Web.com Group's (WWWW) CEO David Brown on Q2 2014 Results - Earnings Call Transcript

| About: Web.com Group, (WEB)

Web.com Group (WWWW) Q2 2014 Earnings Call July 31, 2014 5:00 PM ET

Executives

Jenny R. Kobin - Vice President of Investor Relations

David L. Brown - Chairman, Chief Executive Officer and President

Kevin M. Carney - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Analysts

Walter H. Pritchard - Citigroup Inc, Research Division

Matthew Thornton - SunTrust Robinson Humphrey, Inc., Research Division

Sterling P. Auty - JP Morgan Chase & Co, Research Division

Samad Samana - FBR Capital Markets & Co., Research Division

Gray Powell - Wells Fargo Securities, LLC, Research Division

Rohit Kulkarni - RBC Capital Markets, LLC, Research Division

Tim Klasell - Northland Capital Markets, Research Division

Hamed Khorsand - BWS Financial Inc.

Lloyd Walmsley - Deutsche Bank AG, Research Division

Sameet Sinha - B. Riley Caris, Research Division

Mitchell O. Bartlett - Craig-Hallum Capital Group LLC, Research Division

Operator

Greetings, ladies and gentlemen, and welcome to the Web.com Second Quarter 2014 Earnings Conference Call. [Operator Instructions] As a reminder this conference is being recorded. It is now my pleasure to introduce your host, Ms. Jenny Kobin, VP of Investor Relations. Please go ahead, Ms. Kobin.

Jenny R. Kobin

Thank you. Good afternoon, and thank you for joining us today to review Web.com's second quarter 2014 financial results. With me on the call today are David Brown, Chairman and CEO; and Kevin Carney, Chief Financial Officer. After prepared remarks, we will open up the call to a question-and-answer session.

In the Investor Relations section of our website, we have provided our financial summary slide presentation, which is intended to follow our prepared remarks and provides a reconciliation of differences between GAAP and non-GAAP financial measures. Please note that our remarks today contain forward-looking statements. The words expect, believe, will, going, begin, be, plan, continue and similar expressions are intended to identify forward-looking statements. These statements are based solely on our current expectations, and there are risks and uncertainties that can cause actual results and the timing of such results to differ materially from those projected in the forward-looking statements. Please refer to our filings with the SEC and the risk factors contained therein, including our quarterly report on Form 10-Q for the quarter ended March 31, 2014, for more information on these risks and uncertainties and our limitations that apply to our forward-looking statements. Web.com expressly disclaim any obligations or undertaking to release publicly any updates or revisions to any forward-looking statements made herein.

With that, I would like to turn the call over to our Chairman and CEO, David Brown. David?

David L. Brown

Thank you, Jenny, and thank you all for joining us on the call. In our prepared remarks this afternoon, I will discuss our second quarter business highlights and financial performance, address the strength of our competitive differentiation and provide an overview of today's acquisition announcement. Then Kevin will provide a detailed review of the second quarter and our guidance for the full year and third quarter of 2014.

During the second quarter, Web.com generated double-digit revenue, EPS and cash flow growth compared to the year-ago quarter. We drove strong subscriber additions, expanded ARPU and continued to delever the balance sheet. During the quarter, we also continued making investments to drive future revenue growth. We launched a targeted initiative to increase our growth in the Canadian market, enhanced our product offering with a next-generation website builder platform and continued our investment in building a local direct sales force in the U.S. Importantly, our second quarter results indicate our ability to generate best-in-class profit margins, while continuing to invest to drive additional growth.

While we were pleased that our business generated over 200 basis points of revenue growth acceleration year-over-year and that we achieved our expected earnings for the second quarter, we were disappointed to not achieve our expected revenue. Strong revenue growth in our core value-added services contributed to growth going from 7.9% in the second quarter last year to 10.1% in the second quarter of 2014. However, timing issues, and lower-than-projected levels of improvement, and underlying drivers, such as staff headcount and conversion rates, prevented us from reaching our higher-level goals for the quarter, and this impacts our view for the year as well.

Let me address how we are moving forward from an operating perspective to build on our success and drive further improvements that we are confident can be achieved. There are 2 focus areas on the revenue side.

First, we are prioritizing and adding resources in the areas of our business that will drive strong, higher-margin growth, including areas such as enhanced solutions for large or small businesses, reseller and franchise relationships and international expansion.

Second, we have made a strategic decision to discontinue handling various national accounts, which is a legacy, nonstrategic business that was primarily inherited from Network Solutions. Unlike Web.com's core business, these national accounts represent a small number of larger deals that have shorter duration periods than our typical customers. They are hard to predict and have a much lower margin profile than our core business that is focused on serving the fragmented small business market directly. Over the past year, these accounts have totaled an average of about $5 million in revenue per quarter, with a small amount of variability. These national accounts are a very small component of our overall business, but our decision to move away from these accounts will reduce our total revenue growth for the year, which Kevin will review shortly. We are always balancing revenue growth with profitability for the best long-term benefit, and we believe it is the right move to focus all of our attention and resources on core growth initiatives.

On the expense side, we plan to continue investing in our strategic growth initiatives, but we will also look to continually reduce costs in areas that won't impact the core business, in order to maintain our targeted EBITDA and profitability margins. The targeted savings are primarily related to reductions in headcount additions, discretionary branding funds and management incentive compensation. In terms of the underlying market opportunity, we continue to expect growing demand by small businesses for our solutions, as they shift their marketing spend online. We see customers embracing the need to change how they reach customers in today's fragmented marketing environment. Our broad suite of do-it-for-me and do-it-yourself services and solutions can help modernize their customer outreach efforts.

Over the last several years, we have a track record of delivering increased revenue growth. We've been able to expand revenue from the 8% to 9% range in 2013 and expect 9% to 10% in 2014, excluding the impact of the legacy national accounts. We believe, the secular drivers and our unique highly differentiated set of services and solutions will position Web.com to ultimately achieve revenue growth in the low teens range and earnings growth of mid-teens to 20%. As such, our goal in this area remains unchanged.

Looking at our summary results for the second quarter, non-GAAP revenue was $144.7 million, which was below our guidance range, but still represented year-over-year growth of approximately 10%. In terms of profitability, we again delivered a strong quarter of earnings. Non-GAAP net income was $33.6 million, a 27% increase from last year. This led to non-GAAP earnings per diluted share of $0.62, which was at the high end of our guidance, and a 22% increase on a year-over-year basis. We generated adjusted EBITDA of $41.8 million, yielding a 29% margin, and operating cash flow of $37.1 million, an 11% increase from the year-ago quarter.

During the second quarter, ARPU grew $0.14 to $14.89. ARPU growth is driven by our ability to cross-sell value-added Internet services to our growing subscriber base, and we continue to see positive trends from these offerings, including do-it-for-me websites, lead generation and social media, among others.

Another key driver in our ability to deliver revenue growth is increasing our subscriber base. We had a strong second quarter with approximately 38,500 net new subscribers, bringing our total subscriber base to 3,210,000. This was above our targeted range of 25,000 to 30,000 net subscribers and was driven by a combination of new domain name customers and new value-added services customers.

We are pleased with our continued success in driving significant net customer adds across our product portfolio, which speaks to the effectiveness of our marketing efforts. However, as we've consistently said, our primary focus is on deploying incremental marketing dollars to generate the most additional revenue growth, while maintaining our current levels of profitability. And we continue to believe driving greater adoption of our higher-priced, value-added services is the best way to achieve this goal.

Another key to the predictability and sustainability of our growth is our monthly customer retention rate, which continues to remain at a best-in-class rate of 99%. Our customer support is a highly differentiated part of the Web.com model and is a key driver of our customer satisfaction and low churn rates. One of the ways we can maintain low churn is by continually improving our solutions. A prime example of this occurred during the second quarter in which we introduced our new website builder that offers the do-it-yourself customer a premier experience in designing an effective and attractive website. This is ideal for small businesses that need a cost-effective and simple-to-use solution.

Our do-it-yourself users will now have access to a flexible HTML 5 drag-and-drop capabilities, modern design templates, upgraded photographs in our image gallery, and social media integration. Our differentiated offerings include 24/7 customer support and professionally-written copy that is search engine-optimized in target-specific industries. This can help customers combat initial writers' block. We began the roll out of the next-generation do-it-yourself builder to new customers in June and have been receiving very positive feedback to-date. We believe our builder is best in class now, with features and functionalities that compare favorably to the competition.

With regard to the broader competitive landscape, I would like to comment on our differentiated approach in serving the small business marketplace. We have a large and growing customer base, which provides attractive up-sell opportunities for our value-added services. We have extensive interactions with our customers, a very high touch service approach and the broadest suite of do-it-for-me and do-it-yourself solutions and services for small businesses. We've built a different way of fulfilling our solutions. We used a manufacturing process with automated workflow technologies. As opposed to using technology to eliminate the people in the business, we use technology to make our people more effective and efficient.

We have diverse marketing and customer acquisition strategies, with growth being driven through our investment in multiple channels: online marketing, inbound and outbound telesales, direct response TV and radio ads, and direct local sales or Feet on the Street.

We continue to add resources to each of our channels, and we make frequent adjustments based on the effectiveness each one is generating. From a strategic positioning perspective, we consider ourselves to be an enabler in the marketplace. We are here to help small businesses figure out how to work with all the emerging technologies and social media outlets and get value out of being online. We consider Facebook, Google, Yahoo!, Microsoft, Twitter, Yelp and a variety of other players as part of the ecosystem that we work with in leveraging their tools and offerings to assist small businesses.

The recent entry by Google into the generic top-level domain business represents an opportunity, over time, for Web.com to leverage our do-it-for-me approach for customers who need hands-on assistance in online marketing. This is a role we have been serving for years based on a broad and deep relationship with Google that spans many years. We are the only domain registrar and hosting provider that is a Google AdWords Premier SMB Partner. In addition, we are working closely with Google to market and distribute a 100-plus new domain extensions they will own. In terms of our existing domain customer base and ability to attract new subscribers, we feel confident in the fact that we've been competing successfully for years, with our differentiated approach, in a fragmented sector with many players and commodity pricing.

In addition to the opportunity we have in the U.S., we think there is a tremendous opportunity globally. During the second quarter, we launched an initiative with tailored offerings in marketing to gain more customers and business in Canada. This includes: a Canadian-specific websites, ability for customers to pay in Canadian dollars, and direct TV and radio ads in the market. We initiated this launch in conjunction with the Web.com tournament and small business summit in Nova Scotia, where we already have more than 500 employees located.

And today, we announced our initial European expansion through the acquisition of Scoot, one of the leading online local business directory networks in the U.K. The Scoot network, which includes Touch Local and Central Index, includes the listing of more than 2.6 million local small businesses through 400-plus consumer sites and private label directories, primarily for U.K. newspaper publishers. Web.com and Scoot began a partnership late last year to offer do-it-for-me solutions directly in the U.K. market. Since that time, it became apparent that combining the companies would create an exciting opportunity to better serve small business customers in the U.K. This strategic acquisition will serve as an initial platform for our international expansion. Scoot provides a foothold in the U.K. market, with an established sales and customer service infrastructure serving in the range of 10,000 subscribers who pay for premium listings. We expect to make investments over time to leverage Scoot's existing business and offer a broader range of market-leading online solutions to customers globally. It's very early days, but we are excited about the international growth opportunity.

In summary, as we look to build on our multiyear track record of increasing growth, we are intensely focused on ensuring that we are making the right investments at an appropriate pace to drive growth, while delivering substantial profitability and free cash flow. We still expect accelerated revenue growth from last year, excluding the national accounts impact. Our ultimate focus is on creating significant long-term shareholder value, and we believe driving our business to low to teens -- to low teens revenue growth and mid-teens to 20% earnings growth over time will enable us to do so.

With that, let me turn the call over to Kevin.

Kevin M. Carney

Thank you, David. Let me begin by providing a review of our financial results for the second quarter, and then I'll finish with our updated guidance for the full year and third quarter of 2014. Beginning with the second quarter P&L, non-GAAP revenue was $144.7 million, excluding the $6.5 million impact of the purchase accounting fair value adjustment to deferred revenue in the quarter, and represented 10% year-over-year growth, a significant improvement from the low single-digit growth we generated only a few years ago.

Non-GAAP subscription revenue for the second quarter was up 11% year-over-year, driven by strong 20%-plus growth in areas such as do-it-for-me websites, Leads by Web and Web.com Facebook Boost. While these areas performed well, as David noted, our total revenue did not meet the additional rate of acceleration we were targeting for the quarter.

Let me provide some color on 2 areas, each of which represented about a $1 million of impact in the quarter. The first area was in the domain business, principally driven by softness in domain aftermarket revenue in the quarter, as well as the timing of integration activities, with that SnapNames acquisition, that has since been completed.

Second, we saw lower-than-anticipated improvement in sales productivity, conversion rates and staffing levels in our outbound and local direct sales channels. This impacted overall sales volume versus our expectations. In our local Feet on the Street channel, we continue to refine our hiring, training and product offering, which is paying off and gradually increasing sales per representative. We are always balancing between quality and volume in growing these businesses. And while the trade-off is a more measured ramp of sales staff than original plans, we expect to have more profitable sales channels driving strong growth rates.

On a consolidated basis, ARPU was $14.89, a $0.14 sequential increase from the first quarter and $0.80 from the year-ago quarter. We ended the quarter with approximately 3,210,000 subscribers, which was an increase from approximately 38,500 from the first quarter of 2014. While we outperformed in the quarter, we continue to believe that quarterly net subscriber adds in the range of 25,000 to 30,000 is the appropriate target, as we focus greater resources on our higher-priced value-added services. Our monthly customer retention rate remained at approximately 99%, and we are confident in our ability to maintain this level of customer retention.

Turning to profitability. We generated $96.9 million in non-GAAP gross profit for the second quarter, representing a gross margin of 67%, consistent with the last quarter and down slightly from 68% in the same period last year. Our second quarter non-GAAP income from operations was $38.4 million, representing a 27% non-GAAP operating margin. We generated non-GAAP net income of $33.6 million or $0.62 per diluted share. This represented 27% and 22% year-over-year growth, respectively, and was within our guidance range of $33.4 million to $34.4 million and $0.61% to $0.62 per share.

Moving on, our adjusted EBITDA was $41.8 million for the second quarter, representing an adjusted EBITDA margin of 29%. We are confident in the inherent scalability of our model and our ability to continue investing to drive additional growth, while maintaining margins around current levels.

Turning to our GAAP results. Revenue was $138.2 million, gross profit was $89.6 million, income from operations was $10.4 million, net loss was $0.8 million, and net loss per share was $0.02.

In terms of cash flow, we generated $37.1 million of operating cash flow in the second quarter, which was up 11% from $33.4 million in the same period a year ago. Capital expenditures in the quarter were $5.3 million, which led to $31.8 million of free cash flow. This was up from $29.7 million in the same period a year ago in which there were capital expenditures of $3.7 million.

During the quarter, we paid down $35 million of our outstanding debt. We intend to continue using our growing cash-generation capabilities to rapidly delever our balance sheet.

Moving to the balance sheet. Unrestricted cash and investments were $14.6 million at the end of the second quarter, which compared to $13.8 million at the end of the fourth quarter and is in our target range of $10 million to $15 million. We ended the quarter with a total debt balance of $527.2 million.

With that, let me turn to our guidance. For background, we've undertaken an extensive review of each business line in recent weeks, taking current trends for underlying drivers into consideration, as well as evaluating how we can best deploy resources across our various growth initiatives. First, we have adjusted our near-term expectations for the pace of further improvements in our various marketing channels, in particular, in the outbound sales, Feet on the Street and online domain channels. Our expectation that these channels will drive improved growth over time remains unchanged.

Second, as David commented, we have made a decision to discontinue the non-core national accounts revenue stream that was essentially flat since the Network Solutions acquisition, and it has a much lower margin profile compared to the rest of our business. Over the past year, these accounts have totaled an average of about $5 million in revenue per quarter, with a small amount of variability. Taking these 2 factors into consideration, we are adjusting our full year 2014 revenue guidance to $576 million to $579 million. Approximately half of the reduced forecast relates to the exiting of the legacy national accounts, which will be largely gone in the second half, and the remainder relates to the slower pace of improvements just noted.

From a profitability perspective, we are continuing to target an adjusted EBITDA margin of approximately 29%, which would lead to full year non-GAAP net income in the approximate range of $133 million to $135 million, for $2.44 to $2.48 per diluted share. This assumes an updated share count of 54.5 million. We continue to expect our cash tax rate for 2014 in the low single digit range.

In terms of cash flow, our updated expectation is to generate approximately $105 million. This includes: impacts from the Q2 lower base of revenue and EBITDA, timing of the cash benefit of reduced incentive compensation, lower deferred revenue from a slightly decreased average domain renewal term, and investments in new domain extension promotions. Our updated 2014 guidance also incorporates minor adjustments for the Scoot acquisition that we just closed. They have an adjusted revenue -- they have an estimated revenue run rate of around $1.5 million per quarter.

Moving to the third quarter, we are currently targeting non-GAAP revenue in the range of $143 million to $144.5 million. We expect our non-GAAP net income to be in the range of $32.7 million to $33.7 million or $0.60 to $0.62 per diluted share, which assumes 54.2 million diluted shares outstanding. We expect the underlying core business to generate ARPU growth. However, there will be a one-time impact to ARPU from exiting the legacy national accounts, which we expect to net to a sequential decrease in the $0.30 range in the third quarter.

In summary, we believe that we have many levers to improve our core business, while pursuing new growth opportunities. We see a long runway to continue executing on our strategy of expanding and cross-selling across our large and growing customer base. We've been able to expand revenue growth from the 8% to 9% range in 2013 and expect 9% to 10% in 2014, excluding the impact of the legacy national accounts. This progress provides us confidence in our ability to achieve low-teens revenue growth, mid-teens to 20% earnings growth, and scaling free cash flow generation over time.

With that, we would now like to take questions. Operator, if you could please begin the Q&A session.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Walter Pritchard with Citigroup.

Walter H. Pritchard - Citigroup Inc, Research Division

I'm wondering if you can talk a bit about just the ARPU -- forgetting about the national account exit here, and if I look at ARPU over the last couple of quarters versus the improvement you saw in 2013, it does suggest that the majority of what you're adding are very low-cost domains. And I'm wondering just sort of -- as we think through the impact of that, both your ability to up-sell those, how much you have taken into account the potential risk there in your guidance; and then also, if you could quantify for us maybe how you expect. You mentioned the renewal rate could show some deterioration, how -- what do you expect that to be?

Kevin M. Carney

A couple of comments. But I think that, obviously, being a subscription business, as we said, the slower rate of improvement in some of the underlying metrics than anticipated and the shortfall on our revenue expectations will roll forward throughout the balance of the year. And obviously, that has some impact on ARPU on a go-forward basis. You're right. Certainly, at the same time this quarter, having not met our revenue expectations and having outperformed on the net subscriber additions, which, as you pointed, out come largely through domain name products, that too has put some pressure on ARPU in the quarter. Going forward, as we pointed out in the third quarter, we will see an impact from the -- exiting the national account revenue stream, which, as we said, has about -- been averaging about $5 million a quarter. So if you think about what we commented on, on the call in our comments of a net decrease anticipated for the next quarter, you can see that the underlying business continues to grow. We'll continue to see ARPU expansion in the quarter. And I think you'll continue to see that, if you look at the implied guidance for the fourth quarter, as well as our suggested -- kind of directional guidance on net subscribers of 25 to 30, there too you'll see acceleration in the ARPU, similar to what you've seen at least -- trend-wise, similar to what you saw last year. Now in terms of your comment on renewal rates, I think what we were -- my comments really had, I think, more to do with -- I think we were expecting to see steady renewal rates of 99%. I had made a comment about renewal term, which has pulled in a little bit, which has affected kind of our near-term cash flow expectations, but not expecting any change in renewal rates.

Walter H. Pritchard - Citigroup Inc, Research Division

I guess, Kevin, just to follow up on that, what's the risk that we get to 1Q, 2Q of next year and that some of these names you've been adding during the periods this year drive churn up, just given you're not able to upsell them, either you choose to turn them off or -- as their price goes up, or they move away as if they're not activating the domains?

Kevin M. Carney

Sure. Yes, I mean, I think a couple of things. I think that we've been using promotional pricing now for a number of years. And as we've commented, we've not seen any discernible impact on our renewal rates. They have remained strong. As it relates to some of the newer TLDs, a lot of that activity is to existing customers. So they're not resulting in additional net subscribers. And whether they -- the renewal rate there will have a bearing on ARPU and revenue growth, and we certainly consider that in our outlook but won't have any impact on renewal rates or net subscriber growth.

Walter H. Pritchard - Citigroup Inc, Research Division

And should -- just last question, should we expect that you continue to be pretty aggressive in terms of that tactic of bringing in low-price to upsell? Or does the lack of upsell success during the quarter, temper your aggressiveness on that type of a strategy?

Kevin M. Carney

No. I think -- as I said, I think the underlying business continues to perform. I think that it continues to work for us, so the economics around that are holding. We get a good return just on renewal rate at the retail pricing. And as we said, it's the customer then that we have an opportunity to upsell. So I think the economics work on their own, and then we -- as I said, we have an opportunity to upsell.

Operator

Our next question comes from the line of Matt Thornton with SunTrust Banks.

Matthew Thornton - SunTrust Robinson Humphrey, Inc., Research Division

It's Matt in for Bob Peck. First, obviously, the tone of this call is very different from 3 months ago. So I'm just curious, maybe, if you could provide some color on the linearity in the quarter, exactly when things started to slip, just a little more color around that would be very helpful. And then, secondly, again, are we to believe that none of this is a function or a byproduct of competition or any other external factors? And related to that second question, churn, I know it remained at about 1% monthly, but I guess, within that 1%, was there any uptick in the churn number?

David L. Brown

So our 2Q plan really assumed continued improvement from 1Q and, obviously, from last year. And in essence, what we've reported is that we didn't achieve the level of improvement that we had expected. We still performed well. We still put up a 10% number year-over-year, and from our perspective, our business is intact. Our machine works, but it clearly requires focus in our business to make all of our drivers of our business work well, and they didn't achieve our expectations. We were strong in several areas. Churn continued to be very, very strong for us. In other words, our retention rate was very stable. We made progress in conversion rates in many of our areas, but we have to be very focused in our execution. We think the market is still very strong, and will be strong for years to come. We believe that we're in the very beginning of the cycle of small businesses beginning to adopt the Internet and move up the value-added chain, and we're well prepared to handle that, and we're pretty confident in our ability to execute, given the last year's as we've ramped up our revenue growth rate. And so we're now refocusing our efforts, and refocusing means making sure that we're not paying attention on things that aren't core and aren't going to contribute to our method, which is improving revenue growth and strong profitability. So I would say the underlying drivers of our business are very strong. We saw acceleration in growth from last year to this year, and we expect to see it in future years as well.

Operator

Our next question comes from the line of Sterling Auty with JPMorgan Chase.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

So I want to get into a couple of areas. So I understand exiting the national accounts. I think that is what it is and it has the magnitude of the impact. But I guess, the 2 areas that I really want to better understand is, first, specifically, the outbound sales. Is it that you had churn in headcount and weren't able to replace fast enough? Or you made -- in 2 parts of the prepared remarks, you talked about the conversion rates. What was it that suddenly, the conversion rates either weren't improving where you hit a ceiling? Or something else happened?

David L. Brown

Yes. So in our outbound sales organization, we have a number of drivers for the business. Obviously, you've hit on 2 of them, the number of headcount we have and how well they convert in their daily process. And it's a fine balance of adding new staff, so growing our existing base of salespeople. And really, not meeting our expectations here was a function of not being able to successfully add people at the rate that we had expected to add them at and, at the same time, deliver conversion rate improvement at the level that we wanted to. And again, we manage our business to a balance of profit and revenue growth, and we won't sacrifice one for the other too much. So if we find that we have too many new people coming in and that can affect our conversion rates, you'll see us temper our expectations on how many people we're going to bring in. So we've really indicated to you today that we've looked at the remaining part of the year, and we've tempered our expectations for the rate at which we can add resources and, at the same time, improve conversion rates in all of those drivers.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

So within that, though, something had to change from where it was before. Why were you anticipating in the back half of the year, adding sales resources at a faster rate than you had, and maybe you've hit a functional limit?

David L. Brown

Well, there certainly -- we don't believe there is -- we've hit any functional limit, but it does require focus and execution. And as we get bigger and we accelerate our growth, it requires even more focus and execution. And so we've had to step back and re-examine, including our own expectations of how fast we can drive this. So I think it's really more an issue of that than it is whether the market is receptive. I don't see any, really, limit at this point to our ability to improve other than timing, speed.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

But did you lose more headcount in the second quarter than you anticipated? And that also caused -- or what is it simply just the churn in your own sales staff was constant and it was just this pace of adding them?

David L. Brown

Our fundamental issue here is we were planning on going from 10% to 11%. And so it really wasn't an issue of losing people as much as it was not being able to add new people that were effective in the period.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

Okay. And last question, I'll jump back in the queue. Is it harder to find -- given where we are in employment levels and when you think about 2009, 2010, et cetera, you guys were probably hiring at a time where many other businesses weren't. Are you finding it a little bit more challenging to find the right type of person at the right cost to plug in to be successful?

David L. Brown

Fortunately, no. Our model, because of our manufacturing process, we're able to -- there's virtually -- there's a vast supply of individuals that are looking to work in Internet companies that don't happen to have Internet skills, and our particular process allows us to bring those people in and train them and get them to be effective using the technology and the tools we have. So we haven't really experienced any difficulty in these particular areas. So certainly, not the outbound sales channel in hiring people, but there is -- again, you have to be able to hire them, train them, on-board them and get them up the learning curve quickly. And as the organization gets bigger, that process requires focus and fine-tuning.

Operator

Our next question comes from the line of Samad Samana with FBR Capital Markets.

Samad Samana - FBR Capital Markets & Co., Research Division

I have a few questions. So the first one is, can you comment on where conversion rates were particularly weak in terms of product categories, i.e., was it the core website design business that's really been the company's flagship product? Or was it at some of the newer products, such as Feet on The Street? Or the new very high-end website solution that you've rolled out? And help us understand where the shortfall fell with those products?

David L. Brown

So I can focus on one of them, and I think we should just add some perspective here. It -- really, our issue is that we had expectations, and we always have expectations, of improving metrics. We believe in the concept of constant improvement, and that's what we work on. And so we were looking for improvement, say, in our Feet on The Street conversion rates per employee, and good news, we got improvement, just not as much as we had anticipated. So we believe we'll continue to see improvement in this area. We have for -- now for a number of years, and we're very pleased with the fact that we're able to continue to improve there, but we just didn't achieve the level of improvement, and I would say I would single out that one as a conversion rate area. In other areas, it could be other drivers, such as headcount, but that would be the one for conversion rate.

Samad Samana - FBR Capital Markets & Co., Research Division

Okay. And then in terms of -- as I look at last year for the products that Web is offering on the value-added services side, prices for a couple of key products were raised over the last year. Do you think that, that's had an impact into 2014 on conversion rates, potentially moving prices a little bit higher and maybe needing to bring them back down a little bit somewhere between where they were last year and this year for those products?

David L. Brown

Well, I would tell you that conversion rates in our outbound area have improved. So I don't think that we can validate that theory. I think that, in fact, there is -- we believe, and have always believed, that there is tremendous opportunity to raise price in some of these areas. But we were unwilling to do it during the 2008 to 2011 time period, and we're still very cautious in raising price, but it has more to do with a challenged marketplace than it does with the elasticity of pricing and demand. So you will likely continue to see us raise price as we add more functionality. For instance, our Facebook product has gone up a number of times, just proving the value that it creates, and we've not seen a decline in net revenue from that at all. In fact, the net revenue continues to grow. So I think there is good opportunity here. And on that particular example you raised, we've not seen any proof that prices had any impact. Again, our issue is we are seeing improvements in the underlying drivers. So we're very confident in the business model. We just didn't achieve the full extent that we had planned for.

Samad Samana - FBR Capital Markets & Co., Research Division

Okay. And then one more for me. So I guess, on the positive side, the sub-number was nice, and I think it shows that the company has good control over adding subs for the pipeline. Could you comment on Google? I think there's a lot of people that would like to know if you see them as a potential threat on the domain side and whether that's an issue even for pricing and how much more sensitivity there is. And then within that, is there an opportunity to become the do-it-for-me partner with Google, just similar to the way that they did on the DIY side with some of these smaller players?

David L. Brown

So let's just hit the Google thing head-on. We don't see any competitive threat from Google relative to domains. Google is a fantastic company, growing at a fantastic growth rate in a number of high-priced categories, and we don't see them shifting their focus to a commoditized, low-growth industry anytime soon. However, we do see them taking advantage of new top-level domains in specialty areas, and good news, we're partnered with them. We're going to be one of the registrars that helps them distribute those into the marketplace. So we'll benefit, actually, from Google's entry into the domain space, but we don't see Google shifting their business model into the domain industry in any meaningful way. We, on the other hand, are one of the -- already one of the most significant do-it-for-me partners for Google in our online marketing space. I commented earlier, we're the only domain name and hosting company that's a premier partner for Google, and we have been for years. So we think we can benefit from them working in the new gTLD space because they're going to be possibly creating opportunities for people to grab new domain names, and that creates opportunities for us in the online marketing space and even in the DIFM website space.

Operator

Our next question comes from the line of Gray Powell with Wells Fargo.

Gray Powell - Wells Fargo Securities, LLC, Research Division

Just had a couple. So if I look at guidance for the year and then the Q3 guidance, it implies about 2.5% sequential revenue growth in Q4. I know you talked about some of the improvements you've seen. Could you give us a sense as to what exactly you're seeing in the month of July, or maybe late June in terms of trends getting better? Does that give you the confidence that you can actually achieve this, the acceleration in growth in the latter part of the year?

David L. Brown

Well, I think if we can speak to the fact that just in 2Q alone, we had over 200 basis points of improvement from the previous year, so we feel good about the continuation of improvement through that point in time. We are discontinuing a small class of revenue, $5 million a quarter approximately, which impacts our growth rate, and we're also taking a more -- I hate to use the word -- but cautious approach to the rate that our metrics and underlying drivers can continue to improve. So -- but I think just the very fact that we saw a nice step-up from last year in 2Q over 2Q and what we see in the underlying metrics of our business I've alluded to it several times here, we're seeing improvements in conversion rates in our business. We're seeing very steady stable retention rates in our business. We're continuing to grow ARPU. So we don't see anything here other than we didn't -- we failed to meet improving expectations.

Gray Powell - Wells Fargo Securities, LLC, Research Division

Okay. And then you may have [indiscernible] on this already. I just want to make sure I understand it correctly. How should we think about the timing of the $5 million in quarterly revenue from the national accounts coming out of the business? Does that full run rate hit in Q3? Or does it get phased in over the next 6 months?

Kevin M. Carney

Yes. We had commented -- in the prepared remarks, I think that you'll see it -- I think the comment, the characterization was that it would largely be gone at this point. I mean, there will be some small amount that does roll forward and -- but largely gone in the second half.

Gray Powell - Wells Fargo Securities, LLC, Research Division

Okay. So if I kind of want to, like, normalize my Q3 versus Q2 comparison, I should basically -- for apples-to-apples purposes, thinking about -- think about adding back the bulk of that $5 million. Does that make sense?

Kevin M. Carney

Yes.

Operator

Our next question comes from the line of Rohit Kulkarni with RBC Capital Markets.

Rohit Kulkarni - RBC Capital Markets, LLC, Research Division

Okay, great. I know you talked about kind of anticipated improvement in underlying metrics and conversion rates, and it kind of came in below your expectations internally. I guess, for the next 6 months, when you thought about giving guidance and you decided to model certain levels of improvement or lack of anticipated improvement, I guess, can you talk through your thought process as in what led you to kind of come up with a certain number? And what can you do to kind of change operationally or tactically over the next few months to get the old, anticipated improvement that you hope to, 3 months back? And is it more of the same, more of the same, look for good outbound salespeople and hope to get that anticipated improvement? Or is there something tactically that you can do quickly to, perhaps, later on prove that the current expectation is actually you being cautious?

David L. Brown

Sure. So to the broad theme that you're raising, the most important thing that we can do is be focused in our work and focus our resources in the areas that count. So as a result, we've taken a very hard look at our business. We've shifted resources around. We've added some new resources. We're very excited to have added some additional management to our team and additional staff to our team, and we're making sure that when we add resources, we add them into the high-growth areas, where they can have the greatest impact. We've also -- I mentioned, we've mentioned that we've added focus in some new growth areas, like multi-location franchise and resellers and international, which represent real growth opportunities for the business. So we can do those things as well, but I'd say the most important thing that we can do is to be focused, not spend our time on things that are not core to the business and put all of our focus on things that further our core mission, which is helping small businesses, at a very fragmented part of the small business marketplace, to use the Internet.

Rohit Kulkarni - RBC Capital Markets, LLC, Research Division

Okay. And are you seeing -- in terms of competition, I know Google came up, but another large private company which probably would come to the public markets. Are you -- and generally, companies tend to be very aggressive a few months prior to coming to a public market. Are you seeing any effect of changes in competitive landscape in terms of, a, either hiring salespeople at a low cost or getting good quality salespeople or even at the high end, Feet on the Street people churning off at a certain rate higher than expected.

David L. Brown

Sure. So at this point, we've seen very little competitive change in the market that the mere fact that companies go public or prepare to go public doesn't mean that they haven't been in the market and haven't been preparing. And we've been competing very effectively. We just don't see competitors that have our breadth of product or our depth of delivery to the market, or even our approach to the market, and therefore, we haven't felt any change in the competitive landscape from those competitors.

Operator

Our next question comes from the line of Tim Klasell with Northland Securities.

Tim Klasell - Northland Capital Markets, Research Division

Yes. Most of mine have been asked, but on the Feet on The Street program, you are adding in new products or giving them a larger set of products to carry. Do you think that took away focus and caused a lower-than-anticipated conversion rate there?

David L. Brown

We're actually quite pleased. It's early, we've launched a number of products. We're seeing good traction. It will ultimately enhance our average sales per rep, and we're seeing that now as I commented. We are seeing increases in average sales per rep, and we're pretty pleased with that, except we'd be more pleased if it met our expectations. And one of the things we've done in this planning cycle is being more cautious about our expectations going forward.

Tim Klasell - Northland Capital Markets, Research Division

Okay, good. And then I think you made a comment that the SnapNames acquisition had some extra challenges in getting that integrated. What were those? And how do you feel about the latest acquisition?

David L. Brown

Yes. It -- this was not -- it was -- we mentioned it as not the major contributor in that category, but a small contributor. It was a short term -- it's actually finished. All done within one quarter so, but it did impact our expectations, and it had more to do with a partner in the process, not being prepared to do their job on time, far less our own organization. So we were actually helping someone, and we got revenue from them, and they dropped the ball. We eventually got them back them in to their -- on their horse, and everything is moving forward fine now.

Operator

Our next question comes from the line of Hamed Khorsand with BWS Financial.

Hamed Khorsand - BWS Financial Inc.

Just a couple of questions. One, can you just walk us through the guidance a little bit and what you guys are talking about, more so from the profit line standpoint? Because it looks like you are guiding -- profit level has not really changed much, even though you're telling the Street, expect almost $20 million reduction in second half revenue compared to your prior guidance. I mean, is that really cost controls? I mean, was this revenue that you're not accounting for anymore just really unprofitable?

Kevin M. Carney

Yes. No, I think mostly, cost control. I think -- I could call out a few items that we mentioned, which would be some of the basically not adding. Some of -- we're not seeing the growth that we had anticipated and planned for, for the year. So we've planned for some, let's just say, slower rate of headcount additions. So there are certainly some staffing compensation savings there. The other would be incentive compensation, which has been adjusted accordingly with our revised outlook. And then the third was some discretionary, uncommitted branding dollars in our budget that will not be impactful to the year-on-year term growth rate, but those are the areas that we have focused on.

David L. Brown

But it is also true that the national accounts business was low-margin business, and so it doesn't have near-the-impact leading that our core business would have.

Hamed Khorsand - BWS Financial Inc.

Okay. And then, if you could repeat, what was the, in the prepared remarks, the impact on ARPU in Q3 because of the exit?

Kevin M. Carney

Sure. I think we didn't actually call out the specific number, but what we said is what we are guiding to and what's reflected in the outlook would be a -- what we would expect to see is a sequential decrease in the $0.30 range as a result. I think if you were to do the math, roughly speaking, you'd probably see something in the order of $0.50 just given the average the $5 million that we talked about as the average on a quarterly basis on a current subscriber base.

Hamed Khorsand - BWS Financial Inc.

Okay. And last thing is, okay, if I'm just doing the simple math here, $5 million, $5 million is $10 million, reducing the guidance by $20 million, or -- and I take out another $1.5 million because you missed it in Q2. There's still $8.5 million that you're reducing guidance by. Is the core business just not producing the revenue you're looking for?

Kevin M. Carney

Well, I mean, I think there's 2 points around that. I think you're right. I mean, roughly speaking, your math, half of it being the national accounts, the other being one, not meeting our expectations this quarter and being a subscription business, that rolls forward into -- will it roll forward into the next 2 quarters. And then there's what we've been talking about, just having a more measured approach and assumptions around the assumed continued improvements in all the underlying metrics we were talking about. So the combination of the roll-forward and a more measured sort of thinking and approach around some of those drivers would constitute the other half.

Hamed Khorsand - BWS Financial Inc.

Okay. And then my last comment or question really is, I remember during Analyst Day earlier in the year, you guys were talking about large ticket sales, making up for ARPU. I mean, how is that traction going? I mean, is it something that you could still hang your name on it after this kind of quarter and announcement you guys had today.

David L. Brown

I think we were -- I'd comment I believe we were -- we've been referring to our Feet on the Street project, where we sell $1,000 per month subscriptions to small businesses. And that continues to be a very robust and, we think, will be a very strong. In fact, it is growing at a very high rate, and so we are very confident that, that can continue on, and those ARPUs will be out there. We're talking here about ARPU per deal more likely in the millions. So we're talking about a handful of large deals that are generally short-duration and as much as $1 million when we talk about the national accounts.

Operator

Our next question comes from the line of Lloyd Walmsley with Deutsche Bank.

Lloyd Walmsley - Deutsche Bank AG, Research Division

Excuse me if I'm asking something that's already been covered, but can you just give us a little bit more color on this national accounts business? What exactly is it? Like is it a small group of customers? And is this really a function of competition? It would seem like a high-margin business, given big $1 million contracts and, I would think, pretty simple implementation. And if you could just give us some color on the impact to free cash flow from taking out this revenue.

David L. Brown

Sure, I can give you an idea of what they look like. These are -- these would typically be Fortune 500-type companies that might have had a branding program going on where they wanted to advertise in the digital assets of companies like Network Solutions. And because they are Fortune 500 companies, they are not high-margin businesses. They are hard to identify, hard to negotiate. They require senior management involvement to get them and manage them. And as we have expanded -- and so therefore, they're just not something we want to focus on. We're interested in serving small businesses, and so exiting this and getting our management team and our entire company focused on our core mission is really what we're doing here.

Lloyd Walmsley - Deutsche Bank AG, Research Division

Okay. And the impact on free cash flow?

Kevin M. Carney

Yes, I mean, I think that not calling out of -- I think the specific, let's just leave it, It's certainly well below our average gross margins for this business. But I think if you look at -- I made some comments about sort of bridging our earlier guidance on free cash flow and our current expectations, and given the reduction in our revenue outlook, what with the cost containment, and again, this revenue coming out at much lower margin, we're looking at a few million dollars of EBITDA impact. The difference, really, are 3 areas that I called out. One is the fact that some of the cost containment that we will achieve this year is in the form of reduction of management incentive compensation. We won't get the benefit from a cash perspective in the year. We'll see that benefit in the first quarter of next year. And the other areas that I've called out were some in our domain renewals, seeing our average term pull in a little bit, which affects near-term cash flow. And then the other area would be some of the investments that we're making in the domain, some of the newer domain promotions. So those -- actually, that the revenue impact, and we've mitigated that pretty well with the exception of the timing around the incentive compensation.

Lloyd Walmsley - Deutsche Bank AG, Research Division

Okay. And then if I can throw in one more. As the new TLDs come online and you're seeing customers come back to buy those, what kind of attach rates are you seeing on some of the other products that are higher-margin?

David L. Brown

It's really very early. These are generally sold to existing customers, and we would view them as a customer, not a domain. So we would look at that as a customer buying an additional domain, which is an attach rate in and of itself. And there might be some additional products sold along with it, some of our privacy products. Possibly, e-mail might go with it, so there's attachments there. But we would view it as already a subscriber, and this would be potentially driving ARPU for us through the additional attachments.

Lloyd Walmsley - Deutsche Bank AG, Research Division

And does it seem like it's actually -- I think you've always described it as almost like a traffic driver on which you can upsell some of these other things. Is that playing out in these early days?

David L. Brown

It's really too soon for us to say. We're literally in the very -- in the early months of the new gTLDs. I mean, literally, the decent ones have just been out for a quarter. And as you might know from some of the published data, there is -- it's still almost -- I wouldn't call it a yawn, but I would say it's not a huge volume of activity yet, and so I think the better days are ahead of us as more of the generic top-level domains come out. But we have seen some cross-sell and upsell already in our channel.

Operator

Our next question comes from the line of Sameet Sinha with B. Riley & Co.

Sameet Sinha - B. Riley Caris, Research Division

A couple of questions here. David, you had mentioned the word lack of focus a couple of times on the call. Can you give us examples of how that kind of manifested itself? Secondly, say, on the marketing cost, you've done a good job of bringing down the customer acquisition cost so as your marketing absolute numbers also kind of taper off. Is that real leverage? Or is it one of the areas of cutbacks that you've identified? And my last question is around the .xyz domain. It seems like at least from media reports that you were giving it to your Network Solutions customers. Can you elaborate on what sort of promotion that is? Or what sort of an impact it could have? And what sort of benefit do you expect from it?

David L. Brown

Sure. So we'll take the first one. I don't actually recall saying the words lack of focus. I think I said it requires more focus, which I just happened to believe that, that's -- it always requires more focus. Management requires constant focus, and I believe in constant improvement, so you're always going to get that kind of train of talk from me, which is how do we get better, how do we get more focused, how do we put our resources where we need them to be, and that's what I believe. I'm quite proud of our team and the progress we've made over the last few years. I just want to remind you that this is a company that has been accelerating top line and bottom line, and we expect to continue to do that, did it and we expect to continue to do it. But you have to be pragmatic, what does it take? It takes improvement in every area, and one of them is management focus. In the second area, we absolutely have not cut in the area of cost of sales. We've cut very discretionary expenses like additional people that were planned to be here, but the growth doesn't warrant them, or we have cut some brand advertising that wasn't even committed later in the year out of our plan. And of course, we commented that our management incentive compensation plan has been reduced. So those kinds of things are what have contributed to the cutbacks. And then finally on the xyz, we have a long history of offering domain names at very low price in order to attract customers. And then after a year with us, if they choose to renew, we have some additional revenue. And we've been testing this process for years. It has worked for us and allowed us to be very competitive in an extremely competitive and marginalized business. And so xyz could have been an example of that.

Operator

Our next question comes from the line of Mitch Bartlett with Craig-Hallum.

Mitchell O. Bartlett - Craig-Hallum Capital Group LLC, Research Division

Yes. I don't mean to beat a dead horse, but at the Analyst Day, you separated your business into 3 kind of buckets: value-added services, DIY and hosting and domain. The impacts that we're talking about, or with this, the outbound sales force, which of the first 2 buckets is that most affecting? Is it the hiring stuff? Or the DIY and the hosting? And then second question, just -- and I'll leave it at that. Kevin, I think you were talking to Hamed, and you talked about net, it would be the $5 million be a $0.50 impact to ARPU. You're talking about $0.30, so you're seeing a sequential improvement in your ARPU going up $0.20 or so.

Kevin M. Carney

Exactly. Thank you for summarizing that well.

David L. Brown

And I think on your first question, I think it's in the higher -- we didn't achieve as much improvement in revenue per employee and per customer as we had expected to achieve. And it was in the high end of $1,000 a month, and that's what I focused on in a previous question. Correct.

Operator

Our next question is a follow-up from the line of Sterling Auty with JPMorgan.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

Since we've gone through a lot of material, I just want to make sure that I come back and just make sure that I have the right focus here. Do you really think that the issue or the shortfall is really a falloff in end market demand or something fundamental? Or more of an execution issue due to staffing the right resources and getting them ramped to the right level of productivity?

David L. Brown

The latter, period. The market is strong. The market is going to get stronger, and we're well-poised to take advantage of the market. We just have to do it.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

You did mention on the Feet on the Street as part of the outbound selling that perhaps contributed to some of the shortfall. I didn't quite catch in any of the answers. What specifically was the issue with the Feet on The Street and what you're doing to change it?

David L. Brown

Yes. So fewer people than anticipated or expected and lower sales per employee than expected. However, both up in the period from the prior period, just not as much as we had hoped for. And one of the things that we have done is reevaluate it, what's realistic and doable in the going forward period. And our guidance reflects what we think is realistic and doable based on our learnings.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

Okay. And last question, more mechanical, I think. Kevin, in the other income, can you give us -- other income and expense, can you give us a little bit more of a breakdown? I think that helped EPS a bit. Was there anything a little -- I'm not saying unusual, but something that was a little bit larger than anticipated there?

Kevin M. Carney

In -- no. There's nothing unusual there. You're not talking about professional services?

Sterling P. Auty - JP Morgan Chase & Co, Research Division

No, no, no. Below the line. So as I'm looking at total other income, so interest income, interest expense. I think there was a negative $4.5 million in the quarter, if I'm not mistaken. I would have thought it would've been more closer to over negative $5 million. Just wondering the makeup there.

Kevin M. Carney

No, nothing unusual. Nothing unusual there. Cash, cash interest.

Operator

Our next follow-up question is a follow-up from Matt Thornton with SunTrust Banks.

Matthew Thornton - SunTrust Robinson Humphrey, Inc., Research Division

Just another question on the national accounts legacy business. Just curious if -- is this something that had been up for a review for quite some time? When did you actually make the decision to shutter that business? And then as a follow-up, as we look beyond 2014, if we look to 2015, David, and then we think about, again, that reacceleration to the low-teens revenue, kind of run rate, can you kind of walk us through what the drivers are? Is it international? Is it the new TLDs? Is it new products? Can you just walk us through how we get from here to there?

David L. Brown

Sure. So on the national account, again, we've had this business in our -- here for 3 years now. It's been relatively stable. It's gotten harder and harder after years with the short duration of these deals to continue to do them. We have low visibility on them because we're negotiating with giants, and they don't produce much money. And in an era of get focused, now is the time to make that decision given all the factors that we had. So I would say this is something that we came to a conclusion here recently and as a result of all of the factors that I just said. And in terms of the drivers, we believe that the businesses, our DIFM business, our DIY business, our Feet on The Street business. Those businesses are all growing at very strong rates, 20%-plus rates of growth. And as we continue to invest in them, they can contribute to acceleration of growth. And add on top of that, expanding a new channel in the reseller space, the multi-location franchise space. And add to that beginning to go international and really access markets that we haven't played in before that frankly, desperately need the kinds of services that we have because they're behind the United States in the adoption of the Internet. And we think the accumulation of those things are what give us confidence that we can drive our revenue growth back again into the double digits and then into the low-teens.

Matthew Thornton - SunTrust Robinson Humphrey, Inc., Research Division

And just one last follow-up to that point there. I mean, obviously, you talked about Canada, you just announced a deal in the U.K. I mean, can we go out to 2015 and see international large enough that you actually break it out whether it's 5% type of revenue kind of book. Could it be material as early as 2015?

David L. Brown

It's too soon for us to say. I mean, we just made the acquisition today in the U.K., and we just launched -- literally, it was about a month ago in Canada. But whatever happens here, it's going to be additive to the business that we have. So again, it's -- all of that will be a contributor, and we expect to learn from both of these initiatives and use that learning to get even better. Again, constant improvement going forward.

Operator

At this time, I would like to turn the conference back to David Brown for closing comments.

David L. Brown

Well, thank you, all, for joining us today to review our second quarter and the outlook for our business. We appreciate your interest and look forward to speaking with you about our progress. We'll be participating in the Citibank, Deutsche Bank and BWS conferences coming up in August and September. And as always, feel free to contact us here at Web.com if you have additional questions. Thank you, and good night.

Operator

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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