Omniture, Inc. (OMTR) Q2 2009 Earnings Call July 22, 2009 5:00 PM ET
Good day, ladies and gentlemen, and welcome to the Q2 2009 Omniture Inc. earnings conference call. My name is Deanna and I will be your operator for today. (Operator Instructions)
I would now like to turn the presentation over to your host for today's call, Mr. Michael Look, Vice President, Investor Relations. Please proceed, sir.
Thank you, Deanna. Good afternoon and thank you for joining us today.
During the call, we will discuss Omniture's financial results for the second quarter ended June 30, 2009. By now you should have a copy of our press release, which crossed the wire approximately 45 minutes ago. If you would like to review a copy of the press release, please visit our website at www.omtr.com.
Please note that we’ll be referencing, both GAAP and non-GAAP financial measures and wish to note that GAAP reconciliation information is provided in the press release and on the website.
Also, we wish to emphasize that some of the information discussed during this call, particularly the information regarding our revenue and operating profit margins or profit targets, including expectations concerning future GAAP and non-GAAP revenue and revenue growth; GAAP and non-GAAP net income and loss, and adjusted EBITDA; business strategy; customer demand; market observations, and future product plans are based on information available as of today, July 22, 2009.
We believe that some of the statements we will make on today's call, including statements about the expectations I just mentioned may constitute forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933.
Accordingly we wish to caution you that such statements are just predictions based upon current expectations and assumptions regarding future events and business performance and involve risks and uncertainties that could cause actual results to differ materially. We refer you to the reports that Omniture files from time-to-time with the U.S. Securities and Exchange Commission, which are available on our website and contain and identify important factors that could cause the actual results to differ materially from those contained in our projections or other forward-looking statements.
Omniture undertakes no duty to update any forward-looking statements to conform the statements to actual results or changes in the company's expectations.
Following prepared remarks from Mr. Josh James, our Chief Executive Officer and Mr. Mike Herring, our Chief Financial Officer, we will open up the call for Q&A. Let me now turn the call over to our CEO, Mr. Josh James. Go ahead, Josh.
Thank you. Hello and thank you everyone for joining us this afternoon.
As you can see from our press release issued earlier this day, the Omniture online marketing suite is resonating very well in the marketplace. Despite a very challenging economy, Omniture delivered solid Q2 results with non-GAAP revenues of $8 million, which was at the low end of our guidance range, while exceeding the high end of the range for non-GAAP earnings at $0.13 per fully diluted share. That equates to non-GAAP revenue growth of 17% year-over-year and a 44% increase in non-GAAP net income from the same quarter a year ago as a result of company-wide focus on managing expenses appropriately.
During the quarter, we began to see signs of some stabilization in our business and new AT rebookings or once again reasonable for the quarter, considering the economic environment.
Up 25% sequentially from Q1, although down 15% year-over-year on a tough comparison as 12 months ago economic conditions were much different than they are today.
While revenue in Q2 remained essentially unchanged from the prior quarter, due to significant decline in over-usage revenues, our contracted revenue grew on both a year-over-year and sequential basis.
So on a tentatively positive note, we believe these are encouraging signs that the worst may be behind us. That said, it does not feel like things are trending back up yet and we still have not seen a material improvement in customer purchasing behavior.
Sales cycles continue to be long due to tighter budgets and more stringent approval processes within customers and prospects and we are assuming that selling conditions will remain difficult for the rest of 2009.
Regards to performance in Q2, I’d like to thank our employees who have rallied around the business by focusing on our customers. We’re only as successful as our customers and this is especially critical to remember in these economic times.
We’ve been addressing the customer experience by improving both our products and our services. Using customer input, we continue to change the game by increasing the depth of product integration with the Omniture online marketing suite. This has resulted in very positive momentum in our search center, test and target, and Omniture insight businesses. Omniture insight is formerly known as Omniture discover on premise.
On the customer service front, we’re excited to preview an announcement that we will make tomorrow about a new customer portal that will be available September 1 at customers.omniture.com. This system will provide our customers with real time insight into the service performance of their Omniture environment and will serve as a one-stop system for managing quality assurance, operations and support issues.
The announcement directly supports our commitment to “best in class” enterprise level support and also highlights our open transparent relationship with our market-leading customer base.
Uniqueness of the Omniture online suite drives our success and contributes substantially to our competitive position. The breadth, depth, and quality of our offering have led several large customers each quarter to move from our direct competitor’s products to the Omniture online marketing suite. As a result, we continue to grow our market share at the expense of our competition.
Our customers are increasingly leveraging the multiple products in the Omniture online marketing suite to move well beyond with analytics towards optimization. While leveraging the share of the trillions of transactions we are practicing and managing, our customers have publicly published over 30 case studies so far this year where the resulting uplift was only made possibly by using multiple products in our online marketing suite.
These case studies demonstrate how our optimization products are using the raw data to create personalized experience kindred to each individual website visitor. For example, we have a major consumer electronics retailer who recently deployed our test and target product to personalize promotional offers on their homepage and they were able to increase revenue per visit by over 115% and increase quick throughs by over 80%.
Separately, a top apparel retailer analyze searches on their sites and found a large number of visitors searching for wedding-related items that this retailer did not offer. By adding a wedding section to their site, the retailer was able to drive over $2 million dollars in incremental sales in one month.
In another example, U.S.A. Auto Parts Network is using Omniture’s genesis integration with its email vendor to send targeted emails to generate 50 times higher revenue than their standard promotional emails.
Lastly, one of our multinational tele-co customers, Vote-a-Phone, used the integration between our site catalyst and search center products to create search bidding rules and was able to increase return on ad spent by more than 400%.
With case studies like these, particularly in this type of environment, we remain extremely confident in Omniture’s long-term growth prospects as driven by the success and the utility provided by our online marketing suite. However, as we stated earlier, the selling environment remains difficult and we’ve made some changes to our sales strategy and structure in Q2 that placed an increased emphasis on selling additional products and services back into our customer existing customer base. We’re finding that it’s easier to demonstrate value through proof of concepts or trials with customers that are already on our platform than it is getting a customer to start a new online optimization project from scratch.
This is proving to be especially true as we leverage the cross-sell momentum that we established from our customer summit in February and April of this year. It is investments and events such as our customer summits that enable us to grow our contracted revenue base by more than 20% year-over-year and increase the average number of products per customer, which grew to $1.39 in Q2.
We also will continue to focus on attracting new customers, though it is clearly more challenging in this macroeconomic environment. One area, however, where we are seeing positive development is in our channel strategy. We are finding that agency and partner solution relationships are becoming increasingly important to client relationships in general and in their selling process specifically.
In Q2, for example, nearly one quarter of our ACV bookings were influenced by one or more of our partners. Furthermore, these channels had sale cycles that were 20% to 30% shorter than our direct sales.
Utilizing our extensive and expanding community of more than 200 genesis partners and more than 500 channel partners, we are able to create additional growth opportunities for the company. Our strategic partnership with WPP, for example, is already contributing to sales with several WPP influenced deals having already been closed. We expect continued momentum from this relationship, as we have already trained over 350 WPP consultants on Omniture products as of the end of June.
The healthy ecosystem of genesis and distribution channel partners is just one component to our growth strategy. Throughout this economic downturn, we have remained committed to the investments that will drive the long-term growth of our business with the objective of helping our customers leverage the more than one trillion transactions that we capture for them every quarter.
Some of our key investments are in areas such as extending our solutions and offerings into the mobile industry and social network community. Engineering efforts to identify increased efficiencies within our vast network, expanding our global presence into high growth regions such as the Asia Pacific region, and continually enhancing the capabilities and performance of the Omniture online marketing suite.
For several acquisitions and new product creations, we launched our online marketing suite at our customers summit and that consolidated product strategy is working well. We are now rapidly approaching an average of almost two products per customer in some of our customer segments. Among our private accounts, we had several customers who have four to five products and overall our enterprise customers are adding new products at a very rapid rate and we are highly confident this will continue as they buy more and more of the Omniture online marketing suite.
As for the trillion transactions, we believe they represent one of the most valuable resources and opportunities for Omniture, as our customers continue to forge ahead creating individualized offerings for their visitors based on each specific piece of data.
It is important to note that also these transactions are collected on behalf of our customers. It is their data and it is not owned by others. It is not some giant cross domain network filled with privacy land mines. It is collected on behalf of our customers and the visitors to their sites can feel good about the fact they are visiting sites in a safe environment.
By helping our customers leverage these one trillion transactions through optimization products, we are helping generate more revenues and profits for our customers, because they can be smarter and more targeted in having interacted with their customers. For example, more targeted emails, ad serving, search marketing, social media, mobile media, site content, etc. In many cases, these transactions are becoming a key input into dashboards for the overall health of the company at the CMO and executive marketing level and more frequently at other executive levels throughout the entire business.
Regarding our internal expense reductions in Q2, the vast majority of the reductions that enabled us to exceed our profitability goals were the result of right sizing efforts within our sales organization. The introduction of processes to work more efficiently, such as less travel, more teleconferencing, and the postponing of engineering projects, such as localization efforts that were not expected to deliver meaningful returns over the next 12 months.
After we challenged our employees to be as cost conscience as possible given the environment, we had hundreds of ideas and examples of ways to save to anywhere from $20 to tens of thousands of dollars. One of our employees in London, Martin Javer, took the challenge one step further and wrote the Green Manifesto. Part expense control ideas and part rallying cry that I distributed to the worldwide organization and have further inspired the team around efficiency and became the company-wide triage for being efficient while delivering superior results. It is a sign of the times with that focus on efficiency, along with the maniacal focus on customers has given all of us renewed energy and drive.
As I mentioned, we believe we have seen some stabilization in our business as well as in some of our customers’ businesses and there is certainly hope that two or three quarters from now we’ll start to see the beginnings of returning to some semblance of normalcy.
As our customers hear more and more about case studies, like Ameritrade, we use multiple products from our online marketing suite to generate a multimillion dollar revenue increase by dynamically targeting and serving content on their site and as we hear more and more about the case studies I mentioned earlier, we believe we will be well positioned for stronger growth once the economy recovers.
I’d like to thank our customers for their business and their continued belief in us and again I’d also like to recognize and thank the members of the Omniture team who produced these results.
With that, I’ll now turn the call over to Mike Herring, who will review our Q2 performance in greater detail and also the outlook for Q3.
Thanks, Josh, and good afternoon, everyone.
As Josh stated at the beginning of the call, despite a very difficult business environment, Omniture was able to deliver solid results in Q2.
Revenue for the second quarter was just below our target for the quarter with profitability coming in higher than expected as result of tighter expense management during the quarter and a lack of the kind of unfavorable surprises we saw in the first quarter. An indication that the business environment appears to have stabilized. Although variable revenue was down from the first quarter, we grew our contracted revenue base as a result of solid bookings and revenue was slightly up sequentially. However, the macro environment continues to be difficult and our Q2 results reflect that.
Allow me to take a few minutes to review our financial results in greater detail. Total revenue for the second quarter of 2009 were $87.6 million on a GAAP basis and $87.9 million on the non-GAAP basis. These results represent increases of 22% and 17% respectively over the same period a year ago. Reflected in Q2’s revenue results is a significant sequential decline in over-usage revenue.
Historically, variable revenue, which is largely driven by over-usage fees have represented as much as 6 to 8% of total revenue. In Q2, we experienced a nearly $1 million dollar sequential decrease in variable revenue, as transaction volume growth was up only slightly to 1.05 trillion transactions and reflect a slow traffic growth overall and a lack of the traffic spike that drive variable revenue. We believe these trends in traffic activity are a result of the decline in the product launches and marketing campaigns by our customers that drive traffic.
Turning to revenue mix, product revenues for the second quarter were $77.4 million on a GAAP basis and $77.7 million on a non-GAAP basis.
Professional services revenues were $10.2 million and represented approximately 12% of total non-GAAP revenue. We are seeing good momentum in adoption of our Omniture online marketing suite and thus contracted product revenue has been building for cross-sell products and demand for our professional services continues to be strong, as customers seek to outsource many projects to Omniture Consulting to leverage these products following significant cuts to their own budgets and staffing as a result of the current economic downturn.
On the international front, our business continues to perform well. International revenues in Q2 totaled $24.7 million or 28% of total revenue. That is a 21% year-over-year increase in revenue, despite the strengthening of the U.S. dollar.
Constant dollar growth adjusted for foreign exchange fluctuations for international business was 38% year-over-year. We believe there are continued opportunities for growth in our international business and we’ll continue to make investments in this area.
Non-GAAP product gross margins fell more than 300 basis points year-over-year, 65% in Q2, and were negatively impacted by four primary factors. Foreign exchange effect associated with the strengthening of the U.S. dollar, a significant increase in third party API fees, the previously mentioned decline in over-usage variable revenue, and pricing dynamics that make improving product margins and pricing pieces difficult in this kind of environment.
Professional services gross margins, however, were 61%, up significantly from 52% in Q2 of last year and 59% in Q1 of this year. Our increasing gross margin reflect the higher utilization of our professional services team.
GAAP operating expenses were $54.2 million, an increase of 3% from the same period a year ago. Non-GAAP operating expenses were $45.1 million, up just 6% from the same period a year ago and down 8% from the prior quarter. Clearly the tighter expense management is having a desired effect. Some of the changes made include tougher restrictions on hiring and a requirement of more media and definable returns associated with approvals related to TNE and other expenses.
Non-GAAP sales and marketing expenses at the percentage of total revue was 31%, down significantly from 36% in the prior quarter, as we benefited from the U.S. Summit and sales kickoff and related expenses that occurred in the first quarter, combined with tighter cost controls to cut back on many marketing programs in general and a more streamlined sales team.
With our new focused quarterback sales structure, we have been able to reduce our account from 154 to 139 in Q2.
Non-GAAP R&D, some modest reductions in Q1, and remained essentially unchanged at 9% of total revenue.
G&A expenses also remained flat at 11% of total revenue, as the cots incurred related to our proxy annual meetings and from our recent option exchange program were offset by the deferring of other investments and overall expense reductions.
As Josh indicated at the beginning of this call, we believe we have seen some stabilization in our business, but have not yet seen a material improvement in customer purchasing behavior; therefore, we will continue to maintain a tight control on expenses.
We are pleased with the achievement of non-GAAP operating margin of 13% in Q2. This represents a 50% increase in operating income or a 350 basis point improvement in operating margin over the same period a year ago.
Sequentially, our Q2 non-GAAP operating margin represents 28% increase in operating income and a 290 basis point improvement in operating margin over the prior quarter.
With the improvement in the second quarter, we are confident that we have a solid path to achieving our fourth quarter 2009 operating margin target of 14%.
GAAP net loss was $4.9 million, or $0.06 per fully diluted share and represents the better than expected bottom line results and lower stock base compensation expenses following the completion of our option exchange program in June.
Non-GAAP net profit was $11 million, or $0.13 per full diluted share, and significantly better than expectations. Adjusted EBITA was a record $18.9 million.
As Josh stated earlier, Q2 returned reasonable sales results and ATV bookings grew by more than 25% over the prior quarter. Our ATV booking figure represents only incremental changes to contracted revenue and does not include any renewals at the same value, a typical way to measure subscription based businesses.
Total billings, defined as revenue across the change in deferred revenue, was $92 million, flat from first quarter and down slightly from Q208, a quarter where we had an unusually large multi-year payment.
Turning to customer metrics, we added more than 115 customers to our platform in Q2and our total customer account remains essentially unchanged with over 5,000 customers worldwide. We continue to experience attrition within our customer base, as customers deal with the effects of this very challenging economic environment, yet overall attrition patterns remain unchanged from the last few quarters. Nominal attrition is concentrated largely among mid-market customers.
We’ve also reached the 18th month anniversary of our acquisition of the HBAC customer and while we have already exceed the revenue retention goals that we’ve set for ourselves at the start, there still remain a number of HBAC customers that have not yet migrated over to stay catalysts. These un-migrated HBAC customers have higher attrition rate and represent a disproportionate percentage of overall customer cancellations. Catalyst retention rates are similarly as in previous quarters with enterprise customer rate at approximately 95%, while overall retention rates are around 90%.
Generally speaking, the attrition increases we have seen over the last few quarters are not competitively driven, but rather reflect the turmoil of the economic environment.
We continue to grow our market share overall with the ratio of competitive displacement at a favorable 6 to 1 ratio or better.
Finally, looking at our balance sheet, total cash and investments at the end of the quarter totaled $131 million, up $36 million from the end of 2008 and up $6 million from the prior quarter.
Accounts receivable increased $119 million resulting in a DSO of 123 days, as we are increasingly billing annually in advance and customers overall are paying at a slower pace. Payment trend is reflected in adjusted DSO or DSO after removing deferred revenue embedded in the AR balance, which was 56 days, only one day more than the adjusted DSO figure in the first quarter.
Deferred revenue increased to $121 million, up $4 million from the first quarter. We continue to maintain healthy bad debt reserves to account for the increased customer attrition over the past few quarters.
Turning to cash flow, we generated $15 million in cash flows from operations in the quarter.
CapEx for the quarter totaled $6 million with $1.3 million of it related to either facility or corporate investments. As a result, adjusted free cash flow was $9 million.
During the quarter, we also put in an additional $1.5 million of data center purchases on operating needs. The total data center and CapEx investment was about $6 million in the quarter.
Looking forward to the back half of 2009, we believe that the economic environment has stabilized, but so far we are not seeing signs of near term improvement. We’re continuing to be zealous in our cost controls and cautious in our revenue outlook.
Fort the third quarter, we are targeting flat revenues from the second quarter with EBIDTA and EPS approximately the same.
We expect there to be opportunities for revenues and earnings growth in the fourth quarter and into 2010 and we are still targeting 15% annual revenue growth for 2009 and 14% operating margins in the fourth quarter.
Although these are difficult economic times, we are managing our business closely and we believe we are in excellent position to capitalize in our market share when the macro environment improves.
We would now like to take any questions you may have. We would appreciate it if you could limit each person to one question. Operator?
(Operator Instructions). Your first question comes from the line of Steve Ashley of Robert W. Baird. Please proceed.
We have a question from the line of Tom Ernst of Deutsche Bank. Please proceed.
Tom Ernst - Deutsche Bank Securities
This is Nandom on behalf of Tom. What percentage of your bookings this quarter for upsells versus a new customer?
As in prior quarters, we’ve the shift of our new bookings towards sales to existing customers rather than on the acquisition of new customers and that continued in the third quarter. Josh mentioned specifically that that’s been a focus of our sales team and realigning of our sales strategy and we’ve seen the majority of our sales come from existing customers the last three quarters.
Next question from the line of Michael Huang - ThinkEquity
Michael Huang - ThinkEquity
Could you help me reconcile the new customers you’re adding, that you had in Q4 and Q1 and Q2 with your guidance for flat revenue growth in Q3. Are you being extra conservative around attrition? Is it more around overage revenue? Are customer taking longer to onboard?
We have been adding on a growth level, customers the last few quarters, although our total customer count has stayed relatively consistent. The contracted revenue is a revenue that’s being committed, actually been growing each quarter, but we’ve seen a decrease in that variable revenue. In particular from Q1 to Q2, I mentioned we had nearly a million dollar drop in that piece of revenue. It was more than made up by increase in contracted revenue, but that is a significant headwind in the short term. It can only drop so much in the low single digit percentages of revenue, but it has been a significant head win. The last three quarters, so has attrition, which we talked about quite a bit. We think that that stabilized though, but we expect it to be another quarter of kind of steady-as-she-goes business before we can see growth again.
We’ve mentioned in the past that because we’re a subscription business that tends to have one year minimum contracts, it’ll take us three or four quarters to get through an entire kind of subscription renewal cycle within the recession to see the full impact of it and we’re three quarters into that now. The third quarter again will be a quarter where it will be doing renewals on customers that are renewing for the first time since the true impact the recession has felt. And so, we’re being cautious about how we are going to be able to drive revenue in the short term.
We have a question from the line of Keith Weiss - Morgan Stanley
Keith Weiss - Morgan Stanley
I was wondering if we could talk a little bit about how renewals are going and particularly around pricing on how well you guys have been able to maintain your pricing when customers are renewing. You talked previously about working with giving additional products down the road. Can you tell us how that dynamic has been pointing out in most recent quarter?
I think that dynamic continued. We haven’t seen things get worse, but they haven’t gotten better either. So we do see customers who are renewing and renewing at lower rates on their installation just because traffic is lower. They’re not investing aggressively at the margin and not driving increased traffic, but oftentimes where we’ll see makeup that dealt with the sales of additional products and when the economy rebounds and the traffic starts to grow again, we expect the overall size of that account to then increase.
We are seeing that. Those conversations happen quite a bit on those renewal dates and that’s one of the reasons we talk about having to go through the renewal cycle for a full year until we get a sense of where the base is that we can grow on.
When we’re going through that renewal process and not just the renewal process, but our sales people spending a lot of time with these folks just helping them understand the values that is what they’re getting out of the original profits that they have from Omniture’s online marketing suite. So the conversations are still taking place and we’re spending a lot of time with our customers and we hear about these case studies that we’re referring to and we see them and visit with them when they come to our customer summit and they’re ready and they have an appetite for more incremental products and that’s why we alluded to in the prepared script, the proof of concepts and the pilots that we’re doing. We’ll have customers that are already installed with that catalyst that want to try out a custom target products are try out certain center and because we already have a relationship with them, letting them go through those trials has been a pretty positive way to look for some of that upside and capture some of the value associated with that data that they’re already managing and collecting.
Keith Weiss - Morgan Stanley
Have you guys seen any type of uplift in transactions from like some of the web 2.0 functionality like Facebook or Twitter or anything on the mobile side?
It has an impact on transaction volumes, but the big impact is going to come overtime. In Japan, we have customers that are driving more traffic through their mobile site than they are through their traditional PC-based websites and we’re seeing more and more of our customers create specific sites for the mobile experience. Over time it drives a lot of transactions, but what’s really important is in the sales process. If you’re on top of new technology and cutting edge technologies, then it really does become more a consultative sell. You become the experts and you help them understand what the rest of the market is doing and how they’re using those different types of technologies and we’ve seen time and time again as soon as we start to support a technology, our customers are going to embrace that and start using that and testing that and trying to figure out if that’s really going to grab their business or not. It does a tremendous amount for our position in the marketplace.
Your next question will come from the line of Brian McGraff – Credit Suisse.
Brian McGraff – Credit Suisse
Second quarter in a row where professional services revenue is going to come in pretty strong, about $10 million and roughly 12% of revenue, is this kind of the new threshold where we should be thinking about where services is going to come in?
When you cited those retention numbers, is that on a revenue basis?
Q1 was a very high quarter and we expected it to be down quarter-over-quarter from a professional services revenue and it was, but only slightly. Again with best practices consulting really being the driver of high consulting revenues in Q2. Looking into Q3, I expect that services revenue line to be down again, though there still is significant demand for those services and backlog in that revenue stream.
I mentioned briefly in my comments that we’re seeing that demand driven by customers who have projects that need to get done, but don’t have the staffing level internally and they’re turning more to external consultants to get that done, particularly around optimization projects. It’s one of the reasons why there is such demand from agencies right now for certification on our product, etc., is one of the driving factors behind the WPP initiative to get 500 people trained in our consulting services and that works to help drive product revenue. So we’re very supportive of agencies who are making that initiative.
In a different kind of environment, we’d be hiring pretty aggressively in that area, because we have a pretty substantial backlog, but in this kind of environment, we like to have a substantial backlog and we’ll forego some revenue and opportunity there just to make sure that we’re hitting really good utilization, but it’s certainly an opportunity in the area for growth over the long haul and also like Mike just alluded to is very alluring to our agency partners, because where we will go in and film a dollar a product and associate with that dollar product, there will be $3-4-5 dollars of consulting that our partners will pick up just to help our customers understand how to use the products as effectively as possible and get the most bang for their buck.
So it’s an opportunity for Omniture, but it’s also a really big opportunity for creating very pet relationships with these big agency partners that we’ve been lining up.
We have a question from the line of Imran Khan - J.P. Morgan
Imran Khan - J.P. Morgan
It’s L. Plinskly dialing in for Imram. Quick question on the progress with cross-sells. I think, Josh, you mentioned 1.39 product lines per customer. If I’m reading that correctly, that’s in line with what it was in Q1. So I just wanted to be clear if that’s a slightly different number than what you gave in Q1 or if there’s sort of a little bit of slow down across all sales.
It was up just slightly from where we were last quarter, but what we are seeing in some segments, we have about 5,000 customers, so across all of those customers it’s hard to make that number move very substantially. We are definitely seeing is our very largest customers, if you look at the top 100-200 customers, there’s a handful of them that have bought four or five or six products and over time we believe that all those customers will do the same.
They’re a little bit more slower moving than this kind of a customer segment right below that. Customers, let’s say 150, 200, on down to 1,000, is kind of the bulk of our enterprise customers. Those folks are averaging, they’re approaching two products per customer, and they’re moving much more aggressively. There’s a right size where they’re got enough resources internally. When they find a small improvement, it really moves the dial in terms of nominal dollars. That segment, we’re seeing a lot of success and over time we think we’ll see that same success in the mega customers and see that same type of success in the market as we get more effective and streamline the selling and support process.
I think before we get really successful in the mid-market area, we’re going to have to continue to roll out more and more integrations workflow inside our products just to make it easier and easier to not only use the products and jump from one product to the other and make it feel like it’s a completely seamless process, but also there’s a lot we can do to sell incremental products inside the products. Right now, every sale pretty much involves a salesperson and over time we want a lot of those, at least leads and hopefully some sales, to be able to be upgrade that you’re clicking on and we have one customer in particular that we think about in terms of an analogy. It’s a genealogy site called ancentry.com and when you’re in there using their products, you find out that you might have a relative. You bought the basic subscription to the product and you find that you might have a relative in the middle of Tennessee and if you want to pay an extra $10, you can see the newspaper that’s been scanned and of course you pay that extra $10 bucks and you do it all right there online and we like to think about that same type of analogy for a software service, because it presents a different dynamic and opportunity than ever existed before in software and if you’re in there using the site catalyst and you’re looking at your search results and you could right there click and start using your search center product and you can right then and there start downloading and installing your testing and target functionality without having to call anybody. You could create a segment to start using Discover without having to call anybody. We think that’s what the future is going to look like and so that’s a big opportunity for us over time and that’s really going to streamline and make much more efficient sales process to the mid market.
Your next question comes from the line of Steve Ashley - Robert W. Baird.
Steve Ashley - Robert W. Baird
This is actually Joel Hammond filling in for Steve. Mike, regards to bad debt expense, I am curious as to how bad debt expense in Q2 compares with bad debt expense in Q1 and how it shook out relative to your expectations and then also what are your expectations for bad debt expense for the back half of the year?
Bad debt expense form Q1 to Q2 actually increased somewhat, but it was within our expectations. We talk a lot last quarter getting a lot more conservative in our expectations. From a dollar amount, we didn’t see that continue to grow as we have seen bankruptcies continuing at some level within our customer base and some kind of new higher level activity in Europe in particular. Taking that into account, we have higher reserves which drive that expense.
It wasn’t a surprise to us this quarter, however. We built in that expectation. Looking into the back half of the year, we’re basically expecting it to stay relatively similar to Q2. From a U.S. customer base perspective, we’ve seen the worst. It stabilized and we’re not seeing it get worse. Putting that together into the context of our overall AR balance, we think it could get better, but the worse case it would stay about the same.
Next question will come from the line of Robert Breza - RBC Capital Markets
Robert Breza - RBC Capital Markets
This is actually Matt Headberg sitting in for Rob. Could you talk a little bit more about gross margins into Q3. How should we think about the product side. You mentioned four things that impacted in Q2. I guess relative to your earnings guidance, how should we think about that?
Then as a follow-up on QBSRs being down 15 sequentially. I think you talked about maybe two or three quarters until things returned to normalcy. How should we expect that to trend over those next couple quarters?
From a gross margin perspective, we talked about four things that have effective gross margins. We’re really talking about the year-over-year difference in particular around foreign exchange impact. So that actually will be mitigated as we move through the year we’ll be comparing more like year-over-year exchange rates. There’s some pieces that we have a decent amount and others are more complex. I think for the most part, things like API fees and over-usage revenue, we’re going to kind of see a pretty consistent sequential impact from those going forward. Both those things were up in Q2 in particular or had a negative impact, I should say up, the fees were up and the variable revenue was down.
Pricing dynamics, as we’ve said, we think are relatively stable. So gross margins are going to be difficult to improve this year and hopefully we’ll be able to see some stabilization in some of the more variable pieces of it and be able to get some efficiencies and bring those back up. We’re already seen some of our CapEx expenditures and such decline as we’re managing much traffic. That’s good news and hopefully we can sustain that in order to keep costs relatively even with where revenue is trending.
This is Josh. We’re going to kind of take it as it comes. It’s hard to predict what’s going to happen next week, let alone over the next few quarters, but it’s really going to be based on the demand that we’re seeing from customers. There’s definitely some places that we’d like to go and stick some salespeople. There’s some opportunities we see inside our product base where we know there’s opportunities for growth, but at the same time we’re not going to extend ourselves if we don’t believe that we can see some near term intra-quarter results. So we’re probably not going to be making very much movement on the QBSR front.
You have a question from the line of Youssef Squali - Jefferies & Company
Youssef Squali - Jefferies & Company
This is Sandeep dialing for Youssef. How should we be thinking about CapEx? You had previously guided $10 million run rate per quarter and CapEx was below that level, around 7%. Was that due to lower growth and transaction volume or are you going to be able provide the same stability and reliability to the customers at this level of spend moving forward?
The reality is CapEx is probably above what it would have been in an normalized state in Q1, because we were creating some buffer around our product, in particular the integrations, the demand the integrations were putting on our data. So we hedged that a little more than usual in Q1 and Q2 those buffers were actually pretty healthy and traffic growth was actually a little bit lower than we expected through the quarter. So we didn’t have to purchase as much in terms of equipment or CapEx into the infrastructure.
Moving forward, we talked about 6 to 8% of revenue essentially for the year that’s going to kind replacing CapEx. So there’ll be some run rate associated with that. We do have significant efficiency efforts. We’re trying to continually get better performance out of our infrastructure, but if traffic and revenue continue to be relatively flat and we’re not growing, then we’ll be able to keep CapEx at a lower level. If economic environment improves and bookings pick up, then we’ll probably increase CapEx as we move forward.
We have a call from the line of Shyam Patil - Raymond James
Shyam Patil - Raymond James
This is R. Shadaw filling in for Shyam. In your product portfolio, which are the top three or four products that can get to $20-$30 million dollars in annual revenue the fastest and what would be a good timeframe assumption for that?
We’re getting close on a few. In this kind of environment, you have some growing and some that aren’t. It’s just to difficult to give you any kind of predictions, but the products that are doing fairly well are the ones that I mentioned. Our test and target product line is doing very well. Our Omniture insight that we just rebranded, used to be known as Discover on Premise, and then search center. We continue to make progress with our search center products. So those three in particular doing very well.
Your next question comes from the line of Mark Murphy - Piper Jaffray
Mark Murphy - Piper Jaffray
Mike, how did the ACV bookings that was added in the quarter compare to the amount that turned off?
It was higher than the amount that turned off, but there’s a time difference in when it gets recognized into revenue, what gets added. The transition isn’t as one to one in a given period.
Mark Murphy - Piper Jaffray
So the timeframe for revenue recognition, you’re basically referencing the deployment times?
Mark Murphy - Piper Jaffray
You think the current ratio of the ACV bookings being added quarterly versus those that are being depleted that that is essentially resulting in roughly $1 million sequential revenue growth and then that’s being offset by the decline in variable revenue. Looking at the Q2 results as a proxy, I mean is that a fair way to think about the revenue dynamic as long as the bookings are at that ratio and the variable, the slope of the variable is coming off like this?
I think that’s a fair overall way to think about it. Comparing it any one quarter has complexities with the timing that I mentioned, but we’re talking about contracted revenue growing on a net basis. The reason is not always getting reflected cleanly into our numbers have to do with the variable revenue as you identified.
Mark Murphy - Piper Jaffray
Do the Google analytics security mishap seem to have any impact on our customer behavior. Is there any incremental concern in the marketplace that some of the low end products could have some design flaws or perhaps anything that potential could help your pipeline a couple quarters down the road?
It absolutely made a difference and I think it just highlights who is a priority there. Their customers are not the priority, because they’re not paying for anything. So I think it definitely highlights the importance of enterprise class product and support and it’s something that works very effectively for us out there on the marketplace. It spread around like wild fire in the analytics market for sure and came up in many, many examples, because a lot of times people just bring that product because it’s provocative because it’s free, but when the executives get the answer back that did you know there was a security flaw and did you know that there’s no SOA’s and did you know you don’t even actually own the data. It helps pretty substantially to kind of stem any conversations from progressing beyond just kind of curiosity. We like to see those kind of things happen. You need enterprise class products and services and it’s not just about the data. It’s your data and you need to have that data managed by an enterprise class company so that you can do all the other things that you want to do with the data like provide that personalized experiences for your visitors that are coming to your site with that kind of personalized experience. That’s really what it’s all about.
Your next question will come from the line of Dan Salmon - BMO Capital Markets
Dan Salmon - BMO Capital Markets
Break in news, Amazon announced they’re acquiring Zappos here after the bell. Could you give us quick ideas on your relationship with those two companies and how this may impact you?
We don’t think that’s going to have any meaningful impact to our business, at least not in the short term. Over the long term, one of the things that we continue to see is as customers get more and more sophisticated the way they run their websites and online businesses, they want to not just have the data, which some companies are good at having data, but actually try to figure out how to leverage that data and use some of the other products that we have that are becoming more and more enterprise class as we have them for longer periods of time. I think over time we’ll see the relationship that we have Amazon continue to strengthen. We didn’t have a relationship with Zappos and so I think that presents an opportunity for us.
Your next question will come from the line of Carter Malloy, Stevens Inc.
Carter Malloy, Stevens Inc.
Looking at the enterprise side, but would be curious to know across the board on the increased turn particularly in your enterprise customers. Was that all because of guys that went out of business?
Can you say that again, it was hard to hear you.
Carter Malloy, Stevens Inc.
The turn in your enterprise customer base which ticked up sequentially, is that just because of a few guys that went out of business or actually a few that left you for competitors?
We don’t see any trends about customers leaving and going to our competitors. There’s definitely pressure out there for companies that are really struggling. You know, bankruptcies. You know, the conversation, if I’m sitting on their side when they say to us – look I had 50 people in my department. I cut 35 of them yesterday. We can’t afford to pay you guys. And you say – okay well what is it that you really want? Then they say – I don’t care. I don’t need anything. Anything I can’t get for free. That’s what we’re going to do for now, because we don’t have anybody to look at the data anyway. So those are the types of voices where you have some difficulty and there’s anomalies here and there certainly, but we’re not seeing any trends in our enterprise business that’s alarming to us. There is kind of spikes that might refer to that we’re seeing right now with the HBX business, because we converted a pretty meaningful chunk of that business over to our platform due to the head of schedule that we were hoping for and we already exceeded the initial target that we’ve set for ourselves. So we’ve been pretty pleased with that overall, but that doesn’t change the fact that right now we’ve got a bunch of customers that are sitting on product that aren’t engaged enough in many cases to engage with us and not necessarily using the product that they currently have installed and not really a focus for them and in this kind of environment that only gets exasperated. So there’s some anomalies going on right now with some of the turn, but from an enterprise perspective, nothing concerning to us.
The next question will come from the line of Brad Whit – Broadpoint
Brad Whit – Broadpoint
I’m just curious if you could comment on, since you’ve had some changes in the sales organization this year, how have you changed the comp plans and quotas and that type of thing. Whether or not that’s been fully implemented at this point.
We roll out new comp plans at the beginning of the year and there’s definitely a focus this year on cross-sells. We’ll provide different incentives along the way. We’re not so static that we do one thing at the beginning of the year and then never make any kind of amendments to it throughout the year and this year we’re certainly seeing more and more opportunity inside the customer base and it’s more and more difficult to get new customers in this kind of an environment. It’s not something that was completely obvious to us at the beginning of the year, but as you think about it, people either haven’t done anything in online marketing and they don’t have analytics and if they have nothing, then they’re less likely to make a step forward in this space, but if they already have analytics and they’re already looking at data and they’re seeing reports and they’re seeing opportunities and they have resources, then they’re much more likely to go and acquire an incremental product.
So we’ve tried to align the compensation plan with the opportunity. We also this year went more to the quarterbacking model and we’re still tweaking that along the way as we try to make sure that we have the right relationship with our customers and that we also have alignment inside the sales organization for them to all help each other and fortunately with salespeople you don’t have to worry about them helping each other out of the goodness of their heart, because they don’t do that. They help each other, because it’s good for their pocketbook and so it’s our job just to make sure that we have the compensation plans and we’re pretty close to that and we’ll continue to improve that over time.
Brad Whit – Broadpoint
Final question on the new customers, 150 this quarter. Is that kind of the number we should think about as kind of the base, as kind of where it should shake out over the next couple quarters based on what you’re seeing?
It’s difficult anything that’s going on right now, just other than to say it doesn’t seem like things are getting worse, it doesn’t seem like things are getting better, and I think that probably implies in one way or another that that number plus or minus 50. I don’t know, but we’re going where the money is. I think the new customer count number and the total customer count number certainly can be misleading in terms of the health of the business and the opportunity of the business, because we’re seeing so much cross-selling into the current customer base.
Your next question comes from line of David Hilal of FBR. Please proceed.
David Hilal - FBR
Just a question on OpEx. Obviously performance, this quarter I’m bringing that down. How much more room is there to go or do you think you’re kind of at a sustainable OpEx level, given the revenues.
I’ll talk about it for just a second and then let Mike chat about it. This is where you’ve got to make judgment calls. You’ve worked really hard and you’ve got a lot of great people and you’ve built a business that, you know, you continue to hear in these kind of times there’s an opportunity. There’s an opportunity to beat up on the competition, there’s an opportunity to improve products, there’s an opportunity to invest when few other people are investing, and we talked a little bit in our call today that we’re continuing to invest in the most strategic opportunities that we’re sensing inside the organization. So there’s some places that we still are investing and if this environment continues for awhile, then I think we’re going to continue to invest at this rate. If things get dramatically worse or if they start to materially improve, then we’ll change the way that we’re investing, but there’s still opportunity and leverage for our business over the long haul and the guidance that we’ve given previously in terms of what we think about in Q4 and marching up that margin and in terms of the long term margin opportunity for the business, definitely still hold firm and true.
Next question will come from the line of Sasha V. – J. Montgomery Scott
Sasha V. – J. Montgomery Scott
I was wondering if you could provide some commentary, you were mentioning stabilization domestically, but I was wondering if you were seeing similar situation abroad and if there’s any difference amongst the geographies.
There’s definitely a difference in the geographies, but as a whole it’s probably a little bit more shifty internationally than it is domestically, but there’s pockets internationally that are doing just fine and there’s other countries that are not doing fine.
So there’s not a whole lot of consistency other than no one seems to be doing all that well. I think going into all of this, we all heard that Europe in particular was going to do a lot better than domestic was going to do, generally speaking, kind of from a macro perspective, and certainly that’s not what we’ve seen. Both locations and regions have struggled, but at the same time we’ve got a pretty healthy business overseas and in many cases there’s not 20 competitors running around. There may be two or three competitors that you’re dealing with. And so, you don’t need to invest as aggressively. There’s also we invested and had fortunately supported our investors from early on to go and invest internationally and by doing that in many locations, we were the first to the market and we own many of the big customers that everyone else wants to follow and when you go into those countries, you can build up 10 to 20 people in some countries where it’s going to be really difficult for someone else to come and build that same size of infrastructure and you kind of have the competitive advantage at that point from a services perspective and that really is extremely important, based on international market.
So overall, I wouldn’t say there’s too much of a difference and as Mike mentioned in his remarks, we continue to see opportunity to invest internationally and we’re going to continue to do that.
You have a question from the line of Richard Baldry of Canaccord Adams. Please proceed.
Richard Baldry - Canaccord Adams
Given the heightened focus on cross-selling products, could you talk about your M&A strategy in terms of broadening the portfolio. We haven’t really seen an acquisition for a brief period of time anyway, whether that’s changed going forward. And then maybe a little broader in terms of WPP relationship, whether you think that would have more of an impact on acquiring new customers or maybe help in terms of cross-selling. And then also on WPP, whether the focus would be more domestic initially at least versus international.
On the M&A strategy, I think most of that’s been driven by there was a misalignment for awhile there in public company multiples versus private company multiples and private company expectations and those certainly have dramatically changed to where they’re both now in the same range where you can find accretive deals. So I think over the next few quarters, there’s several deals that we have in the pipeline that we’re looking at and deliberately walking through all those processes, but at least we’re not where we were six months ago where the initial price conversation has just stopped the progress altogether.
So from a cross-selling perspective, that certainly is interesting and one of the things we always look at is what’s the leverage you can get out of a customer base when you make these acquisitions. So we’ll continue to look at that as an opportunity.
In terms of WPP, they help us in all four of those areas. So help us in new customers where there may be particular segments that we don’t have strong inroads or great case studies, because we just haven’t made a lot of hay there in that particular area and they’ve got very tight relationships with the CEO-CMO level and they can walk us in and say – here’s the value that you can get and we’re trained on this and we’re standing behind it and they walk us in the door that way and so that’s been great. There’s been some deals that we would have never heard about that never in same cases didn’t go to RFP. They were just really tight relationships that they had and if this will help you in your business and help us help you manage your business.
Then with cross-selling, the fact that we mentioned in our prepared remarks, you can go into these places and they have the confidence of their executives, because they’re a trusted partner and their agency is also in there supporting this. It makes it a little bit easier when we’re in an environment where people are hesitant to take risks. It’s nice that there’s more people around the table with credibility that are saying positive things about the products and the opportunity and the return that they expect you to get on the investments.
From a domestic versus international perspective, I think domestically it’s going to be the help that we’re going to get is going to be in places that we just wouldn’t otherwise be. Certain verticals with a CPG, for instance, where we don’t have the kind of business yet, where agencies are extremely strong. Then also cross-selling. Places where they have analytics, because they knew that we were the leader in analytics, but we don’t have a senior or executive enough relationship to really drive incremental purchases. They help us in those types of areas.
Internationally, they help us with both those, but they also help us with the big dogs from those areas that we’re trying to sign up for our many products and services. We might not have ten salespeople running around in Brazil or ten salespeople running around in some country in Eastern Europe, but they have a great relationship with the really big customers there and they walk us right into the front door.
So they’re just great relationships and we’re going to continue to see a lot more of them. We’ve got relationships with pretty much all of the top agencies out there and we’re going to see more and more announcements that demonstrate the level of relationship and involvement that we have with each of these agencies.
With that, I’d like to thank everyone for their time and thank everyone for their questions and we’ll see you at the upcoming conferences. Thank you.
Thank you for your participation in today's conference. This concludes your presentation. You may now disconnect. Have a good day.
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