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Edited Transcript of GRUB earnings conference call or presentation 27-Apr-17 2:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 GrubHub Inc Earnings Call

Chicago May 29, 2017 (Thomson StreetEvents) -- Edited Transcript of GrubHub Inc earnings conference call or presentation Thursday, April 27, 2017 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Adam J. DeWitt

GrubHub Inc. - CFO and Treasurer

* David Zaragoza

* Matthew M. Maloney

GrubHub Inc. - Founder, CEO, President and Director

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Conference Call Participants

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* Aaron Michael Kessler

Raymond James & Associates, Inc., Research Division - Senior Internet Analyst

* Brian Thomas Nowak

Morgan Stanley, Research Division - Research Analyst

* Heath P. Terry

Goldman Sachs Group Inc., Research Division - MD

* Jason Stuart Helfstein

Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst

* John Egbert

Stifel, Nicolaus & Company, Incorporated, Research Division - Associate

* Mark Alan May

Citigroup Inc, Research Division - Director and Senior Analyst

* Michael Patrick Graham

Canaccord Genuity Limited, Research Division - MD and Senior Equity Analyst

* Nathaniel Holmes Schindler

BofA Merrill Lynch, Research Division - Director

* Paul Judd Bieber

Crédit Suisse AG, Research Division - Director

* Ralph Edward Schackart

William Blair & Company L.L.C., Research Division - Partner and Technology Analyst

* Ronald Victor Josey

JMP Securities LLC, Research Division - MD and Senior Research Analyst

* Thomas Ferris Forte

Maxim Group LLC, Research Division - SVP, and Senior Consumer and Consumer Internet Analyst

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Presentation

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Operator [1]

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Good morning. My name is Jodie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Grubhub First Quarter 2017 Earnings Conference Call. (Operator Instructions)

David Zaragoza, Head of Investor Relations, you may begin your conference.

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David Zaragoza, [2]

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Good morning, everyone, and welcome to Grubhub's First Quarter of 2017 Earnings Call. I'm Dave Zaragoza, Head of Investor Relations, and joining me today to discuss Grubhub's results are our CEO, Matt Maloney; and our CFO, Adam DeWitt.

This conference call is available via webcast on the Investor Relations section of our website at investors.grubhub.com. In addition, we'll be referencing our press release, which has been filed as an exhibit to a current report on Form 8-K filed with the SEC.

I'd like to take this opportunity to remind you that during the course of this call, we will be making forward-looking statements, including guidance to our future performance. These forward-looking statements are made in reliance on the safe harbor provisions of the Securities and Exchange Act of 1934 as amended and are subject to substantial risks and uncertainties that may cause actual results to differ materially from those in these forward-looking statements.

For additional information concerning factors that could affect our financial results or cause actual results to differ materially, please refer to the cautionary statements included in our filings with the SEC, including the Risk Factors section of annual report on Form 10-K for the fiscal year ended December 31, 2016, filed with the SEC on February 28, 2017 and our quarterly report on Form 10-Q for the quarter ended March 31, 2017 that will be filed with the SEC. Our SEC filings are available electronically on our investor website at investors.grubhub.com or the EDGAR portion of the SEC website at www.sec.gov.

Also, I'd like to remind you that during the course of the call, we'll discuss non-GAAP financial measures in talking about our performance. Reconciliations to the most directly comparable GAAP financial measures are provided in the tables in the press release.

And now, I'll turn the call over to Matt Maloney, Grubhub's CEO.

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Matthew M. Maloney, GrubHub Inc. - Founder, CEO, President and Director [3]

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Good morning, everyone, and thanks for joining the call.

2017 is off to a strong start, and I'm excited to share our progress. Capitalizing on our business and product transformations in 2016, we've become more aggressive in showcasing our improved platform to a wider diner audience than ever before. Our product is the most engaging and personalized it's ever been. Our brand is resonating strongly with diners and our restaurant network is getting better in quality and quantity, most notably in Tier 2 markets.

The numbers speak for themselves. In the first quarter, we added more active diners in more restaurants than ever before. We sent $10 million in takeout orders to our more than 50,000 restaurant partners every day. We generated close to 40% year-over-year revenue growth and increased our EBITDA per order by 10%. We're capitalizing on the enormous market opportunity and we're excited about what's ahead of us.

Grubhub generated $156 million of net revenue in Q1 compared to $112 million last year. We saw our typical uptick in business in the first quarter even with some abnormally mild and dry weather patterns across the Northeast and Midwest. Chicago, for example, had no snow in January or February for the first time since weather has been tracked. Nonetheless, our growth was deep and broad. 28 of our markets generated more than 1,000 DAGs, up meaningfully from 22 in the fourth quarter of last year.

Net income was $17.7 million for the quarter, an increase of 78% from the prior year. Adjusted EBITDA was $43 million for the quarter, growing 32% year-over-year. Adjusted EBITDA per order was $1.46 (inaudible) per order in the prior year.

Over the course of last year, we have improved our delivery efficiency significantly, allowing us to invest in product and marketing while simultaneously increasing our profitability. These investments will drive growth in diners, orders and, ultimately, EBITDA.

We ended Q1 with 8.8 million active diners, growth of 26% versus the prior year. Our traction in Tier 2 and Tier 3 markets are strong, growing twice as fast as our Tier 1 diner base. This accelerating pace of diner growth was driven by our best quarter ever in active diner additions and highlights the success of our increased advertising in the first few months of the year as well as the opportunity ahead of us. Given our performance year-to-date, we are optimistic about our ability to continue this high level of advertising throughout 2017 while maintaining high ROIs.

We generated gross food sales of $898 million for our local restaurant partners in the quarter, an increase of 26% year-over-year. While adding new restaurants helps drive our gross food sales and diner growth, it also creates a rising tide that lifts all boats in our ecosystem, driving more orders to all of our restaurants. This network effect makes us an increasingly important partner to all our partners as the business grows.

Restaurants that have been on Grubhub for more than 2 years generated greater than 10% gross food sales growth year-over-year in Q1 of 2017. It's clear we provide a tremendous benefit to our restaurants, and we're pleased to be able to help them grow year-after-year. This is the reason that our nondelivery commission rates have gone up every year.

At the beginning of 2017, we spoke about our plan to invest more aggressively in advertising than we did last year. We've improved our product, our restaurant network and the overall diner experience. These improvements give us confidence that when we bring on more new diners outside of our Tier 1 markets, they are going to love what they see.

As planned, we ramped up our advertising in the first quarter. We were able to increase spend effectively within online channels that were leveraged in the past like search, social and a variety of other digital media. In addition, our improved restaurant network breadth enabled us to deploy broader-based offline media and still yield strong returns across markets.

Many of you have seen our national TV campaign over the past few months. Early results have been extremely positive, driving unaided brand awareness and new diner growth, primarily in key Tier 2 markets.

As our Tier 2 markets continue to grow, we can more effectively push out-of-home advertising on a market-specific basis as well. Our diners in New York, Chicago and the rest of our Tier 1 markets have always seen Seamless and Grubhub media around their cities. We're now at sufficient scale to extend that to a number of our Tier 2 markets.

We had great results from these efforts. In Q1, we accelerated active diner growth, posted our best quarter of organic diner net adds in the history of the company and cost per net new active diner was on par with the fourth quarter. Given this success, we will maintain a more aggressive stance on marketing and look for efficient opportunities to spin into this strength.

We also continue to make great strides in our restaurant network. After an outstanding fourth quarter, our sales force outperformed themselves yet again and recorded our highest quarter of restaurant additions ever. We are notching successes across the board. Not only did we add several exciting new chain partners over the past few months, including TGI Fridays, Chili's, Maggiano's and Rubio's Coastal Grill, but our existing partners continued to expand their coverage with us. After strong initial pilots, we're now supporting around 750 locations for SUBWAY, 50 for Red Robin Gourmet Burgers and over 100 for Buffalo Wild Wings and over 125 for Denny's. The chain momentum is great, but we've also continued our focus on adding local cult favorites that our diners love like The Meatball Shop in New York and Revival Food Hall in Chicago.

Our goal is to have exactly what each diner wants the moment they come to Grubhub, whether that's fast food, fast casual, full service or value price points or even a white tablecloth meal delivered to their door. We will have it all at the lowest possible price. We are already delivering on the promise of the most comprehensive takeout marketplace in the U.S. and we see a lot of opportunity to make it better.

On the product side, our team continues to be heads-down focused on anything and everything that can improve the diner experience and diner lifetime value. Our recent tests run the gamut from more complex projects like improving our short algorithm and beta testing the dietary tags, some of you have already noticed, to smaller and less noticeable changes like the positioning of fields in our checkout process or upselling diners on additional items. Our product team is also increasingly partnering with marketing to place the Grubhub ordering platform front and center for consumers however they want to engage with us, whether it's using Alexa Voice ordering on an Amazon device or by sending a gift card to a friend via iMessage for that special occasion.

Finally, on the operational side, we are moving quickly on streamlining our delivery operations and technology. We discussed last quarter that we will be consolidating our RDS platforms onto the Grubhub brand in 2017, and we're ahead of schedule. If any of you happen to have visited DiningIn, Restaurants on the Run, Delivered Dish or LAbite in the last few weeks, then you've noticed that those sites now link consumers through Grubhub for our UI restaurant network and lower diner-facing fees have the potential to increase ordering habits.

For the corporate clients of our acquired RDS brands, we are now offering what we've branded as Grubhub for Work. Focused on the small business portion of the corporate market that RDS has generally served, this product offers robust functionality around scheduled recurring orders, catering orders and customized group ordering. While in the very early stages, we will refine and grow this product over time to serve the broader overall SMB market nationwide.

We're excited by the progress we've made so far in 2017 in such a short period of time. All the teams here, from technology to marketing to delivery and product, are reinvigorated by our success and the large and growing opportunity in front of us. I look forward to giving you more updates on our success as the year rolls on.

And with that, I will hand it over to Adam, who will walk you through the financials and future guidance. Adam?

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Adam J. DeWitt, GrubHub Inc. - CFO and Treasurer [4]

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Thanks, Matt. Good morning, everyone.

As Matt highlighted in his remarks, we are pleased with our start to 2017. Our active diner growth accelerated to 26% compared to the first quarter of last year, our highest growth rate since 2015 and easily the most net active diners we've added organically in a quarter. We processed 324,600 daily average grubs and nearly $900 million in gross food sales during the quarter, a 21% increase and a 26% increase year-over-year, respectively. The acquisition, LAbite, which we will fully anniversary in May, contributed approximately 1.5% to active diner growth, 1% to DAG growth and 3% to gross food sales growth.

First quarter net revenues were $156 million, 39% higher than the year-ago quarter of $112 million. If we exclude the impact from LAbite, revenue growth would have been approximately 34%. Net revenue as a percentage of gross food sales was 17.4% during the first quarter. This compares to 15.7% during the first quarter of last year.

We have talked about how our capture rate has increased over the past 24 months due to the increase in the percentage of orders that we deliver because those orders carry a higher capture rate than orders that restaurants deliver for themselves, but it has also increased because as our marketplace grows, restaurants want to pay a higher commission rate in return for exposure to more diners on our platform. This latter dynamic, while much smaller than in delivery impact, has an exaggerated impact on our bottom line as nearly all the increased revenue capture flows through to profit. We hope to continue to see some benefit here over time due to our strong network growth as well as newer opportunities for restaurant visibility in our platform like sponsored listings, carousels and more targeted CRM.

Matt and I have both noted the strength in new diner acquisition during the first quarter, which certainly contributed to order growth. However, it's worth noting that 95% of our orders come from repeat diners. Our cohorts remain extremely sticky and generally drive more revenue over time. For example, diners that ordered with us the first time in January of 2013 generated more revenue for us in March of 2017 than they did in March of 2016. This creates a natural perpetual tailwind for long-term revenue growth.

On the expense side, total sales and marketing expenses were $35.4 million in Q1, a 23% increase compared to the same quarter last year and a sequential increase of 20% compared to the fourth quarter. Last quarter, we highlighted our intention to increase advertising spend this year, and the active diner growth I highlighted earlier is a testament to our ability to maintain effectiveness at a higher level of spend.

Of note, this strength in new diner acquisition was broad in our most penetrated markets as well as our smallest, newest markets. When a diner joins our platform and has a good experience in terms of restaurant selection, restaurant quality, diner fees and service levels, they tend to become habitual repeat diners. Given this predictability, we have good insight into diner lifetime value by market and by channel. This makes us comfortable spending upfront to acquire diners that generate long streams of profitable revenue over time.

Of note, the strong recent growth of our restaurant network, both in quantity and quality in many of our less penetrated markets, has improved the first time diner experience, giving us the ability to spend more dollars in these markets while maintaining reasonable CPAs and high lifetime values. We will continue to take advantage of these opportunities as we see them.

However, we expect sales and marketing spend to be down in the single digits sequentially because of seasonality. This is less than it would typically be down in the second quarter, which, along with the third quarter, make up the softer half of the year for us. We do expect total sales and marketing percentage growth to be in the mid to high 20s for the full year 2017, consistent with prior expectations.

Operations and support expenses in the third quarter were $59.5 million, a 70% increase compared to the $35 million in the first quarter of last year and sequential increase of 15% compared to the fourth quarter. This increase is mostly from the steep growth in our delivery orders, but also the inclusion of LAbite and organic growth in overall orders.

We continue to make very good progress on our delivery organization's efficiency. Once again, our revenue growth per order on a nominal basis outpaced the growth in ops and support per order on a nominal basis compared to a year ago. As a result, EBITDA per order grew from $1.33 to $1.46 during the period. We are making excellent progress toward our goal of de minimis investment delivery by the end of 2017.

Technology expenses, excluding amortization and web development, were $13.2 million for the quarter, increasing 29% from Q1 of 2016 due to investments we are making and continuous product improvement. This includes the addition of folks from Zoomer that we talked about last quarter.

Depreciation and amortization was $10 million for the quarter, a sequential increase of 1% from the fourth quarter and 37% from a year ago. The year-over-year increase is due to investment in our platform, intangibles from the acquisition of LAbite and our headquarters build-out last year.

G&A costs were $13.0 million, a sequential increase of 6% from the $12.3 million in the fourth quarter, consistent with growth to support our business.

Net income was $17.7 million compared to the prior year of $9.9 million. Net income per fully diluted common share was $0.20 on approximately 87 million weighted average fully diluted shares.

Our tax rate for the fourth quarter was around 29%, lower than our normalized tax rate of 40.5%, driven by the new accounting rules for tax benefit or loss related to stock-based compensation and, to a lesser extent, a couple of onetime credits.

The new accounting rules, which we and other companies generally adopted in the first quarter, call for a change in the recognition of excess tax benefits or deficiencies from stock-based compensation. Historically, this impact was ignored on the P&L and you would see it on the cash flow statement in the financing section. The new rules dictate that these impacts move to the P&L in the form of a reduction or increased income taxes in the period. This change resulted in approximately 8 point decrease to our effective tax rate in the quarter. Because the benefit or deficiency is generated when employees exercise options where RSU is best and depends on both the strike price or grant price of those shares as well as the market price at the time of exercise or vest, it is inherently unpredictable and difficult to forecast.

So while our expectation for our normalized tax rate remains 40.5% going forward, our actual tax rate quarter-to-quarter may vary significantly. It is important to note that these benefits or deficiencies have always been and will continue to be real impact to the cash. A reduction in taxes is a real reduction and a deficiency is a real increase in taxes. It's just that, prior to this quarter, this impact to taxes was only identified and quantified in the cash flow statement.

Non-GAAP net income was $25.1 million or $0.29 per fully diluted common share compared to the prior year of $17.2 million or $0.20 per fully diluted common share. Non-GAAP net income excludes amortization of acquired intangibles, acquisition and restructuring costs and stock-based compensation expense as well as the income tax effects of these non-GAAP adjustments.

Adjusted EBITDA for the quarter was $42.7 million, an increase of 32% from $32.4 million in the same quarter of the prior year. Adjusted EBITDA margin was 27%, driven by our continued mix shift towards delivery and recent investments in marketing and technology. We ended the quarter with approximately $360 million in cash or roughly $4 per share.

Before I move into our guidance, it's important that I spend a moment on seasonality to help people how to think about modeling our full year. In a typical year, we expect warmer weather and summer vacations to reduce orders in the second quarter, somewhere in the low to mid-single-digit percentages compared to the first quarter followed by another small decline in the third quarter. We then see a significant uptick in the fourth quarter followed by another meaningful uptick in the first quarter. Once you strip away acquisitions and other noise, we have seen this pattern occur consistently throughout our history. 2016 was unique with a sequential uptick in orders in the second quarter led by dramatic product improvements and weather. We expect a more historical pattern to return this year and our guidance reflects that.

For revenue, we expect Q2 to be in the range of $153 million to $161 million and we are raising the full year guidance to be in the range of $632 million to $662 million. This includes the healthy diner growth we saw in the first quarter as well as more confidence as to where the percentage of delivery orders is headed.

We expect adjusted EBITDA to be in the range of $38 million to $44 million for the second quarter and are increasing full year adjusted EBITDA to be between $170 million and $190 million for the full year based on first quarter performance and updated full year expectations.

The seasonal impact on order growth I just detailed has a similar effect on EBITDA. There is a portion of our cost structure that is variable with order volume and so it declines sequentially in Q2 along with our marketing spend. Our fixed cost infrastructure, however, typically increases modestly.

All things considered, this translates into slight sequential declines in EBITDA in the second and third quarters. Like order growth, this EBITDA trend reverses in the fourth quarter and first quarter as the activity of our diners picks back and, given the high-profit flow-through of each incremental order, drives a strong uptick in EBITDA from the prior 2 quarters.

We are firmly on track to meet our goals for the year, showcasing our improved restaurant network and platform to more diners across the country. We are excited by our performance in Q1 and we'll continue to make investments to drive long-term profitable growth.

With that, Matt and I will take your questions. Operator, please open up the lines.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Brian Nowak from Morgan Stanley.

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Brian Thomas Nowak, Morgan Stanley, Research Division - Research Analyst [2]

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I have 2. Just the first one on the Tier 2 markets. It seems like you're making good traction in the markets with active diners. I'd be curious for anything, early learnings or observations of how these new active diners are acting in the new markets compared to the core markets. Any reason to assume that the cohorts and the [purchase velocity] wouldn't be similar?

And then, secondly, Matt, you talked about drivers of higher delivery efficiency. Can you just give us some examples of how you're making the delivery process more efficient? What are still some low-hanging fruit opportunities to make delivery even more efficient?

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Adam J. DeWitt, GrubHub Inc. - CFO and Treasurer [3]

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Yes, Brian. It's Adam. I want to take the first and I'll let Matt take the second. So in terms of the diners for the Tier 2 markets, yes, really I think it's the same story that we've been seeing throughout the past several years, which is you really have a difference in behavior in the Manhattan and corporate diners and then the rest of the country is very similar. So the Tier 2 markets, obviously there's some diversity amongst those, but they're generally in the same vicinity. So if you're comparing it to the overall, we obviously have a lot of business in New York and with corporate. So it's, on the average, it's a little bit lower, but they're behaving very similar to other markets outside of Manhattan and corporate.

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Matthew M. Maloney, GrubHub Inc. - Founder, CEO, President and Director [4]

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Brian, it's Matt. In terms of delivery efficiency, I mean, really where we're seeing the gains is all around things that are scale-based. So as our order volume in the market increases, our ability to staff, dispatch, route, batch orders, this all improves. This all drives a throughput of our driver network up and obviously our costs -- our driver costs down.

One other element when we think about efficiency -- pardon me -- kind of the dirty secret in all this delivery is all the nondriver costs, and people don't really talk about that. Breakeven on a driver pay basis is really only half the battle and we've actually found ways to noticeably increase or, I'm sorry, improve our cost efficiency in things like driver recruiting, driver on-boarding, gear distribution and a lot of other of these nondriver pay-related areas of delivery, which, overall, increases our efficiency.

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Operator [5]

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Your next question comes from the line of Ron Josey from JMP Securities.

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Ronald Victor Josey, JMP Securities LLC, Research Division - MD and Senior Research Analyst [6]

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Great. I wanted to ask on just marketing campaigns given it's coming in full swing here. Can you just remind us a little bit more about how you think about the ROI and payback period for marketing spend? And then, the tools you all have to basically get these newer diners to repeat and increase and drive the engagement higher.

And then, bigger picture, Matt, in terms of delivery, have you ever thought about potentially, now that delivery is in, what, 70-plus markets with more national coverage, potentially offering a subscription product around -- for unlimited delivery or things along those lines?

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Adam J. DeWitt, GrubHub Inc. - CFO and Treasurer [7]

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Yes. Ron, it's Adam. I'll take the marketing question. So how we think about ROI, what we -- when Matt talked -- what I talked about in my script, I think Matt mentioned it as well, we have diners come on board, they tend to stay with us for a very long time. I think we talked about in the past when we're generating internal lifetime value models that we actually have to force attrition into the model even though we're not seeing it. We've always talked about the cohorts increasing in value over time after the first few months.

So the lifetime values are very high. Generally, what we see on the CPA side is that it's coming in generally a lot lower than our LTVs and so we feel very comfortable. It's just when we talk about the limits of our marketing and being able to spend efficiency -- efficiently, we get to this point in some of these channels where the increased spend, the increased spending actually doesn't generate any new diners. And so we're generally spending to that point of what I call dramatic inefficiency.

If you're thinking about payback time, I think it depends on channel, depends where we're getting the diners from. And so it could be anywhere from a few months to even less to all the way up to a year, but we're getting payback from those diners over a very long period of time.

I think you asked about the reengagement. I think one of the things that we've been doing differently there or we've improved on over the past 12 to 18 months is a lot of personalization. And I think part of what's enabled us to do that is the -- especially in the Tier 2s where we've dramatically improved the quality of our restaurant network. And so we're able to match specific diners with specific restaurants that we know are really popular, and we have a really good hit rate because of the breadth of restaurants that we have. And so being able to send an e-mail at the right time to encourage an order on a Tuesday night when a diner typically orders on a Friday or Saturday and get them to order more is something that we've been able to have a lot of success on.

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Matthew M. Maloney, GrubHub Inc. - Founder, CEO, President and Director [8]

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Ron, in terms of a subscription-like service, we've always been testing things. We've tested subscription services before. We haven't really found that right balance of something that would really lock in that diner side demand. And part of the problem is economics. I mean, they're just tight. I mean, you can do the math yourself. And in order to even come close to breakeven, it's a pretty hefty annual fee in order to make something like this happen. But remember, we're testing delivery fees on a city by city basis constantly, making sure we're optimizing for conversion rate and making sure we can float the economics. And when we think about diners that are cost-sensitive, remember, we have over 10,000 restaurants that have free delivery always on the site because they do their own delivery and they don't have a delivery. So thinking about this from a competitive perspective, we will always have a baked-in advantage in terms of price point per diners.

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Operator [9]

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Your next question comes from the line of Ralph Schackart from William Blair.

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Ralph Edward Schackart, William Blair & Company L.L.C., Research Division - Partner and Technology Analyst [10]

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Looking at the strong diner additions in Q1 and clearly the marketing campaign has shown some early positive signs, how should we think about the pace of that sort of diner addition throughout the year as you add on incremental marketing campaigns?

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Adam J. DeWitt, GrubHub Inc. - CFO and Treasurer [11]

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Yes. So Ralph, I think I mentioned in the script that we'll -- even though sales and marketing, I think, will be down a few points in the second quarter, that that's probably -- that's actually a little bit higher than it would typically be in the second quarter. So we're going to continue to spend at a higher level overall and we expect to see good continued growth in new diners.

In terms of the percentage, I think it's a little tough to handicap. Obviously, our guidance has a range of outcomes. We have a lot of confidence that the additional expense is going to yield new diners. And over time, it's going to lead to more order growth. I think just one thing to remember in your -- for your modeling is LAbite. We were lapping in the second quarter. And I think we talked about before that something about -- something around 100,000 diners or something we acquired in last year's second quarter. So that will affect your modeling a little bit.

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Operator [12]

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Your next question comes from the line of Paul Bieber from Crédit Suisse.

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Paul Judd Bieber, Crédit Suisse AG, Research Division - Director [13]

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I was hoping that you could help us reconcile the comments about the stable cost of net new active diners just with the fact that the competitive landscape is pretty intense. It's pretty unusual to see stable customer acquisition costs in a very competitive market. So I was hoping you could provide some color about that.

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Matthew M. Maloney, GrubHub Inc. - Founder, CEO, President and Director [14]

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Sure, Paul. I can kind of address the competition question head-on and then how it -- how an increasing competitive arena impacts CPAs. Maybe Adam can follow-up a little bit on the market.

I mean, it's -- I think I've answered this question pretty consistently on the past 4 or 5, maybe 6 earnings calls, but we just continue to show great growth rates across our business and, again, we just posted our best quarter of diner adds in the history of the company. And don't forget that all material or meaningful competition was in the market more than a year ago as well. So I when I look at the marketplace, I see that we have significant structural advantages and that we're known for just one thing like we just do takeout ordering and we back it up with world-class service and we'll succeed because of the singular focus and our ability to engineer our entire product around this purpose. The Grubhub for Work products that we talked about or I talked about today in the prepared remarks is a classic example of this. We really talked to our customers, found out what they wanted, how they wanted to engage with their local restaurants and we built the tool around that specific use case with only that use case in mind.

So industry-wide, I think we have a huge advantage because we clearly have the most restaurants, over 50,000 now, and the lowest diner-facing fees like I just spoke about in terms of -- to Ron actually. And so you think about we have the best product experience, we have the most restaurants, we have the largest platform, we have the best customer support, we continue to accelerate on all fronts and it's a massive marketplace. So as the industry is growing and I believe competition is increasing awareness broadly, which is accelerating our offline to online transition, I think it's just a big growth time for this industry. And as you look at our distinct competitive advantages, just to break it down one level deeper, I mean, scale, we have the largest scale in the industry and that gives us meaningful efficiency and competitive advantages others just can't reproduce. The product focus I talked about, it's all we do. That's all we think about. All of our people do this. That's what we do every day. We're not going to be held up by delivering iPods or toothpaste or groceries. We have the lowest facing fees and I believe everyone will agree that cost matters to consumers. We pride ourselves on cost transparency, the best service, the lowest fees. And we're not at a significant disadvantage to anyone in terms of delivery time. In fact, oftentimes, we are the fastest and most consistent food delivery option available, especially during rush hour or, as we call it, dinner time. Adam?

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Adam J. DeWitt, GrubHub Inc. - CFO and Treasurer [15]

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Yes, just to answer just more specific question about CPAs, I think what we see over time is you have to remember this is, as Matt mentioned, it -- kind of we're capturing an offline to online transition, right? And so there's more eyeballs available for us on the web. And so it's not a matter of having to bid more for keywords. It's getting more clicks and it's expanding the keywords, right, as we expand our restaurant network. So that's an easy way to think about the cost kind of remaining stable while we increase new diners. I think adding high leverage out of home or offline advertising like TV that can boost the efficiency of our online digital, I think, are other ways that we've kind of managed to keep CPAs relatively flat. And as Matt said, look, if there is competition in certain markets, in some ways, it is creating more awareness for the product. And remember, we're all trying to capture some of this offline to online transition. So in some ways, that perhaps helps us.

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Operator [16]

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Your next question comes from the line of Jason Helfstein from Oppenheimer.

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Jason Stuart Helfstein, Oppenheimer & Co. Inc., Research Division - MD and Senior Internet Analyst [17]

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Two questions. One, any more commentary you can provide on competition by geography or tier size?

And then, secondly, can you talk about product features that would address callers? So specifically, we've done some work that suggested that the biggest opportunity for you is to address, basically, diners who call the restaurant because they have questions and then end up ordering that way as opposed through your app. Given the face of Facebook's presentation -- update about messaging and a partnership, some things they're doing with delivery.com, maybe just talk about how you plan to address in the future being able to answer questions so that diners don't have to call restaurants.

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Matthew M. Maloney, GrubHub Inc. - Founder, CEO, President and Director [18]

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Sure, Jason. Let me -- I don't really have much more commentary on competition. I kind of exhaustively covered that a minute ago.

In terms of geo and tier, I think that Grubhub has a very secure base in the Tier 1 major metros and we're not seeing that erode. In fact, we're seeing that grow. And then, in Tier 2, we've said a bunch of times that this is a key focus, Tier 2, Tier 3, on growth for us given our success in delivery over the past year. And so we're seeing outsized growth there. Clearly, competition isn't impacting our growth rate there either.

Product features on callers. Calling is tricky because it requires the bidirectional communication and kind of what our product is doing is trying to alleviate the friction around the telephone. And so we are definitely trying to figure out ways to answer diners' questions in real time, but without actually having someone at the restaurant have to pick up the phone. That is a very difficult problem to solve, and I'd say we are definitely thinking about it. Clearly, with the advent of more automated systems around like chat bots and iMessage, I think there's a lot of opportunity, opportunities that have never been available before. Part of it is the -- is the actual communication. Another part of it is the metadata inside the menus.

We spoke a few earnings calls ago about normalizing menu data and making sure that our menu data is comparable and understandable from a big data perspective. And we actually continue to invest in that, which is really interesting. And one thing I didn't mention in the prepared remarks is that we -- or I think I did actually, we rolled out some dietary tags in the menus, which are really interesting. It's a way for us to almost micro select dishes across restaurants that are vegan, for example, or other various forms of dietary tags. And actually collecting that is nontrivial and keeping that updated is harder than you would expect. And so we're working through elements like this, but as we continue to flesh out more data on a dish level, then it will be available to query from diners. And I think that's really where you're getting at.

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Operator [19]

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Your next question comes from the line of Heath Terry from Goldman Sachs.

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Heath P. Terry, Goldman Sachs Group Inc., Research Division - MD [20]

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Great. Adam, I guess, just one quick housekeeping question on the -- I believe I heard you say that EBITDA would be down sequentially in Q2. Were you referring to the midpoint because at the higher end, it looks like -- of the guidance looks like it would actually be up? I just wanted to clarify that.

And then, Matt, as you talk about the customers that you're -- the new customers that you're bringing on and the incredible growth that you saw this quarter in customer additions, do you have a sense of what the older cohorts in these Tier 2 markets that are predominantly or becoming predominantly delivery-driven, how those perform as they age relative to what you're seeing? I guess, you've talked about frequency before. How long do you see it taking before that once-a-month order in Denver gets to the 4 to 6x a month that you see in New York, San Francisco, Chicago, et cetera?

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Adam J. DeWitt, GrubHub Inc. - CFO and Treasurer [21]

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Yes, Heath. I'll take the EBITDA question real quick. Yes, absolutely, it's referring to the midpoint. Our guidance obviously has a range of outcomes. Last year, we had -- our EBITDA was a little bit higher in the second quarter than the first quarter. But my commentary is around the second quarter, we typically expect it to be, all things equal, we would expect a little -- it just makes sense that there's a little bit of a tiny step back in kind of anticipation for the big step forward in the fourth quarter and first quarter. So yes, the commentary was around the midpoint as opposed to the high end of the range.

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Matthew M. Maloney, GrubHub Inc. - Founder, CEO, President and Director [22]

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And then, Heath, in terms of the older cohorts in the Tier 2, Tier 3 markets and how they're performing with additional delivery restaurants, they're all performing much higher than they were before. They're all getting better. And if you think about cohort performance, it's really a function of restaurant density. And so as you add restaurants to a marketplace, you're going to see those older cohorts actually perform at a higher rate. And I wouldn't -- you're exactly right. The spectrum is from the lower restaurant density markets that historically have not had a robust self-delivery ecosystem all the way up to the high end, which is Manhattan, which is the highest performing marketplace in the country in terms of diner performance. And so as we continue to add restaurants, you're going to see those cohorts perform more in line with what you'd expect. And I'd expect Denver to progress to more of a Chicago, San Francisco range before it ultimately gets up to Manhattan.

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Operator [23]

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Your next question comes from the line of Mark May from Citi.

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Mark Alan May, Citigroup Inc, Research Division - Director and Senior Analyst [24]

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First, I know the focus is more on EBITDA per order and that there are a number of variables that come into play in the capture rate, but can you talk about the top couple of factors driving the capture rate increase in the quarter? For instance, did sponsor listings play a key role? What about the mix of delivery?

And then, I know you've talked a lot about the performance of the Tier 2 markets, which is great. Just wondered, and sorry if I missed this, if you could talk about the growth rates that you're seeing in the Tier 1 markets and kind of how those have trended in the last couple of quarters?

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Adam J. DeWitt, GrubHub Inc. - CFO and Treasurer [25]

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Yes, Mark. It's Adam. In terms of the capture rate, happy to talk about that a little bit. It does -- in some of my prepared remarks, we talked a little bit about this. Clearly, look, most of the increase is the increase in delivery orders as a percentage of overall orders, right? On delivery order, just to remind everyone, on delivery order, Grubhub gets the delivery fee and also some additional commission from the restaurant and most of that goes to paying for drivers. So we do see an increase in take rate. It's much higher on delivery orders, but most of that we see come back out in the expense side. But we do have, and we've had historically over time, had an increase in the commission rate that restaurants are willing to pay for the demand generation. And so as markets grow and there's more restaurants and more diners, restaurants tend to -- will pay more for more exposure because there's more value on the network for them. There's more orders, there's a bigger audience, et cetera. And so restaurants are willing to pay for that exposure. You asked the question. So we've certainly seen some improvement in the capture rate there. It's a lot smaller than the delivery mix impact, but it does drop right to the bottom line.

You mentioned kind of what's driving that. And the sponsored listings, it's basically there's a number of areas on the site where a number of opportunities for restaurants to get more exposure, and we've been continually working on that. One is the sponsored listings. Another is if you use the platform, you'll notice there's carousels, whether it's on the home page or at the end of menus or other locations on the site. A third is, I mentioned earlier, more targeted CRM. We're matching specific restaurants to specific diners, and we're getting better at it. So there's all these opportunities for restaurants to get more exposure and they're willing to pay more as a result. So we have seen -- we have seen improvement in capture rate. It will be incremental over time and we think that we'll continue to see that.

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Mark Alan May, Citigroup Inc, Research Division - Director and Senior Analyst [26]

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What was the delivery mix in the quarter?

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Adam J. DeWitt, GrubHub Inc. - CFO and Treasurer [27]

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I don't think -- so I don't think we've given specifics. What we have taught -- so in terms of delivery right now, if you look at delivery on our platform, we're a little bit -- we're at run rate a little bit higher than 10% -- I'm sorry, a little bit higher than 20% overall.

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Mark Alan May, Citigroup Inc, Research Division - Director and Senior Analyst [28]

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Any comments on Tier 1 growth?

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Adam J. DeWitt, GrubHub Inc. - CFO and Treasurer [29]

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Yes. So your second question, Tier 1 growth versus Tier 2 growth. I think it's a similar story as it is before, right? Tier 1s are just, by sheer size, are -- make up a large percentage of our volume. So if their growth rate was significantly lower or higher than -- if it was -- it would be hard for Tier 1 growth rate to be much different than the overall company growth rate I think is an easier way to say it. It would be very difficult for...

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Mark Alan May, Citigroup Inc, Research Division - Director and Senior Analyst [30]

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And Tier 2 growing twice as fast?

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Adam J. DeWitt, GrubHub Inc. - CFO and Treasurer [31]

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Yes. I already said that in the remarks. Yes.

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Operator [32]

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Your next question comes from the line of Nat Schindler from Bank of America Merrill Lynch.

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Nathaniel Holmes Schindler, BofA Merrill Lynch, Research Division - Director [33]

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Yes. Matt, not to belabor the point, and I know you're sick about answering this, but I'm going to take it from a different angle. Clearly, you have network effects making competition within your Tier 1 markets very, very difficult. And it's undoubtedly overtalked about by Wall Street. But not the Tier 1, not the Tier 2s, not even the tertiary markets, but markets where you barely are, quaternary markets. Are there markets out there that could be substantial on your long-term calculations when you start looking at the market sizing where you just haven't gotten around to really building up substantial presence that you see other players building in? And does that cut off any of the -- to be honest, very long-term growth for the company?

And then, for a second question for Adam just quickly. You mentioned that take rates are going up less on the marketplace side. Just wanted to know if you could give any more color on that. If you -- the last time, we really had a clean number for that before you had delivery. I think it was around 15.2%. And you said it was roughly stable because new markets would come in lower and old markets go up, so they balance each other out. Where is that going? And what do you think the dynamics that are really moving it around are?

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Matthew M. Maloney, GrubHub Inc. - Founder, CEO, President and Director [34]

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Nat, yes, it's an interesting way to position that question. So I think you're right. There is definitely a first-mover advantage in this industry because once you build scale in orders, the restaurants really want to work with you and it's that much harder to prove yourself as a second comer. Because of that, for a long time, we've been very aggressive expanding our services. So clearly, before delivery, I think we were in -- we were incorporating thousands of cities in our self-delivery platform, and that was our initial base. And then, we saw how delivery could fundamentally accelerate the market dynamics and the flywheel in these markets and so we went very aggressively in the delivery a year ago. And I think we immediately went -- we're at like 70 or so, maybe 100 by now, I'm not really sure, markets.

So when you think about are there substantial -- potentially substantial markets that we're not in yet, I would say no. There are -- in aggregate, there are a lot of markets we're not in yet that together could be substantial for sure, but no one else is there. And we're talking broad areas in the Midwest, for example. We hit the key markets. But in between Columbus and Indianapolis, for example, we have very little or no presence. In aggregate, those geographies are going to be meaningful in the long-term, but I don't think any rational competitor is going to go aggressively into those spaces without first taking the intermediary second and third and even fourth tier markets. So I don't see a strategic way for a competitor to cut off our long-term growth by addressing these markets first. And frankly, we're aggressively expanding in the suburbs of Indianapolis, for example. That is -- those are geographies that you don't see other markets or other competitors expanding in. It's because we do truly understand the impact of first-mover advantage in our space.

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Adam J. DeWitt, GrubHub Inc. - CFO and Treasurer [35]

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Yes, Nat. In terms of the marketplace, our add fee rate or however you want to describe it, we're not going to break it out from the overall capture rate, but what I can tell you is obviously that impact is a lot smaller on the capture rate than the delivery mix. When we're talking about increases, we're really talking about 10, 20, maybe 30 basis points at a time overall. And in the first quarter, we added to the commentary just because it's larger than it has been, but even if you look at 10, 20 basis points, you apply that to all of our order volume and drop it basically to the bottom line, it becomes material.

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Operator [36]

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Your next question comes from the line of Michael Graham from Canaccord.

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Michael Patrick Graham, Canaccord Genuity Limited, Research Division - MD and Senior Equity Analyst [37]

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I wanted to go back to the diner app just because it's such a whopper of a number, and congrats on that. You had a lot of improvements to the app over the course of the last 12, 18 months. And I'm wondering, given that your diner number is an annual backward-looking for a year, I'm wondering if any of the strength was due to retention rather than gross adds?

And I'm also wondering, some similar companies have -- when they've switched to more of a brand marketing emphasis, television and that sort of thing, they've noticed that the customers that are coming in are more sort of focused on aligning with the brand and the experience and, therefore, they're stickier and more active as opposed to a direct response customer coming in from search or a social ad. I'm just wondering if you're seeing the same thing.

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Adam J. DeWitt, GrubHub Inc. - CFO and Treasurer [38]

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Yes, Mike. In terms of your question on retention, that's certainly -- it certainly helps the number and we have seen the improvements in the product help our long-term retention numbers. A diner saved is the equivalent of a new diner. In some ways, it's better. But to be honest, historically, we haven't had a big attrition problem with diners that have been on the platform for a few months. So it helped, but I think, at the end of the day, it's really about the restaurant network, the more efficient advertising. And in this case at least, it's been a little bit more top of funnel than it has been a throughput on the funnel.

In terms of the diners, I'd say that they're similar as opposed to much better or much worse. I think they do identify with the brand, but at the end of the day, you've got to remember, this is a -- what we're presenting to the market is a reason to move offline to online. And so we're not -- in a lot of cases, these diners are not coming to us after one touch, right? They're seeing us on TV. They're seeing us on display. They're seeing us on SEM. And they're coming to us after a number of touches and they're high quality. I think the one thing I will say is TV diners are -- and in all cases, I think all diners are generally better if they're coming through some type of advertising medium or some channel that's not through a promotion. So if you get a diner that's coming to us because of what we do as opposed to a free meal or a free delivery, those diners tend to be higher quality.

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Operator [39]

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Your next question comes from the line of Tom Forte from Maxim Group.

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Thomas Ferris Forte, Maxim Group LLC, Research Division - SVP, and Senior Consumer and Consumer Internet Analyst [40]

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Great. So real quickly, I wanted to see how you felt about chain restaurant delivery, specifically in the QSR category, given that McDonald's has started to ramp its efforts there.

And then, second, wanted an update on the economics of chain restaurant delivery versus independent restaurant.

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Matthew M. Maloney, GrubHub Inc. - Founder, CEO, President and Director [41]

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Tom, yes, chain delivery is a big area of growth for us. I went through a bunch of chains that we were -- we signed on with pilots. I think that people should assume that we're talking to every chain realistically that could benefit from delivery at this point. I also walked through a few partners of ours that we've had a successful pilot and they are expanding our relationship, which is really an important point when you think about the growth of our business, especially in Tier 2, Tier 3 markets where chains just make up a higher proportion of not only the inventory, but of what diners want to order in those geographies.

So I think that, from a chain's perspective, they've always been interested in our demand and the ability to incrementally add revenue. Now with the -- with our ability to deliver and deliver at a very high service level very consistently, that was always a logistical hurdle that they were not interested in doing themselves for the most part. I mean, obviously, other than the major pizza chains, most chains just did not want to do deliveries. So the fact they can partner with us and we will support them and be their partner in this delivery function as well as bring tremendous new demand in a bunch of markets in ways that they were previously unable to do, this is pretty much a slam dunk from their perspective.

In terms of economics, I can let Adam speak to that.

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Adam J. DeWitt, GrubHub Inc. - CFO and Treasurer [42]

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Tom, consistently, the story with the chains has been, on the economic side, that it's not materially different than our relationships with the independent restaurants. They're coming to us because we can provide something that is more efficient to get through Grubhub than it is through themselves. And in most cases, that's a combination of the logistics and the demand generation. And as our pool of active diners continues to grow, it's close to 9 million now, that's a way for them to drive volume where it's hard to access those diners in other places. So we haven't found the economics to be really different between the chains that we've signed up and the independents.

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Operator [43]

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Your next question comes from the line of Aaron Kessler from Raymond James.

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Aaron Michael Kessler, Raymond James & Associates, Inc., Research Division - Senior Internet Analyst [44]

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Great. Just a couple of quick questions. First, can you just talk a little bit about the demographics of new users? Our survey work continues to show kind of younger users much more likely to join these or to sign up.

Secondly, just any -- have you guys done much delivery pricing tests? And are you still testing that? I've seen a lot of kind of variability in terms of delivery pricing in San Francisco at least.

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Matthew M. Maloney, GrubHub Inc. - Founder, CEO, President and Director [45]

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Aaron, in terms of demographics, I mean, we're seeing adds across the board honestly. I mean, clearly, the millennials and younger users are more apt to turn to their mobile phones for anything in their life at this point, but the success of our advertising across TV and other offline channels really has brought in a wide segment of new diners. And we're seeing it, I mean, honestly, across the board from older segments through kids. We see a lot of new parents spike usage through college and even younger. And frankly, high school kids when they have to figure out their own meal. So I would -- in terms of demographics, you're not going to see outsized growth in one specific segment because the entire industry is transitioning and that impacts everyone.

For delivery pricing tests, I'm not sure if you're talking about fees to diners, if you're talking about fees to restaurants, but in both...

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Aaron Michael Kessler, Raymond James & Associates, Inc., Research Division - Senior Internet Analyst [46]

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Yes. Fees to diners, sorry.

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Matthew M. Maloney, GrubHub Inc. - Founder, CEO, President and Director [47]

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Yes. We are absolutely testing this, I think I mentioned it earlier, we're testing on a per market basis. We're trying to figure out what is the expectation. I mean, the expectation in delivery fee is set from historical norms based on what their delivery ecosystem looks like. In Manhattan, it's always been free or very small. In markets where there isn't that much delivery available, they charge a higher fee in order to justify the incremental expense. So we're trying to gauge on a per market basis, ultimately, what impacts conversion the most because all we look at is lifetime value. And then, what happens when we decrease that fee? Do we see an increase in frequency? Do we see the people turning to their local restaurants more consistently to feed their families? And how -- we're just constantly looking through both product and advertising to how do we increase the lifetime value, increase the conversion, increase the frequency of diners. And that's -- we're constantly testing.

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Operator [48]

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Your final question comes from the line of John Egbert from Stifel.

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John Egbert, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [49]

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Matt, you noted that you're starting to push users of your acquired delivery services towards the Grubhub with them benefiting from lower delivery fees. Have you measured any change in order frequency for those customers?

And not to dwell too much on competition, but at restaurants where you overlap with other delivery services, have you looked at how your delivery fees compare on average? Are they meaningfully lower? And if so, is that something that might ever become part of like targeting marketing messages in those cities?

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Matthew M. Maloney, GrubHub Inc. - Founder, CEO, President and Director [50]

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Yes, sure. We definitely see increased frequency as you decrease delivery fees to diners. I mean, it's classical. You reduce transactional cost, you see higher frequency of transaction. There is diminishing returns. I mean, the difference between a $10 transactional fee and a $3 transactional fee is dramatic in terms of diner frequency. The difference between a $3 and a $1 is definitely not as dramatic. There is, clearly, segments of diners that are very cost conscious. In which case, they're always looking at our free delivery restaurants, which are predominantly or actually exclusively self-delivery restaurants that recognize the value of low transactional fees. And I think, as I said before, we will always have that advantage because those restaurants do it themselves. We don't have to pay for the delivery there. So there's a range or there's a slope of impact and then that slope is definitely is a different line or separate for various markets.

Now, competitively, this is even more interesting because the way that we execute, we have a lower cost per delivery, especially from the groups that are doing non-contracted delivery. Anyone who is doing non-contracted delivery, your incremental cost is anywhere from $6 to $10. And so you really can't get away with any type of diner fee less than that if you actually intend to make money at some point in the future. And so we are clearly cheaper on a transactional basis for diners and in -- on all bases for diners than non-contracted. Versus other contracted shops, I think it really depends on how the restaurant contract is structured, but generally we are significantly cheaper than everyone else. And in fact, we do use that as a key marketing message.

Now, you don't want to cheapen the value of your product because fundamentally we're here for selection convenience, consistently high-quality service, but you know what? All things equal, pretty much everyone is going to choose the lower cost provider on that. And so I think we sent out a broad-based e-mail a week or 2 ago highlighting the fact that we have over 10,000 restaurants with no delivery fee. And that's not a special that we have for this week or the rest of this month. This is a permanent fixture of the way our marketplace works. And we will always be cheaper than everyone else. So I think that there's a lot of legs on that marketing communication. And we're going to continue to push that. And if you look at the rack rates for diners in terms of delivery fee across the competitive arena, I think you will agree that we are materially cheaper than everyone else.

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Operator [51]

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This completes the Q&A period. I will turn the call back over to David Zaragoza.

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David Zaragoza, [52]

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All right, everyone. Thanks for your time today and the questions. We look forward (inaudible).

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Operator [53]

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This concludes today's conference call. You may now disconnect.