particular call, but we are -- we have an extensive overview for 4 hours planned to take you through a lot of the thinking behind a lot of our strategy in '13. And a big part of our strategy, as I mentioned, we're going to be releasing more new products in '13 than we ever have, both in beta and release form, as a company. So again, I do highly recommend that everybody who possibly can go there, because I think we'll really be able to give you a sense for what those products are and how they all fit in. But -- at a high level, Gene, what's become very clear to us is that local really is about what we call the Local Commerce funnel, right? It is this process from lead generation that a customer goes through to lead conversion, to booking an employment to actually buying with a local merchant. Now that whole process is moving from off-line to online. And our primary business has been very much focused over the first 8 or 9 years of our existence, really if you think about it, just on the lead degeneration portion of it. Our products, ReachSearch, ReachDisplay, ReachCast, those are all products designed to generate leads. What is guiding our strategy in our division and the products that we selected to build is really completing that funnel. And the pieces that are missing are many fold. On the lead conversion side, I mean one piece is to generate a lead for a customer but to make sure that, that lead then converts with that merchant. There's an opportunity there in products such as proprietary websites. Our customers, I think, could do much better with smarter websites, so that's an area that you're going to start to see us expanding to in '13, with a proprietary website solution, as well as expanded SEO. We made the acquisition of RealPractice last year. You'll see us introduce a reach-convert product in 2013 that's been based off of that acquisition to help our customers, again, convert those leads into real business. And then, the big missing piece that we don't have today but we will be having in '13 is really around the booking and buying process, right? To basically create a technology, which we'll be showcasing on our Analyst Day and taking you very, very deeply through around helping our customers actually book appointments on our technology and actually process payments and actually process things such as estimates and invoices. So it is a very broad vision. It really is about completing the end-to-end funnel of a fully integrated solution, and a lot of what's guiding us, Gene, is really building in those pieces that we don't have so we can have a real end-to-end solution, both for our merchant and a much better digital experience for our consumers. So we're quite excited about it. We think it is a market-leading vision and the good news is it's not just so much a vision. What we're going to show everybody on the 21st is that it's a reality. So we're very excited about that and that's really what's guiding us. In terms of the specifics around market and impact in '13, I don't think we're really going to get into that on this particular call. We are going to have a discussion on Analyst Day that shows sort of our initial results on some of the products that we've been beta-ing and piloting. We're going to talk to you about the margin profile, the potential margin profile of the new products as they come out. And I think that's a better forum for that discussion than on this call.

Ross G. Landsbaum

And I think, Gene, the only thing I would add is that as we came out with our '13 guidance, we're assuming relatively modest impact of these new products in the current year. I mean we've done a lot of work both on, obviously, validating the customer view of these products and we're doing a lot of beta testing around them. But practically speaking, we're certainly not counting on them to make our numbers. We do have a very good view of these as we think about '14 and beyond, and really think there's a long-term value to this approach and we'll lay that out more at the meeting next week.

Charles Eugene Munster - Piper Jaffray Companies, Research Division

Okay, that's helpful. And then just a follow-up on the Upper versus Underclassmen. Is there a some sort of a -- Ross maybe talked about that mix is going to change kind of going forward, is there any sort of margin impact on that front because Upperclassmen, they tend to be more of that mix? Does that have any margin impact longer-term that we should be aware of?

Zorik Gordon

No. Well, I mean, it certainly does. I mean, for example, I think I noted earlier in my comments that we look at our established markets where we've been in for a while, where we do have a bigger mix of Upperclassmen. Underclassmen, we saw 250 basis points of improvement in sales and marketing costs year-on-year. So we're definitely seeing the value of that and we're continuing to get leverage off of their productivity. For a practical perspective though, we're still making very significant investments in our international expansion, the launch of the inside sales group and so there -- and the Sales 2.0 and verticalization initiatives. So there's a lot of other costs that are going to help leverage. So there's a lot of investment going on it, but we're definitely get margin lifts from that balance shift.

Charles Eugene Munster - Piper Jaffray Companies, Research Division

Okay. I guess just one final question. The -- I think if you look out beyond this year or just kind of state of the union for the small business, I mean, where is their head at right now?

Zorik Gordon

From a macro perspective?

Charles Eugene Munster - Piper Jaffray Companies, Research Division

Yes.

Zorik Gordon

Look, I think the market's a little bit ahead of where the reality on the actual "street" is. I think that things -- there is some budding optimism, but I think that things are still a little bit unstable out there. So we're cautiously optimistic, but I think that we're far from raising a victory flag here. And I think the sentiment of the small, medium-sized businesses correlates with that statement. So I think that it's -- there's a little bit of a disconnect here between what the market is viewing as kind of 6 to 12 months out versus the reality on the street today.

Charles Eugene Munster - Piper Jaffray Companies, Research Division

And obviously, your guidance reflects that level of conservatism.

Zorik Gordon

Absolutely, as we always do.

Operator

Our next question comes from the line of Shyam Patil with Raymond James.

Brandon Pickett

This is actually Brandon Pickett filling in for Shyam today. I just want to start off kind of, I guess, going off the last question. When you look at the macro pressures that the SMB market's facing, both internationally and the U.S., can you just compare and contrast those?

Zorik Gordon

So I mean, I think if you look at it, I think one of the key differences that we've seen across the market, and if you keep in mind, obviously, the recession in North America started a fairly long time ago. And when it did start, the U.S. was a borrow-to-spend market. And so people went into what was a difficult time with relatively unhealthy balance sheets. And that was from consumers on up through small businesses. Whereas in a lot of the regions we are in internationally, and keep in mind, we're not in Southern Europe, we're in Northern Europe in the stronger countries, this gives much -- as they tended to be much more save to spend. And so while growth has slowed in some of those markets, the practical issue is that the small businesses and the consumers had a much healthier balance sheet going into that. So we haven't seen the same kind of macro challenges in our international markets that exist in North America.

Brandon Pickett

Got it, that's helpful. And then can you just provide us a little bit update on the competitive landscape that you're seeing internationally?

Zorik Gordon

I think internationally the levels of competition are significantly less than they are in the U.S. I think in the U.S, we face competition from all the incumbent Yellow Page companies, all the incumbent newspaper companies, as well as a very, very aggressive small mom-and-pop type providers, both from website and SEO providers. Those levels of competition have not expressed themselves equally in other countries such as Australia where there's been one incumbent Yellow Page provider and the levels of competitive response have been significantly smaller. We've seen that as we move from Australia to Europe to now even into Japan and Brazil, that the levels of noise in those markets are significantly less, and we're taking advantage of that. And I think that's a -- that bodes well for our international efforts, it bodes well for our deployment of capital as we deploy IMCs in those markets where we have a big first mover advantage and we have lower levels of competition. I think that's going to bode well for our long-term market share internationally. And as I mentioned on my call, it's important to note how many more cities are still out there just within the regions that we've opened up operations in. And there's over 100 cities with 1 million-plus population just in the regions across Europe, South America and Japan that we're not in today. So I think that the dynamics, the market and competitive dynamics internationally bode very, very well, including also some of the opportunity in the addressable markets. So we continue to be quite excited about international for ReachLocal.

Operator

Our next question comes from the line of George Sutton with Craig-Hallum Capital Group.

George F. Sutton - Craig-Hallum Capital Group LLC, Research Division

First, relative to consumer confidence, which you've talked about being relatively highly correlated to your business in, it really did weaken in Q4. And obviously, we had the fiscal cliff issue. So I'm curious, obviously, your numbers came out very well in spite of that. Can you just give us a sense of how much opportunity was left on the table from that dip in consumer confidence late in the quarter?

Ross G. Landsbaum

I mean, honestly, George, it's really hard to say. I mean, it tends to be a concurrent leading and trailing indicator, and things tend to be bumpy. And I think we definitely -- and a lot of businesses obviously saw the impact of various macro sentiments going on. We, I think, just keep persevering and working through it and delivered what we believe to be a very good year in the face of what is a choppy and difficult macro environment. But we've been really pleased with our progress in that environment.

George F. Sutton - Craig-Hallum Capital Group LLC, Research Division

Okay. And now relative to inside sales, as you mentioned, you're taking it out of beta mode and formally launching it. Can you give us a sense of what exactly that means in terms of numbers?

Zorik Gordon

I mean ballpark-ish, we're not going to give specific numbers, but this will give you a good sense for what it is. I mean we're going to move to, in North America, roughly 50-ish IMCs plus or minus inside IMCs towards the end of the year. That would be our goal, and that's probably up from a beta test group of sub-10, close to 10. So we're going to be scaling that business up, infrastructures there. And again, the performance that we saw, one, as you remember, the logic is, is they're targeting markets that we're not going to be deploying feet-on-the-street IMCs into. So it does expand dramatically our total addressable market in North America, potentially internationally. So we've built the infrastructure for that, and I think that you'll see that rolling out across North America in '13. And then potentially, we'll see, but we do think that, that amount will be a viable model for international and the U.S. beyond.

George F. Sutton - Craig-Hallum Capital Group LLC, Research Division

Got you. Lastly for me, you made some good investments last year in NBAR that really turned that business around. Can you talk about your plans from additional investments in that channel this year?

Ross G. Landsbaum

I think we're on a pace of continued investment there. We're also relying on a lot of the expertise that's in that NBAR channel. That's part of our verticalization improvements that we'll be speaking about at the call next week. I think the challenge with NBAR a little bit is that just given the nature of the clients, it doesn't have the same metric-oriented predictability as our Direct Local business does. So we do make rational investments there where we see the opportunity and we're going to continue to do that.

Operator

Our next question comes from the line of Neil Doshi with Citigroup.

Neil A. Doshi - Citigroup Inc, Research Division

Ross, can you maybe describe the IMCs domestic versus international? Are you seeing more Underclassmen graduating to Upperclassmen in the international side versus domestic side? And if that's the case, is there anything you can do on the domestic side to help improve that graduation rate? And then, Zorik, also on the mobile side, you discussed that you're getting good leads off of that, and is there an opportunity to, at some point, maybe create a different pricing model for mobile versus desktop?

Ross G. Landsbaum

Let me talk to the IMC question first, because I think instead of thinking about it as North America versus international, I think you need to look -- think about it more established markets versus newer market. And in the markets where we have large established bases of performing Upperclassmen, I think really, and what Sales 2.0 and verticalization, a number of the things that we've been talking about are really focused on is what's the best way to deploy dollars in those markets. And it's not necessarily just hiring more Underclassmen to be in those markets. It's about trying to figure out the best way to leverage and get incremental productivity out of those Upperclassmen. So in some cases, in markets where you have a solid foundation, it might not make sense to hire as many Underclassmen. And I think that's part of the shift that maybe you're observing. So it's not necessarily really about graduation rates, it's really more about what's the right investment to deploy to match sort of like the distribution organization as to where it is kind of in its point of productivity and the foundation that it's built.

Zorik Gordon

Neil, this is Zorik. In terms of Mobile, yes, I mean we did before our ReachLocal Mobile App. We are getting significantly higher levels of mobile engagement, something in the factor of 4x. We're getting more people to rate leads across that. I think from a price point perspective, especially in lieu of the specific changes that Google just announced in the last week or so where they're actually standardizing, really kind of eliminating the difference between desktop and mobile, that's not going to be, I think, disruptive enough for us to be able to think about different pricing paradigms. I actually, going back to some of my previous statements, where I think there might be possibility theoretically is as the products in our space evolve more from just lead generation to actually real production products, where not only do we have visibility and how many leads you drove, but really how many dollars you drove to the end customer. When you start getting that level of visibility, the ability to then open up models where, well, now I know exactly to the penny how much I drove, you can begin to start pricing potentially things on a different level, i.e. a CPA-based model, right? Whenever you can introduce true transaction transparency into a model, CPA models become viable today and most of the lead gen products out there today because we stop it at the cull, which is much better than historically what these SMBs have had, which was sort of cut a check to the Yellow Page company and then -- and they just got the ad. With ReachLocal, we do track the calls, we record the calls, we bring that back, but it's still not 100% transparent into the transaction. So I think to really change pricing paradigm, the space is going to need to evolve more to a space that includes visibility in the transaction. I think part of what's going to happen on Analyst Day is we're going to show you how we believe that, that's going to happen and how we're going to deploy that ability into our ecosystem and combine that with lead gen for something extremely powerful. And I think that opens that sort of Pandora's box.

Neil A. Doshi - Citigroup Inc, Research Division

Great. And then on the ReachCast product, I know in the past, the price point may have been too high. Have you guys done anything to that side to maybe bring the price point lower or is that product maybe out of date and maybe we'll see something new announced on that side on the Analyst Day?

Zorik Gordon

So I think the way we classify ReachCast, I think it's around 5-ish percent of our product mix in revenue. So I think it's a successful product we needed to sell for social. I think social inherently, in a true ROI environment, which is what our customers demand some real visibility into how much return on investment, I guess, social is -- there is a difficulty into truly ascertaining, and our friends at Facebook and at Twitter wrestle with this issue on social, which is really what am I getting. So from that perspective, and those are limitations in the space in general, but where you'll see us in '13 start to move a lot of our ReachCast capabilities is into our, what we call expanded SEO bundle. And as I mentioned, some of the key initiatives in lead generation and lead conversion are going to be around proprietary websites, as well as expanded SEO capabilities. And a lot of those expanded SEO capabilities are going to be leveraged off of both the people and the technology that today exist in ReachCast. So we continue to evolve always and to innovate those products and to move them forward and to move them in a direction where we believe we can best service our customers. So we're going to continue on and we think that, that could reignite, in maybe a slightly different or augmented form the value of that particular product. And in terms of price points, we'll revisit that once we sort of get the right balance. But they'll probably also be right around where they are today, maybe some higher- and lower-priced packages. So I think they'll stay within those ranges. But again, not to tout Analyst Day too much, but I do think we'll have a deeper [indiscernible] into what we're planning there on -- during those discussions as well. .

Operator

Our next question comes from the line of Yun Kim with Janney Capital Markets.

Yun S. Kim - Janney Montgomery Scott LLC, Research Division

As you extend your product offerings perhaps beyond advertising and lead generation, is it your strategy to cross-sell these products to your current install base or do you plan on perhaps targeting these new products to new customers just as equally? And maybe how should we think about the marketing costs to support these new products?

Zorik Gordon

Yun, this is Zorik. I mean, clearly, one of our biggest assets is our distribution and service platform. We have the capability to reach as far or further into local markets as anybody out there. So when we introduce new products, we want to leverage that huge asset both with our existing customer base and, obviously, to acquire new customers. So as we introduce these solutions, we really envision them being applicable to both, and there are more customers out there than we have on our platform for sure. So we would hope that they would have huge penetration with our existing base and we have high hopes for that, but as well, we think that they're going to be a great entrées into bringing in new customers into our ecosystem. One of the things as we look at our product strategy and our product vision is the products that we're going to be discussing next week, the percent of what I call sort of, they're nonconsumption products. So the typical SMB that we would talk to probably do not have a solution for that today and they need one. So we love markets like that where we can be the first to offer a product that they definitely need to be -- need to have in their mix and the capability they need to have, and we're the first people talking to them about it. So we do think the conversations are going to be spread across new customers, existing customers, and I also think being able to introduce products outside of lead gen, which is the most mature local marketing solution product, where it's been out there for 8 or 9 years. We pioneered it. We birthed it. Being able to have other products to start discussions with customers with is also another huge asset. So we're quite excited, and again, we really do believe that a lot of the investment in infrastructure and salespeople and service that we have has really been geared towards eventual product expansion where we can walk people from lead generation into the other products that they're going to need today and in the future.

Ross G. Landsbaum

Okay. And to your question on marketing costs, obviously, we're rolling out a number of products this year. The cost of those products is embedded in our guidance for the year. And as we look to the near-term, I think even with the potential marketing costs associated with these products or the leverage that we'll put into our platform, we still obviously believe that we'll have solid revenue growth and earnings growth in line with what we're looking for this year. So I think it all fits well within our balance revenue and bottom-line growth model.

Yun S. Kim - Janney Montgomery Scott LLC, Research Division

Okay, great. And then one more question. Looks like the revenue per advertising metric continues to spike up nicely, but the campaigns for advertisers have remained relatively flat. So does this mean that you guys are doing a much better job taking a bigger share of your customers' ad budget or is this somewhat also driven by maybe potentially going more upscale in terms of your target advertising base?

Zorik Gordon

So it's a combination of a few things. One is Direct Local continues to have a bigger piece of the overall revenue share versus NBAR. Those advertisers, in general, are spending larger budgets. We're also seeing that most of the international clients that we're bringing on board are spending slightly larger budgets relative to Direct Local clients. So it's the mix of those dynamics with the addition of things like ReachRetargeting coming through North America. And we think all of that is really moving to continue to gradually increase revenue per an advertiser. And so, again, it's one of the dimensions that we can continue to grow the business in, and obviously, in the long-term, the number of new products that we're putting out are all things that we believe would contribute to that approach.

Yun S. Kim - Janney Montgomery Scott LLC, Research Division

Okay. And then just a quick one last one. A quarter or 2 ago, you talked about franchising. And just wondering how much of your entry to new countries this year will be driven by franchising.

Zorik Gordon

So we mentioned this kind of relationship. We think that the approach we utilized there is intelligent. I mean, clearly, we've mentioned how large an opportunity we see international being. There are clearly Tier 1 markets that we're going to directly enter to, and you saw we did that with Japan last year and Brazil. So the [indiscernible] that we saw a huge opportunity in Eastern Europe. It's somewhat smaller markets that we've historically been. It's just so we saw the ability to structure a franchise relationship and to grow those markets, so with the idea eventually to grow those potentially to bring those into the fold when the time is right. We like the way that, that's progressing. We love the structure we did there. I think we see other possibilities and we'd probably look to try to get one more at least this year, in '13, in terms of another franchise relationship in a key geographic region. And if we're able to find the right partner, I think we wouldn't hesitate to go ahead and do that sometime this year.

Ross G. Landsbaum

Yes. And the other thing I would say though that's in line with our multi-international strategy, we'll also be entering at least 2 countries directly this year as well.

Operator

[Operator Instructions] And your next question comes from the line of Nat Schindler with Bank of America.

Nathaniel H. Schindler - BofA Merrill Lynch, Research Division

Just want to get -- look, you're raising -- your margin guidance is up 50 basis points year-over-year to about 5.7 from 5.2 just using the midpoints of your guidance, while you're taking your Underclassmen down sequentially or year-over-year about 25%. Underclassmen cost you money, isn't that correct? And in which case, how much of that 50 basis points is simply shrinking your Underclassmen pool? And how much is just growth in the business and the improvement in margins in the business?

Ross G. Landsbaum

So, Nat, I'm just going to run a number really quickly. Underclassmen expense is actually going to be roughly about the same amount of money relative to the prior year. So we are getting some scaling there. That being said, we're also investing in Sales 2.0 and a number of other initiatives to really extend the sales force. So particularly as we look at North America and the other more established markets, it isn't an absence of investment that's actually driving the scaling. We are seeing scaling. We'll see probably scaling off of G&A and we'll see some scaling on sales and marketing. But the real driver isn't necessarily a lack of investment. It really is just more scaling against the base.

Nathaniel H. Schindler - BofA Merrill Lynch, Research Division

GGreat. And just one more follow-up on it. Do you expect to grow your Underclassmen again or do you think that you've basically -- this 300 to 340 level is going to be a steady state that you can add that much, and as long as you keep your Upperclassmen, you can grow the business nicely?

Zorik Gordon

Look, I think, Nat, this is Zorik, I think we take that on a year-by-year basis. Based on what we're seeing, where we are strategically, we felt that these levels were appropriate, and the distribution across international versus domestic versus inside and non-inside IMCs was correct. So I think that directionally, what you said is correct, but I would not be surprised down the road, based on sort of product penetration and product adoption, if we could -- if we would want to change that pretty dramatically, or based on sales optimization efforts that we have, which we'll talk about on Analyst Day, that could actually drop, right? Because we become more efficient with -- we do less with more -- sorry, we do more with less, better said. So I think really, I wouldn't read too much into it, but I think directionally if you look over this year versus last year, I think you'll kind of see where we believe we are over a 24-month period. But there are things that could change that and we do retain the freedom to do that at any time.

Operator

Thank you. And ladies and gentlemen, that concludes our ReachLocal Fourth Quarter Fiscal Year and 2012 Earnings Conference Call. We thank you for your participation today, and you may now disconnect.

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