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CARB > SEC Filings for CARB > Form 10-Q on 10-Nov-2011All Recent SEC Filings

Show all filings for CARBONITE INC

Form 10-Q for CARBONITE INC


10-Nov-2011

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our prospectus filed pursuant to Rule 424(b) under the Securities Act of 1933, as amended, with the Securities and Exchange Commission on August 11, 2011.
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains "forward-looking statements" that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or Exchange Act.
Forward-looking statements are often identified by the use of words such as, but not limited to, "anticipate," "believe," "can," "continue," "could," "estimate," "expect," "intend," "may," "will," "plan," "project," "seek," "should," "target," "will," "would," and similar expressions or variations intended to identify forward-looking statements. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled "Risk Factors" included in this Quarterly Report on Form 10-Q. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.
Overview
We are a leading provider of online backup solutions for consumers and small and medium sized business, or SMBs. We provide easy-to-use, affordable, unlimited, and secure online backup solutions with anytime, anywhere access to files stored on our servers, which we call the Carbonite Personal Cloud. We believe that we are the best known brand in the online backup market.
In 2005, we began development of our Carbonite backup solution and raised our first capital from investors. We sold the first subscription to our Carbonite backup solution in 2006. In 2010, we introduced our SMB solution, opened our office in Beijing, China, and expanded our management team to better focus on our consumer and SMB markets. We surpassed 100,000 subscribers in 2008, 500,000 subscribers in 2009, and 1,000,000 subscribers in early 2011. Today we have subscribers in more than 100 countries, with 94% of our subscribers based in the U.S.
We derive our revenue from subscription fees from consumers and SMBs. We charge consumers a $59 flat fee for one year of unlimited online backup, with discounts for multi-year subscriptions. Our SMB solution allows for an unlimited number of users, with tiered pricing based on the total amount of data backed up. As of September 30, 2011, approximately 70% of subscribers to our consumer service have one year subscriptions, although the percentage of customers with multi-year subscriptions has increased over time. We charge customers the full


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subscription amount at the beginning of each subscription period. We initially record a subscription fee as deferred revenue and then recognize it ratably over the subscription period. The annual or multi-year commitments of our customers enhance management's visibility of our revenue and charging customers at the beginning of the subscription period provides working capital.
We are investing aggressively in customer acquisition because we believe that the market for online backup is in the early stages of development. Our largest expense is advertising for customer acquisition, which is recorded as sales and marketing expense. This is comprised of radio and television advertising, online display advertising, print advertising, paid search, direct marketing, and other expenses. In 2008, 2009, and 2010, our total advertising expense was $7.6 million, $10.8 million, and $23.6 million, respectively. We generally spend more on advertising in the first and third quarters of each year based on the seasonality of customer purchasing patterns and fluctuations in advertising rates.
As we grow our business we continue to invest in additional storage and infrastructure. Our capital expenditures in 2008, 2009, and 2010 were $4.7 million, $7.1 million, and $10.7 million, respectively.
Our revenue has grown from $8.2 million in fiscal 2008 to $38.6 million in fiscal 2010 and $43.2 million in the nine months ended September 30, 2011. At the same time, our total operating costs have grown from $21.8 million in fiscal 2008 to $48.2 million in fiscal 2010 and $44.2 million in the nine months ended September 30, 2011, principally as a result of our investment in customer acquisition. We expect to continue to devote substantial resources to customer acquisition, improving our technologies, and expanding our solutions. In addition, we expect to invest heavily in our operations to support anticipated growth and public company reporting and compliance obligations. We defer revenue over our customers' subscription periods, but expense marketing costs as incurred. As a result of these factors, we expect to continue to incur GAAP operating losses on an annual basis for the foreseeable future.
In August 2011, we closed our initial public offering of 7,187,500 shares of common stock at an offering price of $10.00 per share, of which 6,303,973 shares were sold by us, including 937,500 shares pursuant to the underwriters' option to purchase additional shares, and 883,527 shares were sold by selling stockholders, resulting in net proceeds to us of approximately $58.6 million, after deducting underwriting discounts, but before offering expenses of $2.9 million.
Recent Developments
On November 1, 2011, we introduced two additional solutions for our consumer customers, which include new features and expanded functionality. Our current consumer offering, re-branded as Carbonite Home, continues to include unlimited online backup with annual pricing starting at $59. Carbonite Home Plus provides customers with additional backup and restore features for external hard drives with annual pricing starting at $99. Carbonite Home Premier further includes automatic online backup for video files as well as a recovery-by-mail feature with annual pricing starting at $149. Our Business Model
We evaluate the profitability of a customer relationship over its lifecycle because of the nature of our business model. As we generally incur customer acquisition costs in advance of subscriptions while recognizing revenue ratably over the terms of the subscriptions, a customer relationship may not be profitable at the beginning of the subscription period, even though it may be profitable over the life of the customer relationship. As we also


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generally incur capital equipment costs in advance of subscriptions, a customer relationship may not result in positive cash flow at the beginning of the subscription period, even though it may result in positive cash flow over the life of the customer relationship. While we offer both annual and multi-year subscriptions to our customers, a significant majority of them are currently on one year subscription plans. We typically generate positive cash flow during the first year of a multi-year subscription as we charge the subscription fee for the entire period at the beginning of the subscription. Key Business Metrics
Our management regularly reviews a number of financial and operating metrics, including the following key metrics, to evaluate our business:
Total customers. We calculate total customers as the number of paid subscriptions from consumers and SMBs at the end of the relevant period. A consumer who has more than one computer may have multiple subscriptions, each of which is treated as a separate subscription. An SMB subscription may cover multiple computers and users but is treated as a single subscription.

Annual retention rate. We calculate annual retention rate as the percentage of customers on the last day of the prior year who remain customers on the last day of the current year, or for quarterly presentations, the percentage of customers on the last day of the comparable quarter in the prior year who remain customers on the last day of the current quarter. Our management uses these measures to determine the stability of our customer base and to evaluate the lifetime value of our customer relationships.


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Renewal rate. We define renewal rate for a period as the percentage of customers who renew annual or multi-year subscriptions that expire during the period presented. Renewal rate excludes customers under our discontinued third-party distribution agreements and prior SMB offering with subscriptions that remain active until cancelled. Our management uses this measure to monitor trends in customer renewal activity.

Bookings. We calculate bookings as revenue recognized during a particular period plus the change in total deferred revenue (excluding deferred revenue recorded in connection with acquisitions) during the same period. Our management uses this measure as a proxy for cash receipts. Bookings represents the aggregate dollar value of customer subscriptions received by us during a period. We initially record a subscription fee as deferred revenue and then recognize it ratably, on a daily basis, over the life of the subscription period.

Free cash flow. We calculate free cash flow as net cash provided by (used in) operating activities, less purchases of property and equipment, and adjusted for any extraordinary items. Our management uses this measure to evaluate our operating results.

Subscription renewals may vary during the year based on the date of our customers' original subscriptions. As we recognize subscription revenue ratably over the subscription period, this generally has not resulted in a material seasonal impact on our revenue, but may result in material monthly and quarterly variances in one or more of the key business metrics described above. Performance Highlights
The following table presents our performance highlights for the three months ended September 30, 2011 and 2010:

                                             Three Months Ended
                                                September 30,
                                       2011                        2010
                                   (in thousands, except percentage data)
       Total customers                         1,164                       869
       Annual retention rate                      81 %                      82 %
       Renewal rate                               82 %                      82 %
       Bookings                $              20,468         $          14,142
       Free cash flow          $                (489 )       $          (4,512 )

Our total customers and bookings increased for the three months ended September 30, 2011 compared to the three months ended September 30, 2010 and we are continuing to invest substantially in customer acquisition in an effort to drive future growth in total customers and bookings. While we expect our total customers to continue to increase on an absolute basis, we expect that our annual percentage increase in total customers will decline as our customer base grows.
In June 2010, we decided to cease distribution of our consumer solutions through third-party distribution channels, and we terminated most of our distribution agreements at that time. During 2010, subscriptions purchased through third-party distributors accounted for 8% of our revenue. Historically, renewal rates for subscriptions purchased through third-party distributors were lower than for direct sales. Excluding renewal activity related to third-party distributor sales, our annual retention rates for the three months ended September 30, 2011 and September 30, 2010 were 86% and 84%, respectively.


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Our free cash flow for the three months ended September 30, 2011 compared to the three months ended September 30, 2010 has improved due to economies of scale and the impact of higher per customer profitability associated with customers who continue beyond a single year. However, the results of individual periods vary based on the timing of our expenses, particularly customer acquisition costs, including radio and television advertising. We generally spend more on advertising in the first and third quarters of each year based on the seasonality of customer purchasing patterns and fluctuations in advertising rates, which affects our free cash flow for the interim periods presented. Similarly, we generally spend more on capital equipment in the first and third quarters of each year as we add capacity to service new customers. Key Components of our Consolidated Statements of Operations Revenue
We derive our revenue from subscription fees from consumers and SMBs. We typically charge a customer's credit card the full price of the subscription at the commencement of the subscription period and at each renewal date, unless the customer decides not to renew the subscription. We initially record a customer subscription fee as deferred revenue and then recognize it ratably, on a daily basis, over the life of the subscription period. Cost of revenue
Cost of revenue consists primarily of costs associated with our data center operations and customer support centers, including wages and benefits for personnel, depreciation of equipment, rent, utilities and broadband, equipment maintenance, software license fees, and allocated overhead. The expenses related to hosting our services and supporting our customers are related to the number of customers and the complexity of our services and hosting infrastructure. We expect these expenses to increase in absolute dollars as we continue to increase our number of customers. On a per subscriber basis, our costs have been decreasing as we achieve economies of scale and purchase equipment and services in larger quantities. There has also been a long term downward trend in the cost of storage equipment and broadband service, which we expect will continue in the future.
Gross profit and gross margin
Gross profit is our revenue less our cost of revenue. Our gross margins have historically expanded due to price increases for our consumer solutions and from economies of scale. We expect our gross margins to be relatively flat in the remaining portion of 2011 due to expenses associated with the relocation of our support services from India to the U.S. Operating expenses
Research and development. Research and development expenses consist primarily of wages and benefits for development personnel, consulting fees, rent, and depreciation. We have focused our research and development efforts on both improving ease of use and functionality of our existing services and developing new offerings. The majority of our research and development employees are located at our corporate headquarters in the U.S., with another group at our offices in China. We expect that research and development expenses will increase in absolute dollars on an annual basis as we continue to enhance and expand our services.
General and administrative. General and administrative expenses consist primarily of wages and benefits for management, finance, accounting, human resources, legal and other administrative personnel, legal and accounting fees, insurance, and other corporate expenses. We expect to continue to add personnel and enhance our internal information systems in connection with the growth of our business. We expect our general and administrative expenses to increase given that we have become a public company as we expect our accounting, legal, and personnel-related expenses and directors and officers insurance costs to increase as we have instituted and continue to monitor a more comprehensive compliance and board governance function, maintain and review internal


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controls over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act, and prepare and distribute periodic reports, as required by the rules and regulations of the Securities and Exchange Commission. As a result, we expect that our general and administrative expenses will continue to increase in absolute dollars on an annual basis.
Sales and marketing. Sales and marketing expenses consist primarily of advertising costs, wages and benefits for sales and marketing personnel, creative expenses for advertising programs, credit card fees, commissions paid to third-party partners and affiliates, and the cost of providing free trials. The largest component of sales and marketing expense is advertising for customer acquisition, principally radio, television, and print advertisements. Online search costs consist primarily of pay-per-click payments to search engine operators. Advertising costs are expensed as incurred. To date, marketing and advertising costs have been incurred principally in the U.S., but we expect to increase our marketing and advertising expenditures in other countries. We expect that we will continue to commit significant resources to our sales and marketing efforts to grow our business and awareness of our brand and services. We expect that sales and marketing expenses will continue to increase in absolute dollars on an annual basis.
Critical Accounting Policies
Our financial statements are prepared in accordance with accounting principles generally accepted in the U.S., or GAAP. The preparation of our financial statements and related disclosures requires us to make estimates, assumptions, and judgments that affect the reported amount of assets, liabilities, revenue, costs and expenses, and related disclosures. We base our estimates and assumptions on historical experience and other factors that we believe to be reasonable under the circumstances, but all such estimates and assumptions are inherently uncertain and unpredictable. We evaluate our estimates and assumptions on an ongoing basis. Actual results may differ from those estimates and assumptions, and it is possible that other professionals, applying their own judgment to the same facts and circumstances, could develop and support alternative estimates and assumptions that would result in material changes to our operating results and financial condition.
We consider the assumptions and estimates associated with revenue recognition, goodwill and acquired intangible assets, income taxes and stock-based compensation to be our critical accounting policies and estimates. There have been no material changes to our critical accounting policies since December 31, 2010. For further information on our critical and other significant accounting policies, see the notes to the condensed consolidated financial statements appearing elsewhere in this Quarterly Report on Form 10-Q and our Prospectus filed pursuant to Rule 424(b) under the Securities Act with the Securities and Exchange Commission on August 11, 2011. Results of Operations
The following table sets forth, for the periods presented, data from our consolidated statements of operations as the percentage of revenue that each line item represents. The information contained in the table below should be read in conjunction with financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q.


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                                                     Three Months Ended                 Nine Months Ended
                                                       September 30,                      September 30,
                                                   2011              2010             2011             2010
                                                                         (% of revenue)
Consolidated statements of operations data:
Revenue                                              100.0 %          100.0 %           100.0 %         100.0 %
Cost of revenue                                       38.4             41.3              38.0            43.4

Gross profit                                          61.6             58.7              62.0            56.6
Operating expenses:
Research and development                              27.2             29.1              27.9            29.6
General and administrative                            11.6              8.5              10.9            10.8
Sales and marketing                                   69.6             85.9              63.6            93.8

Total operating expense                              108.3            123.6             102.4           134.1

Loss from operations                                 (46.7 )          (64.9 )           (40.4 )         (77.5 )
Interest and other income, net                         0.1              0.4               0.1             0.6

Net loss                                             (46.6 )%         (64.5 )%          (40.3 )%        (76.9 )%

Comparison of the Three and Nine Months Ended September 30, 2011 and 2010
Revenue

                        Three Months Ended                     Nine Months Ended
                           September 30,                         September 30,
                   2011         2010       Change        2011         2010       Change
                                 (in thousands, except percentage data)

$ 15,926 $ 10,322 54 % $ 43,168 $ 27,007 60 %

Revenue increased $5.6 million for the three months ended September 30, 2011 compared to the three months ended September 30, 2010, primarily due to a 38% increase in the number of total customers over the period. Revenue increased $16.2 million for the nine months ended September 30, 2011 compared to the nine months ended September 30, 2010, primarily due to a 45% increase in the number of total customers over the period. The increase in revenue during these periods was driven in part by increased advertising expenditures in prior periods, as well as an 8% overall increase in pricing of our consumer service in April 2011 that resulted in a continued shift in subscriber mix towards three year subscriptions. In addition, we released our first SMB offering in February 2010 and revenue from SMB customers was approximately $1.7 million in the three months ended September 30, 2011 compared to $0.3 million in the corresponding 2010 period.
Cost of revenue, gross profit, and gross margin

                               Three Months Ended                    Nine Months Ended
                                  September 30,                        September 30,
                          2011        2010       Change        2011         2010       Change
                                        (in thousands, except percentage data)
       Cost of revenue   $ 6,109     $ 4,261          43 %   $ 16,420     $ 11,710          40 %
       Gross profit      $ 9,817     $ 6,061          62 %   $ 26,748     $ 15,297          75 %
       Gross margin         61.6 %      58.7 %                   62.0 %       56.6 %

Cost of revenue increased $1.8 million for the three months ended September 30, 2011 compared to the three months ended September 30, 2010, primarily due to an increase in the total number of customers. The increase in cost of revenue was comprised primarily of hosting costs of $1.6 million, including depreciation of equipment, personnel related costs of our operations employees and increases in our data storage capacity, and customer support costs of $0.2 million, primarily associated with the cost of new employees to replace outsourced support in India. Gross profit increased primarily as a result of increases in revenue and gross margin increased primarily due to economies of scale.
Cost of revenue increased $4.7 million for the nine months ended September 30, 2011 compared to the nine months ended September 30, 2010, primarily due to an increase in the total number of customers. The increase in cost of revenue was comprised primarily of hosting costs of $3.7 million for the nine months, including depreciation of equipment, personnel related costs of our operations employees and increases in our data storage capacity, and customer support costs of $1.0 million, primarily associated with the cost of new


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employees to replace outsourced support in India. Gross profit increased primarily as a result of increases in revenue and gross margin increased primarily due to economies of scale.
Operating expenses

                                     Three Months Ended                     Nine Months Ended
                                        September 30,                         September 30,
                                2011        2010        Change        2011         2010       Change
                                              (in thousands, except percentage data)
 Research and development     $  4,336     $ 3,008           44 %   $ 12,046     $  7,981          51 %
 General and administrative   $  1,841     $   879          109 %   $  4,719     $  2,912          62 %
 Sales and marketing          $ 11,078     $ 8,869           25 %   $ 27,436     $ 25,333           8 %

Research and development. Research and development expenses increased $1.3 million for the three months ended September 30, 2011 compared to the three months ended September 30, 2010 and increased $4.1 million for the nine months ended September 30, 2011 compared to the nine months ended September 30, 2010, primarily due to additional hiring in the U.S. and China to enhance the functionality of our solutions and to develop new offerings.
General and administrative. General and administrative expenses increased $1.0 million for the three months ended September 30, 2011 compared to the three months ended September 30, 2010, primarily due to a $0.5 million increase in professional fees, including legal and accounting fees and a $0.2 million increase in personnel related costs as a result of additional employees. General and administrative expenses increased $1.8 million for the nine months ended September 30, 2011 compared to the nine months ended September 30, 2010, primarily due to a $1.2 million increase in professional fees and a $0.3 million increase in personnel related costs. The increase in professional fees was driven by increased legal costs as we prepared to operate as a public company . . .

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