Endurance International Group Holdings Incorporated (NASDAQ:EIGI)
Q2 2016 Earnings Conference Call
August 02, 2016 08:00 AM ET
Angela White - VP, IR
Hari Ravichandran - Founder & CEO
Marc Montagner - CFO
Jason Helfstein - Oppenheimer
Stephen Ju - Credit Suisse
Brian Fitzgerald - Jefferies
Heath Terry - Goldman Sachs
Gregg Moskowitz - Cowen
Gray Powell - Wells Fargo Securities
Deepak Mathivanan - Deutsche Bank
Arun Seshadri - Credit Suisse
Good day, ladies and gentlemen and welcome to the Second Quarter 2016 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today’s conference Miss. Angela White, Vice President of Investor Relations. Ma’am you may begin.
Thanks Elaina. Good morning everyone, it’s my pleasure to welcome you to our second quarter 2016 earnings call. First we’ll go through some prepared remarks after which we’ll turn to Q&A. We have prepared a presentation to accompany our comments which is available at the Investor Relations section of our Web site at ir.endurance.com. While not necessary to follow along, we recommend referencing the presentation slides alongside our prepared remarks. As is customary, let me now read the safe harbor statement.
Statements made on today's call will include forward‐looking statements about Enduranc’s future expectations, plans and prospects. All such forward‐looking statements are subject to risks and uncertainties. Please refer to the cautionary language in today's earnings release and to our Form 10‐Q filed with the SEC on May 09, 2016 for a discussion of the risks and uncertainties that could cause our actual results to be materially different from those contemplated in these forward‐looking statements. Endurance does not assume any obligation to update any forward‐looking statements.
During this call, we will reference several non‐GAAP financial measures, including revised and previous adjusted EBITDA, free cash flow, adjusted revenue, and average revenue per subscriber. A reconciliation of these non‐GAAP financial measures to the most directly comparable GAAP measures is available in the presentation located in the investor relations section of our Web site. In addition, please note that references to year‐over‐year pro forma growth refer to our pro‐forma results as if we had owned Constant Contact for all of Q2 2015.
With that, I will turn you over to Hari Ravichandran, our Founder & CEO.
Thanks Angela. For people following along with slides, I’m on Slide 4. Good morning everyone, and welcome to our second quarter 2016 earnings call. Our Q2 results reflected continued growth in revenue and adjusted EBITDA. GAAP revenue was $290.7 million. GAAP net loss was 33.4 million, and GAAP cash from operations was 53.8 million. Adjusted EBITDA was $76.9 million, and free cash flow was 41.6 million. I would like to highlight that starting this quarter, our adjusted EBITDA is based on a revised definition, which Marc will discuss on Slide 9. Overall, we continue to focus on opportunities ahead of us, which we believe will fortify our position as a leader in the online small business marketing space for years to come. Our year-over-year pro forma revenue growth was 6%, and pro forma adjusted EBITDA growth was 13%. This reflects healthy growth as we progress toward a longer‐term vision.
Slide 5. Our plan for 2016 was to invest in expanding our addressable market and deploy more marketing spend into growth products, while maintaining marketing spend at 2015 levels in our core hosting brands. The plan was based on key initiatives which we believe will drive our longer‐term strategic and financial goals.
Our flagship business, which includes brands such as Bluehost, Hostgator, and iPage, continues to deliver strong free cash flow for the Company. Due to the scale and maturity of both our business and the hosting space generally, our top-line growth has come down in this business. In order to maintain an overall healthy growth rate into the future, our strategy has been focused on extending our reach and bringing subscribers to platform through new gateway products such as site builder.
Additionally with the acquisition of Constant Contact earlier this year, we added an important product set as we expand our solutions to other adjacencies targeted at small businesses. First, starting with Constant Contact, the business delivered better than expected results during the quarter. Profitability was higher than expected as integration progressed ahead of plan. Upon acquisition of Constant Contact, we made the deliberate decision to run this business for steady, but slower, top-line growth. We continue to take this approach, and we see excellent lifetime value trends for Constant Contact subscribers.
We will continue to invest behind this brand for sustained contribution both strategically and financially over the long-term. In our flagship business, our 2016 marketing plan called for flat spend relative to 2015. Given the larger base of subscribers, this leads to a lower‐growth core business in which the bulk of gross subscriber additions serves to replenish the natural churn of the business. Our 2016 plan in this core business is to focus more on retention programs, while maintaining the same level of investment in order to maximize free cash flow. We see attractive average revenue per subscriber opportunities overtime and consistent yields in this business, and it continues to drive scale and opportunity to fund investments for the future.
Turning now to our gateway products, which include our site builder product as well as others in the portfolio. This year, our new investments have focused primarily on this set of products, for example, in 2016 we expect a drag of $40 million to our previously defined adjusted EBITDA from channel spend alone. Strategically, these products expand our subscriber funnel and reach. Financially, we expect these products to drive future growth and profitability. Through the first half of the year, as we ramped marketing in these newer products, subscriber acquisition costs and initial churn were higher than expected. As we sought to balance investment yields within this portfolio, our decisions resulted in sub‐optimal contribution and greater than expected spend in H1.
We expect the second half of the year to be a period of transition to more calibrated marketing spend. We continue to believe these products are an important component of our overall strategy and will continue to refine our efforts. We are streamlining operations and teams responsible for managing our growth portfolio, and in July, we consolidated most of these products into one entity and increased our ownership in WZ UK, Ltd. to 86.4%. We believe this will provide us more central management for this portfolio as it scales.
Another initiative supporting our efforts for longer‐term growth and expansion of our gateway products is the integration of the AppMachine and Webzai teams as we continue to focus on product strategy. Subsequent to quarter end, we purchased the remaining equity in AppMachine BV, the Dutch developer of mobile app solutions from which our Impress.ly site builder was developed.
In 2014, we made an initial investment of $15.2 million for 40% of the company. In July, we purchased the remaining 60% for $22.5 million, payable over a four year period. The fiscal 2016 payment is approximately $5.5 million. With this acquisition, we will combine Webzai development with the team in Holland. We believe these are best in class developers for these innovative products, and combining will only enhance our capabilities.
Slide 6. The impact of our lower than expected returns on marketing investment in our growth products in H1 will have a negative impact to H2 and our full year guidance. We believe that H2 will be a transition period as we work to balance our marketing spend and yields across the entire portfolio. We expect to provide more visibility into 2017 by the end of the year. Despite the disappointment of lowering our expectations in the near‐term, we are pleased at the progress we are making overall to fortify Endurance.
While it’s too early to provide detail on 2017, for the remainder of the year we expect to continue to refine and realign our marketing plans. We see steady performance and contribution from our flagship brands, which allow us to fuel investment in our growth brands. Over the longer‐term, we expect these growth brands to provide increasing contribution to profit as well as drive top-line growth. Constant Contact has exceeded our expectations, which contributes additional flexibility in our investment decisions. All of this supports our long‐term strategic vision in addition to financial returns. Our efforts combine to provide opportunity for continued growth in adjusted EBITDA and strong free cash flow generation. Whether to fund repayment of debt, invest in the future, or other uses, we believe our focus and execution will provide flexibility in our capital allocation decisions.
Slide 7, we continue to see much opportunity for Endurance businesses, and as I think about our accomplishments and efforts, I am pleased with the steps we are taking toward our path from a hosting provider to becoming a platform for online solutions. We continue work towards a future in which we serve SMBs through a seamless experience, enabled by an integrated platform, irrespective of the product or service through which they come to us.
With that, I will turn the call over to Marc Montagner, our Chief Financial Officer.
Thank you Hari. Slide 9. Before I review second quarter results, I’d like to review important changes in our disclosed metrics. In light of the SEC communication to all issuers in its Compliance and Disclosure Interpretations issued on May ’17, and in an effort to simplify some of our non‐GAAP measures, starting in the second quarter, we will be making changes to the non‐GAAP financial information that we report. As noted here on Slide 9, we will make the following changes starting in the second quarter.
One, we will only report and refer to GAAP revenue instead of adjusted revenue. Two, ARPS will now be based on GAAP revenue versus adjusted revenue. Three, in our revised adjusted EBITDA definition, we will no longer add back changes in deferred revenue. We will also include the negative impact of the following items which were previously excluded. Integration expenses, legal advisory expense, the impact of the reduced fair value of deferred domain registration costs, and a gain or loss on sale of assets and four now, in our revised adjusted EBITDA definition, we will continue to exclude the impact of share based compensation, transaction expenses, restructuring expenses, gain or loss of unconsolidated entities, and impairment charges.
For the second quarter only, we will provide both the previous metrics and the revised metrics. In addition to these changes, going forward we will provide a calculation of bank adjusted EBITDA as defined in our credit agreement. Please also refer to our appendix slides where we have provided reconciliations for the updated definitions.
Slide 1. In the second quarter, GAAP revenue was $290.7 million, reflecting 6% growth year over year versus pro forma second quarter 2015. Adjusted EBITDA was 76.9 million reflecting 13% growth year over year versus pro forma second quarter 2015. Based on our previous definition, adjusted EBITDA was 93.8 million. The difference between adjusted EBITDA and our previously defined adjusted EBITDA consisted of approximately $11.9 million in net change in deferred revenue, $4 million in integration expense, 1.5 million in legal advisory expense, a 0.3 million impact on the reduced fair value of domain registration costs and a $0.2 million gain on sale of assets.
Slide 11. On a reported basis, GAAP cash flow from operations was 53.8 million, reflecting growth of 17% versus second quarter 2015. CapEx was 12.3 million, or 4.2% of GAAP revenue, and free cash flow grew 10% year-over-year from second quarter 2015 to $41.6 million. Slide 12 shows GAAP revenue and adjusted EBITDA for the last eight quarters. Again, please refer to the appendix for reconciliation to our previous adjusted EBITDA numbers. We’ll show you historical financial data in order to facilitate an apples-to-apples comparison.
On Slide 13, you can see that our total subscriber number increased by approximately 35,000 subscribers from first quarter to the second quarter 2016. We are seeing lower increases primarily as a function of marketing decisions related to our growth brands and the associated lower than expected marketing returns. As we recalibrate marketing efforts, we expect lower to flat net subscriber increases through the remainder of the year.
On a combined company basis, average revenue per subscriber ARPS for the second quarter was $17.74. ARPS for standalone Endurance was 13.32 and Constant Contact also 56.68. Drivers of the decrease in standalone ARPS year-over-year include product mix shift and lower contribution to revenue from co‐marketing funds and domain monetization. As we look at the different components of revenue, during second quarter, hosting services and add‐ons such as security, mobile optimization, and e‐commerce integration now represent approximately 48% of our revenue. Email marketing accounts for approximately 33%, domain registrations approximately 13%, and the remainder of the business, such as domain monetization and co‐marketing funds, accounts for approximately 6%.
Slide 14. Now that we have reviewed our financial and operating metrics, let’s turn to our updated guidance for 2016. We are presenting our guidance for full year 2016 on a closing date basis, with Constant Contact results included since February 10, 2016, the day after the closing. We are also presenting guidance on a combined pro forma basis, as if the Constant Contact acquisition had closed on January 01, 2016. This guidance assumes no incremental M&A. Our updated guidance includes our change in outlook, as well as the impact of our move to GAAP revenue and the changes in our definition of adjusted EBITDA. Going forward, our guidance will be based on GAAP revenue, adjusted EBITDA under our revised definition, and free cash flow defined as operating cash flows less CapEx and capitalized leases. For full year 2016, on a closing date basis, we now expect the following.
One starting with our original adjusted revenue guidance, we are reducing our outlook by approximately 60 million from 1.175 billion to 1.115 billion. Our move to GAAP revenue guidance reduces this further by approximately 25 million for purchase accounting and other adjustments. Our updated guidance now calls for GAAP revenue of approximately $1.090 million. Two for adjusted EBITDA, our original guidance, based on our previous definition, was $400 million. Expectations to original guidance are lowered to $370 million. After eliminating items no longer a part of our adjusted EBITDA definition, our adjusted EBITDA expectation is approximately $270 million for 2016. Free cash flow, defined as GAAP cash flow from operations, less CapEx and capitalized leases, is now expected to be approximately $100 million.
Note that this figure reflects the negative impact on free cash flow of approximately $65 million in transaction expenses, integration expense, legal advisory expenses, and restructuring expenses. The majority of which are associated with the Constant Contact transaction. Free cash flow excluding these expenses would be approximately 165 million for 2016, which will setup a healthy run rate for 2017.
Slide 15, looking at guidance on a combined pro forma basis. One, after the reduction in outlook of approximately $60 million to adjusted revenue and changes due to purchase accounting and the timing of the close of the Constant Contact transaction, we now expect pro forma GAAP revenue of $1.130 million. Our implied adjusted revenue growth rate from 2015 to 2016 is now reduced to approximately 5% versus prior expectation of 10%.
Three, our previous adjusted EBITDA expectations are lowered by $30 million to 375 million for $405 million. After reduction related to our revised definition of adjusted EBITDA, we now expect adjusted EBITDA of $275 million on a pro forma basis. For 2016, the items no longer including in our revised definition lead to a difference of approximately 25% between adjusted EBITDA of $275 million and our previous adjusted EBITDA. Overtime, we expect this difference to trend to the lower teens.
Slide 16, we ended the quarter with $2.078 million in total senior debt. Including other deferred obligations and capital leases, total debt at the end of the period was $2.139 million. We finished second quarter 2016 with approximately $79 million of cash on the balance sheet, including restricted cash. During the second quarter 2016, we paid down approximately $25 million of our senior secured debt.
Slide 17. Going forward we will provide our investors with a calculation of bank adjusted EBITDA as defined in our credit agreement. Our senior debt covenants are based on last 12 month bank adjusted EBITDA, which in the second quarter was $398.7 million. Our senior debt leverage ratio was 4.2 turns bank adjusted EBITDA at the end of the second quarter. We remain well below our maximum allowed leverage of 6.5 turns. Our focus is still on delevering our balance sheet and using our free cash flow to pay down our debt.
In conclusion, we continue to balance near and long-term goals. Our updated guidance calls for a strong year, and we continue to make investments for the future of the company. Increasing free cash flow is a priority. Our free cash flow guidance for 2016, excluding the transaction expense, integration expense, legal expenses and restructuring expenses, is expected to be approximately 165 million, establishing a strong run rate for the future.
Now I would like to turn the call back to Hari for a few closing comments.
Thanks Marc. We look at the business over a multi‐year period, and as such, have placed importance on continuing to invest toward sustainable growth. We expect revenue of over $1 billion this year, and with almost 5.5 million subscribers, we’ve reached considerable scale, which allows us to drive significant free cash flow generation. We believe that our investment decisions this year, as in the past, will augment our position in the marketplace and fortify our foundation. We are proud of our continued efforts to build a long‐standing business and provide valuable solutions to help small businesses as they grow.
Thank you for listening today, and now I’ll turn the call back to the operator to begin Q&A.
[Operator Instructions] And our first question comes from the line of Jason Helfstein with Oppenheimer. Your line is now open.
Thanks. So just a housekeeping, and then I’ll go into the business. So what is the difference between the bank definition of EBITDA and now the new company definition of EBITDA to make the regulators happy? Just more can you just go over that the different between the bank definition and now the new EBITDA definition?
Sure. In the bank definition a few items to note. Obviously that allows for the change in deferred revenue to be added back, which was in our previous definition of EBITDA, which is no longer in place. It also looks at things on a TTM basis, which then sets -- thinks back for the last 12 months. Integration and one-time expenses can be added back and realize both synergies can be added back, which is not the case in the new definition. So those are the major items that creates that difference Jason.
Okay. And we look at the business, so if I’m doing the math right on the non-Constant Contact subs were up 2% quarter-to-quarter and 14% year-over-year. Is that math what you guys have?
In terms of peeling off the 500,000 or so Constant Contact subscriber safe into those…?
Yes. We don’t have that handily in front of us, but if you took it off and did the math and that’s where it’s coming out, it’s probably pretty close yes it is, , actually Angela is telling me it is 40% correct yes.
Okay. So but then obviously ARPU just doing this math, if I am doing this right, ARPU looks like because we got to do like adjusted versus [Multiple Speakers]. Yes. So let’s get into like into the ARPU. How much of that is promotional pricing versus change in mix, versus whether it’s what they’re buying or is it shifts to longer term plans. I want to understand the drivers in that ARPU change?
Sure. There is multiple elements there Jason. The first thing is obviously as we are investing dollars behind these growth gateways is that I think we mentioned on the call that just the drag on channel spend alone this year around a lot of growth gateways is almost $40 million of an impact to EBITDA. The subscribers that are coming on-board from that, typically tend to be at lower pricing as we enter a lot of these product categories and it takes some time for those to get aligned. So that’s one major contributor. The second one I would say is promotional pricing, though I don’t believe that’s been much more or much less than in another quarter. So whatever the typical drag there is we still have that, the third thing to also keep in mind is there are a couple of areas of our business especially around domain monetization and co-marketing funds, which we disclosed is about 6% of our total revenues at this point, which are areas that we invest less so behind anymore. So there is an impact to average revenue per sub as that line of business starts to sort of not grow as quickly as it did in the past.
And then just lastly, a big picture question we saw stellar results from VICS 50% organic growthish, we’ll get results that of GoDaddy tonight but I might sense that they can be pretty good. I mean just given that they are like where 2 to 3 years from now, you want the company to fit in, in the ecosystem where VICS is going after the SMB, do it yourself suite. We have GoDaddy that seems to be going after businesses who want more support et cetera. How do you ultimately see Endurance like the niche for Endurance?
Sure, so the way we think about where we fit in the ecosystem is obviously there is the DIY segment of the market where VICS has been very strong as you point out. There is sort of the do it for me or do it with me segment where GoDaddy is very strong. We probably fit closer to the do it with me segment with a lot of investments behind do it yourself as well, especially the investment behind Webzai, the consolidation of that asset, the product getting more and more ramped up. But if you were to think about where Endurance fits in the ecosystem, it’s still leading with products that don’t specifically index towards domain led which is where GoDaddy tends to have a very strong presence. We tend to be with hosting and other subscription services such as Constant Contact for email marketing, that are more deeply embedded with the subscriber base, the starting average revenue per user on a lot of these products tend to be higher.
We want to continue to focus in that segment, while at the same time realizing and acknowledging that at the scale we’re at now with the size of funnel we have in the front-end continuing to simply acre on hosting as the only opportunity to bring customers on-board. We don’t see that as an opportunity that can scale at the levels we’d like for it to scale out over the next 3 to 5 years. So we continue to keep making investments and alternative product gateways that can bring on-board high quality subscribers that we think will become part of our platform. And as we get these products to work better, simplify our business down, prune our product portfolios et cetera we think we can drive much higher user satisfaction and much better user economics as we refine and get these subscribers on-boarded via high quality products in the front-end.
And our next question comes from the line of Stephen Ju with Credit Suisse. Your line is now open.
Hi guys. I think on Page 14, you guys present a bridge from how you got to the old previous definition of EBITDA to the current one. I was wondering if you can provide a bridge for free cash flow from the 140 to 150 to the current 100 as well. Thanks?
Sure, I think at a high level the previous definition of free cash flow was OCF minus CapEx and capitalized leases. That still continues to look the same, obviously we’re going from the 170 million to 180 million guide to now the 165 million that we’re referencing here. The delta there is integration expenses, a one-time expenses, which is the majority of it, which include two big items. One is the fees that we pat to the bankers that is part of that 65 million. The second one was acceleration of options, that we had to do as part of the Constant Contact transaction. The majority of that 65 million are those two items and obviously those are one-time expenses that we would not anticipate seeing going into next year, as they were related to the Constant Contact transaction.
And our next question comes from the line of Brian Fitzgerald with Jefferies. Your line is now open.
Thanks. Hari you highlight growth products came in below expectations with higher marketing cost. Were those impacts evenly seen across Webzai and Impress.ly and then on the gateway products. Any dynamic to call out differentiating traction across your suite of gateway products? Thanks.
Sure. As the majority of investment in the first and second quarter have been around the Webzai the builder product, while we’ve gotten good scale on that product, what we’re seeing is in the channel, the starting point for caustic wire, is starting high and the amount of time it’s taking for it to come down is a little longer than we thought. At the scale we’re at those tend to add up fairly quickly in terms of drag to EBITDA. So when we think about sort of the balancing of short-term and longer term growth, we made a pretty conservative decision internally to continue the investment track, which I think drives better value for the business in the future.
When we look at the early returns in terms of Webzai customers, we see that the churn profiles are somewhat consistent with hosting customers. We see that pricing power might be somewhat similar as well. And as we add more additional products for subscribers to leverage off of our Webzai platform, we see a lot of optimism there as well. But given the fact that we don’t have pay or rather the way that we go out to market is even the affiliate channel. When we first start out, you have to pretty much acquire all customers until you build up a base, since you’re basically paying to buy the customers. Whereas things like hosting, where we’ve been in that market from many years, we have a halo and we have user referrals that send a lot of traffic to those brands. It just takes some time for those to build up within the builder brand. But we think that the profile of customers has been really good and we want to continue to keep investing behind the builder brands, which we think adds a good amount of traction down the road.
Got it. Thank you.
And our next question comes from the line of Heath Terry with Goldman Sachs. Your line is now open.
Great. Thanks. Hari, I was wondering, if you could dig a little bit into your comments around ROI more I know, you touched on a little bit and so the specific brands there. But is that cost to on-board that you referenced. Is that a function of the price of advertising being driven off, is it a function of lower conversion rates from the advertising that you’re buying. Can you give us a sense of what’s driving that? And I guess how you get comfortable with the idea that this isn’t sort of a permanent decrease to the ROI either because of the level of penetration you’ve gotten in the segment or the more competitive environment that you’re seeing that Jason referenced?
Sure happy to Heath. So I think the first thing we look at when we sort of enter these channels is to see if we can actually generate volume of traffic from the affiliate channel on to our builder brand. So with the builder brands we’ve now been in that market a little bit over a year I think in the last February, March is when we started getting to that market. We’ve had good success with volume, we feel good about that. The way that we get the traffic is again through the affiliate channel where it’s a CPA model you effectively pay for success versus paying for clicks or paying for something that may not convert into a customer. So that’s still working well, we still think that the marginal cost of bringing a customer on-board with something like Webzai is consistent if not better than the marginal customer that we can bring on-board with hosting. So those are all good metrics.
Where we’ve experienced some challenges has been where the pricing has started in the channel in terms of what we’re actually paying to affiliates upfront. And the amount of halo that gets created as you get more volume to drive word of mouth referrals has taken a bit longer and so as a result where you end up seeing the challenges is the starting point of the cost to acquire the SAC and the ramp down of that SAC to a lower number, over a period of time has taken longer as well. So the combination of those two things then puts the company in a position to look at the returns you’re getting from these subscribers, what does the churn profile look like now that we’ve had some time to look at the data over the last year and then trying to make a decision as to whether or not that’s money good going forward in terms of continuing to make investments behind it. We’re of the view point that it’s still very accretive returns for us it’s a lot of opportunity for growth. It’s just starting a little higher and taking a little while longer which is making the time we can balance our in year returns a bit and try to figure out how to keep investing behind it.
Got it. And as you look at the balance sheet and sort of the appetite that you’ve got for incremental M&A I know you said the guidance doesn’t necessarily include it but how much will M&A be part of your strategy to reaccelerate growth and get ARPU moving back in the right direction?
From our viewpoint, as we think about the next couple of years, we think that the highest sort of and best use of capital is to delever the business. So we would like to continue to take all our free cash flow that we are generating and spending as much of it as possible to bring our debt levels down. As a private company, we’ve had leverage levels that have been well North of 5.5 turns and the company generates enough free cash flow to support the debt and that net of the debt payment still generates a good amount of free cash flow which gives us comfort but it’s a public company we believe it’s prudent and also a good use of capital given sort of the -- where the balance sheet is at this point we are going to continue to keep paying down debt. So we will still continue to look at M&A opportunistically but the bar is very high and we’re internally of the viewpoint that we stay the course in terms of delevering the business and that helps derisk the equity profile of the business.
Great, thank you.
And our next question comes from the line of Gregg Moskowitz with Cowen & Company. Your line is now open.
Okay, thank you and good morning guys. I apologize if I missed it but I didn’t hear any comments on MRR, can you update us on how that looked this quarter?
Sure. I think last quarter, we said that we would not be using the MRR metric and the big reason for that Gregg is because the churn in Constant Contact historically, if you look at the data has been negative meaning that their ARPU has been significantly higher. So as we integrate quarter-over-quarter. And since the MRR incorporates both subscriber churn and increase in revenue per user, we think that may not be a measure that sort of reflects sort of everything that’s happening in the business as we get bigger. We are still contemplating internally about the right set of operating metrics that we can provide to investors in the future and as we have updates, we can provide you some.
And I guess just a bit of a follow-up on the ROI question that Heath was asking. And you referenced raising the 40 million channel spend alone with respect to some of the gateway products. But given the lower yield on investment that you saw this quarter. Are you able to put a finer point on how much you’re going to collaborate that marketing spend over the balance of the year?
Sure. I think our updated guidance does do that. Because what we look at again it’s not simply 2016, but we look at the horizon of the company across ’17, ’18, ’19, ’20, ’21 and when we think about where to make the right investments, the trade-offs are always generating cash flow presently versus investing in the business towards driving good growth in the business in the future as well. So the $40 million, it’s again not a spend it’s actually a direct drag to the previously defined EBITDA number.
To the old EBITDA.
To the old EBITDA definition for the business. And there when we look at the returns on it obviously we think that quite carefully and as we think about the marketing yields on these. Our viewpoint is things that drive high IRR over the next three to five years versus just presently is the calculus we go through. And with the data we have so far, we feel pretty comfortable that the returns that we’ll get on the incremental marketing spend we’ll pay off in future years.
Okay. Thanks. And one, last one if I could. Just the earnings release as referencing 9% downward adjustment to your subscriber account due to some classification changes. I had some of your changes to that subscriber account were right sized last quarter after the Constant Contact deal closed. Just wondering if you could walk through what caused this incremental adjustment and if you think you are indeed right sized going forward? Thanks.
Sorry. So the downward adjustment are, I think it was I don’t believe it was adjustment but it was some -- across our platform. As we find accounts that basically start to fit our definition of subscriber does always true ups, it’s always been part of our business, where we have it up or down a bit. But I don’t think it was a meaningful number and so it’s about 3,000 or so is what I’m being told, 3,000 subscribers.
Your next question is from the line of the Gray Powell with Wells Fargo. Your line is now open.
Great. Thanks for taking the questions. I had just a few here if I may. So you breakout hosting and related add-ons at about 48% revenue in the presentation. Can you talk about the mix between hosting and the add-ons and how we should think of the growth of those two components?
The majority of them tend to be and hosting again on 1.90 billion or so I think if about half of it I am just doing rough math here is about 0.5 billion or so. A lion share that would be hosting and the rest of it would be add-on products and services. The add-on products and services does tend to grow faster than the core hosting element and I don’t have that breakout exactly in front of me since we don’t unnecessarily look at it that way because we think of it as one kit of revenue basically, Gray.
Understood, okay. And then I just want to follow-up on a prior question. So on Slide 14, you just you have the different bridges and you have the free cash flow guidance going from 140 to 150 the updated guidance of 100 million. So obviously EBITDA is down $30 million, CapEx is unchanged, are the free cash flow numbers apples-to-apples or is there something that I am missing in terms of [Multiple Speakers].
There is also transaction expenses, so there were 2 numbers that we provided at the beginning of the year. Gray one was the 170 million to 180 million of guidance basically inclusive of all the transaction expenses. The equivalent of that now is $165 million basically; there is about $65 million of adjustments that are related to integration expenses, realizing the synergies which were ahead of plan on for Constant Contact. It’s the banker fees, it’s the stock option acceleration, it’s all of those onetime items basically.
Okay. So like another way to think about it is EBITDA is gone down but maybe there is like an offset?
Free cash flow against the 170 to 180 is holding much more steady correct.
Okay. All right, cool. Thank you.
And our next question is from the line of Deepak Mathivanan with Deutsche Bank. Your line is now open.
Thanks guys. Two questions, first again on the EBITDA reduction consistent with your prior definition. So what is the breakdown between the core hosting versus lower yield on products like site builder it seems like the 40 million number is pretty sizeable considering all the size of products like website builder et cetera. And then the second question I have is also somewhat related to Jason’s question from earlier. Are you seeing lower demand from competition due to the site building guys like VICS et cetera that’s probably impacting the demand for hosting products. Can you address the growth profile and churn rates for the hosting asset specifically maybe in the last couple of quarters? Thanks.
Sure, I’m happy to do it. So let me take the second one first Deepak. So when we looked at the funnel that we have, right so I am just going to do some rough math, so you have 5 million customers and I think in 2014 we gave you the subscriber churn number which was say 20%. So is about a million or so subscribers that you churn. We’ve spent the same amount of dollars this year on hosting marketing as we did last year except our base is much bigger. So what we’re seeing is the subscriber acquisition costs are very steady inside those things we see that the funnel is bringing in the same level of customers that we’ve always had. However, as the base is bigger, just a lot of large numbers ends up that the growth rate starts to slowdown because you’re bringing in the same number of customers and losing more because your current base is larger.
So the level of competition we’re seeing in hosting has been consistent with the past years, just with the incremental scale as we look at marginal dollars and where to put our money to work looking forward, we see that the subscriber acquisition cost on a marginal basis for hosting is high because there is just only so much you could expend inside that segment of products. And so at our scale, we think it’s prudent to continue to invest behind alternative gateways, other ways to bring customers on-board and the $40 million of burn that we talked about were across the site builder product, Impress.ly product and a variety of other growth gateways that we keep experimenting with though the majority of that is around the builder product at this point. And that’s primarily because you’re starting from scratch there where effectively you didn’t have gateways inside that segment before and as we get ramped up there, that is typically what we’ve seen the affiliate channel is subscriber acquisition costs are high on the front-end and that overtime they start to come down as your mix of word of mouth and halo customers start to come in at that increasing rates overtime. And that’s the part that we’re saying that is starting high and it’s taking a little longer, which is part of the impact for our current year returns.
Okay. Got it. That makes sense. One housekeeping question finally. What is the revenue run rate for AppMachine for the back half given the consolidation and are they profitable on EBITDA basis at all? Thanks guys.
Hari K. Ravichandran
They are not profitable on an EBITDA basis and there is I mean less than $1 million. It is very, very small.
Got it. Okay. Thank you.
So both on Webzai, which when we acquired that asset that had $0 of revenue and as we acquired the product as again, it’s acquiring both developers and the platform that’s allowing us to integrate the Webzai product with the Impress.ly product to come out with one state-of-the-art builder product basically as we get out in the market.
[Operator Instructions] And our next question comes from the line of Arun Seshadri with Credit Suisse. Your line is now open.
Yes. Hi guys. Thanks for taking my question. First, I wanted to ask with the exchanges that you’ve made to your non-GAAP reporting metrics, as well as EBITDA and free cash flow. What is your outlook in terms of the SEC subpoena and related investigation and do you expect to sort of see them kind of say something formalized regarding this?
Arun so the two sort of separate issues. The C&DI that came from the SEC was for all public companies that are required to make changes. And we took that into consideration as we kind of looked at the rest of the year and going forward, trying to give investors a transparent, but simple view of the business that is consistent with what the SEC asking of us, which is, us and every other public company. But separate then obviously the two SEC subpoenas where in the midst of one through Constant Contact and one for Endurance on its own. That process continues to move forward. We are providing them and incorporating with them and giving them the documents and information that they’re looking for.
We have no further update in terms of timing, but as we go through the year. We continue to keep refining, a lot of the or the SEC subpoena keeps refining their focus more and more and as we mentioned in the last call, the focus has primarily just been around non-GAAP metrics and nothing around the financials. So the process moves on and as we have more info on that we’d be happy to provide that as we get it.
Okay. Great. Thank you. And then as far as the cost savings go the 65 million integration cost savings. Are those largely complete now, just wanted to understand how much was in the Q2 numbers and if there is sort of additional savings that you’re looking at?
So to breakout the 65 million, it’s not all cost savings or synergies a lion share of it are the two one-time expenses which are basically $30 million plus of fees that we paid as part of the transaction and acceleration of stock for Constant Contact. There is some integration expenses that are in that $65 million number and legal expenses that are one-off related to the deal. However, a large portion of the synergies for Constant Contact have at this point been realized, there are as we kind of mentioned in the last call. We had anticipated about $25 million of realized synergies over the course of this year and we’re ahead of pace on that as things stand right now.
There is a few factors to consider there on the high yield side obviously with the loan agreement there is a basket for buyback which is about 120 or so million dollars in total. So within that limit we have the ability to buyback if the company feels so that is the best use of capital. On the term loan, we have to weigh the maturity data for term loan the first tranche of it and whether or not there is good returns to the company by paying that down in a prepayment mode. So we tend to look at the best things that delever the company while at the same time the best return to investors in either buying back the high yield or paying down the term loan and those are the factors that go into trying to figure out where the dollars would be spent. As of right now, I think that in the second quarter we paid about $25 million towards the term loan.
And that is all the time we have for questions. I would now like to turn the call back over to Mr. Hari Ravichandran with any closing remarks.
Thanks everyone for joining the call this morning. As we think about the short-term and long-term view of the business, we believe we’ve taken the right steps here and we’re balancing the business towards long-term growth. We’ll work hard in the second half of the year and in future years and believe we’re taking all the right steps and focusing the company towards the longer term view. I appreciate the time today and look forward to talking soon.
Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program, you may now disconnect. Everyone have a great day.
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