ReachLocal's (RLOC) CEO Sharon Rowlands on Q2 2014 Results - Earnings Call Transcript

| About: ReachLocal Inc. (RLOC)

ReachLocal (NASDAQ:RLOC)

Q2 2014 Earnings Call

August 06, 2014 5:00 pm ET


Alex Wellins - Co-Founder and Managing Director

Sharon T. Rowlands - Chief Executive Officer and Director

Ross G. Landsbaum - Chief Financial Officer


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

Jason Mitchell - BofA Merrill Lynch, Research Division

Charles Eugene Munster - Piper Jaffray Companies, Research Division


Good day, and welcome to the ReachLocal Second Quarter 2014 Conference Call. Today's call is being recorded. [Operator Instructions] At this time, I would like to turn the conference over to Alex Wellins in Investor Relations. Please go ahead.

Alex Wellins

Thanks 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

With me on today's call are ReachLocal's CEO, Sharon Rowlands; and CFO, Ross Landsbaum. During the course of this conference call, management may make projections or other forward-looking statements, which are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve risks and uncertainties that could cause actual results to differ significantly from those projected. You are cautioned not to place undue reliance on the forward-looking statements, which speak only as to the date of this call. A detailed discussion of the material factors that may cause results to differ from the statements made can be found, for example, in the Risk Factors section at ReachLocal's filings with the SEC, including its annual report on Form 10-K, ReachLocal's update in its quarterly reports on Form 10-Q and current reports on Form 8-K, including the Form 8-K in the attached press release filed today.

Certain supplemental financial measures we will use on this call, such as adjusted EBITDA, non-GAAP net income, non-GAAP net income per share and constant currency revenues are expressed on a non-GAAP basis. Definitions and calculations of these financial measures, and in the case of adjusted EBITDA, non-GAAP net income and constant currency revenue, a GAAP to non-GAAP reconciliation can be found in our earnings release. These financial measures are not intended to replace any GAAP financial measure. You should rely primarily on our GAAP results and consider adjusted EBITDA, non-GAAP net income, non-GAAP net income per share and constant currency revenues only as a supplement to our GAAP results.

With that said, I'll turn the call over to Sharon Rowlands. Sharon?

Sharon T. Rowlands

Thank you very much, Alex, and good afternoon, everybody. When I talked to you last, I was only 5 weeks on the job. At that time, I told you that my sense of this company was that we had the right strategy but had a number of execution issues and challenges to overcome. 16 weeks into the job, I've had the opportunity to meet a large number of our clients, visit with employees and obtain the benefit of a significant amount of analysis. And while I believe we still have much work to do, I'm more confident than ever that the underlying ReachLocal asset is solid. We have a scalable business at nearly $0.5 billion in annual revenue, over 23,000 clients and a solid global footprint.

We've done a fair amount of client research assessing the market opportunity over the last couple of months. In many ways, it's quite simple. We operate in a large, fragmented market. Our clients are overwhelmed by the myriad of choices and point solutions and are desperately in need of an easier way to get the marketing job done. In short, they're looking for a one-stop shop to solve their digital marketing needs. We're confident that ReachEdge can serve as the system to address those needs. Moreover, I believe that my broad range of experience in product development and go-to-market strategies is precisely the experience required to move us through the next phase of the company's journey.

Transforming ReachLocal is necessary to take advantage of the market opportunity. To do this, I focus the company on a number of priorities, including the following. It's now abundantly clear that our December 2013 sales force realignment in North America was poorly executed. However, we've learned a lot. We've identified some underlying deficiencies and know how to get back to the right place to both serve the needs of our clients and reaccelerate growth. Under new leadership, this turnaround is underway. Globally, we have an opportunity to be smarter in our overall sales and marketing strategy with more effective lead gen. This is causing us to rethink the way we package and bundle our software and media products to make it easier for us to identify the right prospects to sell to and also to make it easier for our clients to buy a total digital marketing system from us. We believe that this will give us the dual benefit of accelerated growth and a reduction in our client acquisition costs. While our ReachSearch product remains the leading search product for local businesses, it's clear that we need to further expand our product development efforts to take our media business to the next level. Our initial release of ReachEdge is a good start, but we're going to deploy additional resources towards product development to accelerate our subscription software revenues. Our focus is on turning ReachEdge into a best of breed total digital marketing system that comprehensively addresses a full range of digital marketing needs for our clients.

We've commenced an initiative to transform our client experience. We have an active multidisciplinary tiger [ph] team working to improve all touch points between ReachLocal and our clients from initial sales through on-boarding, to ongoing service support, all with an eye towards better demonstrating our value proposition to our clients.

I've done a review of our international businesses, and it's clear that we have a significant opportunity to drive greater penetration of some very large markets by expanding the availability of our product suite there. We also believe there's an opportunity to prioritize the allocation of resources to get improved profitability and a better return on our investment.

By putting a laser focus on these priorities, we will revitalize ReachLocal. However, it will take time, and I want to set realistic expectations. In that regard and given the magnitude of the changes we are making, we've decided to only provide one quarter's outlook at this time. I'm doing that to maintain strategic and tactical flexibility to do the right things for the business.

Now, I'd like to give you a quick business update, Ross will then follow with a financial review, and I'll conclude with the some more insights into our product strategy.

First of all, North America. Q2 revenues were down 11% from Q2 2013. As I had mentioned on the last call, I saw the fixing of this business to be a 9- to 12-month job. We are addressing many of the identified challenges and still believe that's the right time horizon. We have reorganized our management and have a new leader and team in place. I'm confident we can rally the North American sales force to win. We're doing all the right blocking and tackling activities to get this organization on the right trajectory, with a specific focus of investing in training. At this stage, our immediate priority is on getting the right productivity levels out of our sales force. As previously mentioned, we're testing a number of lead gen solutions that we believe will improve our customer acquisition costs and, at the same time, putting more focus on client experience.

International revenue was up 14% over Q2 of the last year on a constant currency basis, which is positive but does represent a slower growth rate than we have been posting historically. The combined Australia and New Zealand market has always been our largest international market. It represented 18% of revenue this quarter. While it remains a very good market for us, Q2 revenues were somewhat adversely impacted by poorer sales performance, exacerbated by poor retention on our display product where we are now improving the effectiveness of our inventory. However, we have a great team running this business, who have consistently performed, and we continue to see this territory as a strong market opportunity for us. Our launches of ReachEdge and ReachSEO in Australia, while early, are being well received and I am confident we can reaccelerate our growth here as we build out a stronger product lineup.

Next, let's cover Europe. As we mentioned on the last call, we had some challenges, particularly in the U.K. and Germany, which caused greater client and sales force attrition. The good news is that we've now built out a really strong team. Our new European leader has been on the ground for 6 months and brings a wealth of experience from our Australian business. We also have added to the roster a great Head of European Sales and new Country Managers for both the U.K. and for Germany. We're seeing some signs of stabilization in the U.K., and we're excited by the upcoming launch of ReachEdge in that market this quarter.

Finally, Latin America. Our performance here is strong. Brazil, one of our newer markets, is already on a $7 million run rate, and after 18 months in the market, we have over 400 clients, and our average Brazilian client is spending $1,500 for campaign cycle, which we consider to be a very solid result for an emerging market.

So with that overview, I'd now like to turn it over to Ross for a deeper look into our financials.

Ross G. Landsbaum

Thank you, Sharon. Let's turn to a discussion of our results for the second quarter ended June 30, 2014. All comparisons are to the quarter ended June 30, 2013, unless I state otherwise. As noted in our earnings release, we are defining North America to continue to include only the U.S. and Canada. Mexico, along with all other markets in which we do business, are included in the international [indiscernible] for the purpose of our discussions and reporting.

Revenue for the second quarter of 2014 was $123.6 million, down 3% or 2% on an FX constant basis. Direct local revenue for the second quarter was $97.2 million, down 4% or 3% on an FX constant basis. Excluding the revenues from SureFire, which were previously classified as NBAR revenue, direct local revenue declined by 6%. The realignment of our North American outside direct local sales force impacted our sales productivity and customer retention last quarter and was the primary driver of North American direct local revenue declining 16% and 2% versus the first quarter. The impact of the realignment will continue to weigh heavily on us through the balance of the year.

Direct local represented 79% of total quarterly revenue, reflecting a decline of 4% as a result of the challenges in this channel in North America. Revenue from the NBAR channel grew to $26.4 million in the second quarter, up 3%. The increase in NBAR was due to growth in a number of international agencies and resellers, partially offset by a decrease in the number of international and national brands clients. Revenue from agencies and resellers grew by 11%, and national brands declined by 7%.

Excluding the revenues from SureFire in the prior period, which are now classified as direct local revenue, NBAR grew by 8%. Agencies and resellers grew by 21%, a growth channel we see as important to us as we broaden our product portfolio and look to reduce our cost of acquisition.

On a regional front, overall, North America revenue declined by 11% to $77 million, but was stable relative to the first quarter of 2014. And international revenue for the second quarter grew to $46.6 million, up 14% or 15% on an FX constant basis. As a percentage of revenue, international now represents 38% of total revenue, up by 560 basis points.

Moving on to [indiscernible] to drive revenue, we ended Q2 with 34,600 Active Product Units, down 1% and 23,200 active clients, down 2%. Included in the Active Product Units are approximately 1,400 running ReachEdge units, plus the initial subscriptions to our newest product, ReachSEO. The number of product units per client remain flat at 1.5 and the average quarterly revenue per client was approximately $5,225, and as in the prior quarter, includes approximately 550 ReachEdge only clients, which have a lower average sales price.

Cost of revenue for the quarter was $63.5 million or 51.4% of revenue compared to 50.2% of revenue. This increase was primarily due to an increase in service and support costs and the change in our geographic product and service mix, partially offset by improved media buy-in [ph] efficiencies and an increase in publisher rebates. The increase in service and support cost was principally in support of new products and expansion in our international markets to address continued growth. Publisher rebates as a percentage of revenue was flat at 4% of revenue compared to 4.1%. As previously announced, in June, we entered into a new global agreement with Google. The new agreement provides rebates based on overall global growth of our spending with Google as opposed to the commitments to enter new markets and market-specific growth targets in the recently concluded agreement. While this new agreement provides us with sought after operating flexibility, given our recent operating performance and our current operating expectations, we expect rebates from Google to decline during the second half of 2014, reducing total rebates for the remainder of the year. Under the arrangement, when we return to more normalized growth, our rebates should return to levels consistent with prior periods.

Sales and marketing expense for the quarter was $48.1 million, or 39% of revenue compared to 35.6% of revenue. We continue to see the impact of the increase in salaries and fixed cost as a result of changing our compensation structure in North American Direct Local. The increase is partially offset by a decrease in commission expense as a percentage of revenue from 10.3% to 8.6% due to a decrease in sales activity, a change in North American commission rates and a higher percentage of revenue from our international channel, for which we have historically paid lower commissions.

Product and technology expenses totaled $6.8 million or 5.5% of revenue and are net of $3.7 million of cost capitalized. This compares to $5.3 million in expenses or 4.1% of revenue, which was net of $3.1 million of cost capitalized. The increase was attributable to $2.2 million increase, primarily due to increased salaries and compensation expense as a result of increased headcount related to the ongoing development of our technology platform and new product initiatives. The increase was partially offset by a $0.6 million increase in capitalization.

General and administrative expenses for Q2 were $14.5 million or 11.8% of revenue, an increase from 7.6% of revenue compared to the prior year. The increase was primarily due to a $2.5 million increase in legal fees, contingencies and bad debt accruals related to one of our international markets, a $1.3 million increase in employee-related costs and a $0.6 million increase in stock-based compensation expense. As Sharon noted, we are continuing to evaluate the operations of the business with a view towards returning to revenue growth and enhancing long-term profitability. In addition to opportunities in product and go-to-market strategies, we are also addressing efficiencies that can be taken. To that end, we took an additional restructuring charge of $2.2 million related to a workforce reduction and resizing of some of our North American real estate footprint in this quarter, bringing the total restructuring charge to $4.1 million [ph] year-to-date. As a result of the actions taken today, we have eliminated roughly $10 million of annual run rate OpEx from the business. We expect additional charges over the course of 2014 as we continue to assess our business.

For Q2, we reported an adjusted EBITDA loss of $1.9 million or a negative 1.5% of revenue, down from the adjusted EBITDA of $9.1 million or 7.1% of revenue. The decline is primarily due to lower business performance, which is generally attributable to our challenges in North America. We finished the quarter with cash and cash equivalents and short-term investments totaling $64.5 million and 29,152,000 shares outstanding.

Now, let's turn to our business outlook. The next quarter will be weighed down by both the lower productivity we experienced in the first half of the year and the normal seasonality of our business. In line with Sharon's comments, we continue to take aggressive actions throughout 2014 to reshape the business to deliver better growth and a profitable business in 2015. In line with the priorities that Sharon has laid out, we have launched a number of work streams to address issues caused by the North American sales force realignment and towards accelerating our product pipeline and our moves towards profitability in all of our international regions. All of these actions require investment and focus. As we get our go-to-market approach in order, including our work streams on lead gen [indiscernible] drive more efficient client acquisitions, we are looking at revenues which might not be profitable in the near term. While all of these activities benefit the mid- to long-term [indiscernible] of the business, we are expecting them to further constrain our growth for the rest of the year. This, combined with the additional investment to address the priorities Sharon laid out, will result in pressure on adjusted EBITDA as well. Therefore, our outlook for Q3 is revenue in the range of $116 million to $121 million and adjusted EBITDA in the range of a loss of $4 million to $7 million.

In order to maintain maximum flexibility during the transitional period, we will only provide a quarterly outlook. Accordingly, our prior full year outlook is withdrawn.

With that, let me turn the call back to Sharon.

Sharon T. Rowlands

Okay. Thank you very much, Ross. I strongly believe that a great company needs 2 main ingredients: great talent and great products that have a strong value proposition for the client. Our product strategy is focused on building out ReachEdge as a simple, innovative, 360-degree total digital marketing system for local businesses. Our product team to date has made good progress in developing ReachEdge, which includes the following key capabilities: a best-in-class lead gen and marketing automation tool; capture analytics and conversion tools; a smart website designed to maximize lead gen and optimize across desktop and mobile platforms; and seamless integration into our leading digital media solutions, including search, display, SEO and chat. We intend to accelerate investments to make it even more robust and differentiated, including building on our current mobile and social offerings.

We're already seeing proof points of the success of this strategy. So let me tell you about a client that recently joined us in northern California, a full service plumbing contractor, who serves residential customers in the Bay Area. This client wanted to grow his business and needed an integrated digital marketing system. We provided him a total solution with ReachEdge at its core. We gave him every product we have, including a smart website, search engine advertising, display advertising, retargeting services and online chat. And as a result of ReachEdge's holistic analytics and convert software, he was able to improve his advertising performance and lower his customer acquisition cost. Indeed, this client has seen a 200% increase in customer leads, including a 73% increase in calls since moving from a competitor in February of 2014. This is just one of the many examples of how the total digital marketing solution of ReachEdge is revolutionizing the performance of our clients' business.

In summary, before moving on to take your questions, I firmly believe that the focus we have on the priorities that I've laid out will result in an accelerated sales growth, will improve client retention and increase ARPU [ph] and ultimately drive a better margin business, creating shareholder value. We're aggressively managing change at ReachLocal that will set the stage for a return to stronger growth and profitability in the future.

We'd now like to open up the call to your questions, and so I'd like to hand back to the operator.

Question-and-Answer Session


[Operator Instructions] And we'll first take Douglas Anmuth with JPMorgan.

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

It's Diana on for Doug Anmuth. I just wanted to get a little bit more information. You said training was an integral part of some of the return to growth for the North America sales force realignment. Can you talk about what specifically is changing with the sales force and kind of any points that you can point to for why you're having [ph] confidence it will still within the 9- to 12-month range?

Sharon T. Rowlands

All right, okay. I think -- thank you for that question. I think it really gets to the heart of a key issue for us, which is what are we doing to improve things in North America. I'd like to start by -- I want to give you a very full answer here, so please bear with me. First of all, we've learned a number of things over the last few months related to the realignment, and that's all driving our activity. We've learned that a significant source of our business historically actually came from referrals. And we've lost a lot of that. We've learned how important the relationship of the seller was to the client and we've impacted that. We've learned that changing our compensation models focused on new business acquisition negatively impacted our focus on retention. And I think particularly important, we've learned that cold calling is a very expensive model with a field sales force. So given what we've learned, what we've done over the last 3 months is, first of all, focused on hiring the right people, and we believe we've now reached the appropriate level of headcount. However, that does mean we have a lot of inexperienced people on our sales force and that is impacting performance. Now, the things we are actually working on right now are, first of all, an aggressive training plan that I really think over the next 3 to 6 months will take that inexperienced group and ramp them up to the right level of market, product, knowledge to be able to do an effective job in the field. So we see that as a 3 to 6 month time frame. Secondly, this quarter, we've adjusted our compensation plans to properly incentivize the sales teams around referrals, win backs, a TCB-based [ph] selling rather than a focus on units. The next step for us, and this is really critical, is to really focus on lead gen and provide our sales team with quality leads to pursue, which we really believe will bring down the cost of acquisition for us. So during Q3, we'll be testing various lead gen activities, including radio, as well as new processes and tools using data and analytics to do a better job of getting the right lead to the right salesperson at the right time to really enhance conversion. We're also testing a number of pricing and product bundling models to get efficiency and higher ARPU out of the sales process. And then particularly for ReachEdge, over the second half of the year, our plan is to decouple the software from the website in order to expand our addressable market. Now, we have tight management of all these work streams. We are working through them in a highly analytical way with the right testing, with the ultimate goal of re-energizing growth and a focus on the cost of acquisition as it relates to lifetime value. And our goal is to make enough progress on the execution of these work streams so that as we move into 2015, we are starting to get back to growth and profitability, which is in line with the time frame that we've laid out to you.


We'll take our next question from Jason Mitchell with Bank of America Merrill Lynch.

Jason Mitchell - BofA Merrill Lynch, Research Division

This is Jason here for Nat. I just kind of wondered if you could elaborate a little bit more on ReachEdge. I think you mentioned that you're rolling it out to Australia. What kind of barriers do you have or what kind of barriers do you need to overcome when you roll that out into an international market? And just a second ago, you decoupling ReachEdge from the website. What kind of work needs to go into that to make that happen? And then just finally, maybe I missed it on the call, but did you have an update on how the German market's going?

Sharon T. Rowlands

Yes. So we'll take all of those one by one. Okay. So in terms of rolling out to a new market, there is development effort involved with really creating the right template, the right format, spelling, et cetera in the rollout to a new language -- to a new country. That work is being completed for Australia and we've been live for a couple of months there, and I'm very pleased with the progress that we're seeing with ReachEdge. We're in beta test right now in the U.K. and we'll go live with ReachEdge in that market within October. So we're starting to get to a good place in terms of how to systematize the expansion and rollout in new markets. The decoupling is going to be really important for us, not just to expand the addressable market in North America but actually to expand the addressable market globally. Essentially, at the moment, in order for a client to get our ReachEdge marketing automation system, because if you think about that's what ReachEdge is. It's a marketing automation software solution, they also have to take the ReachEdge website. So the addressable market we have is for clients that want to change their website. We typically know that SMBs change their website every 3 to 4 years. So if they don't want to change their website, that is a barrier to us selling ReachEdge into that client. By decoupling ReachEdge from our website, that will mean if the client needs or wants a new website, we can sell the full package, but it also means we'll be able to sell ReachEdge onto an existing client's website and also through other website partners. So that will expand the addressable market. It will also make it easier for us to launch into multi new countries faster. It isn't a huge amount of work, but it actually will probably take us most of the second half of this year to get the work done, to test the work, and we expect to be live with the decoupled version as we move into the start of 2015. As far as Germany specifically is concerned, we are still seeing growth in that market. I think we identified for you, some of the challenges we had in that market really were to do with the maturing of the business as it scaled and weaker leadership that had really led to poor hiring practices, resulting in extremely high turnover in our sales force. We're feeling much more comfortable that we have built out the right leadership. We have a great new Head of European Sales. We have hired a very experienced new Head of Germany that will be starting at the end of August, and we feel very confident that as we sort of look out over the next 6 to 9 months, Germany is capable of being a very large and very successful market for us.


The next question comes from Piper Jaffray, Gene Munster.

Charles Eugene Munster - Piper Jaffray Companies, Research Division

You had mentioned that lead gen is an important part of kind of increasing the number of leads. How much in getting the word out, whether it's through television or radio and getting -- increasing the awareness of what you're doing? Can you talk a little bit about, if you look at the next chapter, how much of it is, if you're going to put like percentages on this, is increasing awareness? How much would be changes to the sales force and how much is still left in terms of the Edge product, refining the product, decoupling it? Is that is 1/3 for each or how should we think about those 3 factors?

Sharon T. Rowlands

Well, I think, you hit on my 3 priorities, right, really getting our product road-mapped, going in the right direction of building on the successes we have, getting the right sales force model and really driving marketing and sort of like lead gen. It's hard to put percentages on those, because frankly, they all work together and a part of the puzzle is us getting to the right place. And so we're really driving them in parallel and frankly, analyzing and testing as we go and reiterating. Particularly around marketing and lead gen, I'm really glad you phrased the question in the way that you did, because ReachLocal historically has put very little investment into, if you like, getting the word out, building the brand, building awareness. And that has been exposed by the transition in our North American sales force because what we're now seeing is having to get productivity from a pure cold calling model just takes too much activity and too much expense to get the right customer acquisition. So what we're doing over Q3 is we're going to be testing lead gen and the lead gen will be a combination of creating awareness but firstly, with calls to action that actually will generate trials and warm leads for us then to apply the sales force against. And as we see which of those lead gen processes are working, we'll then start to scale and build upon them. And my belief is that by investing more in marketing and lead gen, we will drive significant increase in productivity off of the same number of sales heads that we have today, which will then bring down our customer acquisition cost dramatically. So that really is how the way I see it, and we're really morphing all these things in parallel right now. Does that make sense?

Charles Eugene Munster - Piper Jaffray Companies, Research Division

It does. And on the sales force side, can you -- I know you've touched on it, but can you recap in terms of how you're thinking about the changes to the sales force going forward? You said that feet-on-the-street is more expensive. Does that basically imply that you're going to shift entirely or partially over [indiscernible] sales or any sort of feedback in terms of how you see that evolving would be helpful.

Sharon T. Rowlands

Yes. So what I would say is we actually believe the feet-on-the-street model is actually a core part of our value proposition and frankly, highly differentiated. One of the interesting things that really came through in the client research that we did is that clients really value expertise and, in particular, are looking for help getting the job done. So I believe that for a higher value product where we're really looking at a very high ARPU, a little bit like that plumber client I described to you about earlier, that's a client that's going to spending anywhere between a $5,000 to $8,000 a month ARPU with us that's going to be a long-term client that we're going to keep for many, many years. Applying a feet-on-the-street model to that segment of the client base actually is very effective and strongly differentiated. So we really see the model being lead gen, e-commerce for if you like some of our smaller bundles that could just be bought online that are tasters [ph], to leveraging our telesales with smaller clients and also doing more lead qualification and then using our really experienced people in the field to really convert these higher value prospects and ultimately give us a total return. So it really is the balancing of all those models together.


And at this time, we have no further questions. I'd like to turn the conference back over to management for any additional or closing remarks.

Sharon T. Rowlands

Okay, thank you. Well, listen, I think those 3 questions we had were completely spot on. So thank you very much for that. I appreciate you all dialing in to the call today.

In terms of ending, I really would like to highlight for you that ReachLocal operates in a very large, growing and attractive market. I think given the tactical challenges we're facing, it's very easy to forget that. Our focus over the second half of this year is ensuring we make substantial progress in fixing some of our execution issues, as well as enhancing our strategic position with great product and improved client experience and an effective go-to-market model. We already have a stronger management team and are taking the right steps to revitalize ReachLocal and ensure that in 2015, we can show you growth, improved profitability and value creation. Thank you.


Once again, that does conclude today's conference. Thank you for your participation.

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