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WWWW > SEC Filings for WWWW > Form 10-Q on 5-Nov-2012All Recent SEC Filings

Show all filings for WEB.COM GROUP, INC.

Form 10-Q for WEB.COM GROUP, INC.


5-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Forward Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the "safe harbor" created by those sections. Forward-looking statements are based on our management's beliefs and assumptions and on information currently available to our management. All statements other than statements of historical facts are "forward-looking statements" for purposes of these provisions, including any projections or earnings. In some cases, you can identify forward-looking statements by terms such as "anticipate," "believe," "could," "estimate," "expect," "intend," "may," "plan," "potential," "predict," "project," "should," "will," "would" and similar expressions intended to identify forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors, which may cause our actual results, performance, time frames or achievements to be materially different from any future results, performance, time frames or achievements expressed or implied by the forward-looking statements. We discuss many of these risks, uncertainties and other factors in this Quarterly Report on Form 10-Q in greater detail under the heading "Risk Factors." Given these risks, uncertainties and other factors, you should not place undue reliance on these forward-looking statements. Also, these forward-looking statements represent our estimates and assumptions only as of the date of this filing. You should read this Quarterly Report on Form 10-Q completely and with the understanding that our actual future results may be materially different from what we expect. We hereby qualify our forward-looking statements by these cautionary statements. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

Safe Harbor

In the following discussion and analysis of results of operations and financial condition, certain financial measures may be considered "non-GAAP financial measures" under Securities and Exchange Commission rules. These rules require supplemental explanation and reconciliation, which is provided in this Quarterly Report on Form 10-Q. We believe presenting non-GAAP net income attributable to common stockholders, non-GAAP net income per share attributable to common stockholders and non-GAAP operating income is useful to investors, because it describes the operating performance of the Company and helps investors gauge the Company's ability to generate cash flow, excluding some recurring charges that are included in the most directly comparable measures calculated and presented in accordance with GAAP. We use these non-GAAP measures as important indicators of our past performance and in planning and forecasting performance in future periods. The non-GAAP financial information we present may not be comparable to similarly-titled financial measures used by other companies, and investors should not consider non-GAAP financial measures in isolation from, or in substitution for, financial information presented in compliance with GAAP.

Overview

We are a leading provider of internet services for small- to medium-sized businesses, or SMBs and a global domain name registrar. We seek to meet the internet needs of SMBs anywhere along their lifecycle with affordable subscription solutions including domain name registration, website design and related services, search engine optimization, search engine marketing, social media and mobile products, local sales leads, eCommerce solutions and call center services. We offer SMBs a single point of entry to an array of effective, affordable online products and services that will help drive their business. The breadth and flexibility of our offerings allow us to address the web services needs of a wide variety of customers, ranging from those just establishing their websites to those that want to enhance their existing online presence with more sophisticated marketing and lead generation services. We offer our customers a full range of web services and products on an affordable subscription basis. With nearly 3 million subscribers as of September 30, 2012, we are one of the industry's largest providers of domain names, affordable web services and products that enable SMBs to have an effective online presence.

We have positioned ourselves as a partner to SMBs across all phases of their business's adaptation to internet technology, from their initial entry onto the web to their use of cutting-edge innovations as they mature. As a domain registrar, we allow the business to establish an online presence by buying a domain name. This basic service is the entry point to higher priced offerings. Having secured a domain, a business next needs a website and email service. Our offerings for these fundamental services span the range of customer budgets and expertise, from inexpensive Do It Yourself website and email hosting for the technically-savvy, to Do It For Me custom website design services, online marketing and eCommerce solutions. Customers can engage our experienced consultants for services that range from web design to online advertising campaign management. When online innovations emerge, we can help SMBs leverage the new capabilities.

On October 27, 2011, we completed the acquisition of Network Solutions, a provider of domain names, web hosting and online marketing services. The purchase price paid to the Sellers was approximately $569.0 million consisting of $405.1 million in cash and the issuance of 18 million shares of Web.com common stock valued at $9.16 per share. In connection with the acquisition, the Company assumed the obligation to pay approximately $211.7 million of outstanding debt of Network Solutions and paid off such liabilities at closing with borrowings from the Company's new credit facilities, and assumed certain other liabilities. See Note 7 to the Company's financial statements for the fiscal year ended December 31, 2011 included in the Company's annual report on Form 10-K filed on March 13, 2012 with the SEC. With approximately 2 million subscribers acquired, Network Solutions represents a substantial cross- and up-sell opportunity for us. We determined that the operations of Network Solutions are considered Web products and services and therefore, no change to our operating segment resulted. See Note 3, Business Combinations, for additional information on the acquisition.

We sell our products and services via our direct sales force, which operates in the U.S. and Canada. In addition to these sales centers, we acquire many customers through online and affiliate marketing activities. Recently, we rolled out a "Feet on the Street" direct sales initiative, a Direct Response Television, or DRTVcampaign and entered into certain brand-oriented sponsorship programs. We also sell web services and products to customers identified by companies with which it has strategic marketing relationships. Typically, our strategic marketing partners have established brand names and attract a large number of SMB customers. We also acquire a large number of customers directly through online and affiliate marketing activities that target SMBs that want to establish or enhance their online presence.

To increase our revenue and take advantage of our market opportunity, we plan to expand our subscriber base as well as further our cross-sell/up-sell strategy with our domain name customers from Network Solutions and Register.com LP. We intend to continue to hire additional personnel, particularly in outbound and inbound sales and marketing; develop additional services and products; add to our infrastructure to support our growth; and expand our operational and financial systems to manage our growing business. As we have in the past, we will continue to evaluate acquisition opportunities to increase the value and breadth of our Web services and product offerings, and expand our subscriber base.

Key Business Metrics

Management periodically reviews certain key business metrics to evaluate the effectiveness of our operational strategies, allocate resources and maximize the financial performance of our business. These key business metrics include:

Net Subscriber Additions

We maintain and grow our subscriber base through a combination of adding new subscribers and retaining existing subscribers. We define net subscriber additions in a particular period as the gross number of new subscribers added during the period, less subscriber cancellations during the period. For this purpose, we only count as new subscribers those customers whose subscriptions have extended beyond the free trial period. Additionally, we do not treat a subscription as cancelled, even if the customer is not current in their payments, until either we have made numerous attempts to contact the subscriber or 60 days have passed since the most recent failed billing attempt, whichever is sooner. In any event, a subscriber's account is cancelled if payment is not received within approximately 80 days.

We review this metric to evaluate whether we are performing to our business plan. An increase in net subscriber additions could signal an increase in subscription revenue, higher customer retention, and an increase in the effectiveness of our sales efforts. Similarly, a decrease in net subscriber additions could signal decreased subscription revenue, lower customer retention, and a decrease in the effectiveness of our sales efforts. Net subscriber additions above or below our business plan could have a long-term impact on our operating results due to the subscription nature of our business.

Monthly Turnover (Churn)

Monthly turnover, or churn, is a metric we measure each quarter, and which we define as customer cancellations in the quarter divided by the sum of the number of subscribers at the beginning of the quarter and the gross number of new subscribers added during the quarter, divided by three months. Customer cancellations in the quarter include cancellations from gross subscriber additions, which is why we include gross subscriber additions in the denominator. In measuring monthly turnover, we use the same conventions with respect to free trials and subscribers who are not current in their payments as described above for net subscriber additions. Monthly turnover is the key metric that allows management to evaluate whether we are retaining our existing subscribers in accordance with our business plan. An increase in monthly turnover may signal deterioration in the quality of our service, or it may signal a behavioral change in our subscriber base. Lower monthly turnover signals higher customer retention.

Average Revenue per Subscriber

Average revenue per subscriber, or ARPU, is a metric we measure on a quarterly basis. We define ARPU as quarterly subscription revenue divided by the average of the number of subscribers at the beginning of the quarter and the number of subscribers at the end of the quarter, divided by three months. We exclude from subscription revenue the impact of the fair value adjustments to deferred revenue resulting from acquisition-related write downs. The fair market value adjustment was $18.4 million and $2.8 million for the three months ended September 30, 2012 and 2011, and $69.0 million and $12.3 million for the nine months ended September 30, 2012 and 2011, respectively. ARPU is the key metric that allows management to evaluate the impact on monthly revenue from product pricing, product sales mix trends, and up-sell/cross-sell effectiveness.

Sources of Revenue

We derive our revenue from a variety of services to SMBs, including web design and services, domain name registration and services, online marketing, search engine optimization, eCommerce solutions, logo design and home contractor lead services. Leads are generated through online advertising campaigns targeting customers in need of web design, hosting or online marketing solutions, through strategic partnerships with enterprise partners, or through our corporate websites. In addition, we continue to up-sell to the acquired customer bases of Register.com LP and Network Solutions.

Subscription Revenue

We currently derive a substantial majority of our revenue from fees associated with our subscription services, which are generally sold through our web services, online marketing, eCommerce, and domain name registration offerings. A portion of our services are offered free of charge for a 30-day trial period during which the customer can cancel at any time. After the 30-day trial period has ended, the revenue is recognized on a daily basis over the life of the contract. We bill a majority of our customers in advance through their credit cards, bank accounts, or business merchant accounts, and revenue is also recognized on a daily basis over the life of the contract which can range from monthly up to 100 years.

For the three and nine months ended September 30, 2012, subscription revenue accounted for approximately 97% of our total revenue as compared to 99% and 98% for the three and nine months ended September 30, 2011, respectively. The number of paying subscribers of our Web services and lead generation products drives subscription revenue as well as the subscription price that we charge for these services. The number of paying subscribers is affected both by the number of new customers we acquire in a given period and by the number of existing customers we retain during that period. We expect other sources of revenue to decline as a percentage of total revenue over time.

Professional Services and Other Revenue

We generate professional services and other revenue primarily from custom website design, eCommerce store design and support services, and Do It Yourself logo design. Our custom website design and eCommerce store design work is typically billed on a fixed price basis and over very short periods. Our Do It Yourself logo design is typically billed upon the point-of-sale of the final product, which is created by the customer.

Cost of Revenue

Cost of Subscription Revenue

Cost of subscription revenue consists of expenses related to compensation of our Web page development staff, domain name registration fees, directory listing fees, customer support costs, search engine registration fees, billing costs, hosting expenses, marketing fees, and allocated overhead costs. We allocate overhead costs such as rent and utilities to all departments based on headcount. Accordingly, general overhead expenses are reflected in each cost of revenue and operating expense category. As our customer base and Web services usage grows, we intend to continue to invest additional resources in our website development and support staff.

Cost of Professional Services and Other Revenue

Cost of professional services revenue primarily consists of compensation expenses related to our Web page development staff, eCommerce store design, logo design, and allocated overhead costs. While in the near term, we expect to maintain or reduce costs in this area, in the long term, we may add additional resources in this area to support the growth in our professional services and custom design functions.

Operating Expenses

Sales and Marketing Expense

Our largest direct marketing expenses are the costs associated with the online marketing channels we use to acquire and promote our services. These channels include search marketing, affiliate marketing, direct television advertising and online partnerships. Sales costs consist primarily of compensation and related expenses for our sales and marketing staff. Sales and marketing expenses also include marketing programs, including advertising, corporate sponsorships, events, corporate communications, other brand building and product marketing expenses and allocated overhead costs.

We plan to continue to invest in sales and marketing by increasing the number of direct sales personnel in order to add new subscription customers as well as increase sales of additional and new services and products to our existing customer base. In addition, we plan to expand our resources to direct response television advertising to further increase revenue growth. Our investments in this area will also help us to expand our strategic marketing relationships, to build brand awareness, and to sponsor additional marketing events. Accordingly, we expect that, in the future, sales and marketing expenses will increase in absolute dollars.

Research and Development Expense

Research and development expenses consist primarily of compensation and related expenses for our research and development staff and allocated overhead costs. We have historically focused our research and development efforts on increasing the functionality of the technologies that enable our Web services and lead generation products. Our technology architecture enables us to provide all of our customers with a service based on a single version of the applications that serve each of our product offerings. As a result, we do not have to maintain multiple versions of our software, which enables us to have lower research and development expenses as a percentage of total revenue. We expect that, in the future, research and development expenses will increase as we continue to upgrade and extend our service offerings and develop new technologies.

General and Administrative Expense

General and administrative expenses consist of compensation and related expenses for executive, finance, administration, and management information systems personnel, as well as professional fees, corporate development costs, other corporate expenses, and allocated overhead costs. We expect that general and administrative expenses will increase in absolute dollars as we continue to add personnel to support the growth of our business.

Depreciation and Amortization Expense

Depreciation and amortization expenses relate primarily to our intangible assets recorded due to the acquisitions we have completed, as well as computer software and hardware, equipment, furniture and fixtures, building and building improvements.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements requires us to make estimates, assumptions and judgments that affect our assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. We base these estimates and assumptions on historical data and trends, current fact patterns, expectations and other sources of information we believe are reasonable. Actual results may differ from these estimates. For a full description of our critical accounting policies, see Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations in the 2011 Annual Report on Form 10-K.

Results of Operations



Comparison of the Results for the Three Months Ended September 30, 2012 to the
Results for the Three Months Ended September 30, 2011



The following table sets forth our key business metrics for the three months
ended September 30:



                                              Three months ended September 30,
                                                2012*                  2011
Net subscriber additions (reductions)               17,871                 (12,642 )
Churn                                                    1 %                     2 %

Average revenue per subscriber (monthly) $ 13.49 $ 16.73

*The metrics for the three months ended September 30, 2012 include the operating results of Network Solutions.

Net subscribers increased by 17,871 customers during the three months ended September 30, 2012 as compared to a decrease of 12,642 during the three months ended September 30, 2011. In addition, due to a continued downward trend in churn as well as the acquisition of Network Solutions' lower churning significant customer base, churn decreased to approximately 1% in the three months ended September 30, 2012 as compared to approximately 2% from the same prior year period ended. The increase in customers is primarily due to our increased marketing efforts during the third quarter ended September 30, 2012.

The average revenue per subscriber was $13.49 during the three months ended September 30, 2012, down from $16.73 for the same prior year period. The decrease in average revenue per subscriber was due to the addition of lower revenue subscribers from our acquisition of approximately two million Network Solutions' customers. Excluding the impact of the Network Solutions acquisition, the average revenue per subscriber increased from the prior year period. Further, the average revenue per subscriber of $13.49 represents an increase of 1% over the average revenue per subscriber of $13.34 for the second quarter ended June 30, 2012. When compared to the pro forma average revenue per subscriber of $12.86 for the three months ended December 31, 2011 giving effect to the Network Solutions acquisition, the three months ended September 30, 2012 was up 5 percent. The growth in average revenue per subscriber continues to be driven principally by our up-sell and cross-sell campaigns focused on selling higher revenue products to our existing customers as well as the introduction of new product offerings and sales channels oriented toward acquiring higher value customers.

Revenue



                                     Three months ended September 30,
                                        2012                   2011
                                         (unaudited, in thousands)
Revenue:
Subscription                      $         102,279       $        43,398
Professional services and other               3,474                   505
Total revenue                     $         105,753       $        43,903

Total revenue for the three months ended September 30, 2012 increased $61.9 million primarily due to the acquisition of Network Solutions in October 2011. The majority of the increase was associated with our domain and web-related services. In addition, the operations of Network Solutions began integrating with the existing legacy Web.com operations immediately following the closing of the acquisition on October 27, 2011. Furthermore, we increased revenue by continuing to up-sell our Do It For Me products to the acquired Register.com LP and Network Solutions customer base, in addition to favorable results from our direct advertising television campaigns and increased marketing efforts for our online marketing products.

Subscription Revenue. Subscription revenue increased $58.9 million to $102.3 million in the three months ended September 30, 2012 from $43.4 million for the same prior year period. The increase is due to the overall revenue drivers discussed above.

Professional Services and Other Revenue. Professional services revenue increased $3.0 million to $3.5 million in the three months ended September 30, 2012 from $0.5 million in the same prior year period ended. Professional services revenue increased primarily due to non-recurring website design revenue generated, in addition to increased custom website development service volume resulting from both the Register.com and Network Solutions acquisitions.

Cost of Revenue



                                    Three months ended September 30,
                                       2012                  2011
                                               (unaudited)
Cost of revenue:
Subscription                      $        38,096       $        17,026
Professional services and other             2,099                   335
Total cost of revenue             $        40,195       $        17,361

Cost of Subscription Revenue. Cost of subscription revenue increased $21.1 million to $38.1 million, or 37% of subscription revenue, in the three months ended September 30, 2012 from $17.0 million, or 39% of subscription revenue, in the three months ended September 30, 2011 primarily due to additional costs related to the revenue from the Network Solutions acquisition.

Our gross margin on subscription revenue increased from 61% during the three months ended September 30, 2011 to 63% during the three months ended September 30, 2012. The gross margin was negatively impacted by amortizing into revenue, deferred revenue that was written down to fair value at the acquisition date which was approximately 51% lower than the historical basis of Register.com LP and Network Solutions. Excluding the $18.4 million and $2.8 million effect of the adjustment related to the fair value of acquired deferred revenue for the quarters ended September 30, 2012 and 2011, respectively, the gross margin was 68% and 63%, respectively. The increase is related to a favorable gross margin product mix, such as domain name registration and related services.

Cost of Professional Services and Other Revenue. Cost of professional services revenue increased by $1.8 million to $2.1 million in the three months ended September 30, 2012 from $0.3 million during the same prior year period. The increase was primarily the result of the volume increase in custom website design revenue.

Operating Expenses



                                  Three months ended September 30,
                                     2012                  2011
                                             (unaudited)
Operating Expenses:
Sales and marketing             $        30,892       $        11,080
Research and development                  7,883                 3,264
General and administrative               11,417                11,207
Restructuring charges                     1,171                    85
Depreciation and amortization            19,816                 4,696
Total operating expenses        $        71,179       $        30,332

Sales and Marketing Expenses. Sales and marketing expenses increased $19.8 million to $30.9 million, or 29% of total revenue, during the three months ended September 30, 2012, up from $11.1 million, or 25% of total revenue, during the three months ended September 30, 2011. Our sales and marketing expenses increased primarily due to the acquisition of Network Solutions. However, the increase is also driven by our further investment in sales and marketing activities including direct response television advertising, corporate sponsorships, additional sales resources and online marketing. Overall, there were increases in compensation and benefits of $8.0 million and customer acquisition and marketing expenses of $10.9 million as compared to the same prior year period.

Research and Development Expenses. Research and development expenses increased $4.6 million to $7.9 million, or 7% of total revenue, during the three months ended September 30, 2012 from $3.3 million, or 7% of total revenue, during the three months ended September 30, 2011. Our research and development expenses increased primarily due to the acquisition of Network Solutions. Overall, there were increases in compensation and benefits of $1.7 million and data and software supporting costs of $2.2 million as compared to the same prior year period.

General and Administrative Expenses. General and administrative expenses increased $0.2 million to $11.4 million, or 11% of total revenue, during the three months ended September 30, 2012, up from $11.2 million, or 26% of total revenue, during the three months ended September 30, 2011. Our general and administrative expenses increased as compared to the same prior year period primarily due to the acquisition of Network Solutions. Overall, there were increases in compensation and benefits of $3.2 million, professional fees of . . .

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