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CTCT > SEC Filings for CTCT > Form 10-K on 5-Mar-2014All Recent SEC Filings

Show all filings for CONSTANT CONTACT, INC.

Form 10-K for CONSTANT CONTACT, INC.


5-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and the related notes and other financial information, included elsewhere in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report on Form 10-K, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties. You should review the "Risk Factors" section of this Annual Report on Form 10-K for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.

Overview

We are a leading provider of online marketing tools that are designed for small organizations, including businesses, associations and non-profits. We seek to help our customers succeed by creating and growing their customer and member relationships through our easy-to-use products combined with education, support, KnowHow and coaching. Our tools include our email marketing, social media marketing, event marketing, local deals, online listings and survey products.

We market our products and acquire our customers through a variety of sources including online marketing, such as search engines and advertising on online networks and other websites, offline marketing through television and radio advertising, local seminars, relationships with our partners, referrals from our growing customer base, general brand awareness and a link to our website in the footer of substantially all of the emails sent by our customers.

We have grown rapidly since launching our first on-demand product in 2000. We ended 2013 with approximately 595,000 unique paying customers and had revenue for that year of $285 million.


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Our business strategy is to expand beyond email marketing to provide an integrated multi-product offering that drives higher customer life-time value driven by improvements in average revenue per customer and retention. We believe increasing our customer's life-time value will be a key contributor to our continued success. To drive life-time value, we intend to continue to focus on acquiring and supporting customers in a cost-effective manner, increasing average revenue per customer (through cross-selling, list size growth and bundling of our products) and improving customer retention rates. We continue to test pricing and product bundling. Bundled product offerings provide access to multiple products for one set monthly fee. We expect to offer a variety of packages that will contain different product combinations and pricing tiers. We believe, when used in combination, our integrated products provide customers with a unified online marketing platform and that by offering bundles, we will be able to achieve increased product usage, increased revenue per customer and higher retention rates.

Recent highlights include:

• Introduced our new contact management functionality and have been rolling out this functionality in a phased manner to all of our customers. This enhanced functionality enables our customers to have additional views of their contacts and allows them to run targeted campaigns to specific segments of their contact list. It also allows customers to track and manage engagement over time, across all of our different marketing campaign types and to build and store contact lists without having a contact's email address.

• Introduced Digital Coupons, a trackable and customizable digital coupon that when coupled with deals from SaveLocal gives small businesses the ability to offer discount types mapped to their particular goals and objectives from one integrated resource.

• Launched several enhancements to our mobile marketing integration tools, including mobile email list building and location-aware text check-ins, as well as Android and iOS versions of our MyLibrary Plus application.

• Rolled out our new in-product messaging center. We can now run targeted marketing campaigns to customers, based on specific demographic and behavioral characteristics.

• Announced new SinglePlatform opportunities. In April 2013, we announced that Yelp is part of our SinglePlatform network of publishers. In June 2013, we announced a partnership with GrubHub®, a leading online and mobile food ordering service, to become a menu provider for GrubHub's AllMenus.com and integrate GrubHub's online ordering platform into SinglePlatform menus.

• Announced a stock repurchase program in April 2013. Under the repurchase program, we were authorized to repurchase up to $20 million of our common stock through December 31, 2013. Shares could be repurchased from time to time in the open market or privately negotiated transactions in accordance with applicable securities and stock exchange rules. Through December 31, 2013, we repurchased 285,900 shares of common stock at an average price of $18.77 per share for a total cost of $5.4 million. As of December 31, 2013, the stock repurchase program has ended.

Key Financial and Operating Metrics

In connection with the ongoing operation of our business, our management regularly reviews key financial and operating metrics. Given our growth strategy, we pay particular attention to customer life-time value, customer acquisition metrics, trialer growth, customer attrition, success in cross-selling and growing customer list sizes, number of products per customer and average revenue per customer. We also consider other financial and operating metrics such as revenue, gross margin, expenses, customer satisfaction rates, average speed of answer for customer support calls, email deliverability rates and capital expenditures, among others. Management considers these financial and operating metrics critical to understanding and improving our business, reviewing our historical performance, benchmarking our performance versus other companies and identifying current and future trends, and for planning purposes.


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In addition, we consider the following non-GAAP financial measures to be key indicators of our financial performance:

• "adjusted EBITDA," which we define as GAAP net income (loss) before income taxes, interest income and other income (expense), depreciation and amortization, stock-based compensation, litigation contingency accrual and contingent consideration adjustment;

• "adjusted EBITDA margin," which we define as adjusted EBITDA divided by revenue;

• "non-GAAP net income," which we define as GAAP net income (loss) before the non-cash portion of income taxes, stock-based compensation expense, litigation contingency accrual and contingent consideration adjustment; and

• "free cash flow," which we define as net cash flow from operating activities less acquisition of property and equipment.

We believe that these non-GAAP financial measures are useful to management and investors in evaluating our operating performance for the periods presented and provide a tool for evaluating our ongoing operations. These non-GAAP financial measures, however, are not a measure of financial performance under accounting principles generally accepted in the United States of America, or GAAP, and should not be considered a substitute for GAAP financial measures, including but not limited to net income (loss) or cash flows from operating, investing and financing activities and may not be comparable to similarly titled measures reported by other companies.

Certain Trends and Uncertainties

The following represents a summary of certain trends and uncertainties, which could have a significant impact on our financial condition and results of operations. This summary is not intended to be a complete list of potential trends and uncertainties that could impact our business in the long or short term. This summary should be considered along with the factors set forth under Part I, Item 1A-"Risk Factors" and elsewhere in this Annual Report on Form 10-K.

• Our long term strategy is substantially dependent on our ability to continue to generate interest in our existing products and to enhance, expand and integrate our product offerings to serve the online marketing needs of small businesses, associations and non-profits. If we fail, our financial results could be adversely impacted.

• In connection with our acquisition of SinglePlatform, as of December 31, 2013, we have an obligation to the former shareholders of SinglePlatform to pay additional cash consideration of up to $7.5 million, contingent on the achievement of certain revenue targets through June 2014. Based on our assumptions and estimates related to our revenue forecasts we do not believe we will pay this additional consideration and have recorded no liability at December 31, 2013. We will continue to assess these assumptions and estimates on a quarterly basis. Changes in the estimated liability related to updated assumptions and estimates and to the actual revenue achievement will be recognized within the consolidated statements of operations. If our assumptions and estimates change significantly or if actual revenue achievement is significantly different than our estimates, our results of operations and cash flows could be materially affected. See also Note 4, Acquisitions, of the Notes to Consolidated Financial Statements, included elsewhere in this Annual Report on Form 10-K. In addition, our operating results could be adversely impacted if we fail to successfully integrate SinglePlatform or if we fail to successfully sell SinglePlatform's product.

• We continue to test new bundled product offerings that will allow our customers to have access to multiple products for one monthly fee. Our efforts to offer product bundles may not result in significant revenue growth, may negatively impact trialer conversion rates and may be confusing to our customers, any of which may harm our financial performance and impede our long-term growth strategy.


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• We believe that given the size of our potential market and the relatively low barriers to entry, competition may increase. Increased competition could result from existing competitors, existing competitors that have been acquired by larger enterprises or new competitors that enter the market because of the potential opportunity. We will continue to closely monitor competitive activity and respond accordingly. Increased competition could have an adverse effect on our financial condition and results of operations.

• From time to time, we may be subject to various claims and lawsuits by partners, customers, or other parties arising in the ordinary course of business, including lawsuits alleging patent infringement. We are currently a party to actions that are described in Part I, Item 3 "Legal Proceedings", included elsewhere in this Annual Report on Form 10-K. These matters can be time-consuming, divert management's attention and resources, and cause us to incur significant expenses. Furthermore, the results of any of these actions may have a material adverse effect on our operating results.

• We believe that as we continue to grow revenue at expected rates, our cost of revenue and operating expenses, including sales and marketing, research and development and general and administrative expenses, while expected to decline on a percentage of revenue basis, will increase in absolute dollar amounts. For a description of the general trends we anticipate in various expense categories, see "Cost of Revenue and Operating Expenses" below.

Critical Accounting Policies

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. 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 believe that the estimates, assumptions and judgments involved in the accounting policies described below may have the greatest potential impact on our financial statements and, therefore, consider these to be our critical accounting policies. Accordingly, we evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates under different assumptions and conditions. See also Note 2, Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements, included elsewhere in this Annual Report on Form 10-K for information about these critical accounting policies, as well as a description of our other significant accounting policies.

Revenue Recognition. We provide access to our products primarily through subscription arrangements whereby the customer is charged a fee for access for a defined term. Subscription arrangements include access to use our software via the Internet and support services, such as telephone, email and chat support. When there is evidence of an arrangement, the fee is fixed or determinable and collectability is deemed reasonably assured, we recognize revenue on a daily basis over the subscription period as the services are delivered. Delivery is considered to have commenced at the time the customer has paid for the products and has access to the account via a log-in and password. We also generate a small amount of revenue from our SaveLocal product by charging a fee to our customers based on the number of deals sold by our customers and the value of the successful deal. We recognize revenue from the fee charged when there is evidence of an arrangement, the fee is fixed or determinable and collectability is deemed reasonably assured. We also offer ancillary services to our customers related to our subscription-based products such as custom services and training. When sold together, revenue from custom services, training and our subscription products are accounted for separately based on vendor specific objective evidence of fair value of each of the services as those services have value on a standalone basis and do not involve a significant degree of risk or unique acceptance criteria. Revenue from custom services and training is recognized as the services are performed.

Income Taxes. Income taxes are provided for tax effects of transactions reported in the financial statements and consist of income taxes currently due plus deferred income taxes related to timing differences between the basis of certain assets and liabilities for financial statement and income tax reporting purposes. Deferred taxes are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. A valuation allowance is provided if, based upon the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.


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We account for uncertainty in income taxes recognized in our financial statements by applying a two-step process to determine the amount of tax benefit to be recognized. First, the tax position must be evaluated to determine the likelihood that it will be sustained upon external examination. If the tax position is deemed "more-likely-than-not" to be sustained, the tax position is then assessed to determine the amount of benefit to recognize in the financial statements. The amount of the benefit that may be recognized is the largest amount that has a greater than 50% likelihood of being realized upon ultimate settlement.

Goodwill and Acquired Intangible Assets. We record goodwill when consideration paid in a purchase acquisition exceeds the fair value of the net tangible assets and the identified intangible assets acquired. Goodwill is not amortized, but rather is tested for impairment annually or more frequently if facts and circumstances warrant a review. We perform our assessment for impairment of goodwill on an annual basis and we have determined that there is a single reporting unit for the purpose of conducting this annual goodwill impairment assessment. For purposes of assessing potential impairment, we annually estimate the fair value of the reporting unit (based on our market capitalization) and compare this amount to the carrying value of the reporting unit (as reflected by our total stockholders' equity). If we determine that the carrying value of the reporting unit exceeds its fair value, an impairment charge would be required. We completed our most recent annual impairment test of goodwill on November 30, 2013. Based upon that evaluation, we determined that our goodwill was not impaired.

Intangible assets are recorded at their estimated fair values at the date of acquisition. We amortize acquired intangible assets over their estimated useful lives based on the pattern of consumption of the economic benefits or, if that pattern cannot be readily determined, on a straight-line basis.

Software and Website Development Costs. Relative to development costs of our on-demand products and website, we capitalize certain direct costs to develop functionality as well as certain upgrades and enhancements that are probable to result in additional functionality. The costs incurred in the preliminary stages of development are expensed as incurred. Once an application has reached the development stage, internal and external costs, if direct and incremental, are capitalized as part of property and equipment until the software is substantially complete and ready for its intended use. Once placed in use, capitalized software is amortized over a three-year period in the expense category to which the software relates.

Stock-Based Compensation. We value all stock-based compensation, including grants of stock options, restricted stock and restricted stock units, at fair value on the date of grant, and expense the fair value over the applicable service period. The straight-line method is applied to all awards with service and market conditions, while the graded vesting method is applied to all awards with both service and performance conditions.

We base the fair value of common stock on the quoted market price of our stock. The fair value of restricted stock and restricted stock units for awards with time-based and performance-based vesting conditions are based on the fair value of common stock on the date of grant. We value restricted stock units with market-based vesting criteria using a Monte Carlo simulation model. The number of shares expected to be earned, based on achievement of the market condition, is factored into the grant date Monte Carlo valuation for the awards. The grant date fair value is not subsequently adjusted regardless of the eventual number of shares that are earned based on the market condition.


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The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The expected term assumption is based on the "simplified method" for estimating the expected term for awards that qualify as "plain-vanilla" options. Expected volatility is based on historical volatility of the publicly traded stocks of a peer group of companies, inclusive of us, commencing October 2007. The risk-free interest rate is determined by reference to U.S. Treasury bond yields at or near the time of grant for time periods similar to the expected term of the award. The relevant data used to determine the value of the stock option grants is as follows:

                                                     Years Ended December 31,
                                                  2013         2012         2011
      Weighted average risk-free interest rate      1.07 %       0.81 %       1.82 %
      Expected term (in years)                       4.6          4.6          5.5
      Weighted average expected volatility         51.14 %      53.58 %      52.15 %
      Expected dividends                               0 %          0 %          0 %

These assumptions represented our best estimates, but the estimates involve inherent uncertainties and the application of our judgment. As a result, if factors change and we use significantly different assumptions or estimates, our stock-based compensation expense could be materially different. Authoritative guidance requires that we recognize compensation expense for only the portion of awards that are expected to vest. In developing a forfeiture rate estimate, we have considered our historical experience to estimate pre-vesting forfeitures for awards with service conditions. For awards with performance conditions we estimate the probability that the performance condition will be met. If our actual forfeiture rate is materially different from the estimate, our stock-based compensation expense could be significantly different from what we have recorded in the current period. As of December 31, 2013, we had $24.4 million of unrecognized compensation expense associated with outstanding equity awards, which is expected to be recognized over a weighted-average period of 2.54 years.

Fair Value of Financial Instruments

Certain assets and liabilities are carried at fair value under GAAP. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. A fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last is considered unobservable, are used to measure fair value:

• Level 1 - Quoted prices in active markets for identical assets or liabilities.

• Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

• Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Unobservable inputs are developed based on the best information available, which might include our own data.

Sources of Revenue

We derive our revenue principally from subscription fees from our customers. Our revenue is driven primarily by the number of paying customers and the subscription fees for our products and is not concentrated within any one customer or group of customers. In 2013, our top 100 customers accounted for less than 1% of our total revenue. We generally do not require our customers to commit to a contractual term; however, our customers are required to prepay for subscriptions on a monthly, semi-annual, or annual basis by providing a credit card or bank check. Fees are recorded initially as deferred revenue and then recognized as revenue on a daily basis over the prepaid subscription period. Our pricing for our SaveLocal product is a fee based on the number of deals sold by our customers and the value of the successful deal. We have not yet generated significant revenue from this product.


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We also generate a small amount of revenue from ancillary services related to our products, which primarily consist of custom services and training through our experts program. Revenue generated from professional services and training accounted for approximately 1% of total revenue for each of the years ended December 31, 2013, 2012 and 2011.

Cost of Revenue and Operating Expenses

We allocate certain occupancy and general office related expenses, such as rent, utilities, office supplies and depreciation of general office assets to cost of revenue and operating expense categories based on headcount. As a result, an occupancy expense allocation is reflected as personnel costs in cost of revenue and each operating expense category.

Cost of Revenue. Cost of revenue consists primarily of wages and benefits for software operations and customer support personnel, credit card processing fees, depreciation and amortization, and maintenance and hosting of our software applications underlying our product offerings. We allocate a portion of customer support costs relating to assisting trial customers to sales and marketing expense.

The expenses related to our hosted software applications are affected by the number of customers who subscribe to our products and the complexity and redundancy of our software applications and hosting infrastructure. We expect cost of revenue to increase in absolute dollars as we expect to increase our number of customers but to decrease as a percentage of revenue over time as we gain efficiencies created by our expected revenue growth and cost savings.

Research and Development. Research and development expenses consist primarily of wages and benefits for product strategy and development personnel. We have focused our research and development efforts on improving ease of use, functionality and technological scalability of our existing products as well as on the development of new product offerings. We primarily expense research and development costs. However, direct development costs related to software enhancements that add functionality are capitalized and amortized over their useful life. We expect that on an annual basis research and development expenses will continue to increase both in absolute dollars and as a percentage of revenue due to our expanded investment in our product roadmap. Over the longer term we expect our research and development expenses to increase in absolute dollars but decrease as a percentage of revenue as we expect to grow our revenue at a faster rate.

Sales and Marketing. Sales and marketing expenses consist primarily of advertising and promotional costs, wages and benefits for sales and marketing personnel, partner referral fees, the portion of customer support costs that relate to assisting trial customers and amortization of sales and marketing relating intangible assets. Advertising costs consist primarily of pay-per-click advertising with search engines, other online and offline advertising media, including television and radio advertisements, as well as the costs to create and produce these advertisements. Advertising costs are expensed as incurred. Promotional costs consist primarily of public relations, memberships and event costs. Additionally, sales and marketing expenses include costs related to our efforts to retain our customers and to cross-sell and increase usage of our products. In order to continue to grow our business and brand and category awareness, we expect that we will continue to commit substantial resources to our sales and marketing efforts. As a result, we expect that on an annual basis, sales and marketing expenses will increase in absolute dollars, but continue to decrease as a percentage of revenue 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 administrative, human resources, internal information technology support, finance, accounting and analytics personnel, . . .

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