ReachLocal Management Discusses Q4 2013 Results - Earnings Call Transcript

Feb.11.14 | About: ReachLocal Inc. (RLOC)

ReachLocal (NASDAQ:RLOC)

Q4 2013 Earnings Call

February 11, 2014 5:00 pm ET

Executives

Alex Wellins - Co-Founder and Managing Director

David Scott Carlick - Chairman of the Board and Interim Chief Executive Officer

Joshua Claman - President and Chief Revenue Officer

Ross G. Landsbaum - Chief Financial Officer

Analysts

Diana R. Kluger - JP Morgan Chase & Co, Research Division

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

Charles Eugene Munster - Piper Jaffray Companies, Research Division

Todd Van Fleet - First Analysis Securities Corporation, Research Division

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

Jason Mitchell - BofA Merrill Lynch, Research Division

Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the ReachLocal Fourth Quarter and Fiscal Year 2013 Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to Alex Wellins with BlueShirt Group. Please go ahead.

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 Chairman and interim CEO, David Carlick; company's President, Josh Claman; 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 of 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, 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, as well as constant currency revenues 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 and constant currency revenues a GAAP to non-GAAP reconciliation can be found in our earnings release. These financial measures are not intended to replace any GAAP 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, as well as constant currency revenues only as a supplement to our GAAP results. With that said, I'll turn the call over to David Carlick. David?

David Scott Carlick

Thanks, Alex. ReachLocal recently celebrated its 10th anniversary. And as one of the original investors and a board member since 2004, I could not be more proud of the $0.5 billion business we've built with 3,900 clients served by more than 2,000 employees across 6 continents. This earnings call comes in the midst of a transformation of our business that started in 2013. I'm going to make some brief high-level comments regarding the current state of the company, the proactive steps we are taking to improve results, specifically in North America, and the execution of a plan put in place by management with the full support of the board to increase investment that we believe will drive more robust top and bottom line growth in 2015 and beyond.

Specifically, when we finish this year, we will have a product suite that we expect to increase our TAM by over 3x, to reduce our cost of acquisition, improve the lifetime value of our clients and we believe reaccelerate growth of our business. We will deliver a company in 2015 that is moving towards our long-term goal of a 15% to 20% revenue growth rate with adjusted EBITDA CAGR of at least 25%. To deliver this better future, we need to make the investment in the first half of the year. And while the investments are material, it's best to move quickly.

After my comments, our President, Josh Claman, will give you further operational details. And our CFO, Ross Landsbaum, will provide a deeper look into the financials and our guidance before we take your questions.

As you've seen from our press release, Q4 and fiscal year 2013 revenue was slightly below our prior guidance. We had solid Q4 adjusted EBITDA, reflecting modest scaling of our operations and the classification of ClubLocal as a discontinued operation, offset in part by the $4.8 million in impairments attributable to our franchise operations in Eastern Europe.

Our 11% growth in Q4 was driven by our continued growth in our international markets, which were up 35% or 41% on a constant currency basis versus 2012. As we have previously discussed, revenue growth in North America, our largest market, remains our biggest challenge. In December, after extensive testing, we implemented the new sale structure that we first laid out for you at our Analyst Day in February. This is designed to reignite growth in North America. However, it has caused disruption to our sales force in Q4. And we expected to take the first half of 2014 to get the organization to the expected increased level of productivity.

Moving to our largest growth driver, international, I'm pleased to report that we've opened our first office in Mexico, the only new major market we intend to open in 2014. While in the past 3 years we have focused on expansion, we will now move our focus from expanding to capitalizing on the beachhead that we have built in extremely large markets, including Germany, Brazil and Japan, which we believe present substantially larger market opportunities than Australia, which is currently our largest international market.

10 years ago, ReachLocal set out to help SMBs in the U.S. maximize their investment in local search by providing them with an exceptional platform for generating traffic to those SMBs' websites and for conversion-based optimization, including sophisticated call tracking technology, all accompanied by a full range of support services.

Today, we have an invaluable field and services organization in place around the world. And we are in a position to help SMBs around the world overcome increasingly complex marketing challenges by delivering them state-of-the-art solutions.

We are now taking a proactive series of steps to accelerate our business. On the sales and service side, we are realigning our North American distribution organization. On the product side, we are directing our development resources toward our technology platform to enable us to address more of our customer's existing needs, while enabling them to increasingly leverage the power of automation and data.

As previously announced, we are currently working on divesting ClubLocal from the company, which we expect to complete in this quarter. Once we complete this transaction, 100% of our technology resources will be focused on fortifying and extending our platform. Our cornerstone new software product, ReachEdge, has been successfully rolled out in North American and very well received. We have sold more than 1,200 ReachEdge licenses since it was introduced late last year, and we are planning to deliver this game-changing product to Australia and the U.K. during 2014.

ReachEdge includes proprietary data capture technology and marketing automation and is delivered with a responsive website design that fluidly serves desktop and mobile inquiries. This platform puts us in a position to attach a number of additional complementary products to help our clients. Our new SEO product is well known and is a solution that our customers have asked for persistently and spend on today, and which represents almost 10% of our clients' digital marketing wallet.

To that end, we've introduced ReachSEO, a new product for our ReachEdge customers that will drive inquiries to the website through organic search, directories and other sources in North America and Australia, and we plan to expand to the U.K. by mid-year. The results, we are covering the majority of our client base and our biggest selling territories with a robust product suite, representing a single solution that now addresses over 50% of our clients' marketing wallet or 3x the TAM we could address 12 months ago.

Our commerce initiative remains in beta. We are retaining IT developed with the ClubLocal project centered around back-end commerce platforms. And we are engaged in product development and testing, including the previously announced plans to integrate with Yelp. We look forward to discussing our continued opportunities in the area, facilitating lead conversions for our SMB clients.

As I mentioned at the top of the call, we are increasing investment substantially in 2014, as is reflected in our adjusted EBITDA guidance. The board strongly believes that these investments will result in a return to stronger growth in 2015 and may fall into 4 buckets, totaling in excess of $20 million.

First, an increased investment in newer international markets to drive and to scale more rapidly. We had to invest heavily in infrastructure when we launch our non-English-speaking markets, including Germany, Japan and Brazil. And so to scale these locations more quickly, we need to incrementally invest to align the scale of our distribution organization to match the infrastructure investment we've already made. Second, the incremental cost related to the realignment of the North American sales and service organizations. Partially offsetting that investment is a restructuring program that will require a restructuring charge in 2014, which should result in an annual savings run rate of $9 million to $10 million.

Third, an investment in expanding our inside sales efforts in North America and launching that program in Europe and Japan. And finally, an increase in operating expenses plus additional capital spending to increase our product resources by about 1/3 over 2013. By focusing on product, we are attacking the market to offer an integrated solution for SMBs and expand our TAM from the 10% to 12% of the digital marketing we have today to 50% to 60% of the marketing wallet that we have always aspired to take.

These investments will reduce adjusted EBITDA for 2014 as compared to what we delivered in 2013 to our guidance of $23 million to $27 million. But they position us for accelerated revenue growth and expanded adjusted EBITDA margins in 2015 and beyond. We are confident we are doing what needs to be done to deliver strong growth and profitability over the next several years. While the CEO search is ongoing, the management team recommended a path of immediate action. The board agrees strongly that this transition greatly improves the probability and accelerates the timeline of our success.

Our technology platforms have long generated very high-quality traffic to our client websites. Our evolution is to shift to what our clients need and want, which is an integrated set of platform services to take that traffic and turn it into leads and to turn those leads into new customers, the lifeblood of the SMBs we serve around the world.

Thanks for your attention. I'll now turn the call over to Josh for more details on the transformation of our technology and distribution organizations.

Joshua Claman

Thank you, David. Now that David has laid out the main pillars of our strategic plan, I'll give you some data and details on how these translate to specific fiscal year '14 actions. I'll start out by saying that we have a great set of assets at ReachLocal. As we reflect on our 10-year history, we have surpassed the $0.5 billion run rate, we have a presence in 5 continents and we believe that we have the best SEM platform in the market. This is validated by our recent Google award for Premier SMB Partner for best quality accounts, directly reflecting on the value we offer our clients.

The market is growing quickly and is extremely fragmented. There are huge opportunities ahead for ReachLocal. Our approach for the future is comprised of 2 main areas of activity. The first is streamlining our operations, setting a foundation for margin expansion and scaling. The second is product innovation, addressing the constant challenge of our clients to acquire and retain new customers. We do this through world-leading technology delivering optimized and measurable results.

Let's address the operational opportunity first. Historically, we have delivered strong growth with our original IMC model. So we needed to shift the model to counter the slow results in North America the last few years. North American IMC productivity has consistently been lower than that of our international regions. As I outlined in my presentation at our Analyst Day last February, in my experience at managing and building large sales forces around the world, the structure of the sales force does matter. Based on this experience, we aligned the North American sales team into 2 specialist groups, those that acquire new clients and those that manage and continue to look for ways of adding increased value to ongoing clients.

The specialization improves the effectiveness of both roles. Within these roles, we're advancing technologies which will further enhance their performance, state-of-the-art prospecting and lead nurturing for the sales executive and cross-sell, upsell tools for the account executive.

The other advancement we've made was to introduce a go-to market model that includes both inside and outside or feet-on-the-street sales. We ended 2013 with 90 inside salespeople. And we will continue this aggressive investment and expand to both Europe and Asia within 2014.

As part of that exercise, due to reengineering of processes centered around client value, we also recently reduced headcount open [ph] positions by approximately 100 in our U.S. operations, which, with some real estate footprint adjustments, will result in over $9 million of annual run rate savings. We believe that we have a positive impact on our delivery of value to our clients and our expense structure as we underpin more of what we do with automation.

These moves will generate higher productivity, OpEx scaling and better market coverage. We will also be better equipped to tune our cost of acquisition to specific client segments and better direct our sales forces' activity. We strongly believe that this will allow us to enable our sales organization to effectively sell our integrated solution and reignite North American sales. However, in the near term, the transition itself negatively impacted productivity, causing a disruption that impacts our Q4 results and our expectations for the first part of 2014.

We expect that impact in the first 2 quarters to be roughly $20 million in revenue and $11 million in cost, or $3 million in cost net of the savings from the headcount and real estate reductions.

Having provided that background, I'll draw your attention to a couple of areas [indiscernible] for us. The first is stabilizing the new sales structure in Q1 and assuring that the sales team begins to gain momentum in the new model. So far, the initial signs are positive. New client acquisitions per FE are on target and above Q4. The AEs are upselling and cross-selling on target and above Q4 as well. And the aggregate performance of our inside team is bearing out our hypothesis that inside sales is better able to exploit smaller markets. So the key measures of success for the new structure are heading in the right direction.

Secondly, as Dave mentioned, international regions have been a reliable source of growth for us over the years. Our plan is to slow our expansion into new markets and instead penetrate the regions in which we are already established and drive yield and margin by leveraging the infrastructure we put in place, expanding our TAM by penetrating those markets more deeply and delivering new products to those markets more rapidly. It is time to aggressively capture opportunities in our international markets to further drive what are already very significant levels of growth and to apply our best practices from all over the globe to help ensure ongoing strong performance.

Continental Europe continues to grow well over 50% per year. Australia continues to gain share. Brazil grew at twice our target in its first year of operations. So there continues to be huge potential internationally.

Now let's address the technology opportunity. We are leaving Q4 and entering Q1 with big ambitions for our new ReachEdge platform. We have filled over 1,200 licenses since our launch in Q4. We launched this offer at a promotional price of $299 per month. We moved to the list price of $399 beginning February 1. Thus far, we have not seen price as a key consideration in the purchase decision, such you see [ph] in our confidence that this is a well-positioned offer for the premium SMB client. Since its launch approximately 50% of ReachEdge clients renew to ReachLocal, and in January, around 50% of our new clients were acquired on the ReachEdge platform. Of those, approximately 40% had ReachSearch attached at point-of-sale and the rest, obviously, become our targeted leads for cross-sells to ReachSearch and our new SEO offers. We firmly believe that a more deeply embedded ReachEdge platform with a multiproduct sale will have, over time, a material impact on our client retention. ReachEdge is an essential part of our strategy. Clients struggle to manage and realize value from multiple discrete products from different vendors. Integrating products into an automated platform that enables them to optimize, measure and manage a variety of lead sources and conversions is a direct answer to a complex need.

We are extremely excited about ReachEdge as not only a product that moves the needle for our clients, but a signal for the transformation of our company using technology and analytics to constantly improve client value. We are launching ReachSEO and ReachSEO Pro this month in North America and will gradually roll it out to our international markets. ReachSEO is available to our ReachEdge customers on a subscription basis. It's available in 2 tiers: ReachSEO Core at $999 per month and ReachSEO Pro at $1,499 per month. It's value proposition to increase organic traffic and leads by boosting ReachEdge websites in search engines, directory sites, maps and social media. This leverage is a powerful ReachEdge reporting of organic visits, calls, chats and forums.

As such, we differentiate from most of the SEO industry as we'll encourage clients to view productivity of SEO in the same way as PPC. It's about the leads, not about the keyword rank. Through our standard solution suite and our realigned sales force, we can offer ReachEdge, ReachSEO, ReachSearch and other products, potentially substantially increasing our typical client's monthly spend.

I'll conclude by saying that we firmly believe that we are on the right path despite the short-term financial impact. The ongoing sales force disruption will impact the first half of this year, but this is about dramatically increasing the effectiveness of our organization, improving delivery to our clients, and putting the right efforts where they drive the most value for our clients in our company. And all of this is underpinned by our transition to a company that delivers even better value to clients through technology. After the first-half transition, we expect Q3 and Q4 to show definitive signs of recovery and growth and profitability beyond our recent levels. And now over to Ross for the financials.

Ross G. Landsbaum

Thanks, Josh. Let's turn to a discussion of our results for the fourth quarter and fiscal year ended December 31, 2013. As a reminder, we have posted on our Investor Relations site a schedule of the prior quarters reflecting the classification of ClubLocal as a discontinued operation. Unless I state otherwise, all comparisons are against the fourth quarter of 2012 restated to reflect the classification of ClubLocal as a discontinued operation. Revenue for the fourth quarter of 2013 was $132.9 million, up 11% or 13% on an FX constant basis.

For the year, revenue grew to $514.1 million, up 13% or 15% on an FX constant basis.

Direct Local revenue for the fourth quarter was $160 million, up 11% or 13% on an FX constant basis point. Direct Local represented 80% of total quarterly revenue, flat year-over-year. For the year, Direct Local revenue was $410.3 million, up 14% or 16% on an FX constant basis. As a percentage of total yearly revenue, Direct Local represented 80% compared to 79% in 2012. As addressed earlier in our call, the realignment of our North American outside Direct Local sales force impacted our sales productivity the last quarter, and caused North American Direct Local revenue in Q4 to decline 5% versus the third quarter. And as we will discuss later on, this will have an impact on the first part of 2014.

Revenue from the NBAR channel grew to $26.9 million in the fourth quarter, up 11% or 13% on an FX constant basis. Revenue from the National Brands grew by 3%. And our Agency and Reseller channel grew by 17%, driven by strength in our international markets and our agency channel in North America.

For the year, revenue from the NBAR channel grew to $103.8 million, up 8% or 10% on an FX constant basis, principally driven by our international markets. Overall, international revenue for the fourth quarter included above grew to $48.3 million, up 34% or 41% on an FX constant basis, driven by growing overall productivity as the IMCs in our international markets continued to mature. And while representing 38% of revenue on an FX constant basis, our combined international, Direct Local and NBAR sales operations delivered 94% of our dollar growth on an FX constant basis.

For the fiscal year, international revenue grew to $172.3 million, up 35% or 41% on an FX constant currency basis. Moving onto key metrics that drive revenue, we ended Q4 with 35,200 Active Campaigns, up 8%; and 23,900 Active Advertisers, up 9%. The number of campaigns or products per an advertiser remained flat at 1.5 and the average quarterly revenue per an advertiser was approximately $5,700, up over the prior year's quarter in spite of the FX headwinds.

Cost of revenue for the quarter was $65.7 million or 49.4% of revenue, essentially flat as a percentage of revenue, although it was impacted by favorable changes in media-buying efficiency and geographic product and service mix, offset by increased service and support costs and a decrease in publisher rebates. Publisher rebates as a percentage of revenue decreased to 4.5% of revenue from 4.7% in Q4 2012, principally as a result of a shift in product mix. We are currently in expansion negotiations with Google, the source of the bulk of our publisher rebates. In the meantime, we mutually extended our North American Google arrangement through June 30.

Sales and marketing expense for the quarter was $46.8 million or 35.2% of revenue compared to 36.6% of revenue in the prior-year quarter. This decrease as a percentage of revenue reflects the effect of continued scaling of our established markets, partially offset by increased cost related to our new international markets and our inside sales expansion. The decrease also reflects a decrease in commission expense as a percent of revenue from 10.7% to 9.7% due to a higher percentage of revenue from our international Direct Local channel, for which we pay lower commission rates.

Underclassmen Expense in Q4 accounted for $13.2 million of total sales and marketing expense, up 15.6%. For the year, Underclassmen Expense accounted for $48.9 million of total sales and marketing expense, an 8.2% increase. Product and technology expenses totaled $5.5 million or 4.1% of revenue and are net of $3.2 million of cost capitalized. This compares to $5.3 million of expenses or 4.4% of revenue, which was net of $2.1 million of costs capitalized in the fourth quarter of 2012. The increase in absolute dollars was primarily attributable to increased headcount related to the ongoing development of ReachEdge and other products and increased amortization expense related to previously capitalized costs.

For the year, product and technology expenses totaled $22.2 million or an increase of 17.2% over 2012. In 2014, we are expecting our organic TMT [ph] spend to increase by approximately 1/3 as we work to execute on the accelerated product development and launch plans discussed earlier in the call.

General and administrative expense for Q4 were $16 million or 12% of revenue, an increase from 8.5% of revenue. As discussed, we recorded a $4.8 million impairment against the amounts due from our Eastern European distributor in the quarter. Also included in G&A this quarter was $1.3 million related to the continued transition of our founding management, of which $0.6 million was incremental stock-based compensation expense. Absent these items, G&A for the quarter would've been $9.8 million or 7.4% of revenue. For the fiscal year, G&A expense was $46.4 million or 9% of revenue compared to $40.4 million or 8.9% of revenue in the prior year. However, excluding the costs of the Oxata impairments and the founding management transition, which totaled $3 million in the year including $1.4 million of incremental stock compensation costs, G&A would've been $38.6 million or 7.1% of revenue as we continue to scale the business against our infrastructure costs.

And with regard to taxes, we have now run profitably in the U.S. for a sufficient period of time, and it was appropriate to remove the valuation allowances against our U.S. Federal and state net operating losses and other tax attributes and assets in the territory. As a result, our tax provision for the quarter includes a $4 million tax benefit. We still have $47.5 million of foreign net operating losses that remain fully reserved. We will be assessing these quarterly based on the specific tax position of each jurisdiction.

Net loss was $0.6 million or $0.02 per diluted share for the quarter versus a net loss of $0.4 million or $0.01 per diluted share for Q4 of 2012. The change between the periods is principally due to increased noncash depreciation, amortization and stock-based compensation expenses, including amounts attributable to our acquisitions and reduced operating performance of the business in the quarter, including the effects of the founding management realignment and the Oxata impairments, partially offset by a net income tax benefit of $2.6 million versus income tax expense of $0.4 million.

Non-GAAP net income for the quarter was $1.6 million or $0.05 per diluted share versus non-GAAP net income of $4.5 million or $0.15 per diluted share. For the fiscal year, non-GAAP net income was $11.9 million or $0.41 per diluted share versus non-GAAP net income of $17.4 million or $0.60 per diluted share. As above, our non-GAAP net income was negatively impacted by the Oxata impairments, management transition and increased D&A.

For Q4, we reported adjusted EBITDA of $6 million or 4.5% of revenue, down from $7.8 million or 6.5% of revenue. However, if we exclude the impact of the Oxata impairments, adjusted EBITDA would be $10.9 million or 8.2% of revenue for the quarter. For the year, we reported adjusted EBITDA of $32.8 million or 6.4% of revenue, up from $28.1 million or 6.2% of revenue. Keep in mind that the adjusted EBITDA for FY '13 includes the costs related to Oxata and the management transition.

In the fourth quarter, net cash from continuing operating activities was $1.5 million compared with net cash from continuing operations of $12.1 million from the prior-year period. As you recall, in the third quarter, operating cash flow benefited from the favorable timing difference in accounts payable as a result of the delayed payment to a vendor. That delayed payment reversed in the fourth quarter. For the fiscal year, net cash from continuing operating activities was $30.7 million compared with net cash from continuing operations of $46.6 million for the prior year. This decrease is principally due to an increase in clients trading invoice and as we saw our accounts receivable balance nearly double to $10.2 million and a lower increase in deferred revenue, in part due to the lower North American activity in Q4 discussed earlier on the call.

In 2013, capital spending, including technology spend discussed above, but excluding acquisitions, was $19.7 million. During the quarter, we made no stock purchases under our repurchase program. However, over the course of the year, we purchased 1,394,000 shares of our stock using $19 million of the $47 million repurchase program. And we ended the year with 28,259,000 shares outstanding. We finished the year with cash and cash equivalents and short-term investment totaling $79.7 million.

Now let's turn to our guidance. As mentioned earlier in the call and in our press release, we are realigning our North American sales force while increasing investment in key areas as we seek to expand our TAM by accelerating product development and further understand [ph] our international growth. The sales force reorg will continue to be a drag on North American revenue for the first half of the year, and the increased investment is causing a significant reduction in our expected adjusted EBITDA for the year. We expect to take a restructuring charge in the first quarter of 2014 related to the workforce reduction and reciting [ph] some of our North American real state footprint that transpired in the first part of FY '14 in the range of $1.5 million to $2.5 million that will deliver in excess of $9 million in OpEx savings in FY '14.

Therefore, for Q1 2014, we expect revenue in the range of $124 million to $126 million. Driving this guidance is the year-over-year decline in North American revenue of 4% to 6%, reflecting the transitory impact of the sales force realignment, offset by expected continued growth in our international markets.

Adjusted EBITDA in the range of $250,000 to $750,000, reflecting the increased investment we discussed and the lower revenue productivity in North America during the quarter.

For fiscal 2014, we expect revenue in the range of $580 million to $600 million, reflecting the normalization and acceleration of the business as we move beyond the first half of the year, and adjusted EBITDA in the range of $23 million to $27 million. For 2014, we are expecting capital spending on a similar basis to a range between $36 million and $38 million to fund the investments outlined earlier in this call. Significant changes in our sales model have made the way we have traditionally reported IMC accounts much less relevant to our business in 2014 and beyond. Therefore, we will no longer be providing IMC guidance or Underclassmen Expense metrics going forward. Over the course of 2014, we intend to provide other metrics that will allow investors to understand our progress as we move through 2014 starting in our Q1 call.

After working through changes to our model this year, we believe that the shift toward a more technology-focused company with a reorganized sales force and a strong global presence will result in accelerating growth in 2015. With this product and execution focus and an overriding goal to deliver for our clients, we believe we will exit 2014 with a Q4 revenue run rate and adjusted EBITDA margin that moves us toward our goal for 2015 of revenue growth in the range of 15% to 20% and adjusted EBITDA margins between 8% and 10%.

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

Question-and-Answer Session

Operator

We'll take our first question from the line of Douglas Anmuth with JPMorgan.

Diana R. Kluger - JP Morgan Chase & Co, Research Division

This is Diana Kluger on for Doug. I just wanted to get a little bit of a macro sense from you guys on how the quarter went with SMBs, how they're feeling and just a little bit more sense on where the ideal split for you guys, whether it's in North America versus international on the relationship building type of sales force for new customer acquisitions?

Joshua Claman

Diane, it's Josh. Tell me if I didn't understand your question correctly, but I think from a macro sense, we've seen Q4 be similar to the other quarters in the year. We haven't seen the macro environment depress or help our results either way. It's been fairly neutral. In terms of the second part of your question, if I understood it correctly, the sales force structure throughout the world is going to be fairly similar. So we're kind of aligning all of the countries around this common theme of hunters or acquirers that specialize in that and are measured off of that and what we call account executives who basically form or nurture a book of clients, and they're measured on cross-sell and upselling those clients. The reason we're excited about this is, one, performance management is much clearer. Specialization adds a huge value to a sales force. They know what they do when they get up in the morning. They know what their day looks like. They know their week looks like. And they know what they're measured on. Many of our international markets are already on this structure. So they already formed this structure basically around a hunter-farmer model with a [indiscernible] of specialization. The only exception to that is Europe, which is really on the traditional IMC model. And you'll see us migrate over that -- off of that gradually over the next few quarters. But in no market internationally do we expect a wholesale change in the sales structure or the disruption that we've seen in Q4.

Diana R. Kluger - JP Morgan Chase & Co, Research Division

Got it. And what exactly is that split between the 2 groups, whether it's a rough guesstimate or what the idea will be?

Joshua Claman

You mean in terms of numbers?

Diana R. Kluger - JP Morgan Chase & Co, Research Division

What percentage of the sales force will be the hunter versus gatherer as you were talking about?

Joshua Claman

Yes, we think it's going to balance out at about a 1/3 hunters and the rest are managers of books [ph]. The way the metrics flow through the structure, if our hunters ramp up to what we expect them to, and I think that's a -- we had a reasonable expectation of that. So [ph] half of accounts over to the account executives who will then upsell them. We obviously have ratios of account exec to client estimates. And we're fairly confident in those estimates, about 1/3 to 2/3.

Operator

And our next question is from the line of George Sutton with Craig-Hallum.

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

I appreciate that you feel that the back half of '14 and beyond should start to see the impacts, the positive impacts of these changes. I'm curious, how are you going to be viewing things in the first half of this year to give you an indication that these changes are working? What kinds of things should we be focused on as a result?

Joshua Claman

Let me take that, and then maybe Ross has a couple of comments. We're already looking, you can imagine, under the covers and looking for indicators within our metrics that things are going in the right direction. So instead of the IMC economics that I think you're all used to, we're moving to what are far more widespread and far more traditional measures of sales force efficiency and effectiveness, productivity, ARPU, number of products per client, and of course, the number of clients that an SE would acquire every month. So we're going to be looking at these leading indicators very closely. What we share with you over time will be measures that we both find relevant to judge the progress of our business and that you will find material in doing the same. So we do plan on being transparent, but we don't want to overload you with metrics. I will say that some of the indicators thus far are positive. So we had a ramp of SE productivity in terms of new client acquisition, and our SEs are basically tracking to that ramp, which is about 20% ahead of Q4 and about back to Q3 levels. So we're fairly encouraged about that. The dollars that are upsold and cross-sold by AE, again, are tracking to plan. Our inside sales force in aggregate is tracking to our targets. So we are -- right now, I'll characterize it as we're sort of seeing that the seeds are germinating, and we're very optimistic as we see some green shoots. I think when we exit Q1 and about midway through Q2, we'll start seeing some green shoots and we'll know in more definitive terms whether this realignment has taken hold. But again, we -- our confidence is very, very high in this. And the energy in the field is very, very high with this realignment.

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

You've obviously -- you're making a lot of changes with an interim CEO. And I'm curious as you're out in the market looking for a full-time CEO, what's the -- how does this get impacted? Obviously, when you're making these kinds of changes, anybody from the outside will be looking for some clear indication that things have leveled off. If you can just help us with the timing and thought process there?

David Scott Carlick

Carlick here, interim CEO or from the CEO temps agency at -- down the street. We felt, and the board strongly agreed, that we needed to be aggressive, taking the company where it needs to go and do what needs to be done now. And we're doing all this with the intention that any CEO candidate who is taking a look at what we're doing would go, that's the right steps to be taking. That's the kind of company I want to join.

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

Okay. Lastly, Ross, you mentioned real quickly the Eastern European distributor issue. Could you just -- could you spend a little time on that in terms of what is exactly is happening there?

Ross G. Landsbaum

Sure, George. So -- and you may recall, we did a franchise agreement with this distributor about 1.5 years ago. It's the only one that we've ever done. We have over 600 distributors. We did something unique here, which we actually lent them a little bit of money to try and leverage our balance sheet a little bit and assist them in accelerating their business. And unfortunately, they just went -- some of the markets they went into just really wouldn't support their model. And quite frankly, they didn't run their business to the nature of, I think, the markets they were in. And the amounts due from them are just not recoverable, and we needed to take the impairment at the end of the fourth quarter. And it's something -- they went south relatively quickly on us, and it's unfortunate.

Operator

And our next question's from the line of Gene Munster with Piper Jaffray.

Charles Eugene Munster - Piper Jaffray Companies, Research Division

A question in terms of the mix between inside sales people and kind of feet-on-the-street versus inside. And the -- are the hunter -- are the gatherers the inside salespeople, did I get that right, at the -- and was that kind of the breakdown or can you kind of recap just big picture, how you see the mix, inside versus feet-on-the-street? And a couple of follow-ups.

Joshua Claman

Yes, let me just kind of frame this for you a little bit. So we have an inside sales force that we started at the beginning of FY '13. We've aggressively invested in that sales force and we have an outside sales force or feet-on-the-street, that was our traditional IMC model. On the outside, we broke in those IMCs into 2 categories, the hunters and the farmers. I don't particularly like that term, but it's fairly descriptive. And again, that's about a 1/3-2/3 ratio. The inside sales team really mimics that. So we have centralized or sort of call center-based hunters, which are, we call them inside SEs, and we have centralized AEs, which we call inside AEs. And so the ratios are largely [ph] the same. We have about 90 -- the total group of AEs and SEs on the inside equal about 90 people force exiting FY '13. We're going to continue to aggressively grow inside sales. In fact, we're going to grow inside sales disproportionately to outside in North America. The reason for that is that we're seeing the ramp of productivity, the new accounts acquired, the quality of accounts do very, very well. It's exceeding our initial expectations, and we were targeting them primarily on cities that we do not have local offices. So we've managed to both lower our calls to acquire new clients and also to cover more of the regional markets, which were largely uncovered previously.

Charles Eugene Munster - Piper Jaffray Companies, Research Division

Okay. And then how about the mix of inside versus -- just rough numbers, you said you're growing inside disproportionately faster. Should we think of this a year from now as 1/3 inside, 2/3 outside or 50-50, any just big picture, just strategic kind of how you're planning for that?

Ross G. Landsbaum

It's Ross. I guess what I would sit here and tell you is that while we're looking to continue to grow inside sales, it's still going to be disproportionately small of our total sales organization. So if you look at this year, we ended with near 1,000 people. We had 90 in inside -- which 90 were in inside sales. We're going to continue to hire and grow that and also expand inside sales in Europe and Asia. But it's still going to be a relatively small portion of our total sales force size, although one that we think is going to be very productive for us.

Charles Eugene Munster - Piper Jaffray Companies, Research Division

Okay. And then can you -- that's helpful. Then just in terms of ReachEdge, you -- can you repeat what the renewal rate was on ReachEdge?

Ross G. Landsbaum

So we haven't actually gotten the renewal rate. We've sold initially north of 1,200 units. Keep in mind, it's only been in the market since September. So we haven't -- it's a product that actually sells. It's a subscription product that has a minimum 6-month term and then it goes auto renew after that. So we don't really have anything in the way of any kind of long-term retention or retention data to really share at this time.

Joshua Claman

Yes, let me just comment on that. Too early to tell. We don't have the data because it's been in the market not long enough. But if you think about a couple of key drivers for client retention, one is how embedded the product is in their business processes. And ReachEdge is designed as an automated platform for digital marketing to be very embedded in the processes of our SMB clients. The other big determinant, the factor that has a very high correlation with retention is how many products you're selling to that client. In other words, how dependent that client really is on your offerings. And you can imagine with ReachEdge out there, and we then launched ReachSEO, and we were only selling ReachSEO to clients that have ReachEdge, and there's a reason for that. The reason is that we're judging our success, our value to clients on SEO not by a page rank, but by the number of leads we generate for that client. So the typical client, I think over time, will have ReachEdge. They'll have Reach SEM. They'll have ReachSEO. And then they'll have a variety of peripheral offers retargeting in chat. So our ARPU per client, but also that retention curve will be fundamentally changed, I think, going forward. So too early, we don't have the proof points of that yet, but we're incredibly encouraged by what we're seeing. And one more point I'll make on ReachEdge is obviously when we design products, we design them to add value to the business of that SMB and the before and after studies we've done in each [ph] sample size, so the number of sites that have been provisioned and been up and running for long enough is still relatively small. But in that sample size, we see a material lift in how their prospective customers engage with their websites. So again, very encouraged by that because I think that, of course -- that value will drive that retention curve as well.

Charles Eugene Munster - Piper Jaffray Companies, Research Division

And just my last question, just in terms of kind of revenue per PMP [ph] and revenue per advertiser. You said it's kind of -- fundamentally changed [ph]. It's been growing. This kind of new world order on new products, is it going to be going up? Is that the idea? And just to be clear on that, you'd see that trending higher? And at what point do you see it continuing to trend higher? Is it kind of back half of the year? Any thoughts on that?

Joshua Claman

I think what I would say is that obviously, our -- the opportunity here is to -- with our expanded TAM and being able to really cover the needs that our clients are already spending wallet share on today, our expectation is that we have an opportunity to lift wallet share. Now keep in mind, we have 6,000-odd customers and clients today. It's going to be a while before we see any mass penetration. And if you look at Edge at $399 per month averaged out over our base, it's going to be a while before it generally lifts the average ARPU. But we would obviously expect to certainly see visibility to that next year. And I think we'll start to see some improvement over time, but I think it's something over time as penetration increases. But obviously, our goal here is, they're already spending wallet on this. We've improved and increased our TAM to be able to sell into that wallet. And that would lead us to believe, obviously, that we should be able to get ARPU [ph] gain share.

David Scott Carlick

Yes, let me just emphasize that point. If you look at sort of a pie chart of digital marketing spend, we -- our legacy was basically or primarily SEM. SEM amounts to about 12% of that total pie of digital spend. When we include our Edge and what [indiscernible] Edge includes plus SEO, suddenly we've more than tripled the addressable market for our client. So if you think about a distribution system around the world, we have IMCs and SEs and AEs around the world that are -- have -- until about 4 months ago, had sold primarily SEM. So 12% of the wallet share of those clients, so now they can be a conduit for over 50% of the addressable market. So a big increase in the addressable market. And we think that's going to flow over time into productivity and our ARPU [ph] or average revenue per client.

Operator

And our next question is from the line of Todd Van Fleet with First Analysis.

Todd Van Fleet - First Analysis Securities Corporation, Research Division

I'm just trying to understand what you're saying in terms of the first-half outlook in the context of how you kind of ended 2013 with respect to Upperclassmen and Underclassmen. And I understand that those definitions might not be as relevant moving forward. But if I think about the fact that you ended 2013 or Q4 had a higher Underclassmen amount -- figure than you originally expected, the Upperclassmen amount was a little bit below what you had originally expected. I'm just trying to think about what those 2 numbers or what's kind of the equivalent of those 2 numbers kind of moving forward, again, recognizing what you've said. Just trying to get an understanding in the business about these Upperclassmen that are attritting, are these -- because the Underclassmen amount just seems to be going up. Again, I'm just trying to understand who's working their way out of the process here in terms of sales? And then -- sorry, that's the first half of that question. The second half, I guess, would be just understanding in the kind of the hunter-gatherer vernacular, how do we think about that in the context of where you ended 2013? So were the 442 Upperclassmen hunters? I mean, how are you thinking about segmenting that and bridging this from the old versus the new vernacular?

David Scott Carlick

Yes, thank you, Todd. Let me give a couple of comments first, and then I'll pass it over to Ross as well. So there is a challenge, I think, in translating the IMC role in -- from the past into the future. And I think it's just something we're all going to have to face. So the IMC was a generalist role. We've been fairly open, just to back up a little bit, we've been fairly open over the last few quarters that our North American growth curve has been declining quarter after quarter. It's been a real problem for us. And we realized that the problem is less about externalities and less about competition and more about the structure of our sales force and how much bandwidth, how much focus we can drive through that sales force. So if we take a given number of SEs and a given number of AEs, the way we would compare the results, are the SEs more productive in acquiring new accounts than the total population was in the previous period? Now our metrics that were at our targets are obviously set above that. And that's why when I mentioned before that we're encouraged by some initial results, that's what I was referring to. So the SEs, over just the first few weeks of the program, are acquiring what we need them to acquire as part of their ramp. So we're going to have to translate the IMC, the old IMC model to the new model in terms of some key metrics. And we need to work through that a little bit, too, and decide what's most relevant to share with all of you and what's most material to the business. In terms of the -- I'm sorry, could you repeat [ph] the hunter-gatherer question?

Todd Van Fleet - First Analysis Securities Corporation, Research Division

Yes, yes. So I was just trying to -- you said 1/3-2/3 was -- it's easy [ph] to get our minds around that distinction. I was just trying to think about, okay, well, what does that mean in the context for the way you report these figures for sales historically in terms of Upperclassmen, Underclassmen? If you could elaborate on that.

Joshua Claman

Yes, we won't -- and I think you hit on another issue, too, when you asked the question. Again, we won't be reporting on IMCs and Upperclassmen and Underclassmen. And that was a distinction that was kind of uniquely relevant to that model. And it's kind of lost its relevance very, very quickly as we've transitioned. The way we chose -- the way we broke out, which I think you were hinting at before, the way we broke out the hunters and the farmers or the gatherers was we used data essentially. We used past performance, how many accounts do they acquire, how effective were they at upselling and cross-selling. And we categorized every person in the organization and split them based on that categorization, which was based on data. There was about 10% of the population that was good at both roles, and we sort of gave them the choice or decided based on bandwidth required for that office. But I hope that answer your question, Todd.

Ross G. Landsbaum

Todd, and this is Ross, maybe a couple of other things to help you understand. So if you look at that, the mix of people that we had, and most of the Upperclassmen growth we saw at the end of the year was really around our international markets. So as we go forward, the North American group, that's in outside sales was effectively going to be probably stable from a headcount perspective this year. We've obviously migrated some people into different roles, as Josh has taken you through. But we're not looking to dramatically grow the outside sales organization in the U.S. this year. It's going to be relatively constant. We are going to be investing in inside sales in North America this year and continue to grow that headcount. And where the bulk of our headcount growth is going to be next year is actually in the international markets. So we grew our headcount in the sales and service organization internationally a little bit north of 20% last year. We're actually going to increase that this year and grow that a little bit more than 30%, 1/3 year-over-year in '14 over '13. International has been obviously a big driver for us. We're in these very large markets where we have a lot of opportunity to penetrate, and we continue to see our opportunity to be able to have that high 30% annual growth in the international markets. And we're going to continue to penetrate and grow out those markets and build market share there.

Todd Van Fleet - First Analysis Securities Corporation, Research Division

Okay, great. Well, just 2 quick ones because I'll follow up with you offline. But I guess the prior questions were really intended to get at your level of comfort that in terms of the attrition level that we'll see kind of into the first half of this year because you've adequately and accurately classified folks in the different categories. But as I said, I'll follow up offline. Second, I guess 2 quick ones, Ross. One is the publisher rebate, sorry if you already gave that, but the publisher rebate in Q4. And then if you have a pro forma EPS figure in the quarter that strips out -- you gave us a $10.9 million adjusted EBITDA. Is there an equivalent? How should I think about the equivalent EPS in the quarter excluding those charges?

Ross G. Landsbaum

Okay. The rebate was 4.5% in the quarter. And we could come up with a pro forma EBITDA number. But if you take out the $4.8 million, it was about $4.8 million and then the management charges. I can work up a number for you. I don't necessarily want to do it live for you right now, but we can figure out a number to help you understand what the impact was.

Operator

And our next question is from the line of Kerry Rice with Needham & Company.

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

Actually to just dovetail exactly what the last point of the last question was, your confidence level around that attrition. As these salespeople transition to either an AE or an SE, how comfortable are you that there won't be an additional fallout that would drive sales down more than you're expecting? Is there some buy-in that they'll be there for the year? Or -- and have the changes already occurred? If you can just talk about that a little bit more?

David Scott Carlick

So Kerry, I'm going to just give a simple answer, and then I'm going to let Josh speak about it. But the practical issue is that we actually have assumed in our modeling some accelerated dislocation that would happen over that period of time than what we would normally expect. So we've done a fair bit of analysis on normal, obviously, IMC retention rates. And we've made some assumptions about what downside cases could look like. And we've included that in our expected guidance.

Joshua Claman

So we -- yes, just a comment on sort of the feel of the team right now and the atmosphere out there, which, by the way, informs our level of confidence. I think the IMC model had its sort of success in the past. I think it's, again, we're obviously attributing a lot of the slowness in North America on that model. And I think the dynamics of that are fairly obvious. If you're managing a book and you're trying to hunt, you're just out of bandwidth. But the other side of that on that for the people was that they were stressed out. I mean, you are trying to manage a book of business. You're managing and overseeing performance of various campaigns and various offers. You're trying to keep those customer relationships intact. And you're being told by your management that you need to hunt and acquire. And what we've seen -- probably [ph], we spent a lot of time on compensation and making sure that people could transition very easily, and it was even sort of compelling for them to transition to one of the specialist roles. But also, we saw that there was, amongst a lot of the population, sort of a sigh of relief. I'm good at nurturing accounts and good at cross-selling, and that's what I'm going to do now. Or I'm good at hunting. I love the chase. I love the gratification of acquiring a new client and ringing the bell. And that's what I can focus on. So I think, again, I don't think this lesson is unique to ReachLocal. I think a lot of companies have found it. But specialization adds both to effectiveness and to satisfaction of the associate.

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

Is there a lot of training that, whether -- either way, if they're going from one group to the other, is there a certain amount of time that they've got to get through training and then ramping up? Or it's just like you said, that that's what they were good at, so that's where they were put in. So there's no group they were put in? So there's no additional training that they're going through per se?

Joshua Claman

Yes, I think, well, there was additional training on processes, et cetera. And obviously, we're launching new products. So there's been Edge training. There will be SEO training ongoing over the next few weeks. So that training will continue. But I think from the early numbers that we've seen that the people have kind of come back from their Christmas and New Year's holidays, found a desk and started working. And the first couple of weeks were slower, and then they really caught their stride. And we ended January with, again, sort of the nontarget performance, which we found encouraging. So a lot of past experience is being brought into these roles as well.

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

Okay. Last question, just as it relates to expansion. You talked a lot about kind of going deeper in your international markets that you're already in. You launched Mexico, which was going to be your only major expansion for 2014. Is there any -- the reason for the slowdown other than just focusing a little bit more on your international -- the existing markets, is there anything changing with your relationship with Google because at one point, these rebates and Google kind of was kind of pushing for this international expansion. Has anything changed there? You mentioned you're negotiating with them. Is that another reason for the pullback in kind of international expansion?

Ross G. Landsbaum

Kerry, this is Ross. No, I think the practical issue is I think they understand, as we understand that Germany and Japan and Brazil are just huge markets. And you can have a choice. You can spread and be thin in a lot of beachheads or you can be really aggressive about building market share and solid positions in markets. And I think that's the right focus for us, and I think Google appreciates that as well.

Joshua Claman

Yes, I think if you think about the size of some of the markets we're in, Germany is the fourth largest GDP in the world, Japan is the [indiscernible]. We're tiny in these markets. We have had robust growth. We see that growth continuing. We're going to double down on headcount investments in those markets. We're going to increase our population by about 1/3 in FY '14. And we expect that growth to continue, and not just for next year. When you think about the size of the advertising spend and the digital marketing spend in these markets and you think about our introduction of new products into the portfolio of these international markets where essentially in the past, we've just had SEM, it gets very exciting very quickly. And so we're not calling it up, but certainly, except for some FX headwind, there's -- we're certainly not at all, and we don't mean to hint that we see a slowdown internationally because we simply -- we are more excited than ever about the opportunity there.

Operator

And our final question is from the line of Nat Schindler with Bank of America Merrill Lynch.

Jason Mitchell - BofA Merrill Lynch, Research Division

This is Jason Mitchell here for Nat. I guess I have 2 questions. First, maybe I missed it, but do you have any kind of update on the Yelp partnership in your ReachCommerce platform? And then my second question is, I guess, you've kind of answered this a little bit, but as we look into the second half of 2014, do you see the bulk of that accelerating revenue growth coming out of North America or kind of split between internationally? And if it is a good portion from international, what regions do you see in driving that growth?

Ross G. Landsbaum

This is Ross. Let me go to both of those. So obviously, our Commerce product is, as we said, we're still in beta right now. We're continuing to work with Yelp engineering and our engineering to move forward on the API integration. I mean, the Commerce product because it still is in beta, is not -- informing our guidance [ph] right now. We're not really giving much value to it in our revenue guide until the product comes out of beta. With respect to our guidance for the back half of the year, it's almost -- it's mostly driven, quite frankly, by our international markets and some -- the continued growth of inside sales in North America. We're assuming some improved performance from the Direct Local side, but it's more of a return to a kind of normalized sustainable model than a growth acceleration model. Towards the end of the year, it starts to accelerate a little bit, but it's a pretty modest part of our growth. And as far as which territories are driving the incremental revenue in the international market, it's really broadly against all of our markets. I mean, whether it's Australia, which is our largest international market and around 16% revenue, it's still a very significant grower for us. And if you look at Continental Europe at over 50%, as well as Japan and Brazil are growing significantly better than that. So I think we see a lot of growth coming from all of the territories. It's fairly evenly balanced throughout the international markets.

Operator

Thank you. And ladies and gentlemen, this concludes our conference. Thank you for your participation. You may now disconnect.

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