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CARB > SEC Filings for CARB > Form 10-Q on 5-Nov-2013All Recent SEC Filings

Show all filings for CARBONITE INC

Form 10-Q for CARBONITE INC


5-Nov-2013

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, 2012, as filed on March 6, 2013 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 cloud backup solutions for small businesses and consumers. We provide easy-to-use, affordable, and secure cloud backup solutions with anytime, anywhere access to files stored on our servers. We believe that we are the best known brand in the cloud backup market.

In 2005, we began development of our cloud backup solution and raised our first capital from investors. We sold our first Carbonite subscription in 2006. As of September 30, 2013, we had more than 1.5 million customers in more than 100 countries and had total revenue for the quarter of $27.7 million. For the year ended December 31, 2012, customers in the U.S. represented 94% of our total revenue.

We derive our revenue from subscription fees from small businesses and consumers. We generally charge customers the full subscription amount at the beginning of each subscription period. Our Carbonite Business and Business Premier solutions provide a fixed amount of storage for an unlimited number of computers. Carbonite Business includes 250GB of cloud storage ($229.99/year). Carbonite Business Premier includes 500GB of cloud storage plus cloud backup for an unlimited number of Windows Servers ($599.99/year). Additional cloud storage in increments of 50GB or 100GB can be purchased for $55.99 and $99.99 per year, respectively. In addition, Enhanced Server Backup is now available as an add-on to Business Premier for $399.99 per year, and provides protection for an unlimited number of servers, databases, and live applications. For consumers, we offer three different annual cloud backup solutions, each including unlimited storage for one computer: Home ($59.99/year), Home Plus ($99.99/year), and Home Premier ($149.99/year).

In October 2012, we acquired Zmanda, Inc. for $13.4 million, net of cash acquired. We believe this acquisition enhances our small business offering with the ability to backup databases and file systems to the cloud, and enables small businesses to obtain all of the backup solutions that they need from one vendor.

We invest in customer acquisition because we believe that the market for cloud 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. 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. We also leverage an indirect distribution network to acquire customers by selling our solutions through our sales channel relationships including major retailers and resellers.


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As we grow our business we continue to invest in additional storage and infrastructure. Our operating costs continue to grow as we add more customers, principally as a result of our investment in customer acquisition and research and development. 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. We generally incur customer acquisition costs and capital equipment costs in advance of subscriptions while recognizing revenue ratably over the terms of the subscriptions. As a result, 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 subscription plans, a significant majority of our customers are currently on annual subscription plans. 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 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 Carbonite Business and Home subscriptions at the end of the relevant period. Each small business subscription covers all computers, servers, and databases of the small business entity; therefore, a small business with multiple computers, servers, or databases may have one subscription. Each consumer subscription covers a single computer; therefore, a consumer with multiple computers would have multiple subscriptions.

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. 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 the cash portion of the lease exit charge, which is classified as restructuring charges. 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 and nine
months ended September 30, 2013 and 2012:



                                   Three Months Ended           Nine Months Ended
                                      September 30,               September 30,
                                   2013           2012          2013          2012
                                       (in thousands, except percentage data)
         Key metrics:
         Total customers             1,514         1,385         1,514         1,385
         Annual retention rate          85 %          84 %          85 %          84 %
         Renewal rate                   79 %          81 %          81 %          80 %
         Bookings                $  27,640      $ 24,329      $ 84,390      $ 70,954
         Free cash flow          $   1,354      $    567      $  3,199      $ (6,149 )


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Our total customers and bookings increased over the periods presented and we continue to invest in customer acquisition in an effort to drive continued growth in total customers and bookings, with bookings for our small business solutions representing 27% of total bookings for the third quarter of 2013, up from 17% in the third quarter of 2012. 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.

Our free cash flow has improved by $0.8 million and $9.3 million over the three and nine month periods ended September 30, 2013, respectively, due to improved management of our working capital accounts, reduced purchases of property and equipment, and increased efficiencies in our business model.

Key Components of our Consolidated Statements of Operations

Revenue

We derive our revenue principally from subscription fees related to our service solutions. 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, amortization of developed technology, 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. On a per customer basis, our costs have been decreasing as we purchase equipment and services in larger quantities and our customer support personnel become more efficient in supporting our customers. We have also experienced a downward trend in the cost of storage equipment and broadband service, which we expect will continue in the future. We expect these expenses to increase in absolute dollars as we continue to increase our number of customers, but decrease as a percentage of revenue due to increased efficiencies in supporting customers.

Gross profit and gross margin

Our gross margins have expanded due to price increases for our consumer solutions, the introduction of higher priced solutions targeting both small businesses and consumers, a downward trend in the cost of storage equipment and services, and efficiencies of our customer support personnel in supporting our customers. We expect these trends 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 solutions and developing new solutions. The majority of our research and development employees are located at our corporate headquarters in the U.S. 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, but decrease as a percentage of revenue over time, as we expect to grow our revenue at a faster rate.

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 that general and administrative expenses will increase in absolute dollars on an annual basis as we continue to add personnel and enhance our internal information systems in connection with the anticipated growth of our business and as we continue to incur costs related to operating as a public company.

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 solutions. 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, as we expect to grow our revenue at a faster rate.


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Restructuring charges. Restructuring charges consists of the accrual of future remaining lease payments associated with the March 2012 closure of our Boston, Massachusetts data center, the moving expenses to relocate equipment formerly hosted in that facility and the charges incurred related to the restructuring of our Carbonite China operations, which are now dormant.

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, business combinations, 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, 2012. 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 6, 2013 with the Securities and Exchange Commission.

Results of Operations

The following table sets forth, for the periods presented, data from our consolidated statements of operations as a 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,
                                                 2013            2012            2013           2012
                                                                   (% of revenue)
Consolidated statements of operations data:
Revenue                                            100.0 %        100.0 %         100.0 %        100.0 %
Cost of revenue                                     32.1           33.4            33.4           34.8

Gross profit                                        67.9           66.6            66.6           65.2
Operating expenses:
Research and development                            18.9           22.7            19.9           24.4
General and administrative                          10.8           12.3            14.4           12.0
Sales and marketing                                 42.4           47.2            45.8           54.4
Restructuring charges                                0.0             -              0.4            1.9

Total operating expense                             72.1           82.2            80.5           92.7

Loss from operations                                (4.2 )        (15.6 )         (13.9 )        (27.5 )

Loss before income taxes                            (4.2 )        (15.6 )         (13.9 )        (27.5 )

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

Net loss                                            (4.3 )%       (15.7 )%        (13.9 )%       (27.6 )%

Comparison of the Three Months and Nine Months Ended September 30, 2013 and 2012

Revenue

Three Months Ended September 30, Nine Months Ended September 30, 2013 2012 Change 2013 2012 Change

(in thousands, except percentage data)

Revenue $ 27,683 $ 21,573 $ 6,110 28.3 % $ 78,407 $ 60,367 $ 18,040 29.9 %


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Revenue increased for the three and nine month periods ended September 30, 2013 as compared to the three and nine month periods ended September 30, 2012, primarily due to increases in the average selling prices for our small business and consumer solutions, and due to a 9% increase in our number of total customers.

Cost of revenue, gross profit, and gross margin

                                           Three Months Ended September 30,                     Nine Months Ended September 30,
                                      2013          2012              Change              2013          2012              Change
                                                                  (in thousands, except percentage data)
Cost of revenue                     $  8,899      $  7,205      $ 1,694       23.5 %    $ 26,192      $ 20,984      $  5,208       24.8 %
Percent of revenue                      32.1 %        33.4 %                                33.4 %        34.8 %
Components of cost of revenue:
Personnel related costs             $  2,631      $  2,020      $   611       30.2 %    $  7,845      $  5,942      $  1,903       32.0 %
Hosting and depreciation costs         5,247         4,603          644       14.0 %      15,306        13,380         1,926       14.4 %
Software, amortization and other       1,021           582          439       75.4 %       3,041         1,662         1,379       83.0 %

Total cost of revenue               $  8,899      $  7,205      $ 1,694       23.5 %    $ 26,192      $ 20,984      $  5,208       24.8 %
Gross profit                        $ 18,784      $ 14,368      $ 4,416       30.7 %    $ 52,215      $ 39,383      $ 12,832       32.6 %
Gross margin                            67.9 %        66.6 %                                66.6 %        65.2 %

Cost of revenue increased for the three and nine month periods ended September 30, 2013 compared to the three and nine month periods ended September 30, 2012 due primarily to an increase in personnel related costs for our customer service organization and storage costs associated with storing a larger volume of customer data. Software and equipment maintenance costs increased as we made investments in our customer service organization to support our growth. We also incurred additional amortization expenses related to our Zmanda, Inc. acquisition in October 2012.

Operating expenses

Research and development.

                                          Three Months Ended September 30,                     Nine Months Ended September 30,
                                     2013         2012              Change                2013          2012             Change
                                                                 (in thousands, except percentage data)
Research and development            $ 5,220      $ 4,890      $  330          6.7 %     $ 15,597      $ 14,759      $ 838         5.7 %
Percent of revenue                     18.9 %       22.7 %                                  19.9 %        24.4 %
Components of research and
development:
Personnel related costs             $ 4,168      $ 3,747      $  421         11.2 %     $ 12,163      $ 11,658      $ 505         4.3 %
Third-party outsourcing costs           453          342         111         32.5 %        1,303           883        420        47.6 %
Hosting, independent contractors
and other                               599          801        (202 )      (25.2 )%       2,131         2,218        (87 )      (3.9 )%

Total research and development      $ 5,220      $ 4,890      $  330          6.7 %     $ 15,597      $ 14,759      $ 838         5.7 %

Research and development expenses increased for the three and nine month periods ended September 30, 2013 as compared to the three and nine month periods ended September 30, 2012, primarily from an increase in personnel related costs associated with employee benefit and performance bonus expenses. The increase was further driven by higher outsourced development costs intended to improve the ease of use and functionality of our existing solutions and the development of new small business offerings.


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General and administrative.

                                                  Three Months Ended September 30,                     Nine Months Ended September 30,
                                             2013         2012              Change                2013         2012              Change
                                                                         (in thousands, except percentage data)
General and administrative                  $ 2,988      $ 2,658      $  330         12.4 %     $ 11,293      $ 7,271      $ 4,022       55.3 %
Percent of revenue                             10.8 %       12.3 %                                  14.4 %       12.0 %
Components of general and administrative:
Personnel related costs                     $ 1,858      $ 1,228      $  630         51.3 %     $  5,559      $ 3,522      $ 2,037       57.8 %
Professional fees                               607        1,061        (454 )      (42.8 )%       3,817        2,693        1,124       41.7 %
Sales tax, consulting and other                 523          369         154         41.7 %        1,917        1,056          861       81.5 %

Total general and administrative            $ 2,988      $ 2,658      $  330         12.4 %     $ 11,293      $ 7,271      $ 4,022       55.3 %

General and administrative expenses increased for the three months ended September 30, 2013 as compared to the three months ended September 30, 2012, primarily due to increased headcount necessary to support our overall growth and administrative requirements of operating as a public company and a sales tax accrual for uncollected sales tax. These increases are offset in part by a reduction of legal costs associated with litigation.

General and administrative expenses increased for the nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012, primarily due to increased headcount necessary to support our overall growth and administrative requirements of operating as a public company, increased legal costs associated with litigation and a sales tax accrual for uncollected sales tax.

Sales and marketing.

                                            Three Months Ended September 30,                     Nine Months Ended September 30,
                                       2013          2012              Change              2013          2012              Change
                                                                   (in thousands, except percentage data)
Sales and marketing                  $ 11,742      $ 10,179      $ 1,563       15.4 %    $ 35,935      $ 32,864      $ 3,071         9.3 %
. . .
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