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CARB > SEC Filings for CARB > Form 10-Q on 31-Oct-2012All Recent SEC Filings

Show all filings for CARBONITE INC

Form 10-Q for CARBONITE INC


31-Oct-2012

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 Annual Report on Form 10-K for the fiscal year ended December 31, 2011, as filed on March 7, 2012 with the Securities and Exchange Commission.

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 online backup solution and raised our first capital from investors. We sold the first Carbonite subscription 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. As of December 31, 2011, we had subscribers in more than 100 countries, with subscribers based in the U.S. representing 94% of our total revenue for 2011.

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 our Carbonite Home solution. Our Carbonite HomePlus and Carbonite HomePremier solutions provide consumers with additional features at annual prices of $99 and $149, respectively. The pricing of all of our consumer solutions is discounted for multi-year subscriptions. Our SMB solutions, Carbonite Business and Carbonite BusinessPremier, allow for an unlimited number of users subject to storage limits and are priced starting at $229 and $599 per year, respectively. We charge customers the full 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 television and radio advertising, online display advertising, print advertising, paid search, direct marketing, and other expenses. Our total advertising expense in 2011, 2010, and 2009 was $25.1 million, $23.6 million, and $10.8 million, respectively, and was $18.8 million in the nine months ended September 30, 2012. 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 2011, 2010, and 2009 were $13.5 million, $10.7 million, and $7.1 million, respectively, and were $10.2 million in the nine months ended September 30, 2012.

Our revenue has grown from $19.1 million in 2009 to $38.6 million in 2010, $60.5 million in 2011, and $60.4 million in the nine months ended September 30, 2012. At the same time, our total operating costs have grown from $29.8 million in 2009 to $48.2 million in 2010, $60.9 million in 2011, and $56.1 million in the nine months ended September 30, 2012, 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.

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 and capital equipment costs in advance of subscriptions while recognizing revenue ratably over the terms of the subscriptions, a customer relationship may not be profitable or result in positive cash flow at the beginning of the subscription period, even though it may be profitable or 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.

Recent Developments

On October 30, 2012, we entered into a general release and separation agreement with Andrew Keenan, which sets forth the terms of Mr. Keenan's resignation as our chief financial officer. Pursuant to the agreement, Mr. Keenan will continue to serve as our chief financial officer until the earlier of January 31, 2013 or the date on which Mr. Keenan accepts subsequent employment. During this time, Mr. Keenan will be entitled to continued (i) payment of his base salary, (ii) participation in our employee benefits plans, (iii) participation in our management bonus plans, and (iv) vesting of stock options. After Mr. Keenan's resignation is effective, he will be entitled to payments in an amount of up to nine times his current monthly base salary and may be entitled to additional benefits, including accelerated vesting of his stock options. In addition, Mr. Keenan will be permitted to exercise his vested stock options through the second anniversary of the effective date of his resignation. The agreement also includes a release of claims by Mr. Keenan in our favor.


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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. Each consumer subscription covers a single computer; therefore, a consumer with multiple computers would have multiple subscriptions. Each SMB subscription covers all computers of the SMB entity; therefore, an SMB with multiple computers would have one 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.

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 offerings 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 represent 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, 2012 and 2011:



                                      Three Months Ended September 30,
                                        2012                      2011
                                   (in thousands, except percentage data)
         Total customers                      1,385                    1,164
         Annual retention rate                   84 %                     81 %
         Renewal rate                            81 %                     82 %
         Bookings                $           24,329          $        20,468
         Free cash flow          $              567          $          (489 )

Our total customers and bookings increased over the periods presented 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 legacy third-party distribution channels, and we terminated most of our distribution agreements at that time. 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 both the three months ended September 30, 2012 and 2011 was 86%.

Free cash flow for the three months ended September 30, 2012 increased by $1.1 million compared to the three months ended September 30, 2011. The increase in free cash flow was due to a $0.5 million increase in cash flows from operating activity and a $0.6 decrease in the purchase of property and equipment.


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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 this trend to continue.

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. 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 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, but decrease as a percentage of revenue.

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 television, radio, online, 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 may 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, but decrease as a percentage of revenue.

Lease exit charge. Lease exit charge consists of the accrual of future remaining lease payments associated with the closure of our Boston, Massachusetts data center and moving expenses to relocate equipment formerly hosted in that facility.

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. Our most critical accounting policies are summarized below.


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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, 2011. 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 Annual Report on Form 10-K, as filed on March 7, 2012 with the Securities and Exchange Commission.


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Results of Operations

The following table sets forth, for the periods presented, data from our consolidated statements of operations as well as the percentage of revenue that each line item represents. The period-to-period comparison of financial results is not necessarily indicative of future results. 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.

                                                   Three Months Ended               Nine Months Ended
                                                      September 30,                   September 30,
                                                  2012             2011             2012          2011
                                                                     (% of revenue)
Consolidated statements of operations data:
Revenue                                             100.0 %         100.0 %          100.0 %       100.0 %
Cost of revenue                                      33.4            38.4             34.8          38.0

Gross profit                                         66.6            61.6             65.2          62.0
Operating expenses:
Research and development                             22.7            27.2             24.4          27.9
General and administrative                           12.3            11.6             12.0          10.9
Sales and marketing                                  47.2            69.6             54.4          63.6
Lease exit charge                                      -               -               1.9            -

Total operating expense                              82.2           108.4             92.7         102.4

Loss from operations                                (15.6 )         (46.8 )          (27.5 )       (40.4 )
Interest and other income, net                         -              0.1               -            0.1

Loss before income taxes                            (15.6 )         (46.7 )          (27.5 )       (40.3 )

Provision for income taxes                           (0.1 )            -              (0.1 )          -

Net loss                                            (15.7 )%        (46.7 )%         (27.6 )%      (40.3 )%

Comparison of the Three and Nine Months Ended September 30, 2012 and 2011

Revenue

Three Months Ended Nine Months Ended
September 30, September 30,
2012 2011 Change 2012 2011 Change
(in thousands, except percentage data)

Revenue $ 21,573 $ 15,926 35.5 % $ 60,367 $ 43,168 39.8 %

Revenue increased by $5.6 million for the three months ended September 30, 2012 compared to the three months ended September 30, 2011, primarily due to a 19% increase in the number of average total customers over the period. Revenue increased $17.2 million for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011, primarily due to a 22% increase in the number of average total customers over the period. These increases were driven in part by increased advertising expenditures in prior periods. In addition, the revenue per average subscriber increased 14% and 15%, respectively, for the three and nine months ended September 30, 2012 as compared to the corresponding 2011 periods due to reduced price discounting associated with a shorter average prepaid subscription term for our consumer offerings and the introduction of new premium consumer offerings and the continued growth of our business offerings, both of which are priced higher than our basic consumer offering.

Cost of revenue, gross profit, and gross margin

                       Three Months Ended                        Nine Months Ended
                          September 30,                            September 30,
                        2012          2011        Change         2012          2011        Change
                                        (in thousands, except percentage data)
   Cost of revenue   $    7,205      $ 6,109         17.9 %    $ 20,984      $ 16,420         27.8 %
   Gross profit      $   14,368      $ 9,817         46.4 %    $ 39,383      $ 26,748         47.2 %
   Gross margin            66.6 %       61.6 %                     65.2 %        62.0 %


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Cost of revenue increased by $1.1 million for the three months ended September 30, 2012 compared to the three months ended September 30, 2011, primarily due to an increase in the total number of customers. The increase in cost of revenue reflects a $1.0 million increase in personnel costs for our operations and customer support teams, as we added new employees to support customer growth and to replace support operations that were formerly staffed with outsourced personnel. In addition, hosting and depreciation costs increased by $0.5 million, which was attributable to the scaling of our infrastructure to support our overall customer growth. These increases were partially offset by a $0.5 million decrease in third-party outsourcing costs as we eliminated our use of outsourced customer support.

Cost of revenue increased by $4.6 million for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011, primarily due to an increase in the total number of customers. The increase in cost of revenue reflects a $4.2 million increase in personnel costs for our operations and customer support teams, as we added new employees to support customer growth and to replace support operations that were formerly staffed with outsourced personnel. In addition, hosting and depreciation costs increased by $2.3 million, which was attributable to the scaling of our infrastructure to support our overall customer growth. These increases were partially offset by a $2.0 million decrease in third-party outsourcing costs as we eliminated our use of outsourced customer support.

Operating expenses

                                           Three Months Ended                        Nine Months Ended
                                              September 30,                            September 30,
                                            2012          2011       Change          2012          2011       Change
                                                            (in thousands, except percentage data)
Research and development                 $    4,890     $  4,336        12.8 %     $  14,759     $ 12,046        22.5 %
General and administrative               $    2,658     $  1,841        44.4 %     $   7,271     $  4,719        54.1 %
Sales and marketing                      $   10,179     $ 11,078        (8.1 )%    $  32,864     $ 27,436        19.8 %
Lease exit charge                        $       -      $     -           -        $   1,174     $     -          N/A

Research and development. Research and development expenses increased by $0.6 million for the three months ended September 30, 2012 compared to the three months ended September 30, 2011 and by $2.7 million for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011, primarily due to $0.3 million and $2.3 million increases, respectively, in personnel related costs attributable to additional employees hired to enhance the functionality of our solutions and to develop new offerings.

General and administrative. General and administrative expenses increased by $0.8 million for the three months ended September 30, 2012 compared to the three months ended September 30, 2011 and by $2.6 million for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011, primarily due to a $0.5 million and a $1.7 million increase, respectively, in personnel related costs as a result of additional employees to support our overall growth and the increased administrative requirements as we operate as a . . .

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