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CARB > SEC Filings for CARB > Form 10-Q on 6-May-2014All Recent SEC Filings

Show all filings for CARBONITE INC

Form 10-Q for CARBONITE INC


6-May-2014

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, 2013, as filed on March 5, 2014 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 provider of backup and business continuity solutions. Our solutions provide advanced features packaged in an easy-to-use, cost-effective and secure manner, and are designed to address the specific needs of small and medium-sized businesses, or SMBs, while also being attractive to consumers and larger enterprises.

While we historically focused on the consumer market for our solutions, we have more recently shifted our attention to the SMB market. In October 2012, we acquired Zmanda, Inc. and believe this acquisition has enhanced our SMB solutions by introducing hybrid solutions that backup databases and file systems to the cloud or to local disk enabling SMBs to obtain all of their backup solutions from one vendor.

We derive our revenue from subscription fees. We generally charge customers the full subscription amount at the beginning of each subscription period. Our tiered business offerings provide a fixed amount of cloud storage for an unlimited number of connected devices while customers can purchase additional cloud storage at any time after the commencement of a subscription. For consumers, we offer three different annual cloud backup solutions, each including unlimited storage for one computer.

We invest in customer acquisition because we believe that the market for our backup and business continuity solutions is in the early stage of development. Our sales model is designed to sell large volumes of our solutions to SMBs globally both directly and through our sales network, including through distributors, value-added resellers, volume resellers, and major retailers. Our inside sales force supplements our channel efforts by, for example, following up on leads generated by our marketing programs and actively working to fulfill sales through our channel relationships. We support our go-to-market network with a marketing approach that leverages our established brand in order to drive market awareness and demand generation among the broad population of SMBs and consumers.

As we grow our business we continue to invest in additional storage and infrastructure. Our operating costs continue to grow as our customers store more data, 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.


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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:

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.

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.

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 payments related to corporate headquarter relocation. 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.


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Performance Highlights

The following table presents our performance highlights for the three months
ended March 31, 2014 and 2013:



                                             Three Months Ended
                                                 March 31,
                                      2014                       2013
                                   (in thousands, except percentage data)
       Key metrics:
       Bookings                $            32,486        $            29,327
       Annual retention rate                    84 %                       85 %
       Renewal rate                             80 %                       82 %
       Free cash flow          $             4,243        $               654

Our bookings increased over the periods presented and we continue to invest in customer acquisition in an effort to drive continued growth in bookings, with bookings for our small business solutions representing 28% of total bookings for the first quarter of 2014, up from 24% in the first quarter of 2013.

Our free cash flow for the three months ended March 31, 2014 improved by $3.6 million compared to the three months ended March 31, 2013 principally driven by growth in bookings 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 or invoice a customer 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. 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 the volume of customer data that we store and the complexity of our services, but decrease as a percentage of revenue.

Gross profit and gross margin

Our gross margins have expanded as the result of introducing higher priced solutions targeting both SMBs and consumers, price increases on our solutions, 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, functionality and technological scalability 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.


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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, commissions 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, which includes television, radio, online, and print advertisements as well as the costs associated with cooperative marketing programs developed with our channel partners, promotional events, and web seminars. Online search costs consist primarily of pay-per-click payments to search engine operators. Advertising costs and sales commissions 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.

Restructuring charges. Restructuring charges consists of 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, 2013. 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 5, 2014 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 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
                                                            March 31,
                                                      2014             2013
                                                          (% of revenue)
      Consolidated statements of operations data:
      Revenue                                           100.0 %          100.0 %
      Cost of revenue                                    31.8             36.1

      Gross profit                                       68.2             63.9
      Operating expenses:
      Research and development                           18.6             22.3
      General and administrative                         12.1             19.5
      Sales and marketing                                40.7             51.8
      Restructuring charges                                -               0.6

      Total operating expenses                           71.4             94.2

      Loss from operations                               (3.2 )          (30.3 )

      Loss before income taxes                           (3.3 )          (30.3 )

      Provision for income taxes                           -                -

      Net loss                                           (3.4 )%         (30.3 )%

Comparison of the Three Months Ended March 31, 2014 and 2013

Revenue

Three Months Ended March 31, 2014 2013 Change

(in thousands, except percentage data)

Revenue $ 29,137 $ 24,508 $ 4,629 18.9 %

Revenue increased for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013, primarily due to increases in the average selling prices for our SMB and consumer solutions.


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Cost of revenue, gross profit, and gross margin

                                                                Three Months Ended March 31,
                                                        2014            2013               Change
                                                           (in thousands, except percentage data)
Cost of revenue                                      $    9,260      $    8,838      $   422         4.8 %
Percent of revenue                                         31.8 %          36.1 %
Components of cost of revenue:
Personnel related costs                              $    2,801      $    2,775      $    26         1.0 %
Hosting and depreciation costs                       $    5,470      $    5,073      $   397         7.8 %
Third-party outsourcing costs, software,
amortization and other                               $      989      $      990      $    (1 )        -  %

Total cost of revenue                                $    9,260      $    8,838      $   422         4.8 %
Gross profit                                         $   19,877      $   15,670      $ 4,207        26.8 %
Gross margin                                               68.2 %          63.9 %

Our gross margin improvement for the three months ended March 31, 2014 compared to the three months ended March 31, 2013 is driven by sales growth of higher margin SMB products, efficiencies realized in our data centers, as well as operating efficiencies realized as we continue to scale our customer service organization. The slight increase in total costs is due primarily to an increase in storage costs associated with storing a larger volume of customer data.

Operating expenses

Research and development

                                                                 Three Months Ended March 31,
                                                         2014             2013               Change
                                                            (in thousands, except percentage data)
Research and development                              $     5,422       $   5,476      $  (54 )       1.0 %
Percent of revenue                                           18.6 %          22.3 %
Components of cost of research and development:
Personnel related costs                               $     4,203       $   4,408      $ (205 )       4.7 %
Third-party outsourcing costs                         $       656       $     423      $  233        55.1 %
Hosting, independent contractors and other            $       563       $     645      $  (82 )      12.7 %

Total research and development                        $     5,422       $   5,476      $  (54 )       1.0 %

Research and development expenses remained consistent for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013 as a result of a decrease in personnel costs offset by an increase in spending on third-party storage costs.


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General and administrative

                                                           Three Months Ended March 31,
                                                 2014            2013                 Change
                                                      (in thousands, except percentage data)
General and administrative                    $    3,520       $   4,777       $ (1,257 )       26.3 %
Percent of revenue                                  12.1 %          19.5 %
Components of general and administrative:
Personnel related costs                       $    2,150       $   1,967       $    183          9.3 %
Professional fees                             $      812       $   2,027       $ (1,215 )       59.9 %
Sales tax, consulting and other               $      558       $     783       $   (225 )       28.7 %

Total general and administrative              $    3,520       $   4,777       $ (1,257 )       26.3 %

General and administrative expenses decreased for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013, primarily due to a decrease of $1.2 million in professional fees related to legal costs associated with litigation.

Sales and marketing

                                                          Three Months Ended March 31,
                                                2014             2013                 Change
                                                     (in thousands, except percentage data)
Sales and marketing                          $   11,873       $   12,682       $   (809 )        6.4 %
Percent of revenue                                 40.7 %           51.8 %
Components of sales and marketing:
Personnel related costs                      $    2,647       $    2,430       $    217          8.9 %
Advertising costs                            $    5,420       $    7,334       $ (1,914 )       26.1 %
Costs of credit card transactions and
offering free trials                         $    1,504       $    1,449       $     55          3.8 %
Outside commissions, agency fees and
other                                        $    2,302       $    1,469       $    833         56.7 %

Total sales and marketing                    $   11,873       $   12,682       $   (809 )        6.4 %

Sales and marketing expenses decreased for the three months ended March 31, 2014 as compared to the three months ended March 31, 2013, primarily due to the $1.9 million decrease in advertising, partially offset by investments made in sales and marketing efforts focused on expanding our presence in the SMB market.


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Other Financial Data

In addition to our results discussed above determined under GAAP, we believe that bookings, annual retention rate, renewal rate, and free cash flow are useful to investors in evaluating our operating performance. Management considers these financial and operating metrics critical to understanding our business, reviewing our historical performance, measuring and identifying current and future trends, and for planning purposes. Securities analysts also frequently use bookings and free cash flow as supplemental measures to evaluate the overall performances of companies.

                                               Three Months Ended
                                                   March 31,
                                        2014                       2013
                                     (in thousands, except percentage data)
     Key metrics:
     Bookings (1)                $            32,486        $            29,327
     Annual retention rate (2)                    84 %                       85 %
     Renewal rate (3)                             80 %                       82 %
     Free cash flow (4)          $             4,243        $               654

(1) We define bookings as revenue recognized during the period plus the change in total deferred revenue (excluding deferred revenue recorded in connection with acquisitions) during the same period.

(2) We define 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.

(3) 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.

(4) We define free cash flow as net cash provided by (used in) operating activities, less capital expenditures, and adjusted for the cash portion of the lease exit charge.

Bookings and free cash flow are financial data that are not calculated in accordance with GAAP. The tables below provide reconciliation of bookings and free cash flow to revenue and cash provided by (used in) operating activities, respectively, the most directly comparable financial measures calculated and presented in accordance with GAAP.

Our management uses annual retention rate to determine the stability of our customer base and to evaluate the lifetime value of our customer relationships. As customers' annual and multi-year subscriptions come up for renewal throughout the calendar year based on the dates of their original subscriptions, measuring retention on a trailing twelve month basis at the end of each quarter provides our management with useful and timely information about the stability of our customer base. Management uses renewal rate to monitor trends in customer renewal activity.

. . .

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