Web.com Group, Inc.
WEB.COM GROUP, INC. (Form: 10-Q, Received: 07/31/2015 11:54:35)


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________________  
FORM 10-Q
________________________   
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2015
 
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                 to                
 
Commission File Number: 000-51595
________________________ 
Web.com Group, Inc.
(Exact name of registrant as specified in its charter)
________________________  
Delaware
94-3327894
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
12808 Gran Bay Parkway, West, Jacksonville, FL
32258
(Address of principal executive offices)
(Zip Code)
 
(904) 680-6600
(Registrant’s telephone number, including area code)
 
(Former name, former address and former fiscal year, if changed since last report)
________________________ 
  
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ý   Yes    ¨   No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ý   Yes    ¨   No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. 
Large accelerated filer x
Accelerated filer ¨
Non-accelerated filer ¨
Smaller reporting company ¨
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨   Yes    ý   No 

Common Stock, par value $0.001 per share, outstanding as of July 27, 2015 : 51,211,379




Web.com Group, Inc.
 
Quarterly Report on Form 10-Q
 
For the Quarterly Period ended June 30, 2015
 
Index
 
Part I
 
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
Item 3.
 
 
 
 
 
 
 
Item 4.
 
 
 
 
 
 
 
Part II
 
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
Item 1A.
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
Item 3.
 
 
 
 
 
 
 
Item 4.
 
 
 
 
 
 
 
Item 5.
 
 
 
 
 
 
 
Item 6.
 
 
 
 
 
 
 
 
 

2



PART I — FINANCIAL INFORMATION

Item 1. Financial Statements.

  Web.com Group, Inc.
 
Consolidated Statements of Comprehensive Income (Loss)
(in thousands, except per share amounts)
(unaudited)  
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2015
 
2014
 
2015
 
2014
 
Revenue
$
135,719

 
$
138,176

 
$
268,319

 
$
272,019

 
 
 
 
 
 
 
 
 

 
Cost of Revenue
47,102

 
48,599

 
95,804

 
95,185

 
 
 
 
 
 
 
 
 
 
Gross profit
88,617

 
89,577

 
172,515

 
176,834

 
Operating expenses:
 
 
 
 
 
 
 

 
Sales and marketing
35,680

 
36,710

 
71,359

 
74,243

 
Technology and development
5,858

 
7,691

 
11,660

 
14,889

 
General and administrative
18,273

 
15,031

 
35,484

 
28,772

 
Restructuring expense
22

 

 
335

 

 
Depreciation and amortization
13,849

 
19,793

 
27,593

 
39,032

 
Total operating expenses
73,682

 
79,225

 
146,431

 
156,936

 
Income from operations
14,935

 
10,352

 
26,084

 
19,898

 

 
 
 
 
 
 


 
Interest expense, net
(5,182
)
 
(7,299
)
 
(10,431
)
 
(14,793
)
 
Net income before income taxes
9,753

 
3,053

 
15,653

 
5,105

 
Income tax expense
(5,203
)
 
(3,847
)
 
(8,764
)
 
(5,409
)
 
Net income (loss)
$
4,550

 
$
(794
)
 
$
6,889

 
$
(304
)
 
Other comprehensive income (loss):
 
 
 
 
 

 
 

 
Foreign currency translation adjustments
797

 

 
90

 

 
Unrealized (loss) gain on investments, net of tax
(4
)
 
4

 
1

 
2

 
Total comprehensive income (loss)
$
5,343

 
$
(790
)
 
$
6,980

 
$
(302
)
 
 
See accompanying notes to consolidated financial statements

3




Web.com Group, Inc.
 
Consolidated Statements of Comprehensive Income (Loss)
(in thousands, except per share amounts)
(unaudited)
(continued)
 
 
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2015
 
2014
 
2015
 
2014
Basic earnings per share:
 
 
 
 
 
 

 
 

Net income (loss) per common share
 
$
0.09

 
$
(0.02
)
 
$
0.14

 
$
(0.01
)
Diluted earnings per share:
 
 
 
 
 
 

 
 

Net income (loss) per common share
 
$
0.09

 
$
(0.02
)
 
$
0.13

 
$
(0.01
)
 
 
 
 
 
 
 
 
 
Basic weighted average common shares
 
50,362

 
50,809

 
50,616

 
50,571

Diluted weighted average common shares
 
52,435

 
50,809

 
52,510

 
50,571

 
See accompanying notes to consolidated financial statements


4




Web.com Group, Inc.
 Consolidated Balance Sheets
(in thousands, except share amounts)
 
June 30,
2015
 
December 31,
2014
 
(unaudited)
 
 
Assets
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
15,906

 
$
22,485

Accounts receivable, net of allowance of $2,010 and $1,705, respectively
14,304

 
16,932

Prepaid expenses
10,468

 
10,550

Deferred expenses
63,069

 
62,818

Deferred taxes
22,699

 
23,750

Other current assets
4,964

 
5,012

Total current assets
131,410

 
141,547

 
 
 
 
Property and equipment, net
43,652

 
44,000

Deferred expenses
49,648

 
50,901

Goodwill
639,648

 
639,564

Intangible assets, net
338,232

 
357,819

Other assets
4,839

 
4,575

Total assets
$
1,207,429

 
$
1,238,406

 
 
 
 
Liabilities and stockholders' equity
 

 
 
Current liabilities:
 

 
 

Accounts payable
$
9,197

 
$
9,940

Accrued expenses
16,205

 
14,937

Accrued compensation and benefits
8,747

 
5,997

Deferred revenue
224,700

 
217,394

Current portion of debt
8,683

 
6,197

Other liabilities
4,667

 
5,069

Total current liabilities
272,199

 
259,534

 
 
 
 
Deferred revenue
189,780

 
185,338

Long-term debt
456,621

 
501,085

Deferred tax liabilities
118,501

 
111,503

Other long-term liabilities
7,178

 
6,856

Total liabilities
1,044,279

 
1,064,316

 
 
 
 
Stockholders' equity:
 

 
 

Common stock, $0.001 par value per share: 150,000,000 shares authorized, 51,245,987 and 52,108,719 shares issued and outstanding at June 30, 2015 and December 31, 2014, respectively
51

 
52

Additional paid-in capital
558,152

 
552,991

Treasury stock at cost, 1,565,068 shares as of June 30, 2015 and 395,395 shares as of December 31, 2014
(30,055
)
 
(6,975
)
Accumulated other comprehensive loss
(1,302
)
 
(1,393
)
Accumulated deficit
(363,696
)
 
(370,585
)
Total stockholders' equity
163,150

 
174,090

Total liabilities and stockholders' equity
$
1,207,429

 
$
1,238,406

See accompanying notes to consolidated financial statements

5



Web.com Group, Inc.
 Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
 
Six months ended June 30,
 
2015
 
2014
Cash flows from operating activities
 

 
 

Net income (loss)
$
6,889

 
$
(304
)
Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Depreciation and amortization
27,593

 
39,032

Stock based compensation
10,184

 
9,442

Deferred income taxes
8,047

 
4,973

Amortization of debt issuance costs and other
5,620

 
5,508

Changes in operating assets and liabilities:
 

 
 

Accounts receivable, net
2,643

 
(2,238
)
Prepaid expenses and other assets
(219
)
 
(874
)
Deferred expenses
1,002

 
(3,226
)
Accounts payable
(373
)
 
(5,191
)
Accrued expenses and other liabilities
1,629

 
2,948

Accrued compensation and benefits
2,690

 
(4,625
)
Accrued restructuring costs and other reserves

 
(1,139
)
Deferred revenue
11,706

 
11,442

Net cash provided by operating activities
77,411

 
55,748

Cash flows from investing activities
 

 
 

Business acquisitions, net of cash acquired
(475
)
 
(7,437
)
Capital expenditures
(7,911
)
 
(8,227
)
Net cash used in investing activities
(8,386
)
 
(15,664
)
Cash flows from financing activities
 

 
 

Stock issuance costs
(50
)
 
(38
)
Common stock repurchased
(2,302
)
 
(4,967
)
Payments of long-term debt
(47,500
)
 
(50,000
)
Proceeds from exercise of stock options
4,221

 
6,724

Proceeds from borrowings on revolving credit facility

 
9,000

Common stock purchases under stock repurchase plan
(29,975
)
 

Net cash used in financing activities
(75,606
)
 
(39,281
)
 
 
 
 
Effect of exchange rate changes on cash
2

 

 
 
 
 
Net (decrease) increase in cash and cash equivalents
(6,579
)
 
803

Cash and cash equivalents, beginning of period
22,485

 
13,806

Cash and cash equivalents, end of period
$
15,906

 
$
14,609

Supplemental cash flow information
 

 
 

Interest paid
$
4,882

 
$
9,544

Income tax paid
$
902

 
$
551

See accompanying notes to consolidated financial statements

6



Web.com Group, Inc.
Notes to Consolidated Financial Statements
(unaudited)

1. The Company and Summary of Significant Accounting Policies
 
Description of Company
 
Web.com Group, Inc. ("Web.com" or "the Company") provides a full range of Internet services to small businesses to help them compete and succeed online. Web.com meets the needs of small businesses anywhere along their lifecycle with affordable, subscription-based solutions including domains, hosting, website design and management, search engine optimization, online marketing campaigns, local sales leads, social media, mobile products and eCommerce solutions. For more information about the Company, please visit http://www.web.com. The information obtained on or accessible through the Company's website is not incorporated into this Quarterly Report on Form 10-Q and you may not consider it a part of this Quarterly Report on Form 10-Q.
The Company has reviewed the criteria of Accounting Standards Codification (“ASC”) 280-10, Segment Reporting, and has determined that the Company is comprised of only one segment, web services and products.

Basis of Presentation
 
The accompanying consolidated balance sheet as of June 30, 2015 , the consolidated statements of comprehensive income (loss) for the three and six months ended June 30, 2015 and 2014 , the consolidated statements of cash flows for the six months ended June 30, 2015 and 2014 , and the related notes to the consolidated financial statements are unaudited.
 
The unaudited consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements for the year ended December 31, 2014 , except that certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or excluded as permitted.
 
In the opinion of management, the unaudited consolidated financial statements include all adjustments of a normal recurring nature necessary for the fair presentation of the Company’s financial position as of June 30, 2015 , the Company’s results of operations for the three and six months ended June 30, 2015 and 2014 , and the cash flows for the six months ended June 30, 2015 and 2014 . The results of operations for the three and six months ended June 30, 2015 , are not necessarily indicative of the results to be expected for the year ending December 31, 2015 .

Pursuant to the rules and regulations of the SEC, certain information and disclosures normally included in the notes to the annual financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been omitted from these interim financial statements. The Company suggests that these financial statements be read in conjunction with the audited financial statements and the notes included in the Company's most recent annual report on Form 10-K filed with the SEC on February 27, 2015, and any subsequently filed current reports on Form 8-K.

Use of Estimates
 
The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Foreign Currency Translation

The functional currency of the Company’s United Kingdom-based operations acquired in July 2014 is the British Pound. The Company translates the financial statements of this subsidiary to U.S. dollars using month-end rates of exchange for assets and liabilities, historical rates of exchange for equity and average rates of exchange for revenues, costs, and expenses. Translation gains and losses are recorded in accumulated other comprehensive (loss) income as a component of stockholders’ equity.




7



Recently Issued Accounting Standards
In April 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2015-03, Interest-Imputation of Interest (Subtopic 835-30), Simplifying the Presentation of Debt Issuance Costs . ASU 2015-03 requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The new standard is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within fiscal years beginning after December 15, 2015. The new standard will not have a material effect on the Company's consolidated financial statements and footnote disclosures.
In August 2014, the FASB issued new guidance related to the disclosures around going concern. The new standard provides guidance around management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted. The adoption of this standard is not expected to have an impact on our consolidated financial statements or disclosures.
In May 2014, the FASB and International Accounting Standards Board (“IASB”) issued ASU 2014-09 Revenue from Contracts with Customers (Topic 606), a converged standard on revenue recognition which supersedes previous revenue recognition guidance. Some of the main areas of transition to the new standard include, among others, transfer of control (revenue is recognized when a customer obtains control of a good or service), allocation of transaction price based on relative standalone selling price (entities that sell multiple goods or services in a single arrangement must allocate the consideration to each of those goods or services), contract costs (entities sometimes incur costs, such as sales commissions or mobilization activities, to obtain or fulfill a contract), and disclosures (extensive disclosures are required to provide greater insight into both revenue that has been recognized, and revenue that is expected to be recognized in the future from existing contracts). This accounting standard will be effective for the Company beginning in its first quarter of 2018, using one of two methods of adoption: (i) retrospective to each prior reporting period presented, with the option to elect certain practical expedients as defined within the standard; or (ii) retrospective with the cumulative effect of initially applying the standard recognized at the date of initial application inclusive of certain additional disclosures. The Company is currently evaluating and has not determined the impact of ASU 2014-09 on its consolidated financial statements.

2. Business Combinations
Acquisition of SnapNames
On February 28, 2014, the Company completed the acquisition of substantially all of the assets and certain liabilities of SnapNames.com, Inc. ("SnapNames"), an Oregon corporation, from KeyDrive S.A., which primarily consisted of intangible assets, including trade names, customer relationships and developed technology. The activities of the acquired business include daily auctions, premium auctions, and brokerage transactions related to domain names (the "SnapNames Business"). The Company paid $7.4 million for this business during the first quarter of 2014. The Company also recorded a $0.5 million holdback liability, and such amount was paid to KeyDrive S. A. during the six months ended June 30, 2015.
The Company has accounted for the acquisition of the SnapNames Business using the acquisition method as required in Accounting Standards Codification 805, Business Combinations ("ASC 805"). As such, fair values have been assigned to the assets acquired and liabilities assumed and the excess of the total purchase price over the fair value of the net assets acquired is recorded as goodwill. The Company, with the assistance of independent valuation professionals, has estimated the fair value of certain intangible assets. The goodwill recorded from this acquisition represents business benefits the Company anticipates realizing from optimizing resources and cross-sale opportunities. The goodwill from the acquisition is expected to be deductible for tax purposes.
Acquisition of Scoot
On July 31, 2014, the Company completed the acquisition of 100% of the equity interests in Touch Local Limited (“Scoot”), the operator of an online business directory network in the United Kingdom, pursuant to that certain Purchase Agreement dated July 31, 2014 by and among Web.com Group, Inc., Balderton Capital III, LP, Mark Livingstone and Gary Dannatt.  The Company believes that the acquisition further enhances its position as a leading provider of online marketing and web services to small businesses and positions its local expansion in the United Kingdom. Consideration for the acquisition included $11.9 million , which is net of cash acquired, $11.0 million of which was paid to the sellers in July 2014 and $0.9 million of which is held in an escrow account and scheduled to be released on July 31, 2015, subject to certain working capital and indemnity adjustments. The Company also recorded a $0.9 million holdback liability that is also scheduled to be paid in July 2015. In addition, the Company issued an aggregate of 213,200 shares of Web.com common stock, with an aggregate acquisition date value of $5.7 million , to the sellers. Finally, $0.3 million of accounts receivable due from Scoot was forgiven by the Company, for total consideration of $18.7 million .

8




The Company has accounted for the acquisition of Scoot using the acquisition method as required in ASC 805. Based on the acquisition method of accounting, the consideration was allocated to the assets and liabilities acquired based on their fair values as of the acquisition date and the remaining amount of the purchase price allocation was recorded as goodwill. The goodwill represents business benefits the Company anticipates realizing from optimizing resources and cross-sale opportunities and is not expected to be deductible for tax purposes.  

3. Net Income Per Common Share
 
Basic net income per common share is calculated using net income and the weighted-average number of shares outstanding during the reporting period. Diluted net income per common share includes the effect from the potential issuance of common stock, such as common stock issued pursuant to the exercise of stock options or vesting of restricted shares.

During the first quarter of 2015, the Company issued an equity award with performance, service and market conditions.
When the conditions are satisfied, the Company will include the impact of the potential issuance of the underlying shares in our diluted weighted average common shares. These awards will be included in basic shares outstanding once all criteria have been met and the shares have vested. Prior to the end of the vesting period, the number of contingently issuable shares included in diluted EPS is based on the number of shares, if any, that would be issuable under the terms of the arrangement if the end of the reporting period were the end of the contingency period, using the treasury stock method and assuming the result would be dilutive. As of June 30, 2015, neither of these conditions have been met, therefore no incremental common shares from this award have been included. See Note 10, Stock-Based Compensation and Stockholders' Equity , for additional information on this award.

During the three and six months ended June 30, 2015, 1.7 million and 2.1 million share-based awards have been excluded from the calculation of diluted common shares, respectively, and 7.5 million share-based awards have been excluded from the calculation of diluted common shares for the three and six months ended June 30, 2014, because including these securities would have been anti-dilutive.

The Company's potentially dilutive shares also include incremental shares issuable upon the conversion of the Company's Senior Convertible Notes due August 15, 2018 ("2018 Notes"). See Note 6, Long-term Debt , for additional information regarding the 2018 Notes. Upon conversion or maturity of the 2018 Notes, the Company may settle the notes with either cash, shares of our common stock or a combination of cash and shares of our common stock, at our election. The Company has adopted a current policy to settle the principal amount in cash and any excess conversion value in shares of our common stock. Because the principal amount of the 2018 Notes will be settled in cash upon conversion, only the conversion spread relating to the 2018 Notes is included in our calculation of diluted net income per common share. When the market price of our stock exceeds the conversion price, as applicable, we will include, in the diluted net income per common share calculation, the effect of the additional shares that may be issued upon conversion using the treasury stock method. There were no incremental common shares from the 2018 Notes that were included in the calculation of diluted shares because the Company's average price of its common stock did not exceed the conversion price during the three and six months ended June 30, 2015 and 2014.

The following table sets forth the computation of basic and diluted net income per common share (in thousands, except per share amounts):
 
 
 
Three months ended June 30,
 
Six months ended June 30,
 
 
 
2015
 
2014
 
2015
 
2014
Net income (loss)
 
 
$
4,550

 
$
(794
)
 
$
6,889

 
$
(304
)
 
 
 
 
 
 
 
 
 
 
Basic weighted average common shares
 
 
50,362

 
50,809

 
50,616

 
50,571

Diluted effect of stock options
 
 
1,800

 

 
1,584

 

Diluted effect of restricted shares
 
 
273

 

 
310

 

Dilutive effect of performance shares
 
 

 

 

 

Dilutive effect of the assumed conversion of the 2018 Notes
 
 

 

 

 

Diluted weighted average common shares
 
 
52,435

 
50,809

 
52,510

 
50,571

Basic earnings per share:
 
 
 
 
 
 
 
 
 
Net income (loss) per common share
 
 
$
0.09

 
$
(0.02
)
 
$
0.14

 
$
(0.01
)

9



Diluted earnings per share:
 
 
 
 
 
 
 
 
 
Net income (loss) per common share
 
 
$
0.09

 
$
(0.02
)
 
$
0.13

 
$
(0.01
)

4. Goodwill and Intangible Assets
 
In accordance with ASC 350, the Company reviews goodwill and other indefinite-lived intangible asset balances for impairment on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of goodwill or indefinite-lived intangible assets below their carrying amount. As of December 31, 2014 , the Company completed its annual impairment test of goodwill and other indefinite-lived intangible assets and determined that there was no impairment. There were no indicators of impairment during the six months ended June 30, 2015 .

The following table summarizes changes in the Company’s goodwill balances as required by ASC 350-20 for the six months ended June 30, 2015 and the year ended December 31, 2014 , respectively (in thousands):    

 
June 30,
2015
 
December 31,
2014
Goodwill balance at beginning of period
$
741,858

 
$
730,139

Accumulated impaired goodwill at beginning of period
(102,294
)
 
(102,294
)
Goodwill balance at beginning of period, net
639,564

 
627,845

Goodwill acquired during the period-SnapNames (1)

 
3,578

Goodwill acquired during the period-Scoot (1)
11

 
8,824

Foreign currency translation adjustments (2)
73

 
(683
)
Goodwill balance at end of period, net *
$
639,648

 
$
639,564

   
* Gross goodwill balances were $741.9 million as of June 30, 2015 and December 31, 2014 . These include accumulated impairment losses of $102.3 million .
(1) The increases of $3.6 million and $8.8 million for the year ended December 31, 2014 are from the SnapNames and Scoot acquisitions, respectively. See Note 2, Business Combinations, for additional information.
(2) The foreign currency translation adjustments are from translating the goodwill acquired from the July 2014 Scoot acquisition at the current balance sheet date.

The Company’s intangible assets are summarized as follows (in thousands): 
 
June 30, 2015
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net
 
Weighted-average Amortization Period in Years
Indefinite-lived intangible assets:
 

 
 

 
 
 
 
Domain/Trade names
$
132,392

 
$

 
$
132,392

 
 
Definite-lived intangible assets:


 


 


 
 
Customer relationships
375,489

 
(202,569
)
 
172,920

 
8.0
Developed technology
107,580

 
(76,194
)
 
31,386

 
2.4
Other
6,151

 
(4,617
)
 
1,534

 
2.8
   Total *
$
621,612

 
$
(283,380
)
 
$
338,232

 
 
 
 
 
 
 
 
 
* Cumulative foreign currency translation adjustments, reflecting the movement in currencies, increased total intangible assets by approximately $0.1 million as of June 30, 2015.
 
December 31, 2014

10



 
Gross Carrying Amount
 
Accumulated Amortization
 
Net
 
Weighted-average Amortization Period in Years
Indefinite-lived intangible assets:
 

 
 

 
 
 
 
Domain/Trade names
$
132,368

 
$

 
$
132,368

 
 
Definite-lived intangible assets:


 


 


 
 
Customer relationships
289,883

 
(105,685
)
 
184,198

 
8.5
Developed technology
193,137

 
(153,681
)
 
39,456

 
2.8
Other
6,134

 
(4,337
)
 
1,797

 
3.3
   Total *
$
621,522

 
$
(263,703
)
 
$
357,819

 
 
 
 
 
 
 
 
 
* Cumulative foreign currency translation adjustments, reflecting the movement in currencies, decreased total intangible assets by approximately $0.8 million as of December 31, 2014.

The weighted-average amortization period for the amortizable intangible assets remaining as of June 30, 2015 , is approximately 7.1 years. Total amortization expense was $9.8 million and $16.3 million for the three months ended June 30, 2015 and 2014, and $19.6 million and $32.5 million for the six months ended June 30, 2015 and 2014 , respectively.
 
As of June 30, 2015 , the amortization expense for the remainder of the year ended December 31, 2015, and the next five years and thereafter is as follows (in thousands):

2015 (remainder of year)
$
19,670

2016
37,389

2017
27,827

2018
25,092

2019
21,661

2020
19,427

Thereafter
54,774

Total
$
205,840


5. Related Party Transactions
Effective February 6, 2015, the Company elected Mr. John A. Giuliani to serve on its Board of Directors. Mr. Giuliani serves as President and Chief Executive Officer of Conversant, a personalized digital marketing platform, which was sold to AllianceData in December 2014. Mr. Giuliani joined Conversant after the acquisition of Dotomi, a dynamic display ad optimization company, where he had served as Chief Executive Officer. During the year ended December 31, 2014, the Company purchased online advertising solutions from Dotomi and Conversant. The Company did not incur any expenses related to services provided by Dotomi during the six months ended June 30, 2015. The Company incurred $0.3 million and $0.5 million of expense related to services provided by Conversant during the three and six months ended June 30, 2015, respectively.
The Company outsources data center services to Quality Technology Services LLC (“QTS”). Prior to May 2014, General Atlantic LLC was one of the Company’s greater than 5 percent shareholders, and had approximately a 50 percent ownership interest in QTS. This business relationship was an agreement between QTS and Network Solutions and was acquired by the Company as a result of the acquisition and commenced on October 27, 2011 upon the consummation of the acquisition. Effective May 2014, General Atlantic no longer held common shares greater than 5 percent of the total outstanding common shares and the affiliated board member has departed the Company's Board of Directors. The Company incurred approximately $0.4 million and $0.8 million of expense for data center services during the three and six months ended June 30, 2014, respectively.

6. Long-term Debt

1% Senior Convertible Notes due August 15, 2018

11




In August 2013, the Company issued $258.8 million aggregate principal amount of 1.00% Senior Convertible Notes due August 15, 2018 (the "2018 Notes"). The 2018 Notes bear interest at a rate of 1.00% per year, payable semiannually in arrears, on February 15 and August 15 of each year, beginning on February 15, 2014. The conversion price for the 2018 Notes is equivalent to an initial effective conversion price of approximately $35.00 per share of common stock. Proceeds, net of original issuance discounts and debt issuance costs, of $252.3 million were received from the 2018 Notes. The net proceeds were used to pay down $208.0 million of the First Lien Term Loan and $43.0 million of the Revolving Credit Facility.

The Company may not redeem the 2018 Notes prior to August 20, 2016 . On or after August 20, 2016, the Company may redeem for cash any or all of the 2018 Notes, at its option, if the last reported sale price of our common stock exceeds 130% of the applicable conversion price on each applicable trading day as defined by the indenture. The redemption price will equal 100% of the principal amount of the 2018 Notes to be redeemed, plus accrued and unpaid interest to, but not including, the redemption date. Holders of the 2018 Notes may also convert their notes at any time prior to May 15, 2018 if the sale price of our common stock exceeds 130% of the applicable conversion price on each applicable trading day as defined by the indenture. In addition, holders may also convert their 2018 Notes any time prior to May 15, 2018 , (i) if during the five business days after any five consecutive trading day period in which the trading price of the 2018 Notes was less than 98% of the product of the last reported sale price of our common stock and the conversion rate, (ii) if the Company calls the 2018 Notes for redemption; or (iii) upon the occurrence of specified corporate events.

Prior to August 20, 2016, the 2018 Notes are also redeemable or convertible upon certain fundamental changes, as defined in the indenture, which may require the Company to purchase the 2018 Notes in whole or in part for cash at a price equal to 100% of the principal amount of the 2018 Notes to be purchased, plus any accrued and unpaid interest to, but not including, the purchase date. The 2018 Notes are senior unsecured obligations and will be effectively junior to any of the Company's existing and future secured indebtedness.

The Company determined that the embedded conversion option in the 2018 Notes is not required to be separately accounted for as a derivative under ASC 815, Derivatives and Hedging . The 2018 Notes are within the scope of ASC 470, Topic 20, Debt with Conversion and Other Options, which requires the Company to separate a liability component and an equity component from the proceeds received. The carrying amount of the liability component at the time of the transaction of $204.4 million was calculated by measuring the fair value of a similar debt instrument that does not have an associated equity component. The fair value of the liability component was subtracted from the initial proceeds and the remaining amount of $47.8 million was recorded as the equity component. The excess of the principal amount of the liability component over its carrying amount will be amortized to interest expense over the expected life of 5 years using the effective interest method.
 
Upon conversion or maturity of the 2018 Notes, the Company may settle the notes with either cash, shares of its common stock or a combination of cash and shares of its common stock, at its election. The Company has adopted a current policy to settle the $258.8 million of principal amount in cash and any excess conversion value in shares of its common stock. Because the principal amount of the 2018 Notes will be settled in cash upon conversion, only the conversion spread relating to the 2018 Notes may be included in the Company's calculation of diluted net income per common share. When the market price of the Company's stock exceeds the conversion price, it will include, in the diluted net income per common share calculation, the effect of the additional shares that may be issued upon conversion using the treasury stock method. As such, the 2018 Notes have no impact on diluted net income per common share until the price of the Company's common stock exceeds the conversion price (approximately $35.00 per common share) of the 2018 Notes.
 
As of June 30, 2015 and December 31, 2014 , the carrying value of the debt and equity component was $223.0 million and $47.8 million and $217.8 million and $47.8 million , respectively. The unamortized debt discount of $35.8 million as of June 30, 2015 will be amortized over the remaining life of 3.1 years using the effective interest method.

Credit Agreement

On September 9, 2014, the Company entered into a Credit Agreement with JPMorgan Chase Bank, N.A. and SunTrust Bank, as co-syndication agents, Regions Bank, Fifth Third Bank, Bank of America, N.A., Barclays Bank plc, Wells Fargo Bank, National Association, Royal Bank of Canada, Deutsche Bank Securities Inc. and Compass Bank, as co-documentation agents, the lenders from time to time party thereto and JPMorgan Chase Bank, N.A., as administrative agent (the "Credit Agreement"). The Credit Agreement provides for (i) a five -year $200 million secured term loan facility (the “Term Loan”) and (ii) a five -year secured revolving credit facility that provides up to $150 million of revolving loans (the “Revolving Credit Facility”). The Credit Agreement replaced the First Lien Credit Agreement, dated as of October 27, 2011 amended and restated as of November 20, 2012, further amended and restated March 6, 2013, and further amended as of April 25, 2014 (the "Predecessor Credit Agreement").

12



The Company used the proceeds of the Term Loan and initially borrowed $109.0 million of loans under the Revolving Credit Facility, together with cash on hand, to repay existing loans under the Predecessor Credit Agreement in their entirety and to pay related fees and expenses. In connection with the repayment, the Company terminated the Predecessor Credit Agreement.
The Term Loan and loans under the Revolving Credit Facility initially bear interest at a rate equal to either, at the Company’s option, the LIBOR rate plus an applicable margin equal to 2.25% per annum, or the prime lending rate plus an applicable margin equal to 1.25% per annum. The applicable margins for the Term Loan and loans under the Revolving Credit Facility are subject to reduction or increase based upon the Company’s consolidated first lien net leverage ratio as of the end of each fiscal quarter. The Company must also pay (i) a commitment fee of 0.4% per annum on the actual daily amount by which the revolving credit commitment exceeds then-outstanding usage under the Revolving Credit Facility, also subject to reduction or increase based upon the Company’s consolidated first lien net leverage ratio, (ii) a letter of credit fee equal to the applicable margin that applies to LIBOR loans under the Revolving Credit Facility and (iii) a fronting fee of 0.125% per annum, calculated on the daily amount available to be drawn under each letter of credit issued under the Revolving Credit Facility.
The Company is permitted to make voluntary prepayments with respect to the Revolving Credit Facility and the Term Loan at any time without payment of a premium. The Company is required to make mandatory prepayments of the Term Loan with (i) net cash proceeds from certain asset sales (subject to reinvestment rights) and (ii) net cash proceeds from certain issuances of debt. The Company is also required to maintain certain financial ratios under the Credit Agreement and there are customary covenants that limit the incurrence of debt, the payment of dividends, the disposition of assets, and making of certain payments. Substantially all of the Company's and certain of its domestic subsidiaries' tangible and intangible assets are pledged as collateral under the Credit Agreement.
The refinancing was partially accounted for as debt extinguishment in accordance with ASC 470, Debt, with the remaining amounts not considered extinguished, treated as a modification of the existing credit agreement. As a result of the extinguishment, the Company recorded a $1.8 million loss for the portion of the debt that was extinguished from accelerating unamortized deferred financing fees and loan origination discounts during the third quarter ended September 30, 2014. Approximately $3.7 million of additional loan origination discounts and deferred financing fees were capitalized in 2014 in connection with the refinancing.
The Company has $99.0 million of available borrowings under the Revolving Credit Facility as of June 30, 2015.
Outstanding long-term debt and the interest rates in effect at June 30, 2015 and December 31, 2014 consist of the following (in thousands):
 
June 30,
2015
 
December 31,
2014
Revolving Credit Facility maturing 2019, 2.44%, based on LIBOR plus 2.25%, less unamortized discount of $1,422 at June 30, 2015
$
47,578

 
$
92,409

Term Loan due 2019, 2.44%, based on LIBOR plus 2.25%, less unamortized discount of $1,492 at June 30, 2015, effective rate of 2.64%
194,758

 
197,052

Senior Convertible Notes, maturing 2018, 1.00%, less unamortized discount of $35,782 at June 30, 2015 effective rate of 5.88%
222,968

 
217,821

Total Outstanding Debt
465,304

 
507,282

Less: Current Portion of Long-Term Debt
(8,683
)
 
(6,197
)
Long-Term Portion
$
456,621

 
$
501,085

 
Debt discount and issuance costs
 
The Company recorded $2.8 million of expense from amortizing debt issuance and discount costs during each of the three months ended June 30, 2015 and 2014 . During the six months ended June 30, 2015 and 2014, $5.6 million and $5.5 million of debt amortization expenses was recognized, respectively.
 
Total estimated principal payments due for the next five years as of June 30, 2015 are as follows:   
Year 1
$
8,750

Year 2
13,750

Year 3
18,750

Year 4
278,750

Year 5
184,000


13



Total principal payments
$
504,000


7. Accumulated Other Comprehensive Loss

The components of accumulated other comprehensive loss were as follows (in thousands):

 
June 30, 2015
 
December 31, 2014
Foreign currency translation adjustments
$
(1,305
)
 
$
(1,395
)
Unrealized (loss) gain on investments
3

 
2

    Total accumulated other comprehensive loss
$
(1,302
)
 
$
(1,393
)
 
 
 
 


8. Fair Value
 
The Company defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company applies the following fair value hierarchy, which prioritizes the inputs used to measure fair value into three levels as follows:
 
Level 1 -Quoted prices in active markets for identical assets or liabilities.
 
Level 2 -Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, 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 -Inputs that are generally unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability.
 
The Company has financial assets and liabilities that are not required to be remeasured to fair value on a recurring basis. The carrying value of the Company’s cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses approximates fair market value as of June 30, 2015 and December 31, 2014 due to the short maturity of these items. As of June 30, 2015 , the fair value and carrying value of the Company’s 2018 Notes totaled $256.8 million and $223.0 million , respectively. As of December 31, 2014 , the fair value and carrying value of the Company's 2018 Notes totaled term debt was $ 237.7 million and $217.8 million , respectively. The fair value of the 2018 Notes, including the equity component, was calculated by taking the quoted market price for the instruments multiplied by the principal amount. This is based on a Level 2 fair value hierarchy calculation obtained from quoted market prices for the Company’s long-term debt instruments that may not be actively traded at each respective period end. The Revolving Credit Facility and Term Loan entered into in September 2014 are variable rate debt instruments indexed to 1-Month LIBOR that resets monthly and the fair value approximates the carrying value as of June 30, 2015 and December 31, 2014.

9. Income Taxes

The Company accounts for income taxes under the provisions of ASC 740, Income Taxes , using the liability method. ASC 740 requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the difference is expected to reverse.

Further, deferred tax assets are recognized for the expected realization of available deductible temporary differences and net operating loss and tax credit carry forwards. ASC 740 requires companies to assess whether a valuation allowance should be established against deferred tax assets based on consideration of all available evidence using a “more likely than not” threshold. In making such assessments, the Company considers the expected reversals of our existing deferred tax liabilities within the applicable jurisdictions and carry forward periods, based on our existing Section 382 limitations. The Company does not consider deferred tax liabilities related to indefinite lived intangibles or tax deductible goodwill as a source of future taxable income. Additionally, the Company does not consider future taxable income (exclusive of the reversal of existing deferred tax liabilities and carry forwards) because we continue to be in a three-year cumulative loss position. A cumulative loss in the most

14



recent three-year period is a significant piece of negative evidence that is difficult to overcome when assessing the realizability of deferred tax assets. 

A valuation allowance is recorded to reduce our deferred tax assets to the amount that is “more likely than not” to be realized based on the above methodology. The Company reviews the adequacy of the valuation allowance on an ongoing basis and adjust our valuation allowance in the appropriate period, if applicable. It is reasonably possible that by the end of 2015, the United States jurisdiction may no longer have a cumulative loss in the most recent three-year period. Based on relevant facts and circumstances at that time, including our projected future earnings and applicable loss carry forward limitations, we may conclude that it is appropriate to release a material portion of the valuation allowance for that jurisdiction.  If such a change in the valuation allowance were to occur, it would result in a change to income tax expense in the period the assessment was made.

The Company recorded income tax expense of $5.2 million and $3.8 million during the three months ended June 30, 2015 and 2014 , and $8.8 million and $5.4 million during the six months ended June 30, 2015 and 2014, respectively, based on its estimated annual effective tax rates for each year. The Company's estimated annual effective tax rate for 2014 and 2015 reflects a net increase in its projected year-end valuation allowance related to an increase in its non-reversing deferred tax liabilities, and reduced by forecasted pre-tax income for each year.


10. Stock-Based Compensation and Stockholders' Equity
 
In March 2014, the Company's Board of Directors adopted, and in May 2014 stockholders approved, the 2014 Equity Incentive Plan (the "2014 Plan"). The Plan is the successor and continuation of our prior incentive plans; and no additional common stock awards have been granted under the prior incentive plans since the adoption of the 2014 Plan. The 2014 Plan provides for the issuances of incentive stock options, nonstatutory stock options, restricted stock awards and units and other stock awards. The terms and conditions surrounding the granting and vesting of these awards are generally consistent with the prior incentive plans.

Performance Shares
During the first quarter of 2015, the Compensation Committee of the Board of Directors approved a performance share equity award. The targeted number of shares under a 100 percent payout scenario are 0.2 million common shares over the 3 year vesting period, with one-third vesting each year. The actual number of shares that may be earned and issued, if any, may range from 0-200% of the target number of shares granted based upon the over achievement or under achievement of the financial measures for the annual performance period. In addition, the number of shares that are earned may also be adjusted higher or lower depending on the performance of the Company's total shareholder return, compared against the Company's peer group.
The award contains a performance condition as defined in ASC 718, Share-Based Payment , and as such, the attainment of the conditions are assessed by the Company at each reporting period. The compensation expense is adjusted to reflect the probability of attainment of each performance condition and the requisite service provided through the reporting period end.
The award also contains a market condition as defined in ASC 718, and as such, the awards are valued using a Monte Carlo simulation model. The model generates the fair value of the award at the grant date, which is then amortized over the vesting period, subject to the above performance condition being probable of being met.
The Company recorded $0.3 million of compensation expense for performance shares during the three and six months ended June 30, 2015.
Stock Options

Compensation costs related to the Company’s stock option plans were $ 2.7 million and $ 3.1 million for the three months ended June 30, 2015 and 2014 , respectively. Compensation costs related to the Company's stock option plans were $5.6 million and $5.9 million during the six months ended June 30, 2015 and 2014, respectively. During the three months ended June 30, 2015 and 2014 , 0.2 million and 0.3 million common shares were issued from options exercised, respectively. During the six months ended June 30, 2015 and 2014, 0.4 million and 0.7 million common shares were issued from options exercised, respectively.
 
Restricted Stock
 
Compensation expense related to restricted stock plans for the three months ended June 30, 2015 and 2014 , was approximately $2.2 million and $1.9 million , respectively. Compensation expense related to restricted stock plans for the six months ended June 30, 2015 and 2014, was approximately $4.2 million and $3.5 million , respectively. During the six months ended June 30, 2015 and 2014 , approximately 0.1 million shares and 0.2 million shares totaling approximately $2.3 million and $5.0 million ,

15



respectively, were withheld by the Company for minimum income tax withholding requirements. During the three months ended June 30, 2015 and 2014, 57 thousand and 41 thousand restricted common shares were granted, respectively. During the six months ended June 30, 2015 and 2014 , 0.5 million and 0.3 million restricted common shares were granted, respectively.

Stock Repurchases

On November 5, 2014 , the Company's Board of Directors authorized a share repurchase program of up to $100.0 million of the Company's common stock. This program, according to its terms, will expire on December 31, 2016 .
The aggregate amount available for repurchase under this program was $59.2 million at June 30, 2015 . Repurchases under the repurchase programs may take place in the open market or in privately negotiated transactions, including structured and derivative transactions such as accelerated share repurchase transactions, and may be made under a Rule 10b5-1 plan. During the three and six months ended June 30, 2015 , the Company repurchased approximately 657 thousand and 1.6 million common shares, respectively. The total amount repurchased during the three and six months ended June 30, 2015 was $14.2 million and $30 million , respectively.
11. Commitments and Contingencies
 
Standby Letters of Credit

The Company utilizes letters of credit to back certain payment obligations relating to its facility operating leases. The Company had approximately $ 2.7 million in standby letters of credit as of June 30, 2015 , $ 2.0 million of which were issued under the Revolving Credit Facility.

Legal Proceedings

Following an investigation by the Federal Trade Commission ("FTC") into the methods by which Network Solutions marketed its domain name and web hosting services to customers, on May 28, 2015, the FTC issued a complaint relating to the use of money back guarantees and entered a consent order that restricts certain of our future web hosting marketing practices, but did not require any changes in current practices and did not impose any monetary penalties or require other payments.  

In addition, from time to time, the Company and its subsidiaries receive inquiries from foreign, federal, state and local regulatory authorities or are named as defendants in various legal actions that are incidental to our business and arise out of or are related to claims made in connection with our marketing practices, customer and vendor contracts and employment related disputes. We believe that the resolution of these investigations, inquiries or legal actions will not have a material adverse effect on our financial position, marketing practices or results of operations. There were no material legal matters that were reasonably possible or estimable at June 30, 2015.
 
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” provisions 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.

16



 
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 measures are useful to investors, because they describe the operating performance of the Company, 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
 
Web.com Group, Inc. ("Web.com", the "Company" or "We") provides a full range of internet services to small businesses to help them compete and succeed online. Web.com meets the needs of small businesses anywhere along their lifecycle with affordable, subscription-based solutions including domains, hosting, website design and management, search engine optimization, online marketing campaigns, local sales leads, social media, mobile products and eCommerce solutions. For more information about the company, please visit http://www.web.com. The information obtained on or accessible through the Company's website is not incorporated into this Quarterly Report on Form 10-Q and you may not consider it a part of this Quarterly Report on Form 10-Q.
  
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, if applicable.

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.

Customer Retention Rate (Retention Rate)

Customer retention rate is defined as the trailing twelve month retention metric which we measure as the subscribers at the end of the period divided by the sum of the subscribers at the beginning of the period and the new subscribers added during the last twelve months. Customer cancellations in the trailing twelve months include cancellations from subscriber additions, which is why we include subscriber additions in the denominator. Retention rate is the key metric that allows management to evaluate whether we are retaining our existing subscribers in accordance with our business plan.

Average Revenue per User (Subscriber)
 
Monthly average revenue per user, 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 $ 4.3 million and $ 6.5 million for the three months ended June 30, 2015 and 2014 , respectively, and $9.3 million and $13.9

17



million for the six months ended June 30, 2015 and 2014 , 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
 
Subscription Revenue

We currently derive a substantial majority of our revenue from fees associated with our subscription services, which generally include web services, online marketing, eCommerce, and domain name registration offerings. We bill a majority of our customers in advance through their credit cards, bank accounts, or business merchant accounts. The revenue is recognized on a daily basis over the life of the contract.
 
Professional Services and Other Revenue
 
We generate professional services revenue from custom website design, eCommerce store design and support services. Our custom website design and eCommerce store design work is typically billed on a fixed price basis and over very short periods. Other revenue consists of all fees earned from granting customers licenses to use our patents. Generally, revenue is recognized when the service has been completed.  

Cost of Revenue
 
Cost of revenue consists of expenses related to compensation of our web page development staff, domain name registration costs, directory listing fees, customer support costs, eCommerce store design, 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.
 
Operating Expenses
 
Sales and Marketing Expense
 
Our direct marketing expenses include the costs associated with the online marketing channels we use to promote our services and acquire customers. 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, such as advertising, corporate sponsorships and other corporate events and communications.
 
We plan to continue to invest in sales and marketing to add new subscription customers, and increase sales of additional and new services and products to our existing customer base. We also plan to continue investing in direct response television and radio advertising. We have invested a portion of our incremental marketing budget in branding activities such as the umbrella sponsorship of the Web.com Tour and other sports marketing activities.
Technology and development
Technology and development represents costs associated with creation, development and distribution of our products and websites. Technology and development expenses primarily consist of headcount-related costs associated with the design, development, deployment, testing, operation and enhancement of our products, as well as costs associated with the data centers and systems infrastructure supporting those products. Technology and development expenses are expected to remain flat as a percentage of total revenue during the remainder of 2015.

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. General and administrative expenses are expected to remain relatively flat as a percentage of revenue during the remainder of 2015.
 
Depreciation and Amortization Expense

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Depreciation and amortization expenses relate primarily to our intangible assets recorded due to the acquisitions we have completed, as well as depreciation expense from computer and other equipment, internally developed software, furniture and fixtures, and building and improvement expenditures. Depreciation is expected to increase slightly as we continue to increase our efforts for internally developed software projects. Amortization expense is expected to continue to decrease as compared to the same prior period for the remainder of 2015 as certain intangible assets became fully amortized in the fourth quarter of 2014.

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 our 2014 Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 27, 2015.


Results of Operations
 
Comparison of the results for the three months ended June 30, 2015 to the results for the three months ended June 30, 2014
 
The following table sets forth our key business metrics:  
 
Three months ended June 30,
 
2015
 
2014
 
(unaudited)
Net subscriber additions
21,493

 
38,498

Average revenue per user (monthly)
$
13.91

 
$
14.89

  
Net subscribers increased by 21,493 customers during the three months ended June 30, 2015 , as compared to an increase of 38,498 during the three months ended June 30, 2014 . The increase in subscribers is primarily due to marketing and customer service efforts in prior periods, as well as during the second quarter ended June 30, 2015 . Our rolling twelve month retention rate as of June 30, 2015 was 87.7% compared to 88.1% during the same prior year period. The retention rate continued to remain strong, also due to customer service and marketing efforts.
 



Revenue

19



 
 
Three months ended June 30,
 
2015
 
2014
 
(unaudited, in thousands)
Revenue:
 

 
 

Subscription
$
133,685

 
$
136,044

Professional services and other
2,034

 
2,132

Total revenue
$
135,719

 
$
138,176

 
Total revenue decreased 2% to $ 135.7 million in the three months ended June 30, 2015 down from $ 138.2 million in the three months ended June 30, 2014 . Total revenue during the three months ended June 30, 2015 and 2014 , includes the unfavorable impact of $4.3 million and $6.5 million , respectively, from amortizing into revenue, deferred revenue that was recorded at fair value at the acquisition date. The unfavorable impact declined $2.2 million during the three months ended June 30, 2015 , compared to the same prior period. The remaining $4.7 million decrease in revenue during the three months ended June 30, 2015 , is driven principally by lower advertising and hosting revenue partly offset by an increase in sales of our email-related products. In addition, the 2014 acquisition of Scoot contributed to our revenue during the three months ended June 30, 2015 when compared to the same prior year period. See Note 2, Business Combinations, for more information.

Subscription Revenue . Subscription revenue decreased 2% during the three months ended June 30, 2015 , to $133.7 million down from $136.0 million during the three months ended June 30, 2014 . The decrease is primarily due to the overall revenue drivers discussed above.
 
Professional Services and Other Revenue. Professional services revenue was slightly lower at $2.0 million in the three months ended June 30, 2015 when compared to the three months ended June 30, 2014 .
 
Cost of Revenue
 
Three months ended June 30,
 
2015
 
2014
 
(unaudited, in thousands)
Cost of revenue
$
47,102

 
$
48,599

 
Cost of Revenue. Cost of revenue decreased 3% or $1.5 million during the three months ended June 30, 2015 , compared to the three months ended June 30, 2014 . The overall cost decrease was due primarily to $1.2 million of lower domain-related costs and $0.9 million of lower online marketing expenses. The decrease was partially offset by approximately $0.2 million of higher salaries and benefits and $0.2 million of higher hosting expenses.

Our gross margin remained at 65% during the three months ended June 30, 2015 when compared to the same prior year period. Excluding the $ 4.3 million and $ 6.5 million effect of the adjustment related to the fair value of acquired deferred revenue for the three months ended June 30, 2015 and 2014 , respectively, gross margin was 66% for both the three months ended June 30, 2015 and 2014.
 
Operating Expenses
 
 
Three months ended June 30,
 
2015
 
2014
 
(unaudited, in thousands)
Operating Expenses:
 

 
 

Sales and marketing
$
35,680

 
$
36,710

Technology and development
5,858

 
7,691

General and administrative
18,273

 
15,031

Restructuring expense
22

 


20



Depreciation and amortization
13,849

 
19,793

Total operating expenses
$
73,682

 
$
79,225

 
Sales and Marketing Expenses. Sales and marketing expenses decreased 3% to $ 35.7 million and were 26% of total revenue during the three months ended June 30, 2015 , down from $ 36.7 million , which was 27% of revenue during the three months ended June 30, 2014 . Included in the $1.0 million decrease is approximately $1.9 million of lower affiliate and online media marketing expenditures, partly offset by a $1.3 million increase in salaries and benefits primarily from the Scoot acquisition in July 2014.
 
Technology and Development Expenses. Technology and development expenses of $ 5.9 million , or 4% of total revenue, declined by $1.8 million during the three months ended June 30, 2015 , from $7.7 million , or 6% of total revenue during the three months ended June 30, 2014 . The decline was primarily from $0.9 million of lower salaries and benefits from a higher volume of capitalized software projects that were internally developed and $0.6 million of lower third-party data center and software support costs resulting from the centralization of data centers.

General and Administrative Expenses. General and administrative expenses increased $3.2 million to $ 18.3 million , or 13% of total revenue, during the three months ended June 30, 2015 , as compared to $ 15.0 million , or 11% of total revenue during the three months ended June 30, 2014 . Overall, during the three months ended June 30, 2015 , salaries and incentive compensation were up a total of $3.0 million when compared to the same prior year period. Legal expenses were down about $0.3 million during the second quarter of 2015 when compared to the same prior year period. In addition, bad debt expense decreased by about $0.3 million during the three months ended June 30, 2015.

Depreciation and Amortization Expense. Depreciation and amortization expense of $ 13.8 million during the three months ended June 30, 2015 decreased $5.9 million when compared to the three months ended June 30, 2014 . Amortization expense decreased by $6.5 million during the three months ended June 30, 2015 , as certain intangible assets primarily from the 2011 acquisition of Network Solutions became fully amortized in the fourth quarter 2014. Depreciation expense increased $0.5 million primarily from an increased volume of internally developed software projects that were placed into service.
 
Interest Expense, net. Net interest expense totaled $ 5.2 million and $7.3 million for the three months ended June 30, 2015 and 2014 , respectively. Included in the interest expense for each of the three months ended June 30, 2015 and 2014 , is $2.8 million of deferred financing fee and loan origination discount amortization. Excluding the impact of amortizing deferred financing fees and loan origination discounts, interest expense decreased $2.2 million during the second quarter ended June 30, 2015 , compared to the second quarter of 2014 , primarily due to the lower interest rates from the September 2014 refinance and from lower debt levels due to repayments made.

Income Tax Expense. We recorded income tax expense of $5.2 million and $3.8 million during the three months ended June 30, 2015 and 2014 , respectively, based upon our estimated annual effective tax rates for each year. Our estimated annual effective tax rate for 2014 and 2015 reflects a net increase in our projected year-end valuation allowance related to an increase in our non-reversing deferred tax liabilities, and reduced by our forecasted pre-tax income for each year.
 
Results of Operations
 
Comparison of the results for the six months ended June 30, 2015 to the results for the six months ended June 30, 2014
 
The following table sets forth our key business metrics: 

 
Six months ended June 30,
 
2015
 
 
2014
 
 
(unaudited)
Net subscriber additions
40,151
 
 
 
89,116
 
 
Average revenue per user (monthly)
$
13.83

 
 
$
14.82

 
  
Net subscribers increased by 40,151 customers during the six months ended June 30, 2015 , as compared to an increase of 89,116 customers during the six months ended June 30, 2014 . The increase in customers is primarily due to marketing and customer service efforts in the six months ended June 30, 2015 , as well as in prior periods. Our rolling twelve month retention

21



rate as of June 30, 2015 was 87.7% compared to 88.1% during the same prior year period. The retention rate continued to remain strong, also due to customer service and marketing efforts.
  
Revenue

 
Six months ended June 30,
 
2015
 
 
2014
 
 
(unaudited, in thousands)
Revenue:
 
 
 
 
 
 
 
Subscription
$
264,145

 
 
$
267,828

 
Professional services and other
4,174
 
 
 
4,191
 
 
Total revenue
$
268,319

 
 
$
272,019

 
 
Total revenue decreased 1% to $268.3 million in the six months ended June 30, 2015 , from $272.0 million in the six months ended June 30, 2014 . Total revenue during the six months ended June 30, 2015 and 2014 , includes the unfavorable impact of $9.3 million and $13.9 million , respectively, from amortizing into revenue, deferred revenue that was recorded at fair value at the acquisition date. The unfavorable impact declined $4.6 million during the six months ended June 30, 2015 , compared to the same prior period. The remaining $8.2 million decrease in revenue during the six months ended June 30, 2015 compared to the same prior year period was principally driven by lower advertising and hosting revenue, partially offset by higher email marketing and ecommerce-related revenues.
 
Subscription Revenue . Subscription revenue decreased 1% during the six months ended June 30, 2015 to $264.1 million from $267.8 million during the six months ended June 30, 2014 . The increase is due to the overall revenue drivers discussed above.
 
Professional Services and Other Revenue. Professional services revenue of $4.2 million during the six months ended June 30, 2015 was consistent with the same prior year period ended.
 
Cost of Revenue 

 
Six months ended June 30,
 
2015
 
 
2014
 
 
(unaudited, in thousands)
Cost of revenue
$
95,804

 
 
$
95,185

 
 
Cost of Revenue. Cost of revenue increased 1% or $0.6 million during the six months ended June 30, 2015 compared to the six months ended June 30, 2014 . The slight increase during the six months ended June 30, 2015 was driven by $0.9 million of higher salaries and benefits, a $0.3 million increase of hosting costs, a $0.4 million rise in security-related expenses and $0.5 million of partner-related commissions. These increases were partly offset by a decrease in domain-related costs and online marketing-related expenditures.
 
Our gross margin of 65% during the six months ended June 30, 2014 declined slightly to 64% during the six months ended June 30, 2015 . Excluding the $9.3 million and $13.9 million effect of the adjustment related to the fair value of acquired deferred revenue for the six months ended June 30, 2015 and 2014 , respectively, gross margin decreased from 67% to 65% during the six months ended June 30, 2015 compared to the same prior year period. The decrease was primarily due to lower advertising revenue during the six months ended June 30, 2015.
 
Operating Expenses 
 
Six months ended June 30,
 
2015
 
 
2014
 
 
(unaudited, in thousands)
Operating Expenses:
 
 
 
 
 
 
 
Sales and marketing
$
71,359

 
 
$
74,243

 
Technology and development
 
11,660

 
 
 
14,889

 

22



General and administrative
 
35,484

 
 
 
28,772

 
Restructuring benefit
 
335

 
 
 

 
Depreciation and amortization
 
27,593

 
 
 
39,032

 
Total operating expenses
$
146,431

 
 
$
156,936

 
 
Sales and Marketing Expenses. Sales and marketing expenses decreased 4% from $74.2 million or 27% of revenue during the six months ended June 30, 2014 to $71.4 million or 26% of revenue during the six months ended June 30, 2015 . The $2.9 million decrease was driven from decreased investments in sales and marketing activities including corporate sponsorships, direct response television advertising, and online marketing expenditures. The decreased marketing activities were partially offset by higher salaries and benefits principally from the inclusion of Scoot that was acquired in July 2014.
 
Technology and Development Expenses. Technology and development expenses decreased 22% to $11.7 million , or 4% of total revenue, during the six months ended June 30, 2015 down from $14.9 million , or 5% of total revenue during the six months ended June 30, 2014 . The decrease was driven by about $1.9 million of lower salary and compensation expense resulting from increased labor dollars being capitalized in connection with internally developed software projects during the six months ended June 30, 2015 when compared to the same prior year period. In addition, software support and data center fees have decreased by $1.2 million during the six months ended June 30, 2015 .
 
General and Administrative Expenses. General and administrative expenses increased 23% to $35.5 million , or 13% of total revenue, during the six months ended June 30, 2015 , up from $28.8 million or 11% of total revenue during the six months ended June 30, 2014 . Overall, during the six months ended June 30, 2015 , salary and incentive-based compensation expense increased approximately $3.0 million, corporate development and professional fees were $1.0 million higher, and audit and tax fees were up by $0.7 million. In addition, data support services increased $0.7 million during the six months ended June 30, 2015 when compared to the same prior year period. Finally, we incurred about $0.6 million of application fees for new registrars during the six months ended June 30, 2015.
 
Depreciation and Amortization Expense. Depreciation and amortization expense decreased to $27.6 million during the six months ended June 30, 2015 from $39.0 million during the six months ended June 30, 2014 . Amortization expense decreased by $12.9 million during the six months ended June 30, 2015 , compared to the same prior year period as certain intangible assets were fully amortized, while depreciation expense increased $1.4 million primarily from internally developed software projects.
 
Interest Expense, net. Net interest expense totaled $10.4 million and $14.8 million for the six months ended June 30, 2015 and 2014 , respectively. Included in interest expense during the six months ended June 30, 2015 and 2014 was $5.6 million and $5.5 million of amortization of debt issuance costs, respectively. Excluding amortization, interest expense decreased $4.5 million during the six months ended June 30, 2015 primarily from lower rates resulting from the September 2014 refinance and from lower overall debt levels.

Income Tax Expense. We recorded an income tax expense of $8.8 million and $5.4 million during the six months ended June 30, 2015 and 2014 , respectively, based upon our estimated annual effective tax rates for each year. Our estimated annual effective tax rate for 2014 and 2015 reflects a net increase in our projected year-end valuation allowance related to an increase in our non-reversing deferred tax liabilities, and reduced by our forecasted pre-tax income for each year.

A cumulative loss in the most recent three-year period is a significant piece of negative evidence that is difficult to overcome when assessing the realizability of deferred tax assets. It is reasonably possible that by the end of 2015, the United States jurisdiction may no longer have a cumulative loss in the most recent three-year period. Based on relevant facts and circumstances at that time, including our projected future earnings and applicable loss carry forward limitations, we may conclude that it is appropriate to release a material portion of the valuation allowance for that jurisdiction.  If such a change in the valuation allowance were to occur, it would result in a change to income tax expense in the period the assessment was made. See Note 9, Income Taxes , for additional information.

Outlook. We continue to believe that we have the potential for additional revenue growth during the remainder of 2015 as we made significant progress in addressing the issues that have been impacting our DIY and DIFM website and online marketing offerings during the second half of 2014. In 2015, we have started our plan to further differentiate our DIY offerings with a modified approach to the market, which is called "Do-It-With-Me" which will provide our DIY customers with an opportunity to speak and work with us via chat, email or telephone while they are building their websites. In addition, we continue to work with our partners to increase the level of high quality lead flow in the DIFM business channel.

23



As we look ahead we are confident we have identified issues impacting our business and have taken steps towards improved revenue growth as we continue to move through 2015. We will continue to use strong cash flows to pay down debt, repurchase common stock and fund marketing investments.  As the impact of the fair market value adjustment to deferred revenue acquired in the Network Solutions and Register.com LP transactions continues to decrease even further during 2015, we expect gross margins to improve.
Liquidity and Capital Resources
 
The following table summarizes total cash flows for operating, investing and financing activities for the six months ended June 30, (in thousands):   
 
Six months ended June 30,
 
2015
 
2014
 
(unaudited, in thousands)
Net cash provided by operating activities
$
77,411

 
$
55,748

Net cash used in investing activities
(8,386
)
 
(15,664
)
Net cash used in financing activities
(75,606
)
 
(39,281
)
Effect of exchange rate changes on cash
2

 

(Decrease) increase in cash and cash equivalents
$
(6,579
)
 
$
803

 
Cash Flows

As of June 30, 2015 , we had $ 15.9 million of cash and cash equivalents and $ 140.8 million in negative working capital, as compared to $ 22.5 million of cash and cash equivalents and $ 118.0 million in negative working capital as of December 31, 2014 . The unfavorable change in working capital is primarily due to increases in deferred revenue and accrued compensation and benefits. The majority of the negative working capital is due to significant balances of deferred revenue, partially offset by deferred expenses and deferred tax assets, which get amortized to revenue or expense/benefit rather than settled with cash. The Company expects cash generated from operating activities to be more than sufficient to meet future working capital and debt servicing requirements.

Net cash provided by operations for the six months ended June 30, 2015 increased $ 21.7 million from the six months ended June 30, 2014 primarily due to lower cash interest payments and favorable changes in working capital during the six months ended June 30, 2015 . The working capital changes are primarily due to lower annual performance bonuses paid in the six months ended June 30, 2015 compared to 2014 and from accounts receivable, deferred expense and accounts payable timing.

Net cash used in investing activities during the six months ended June 30, 2015 was $ 8.4 million , as compared to $ 15.7 million in the six months ended June 30, 2014 . Capital expenditures during the six months ended June 30, 2015 were slightly lower during the same prior year period primarily due to a slight decrease in internally developed software efforts. The quarter ended March 31, 2014 included a $7.4 million payment for the acquisition of SnapNames.com, Inc. from KeyDrive S.A. in February 2014. During the six months ended June 30, 2015, the final working capital hold back was paid to KeyDrive S.A. and recorded as an investing cash outflow. See Note 2, Business Combinations , for additional information surrounding the purchase.

Net cash used in financing activities reflects a $47.5 million reduction of outstanding debt as principal payments were made during the six months ended June 30, 2015 . During the six months ended June 30, 2015, common stock repurchases of 1.6 million common shares totaling $30.0 million were made in connection with our stock repurchase program announced on November 5, 2014. Proceeds received from the exercise of stock options decreased by $2.5 million to $ 4.2 million in the six months ended June 30, 2015 when compared to the same prior year period. Approximately $ 2.3 million and $ 5.0 million of cash was used to pay employee minimum tax withholding requirements in lieu of receiving common shares during the six months ended June 30, 2015 and 2014 , respectively.

Debt Covenants

The credit agreement entered into on September 9, 2014 with respect to the new credit facilities require that we not exceed a maximum first lien net leverage ratio and that we maintain a minimum consolidated cash interest expense to consolidated EBITDA coverage ratio as set forth in the table below. The first lien net leverage ratio is defined as the total of the outstanding consolidated first lien debt minus up to $50.0 million of unrestricted cash and cash equivalents, divided by consolidated EBITDA. The consolidated interest coverage ratio is defined as consolidated EBITDA divided by consolidated cash interest

24



expense. Consolidated EBITDA is defined as consolidated net income before (among other things) interest expense, income tax expense, depreciation and amortization, impairment charges, restructuring costs, changes in deferred revenue and deferred expenses, stock-based compensation expense, non-cash losses and acquisition-related costs.

Outstanding debt as of June 30, 2015 for purposes of the First Lien Net Leverage Ratio was approximately $229.3 million . The covenant calculations as of June 30, 2015 on a trailing 12-month basis are as follows:

Covenant Description
 
Covenant Requirement as of 
June 30, 2015
 
Ratio at June 30, 2015
 
Favorable/
(Unfavorable)
Consolidated Net Debt to EBITDA
 
Not greater than 2.75
 
1.55

 
1.20

Consolidated Interest Coverage Ratio
 
Greater than 2.00
 
9.07

 
7.07

 
In addition to the financial covenants listed above, the credit agreement includes customary covenants that limit (among other things) the incurrence of debt, the disposition of assets, and making of certain payments. Substantially all of our tangible and intangible assets collateralize the long-term debt as required by the credit agreement.

Stock Repurchase Plan

In October 2014, our Board of Directors authorized a plan for the repurchase of up to $100.0 million of our outstanding common shares through December 31, 2016.

The timing, price and volume of repurchases will be based on market conditions, restrictions under applicable securities laws and other factors. The repurchase program does not require us to repurchase any specific number of shares, and we may terminate the repurchase program at any time.

The repurchases may be made periodically in a variety of ways including open market purchases at prevailing market prices, in privately negotiated transactions, or pursuant to a 10b5-1 plan implemented. See Item 2, Issuer Repurchases of Equity Securities , for additional information.

Non-GAAP Financial Measures
 
In addition to our financial information presented in accordance with U.S. GAAP, management uses certain “non-GAAP financial measures” within the meaning of the SEC Regulation G. Generally, a non-GAAP financial measure is a numerical measure of a company's operating performance, financial position or cash flows that excludes or includes amounts that are included in or excluded from the most directly comparable measure calculated and presented in accordance with U.S. GAAP.

We believe presenting non-GAAP measures is useful to investors because it describes the operating performance of the company, excluding some recurring charges that are included in the most directly comparable measures calculated and presented in accordance with GAAP. Our management uses these non-GAAP measures as important indicators of the Company's 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. You are encouraged to review the reconciliation of non-GAAP financial measures to GAAP financial measures included in this Quarterly Report on Form 10-Q.
Relative to each of the non-GAAP measures Web.com presents, management further sets forth its rationale as follows:
Non-GAAP Revenue . Web.com excludes from non-GAAP revenue the impact of the fair value adjustment to amortized deferred revenue because we believe that excluding such measures helps management and investors better understand our revenue trends.
Non-GAAP Operating Income and Non-GAAP Operating Margin . Web.com excludes from non-GAAP operating income and non-GAAP operating margin, amortization of intangibles, fair value adjustment to deferred revenue and deferred expense, restructuring expenses, corporate development expenses, and stock-based compensation charges. Management believes that excluding these items assists management and investors in evaluating period-over-period changes in Web.com's operating income without the impact of items that are not a result of the Company's day-to-day business and operations.
Non-GAAP Net Income and Non-GAAP Net Income Per Basic and Diluted Share . Web.com excludes from non-GAAP net income and non-GAAP net income per diluted share amortization of intangibles, income tax provision, fair value

25



adjustment to deferred revenue and deferred expense, restructuring expenses, corporate development expenses, amortization of debt discounts and fees, and stock-based compensation, and includes estimated cash income tax payments, because management believes that adjusting for such measures helps management and investors better understand the Company's operating activities.
Adjusted EBITDA and Adjusted EBITDA Margin . Web.com excludes from adjusted EBITDA depreciation expense, amortization of intangibles, income tax provision, interest expense, interest income, stock-based compensation, fair value adjustments to deferred revenue and deferred expense, corporate development expenses and restructuring expenses, because management believes that excluding such items helps investors better understand the Company's operating activities.
Non-GAAP Gross Profit and Non-GAAP Gross Margin . Web.com excludes from non-GAAP gross profit and non-GAAP gross margin, fair value adjustment to deferred revenue and deferred expense, and stock based compensation charges. Management believes that excluding these items assists management and investors in evaluating period-over-period changes in Web.com's gross profit without the impact of items that are not a result of the Company's day-to-day business operations.
Free Cash Flow. Free cash flow is a non-GAAP financial measure that Web.com uses and defines as net cash provided by operating activities less capital expenditures. The Company considers free cash flow to be a liquidity measure which provides useful information to management and investors about the amount of cash generated by the business after the acquisition of property and equipment, which can then be used for investment opportunities.
In respect of the foregoing, Web.com provides the following supplemental information to provide additional context for the use and consideration of the non-GAAP financial measures used elsewhere in this press release:
Stock-based compensation . These expenses consist of expenses for employee stock options and employee awards under Accounting Standards Codification ("ASC") 718-10. While stock-based compensation expense calculated in accordance with ASC 718-10 constitutes an ongoing and recurring expense, such expense is excluded from non-GAAP results because such expense is not used by management to assess the core profitability of the Company's business operations. Web.com further believes these measures are useful to investors in that they allow for greater transparency to certain line items in our financial statements. In addition, when management performs internal comparisons to Web.com's historical operating results and compares the Company's operating results to the Company's competitors, management excludes this item from various non-GAAP measures.
Amortization of intangibles . Web.com incurs amortization of acquired intangibles under ASC 805-10-65. Acquired intangibles primarily consist of customer relationships, customer lists, non-compete agreements, trade names, and developed technology. Web.com expects to amortize for accounting purposes the fair value of the acquired intangibles based on the pattern in which the economic benefits of the intangible assets will be consumed as revenue is generated. Although the intangible assets generate revenue, the Company believes the non-GAAP financial measures excluding this item provide meaningful supplemental information regarding the Company's operational performance. In addition, when management performs internal comparisons to Web.com's historical operating results and compares the Company's operating results to the Company's competitors, management excludes this item from various non-GAAP measures.
Depreciation expense . Web.com records depreciation expense associated with its fixed assets. Although its fixed assets generate revenue for Web.com, the item is excluded because management believes certain non-GAAP financial measures excluding this item provide meaningful supplemental information regarding the Company's operational performance. In addition, when management performs internal comparisons to Web.com's historical operating results and compares the Company's operating results to the Company's competitors, management excludes this item from various non-GAAP measures.
Amortization of debt discounts and fees . Web.com incurs amortization expense related to debt discounts and deferred financing fees. The difference between the effective interest expense and the coupon interest expense (i.e. debt discount), as well as, amortized deferred financing fees are excluded because Web.com believes the non-GAAP measures excluding these items provide meaningful supplemental information regarding the Company's operational performance. In addition, when management performs internal comparisons to Web.com's historical operating results and compares the Company's operating results to the Company's competitors, management excludes this item from various non-GAAP measures.
Restructuring expense . Web.com has recorded restructuring expenses and excludes the impact of these expenses from its non-GAAP measures, because such expense is not used by management to assess the core profitability of the Company's business operations.
Income tax expense . Due to the magnitude of Web.com's historical net operating losses and related deferred tax asset, the Company excludes income tax from its non-GAAP measures primarily because it is not indicative of the actual tax to be paid by the Company and therefore is not reflective of ongoing operating results. The Company believes that

26



excluding this item provides meaningful supplemental information regarding the Company's operational performance and facilitates management's internal comparisons to the Company's historical operating results and comparisons to the Company's competitors' operating results. The Company includes the estimated tax that the Company expects to pay for operations during the periods presented.
Fair value adjustment to deferred revenue and deferred expense . Web.com has recorded a fair value adjustment to acquired deferred revenue and deferred expense in accordance with ASC 805-10-65. Web.com excludes the impact of these adjustments from its non-GAAP measures, because doing so results in non-GAAP revenue and non-GAAP net income which are reflective of ongoing operating results and more comparable to historical operating results, since the majority of the Company's revenue is recurring subscription revenue. Excluding the fair value adjustment to deferred revenue and deferred expense therefore facilitates management's internal comparisons to Web.com's historical operating results.
Corporate development expenses . Web.com incurred expenses relating to the acquisitions and successful integration of acquisitions. Web.com excludes the impact of these expenses from its non-GAAP measures, because such expense is not used by management to assess the core profitability of the Company's business operations.

The following table presents our non-GAAP measures for the periods indicated (in thousands):
Web.com Group, Inc.
Reconciliation of GAAP to Non-GAAP Results
(in thousands, except for per share data and percentages)
(unaudited)
 
 
 
 
 

 
Three months ended June 30,
 
Six months ended June 30,

 
2015
 
2014
 
2015
 
2014
Reconciliation of GAAP revenue to non-GAAP revenue
 

 

 

 

GAAP revenue
 
$
135,719

 
$
138,176

 
$
268,319

 
$
272,019

   Fair value adjustment to deferred revenue
 
4,252

 
6,492

 
9,345

 
13,883

Non-GAAP revenue
 
$
139,971

 
$
144,668

 
$
277,664

 
$
285,902

 
 
 
 
 
 
 
 
 
Reconciliation of GAAP net income (loss) to non-GAAP net income
 

 

 

 

GAAP net income (loss)
 
$
4,550

 
$
(794
)
 
$
6,889

 
$
(304
)
   Amortization of intangibles
 
9,822

 
16,320

 
19,638

 
32,504

   Stock based compensation
 
5,137

 
4,939

 
10,184

 
9,442

   Income tax expense
 
5,203

 
3,847

 
8,764

 
5,409

   Restructuring expense
 
22

 

 
335

 

   Corporate development
 

 

 
597

 
40

   Amortization of debt discounts and fees
 
2,822

 
2,790

 
5,620

 
5,508

   Cash income tax expense
 
(520
)
 
(267
)
 
(787
)
 
(399
)
   Fair value adjustment to deferred revenue
 
4,252

 
6,492

 
9,345

 
13,883

   Fair value adjustment to deferred expense
 
167

 
269

 
358

 
570

Non-GAAP net income
 
$
31,455

 
$
33,596

 
$
60,943

 
$
66,653

 
 
 
 
 
 
 
 
 
Reconciliation of GAAP basic net income (loss) per share to non-GAAP basic net income per share








Basic GAAP net income (loss) per share

$
0.09


$
(0.02
)

$
0.14


$
(0.01
)
   Amortization of intangibles

0.20


0.32


0.39


0.65

   Loss on sale of assets








   Stock based compensation

0.10


0.10


0.20


0.19

   Income tax expense

0.10


0.08


0.17


0.11

   Restructuring expense





0.01



   Corporate development





0.01



   Amortization of debt discounts and fees

0.06


0.05


0.11


0.11


27



   Cash income tax expense

(0.01
)

(0.01
)

(0.02
)

(0.01
)
   Fair value adjustment to deferred revenue

0.08


0.13


0.18


0.27

   Fair value adjustment to deferred expense



0.01


0.01


0.01

   Loss on debt extinguishment








   Gain on sale of equity method investment








Basic Non-GAAP net income per share

$
0.62


$
0.66


$
1.20


$
1.32

 
 
 
 
 
 
 
 
 
Reconciliation of GAAP diluted net income (loss) per share to non-GAAP diluted net income per share
 
 
 
 
 
 
 
 
Diluted shares:
 
 
 
 
 
 
 
 
   Basic weighted average common shares
 
50,362

 
50,809

 
50,616

 
50,571

   Diluted stock options
 
1,800

 
3,250

 
1,584

 
3,406

   Diluted restricted stock
 
273

 
507

 
310

 
645

Total diluted weighted average common shares
 
52,435

 
54,566

 
52,510

 
54,622

 
 
 
 
 
Reconciliation of GAAP diluted net income (loss) per share to non-GAAP diluted net income per share
 
 
 
 
 
 
 
 
Diluted GAAP net income (loss) per share
 
$
0.09

 
$
(0.02
)
 
$
0.13

 
$
(0.01
)
   Diluted equity
 

 
0.01

 

 

   Amortization of intangibles
 
0.19

 
0.30

 
0.37

 
0.61

   Stock based compensation
 
0.10

 
0.09

 
0.18

 
0.17

   Income tax expense
 
0.10

 
0.07

 
0.17

 
0.10

   Restructuring expense
 

 

 
0.01

 

   Corporate development
 

 

 
0.01

 

   Amortization of debt discounts and fees
 
0.05

 
0.05

 
0.11

 
0.10

   Cash income tax expense
 
(0.01
)
 

 
(0.01
)
 
(0.01
)
   Fair value adjustment to deferred revenue
 
0.08

 
0.12

 
0.18

 
0.25

   Fair value adjustment to deferred expense
 

 

 
0.01

 
0.01

Diluted Non-GAAP net income per share
 
$
0.60

 
$
0.62

 
$
1.16

 
$
1.22

 
 
 
 
 
 
 
 
 
Reconciliation of GAAP operating income to non-GAAP operating income
 
 
 
 
 
 
 
 
GAAP operating income
 
$
14,935

 
$
10,352

 
$
26,084

 
$
19,898

   Amortization of intangibles
 
9,822

 
16,320

 
19,638

 
32,504

   Loss on sale of assets
 

 

 

 

   Stock based compensation
 
5,137

 
4,939

 
10,184

 
9,442

   Restructuring expense
 
22

 

 
335

 

   Corporate development
 

 

 
597

 
40

   Fair value adjustment to deferred revenue
 
4,252

 
6,492

 
9,345

 
13,883

   Fair value adjustment to deferred expense
 
167

 
269

 
358

 
570

Non-GAAP operating income
 
$
34,335

 
$
38,372

 
$
66,541

 
$
76,337

 
 
 
 
 
 
 
 
 
Reconciliation of GAAP operating margin to non-GAAP operating margin
 
 
 
 
 
 
 
 
GAAP operating margin
 
11
%
 
7
%
 
10
%
 
7
%
   Amortization of intangibles
 
7

 
12

 
7

 
12

   Loss on sale of assets
 

 

 

 

   Stock based compensation
 
4

 
3

 
4

 
3

   Restructuring expense
 

 

 

 

   Corporate development
 

 

 

 

   Fair value adjustment to deferred revenue
 
3

 
5

 
3

 
5


28



   Fair value adjustment to deferred expense
 

 

 

 

Non-GAAP operating margin
 
25
%
 
27
%
 
24
%
 
27
%
 
 
 
 
 
 
 
 
 
Reconciliation of GAAP operating income to adjusted EBITDA
 
 
 
 
 
 
 
 
GAAP operating income
 
$
14,935

 
$
10,352

 
$
26,084

 
$
19,898

   Depreciation and amortization
 
13,849

 
19,793

 
27,593

 
39,032

   Loss on sale of assets
 

 

 

 

   Stock based compensation
 
5,137

 
4,939

 
10,184

 
9,442

   Restructuring expense
 
22

 

 
335

 

   Corporate development
 

 

 
597

 
40

   Fair value adjustment to deferred revenue
 
4,252

 
6,492

 
9,345

 
13,883

   Fair value adjustment to deferred expense
 
167

 
269

 
358

 
570

Adjusted EBITDA
 
$
38,362

 
$
41,845

 
$
74,496

 
$
82,865

Reconciliation of GAAP operating margin to adjusted EBITDA margin

 

 

 

 
GAAP operating margin