Web.com Group Inc. (NASDAQ:WEB)
Q2 2016 Earnings Conference Call
August 4, 2016 17:00 ET
Ira Berger - Vice President, Investor Relations
David Brown - Chairman and Chief Executive Officer
Kevin Carney - Chief Financial Officer
Matthew Thornton - SunTrust
Deepak Mathivanan - Deutsche Bank
Sam Kemp - Piper Jaffray
Andrew Bruckner - RBC Capital Markets
Hamed Khorsand - BWS Financial
Good day and welcome to Web.com’s Second Quarter 2016 Earnings Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Ira Berger, Vice President of Investor Relations. Please go ahead.
Good afternoon and thank you for joining us today to review Web.com’s second quarter 2016 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, believes, will, going, begin, see, plan, continue, guidance, outlook, project, intend, estimate 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 annual report on Form 10-K for the year ended December 31, 2015, and our quarterly report on Form 10-Q for the quarter ended March 31,2016, for more information on these risks and uncertainties and our limitations that apply to our forward-looking statements. Web.com expressly disclaims 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?
Thank you, Ira and thank you all for joining us on the call. In our prepared remarks, I will start with an overview of our business performance and strategy, then Kevin will finish with a detailed financial review and update to our guidance for the third quarter and full year.
Turning to our business highlights, for the second quarter this year, we outperformed against our non-GAAP net income and EPS guidance, while non-GAAP revenue was consistent with our expectations. Value-added digital marketing solutions continue to contribute to our top line growth and now makes up a majority of our business. It is also the fastest growing component of our revenue. This quarter represents the first full quarter with Yodle in our results and I want to start with three important points about the acquisition.
First, our experience has reinforced our conviction that Yodle is a strong, strategic fit for Web.com and accelerates our positioning as the leading provider of value-added digital marketing solutions for small business. In particular, we are encouraged by the growth opportunities associated with the vertical market products and multi-location channel. In fact, to further advance our vertical market strategy, during the quarter we completed a tuck-in acquisition of the assets of TORCHx, an online marketing solution for residential real estate sales professionals. Second, we are both ahead of schedule on realizing the synergies we previously discussed and we have identified additional savings beyond our original target. We now expect to realize $32 million in synergies in our first year of ownership. Third, in bringing our two companies together, we have made a shift in our integration strategy and are putting increased emphasis on taking advantage of our complementary strengths to improve the sales and operational efficiency and customer value, satisfaction and ultimately, retention of our customers.
An important aspect of this change was recently announced – was the recently announced organizational realignment, which is focused on providing clear leadership in the areas of the business where we expect to drive faster growth over time as well as the parts of the business which we have previously discussed are more mature and are under competitive pressure. Taking all this into account, we remain on track to deliver significant profitability in 2016 that is consistent with the previous guidance we shared with you. However, we expect to get there with a modest reduction in sales and marketing from what we originally thought and therefore higher profit margins on a near-term revenue outlook that we have moderated. We believe that this short-term moderation in our growth outlook, while we take steps to improve efficiency and customer retention is the right long-term decision and will enhance our growth profile and profitability going forward.
On the cost side, we are experiencing faster synergy realization and we will prudently manage our expenses. In adjusting our cost structure to match our updated revenue outlook, we will continue to make the investments necessary to successfully execute on our growth initiatives. The expense reductions are in areas that are discretionary and variable in nature. 2016 was and remains a transition year for Web.com. Most important in our view is that everything we have seen in the months since closing the Yodle acquisition supports our thesis for this transaction, our strategic focus on value-added digital marketing solutions as well as the long-term financial profile of our combined operations. We are also confident the steps we are taking now to get the business aligned and optimized sets us up for improving growth and profitability.
As we look out to 2017, we are confident in the strong and growing free cash flow profile of our company. As a reminder, there is a lot going on in 2016 that is not reflective of the underlying and future run rate cash flows. In particular, there are deal-related expenses and working capital uses that are non-recurring this year as well as only partial benefits of the cost synergies compared to a full year of full run rate cost savings in 2017. As we focus on synergies and efficiencies and building upon our foundation for long-term growth, Web.com continues to be a strong cash generator during this transition year. This gives us the flexibility to drive shareholder value in multiple ways. During the quarter, we paid down $20 million of debt, repurchased $5.7 million of stock and acquired the assets of TORCHx. Looking ahead, we intend to continue our emphasis on de-leveraging in the near-term.
Turning to our summary of results for the second quarter, non-GAAP revenue of $193.9 million grew 1% on a pro forma basis and it was in line with our guidance range of $192.5 million to $195.5 million. We had a solid quarter in our value-added services solutions highlighted by positive momentum from our investments in our Feet on The Street and brand network channels, as well as good progress in Leads by Web and our vertical-specific products. This was partially offset by a decline in DIY due to our proactive decision to reduce resources in this area based on the lower returns in that competitive market. I will provide additional color around the size and growth of our various product areas later in my remarks.
From a profitability perspective, we delivered a strong earnings quarter. Non-GAAP net income was $31.5 million, which was above our guidance range of $29 million to $31 million. Non-GAAP EPS of $0.62 also exceeded the high end of our guidance range of $0.57 million to $0.61. We generated adjusted EBITDA of $42.7 million, which equates to a 22% adjusted EBITDA margin. In the second quarter, we generated $26.4 million of free cash flow, which included $1 million of Yodle deal and integration costs, approximately $3 million in higher cash interest versus last year related to the additional debt we took on to finance the acquisition and $4 million of Yodle working capital changes that are non-recurring.
Turning to our operating metrics, we added approximately 20,000 net new subscribers in the second quarter, bringing our total subscriber base to 3,443,000. Our trailing 12-month customer retention was 86.5%, which is down sequentially. As expected, the inclusion of Yodle had a modestly unfavorable impact on our retention metric. Relative to our large base of domain subscribers, Yodle’s products are higher churn, which we view as an opportunity for improvement. This quarter, we will begin providing you with new reporting for our business around three major product categories: value-added services, domains and DIY. We believe this additional information will provide greater insight into the success of our strategy to become the leading provider of value-added digital marketing services.
Let me provide a brief overview of each product grouping. Value-added solutions is the growth engine for Web.com and it is where we are the most differentiated. It makes up more than half of our revenue today and is our fastest growing product group. Products in this area of our business take a domain or basic website and increase their business value by making sure they are found and include tools that drive customer engagement and interaction. Key products that are contributing to our growth in this area include Do-It-For-Me websites, Leads by Web, our brand network platform and vertical market solutions. Domains are the next largest group, comprising over one-third of our revenue. While down slightly year-to-date, the domain business is profitable for us and serves as a quality lead generation engine to cross-sell our value-added services. We are disciplined in this market and make comparatively low investments in our domain business.
As we have discussed in the past, this is a mature part of our business and one where it can be competitive to acquire customers. Over time, we have shifted acquisition dollars towards our VAS products with better returns. We still invest in this area to acquire new customers, but less than in the past. Our main focus is on maintaining stability in this group and optimizing product growth and profitability of the existing base of customers through several initiatives to sell additional domain products and services to current subscribers.
DIY accounts for a little more than 10% of our revenue and predominantly includes DIY websites and hosting, which we have indicated for several quarters now, is a very competitive and increasingly commoditized market. We have reduced, but not abandoned our investment in this area. Our efforts in this space are focused on retention and maintaining a presence to acquire the right type of new customers as well as have this as an option in our up-sell path. The declines in this business are not unexpected based on our shift in marketing resources and are a reflection of our disciplined investment in capital allocation approach.
Overall, on a pro forma basis, revenue grew 1%, driven by a 7% increase in value-added services offset by a 13% decline in DIY and 2% decline in domains. For the year, on a pro forma basis, we expect overall low single-digit revenue growth with rates of change by product group in the back half of the year to trend at similar rates as the first half of the year.
Our strategic vision is to be the premier provider of value-added digital marketing services to small businesses. Small businesses need more than a domain and website to succeed online today. They need solutions that enable them to be found and engage with existing and new customers. Further, they need someone to help them find and implement the solutions that are right for them. This growing market need is aligned with who Web.com has always been and the purchase of Yodle greatly expands our ability to serve this market.
Let me highlight specific areas that make our strategy unique. The first is how we deliver our products and services. We help small businesses utilize technology to be successful online. Since no small business is the same, we engage with them to understand their needs to find the right solution. We then implement that solution for them, which is very distinct and unique compared to others who take a DIY-centric approach to small businesses. Importantly, we provide this hands-on, high-touch service at scale and low cost, which makes it affordable for small businesses and profitable for Web.com. Second, we specialize in online marketing, making sure small businesses are found and can interact and engage with their existing and potential customers in a way that drives business growth and better performance. To that end, we have a large portfolio of marketing solutions available depending on a customer’s needs and maturity. Third, we have a suite of vertical market products that are designed to assist specific market segments in engaging, interacting and transacting with their prospects and customers. These high-value products have high retention because they become operationally embedded in the day-to-day running of a customer’s business.
Before getting into the Yodle integration, I will provide more detail around the multi-location and vertical market opportunity. There are over 750,000 franchise locations in the U.S. and we had identified this as a key growth opportunity over 1 year ago. Yodle had done the same, but was well ahead of us, having built a $60 million business with a robust product and organization behind it. Franchisors and franchisees must work together effectively, but have different operating needs. The multi-location product bridges these two business partners’ requirements with a collaborative solution that provides actionable business intelligence for franchisees to manage their local online marketing presence and campaigns, while at the same time giving franchisors the tools they need to oversee the network and evaluate each location’s performance. This has historically been an underserved market and we believe there is room for growth, not only from adding new franchisors, but growing existing customers. Growing our existing customer relationships happens in two ways: one, additional spending from current locations and two, adding new locations within a network.
Vertical market products address specific industry needs, which means, they deliver more value to customers than mass-market solutions. Our products help small businesses more effectively manage their time and relationships with clients. They are integrated into other management systems and provide functions that are used to run the business on a daily basis, resulting in high ARPU and high-retention products. There are a large number of small business verticals with a very fragmented set of competitors in many verticals. We will continue to evaluate opportunities in this space, but real estate was one of the top ones in our list and we are pleased to have acquired TORCHx.
TORCHx is a provider of digital marketing solutions for the realtor and real estate brokerage community. With about 2 million active real estate agents in the U.S., there is a significant market opportunity to provide these entrepreneurs with a robust cloud-based application that provides lead generation and CRM capabilities in order to grow and manage their business. This investment is about acquiring a software asset that we can scale by leveraging our technology platform and large sales organization. It also dramatically speeds our time to market versus building internally. The acquisition of Yodle and most recently, TORCHx, has greatly expanded our vertical offerings and this is a key area of investment for us going forward. We will continue to look for other opportunities to add additional verticals to our suite of products.
Now, turning to the integration of Yodle, I want to touch on three areas: cost synergies, the new organization structure and the combination of Leads by Web with local Max. We are pleased with the progress we are making on the cost side in terms of momentum and the total amount of cost savings. For the quarter, we realized $1.3 million in synergies, and now we estimate we will achieve $32 million of run-rate synergies by the end of Q1 2017. During the quarter, we began migrating functions to Argentina and in the third quarter, we expect to do the same in Canada. We will continue to look to leverage lower cost geographies.
As part of our revamped organizational structure, we now have dedicated teams focused on the individual customer needs that our various product offerings address. Each of our three product leaders, brand networks, premium services and retail domains, is accountable for product development, sales and fulfillment in their areas. In implementing this new organization structure as part of the overall integration process, we realized it was critical to take a hard look at our product positioning and features and our sales and operating processes. Our goal is to operate more efficiently and improve customer satisfaction and retention. Meaningful changes like this take time to absorb, but they are important and put us in a strong position to drive profitable growth over the long-term.
Finally, we have talked about leveraging the best of Leads by Web and the Yodle platform. Through our testing, we validated an opportunity to utilize the Leads by Web product on the Yodle fulfillment platform, which we believe will reduce our cost and implementation time. In addition, we have expanded our Feet on the Street sales force with sales of this product and we have seen good success in our test lab with the Yodle inside sales resources marketing the Leads by Web product.
In summary, Web.com is making good progress on our strategic initiatives in 2016. We still have more work to do to achieve our objectives, but we remain very confident the steps we are taking in 2016 will pay off in the future. At the same time, our increased scale, strong balance sheet and cash flow generation provide ample opportunity to use our financial resources to drive additional shareholder value. It’s an exciting time at Web.com and I look forward to sharing our progress with you in coming quarters.
With that, Kevin will provide more detail behind the numbers. Kevin?
Thank you, David. Let me begin with a review of our financial results for the second quarter and then I will finish with our updated guidance for the third quarter and full year of 2016.
Beginning with the second quarter P&L, non-GAAP revenue was $193.9 million, which excludes the $6 million impact of the purchase accounting fair value adjustment to deferred revenue in the quarter. On a reported basis, non-GAAP revenue was up 38% year-over-year, and on a pro forma basis, had we owned Yodle in the second quarter of both 2015 and 2016, non-GAAP revenue would have been up 1%. Yodle and Web.com’s value-added services performed well during the quarter and as anticipated, DIY proved to be a headwind in the quarter as we continue to shift our marketing dollars away from DIY to value-added services channels and products with higher returns.
ARPU in the second quarter was $18.66, which was up $3.56 from last quarter and $4.75 from the same time last year. The increase in ARPU was driven by the positive impact from Yodle’s high-ARPU subscribers and in line with our expectations. For Q1, Yodle had a partial period impact on ARPU, and in Q2 Yodle revenue was reflected in ARPU for the full quarter. As we commented last quarter, we continue to focus on the value-added services product category, which we expect to result in lower volumes, but stable to slightly improving ARPU. We ended the quarter with approximately 3.4 million subscribers, which was an increase of approximately 20,000 from the first quarter of 2016. Looking ahead, we continue to target quarterly net adds to be between 10,000 to 15,000.
Turning to profitability, we generated $134.5 million in non-GAAP gross profit for the second quarter, representing a gross margin of 69%, which is up from the same period last year and from the prior quarter, primarily due to the greater mix of higher gross margin Yodle products. Our second quarter non-GAAP income from operations was $37.3 million, representing a 19% non-GAAP operating margin. This compares to a 23% margin last quarter and 25% a year ago. The sequential decline was anticipated and is due to lower operating margins of Yodle. We generated non-GAAP net income of $31.5 million or $0.62 per diluted share. This was above the high end of our non-GAAP net income guidance range of $29 million to $31 million and exceeded the high end of our non-GAAP EPS guidance range of $0.57 to $0.61 per share. Moving on, our adjusted EBITDA was $42.7 million for the second quarter, representing an adjusted EBITDA margin of 22%, reflecting the expected impact from Yodle.
Turning to our GAAP results for the second quarter, revenue was $187.8 million. Gross profit was $128.1 million. Income from operations was $7.6 million. Net loss was $1.6 million and net loss per share was $0.03. GAAP results for 2016 are impacted by the Yodle acquisition. In particular, we incurred higher interest expense, had a $3.9 million reduction in revenue due to purchase price accounting adjustments and additional amortization of intangibles.
In terms of cash flow, we generated $30.8 million of operating cash flow in the second quarter, which was down from $45.5 million in the same period 1 year ago. Higher interest expense, deal-related costs and changes in working capital were the main contributors to the decline in cash flow. As David mentioned, we had approximately $4 million of the working capital uses that were related to conforming Yodle’s payment practices with Web.com’s. The remainder of the working capital changes were primarily a result of timing and in the range of what we experienced in our business. Capital expenditures in the quarter were $4.5 million, which led to $26.4 million of free cash flow. This compares to $41.2 million in the same period 1 year ago, in which there were capital expenditures of $4.3 million.
Moving to the balance sheet, unrestricted cash and investments were $9 million at the end of the second quarter, which compared to $12 million at the end of the first quarter. We ended the quarter with a total debt balance of $738.8 million. This includes paying down $20 million of debt during the quarter. We are very comfortable with our current leverage levels given the amount of free cash flow we generate and our intention to use that free cash flow to de-lever over time.
I am pleased to report that our commitment to de-leveraging will result in a lower cost of capital for the company. Specifically, we will see a 50 basis point reduction in the interest rate on our revolver and term loan from LIBOR plus 300 to LIBOR plus 250 basis points. The lower interest rate will be effective August 10. As it relates to our share repurchase program, during the second quarter we repurchased 335,000 shares for $5.7 million. Through June 30, 2016, we have repurchased 4 million shares for $78.3 million since the board approved a $100 million buyback authorization in November of 2014. We will continue our practice of prudently deploying capital with de-leveraging and the stock repurchase program remains in place with capacity.
With that, let me turn to our updated guidance. As David discussed earlier, we believe we remain on track to deliver against our prior guidance for non-GAAP profitability. However, we expect to do so with higher profit margins on a moderated revenue outlook. For the full year, we are now projecting non-GAAP revenue of $733 million to $740 million, down from our previous guidance range of $748 million to $763 million. As David discussed, we are slowing down some investments as we complete the integration of Yodle. For example, we are reducing our spending in sales and marketing while we reposition some of our products and redesign our sales processes. Also, while our pipeline remains robust, the launch states of a few of our multi-location deals have been delayed to accommodate customer priorities.
From a profitability perspective, we expect adjusted EBITDA margins of approximately 24% for the year, which is up from our prior projection of 23%. We are targeting non-GAAP net income in the range of $130.5 million to $135.5 million or $2.56 to $2.66 per diluted share. This assumes 51 million diluted shares outstanding. This compares to our prior guidance of non-GAAP net income between $125.5 million to $135.5 million or $2.44 to $2.64 per diluted share with 51.4 million diluted shares outstanding.
For the third quarter of 2016, we expect non-GAAP revenue in the range of $193 million to $195 million. We expect professional services revenue to be similar to 2Q 2016 levels. We anticipate EBITDA margins of approximately 24% and non-GAAP net income to be in the range of $32 million to $34 million or $0.63 to $0.67 per diluted share. This assumes 50.7 million diluted shares outstanding. Given our current NOL position, including the $71 million NOL acquired from Yodle, we now expect cash taxes to remain in the low single-digit range through 2018 with a step up after that. This compares favorably to our prior view of low single-digit cash taxes through 2017.
Free cash flow for the year should be around $100 million. The lower outlook on free cash flow is due to the following. First, lower gross profit due to our moderated revenue outlook partly offset by cash cost savings, resulting in a roughly $4 million decrease to cash flow. Second, the $4 million of non-recurring Yodle working capital uses we experienced in the second quarter. And third, we are now targeting capital expenditures closer to the high end of our 2% to 3% of revenue guidance range, which accounts for approximately $5 million of additional CapEx driven principally by the acceleration of cost synergy initiatives. For our share count, we do not take into consideration additional share repurchases, which would increase our EPS guidance.
Finally, going back to David’s opening comments about 2017 free cash flow, it’s important to note that 2016 free cash flow is impacted by one-time items, such as Yodle deal-related costs, cost to achieve synergies, increased cash interest expense and working capital impacts with only the partial benefit of related cost synergies. We understand investors are thinking about 2017, because 2016 is a transition year. As we look ahead to 2017 free cash flow, we would expect to see: one, the benefit of approximately $20 million of additional in-year cost synergies; two, a year-over-year improvement in working capital in the range of $20 million due to nonrecurring impacts in 2016 we have discussed, such as the funding of the $6 million Yodle letters of credit, the $4 million normalization of Yodle working capital and $10 million of other working capital timing differences. And third, a year-over-year increase of approximately $10 million due to the non-recurring deal related costs, severance, retention bonuses and other costs to achieve synergies. Also, we expect to realize the benefits of operating leverage as well as continued de-leveraging.
Finally, to better help investors understand our strategy and 2017 outlook we are planning to host an Investor Day later this year. In summary, 2016 was and remains a transition year for Web.com, as we integrate the Yodle acquisition. We have always believed in profitable growth and remain committed to balancing top line growth with bottom line results. And value added digital marketing solutions are now the majority and fastest growing part of our business and we believe we are well positioned to further leverage our differentiation and investment in this very large and attractive market.
With that, we would now like to take questions. Operator, if you could please begin the Q&A session.
Thank you, Mr. Carney, [Operator Instructions] And we will take our first question from Sterling Auty with JPMorgan. Mr. Auty, your line is open. [Operator Instructions] I hear no response, we will move on to Matthew Thornton with SunTrust.
Yes. Hi, good afternoon guys and thanks for the question. A couple if I could, I guess first, the gross margin in the quarter was a little better than I thought, I am just – I want to make sure there was nothing unusual in that number and if that’s a reasonable number to use on a go-forward basis. Secondly, just wondering if you had a monthly churn number that you could share with us? And then third, I guess Kevin, the non-GAAP EPS guidance update for the year, I heard the high end being $2.66, could you repeat the low end? Thank you.
Absolutely, so this is Kevin. First, on the gross margin question, I would say that nothing unusual there. We are right in line with our expectations and certainly up from where it’s been historically and we had expected that with the combination with Yodle, given that their gross margins were north of 70%. And then let me take the last part of your question. I think on the non-GAAP EPS, just to reiterate the guidance for the full year, our non-GAAP EPS $2.56 to $2.66.
And Matt on the monthly churn number, as we indicated, churn was up slightly on a monthly basis in this quarter, principally reflecting the full addition of Yodle to our mix, which we had indicated in previous – when we bought the company, and last quarter we expected to have happened.
And is that a number you guys will continue to report and is there a number you can offer or how do we think about that?
We shifted to a – a few quarters ago, we shifted to a 12-month, basically look back retention report really to – in response to investor commentary. So we kind of have discontinued providing that. I think it’s something that we would be happy to get for you and provide.
Perfect. Thanks a lot guys. I will jump back in the queue.
Next we will hear from Deepak Mathivanan with Deutsche Bank.
Hi guys. Thanks. Two questions for me as well. So first, with respect to the revenue guidance reduction, can you elaborate what, which part of the business was contributing for us, I heard it’s due to the sales and marketing reductions with respect to Yodle integration, just if you could give some color on that, that would be helpful. And then you added 20,000 subscribers during the quarter, can you maybe parse out between the core business and the Yodle side, what contributed to it?
Sure. So on the revenue guidance, what we have essentially done – first off, we had strong performance in a number of our VAS areas. And we commented in our remarks that our Feet on The Street area, our Brand Networks area, our Leads by Web product, our vertical market area, all of those areas are performing well for us and growing nicely. But what we have indicated is that there is an opportunity for us to take a step back and use the historical strengths that Web brings to the table and that Yodle brings to the table. Web brings a long history of high customer satisfaction and high retention. And Yodle brings to the table some technology assets, and frankly, operating efficiency that we want to leverage. And we think it’s frankly wise right now to incorporate those two strengths into the value added services areas, so that we are not really spending money to bring customers in just to see them churn out at a higher rate than we are capable of providing. So when we – so we are to some extent, reducing our aggressiveness in ramping up sales resources and marketing resources while we make those fine tuning changes in the organization. So we have not lost anything. We will continue to be able to market into the marketplace, but we want to do it on the basis of a much stronger platform using our historical strengths. On subscribers, I would tell you that we continue to – in this quarter, we continued to see the historical mix of new subscribers coming in. So we continued to see domains, DIY, but we are increasingly focused on our VAS area. And as we commented, as we move in that direction, you are likely to see lower subscriber adds, but higher ARPU customers. And that’s really a focus for us going forward.
Okay. If I can squeeze in just one more, can you elaborate a little more on the profile of the TORCHx acquisition, maybe perhaps on how many customers they have and maybe the revenue contribution for the back half, which is in the guidance?
Yes. The way to think about this acquisition is it was an asset acquisition and it was specifically focused on software. We really were just trying to acquire a technology base that would speed up our go-to-market strategy here. So we really acquired very few customers and very little revenue, frankly, negligible revenue, under $1 million going in the remainder of the year, but enough customers for us to know that it hunts it works and frankly a very low churn or very high retention customer base. So it met some of the requirements that we had. Both from a quality of service and customer satisfaction, high retention and it also had all the technology components we were looking for, for a vertical market focused in the real estate area.
Great. Thanks David.
Our next question comes from Sam Kemp with Piper Jaffray.
Hi guys. Thanks for taking the question. Two, if I may, first, Feet on the Street, how important is that to your growth profile for the VAS segment, should we think of that as being a small part, a large part, etcetera, of your growth strategy there. And then separately, in terms of your product platform at this point, there is a lot of emphasis put on by your competitors in terms of channel integration, advertising tools, cloud infrastructure, etcetera, when you look at your product set, do you feel that you are in a good place or do you feel that there are products that still need to be built up? Thanks.
Yes. So the Feet on the Street program, we are excited about it. It’s performing very well in our company. It’s one of the growth drivers of the business right now. We are adding more resources into that area. It’s one of the areas that we are not slowing down in. And we will be adding more sales resources and continuing to ramp in that area. Having said that, it’s still relatively small, we commented previously that it’s still in the 100-plus sales resources. And I think we previously mentioned we will be adding something in the range of 30 more resources this year, most of those in the latter part the year. So it’s important to us as a growth driver. It’s also a new channel for us to evaluate things like selling vertical market solutions face to face. These are high ARPU products that require, in some cases, integration into a customer’s business. So our Feet on the Street channel, we think will be strategically very valuable going forward. And in the product space, I would say that we have a very, very broad array of marketing products, broader than most – frankly, any of the competitors that we are aware of, any of the large competitors, so we feel very comfortable that we have a good array of products today. We are frankly more interested in the enhancement of vertical market strategies that can make those products enhance someone’s business and frankly, beginning to operationally embed us into their business.
Okay. And then if I can follow-up with one more, in terms of the Yodle churn, should we think of that as mostly being related to the media side of the business or is it a mix of the media and the platform segments?
Yes. I think we have commented in the past that – yes, the media, the Max product was one of – certainly, one of the higher churning products and continues to contribute to the overall churn rate, but as we have said, an opportunity, a great opportunity for improvement there. And David commented on the Yodle, Max, Lead by Web combination and that is exactly what that initiative is focused on, is being able to leverage the platform within Yodle, but to apply some of the account management, etcetera, that Web has historically delivered, that drives a higher value and much better retention rate.
Andrew Bruckner with RBC Capital Markets has our next question.
Thank you. I am wondering if you can help de-pack a little bit the ARPU by VAS domains and DIY. And then also if you can talk a little bit about the shape of your marketing funnel then, how many of your customers, at a high level are coming from cross-selling versus digital advertising and how effective you think your brand advertising is? Thank you.
So let me start with the ARPU. So it’s probably the best way to maybe describe it for you is this. I think when you look at the VAS product category, clearly there is a spectrum. As David described, what we include in that, it’s everything from our Do-It-For-Me website fulfillment, which is in the 100 – just a little north of $100, all the way to our Leads by Web product, which is $1,000 a month ARPU. So you have got a broad range there. Domains, we have said historically and you know this is a very low ARPU product. And you would be thinking $2, in that range. And then finally DIY again, a little bit of a spectrum there, but high single-digits to mid kind of double-digit, depending upon what you are looking at there. I mean whether it’s a DIY account, just a hosting account or e-commerce DIY. So it’s clearly lower ARPU than VAS, but a good bit north of domains.
And in terms of the shape of customer adds and frankly, the channels that we use. There is somewhat of a change occurring in our business. We have historically used direct marketing and including online direct marketing, as a major source of acquiring subscribers, especially in the domain and the DIY space. But we have also always had a large sales force. And with the Yodle acquisition, we have added a very significant additional inside sales force. So at this point going forward, especially with respect to VAS, you are going to see that sales force become much more of an asset for us and much more of a differentiator for us, relative to a lot of the DIY players in the marketplace. It really uniquely puts us in a position to sell very sophisticated products and services that cost hundreds to thousands of dollars per month. And even our Feet on the Street channel is a differentiator for us because again, once you reach the $1,000 and up per month area, oftentimes you have to actually sit with someone and explain how it works and follow-up with them. So we think that, that mix of channels is moving more in the direction of our sales force, very significant inside, both inbound and outbound sales force, plus a present sales force.
Perfect. Thank you.
Next, we will hear from Hamed Khorsand with BWS Financial.
Hi, I think this is a follow-up from previous questions here. And during the commentary, you were talking about how domains are declining, how you are shifting away from DIY, but if I look at your guidance for the Q3 period, it feels like ARPU is declining when, in fact shouldn’t it go up because you are putting more emphasis on higher-ARPU products?
Yes. I think we would characterize our ARPU as very stable to slightly up over time. And so we wouldn’t want you to have the impression that we expect ARPU to go down. In fact, as we get fewer subscribers at the bottom of the funnel and more at the top of the funnel, that will tend to drive ARPU up in our business, but again stable to slightly improving.
Okay. But if I am looking at your guidance that you are giving and just being at the...?
Yes, let me – obviously, there is a range – this is Kevin. There is a range there. And so within the range, I think we would characterize it as David just said, which is stable to slightly improving over the second half of the year. I think the other thing to keep in mind is we have covered – talked about this a little bit in the past, the dynamic of – stuff that we just covered, kind of the ARPUs in the three categories VAS, hundreds to thousands domains too and DIY, while we think of it as lower ARPU still north, a good bit north of domains. And so as DIY is shrinking, that puts a little pressure on average ARPU, right, because the average is still, right, below 20. So there is a little bit of that going on. And as David said, we have kind of slowed a little bit here purposefully in the VAS side. But on balance, we expect as I said, stability to slightly improving, as you said, as the VAS accelerates.
Okay. And my last question is how much of the cost synergies will you realize this year?
Again, $32 million in total, we have said about $12 million in year benefits and we will gain another $20 million next year on a year-over-year basis.
[Operator Instructions] At this time, there are no further questions. I will turn the conference over to our presenters for any additional or closing comments.
Thank you all for joining us today to review our second quarter results and the outlook for our business. We appreciate your interest and look forward to speaking with you about our progress. We will be participating in the BWS and Deutsche Bank conferences during the quarter. As always, feel free to contact us here at Web.com if you have additional questions. Thank you and good night.
That does conclude today’s conference. Thank you for your participation. You may now disconnect.
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