Web.com Group, Inc.
WEB.COM GROUP, INC. (Form: 10-Q, Received: 08/08/2016 17:31:23)


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, 2016
 
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 August 3, 2016 : 50,507,033




Web.com Group, Inc.
 
Quarterly Report on Form 10-Q
 
For the Quarterly Period ended June 30, 2016
 
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 (Loss) Income
(in thousands, except per share amounts)
(unaudited)  
 
Three months ended June 30,
 
Six months ended June 30,
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
Revenue
$
187,818

 
$
135,719

 
$
332,616

 
$
268,319

 
 
 
 
 
 
 
 

Cost of Revenue
59,743

 
47,102

 
110,826

 
95,804

 
 
 
 
 
 
 
 
Gross profit
128,075

 
88,617

 
221,790

 
172,515

 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 

 
 
 
 
 
 
 
 
Sales and marketing
58,448

 
35,680

 
100,459

 
71,359

Technology and development
15,533

 
5,858

 
24,611

 
11,660

General and administrative
23,465

 
18,273

 
43,129

 
35,484

Restructuring expense
778

 
22

 
914

 
335

Depreciation and amortization
22,273

 
13,849

 
38,186

 
27,593

Total operating expenses
120,497

 
73,682

 
207,299

 
146,431

 
 
 
 
 
 
 
 
Income from operations
7,578

 
14,935

 
14,491

 
26,084


 
 
 
 
 
 
 
Interest expense, net
(8,662
)
 
(5,182
)
 
(14,259
)
 
(10,431
)
Net (loss) income before income taxes
(1,084
)
 
9,753

 
232

 
15,653

Income tax expense
(522
)
 
(5,203
)
 
(1,500
)
 
(8,764
)
Net (loss) income
$
(1,606
)
 
$
4,550

 
$
(1,268
)
 
$
6,889

 
 
 
 
 
 
 
 
Other comprehensive (loss) income:
 
 
 
 
 

 
 

Foreign currency translation adjustments
(891
)
 
797

 
(1,207
)
 
90

Unrealized (loss) gain on investments, net of tax

 
(4
)
 
28

 
1

Total comprehensive (loss) income
$
(2,497
)
 
$
5,343

 
$
(2,447
)
 
$
6,980

 
See accompanying notes to consolidated financial statements

3




Web.com Group, Inc.
 
Consolidated Statements of Comprehensive (Loss) Income
(in thousands, except per share amounts)
(unaudited)
(continued)
 
    
 
 
Three months ended June 30,
 
Six months ended June 30,
 
 
2016
 
2015
 
2016
 
2015
Basic (loss) earnings per share:
 
 
 
 
 
 

 
 

Net (loss) income per basic common share
 
$
(0.03
)
 
$
0.09

 
$
(0.03
)
 
$
0.14

Diluted (loss) earnings per share:
 
 
 
 
 
 

 
 

Net (loss) income per diluted common share
 
$
(0.03
)
 
$
0.09

 
$
(0.03
)
 
$
0.13

 
 
 
 
 
 
 
 
 
Basic weighted average common shares outstanding
 
49,293

 
50,362

 
49,334

 
50,616

Diluted weighted average common shares outstanding
 
49,293

 
52,435

 
49,334

 
52,510

 
See accompanying notes to consolidated financial statements


4




Web.com Group, Inc.
 Consolidated Balance Sheets
(in thousands, except share amounts)
 
June 30,
2016
 
December 31,
2015
 
(unaudited)
 
 
Assets
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
8,950

 
$
18,706

Accounts receivable, net of allowance of $1,677 and $1,815, respectively
19,356

 
12,892

Prepaid expenses
14,353

 
8,151

Deferred expenses
61,829

 
59,400

Other current assets
3,719

 
4,380

Total current assets
108,207

 
103,529

 
 
 
 
Property and equipment, net
58,880

 
41,963

Deferred expenses
50,271

 
50,113

Goodwill
854,295

 
639,145

Intangible assets, net
473,624

 
318,107

Other assets
12,784

 
4,482

Total assets
$
1,558,061

 
$
1,157,339

 
 
 
 
Liabilities and stockholders' equity
 

 
 
Current liabilities:
 

 
 

Accounts payable
$
20,621

 
$
9,974

Accrued expenses
17,118

 
13,303

Accrued compensation and benefits
11,501

 
13,765

Deferred revenue
238,526

 
219,187

Current portion of debt
12,016

 
11,169

Deferred consideration
19,073

 

Other liabilities
3,683

 
3,802

Total current liabilities
322,538

 
271,200

 
 
 
 
Deferred revenue
196,267

 
191,426

Long-term debt
693,570

 
411,409

Deferred tax liabilities
85,571

 
37,840

Other long-term liabilities
30,795

 
7,287

Total liabilities
1,328,741

 
919,162

 
 
 
 
Stockholders' equity:
 

 
 

Common stock, $0.001 par value per share: 150,000,000 shares authorized, 50,634,010 and 50,683,717 shares issued and outstanding at June 30, 2016 and December 31, 2015, respectively
51

 
51

Additional paid-in capital
572,735

 
565,648

Treasury stock at cost, 2,833,748 shares as of June 30, 2016 and 2,120,944 shares as of December 31, 2015
(58,247
)
 
(44,750
)
Accumulated other comprehensive loss
(3,327
)
 
(2,148
)
Accumulated deficit
(281,892
)
 
(280,624
)
Total stockholders' equity
229,320

 
238,177

Total liabilities and stockholders' equity
$
1,558,061

 
$
1,157,339

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,
 
2016
 
2015
Cash flows from operating activities
 

 
 

Net (loss) income
$
(1,268
)
 
$
6,889

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

 
 

Depreciation and amortization
38,186

 
27,593

Stock based compensation
10,200

 
10,184

Deferred income taxes
599

 
8,047

Amortization of debt discounts and issuance costs
6,685

 
5,620

Changes in operating assets and liabilities:
 

 
 

Accounts receivable, net
(1,758
)
 
2,643

Prepaid expenses and other assets
(10,935
)
 
(219
)
Deferred expenses
(2,586
)
 
1,002

Accounts payable
(1,585
)
 
(373
)
Accrued expenses and other liabilities
(519
)
 
1,629

Accrued compensation and benefits
(7,375
)
 
2,690

Deferred revenue
15,644

 
11,706

Net cash provided by operating activities
45,288

 
77,411

Cash flows from investing activities
 

 
 

Business acquisitions
(303,262
)
 
(475
)
Capital expenditures
(8,306
)
 
(7,911
)
Other
(1,300
)
 

Net cash used in investing activities
(312,868
)
 
(8,386
)
Cash flows from financing activities
 

 
 

Stock issuance costs
(6
)
 
(50
)
Common stock repurchased
(3,233
)
 
(2,302
)
Payments of long-term debt
(32,500
)
 
(47,500
)
Proceeds from exercise of stock options
1,205

 
4,221

Proceeds from borrowings on long-term debt
200,000

 

Proceeds from borrowings on revolving credit facility
115,000

 

Debt issuance costs
(5,700
)
 

Common stock purchases under stock repurchase plan
(16,909
)
 
(29,975
)
Net cash provided by (used in) financing activities
257,857

 
(75,606
)
 
 
 
 
Effect of exchange rate changes on cash
(33
)
 
2

 
 
 
 
Net decrease in cash and cash equivalents
(9,756
)
 
(6,579
)
Cash and cash equivalents, beginning of period
18,706

 
22,485

Cash and cash equivalents, end of period
$
8,950

 
$
15,906

Supplemental cash flow information
 

 
 

Interest paid
$
6,851

 
$
4,882

Income tax paid
$
2,046

 
$
902

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.
In March 2016, the Company completed the acquisition of 100% of the outstanding shares of Yodle, Inc., a Delaware corporation, ("Yodle"), for approximately $341.9 million , which includes $42.0 million of deferred consideration. Yodle is a leading provider of cloud based local marketing solutions for small businesses with approximately 1,400 employees and 53,000 subscribers. See Note 2, Business Combinations , for additional information surrounding the acquisition.

Basis of Presentation
 
The accompanying consolidated balance sheet as of June 30, 2016 , the consolidated statements of comprehensive income for the three and six months ended June 30, 2016 and 2015 , the consolidated statements of cash flows for the six months ended June 30, 2016 and 2015 , 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, 2015 , 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, 2016 , the Company’s results of operations for the three and six months ended June 30, 2016 and 2015 , and the cash flows for the six months ended June 30, 2016 and 2015 . The Company's financial position as of June 30, 2016 includes the assets and liabilities of Yodle and the results of operations and cash flows from March 9, 2016 to June 30, 2016. The results of operations for the three and six months ended June 30, 2016 , are not necessarily indicative of the results to be expected for the year ending December 31, 2016 .

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 26, 2016, and any subsequently filed current reports on Form 8-K.

Use of Estimates
 
The preparation of the consolidated financial statements in conformity with 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.

Sources of Revenue
Subscription Revenue

7



The Company currently derives 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 and recognize revenue on a daily basis over the life of the contract.
Professional Services and Other Revenue  
The Company also generates professional services revenue from custom website design, eCommerce store design and support services. Custom website design and eCommerce store design work is typically billed on a fixed-price basis and over very short periods. 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, eCommerce store design, online marketing costs for services provided, billing costs, hosting expenses,and allocated overhead costs. The Company allocates 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.

Operating Expenses  
Sales and Marketing Expense
The Company's direct marketing expenses include the costs associated with the online marketing channels used to promote our services and acquire customers. These channels include search marketing, affiliate marketing, direct television advertising and partnerships. Sales and marketing costs consist primarily of compensation and related expenses for our sales and marketing staff as well as our customer support staff. Sales and marketing expenses also include marketing programs, such as advertising, corporate sponsorships and other corporate events and communications.
 
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, enhancement of our products and management information systems personnel, as well as costs associated with the data centers and systems infrastructure supporting those products.

General and Administrative Expense
General and administrative expenses consist of compensation and related expenses for executive, finance, and administration, as well as professional fees, corporate development costs, other corporate expenses, and allocated overhead costs.

Depreciation and Amortization Expense
Depreciation and amortization expenses relate primarily to our intangible assets recorded due to the acquisitions we have completed, as well as depreciation expense from computer and other equipment, internally developed software, furniture and fixtures, and building and improvement expenditures.

New Accounting Standards

Recently Adopted Accounting Standards

In September 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2015-16, Business Combinations (Topic 805), Simplifying the Accounting for Measurement-Period Adjustments . The new standard requires an entity recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The standard also requires that the acquirer record, in the same period's financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provision amounts, calculated as if the accounting had been completed at the acquisition date. For public companies, ASU 2015-16 is effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. ASU 2015-16 was adopted during the first quarter ended March 31, 2016 and there was no effect on the Company's consolidated financial statements and footnote disclosures.

Accounting Standards Issued Not Yet Adopted

8



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 is 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). In August 2015, the FASB issued ASU 2015-14 Revenue from Contracts with Customers (Topic 606), Deferral of the Effective Date , which defers the effective date of the new standard by one year, resulting in the new standard being effective for fiscal years, and interim periods within those years, beginning after December 15, 2017 with early adoption as of the original effective date permitted. The Company will use 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. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers: Principal versus Agent Considerations (Reporting Revenue Gross versus Net) . In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing . Also, in May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers: Narrow-Scope Improvements and Practical Expedients . These standards clarify the guidance in ASU 2014-09 and have the same effective date as the original standard. The Company is currently evaluating the impact that the adoption of ASU 2014-09, ASU 2016-08, ASU 2016-10 and ASU 2016-12 will have on our consolidated financial statements.
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 the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Early adoption is permitted. The adoption of this standard is not expected to have an impact on our consolidated financial statements or disclosures.
In January 2016, the FASB issued ASU 2016-01, Financial Instruments — Overall: Recognition and Measurement of Financial Assets and Financial Liabilities , which addresses certain aspects of the recognition, measurement, presentation and disclosure of financial instruments. The amendment will be effective for the Company beginning January 1, 2018 and the adoption of this standard is not expected to have an impact on our consolidated financial statements or disclosures.
In February 2016, the FASB issued ASU 2016-02, Leases , which requires lessees to recognize on the balance sheet a right-of-use asset, representing their right to use the underlying asset for the lease term, and a lease liability for all leases with terms greater than 12 months. The guidance also requires qualitative and quantitative disclosures designed to assess the amount, timing and uncertainty of cash flows arising from leases. The standard requires the use of a modified retrospective transition approach, which includes a number of optional practical expedients that entities may elect to apply. ASU 2016-02 is effective for the Company beginning January 1, 2019 and we are currently evaluating the impact that ASU 2016-02 will have on our consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09, Compensation — Stock Compensation: Improvements to Employee Share-Based Payment Accounting . The standard is intended to simplify several areas of accounting for share-based compensation arrangements, including the income tax impact, classification on the statement of cash flows and forfeitures. ASU 2016-09 is effective for the Company on January 1, 2017 and we are currently evaluating the impact that ASU 2016-09 will have on our consolidated financial statements.
2. Business Combinations
Acquisition of Yodle
On March 9, 2016, the Company executed an Agreement and Plan of Merger (the "Merger Agreement) with Yodle, Inc., a Delaware corporation ("Yodle"), and Shareholder Representative Services, LLC, a Colorado limited liability company. The Company acquired 100% of the outstanding shares of Yodle, Inc. and paid approximately $300.3 million adjusted for, among other things, Yodle's cash and outstanding debt and transaction related expenses. The Company will pay an additional $20.0 million and $22.0 million on the first and second anniversary dates of the closing, respectively, subject to adjustments as described in the Merger Agreement. Finally, the Company converted out of the money stock options held by employees of Yodle to Web.com options, which resulted in additional consideration of $2.3 million , for total consideration of $341.9 million . In addition to the consideration, the Company incurred approximately $3.9 million of acquisition-related transaction expenses which are reflected in the General and Administrative line item of the Consolidated Statement of Comprehensive (Loss) Income for during the six months ended June 30, 2016.

9



The Company has accounted for the acquisition of Yodle using the acquisition method as required in Accounting Standards Codification 805, Business Combinations ("ASC 805"). As such, preliminary 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 also performed preliminary estimates of the fair value of certain intangible assets. The goodwill recorded from this acquisition represents business benefits the Company anticipates realizing from acquiring a leader in value added digital marketing solutions that further solidifies our position as a leading national provider in this space. In addition, Yodle has vertically focused solutions that help small businesses attract new business and retain existing customers through cloud based marketing platforms. Finally, the Company also expects to benefit from synergies from eliminating duplicate operational and administrative expenditures, where feasible. The goodwill from the acquisition is not deductible for tax purposes.
The Company is still reviewing information surrounding intangible assets, property, plant and equipment values, certain assets and liabilities, accrued expenses, deferred revenue and income taxes. These items may result in changes to the Company's preliminary purchase price allocation through the first quarter of 2017. The following table summarizes the Company's preliminary purchase price allocation based on the fair values of the assets acquired and liabilities assumed (in thousands):
 
 
As of March 31, 2016
Adjustments
As of June 30, 2016
 
Tangible current assets
$
7,709

$
(241
)
$
7,468

 
Property plant and equipment
18,157

(17
)
18,140

 
Developed technology
72,500

7,160

79,660

 
Trademarks / trade names
32,500

580

33,080

 
Customer relationships
67,500

(270
)
67,230

 
Other non current assets
277


277

 
Goodwill
218,530

(4,852
)
213,678

 
Current liabilities
(22,308
)
(83
)
(22,391
)
 
Deferred revenue
(8,709
)

(8,709
)
 
Deferred tax liability
(43,532
)
(2,763
)
(46,295
)
 
Other long term liabilities
(245
)

(245
)
 
Purchase price consideration
$
342,379

$
(486
)
$
341,893

 
 
 
 
 

The preliminary customer relationships and developed technology intangible assets will be amortized over 5 years and 6 years, respectively. The trademarks and trade names are indefinite life intangible assets and are not amortized.
 
Yodle contributed approximately $52 million and $61 million in r evenue during the three and six months ended June 30, 2016, respectively. The revenue for the three and six months ended reflects approximately $4 million and $10 million , respectively, of unfavorable impact amortizing into revenue, deferred revenue that was recorded at fair value as of the acquisition date. The operations of Yodle have been incorporated with the existing Web.com Group Inc. operations subsequent to the transaction closing. As such, the determination of operating income and net income is not readily available nor would it be indicative of the standalone entity if presented.

The fair value and gross contractual amount of the acquired accounts receivable was $4.8 million .

Pro Forma Condensed Consolidated Results of Operations

The Company has prepared the unaudited condensed pro forma financial information to reflect the consolidated results of operations as though the Yodle acquisition had occurred on January 1, 2015 for the three months ended June 30, 2015 and the six months ended June 30, 2016 and 2015. The Company has made adjustments to the historical Web.com and Yodle financial statements that are directly attributable to the acquisition, factually supportable and expected to have a continuing impact on the combined results. The pro forma presentation does not include any impact of transaction costs or expected synergies. The pro forma results are not necessarily indicative of our results of operations had the Company owned Yodle for the entire periods presented.

The Company has adjusted the results of operations to reflect the impact of amortizing into revenue, deferred revenue that was recorded at fair value. In addition, interest expense and amortization of intangible assets were adjusted to reflect the cost of the

10



March 9, 2016 debt issued to finance the acquisition and the fair value of the intangible assets on the acquisition date, respectively.

The following summarizes unaudited pro forma total revenue and net loss (in thousands, except per share amounts):

 
 
 
 
 
Six months ended June 30, 2016
Revenue
 
 
 
 
$
372,689

Net loss
 
 
 
 
$
(9,830
)
 
 
 
 
 
 
Basic net loss per share
 
 
 
 
$
(0.20
)
 
 
 
 
 
 
Diluted net loss per share
 
 
 
 
$
(0.20
)
 
 
 
 
 
 
Basic weighted-average common shares outstanding
 
 
 
 
49,334

Diluted weighted-average common shares outstanding
 
 
 
 
49,334

 
 
 
 
 
 
 
 
 
Three months ended June 30, 2015
 
Six months ended June 30, 2015
Revenue
 
 
$
187,085

 
$
361,350

 
 
 
 
 
 
Net loss
 
 
$
(7,695
)
 
$
(15,942
)
 
 
 
 
 
 
Basic net loss per share
 
 
$
(0.15
)
 
$
(0.31
)
 
 
 
 
 
 
Diluted net loss per share
 
 
$
(0.15
)
 
$
(0.31
)
 
 
 
 
 
 
Basic weighted-average common shares outstanding
 
 
50,362

 
50,616

Diluted weighted-average common shares outstanding
 
 
50,362

 
50,616


Acquisition of TORCHx

On May 31, 2016, the Company completed the acquisition of substantially all of the assets and certain liabilities of Brokerage Leader Inc. ("TORCHx"), a Florida corporation, which primarily consisted of customer relationships and developed technology intangible assets. TORCHx is a real estate platform built for agents and brokerages that features search engine optimization (SEO) and responsive design, customer relationship management (CRM) and other tools to help run successful online marketing campaigns. The Company paid $4.4 million for this business during the second quarter of 2016, of which $3.0 million was paid at closing and the remaining $1.5 million is payable on November 30, 2017.

The Company has accounted for the acquisition of TORCHx using the acquisition method as required in Accounting Standards Codification 805, Business Combinations ("ASC 805"). As such, preliminary 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 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 deductible for tax purposes.

The Company is still reviewing information surrounding intangible assets, certain assets and liabilities and deferred revenue. These items may result in changes to the Company's preliminary purchase price allocation through the second quarter of 2017.

Assets and liabilities acquired at May 31, 2016 are as follows (in thousands):





11







        
 
Tangible current assets
$
21

 
Developed technology-7 year useful life
1,790

 
Customer relationships-4 year useful life
360

 
Goodwill
2,262

 
Deferred revenue
(42
)
 
Purchase price consideration
$
4,391


3. Net (Loss) Income Per Common Share
 
Basic net (loss) income per common share is calculated using net (loss) income and the weighted-average number of shares outstanding during the reporting period. Diluted net (loss) 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 and 2016, the Company issued equity awards with performance, service and market conditions. These awards are 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, 2016, neither of the underlying conditions for the 2016 awards has 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 months ended June 30, 2016 and 2015, 9.2 million and 1.7 million share-based awards, respectively, have been excluded from the calculation of diluted common shares because including those securities would have been anti-dilutive.
During the six months ended June 30, 2016 and 2015, 9.2 million and 2.1 million share-based awards, respectively, have been excluded from the calculation of diluted common shares because including those 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 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 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 the Company's stock exceeds the conversion price, as applicable, 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. 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, 2016 and 2015.

The following table sets forth the computation of basic and diluted net (loss) income per common share (in thousands, except per share amounts):

 
 
 
Three months ended June 30,
 
Six months ended June 30,
 
 
 
2016
 
2015
 
2016
 
2015
Net (loss) income
 
 
$
(1,606
)
 
$
4,550

 
$
(1,268
)
 
$
6,889

 
 
 
 
 
 
 
 
 
 
Basic weighted average common shares outstanding
 
 
49,293

 
50,362

 
49,334

 
50,616


12



Dilutive effect of stock options
 
 

 
1,800

 

 
1,584

Dilutive 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 outstanding
 
 
49,293

 
52,435

 
49,334

 
52,510

 
 
 
 
 
 
 
 
 
 
Net (loss) income per basic common share
 
 
$
(0.03
)
 
$
0.09

 
(0.03
)
 
0.14

 
 
 
 
 
 
 
 
 
 
Net (loss) income per diluted common share
 
 
$
(0.03
)
 
$
0.09

 
$
(0.03
)
 
$
0.13


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 its carrying amount. As of December 31, 2015 , 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, 2016 .

On April 1, 2016, the Company paid $1.3 million for registrar credentials purchased from eNOM, Incorporated, a Nevada corporation and Rightside Group, LTD., a Delaware corporation. The credentials were recorded as other intangible assets and are being amortized over 24 months.

The following table summarizes changes in the Company’s goodwill balances as required by ASC 350-20 for the six months ended June 30, 2016 and the year ended December 31, 2015 , respectively (in thousands):    
 
June 30,
2016
 
December 31,
2015
Goodwill balance at beginning of period
$
741,439

 
$
741,858

Accumulated impaired goodwill at beginning of period
(102,294
)
 
(102,294
)
Goodwill balance at beginning of period, net
639,145

 
639,564

Goodwill acquired during the period- Scoot

 
11

Goodwill acquired during the period- Yodle- Note 2, Business Combinations
213,678

 

Goodwill acquired during the period- TORCHx- Note 2, Business Combinations
2,262

 

Foreign currency translation adjustments (1)
(790
)
 
(430
)
Goodwill balance at end of period, net *
$
854,295

 
$
639,145

   
* Gross goodwill balances were $956.6 million as of June 30, 2016 and $741.4 million as of December 31, 2015 . These include accumulated impairment losses of $102.3 million .

(1) 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, 2016
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net
 
Weighted-average Remaining Amortization Period in Years
Indefinite-lived intangible assets:
 

 
 

 
 
 
 
Domain/Trade names
$
165,052

 
$

 
$
165,052

 
 

13



Definite-lived intangible assets:


 


 


 
 
Customer relationships
356,981

 
(143,467
)
 
213,514

 
6.4
Developed technology
274,255

 
(181,937
)
 
92,318

 
5.1
Other
7,745

 
(5,005
)
 
2,740

 
1.8
   Total *
$
804,033

 
$
(330,409
)
 
$
473,624

 
 
 
 
 
 
 
 
 
* Cumulative foreign currency translation adjustments, reflecting the movement in currencies, decreased total intangible assets by approximately $0.6 million as of June 30, 2016.

 
December 31, 2015
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net
 
Weighted-average Remaining Amortization Period in Years
Indefinite-lived intangible assets:
 

 
 

 
 
 
 
Domain/Trade names
$
132,228

 
$

 
$
132,228

 
 
Definite-lived intangible assets:


 


 


 
 
Customer relationships
289,710

 
(128,212
)
 
161,498

 
7.6
Developed technology
193,020

 
(169,819
)
 
23,201

 
2.1
Other
6,027

 
(4,847
)
 
1,180

 
2.4
   Total *
$
620,985

 
$
(302,878
)
 
$
318,107

 
 
 
 
 
 
 
 
 
* Cumulative foreign currency translation adjustments, reflecting the movement in currencies, decreased total intangible assets by approximately $0.4 million as of December 31, 2015.

The weighted-average amortization period for the amortizable intangible assets remaining as of June 30, 2016 is approximately 6.0 years. Total amortization expense was $16.8 million and $9.8 million for the three months ended June 30, 2016 and 2015, respectively. Amortization expense was $28.1 million and $19.6 million for the six months ended June 30, 2016 and 2015, respectively.
 
As of June 30, 2016 , the amortization expense for the remainder of the year ended December 31, 2016, and the next five years and thereafter is as follows (in thousands):

2016 (remainder of year)
$
31,645

2017
55,742

2018
52,302

2019
48,672

2020
46,443

2021
35,392

Thereafter
38,376

Total
$
308,572


5. Related Party Transactions
Effective February 6, 2015, the Company elected Mr. John A. Giuliani to serve on its Board of Directors. Mr. Giuliani served as President, Chief Executive Officer and Director of Conversant, a subsidiary of Alliance Data Systems Corporation, a personalized digital marketing platform. The Company incurred $0.2 million and $0.3 million of expense related to services provided by Conversant during the three months ended June 30, 2016 and 2015, respectively. During the six months ended June 30, 2016 and 2015, respectively, the Company incurred $0.4 million and $0.5 million of expense related to services provided by Conversant.
6. Long-term Debt

14



 
1% Senior Convertible Notes due August 15, 2018

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 its 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 the Company's 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 the Company's 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, 2016 and December 31, 2015 , the carrying value of the debt and equity component was $233.5 million and $47.8 million and $228.0 million and $47.8 million , respectively. The unamortized debt discount of $25.2 million as of June 30, 2016 will be amortized over the remaining life of 2.1 years using the effective interest method.

Credit Agreement

On February 11, 2016, the Company entered into an amendment (the "Amendment") to that certain Credit Agreement, dated as of September 9, 2014 (the "Existing Credit Agreement" and as amended by the Amendment, the "Amended Credit Agreement"), by and among the Company, the several lenders from time to time parties thereto, and JPMorgan Chase Bank, N.A., as administrative agent. On March 9, 2016 (the "Closing Date"), the amended Credit Agreement became effective following the completion of the acquisition of Yodle Inc. (the "Acquisition").

15




The Amended Credit Agreement provides for (i) $390.0 million of five -year secured term loans, replacing and refinancing $190.0 million of secured term loans outstanding under the Existing Credit Agreement and providing for an additional $200.0 million of secured term loans (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"), which replaces the revolving credit facility under the Existing Credit Agreement. On the Closing Date, the Company used the proceeds of the Term Loan and borrowed $115.0 million of loans under the Revolving Credit Facility, together with cash on hand, to complete the Acquisition.

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 3.00% per annum, or the prime lending rate plus an applicable margin equal to 2.00% 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 0.45% 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 accounted for as a modification of the Existing Credit Agreement. As a result, the $5.7 million of additional loan origination discounts and bank arranger fees were capitalized during the first quarter ended March 31, 2016 in connection with the refinancing. Third party fees related to the Amendment were expensed as incurred.
The Company has $55.7 million of available borrowings under the Revolving Credit Facility as of June 30, 2016.
Outstanding long-term debt and the interest rates in effect at June 30, 2016 and December 31, 2015 consist of the following (in thousands):
 
June 30,
2016
 
December 31,
2015
Revolving Credit Facility maturing 2021, 3.44%, based on LIBOR plus 3.00%, less unamortized discount of $2,482 at June 30, 2016, effective rate of 3.92%
$
89,955

 
$
3,437

Term Loan due 2021, 3.44%, based on LIBOR plus 3.00%, less unamortized discount of $5,463 at June 30, 2016, effective rate of 3.81%
382,100

 
191,109

Senior Convertible Notes, maturing 2018, 1.00%, less unamortized discount of $25,219 at June 30, 2016, effective rate of 5.88%
233,531

 
228,032

Total Outstanding Debt
705,586

 
422,578

Less: Current Portion of Long-Term Debt
(12,016
)
 
(11,169
)
Long-Term Portion
$
693,570

 
$
411,409

 
Debt discount and issuance costs
 
The Company recorded $3.7 million and $2.8 million of expense from amortizing debt issuance and discount costs during each of the three months ended June 30, 2016 and 2015 , respectively. During the six months ended June 30, 2016 and 2015, $6.7 million and $5.6 million of amortization expense was recorded, respectively.
 
Total estimated principal payments due for the next five years as of June 30, 2016 are as follows:   
Year 1
$
12,187

Year 2
21,937

Year 3
290,438


16



Year 4
39,000

Year 5
375,188

Total principal payments
$
738,750

On August 15, 2018, the aggregate principal balance of the Senior Convertible Notes (the 2018 Notes) becomes due. The remaining principal requirements reflect quarterly payments under the Term Loan with the remaining balance payable in March 2021. The Revolving Credit Facility matures in March 2021.

7. Accumulated Other Comprehensive Loss

The components of accumulated other comprehensive loss were as follows (in thousands):
 
June 30, 2016
 
December 31, 2015
Foreign currency translation adjustments
$
(3,326
)
 
$
(2,119
)
Unrealized loss on investments
(1
)
 
(29
)
    Total accumulated other comprehensive loss
$
(3,327
)
 
$
(2,148
)
 
 
 
 

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, deferred consideration and accrued expenses approximates fair market value as of June 30, 2016 and December 31, 2015 due to the short maturity of these items. As of June 30, 2016 , the fair value and carrying value of the Company’s 2018 Notes totaled $238.1 million and $233.5 million , respectively. As of December 31, 2015 , the fair value and carrying value of the Company's 2018 Notes was $ 243.2 million and $228.0 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 that were amended on February 11, 2016, 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, 2016 and December 31, 2015. See Note 6, Long-term Debt , for additional information surrounding the amendment.

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.

The Company recorded income tax expense of $0.5 million and $5.2 million during the three months ended June 30, 2016 and 2015 , and $1.5 million and $8.8 million during the six months ended June 30, 2016 and 2015 respectively, based upon the estimated annual effective tax rates for each year. The estimated annual effective tax rate for 2016 reflects the impact of net

17



unfavorable permanent book-tax differences estimated for the year and an increase in the projected year-end valuation allowance related to certain state and foreign deferred tax assets. The estimated annual effective tax rate for 2015 reflected the estimated increase in the Company's projected year-end valuation allowance related to the projected increase in non-reversing deferred tax liabilities, and reduced by forecasted pre-tax income for the year.


10. Stock-Based Compensation and Stockholders' Equity
 
The Company records compensation expense for employee and director stock-based compensation plans based upon the fair value of the award in accordance with ASC 718, Compensation-Stock Compensation .
Equity Incentive Plans
The Company has the 2014 Equity Incentive Plan for the issuance of stock-based compensation, including but not limited to, common stock options and restricted shares to employees. In addition, the Company’s plan provides for grants of non-statutory stock options and restricted shares awards (“RSA’s”) to non-employee directors. The Company issues shares out of treasury stock, if available, otherwise new shares of common stock are issued upon the exercise of stock options and the granting of restricted shares.
Incentive stock options and non-statutory stock options issued generally vest ratably over three to four years, are contingent upon continued service and expire ten years from the grant date. Restricted share awards generally vest 25 percent each year over a four year period.
The Board of Directors or a committee thereof, administers all of the equity incentive plans and establishes the terms of options granted, including the exercise price, the number of shares subject to individual option awards and the vesting period of options, within the limits set forth in the plans. Options have a maximum term of 10 years and vest as determined by the Board of Directors.
The Company has additional equity incentive plans that are established in conjunction with its acquisitions. These plans are considered one-time, inducement awards of incentive stock options, non-statutory stock options and restricted shares. Once the inducement awards are granted, no additional shares, including forfeitures and cancellations, are available for future grant under these plans.
Yodle Equity Grants
In connection with the March 2016 Yodle acquisition, the Company granted 0.3 million restricted shares that vest annually over a four year period and 0.3 million stock options of which 25 percent vest one year from the date of grant and the remaining 75 percent vest monthly over a three year period for a total of four years.
In addition, the Company converted unvested and out of the money existing Yodle stock options to 1.3 million stock options of the Company in connection with the March 9, 2016 acquisition of Yodle. The total value of the converted stock options is approximately $8.3 million . Approximately $2.3 million has been recorded as additional consideration representing the vesting that occurred prior to the closing of the acquisition. The remaining $6.0 million will be amortized to stock compensation expense over the remaining service period of approximately 3 years.
Performance Shares
During the first quarter of 2015 and 2016, the Compensation Committee of the Board of Directors approved performance share equity awards. The targeted number of shares under a 100 percent payout scenario for each of the 2015 and 2016 awards are 0.2 million common shares over the three year vesting periods, 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. The range is based upon (1) the number of shares earned based upon the over achievement or under achievement of the financial measures for the annual performance period and (2) the number of shares earned being adjusted higher or lower depending on the performance of the Company's total shareholder return, compared against the Company's peer group.
Compensation expense related to the performance share stock plan for the three and six months ended June 30, 2016 was approximately $0.4 million and $0.5 million , respectively. This represented the remaining expense for the first tranche of the 2015 award as well as the estimated expense for the 2016 performance period. The Company recorded $0.3 million of compensation expense for the performance shares during the three and six months ended June 30, 2015. The 2015 tranche of the performance share award resulted in a payout of 159% of the target shares, or approximately 92 thousand shares. During the six months ended June 30, 2016, approximately 37 thousand shares totaling $0.7 million , were withheld by the Company for minimum income tax withholding requirements.
Stock Options


18



Compensation costs related to the Company’s stock option plans were $ 2.5 million and $ 2.7 million for the three months ended June 30, 2016 and 2015 , respectively. Compensation costs for the six months ended June 30, 2016 and 2015, $4.7 million and $5.6 million , respectively. During each of the three months ended June 30, 2016 and 2015 , 0.1 million and 0.2 million common shares were issued for options exercised, respectively. During each of the six months ended June 30, 2016 and 2015, 0.1 million and 0.4 million common shares were issued for options exercised, respectively.
 
Restricted Stock
 
Compensation expense related to restricted stock plans for the three months ended June 30, 2016 and 2015 , was approximately $2.5 million and $2.2 million , respectively. Compensation expense for the six months ended June 30, 2016 and 2015 was $5.0 million and $4.2 million , respectively. During each of the six months ended June 30, 2016 and 2015 , approximately 0.1 million shares totaling approximately $2.5 million and $2.3 million , respectively, were withheld by the Company for minimum income tax withholding requirements. During the three months ended June 30, 2016 and 2015, 0.1 million and 57 thousand restricted common shares were granted, respectively. During the six months ended June 30, 2016 and 2015 0.6 million and 0.5 million restricted common shares were granted, respectively. This excludes the Yodle restricted stock awards that were discussed above.

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 remaining available for repurchase under this program was $21.7 million at June 30, 2016 . 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 months ended June 30, 2016 and 2015, the Company repurchased approximately 0.3 million and 0.7 million common shares, respectively. The total amount repurchased during the three months ended June 30, 2016 and 2015, was $5.7 million and $14.2 million , respectively. During the six months ended June 30, 2016 and 2015, 1.0 million and 1.6 million common shares were repurchased for $16.9 million and $30.0 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 $ 8.2 million in standby letters of credit as of June 30, 2016 , $ 1.9 million of which were issued under the Revolving Credit Facility. The letters of credit increased approximately $5.9 million during the six months ended June 30, 2016, primarily to fulfill requirements under Yodle operating leases.

Legal Proceedings

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 investigations, inquires or 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 proceedings for which a loss was reasonably possible or estimable at June 30, 2016.
 
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

19



cause our actual results, performance, time frames or achievements to be materially different from any future results, performance, time frames or achievements expressed or implied by the forward-looking statements. We discuss many of these risks, uncertainties and other factors in this Quarterly Report on Form 10-Q in greater detail under the heading “Risk Factors.” Given these risks, uncertainties and other factors, you should not place undue reliance on these forward-looking statements. Also, these forward-looking statements represent our estimates and assumptions only as of the date of this filing. You should read this Quarterly Report on Form 10-Q completely and with the understanding that our actual future results may be materially different from what we expect. We hereby qualify our forward-looking statements by these cautionary statements. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.
 
Safe Harbor
 
In the following discussion and analysis of results of operations and financial condition, certain financial measures may be considered “non-GAAP financial measures” under Securities and Exchange Commission rules. These rules require supplemental explanation and reconciliation, which is provided in this Quarterly Report on Form 10-Q.

We believe presenting non-GAAP net income attributable to common stockholders, non-GAAP net income per share attributable to common stockholders and non-GAAP operating income 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.

In March 2016, the Company completed the acquisition of 100% of the outstanding shares of Yodle, Inc., a Delaware corporation, ("Yodle"), for approximately $341.9 million , which includes $42.0 million of deferred consideration. Yodle is a leading provider of cloud based local marketing solutions for small businesses with approximately 1,400 employees and 53,000 subscribers. Management's Discussion and Analysis includes the results of operations and cash flows of Yodle from March 9, 2016 through June 30, 2016. See Note 2, Business Combinations , for additional information surrounding the acquisition.   
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 effectively implementing 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.

20




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 (less acquired customers, if applicable) 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 non-GAAP 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 the measurement period in 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 adjustments were $ 6.0 million and $ 4.3 million for the three months ended June 30, 2016 and 2015 , respectively. The fair market value adjustments were $14.6 million and $9.3 million for the six months ended June 30, 2016 and 2015, 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. 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, eCommerce store design, online marketing costs, billing costs, hosting expenses, 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 staff.
 
Operating Expenses

Sales and marketing, technology and development and general and administrative expenses are expected to increase during the remainder of 2016 as we continue to integrate the operations of Yodle.

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 and radio advertising and online partnerships. Sales and marketing costs consist primarily of compensation and related expenses for our sales and marketing staff as well as customer support 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

21



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, enhancement of our products and management information systems personnel, as well as costs associated with the data centers and systems infrastructure supporting those products.

General and Administrative Expense

General and administrative expenses consist of compensation and related expenses for executive, finance and administration, as well as professional fees, corporate development costs, other corporate expenses, and allocated overhead costs.
 
Depreciation and Amortization Expense
 
Depreciation and amortization expenses relate primarily to our intangible assets recorded due to the acquisitions we have completed, as well as 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 as well as from the fixed assets acquired in connection with the Yodle acquisition. Amortization expense is expected to continue to increase during the remainder of 2016 from the amortization of intangible assets acquired from the Yodle acquisition.

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 2015 Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 26, 2016.

Results of Operations
 
Comparison of the results for the three months ended June 30, 2016 to the results for the three months ended June 30, 2015
 
The operations of Yodle began integrating with the existing legacy Web.com operations immediately following the closing of the acquisition on March 9, 2016. As such, revenue, ARPU or gross margin is not specifically segregated subsequent to the acquisition, nor would it be indicative of each of the standalone entities.

The following table sets forth our key business metrics:  
 
Three months ended June 30,
 
2016 (1)
 
2015
 
(unaudited)
Ending Subscribers as of June 30,
3,443,000

 
3,316,000

Net subscriber additions
20,000

 
21,000

Average revenue per user (monthly)
$
18.66

 
$
13.91

(1) The metrics for the quarter ended June 30, 2016 include the operating results of Yodle, Inc.

Net organic subscribers increased by approximately 20,000 subscribers during the three months ended June 30, 2016 , as compared to an increase of approximately 21,000 subscribers during the three months ended June 30, 2015 . The increase in subscribers is primarily due to marketing and customer service efforts in prior periods, as well as during the quarter ended

22



June 30, 2016 . Our rolling twelve month retention rate (1) as of June 30, 2016 was 86.5% compared to 87.7% during the same prior year period.

Revenue
 
Three months ended June 30,
 
2016
 
2015
 
(unaudited, in thousands)
Revenue:
 

 
 

Subscription
$
186,121

 
$
133,685

Professional services and other
1,697

 
2,034

Total revenue
$
187,818

 
$
135,719

 
Total revenue increased to $ 187.8 million in the three months ended June 30, 2016 up from $ 135.7 million in the three months ended June 30, 2015 . Total revenue includes $6.0 million and $4.3 million of unfavorable impact resulting from amortizing into revenue, deferred revenue that was recorded at fair value at the acquisition date during the three months ended June 30, 2016 and 2015, respectively. The unfavorable impact increased $1.8 million during the three months ended June 30, 2016 , compared to the same prior period, due to the deferred revenue of Yodle that was also recorded at fair value at the acquisition date and amortized into revenue during the quarter. The remaining $53.9 million increase in revenue during the three months ended June 30, 2016 , is driven principally by the acquisition of Yodle, in addition to increased Do-It-For-Me website revenue as well as online marketing revenue. These increases were partially offset by a decline in hosting revenue and domain and domain-related product revenues.

Subscription Revenue . Subscription revenue increased during the three months ended June 30, 2016 , to $186.1 million up from $133.7 million during the three months ended June 30, 2015 . The increase is primarily due to the acquisition of Yodle in March of 2016 in addition to the other revenue drivers discussed above.
 
Professional Services and Other Revenue. Professional services revenue was 17% lower at $1.7 million in the three months ended June 30, 2016 down from $2.0 million for the three months ended June 30, 2015 . The decrease was principally driven by a lower volume of custom design professional services.

Cost of Revenue
 
Three months ended June 30,
 
2016
 
2015
 
(unaudited, in thousands)
Cost of revenue
$
59,743

 
$
47,102

 
Cost of Revenue. Cost of revenue increased 27% or $12.6 million during the three months ended June 30, 2016 , compared to the three months ended June 30, 2015 . A majority of the increase was due to the costs associated with the additional revenue due to the Yodle acquisition that closed in March 2016 and to a $1.1 million increase in online marketing expenses. These increases were partially offset by approximately $1.0 million of lower domain-related costs, due to lower overall volume of domains under management as certain promotional domain products became fully amortized.

Our gross margin was 68% during the three months ended June 30, 2016 up from 65% during the same prior year period due to the inclusion of higher margin Yodle products. Excluding the $ 6.0 million and $ 4.3 million effect of the adjustment related to the fair value of acquired deferred revenue for the three months ended June 30, 2016 and 2015 , respectively, gross margin was 69% and 66% for the three months ended June 30, 2016 and 2015, respectively.
 
Operating Expenses
 
 
Three months ended June 30,
 
2016
 
2015

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(unaudited, in thousands)
Operating Expenses:
 

 
 

Sales and marketing
$
58,448

 
$
35,680

Technology and development
15,533

 
5,858

General and administrative
23,465

 
18,273

Restructuring expense
778

 
22

Depreciation and amortization
22,273

 
13,849

Total operating expenses
$
120,497

 
$
73,682

 
Sales and Marketing Expenses. Sales and marketing expenses increased 64% to $58.4 million and were 31% of total revenue during the three months ended June 30, 2016 , up from $35.7 million , which was approximately 26% of revenue during the three months ended June 30, 2015 . Sales and marketing expenses increased approximately $22.8 million primarily due to the acquisition of Yodle in March 2016. In addition, marketing-related compensation expense increased $3.0 million during the three months ended June 30, 2016 when compared to the same prior year period. The increase was partially offset by $1.1 million of overall lower general marketing expenses, primarily from direct response television advertising.
 
Technology and Development Expenses. Technology and development expenses of $ 15.5 million , or 8% of total revenue, increased by $9.7 million during the three months ended June 30, 2016 , from $5.9 million , or 4% of total revenue during the three months ended June 30, 2015 . The increase was primarily from the technology expenses related from the acquisition of Yodle in March 2016 and a $2.1 million increase in compensation and benefits expense.

General and Administrative Expenses. General and administrative expenses increased $5.2 million to $23.5 million , or 12% of total revenue, during the three months ended June 30, 2016 , as compared to $18.3 million , or 13% of total revenue during the three months ended June 30, 2015 . The increase was due to the $7.7 million of additional general and administrative expenses related to the Yodle acquisition in March 2016, as well as, one-time expenses related to the close of the acquisition for investment banking and due diligence services. These expenses were offset primarily by $3.7 million of lower incentive compensation expenses when compared to the same prior year period.

Depreciation and Amortization Expense. Depreciation and amortization expense increased $8.4 million to $22.3 million during the three months ended June 30, 2016 , compared to the three months ended June 30, 2015 . Amortization expense increased by $7.0 million primarily from the intangible assets acquired as part of the Yodle acquisition. In addition, depreciation expense increased by $1.4 million during the three months ended June 30, 2016 , $0.9 million of which, is from depreciating assets acquired from the Yodle acquisition. The remaining $0.5 million increase is from a higher volume of internally developed software projects that were placed into service.
 
Interest Expense, net. Net interest expense totaled $8.7 million and $5.2 million for the three months ended June 30, 2016 and 2015 , respectively. Included in the interest expense for each of the three months ended June 30, 2016 and 2015 , is $3.7 million and $2.8 million of deferred financing fee and loan origination discount amortization, respectively. Loan interest expense, excluding amortization, increased $2.6 million during the second quarter ended June 30, 2016 , compared to the second quarter of 2015 , primarily due to the higher debt levels from the additional debt incurred and slightly higher interest rates in effect from financing the Yodle acquisition.

Income Tax Expense. We recorded income tax expense of $0.5 million and $5.2 million during the three months ended June 30, 2016 and 2015 , respectively, based upon our estimated annual effective tax rates for each year. Our estimated annual effective tax rate for 2016 reflects the impact of net unfavorable permanent book-tax differences estimated for the year and an increase in the projected year-end valuation allowance related to certain state and foreign deferred tax assets. The estimated annual effective tax rate for 2015 reflected the estimated increase in the Company’s projected year-end valuation allowance related to the projected increase in non-reversing deferred tax liabilities, and reduced by forecasted pre-tax income for the year.
 
Results of Operations
 
Comparison of the results for the six months June 30, 2016 and for the six months ended June 30, 2015
 
The following table sets forth our key business metrics: 


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Six months ended June 30,
 
2016 (1)
 
 
2015
 
 
(unaudited)
Ending subscribers June 30,
3,443,000
 
 
 
3,316,000
 
 
Net subscriber additions
90,000
 
 
 
40,000
 
 
Average revenue per user (monthly)
$
16.88

 
 
$
13.83

 
  (1) The metrics for the six months ended June 30, 2016 include the operating results and 53,000 customers of Yodle, Inc.

As part of the acquisition of Yodle, we acquired approximately 53,000 subscribers in March 2016. In addition, net organic subscribers increased by approximately 37,000 subscribers during the six months ended June 30, 2016, as compared to an increase of approximately 40,000 subscribers during the six months ended June 30, 2015. The increase in subscribers is primarily due to marketing and customer service efforts in prior periods, as well as during the quarter ended June 30, 2016 . Our rolling twelve month retention rate as of June 30, 2016 was 86.5% compared to 87.7% 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,
 
2016
 
 
2015
 
 
(unaudited, in thousands)
Revenue:
 
 
 
 
 
 
 
Subscription
$
329,312

 
 
$
264,145

 
Professional services and other
3,304
 
 
 
4,174
 
 
Total revenue
$
332,616

 
 
$
268,319

 
 
Total revenue increased 24% to $332.6 million in the six months ended June 30, 2016 , from $268.3 million in the six months ended June 30, 2015 . The acquisition of Yodle in March 2016 contributed to the majority of the increase in revenue during the six months ended June 30, 2016. Total revenue during the six months ended June 30, 2016 and 2015 , includes the unfavorable impact of $14.6 million and $9.3 million , respectively, from amortizing into revenue, deferred revenue that was recorded at fair value at the acquisition date. The unfavorable impact increased $5.3 million during the six months ended June 30, 2016 primarily from deferred revenue acquired from the March 2016 acquisition of Yodle. Additionally, revenues decreased slightly during the six months ended June 30, 2016 compared to the same prior year period and was principally driven by decreased Do-It-Yourself website revenue, and hosting and advertising revenues, partly offset by improvements in Do-It-For-Me website revenue, as well as higher ecommerce and online marketing revenue.
 
Subscription Revenue . Subscription revenue increased 25% during the six months ended June 30, 2016 to $329.3 million from $264.1 million during the six months ended June 30, 2015 . The increase is due to the overall revenue drivers discussed above.
 
Professional Services and Other Revenue. Professional services revenue of $3.3 million decreased $0.9 million from $4.2 million during the six months ended June 30, 2016 due to a lower volume of custom design professional services.

Cost of Revenue 

 
Six months ended June 30,
 
2016
 
 
2015
 
 
(unaudited, in thousands)
Cost of revenue
$
110,826

 
 
$
95,804

 
 
Cost of Revenue. Cost of revenue increased 16% or $15.0 million during the six months ended June 30, 2016 compared to the six months ended June 30, 2015 . The acquisition of Yodle was the primary driver for the higher cost of revenue during the six months ended June 30, 2016, partly offset by $2.5 million of lower domain-related costs.
 
Our gross margin of 67% during the six months ended June 30, 2016 increased from 64% during the six months ended June 30, 2015 primarily from the higher margin Yodle product offerings in addition to a decline in domain-related expenses. Excluding

25



the $14.6 million and $9.3 million effect of the adjustment related to the fair value of acquired deferred revenue for the six months ended June 30, 2016 and 2015 , respectively, gross margin increased from 65% to 68% during the six months ended June 30, 2016 compared to the same prior year period.
 
Operating Expenses 
 
Six months ended June 30,
 
2016
 
 
2015
 
 
(unaudited, in thousands)
Operating Expenses:
 
 
 
 
 
 
 
Sales and marketing
$
100,459

 
 
$
71,359

 
Technology and development
 
24,611

 
 
 
11,660

 
General and administrative
 
43,129

 
 
 
35,484

 
Restructuring expense
 
914

 
 
 
335

 
Depreciation and amortization
 
38,186

 
 
 
27,593

 
Total operating expenses
$
207,299

 
 
$
146,431

 
 
Sales and Marketing Expenses. Sales and marketing expenses increased 41% from $71.4 million or 27% of revenue during the six months ended June 30, 2015 to $100.5 million or 30% of revenue during the six months ended June 30, 2016 . The $29.1 million increase was driven principally from the additional expenses from the Yodle acquisition. Excluding the impact of the acquisition, compensation and benefits increased $4.4 million during the six months ended June 30, 2016, partly offset by a decrease in affiliate-related marketing expenses, when compared to the same prior year period.
 
Technology and Development Expenses. Technology and development expenses increased 111% to $24.6 million , or 7% of total revenue, during the six months ended June 30, 2016 up from $11.7 million , or 4% of total revenue during the six months ended June 30, 2015. The increase was driven by the acquisition of Yodle in addition to $3.6 million of higher compensation and benefits expense partially from less labor dollars being capitalized in connection with internally developed software projects during the six months ended June 30, 2016 when compared to the same prior year period.
 
General and Administrative Expenses. General and administrative expenses increased 22% to $43.1 million , or 13% of total revenue, during the six months ended June 30, 2016 , up from $35.5 million or 13% of total revenue during the six months ended June 30, 2015 . The acquisition of Yodle resulted in an additional $8.8 million of increased general and administrative expenses during the six months ended June 30, 2016. In addition, acquisition-related closing costs contributed to the higher general and administrative costs, while salary and incentive-based compensation expenses declined $4.6 million during the six months ended June 30, 2016.
 
Depreciation and Amortization Expense. Depreciation and amortization expense increased to $38.2 million during the six months ended June 30, 2016 from $27.6 million during the six months ended June 30, 2015 . Amortization expense is $8.5 million higher during the six months ended June 30, 2016 primarily from amortizing the intangible assets that were acquired from the March 2016 Yodle acquisition. Depreciation expense was also up $2.1 million during the six months ended June 30, 2016 when compared to the same prior year period, also from the assets acquired from Yodle in addition to higher internally developed software projects that continue to be placed in service.
 
Interest Expense, net. Net interest expense totaled $14.3 million and $10.4 million for the six months ended June 30, 2016 and 2015, respectively. Included in interest expense during the six months ended June 30, 2016 and 2015 was $6.7 million and $5.6 million of amortization of debt issuance costs, respectively. Excluding amortization, interest expense increased from $7.6 million and $4.8 million during the six months ended June 30, 2016 and 2015, respectively. The increase was driven from the higher debt levels and slightly higher interest rates resulting from the financing of the Yodle acquisition.

Income Tax Expense. We recorded an income tax expense of $1.5 million and $8.8 million during the six months ended June 30, 2016 and 2015, respectively, based upon our estimated annual effective tax rates for each year. Our estimated annual effective tax rate for 2016 reflects the impact of net unfavorable permanent book-tax differences estimated for the year and an increase in the projected year-end valuation allowance related to certain state and foreign deferred tax assets. The estimated annual effective tax rate for 2015 reflected the estimated increase in the Company’s projected year-end valuation allowance related to the projected increase in non-reversing deferred tax liabilities, and reduced by forecasted pre-tax income for the year.


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Outlook. For 2016, we expect a meaningful increase in our revenue due to the acquisition of Yodle, which closed in the first quarter of 2016. We also anticipate revenue growth from our continued focus on our value added digital marketing solutions partially offset by declines in our Do-It-Yourself and domain name product lines. We expect to generate strong free cash flow which will be used to pay down debt and repurchase common shares.

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,
 
2016
 
2015
 
(unaudited, in thousands)
Net cash provided by operating activities
$
45,288

 
$
77,411

Net cash used in investing activities
(312,868
)
 
(8,386
)
Net cash provided by (used in) financing activities
257,857

 
(75,606
)
Effect of exchange rate changes on cash
(33
)
 
2

Decrease in cash and cash equivalents
$
(9,756
)
 
$
(6,579
)
 
Cash Flows

As of June 30, 2016 , we had $ 8.9 million of cash and cash equivalents and $ 214.3 million in negative working capital, as compared to $ 18.7 million of cash and cash equivalents and $ 167.7 million in negative working capital as of December 31, 2015 . The unfavorable change in working capital is primarily due to increases in deferred revenue, deferred consideration and accrued expenses, primarily resulting from the March 2016 acquisition of Yodle. Accounts payable, prepaid expenses and accounts receivable are also higher when compared to December 31, 2015 primarily from the assets and liabilities of Yodle that were acquired in the three months ended March 31, 2016. In addition, there's approximately $19.1 million of deferred consideration in current liabilities, also resulting from the Yodle acquisition, which is payable to the sellers on March 9, 2017. The majority of the negative working capital continues to be due to significant balances of deferred revenue, partially offset by deferred expenses, which get amortized to revenue or expense rather than settled with cash. We expect cash generated from operating activities to be more than sufficient to meet our future working capital and debt servicing requirements.

Net cash provided by operations for the six months ended June 30, 2016 decreased $32.1 million to $45.3 million down from the six months ended June 30, 2015 . Included in the cash provided by operating activities is $3.9 million of acquisition-related transaction costs that were paid during the six months ended June 30, 2016 . The working capital changes also reflect the requirement to fund $5.9 million of letters of credit that are restricted by operating leases of Yodle. In addition, the annual performance bonuses paid in the six months ended June 30, 2016 were higher than for the same prior year period. Finally, accounts payable and accrued expense payments were also unfavorable during the six months ended June 30, 2016 due primarily to the Yodle acquisition.

Net cash used in investing activities during the six months ended June 30, 2016 was $ 312.9 million , as compared to $8.4 million in the six months ended June 30, 2015 . The quarter ended March 31, 2016 included a $300.3 million payment for the acquisition of 100% of the outstanding shares of Yodle, Inc., a leader in value added digital marketing solutions that further solidifies our position as a leading national provider in this space. In addition, on May 31, 2016, we purchased the assets of TORCHx, Inc. a a Florida corporation for $4.5 million, of which $3.0 million was paid at closing with the remaining $1.5 million payable on November 30, 2017. See Note 2, Business Combinations , for additional information surrounding these acquisitions. Also included in cash used in investing activities for the six months ended June 30, 2016 is a $1.3 million payment for domain registrar credentials that were acquired during the period.

Net cash provided by financing activities during the six months ended June 30, 2016, reflects the increase in long term debt from our amended credit agreement to fund the acquisition of Yodle Inc., on March 9, 2016. During the six months ended June 30, 2016, common stock repurchases of 1.0 million common shares totaling $16.9 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

27



$3.0 million to $ 1.2 million in the six months ended June 30, 2016 when compared to the same prior year period. Approximately $ 3.2 million and $2.3 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, 2016 and 2015 , respectively. The six months ended June 30, 2016 included $5.7 million of loan origination and arrangement fees in connection with the March 2016 amendment to the credit agreement. See Note 6, Long term Debt , for additional information surrounding the amendment.

Debt Covenants

The amendment to the credit agreement entered into on February 11, 2016 with an effective date of March 9, 2016, continue to 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 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, acquisition-related costs and includes the benefit of annualized synergies due to the Yodle acquisition.

Outstanding debt as of June 30, 2016 for purposes of the First Lien Net Leverage Ratio was approximately $470.8 million . The covenant calculations as of June 30, 2016 on a trailing 12-month basis are as follows:

Covenant Description
 
Covenant Requirement as of 
June 30, 2016
 
Ratio at June 30, 2016
 
Favorable/
(Unfavorable)
Consolidated Net Debt to EBITDA
 
Not greater than 3.25
 
2.54

 
0.71

Consolidated Interest Coverage Ratio
 
Greater than 2.00
 
11.27

 
9.27

 
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. See Item 2, Issuer Repurchases of Equity Securities , for additional information.

New Accounting Standards

See Note 1. The Company and Summary of Significant Accounting Policies , for a discussion of recently issued accounting pronouncements that may affect our financial results and disclosures in future periods.


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.


28



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, because management believes that adjusting for such measures helps management and investors better understand the Company's operating activities.
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 basic and diluted share amortization of intangibles, income tax provision, fair value 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 and adjusted EBITDA margin depreciation and amortization expense, 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, because management believes that adjusting for such measures helps management and investors better understand the Company's operating activities.
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 Quarterly Report on Form 10-Q:
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.

29



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 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 acquisitions and the 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.
Monthly average revenue per user, or ARPU . ARPU is a metric we measure on a quarterly basis. We define ARPU as quarterly non-GAAP 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 following table presents our non-GAAP measures for the periods indicated (in thousands, except for per share data and percentages):
 
 
 
 
 

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

 
2016
 
2015
 
2016
 
2015
Reconciliation of GAAP revenue to non-GAAP revenue
 

 

 

 

GAAP revenue
 
$
187,818


$
135,719


$
332,616


$
268,319

   Fair value adjustment to deferred revenue
 
6,038


4,252


14,596


9,345

Non-GAAP revenue
 
$
193,856


$
139,971


$
347,212


$
277,664

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

 

 

 

GAAP net (loss) income
 
$
(1,606
)
 
$
4,550

 
$
(1,268
)
 
$
6,889

   Amortization of intangibles
 
16,844

 
9,822

 
28,148

 
19,638

   Stock based compensation
 
5,392

 
5,137

 
10,200

 
10,184

   Income tax expense
 
522

 
5,203

 
1,500

 
8,764

   Restructuring expense
 
778

 
22

 
914

 
335


30



   Corporate development
 
529

 

 
3,868

 
597

   Amortization of debt discounts and fees
 
3,687

 
2,822

 
6,685

 
5,620

   Cash income tax expense
 
(730
)
 
(520
)
 
(1,055
)
 
(787
)
   Fair value adjustment to deferred revenue
 
6,038

 
4,252

 
14,596

 
9,345

   Fair value adjustment to deferred expense
 
94

 
167

 
152

 
358

Non-GAAP net income
 
$
31,548

 
$
31,455

 
$
63,740

 
$
60,943

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

 

 

 

GAAP net (loss) income per basic share
 
$
(0.03
)
 
$
0.09

 
$
(0.03
)
 
$
0.14

   Amortization of intangibles
 
0.34

 
0.20

 
0.56

 
0.39

   Stock based compensation
 
0.11

 
0.10

 
0.21

 
0.20

   Income tax expense
 
0.01

 
0.10

 
0.03

 
0.17

   Restructuring expense
 
0.02

 

 
0.02

 
0.01

   Corporate development
 
0.01

 

 
0.08

 
0.01

   Amortization of debt discounts and fees
 
0.07

 
0.06

 
0.14

 
0.11

   Cash income tax expense
 
(0.01
)
 
(0.01
)
 
(0.02
)
 
(0.02
)
   Fair value adjustment to deferred revenue
 
0.12

 
0.08

 
0.30

 
0.18

   Fair value adjustment to deferred expense
 

 

 

 
0.01

Non-GAAP net income per basic share
 
$
0.64

 
$
0.62

 
$
1.29

 
$
1.20

 
 
 
 
 
 
 
 
 
Non-GAAP diluted weighted average shares
 
 
 
 
 
 
 
 
Diluted shares:
 
 
 
 
 
 
 
 
   Basic weighted average common shares
 
49,293

 
50,362

 
49,334

 
50,616

   Diluted stock options
 
1,383

 
1,800

 
1,384

 
1,584

   Diluted restricted stock
 
210

 
273

 
318

 
310

Total non-GAAP diluted weighted average common shares
 
50,886

 
52,435

 
51,036

 
52,510

 
 
 
 
 
Reconciliation of GAAP net income (loss) per diluted share to Non-GAAP net income per diluted share
 
 
 
 
 
 
 
 
GAAP net (loss) income per diluted share
 
$
(0.03
)
 
$
0.09

 
$
(0.03
)
 
$
0.13

   Diluted equity
 

 

 
0.01

 

   Amortization of intangibles
 
0.32

 
0.19

 
0.54

 
0.37

   Stock based compensation
 
0.11

 
0.10

 
0.20

 
0.18

   Income tax expense
 
0.01

 
0.10

 
0.03

 
0.17

   Restructuring expense
 
0.02

 

 
0.02

 
0.01

   Corporate development
 
0.01

 

 
0.08

 
0.01

   Amortization of debt discounts and fees
 
0.07

 
0.05

 
0.13

 
0.11

   Cash income tax expense
 
(0.01
)
 
(0.01
)
 
(0.02
)
 
(0.01
)
   Fair value adjustment to deferred revenue
 
0.12

 
0.08

 
0.29

 
0.18

   Fair value adjustment to deferred expense
 

 

 

 
0.01

Non-GAAP net income per diluted share
 
$
0.62

 
$
0.60

 
$
1.25

 
$
1.16

 
 
 
 
 
 
 
 
 
Reconciliation of GAAP operating income to non-GAAP operating income
 
 
 
 
 
 
 
 
GAAP operating income
 
$
7,578