Quarterly Report

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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FORM 10-Q

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(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2009

 

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

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Web.com Group, Inc.

(Exact name of registrant as specified in its charter)

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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)

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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.     x   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).     ¨   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 ¨		Accelerated filer x
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     x   No

 

Common Stock, par value $0.001 per share, outstanding as of July 31 , 2009: 26,285,443

 

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Web.com Group, Inc.

 

Quarterly Report on Form 10-Q

For the Quarterly Period ended June 30, 2009

Index

 

Part I		Financial Information		3
Item 1.		Financial Statements (unaudited)		3
		Consolidated Statements of Operations		3
		Consolidated Balance Sheets		5
		Consolidated Statements of Cash Flows		6
		Notes to Consolidated Financial Statements		7
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		18
Item 3.		Quantitative and Qualitative Disclosures About Market Risk		28
Item 4.		Controls and Procedures		28
Part II		Other Information		30
Item 1.		Legal Proceedings		30
Item 1A.		Risk Factors		30
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		38
Item 3.		Defaults Upon Senior Securities		39
Item 4.		Submission of Matters to a Vote of Security Holders		39
Item 5.		Other Information		39
Item 6.		Exhibits		40
Signatures				41

 

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PART I—FINANCIAL INFORMATION

 

Item 1.

Financial Statements.

 

Web.com Group, Inc.

 

Consolidated Statements of Operations

(in thousands except per share amounts)

(unaudited)

		Three months ended								Six months ended
		June 30, 2009				June 30, 2008				June 30, 2009				June 30, 2008
Revenue:
Subscription		$	25,438			$	30,269			$	51,456			$	60,000
Professional services			1,037				589				1,590				1,271
Other			—				100				1,000				100
Total revenue			26,475				30,958				54,046				61,371
Cost of revenue (excluding depreciation and amortization shown separately below):
Subscription (a)			9,413				11,038				18,721				21,941
Professional services			575				292				876				667
Total cost of revenue			9,988				11,330				19,597				22,608
Gross profit			16,487				19,628				34,449				38,763
Operating expenses:
Sales and marketing (a)			5,881				7,547				11,645				14,953
Research and development (a)			2,086				2,384				4,128				4,666
General and administrative (a)			4,789				5,398				10,851				10,499
Depreciation and amortization			3,441				3,232				6,790				6,582
Total operating expenses			16,197				18,561				33,414				36,700
Income from operations			290				1,067				1,035				2,063
Interest, net			43				192				105				448
Income before income taxes			333				1,259				1,140				2,511
Income tax (expense) benefit			(26	)			578				(43	)			(66	)
Net income from continuing operations		$	307			$	1,837			$	1,097			$	2,445
Discontinued operations
Income from discontinued operations, net of tax			95				360				228				302
Gain on sale of discontinued operations, net of tax			822				—				822				—
Income from discontinued operations, net of tax			917				360				1,050				302
Net income		$	1,224			$	2,197			$	2,147			$	2,747

 

See accompanying notes to consolidated financial statements

 

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Web.com Group, Inc.

 

Consolidated Statements of Operations

(in thousands except per share amounts)

(unaudited)

(continued)

		Three months ended								Six months ended
		June 30, 2009				June 30, 2008				June 30, 2009				June 30, 2008
Basic earnings per share:
Income from continuing operations attributable per common share		$	0.01			$	0.07			$	0.04			$	0.09
Income from discontinuing operations attributable per common share			0.04				0.01				0.04				0.01
Net Income per common share		$	0.05			$	0.08			$	0.08			$	0.10
Diluted earnings per share:
Income from continuing operations attributable per common share		$	0.01			$	0.06			$	0.04			$	0.08
Income from discontinuing operations attributable per common share			0.04				0.01				0.04				0.01
Net Income per common share		$	0.05			$	0.07			$	0.08			$	0.09
Basic weighted average common shares outstanding			25,130				27,806				25,365				27,678
Diluted weighted average common shares outstanding			26,903				30,546				26,603				30,562

 

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(a) Stock-based compensation included above:

 

Subscription (cost of revenue)		$	105			$	83			$	209			$	163
Sales and mar keting			210				229				435				440
Research and development			124				114				249				216
General and administrative			757				812				1,626				1,350
		$	1,196			$	1,238			$	2,519			$	2,169

 

See accompanying notes to consolidated financial statements

 

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Web.com Group, Inc.

 

Consolidated Balance Sheets

(in thousands)

 

		June 30, 2009				December 31, 2008
		(unaudited)				(audited)
Assets
Current assets:
Cash and cash equivalents		$	35,554			$	34,127
Accounts receivable, net of allowance of $493 and $645, respectively			4,690				5,019
Inventories, net of reserves of $0 and $78, respectively			—				39
Prepaid expenses			1,635				1,430
Prepaid marketing fees			621				665
Deferred taxes			1,094				1,093
Other current assets			131				134
Total current assets			43,725				42,507
Restricted investments			316				316
Property and equipment, net			8,783				8,204
Goodwill			11,881				9,000
Intangible assets, net			59,001				62,085
Other assets			293				383
Total assets		$	123,999			$	122,495
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable		$	1,091			$	1,406
Accrued expenses			6,758				6,230
Accrued restructuring costs and other reserves			2,315				2,619
Deferred revenue			7,364				7,831
Accrued marketing fees			195				263
Notes payable, current			—				59
Capital lease obligations			391				—
Other liabilities			136				128
Total current liabilities			18,250				18,536
Accrued rent expense			601				535
Deferred revenue			160				180
Capital lease obligations			512				—
Accrued restructuring costs and other reserves			599				1,214
Deferred tax liabilities			2,748				2,712
Other long-term liabilities			498				25
Total liabilities			23,368				23,202
Stockholders’ equity:
Common stock, $0.001 par value; 150,000,000 shares authorized, 28,093,759 and 28,093,759 shares issued and 26,289,277 and 26,633,436 outstanding at June 30, 2009 and December 31, 2008, respectively			26				27
Additional paid-in capital			257,846				256,763
Treasury Stock, 1,804,482 and 1,460,323 shares at June 30, 2009 and December 31, 2008, respectively			(5,374	)			(3,483	)
Accumulated deficit			(151,867	)			(154,014	)
Total stockholders’ equity			100,631				99,293
Total liabilities and stockholders’ equity		$	123,999			$	122,495

See accompanying notes to consolidated financial statements

 

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Web.com Group, Inc.

 

Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

 

		Six months ended June 30,
		2009				2008
Cash flows from operating activities
Net income		$	2,147			$	2,747
Adjustments to reconcile net income to net cash provided by operating activities:
Gain on sale of discontinued operations, net of cash			(822	)			—
Depreciation and amortization			6,790				6,582
Gain on disposal of assets			—				(1	)
Stock-based compensation expense			2,519				2,169
Deferred income tax			36				(95	)
Changes in operating assets and liabilities:
Accounts receivable			565				(1,007	)
Inventories			39				(49	)
Prepaid expenses and other assets			(298	)			3,350
Accounts payable, accrued expenses and other liabilities			(1,976	)			(9,757	)
Deferred revenue			(900	)			51
Net cash provided by operating activities			8,100				3,990
Cash flows from investing activities
Business acquisitions			(3,490	)			(4,578	)
Proceeds from gain on sale of discontinued operations			822				—
Proceeds from sale of investments			—				7,000
Purchase of investments			—				(2,494	)
Change in restricted investments			—				1,228
Purchase of property and equipment			(510	)			(3,247	)
Purchase of intangible assets			(3	)			(2	)
Net cash (used in) investing activities			(3,181	)			(2,093	)
Cash flows from financing activities
Stock issuance costs			(8	)			(10	)
Common stock repurchased			(3,534	)			—
Payments of debt obligations			(165	)			(1,130	)
Proceeds from exercise of stock options and warrants			215				780
Net cash (used in) financing activities			(3,492	)			(360	)
Net increase in cash and cash equivalents			1,427				1,537
Cash and cash equivalents, beginning of period			34,127				29,746
Cash and cash equivalents, end of period		$	35,554			$	31,283
Supplemental cash flow information
Interest paid		$	13			$	22
Income taxes paid		$	226			$	123

See accompanying notes to consolidated financial statements

 

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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. (formerly known as Website Pros, Inc.) (the Company) is a provider of Do-It-For-Me and Do-It-Yourself website building tools, online marketing, lead generation, eCommerce, and technology solutions that enable small and medium-sized businesses to build and maintain an effective online presence. The Company offers a full range of web services, including online marketing and advertising, local search, search engine marketing, search engine optimization, e-mail, lead generation, home contractor specific leads, website design and publishing, logo and brand development and eCommerce solutions meeting the needs of a business anywhere along its lifecycle.

 

The Company has reviewed the criteria of Statement of Financial Accounting Standards (SFAS) 131, Disclosures About Segments of an Enterprise and Related Information and has determined that the Company is comprised of only one segment, Web services and products.

 

Certain prior year amounts have been reclassified to conform to current year presentation.

 

Basis of Presentation

 

The accompanying consolidated balance sheet as of June 30, 2009, the consolidated statements of operations for the three and six months ended June 30, 2009 and 2008, the consolidated statements of cash flows for the six months ended June 30, 2009 and 2008, and the related notes to the consolidated financial statements for the six months ended June 30, 2009 and 2008 are unaudited. These unaudited consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements for the year ended December 31, 2008, except that certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the U.S. 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, 2009, and the Company’s results of operations for the three and six months ended June 30, 2009 and 2008 and cash flows for the six months ended June 30, 2009 and 2008. The results of operations for the three and six months ended June 30, 2009 are not necessarily indicative of the results to be expected for the year ending December 31, 2009.

 

These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 filed with the Securities and Exchange Commission, or SEC, on March 6, 2009.

 

Use of Estimates

 

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States 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 revenues and expenses during the reporting period. Actual results could differ from those estimates.

Comprehensive Income

Comprehensive income equals net income for all periods presented.

Goodwill and Other Intangible Assets

 

In accordance with SFAS 142, Goodwill and Other Intangible Assets , goodwill is determined to have an indefinite useful life and is tested for impairment, at least annually or more frequently if indicators of impairment arise. If impairment of the carrying value based on the calculated fair value exists, the Company measures the impairment through the use of discounted cash flows. The Company completed its annual goodwill impairment test during the fourth quarter of 2008 and as a result recorded a goodwill impairment charge of $102.3 million. There were no indicators of impairment during the quarter ended June 30, 2009.

 

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Intangible assets acquired as part of a business combination are accounted for in accordance with SFAS 141, Business Combinations and are recognized apart from goodwill if the intangible arises from contractual or other legal rights or the asset is capable of being separated from the acquired enterprise. Indefinite-lived intangible assets are tested for impairment annually and on an interim basis if events or changes in circumstances between annual tests indicate that the asset might be impaired in accordance with SFAS 142.  During the fourth quarter of 2008, the Company determined that one of its domain/trade names was impaired due to a product rebranding effort. The Company recorded an intangible asset impairment charge of $258 thousand. There were no indicators of impairment during the quarter ended June 30, 2009.

Definite-lived intangible assets are amortized over their useful lives, which range between fourteen months to ten years.

 

Earnings per Share

 

The Company computes earnings per share in accordance with SFAS 128, Earnings Per Share . Basic net income per common share includes no dilution and is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted net income per common share includes the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.

 

2. New Accounting Standards

 

SFAS No. 168

 

In June 2009, the Financial Accounting Standards Board, or (FASB) issued SFAS 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles. SFAS 168 establishes the authoritive accounting principles recognized by FASB to be applied by non-governmental entities in the preparation of financial statements in conformity with generally accepted accounting principles. SFAS 168 becomes effective for finanical statements issued for the interim and annual periods ending after September 15, 2009. The Company will begin to use the new Codification when referring to generally accepted accounting principles in its quarterly report ended September 30, 2009. This will not have an impact on the Company’s Consolidated Financial Statements.

 

SFAS No. 165

 

In May 2009, FASB issued SFAS 165, Subsequent Events . SFAS 165 establishes the general standards of accounting for disclosure of events that occur after the balance sheet date but before the financial statements are issued. SFAS 165 becomes effective for financial statements issued for the interim and annual periods ending after June 15, 2009. The adoption of SFAS 165 did not have a material impact on the Company’s Consolidated Financial Statements.

 

3. Discontinued Operations

On May 26, 2009, the Company sold its NetObjects Fusion software business for approximately $4.0 million. The Company no longer considers the NetObjects Fusion license software product core to its predominantly subscription business model. The NetObjects Fusion software business enabled customers to build websites either for themselves or for others.

The Company has received a partial payment of $750 thousand and recorded a $250 thousand receivable in connection with the NetObjects Fusion sale. The remaining $3.0 million of proceeds is expected to be paid over the next several years using a formula based on estimated revenue, with the entire balance expected to be paid by May 26, 2013. The remaining proceeds will be recorded as a gain in discontinued operations as cash payments are received. During the three and six months ended June 30, 2009, the net gain of $822 thousand is included in “Gain on sale of discontinued operations, net of tax” on the Company’s Consolidated Statement of Operations.

For the three months ended June 30, 2009 and 2008, the revenue generated by the NetObjects Fusion software was $162 thousand and $1.0 million and net income was $95 thousand and $360 thousand, respectively. For the six months ended June 30, 2009 and 2008, the revenue generated by the NetObjects Fusion software business was $428 thousand and $1.5 million and net income was $228 thousand and $302 thousand, respectively. Operating results relating to the NetObjects Fusion revenue and expenses for all periods presented are reported in discontinued operations.

 

4. Business Combinations

 

On April 27, 2009, the Company acquired substantially all the assets and select liabilities of Solid Cactus, Inc. and Solid Cactus Call Center, Inc. (collectively, “Solid Cactus”), with its headquarters in Shavertown, Pennsylvania, and offices in Wilkes-Barre, Pennsylvania. Solid Cactus provides a full-range of solutions for new and existing online businesses, including website and eCommerce store design and programming, pay-per-click advertising management, search engine optimization, affiliate program and e-mail marketing management, call center and virtual office services, and Software as a Service products. The Company believes the acquisition of Solid Cactus enhances the Company’s strategic position as a comprehensive, "one-stop" resource for small and medium-sized businesses seeking online marketing and eCommerce solutions. Under the terms of the asset purchase agreement, the Company paid cash consideration of approximately $3.3 million. In addition, the Company expects to pay Solid Cactus contingent consideration of up to an additional $500 thousand in April 2012. Although a reduction is not anticipated, this amount may be reduced by the amount of any unaccrued liabilities that existed at the acquisition date that the Company later discovers.

 

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The results of operations of Solid Cactus for the period from April 27, 2009 through June 30, 2009 are included in the Company’s consolidated statement of operations for the three and six months ended June 30, 2009.

 

As of June 30, 2009, the purchase accounting for this acquisition is still subject to final adjustment primarily for completion of the final valuation of assets and liabilities acquired.

 

The following table summarizes the Company’s purchase price allocation based on the fair values of the assets acquired and liabilities assumed on April 27, 2009 (in thousands):

Tangible current assets		$	132
Tangible non-current assets			1,602
Developed technology			331
Customer relationships			731
Non-compete			477
Domain name			678
Goodwill			2,656
Current liabilities			(2,072	)
Non-current liabilities			(667	)
Net assets acquired		$	3,868

 

The intangible assets are being amortized over a three to four year period, except for the domain name which has an indefinite life.  The goodwill represents business benefits the Company anticipates realizing in future periods and is expected to be deductible for tax purposes.

 

5. Earnings per Share

 

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

 

The following table sets forth the computation of basic and diluted net income per common share for the three and six months ended June 30, 2009 and 2008 (in thousands except per share amounts):

		Three months ended June 30,								Six months ended June 30,
		2009				2008				2009				2008
Income from continuing operations		$	307			$	1,837			$	1,097			$	2,445
Discontinued operations			917				360				1,050				302
Net income		$	1,224			$	2,197			$	2,147			$	2,747
Weighted average outstanding shares of common stock			25,130				27,806				25,365				27,678
Dilutive effect of stock options			1,450				2,412				1,190				2,550
Dilutive effect of restricted stock			321				—				45				—
Dilutive effect of warrants			2				189				3				195
Dilutive effect of escrow shares			—				139				—				139
Common stock and common stock equivalents			26,903				30,546				26,603				30,562
Basic earnings per share:
Income from continuing operations		$	0.01			$	0.07			$	0.04			$	0.09
Income from discontinued operations			0.04				0.01				0.04				0.01
Net Income		$	0.05			$	0.08			$	0.08			$	0.10
Diluted earnings per share:
Income from continuing operations		$	0.01			$	0.06			$	0.04			$	0.08
Income from discontinued operations			0.04				0.01				0.04				0.01
Net Income		$	0.05			$	0.07			$	0.08			$	0.09

 

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For the three months ended June 30, 2009 and 2008, options to purchase approximately 6.4 million and 3.8 million shares, respectively, of common stock with exercise prices greater than the average fair value of the Company’s stock were not included in the calculation of the weighted average shares for diluted net income per common share because the effect would have been anti-dilutive.  For the six months ended June 30, 2009 and 2008, options to purchase approximately 6.9 million and 2.7 million shares, respectively, of common stock with exercise prices greater than the average fair value of the Company’s stock were not included in the calculation of the weighted average shares for diluted net income per common share because the effect would have been anti-dilutive.

 

During the year ended December 31, 2008, the Company announced that its Board of Directors authorized the repurchase of up to $20 million of the Company’s outstanding common shares over eighteen months from the approval date. The timing, price and volume of repurchases will be based on market conditions, liquidity, relevant securities laws and other factors.  The Company may terminate the repurchase program at any time without notice. During the three months ended June 30, 2009, the Company repurchased approximately 196,000 shares of the Company’s common stock for $865 thousand. During the six months ended June 30, 2009, the Company repurchased approximately one million shares of the Company’s common stock for $3.5 million.

6. Goodwill and Intangible Assets

 

The following table summarizes changes in the Company’s goodwill balances as required by SFAS 142 for the periods ended (in thousands):

 

		June 30, 2009				December 31, 2008
Goodwill balance at beginning of period		$	9,000			$	107,933
Goodwill acquired during the period			2,881				3,361
Goodwill impaired during the year			—				(102,294	)
Goodwill balance at end of period		$	11,881			$	9,000

 

In accordance with SFAS 142, the Company reviews goodwill balances for indicators of 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 below its carrying amount. There were no indicators of impairment during the quarter ended June 30, 2009.

The Company’s intangible assets are summarized as follows (in thousands):

 

		June 30, 2009				December 31, 2008			Weighted-average Amortization period
Indefinite lived intangible assets:
Domain/Trade names		$	13,810			$	13,132
Definite lived intangible assets:
Non-compete agreements			3,814				3,337		23 months
Customer relationships			33,475				32,744		61 months
Developed technology			29,203				28,872		50 months
Other			96				93
Accumulated amortization			(21,397	)			(16,093	)
		$	59,001			$	62,085

 

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The weighted-average amortization period for the amortizable intangible assets is approximately 55 months. Total amortization expense was $2.7 million and $2.5 million for the three months ended June 30, 2009 and 2008, respectively. Total amortization expense was $5.3 million and $5.1 million for the six months ended June 30, 2009 and 2008, respectively.

The Company will complete its annual impairment tests of goodwill and other indefinite lived intangible assets in the fourth quarter of 2009. In light of current market conditions and the volatility in the price of the Company’s common stock, management and the audit committee expect to carefully analyze all relevant factors, including the Company’s current market value, legal factors, operating performance and the business climate, to evaluate whether its indefinite lived assets are impaired.

As of June 30, 2009, the amortization expense for the next five years is as follows (in thousands):

 

2009 (remainder of year)		$	5,323
2010			10,240
2011			9,700
2012			9,282
2013			7,524
Thereafter			3,122
Total		$	45,191

 

7. Restructuring Costs and Other Reserves

In connection with the acquisition of Web.com, Inc. (“Web.com”), the Company accrued, as part of its purchase price allocation, certain liabilities that represent the estimated costs of exiting Web.com facilities, relocating Web.com employees, the termination of Web.com employees and the estimated cost to settle Web.com legal matters that existed prior to the acquisition of approximately $11.6 million. As of June 30, 2009, the Company had $2.3 million remaining to be paid for these restructuring costs and other reserves. These plans were formulated at the time of the closing of the Web.com acquisition. These restructuring costs and other reserves are expected to be paid through July 2010.

 

In addition, as part of the liabilities assumed in the Web.com acquisition, the Company has assumed $2.9 million of restructuring obligations that were previously recorded by Web.com. These costs include the exit of unused office space in which Web.com had remaining lease obligations as of September 30, 2007. As of June 30, 2009, the Company had $524 thousand remaining to be paid for these restructuring costs. These restructuring costs are expected to be paid through July 2010.

 

During the year ended December 31, 2008, the Company recorded aggregate charges of $836 thousand for restructuring costs. The Company decided to use existing in-house resources to assist with the future development of its NetObjects Fusion product and terminated its contract for outsourced development. The cost of terminating this contract was approximately $474 thousand. In addition, the Company restructured personnel in its operations and as a result of this reorganization terminated 51 employees and recorded termination benefits of approximately $362 thousand.  As of June 30, 2009, the Company had $136 thousand remaining to be paid for these restructuring costs.  These costs are expected to be paid through December 2009.

 

The tables below summarizes the activity of accrued restructuring costs and other reserves during the the six months ended June 30, 2009 (in thousands):

 

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		Balance as of December 31, 2008				Additions				Cash Payments				Change in Estimates				Balance as of June 30, 2009
Restructuring costs		$	1,009			$	—			$	(340	)		$	(11	)		$	658
Employee Termination Benefits			114				—				(112	)			—				2
Merger related costs			2,710				—				(456	)			—				2,254
Balance		$	3,833			$	—			$	(908	)		$	(11	)		$	2,914

8. Capital Lease Obligations

 

The Company acquired various capital lease obligations as part of the Solid Cactus acquisition, which consisted of non-cancelable lease agreements of computers and equipment that continues through 2013. The required minimum payments on these capital leases as of June 30, 2009 are (in thousands):

 

2009		$	281
2010			494
2011			239
2012			118
2013			36
Total			1,168
Less interest			(265	)
			903
Less current portion			(391	)
Total obligations under capital leases, long term		$	512

 

9. Income Taxes

Prior to adjustments to its deferred tax asset valuation reserves, the Company calculated income tax expense of $1.5 million and $1.4 million in the six months ended June 30, 2009 and 2008, respectively, based upon its estimated annual effective tax rate. In accordance with SFAS 109, Accounting for Income Taxes , the Company reevaluated the need for a valuation allowance on its deferred tax assets as a result of cumulative profits generated in the most recent three-year period as well as other positive evidence. As a result of this evaluation, the Company reduced its deferred tax valuation allowance in the six months ended June 30, 2009 and 2008 and recognized tax benefits of $1.5 million and $1.3 million, respectively, which increased dilutive earnings by $0.06 and $0.04, respectively. The Company reduced its deferred tax valuation allowance based upon an analysis of the amount of deferred taxes that is more likely than not to be realized, which included the consideration of cumulative pretax earnings over the past three years and a short-term forecast of pretax earnings.

Prior to adjustments to its deferred tax asset valuation reserves, the Company calculated income tax expense of $978 thousand and $728 thousand in the three months ended June 30, 2009 and 2008, respectively, based upon its estimated annual effective rate. In accordance with SFAS 109, Accounting for Income Taxes , the Company reevaluated the need for a valuation allowance on its deferred tax assets as a result of cumulative profits generated in the most recent three-year period as well as other positive evidence. As a result of this evaluation, the Company reduced its deferred tax valuation allowance in the three months ended June 30, 2009 and 2008 and recognized tax benefits of $952 thousand and $1.3 million, respectively, which increased dilutive earnings per share by $0.04 and $0.04, respectively.  The Company reduced its deferred tax valuation allowance based upon an analysis of the amount of deferred taxes that is more likely than not to be realized, which included the consideration of cumulative pretax earnings over the past three years and a short-term forecast of pretax earnings.

 

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FASB Interpretation No. 48 Disclosures

The Company accounts for income taxes under the provisions of SFAS 109, Accounting for Income Taxes , using the liability method. SFAS 109 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 calculates its income tax liability in accordance with FASB Interpretation 48 (FIN 48), Accounting for Uncertainty in Income Taxes—an Interpretation of FASB Statement No. 109 . The Company is subject to audit by the Canada Revenue Agency for four years and the IRS and various states for all years since inception. During the year ended December 31, 2008, the Company accrued interest expense of approximately $9 thousand and recorded a reserve for Canadian taxes payable of approximately $88 thousand. There was an increase of $17 thousand of unrecognized tax benefits during the six months ended June 30, 2009 and $11 thousand of interest expense recognized during the six months ended June 30, 2009. As of June 30, 2009, the Company had accrued interest of $20 thousand associated with the unrecognized tax benefits. The Company does not believe there will be any material changes in its unrecognized tax positions over the next 12 months. The Company’s policy is that it recognizes interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense.

Therefore, the Company recognized a tax expense of $43 thousand and $66 thousand for the six months ended June 30, 2009 and 2008, respectively, and tax expense of $26 thousand and tax benefits of $578 thousand for the three months ended June 30, 2009 and 2008, respectively.

 

10. Stock Based Compensation

Equity Incentive Plans

An Equity Incentive Plan (the 1999 Plan) was adopted by the Company’s Board of Directors and approved by its stockholders on April 5, 1999. The 1999 Plan was amended in June 1999, May 2000, May 2002 and November 2003 to increase the number of shares available for awards. The 1999 Plan, as amended, provides for the grant of incentive stock options, non-statutory stock options, and stock bonuses to the Company’s employees, directors and consultants. As of June 30, 2009, the Company has reserved 4,074,428 shares of common stock for issuance under this plan. Of the total reserved as of June 30, 2009, options to purchase a total of 2,278,183 shares of the Company’s common stock were held by participants under the plan, options to purchase 1,543,035 shares of common stock have been exercised and options to purchase 253,210 shares of common stock were cancelled and became available under the 2005 Equity Incentive Plan (the 2005 Plan) and are currently available for future issuance.

 

The Board of Directors administers the 1999 Plan and determines 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 1999 Plan itself. Options under the 1999 Plan have a maximum term of 10 years and vest as determined by the Board of Directors. Options granted under the 1999 Plan generally vest either over 30 or 48 months. All options granted during 2002 vest over 30 months, and in general all other options granted vest over 48 months. The exercise price of non-statutory stock options and incentive stock options granted shall not be less than 85% and 100%, respectively, of the fair market value of the stock subject to the option on the date of grant. No 10% stockholder is eligible for an incentive or non-statutory stock option unless the exercise price of the option is at least 110% of the fair market value of the stock at date of grant. The 1999 Plan terminated upon the Closing of the Company’s initial public offering in November 2005.

 

The Company’s Board of Directors adopted, and its stockholders approved, the 2005 Plan that became effective November 2005. As of June 30, 2009, the Company had reserved 2,682,683 shares for equity incentives to be granted under the 2005 Plan. The option exercise price cannot be less than the fair value of the Company’s stock on the date of grant. Options granted under the 2005 Plan generally vest ratably over three or four years, are contingent upon continued employment, and generally expire ten years from the grant date. As of June 30, 2009, options to purchase a total of 1,606,531 shares were held by participants under the 2005 Plan, options to purchase 23,810 shares of common stock have been exercised and restrictions lapsed on 10,000 shares of common stock. In addition, options to purchase a total of 1,042,342 shares were available for future issuances under the 2005 Plan.

 

The Company’s Board of Directors adopted, and its stockholders approved, the 2005 Non-Employee Directors’ Stock Option Plan (the 2005 Directors’ Plan), which became effective November 2005. On May 8, 2007, the Board of Directors adopted, and its stockholders approved, an amendment to the 2005 Directors’ Plan to modify, among other things, the initial and annual grants to non-employee directors by providing for restricted stock grants and reducing the size of the option grants. The 2005 Directors’ Plan calls for the automatic grant of nonstatutory stock options to purchase shares of common stock, as well as automatic grants of restricted stock, to nonemployee directors. The aggregate number of shares of common stock that was authorized pursuant to options and restricted stock granted under this plan is 985,000 shares. As of June 30, 2009, options to purchase a total of 416,958 shares of the Company’s common stock and 25,334 of restricted shares were held by participants under the plan. As of June 30, 2009, no options have been exercised and restrictions lapsed on 46,666 shares of common stock. In addition, 496,042 shares of common stock were available for future issuances under the 2005 Directors’ Plan.

 

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The Company’s Board of Directors adopted, and its stockholders approved, the 2005 Employee Stock Purchase Plan (the ESPP), which became effective November 2005. The ESPP authorizes the issuance of 669,869 shares of common stock pursuant to purchase rights granted to the Company’s employees or to employees of any of its affiliates. The ESPP is intended to qualify as an “employee stock purchase plan” within the meaning of Section 425 of the Internal Revenue Code. As of June 30, 2009, no shares have been issued under the ESPP.

In connection with the acquisition of Web.com, the Company assumed six additional equity incentive plans: the Interland-Georgia 1999 Stock Plan, Interland 1995 Stock Option Plan, Interland 2001 Equity Incentive Plan, Interland 2002 Equity Incentive Plan, Interland 2005 Equity Incentive Plan, and Web.com 2006 Equity Incentive Plan, collectively referred to as the Web.com Option Plans. Options issued under the Web.com Option Plans have an option term of 10 years. Vesting periods range from 0 to 5 years. Exercise prices of options under the Web.com Option Plans are 100% of the fair market value of the Web.com common stock on the date of grant. As of June 30, 2009, the Company has reserved 2,424,558 shares for issuance upon the exercise of outstanding options under the Web.com Option Plans. Of the total reserved as of June 30, 2009, options to purchase a total of 1,855,764 shares of the Company’s common stock were held by participants under the plan and options to purchase 366,609 shares of common stock have been exercised. All awards outstanding under the Web.com Option Plans continue in accordance with their terms, but no further awards will be granted under those plans.

The Company’s Board of Directors adopted, and its stockholders approved, the 2008 Equity Incentive Plan (the 2008 Plan), which became effective May 13, 2008. The 2008 Plan provides for the grant of incentive stock options, nonstatutory stock options, restricted stock awards, restricted stock unit awards, stock appreciation rights, performance stock awards, performance cash awards, and other stock-based awards (stock-based awards) to the Company’s employees, directors and consultants. The aggregate number of shares of common stock that was authorized pursuant to the stock-based awards granted under the 2008 Plan was 3,000,000. As of June 30, 2009, options to purchase a total of 1,328,964 common shares and 1,243,050 shares of restricted stock were held by participants under the 2008 Plan, options to purchase 145 shares of common stock have been exercised and restrictions lapsed on 51,475 shares of common stock. In addition, 376,366 shares of common stock were available for future issuances under the 2008 Plan.

In conjunction with the acquisition of substantially all of the assets and select liabilities of Solid Cactus, Inc., and Solid Cactus Call Center, Inc. (collectively, “Solid Cactus”) in April 2009, the Company granted inducement awards to 125 new employees from Solid Cactus under the Company’s 2009 Inducement Award Plan (the 2009 Plan), adopted in anticipation of the acquisition. The inducement awards consisted of options to purchase an aggregate of 146,900 shares of the Company’s common stock. The options have a ten year term and an exercise price equal to the closing price of the Company’s common stock on the date of grant. The options vest ratably each month over four years. As of June 30, 2009, options to purchase a total of 143,630 shares of the Company’s common stock were held by participants under the 2009 Plan and no options had been exercised.

The Board of Directors, or a committee thereof, administers all of the equity incentive plans and determines 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 stock option plans. Options have a maximum term of 10 years and vest as determined by the Board of Directors.

The fair value of each option award is estimated on the date of the grant using the Black Scholes option valuation model and the assumptions noted in the following table. Expected volatility rates are based on the Company’s historical volatility, since the Company’s initial public offering, on the date of the grant. The expected term of options granted represents the period of time that they are expected to be outstanding. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant.

		Six months ended June 30,
		2009			2008
Risk-free interest rate		1.36-2.95%			2.23-3.73%
Dividend yield		0%			0%
Expected life (in years)		5			5
Volatility		62-64%			39-41%

 

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Stock Option Activity

 

The following table summarizes option activity for the six months ended June 30, 2009 for all of the Company’s stock options:

		Shares Covered by Options				Exercise Price per Share			Weighted Average Exercise Price				Weighted Average Remaining Contractual Term (in years)				Aggregate Intrinsic Value (in thousands)
Balance, December 31, 2008			7,836,722			$ 0.50 to $185.46			$	6.29
Granted			254,200			3.55 to 4.83				3.98
Exercised			(85,059	)		0.50 to 5.67				2.33
Forfeited			(223,236	)		3.55 to 14.05				8.05
Expired			(136,170	)		0.50 to 149.97				8.85
Balance, June 30, 2009			7,646,457			0.50 to 185.46				6.15				6.19			$	10,553
Exercisable at June 30, 2009			5,620,802			0.50 to 185.46				5.63				5.29			$	9,661

 

Compensation costs related to the Company’s stock option plans were $771 thousand and $1.0 million for the three months ended June 30, 2009 and 2008, respectively. Compensation costs related to the Company’s stock option plans were $1.7 million and $1.9 million for the six months ended June 30, 2009 and 2008, respectively. Compensation expense is generally recognized on a straight-line basis over the vesting period of grants. As of June 30, 2009, the Company had $6.6 million of unrecognized compensation costs related to share-based payments, which the Company expects to recognize through May 2013.

The total intrinsic value of options exercised during the six months ended June 30, 2009 and 2008 was $236 thousand and $1.7 million, respectively. The weighted average grant-date fair value of options granted during the six months ended June 30, 2009 and 2008 was $2.15, and $3.50, respectively. The fair value of options vested during the six months ended June 30, 2009 and 2008 was $1.6 million and $1.8 million, respectively.

The following activity occurred under the Company’s stock option plans during the six months ended June 30, 2009:

Unvested Shares		Shares				Weighted Average Grant–Date Fair Value
Unvested at December 31, 2008			2,456,765			$	3.58
Granted			254,200				2.15
Vested			(459,671	)			3.48
Forfeited			(227,082	)			3.37
Unvested at June 30, 2009			2,024,212				3.44

Price ranges of outstanding and exercisable options as of June 30, 2009 are summarized below:

 

		Outstanding Options												Exercisable Options
Exercise Price		Number of Options				Weighted Average Remaining Life (Years)				Weighted Average Exercise Price				Number of Options				Weighted Average Exercise Price
$0.50			511,801				2.91			$	0.50				511,801			$	0.50
$2.00 – $2.99			993,259				4.09				2.00				993,259				2.00
$3.00 – $3.99			1,520,990				4.85				3.40				1,354,338				3.36
$4.00 – $6.99			950,578				8.28				4.79				435,852				5.05
$7.00 – $9.99			2,699,737				7.32				8.86				1,664,291				8.88
$10.00 – $185.46			970,092				6.96				11.46				661,261				11.94
			7,646,457												5,620,802

 

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Restricted Stock Activity

The following information relates to awards of restricted stock and restricted stock units that have been granted under the 2005 Directors’ Plan, the 2005 Plan, and the 2008 Plan. The restricted stock is not transferable until vested and the restrictions lapse upon the completion of a certain time period, usually over a one to four-year period. The fair value of each restricted stock grant is based on the closing price of the Company’s stock on the date of grant and is amortized to compensation expense over its vesting period, which ranges between one and four years. At June 30, 2009, there were 1,268,384 shares of unvested restricted stock awards and units outstanding.

The following restricted stock award and restricted stock unit activity occurred under the Company’s equity incentive plans during the six months ended June 30, 2009:

Restricted Stock Activity		Shares				Weighted Average Grant–Date Fair Value
Restricted stock awards and units outstanding at December 31, 2008			654,859			$	6.31
Granted			736,000				3.59
Lapse of restriction			(48,225	)			8.71
Forfeited			(74,250	)			4.10
Restricted stock awards and units outstanding at June 30, 2009			1,268,384			$	4.77

Compensation expense for the three months ended June 30, 2009 and 2008 was approximately $425 thousand and $203 thousand, respectively. Compensation expense for the six months ended June 30, 2009 and 2008 was approximately $846 thousand and $276 thousand, respectively. As of June 30, 2009, there was approximately $5.1 million of total unrecognized compensation cost related to the restricted stock outstanding.

11. Related Party Transactions

 

The Company purchases online marketing services, including online advertising, from The Search Agency, Inc. (TSA), an entity in which the Company’s President and Director, Jeffrey M. Stibel, has an equity interest. Mr. Stibel is also a member and chairman of the Board of Directors of TSA. The Company’s purchases of online marketing services from TSA are made pursuant to the Company’s standard form of purchase order. The purchase order imposes no minimum commitment or long-term obligation on the Company. The Company may terminate the arrangement at any time. The Company pays TSA fees equal to a specified percentage of the Company’s purchases of online advertising made through TSA. The Company believes that the services it purchases from TSA, and the prices it pays, are competitive with those available from alternative providers. The total amount of fees paid to TSA for services rendered for the three months ended June 30, 2009 and 2008 was $80 thousand and $232 thousand, respectively. The total amount of fees paid to TSA for services rendered for the six months ended June 30, 2009 and 2008 was $221 thousand and $385 thousand, respectively. There was an unpaid balance of $92 thousand and $63 thousand as of June 30, 2009 and December 31, 2008, respectively.

 

On May 18, 2009 pursuant to its repurchase program, the Company purchased approximately 196 thousand shares of common stock from Mr. Stibel. These shares of common stock were purchased at a discount of 5%, which was based on the May 15, 2009 closing price, for $865 thousand.

 

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12. Commitments and Contingencies

 

Letters of Credit

 

The Company utilizes letters of credit to back certain payment obligations relating to its facility operating leases. The Company had no outstanding borrowings as of June 30, 2009 and had approximately $1.8 million in standby letters of credit.

Legal Matters

 

From time to time the Company may be involved in litigation relating to claims arising out of its operations. There are several outstanding litigation matters that relate to its wholly-owned subsidiary, Web.com Holding Company, Inc., formerly Web.com, Inc. (“Web.com Holding”), including the following:

 

On August 2, 2006, Web.com Holding filed suit in the United States District Court for the Western District of Pennsylvania against Federal Insurance Company and Chubb Insurance Company of New Jersey, seeking insurance coverage and payment of litigation expenses with respect to litigation involving Web.com Holding pertaining to events in 2001. Web.com Holding also has asserted claims against Rapp Collins, a division of Omnicom Media, that are pending in state court in Pennsylvania for recovery of the same litigation expenses. These actions were consolidated in state court in Pennsylvania on September 30, 2008.

 

On June 19, 2006, Web.com Holding filed suit in the United States District Court for the Northern District of Georgia against The Go Daddy Group, Inc., seeking damages, a permanent injunction and attorney fees related to alleged infringement of four of Web.com Holdings’ patents. On January 8, 2009, the parties entered into a confidential settlement and patent cross-licensing agreement, which resolved the lawsuit. The revenue derived from the sale of the patent license is reflected in other revenue for the six months ended June 30, 2009.

The outcome of any litigation cannot be assured, and despite management’s views of the merits of any litigation, or the reasonableness of the Company’s estimates and reserves, the Company’s cash balances could nonetheless be materially affected by an adverse judgment. In accordance with SFAS 5 Accounting for Contingencies , the Company believes it has adequately reserved for the contingencies arising from the current legal matters where an outcome was deemed to be probable and the loss amount could be reasonably estimated. As such, the Company does not believe that the anticipated outcome of any current litigation will have a materially adverse impact on its financial condition, cash flows, or results of operations.

 

13. Subsequent Events

 

The Company has evaluated all subsequent events through August 5, 2009, which represents the filing date of this Form 10-Q with the Securities and Exchange Commission, to ensure that this Form 10-Q includes appropriate disclosure of events both recognized in the financial statements as of June 30, 2009, and events which occurred subsequent to June 30, 2009 but were not recognized in the financial statements. As of August 5, 2009, there were no subsequent events that required recognition or disclosure.

 

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Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of factors, risks and uncertainties, including the risk factors set forth in this discussion, especially under the captions “Variability of Results” and “Factors That May Affect Future Operating Results” in this Form 10-Q. Generally, the words “anticipate”, “expect”, “intend”, “believe” and similar expressions identify forward-looking statements. The forward-looking statements made in this Form 10-Q are made as of the filing date of this Form 10-Q with the Securities and Exchange Commission, and future events or circumstances could cause results that differ significantly from the forward-looking statements included here. Accordingly, we caution readers not to place undue reliance on these statements. We expressly disclaim any obligation to update or alter our forward-looking statements, whether, as a result of new information, future events or otherwise after the date of this document.

 

The following discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto in Item 1 above and with our financial statements and notes thereto for the year ended December 31, 2008, contained in our Annual Report on Form 10-K for the year ended December 31, 2008 filed with the SEC on March 6, 2009.

 

Overview

 

We are a leading provider of Do-It-For-Me and Do-It-Yourself website building tools, online marketing, lead generation, eCommerce, and technology solutions that enable small and medium-sized businesses to build and maintain an effective online presence. We offer a full range of online services, including online marketing and advertising, local search, search engine marketing, search engine optimization, lead generation, home contractor specific leads, website design and publishing, logo and brand development and eCommerce solutions, meeting the needs of small businesses anywhere along their lifecycle.

 

Our primary service offerings, eWorks! XL and SmartClicks, are comprehensive performance-based packages that include website design and publishing, online marketing and advertising, search engine optimization, search engine submission, lead generation, hosting and email solutions, and easy-to-understand Web analytics. As an application service provider, or ASP, we offer our customers a full range of Web services and products on an affordable subscription basis. In addition to our primary service offerings, we provide a variety of premium services to customers who desire more advanced capabilities, such as eCommerce solutions and other sophisticated online marketing services and online lead generation. The breadth and flexibility of our offerings allow us to address the Web services needs of a wide variety of customers, ranging from those just establishing their websites to those that want to enhance their existing online presence with more sophisticated marketing and lead generation services. As the Internet continues to evolve, we plan to refine and expand our service offerings to keep our customers at the forefront.

 

Through the combination of our proprietary website publishing and management software, automated workflow processes, and specialized workforce development and management techniques, we believe that we achieve production efficiencies that enable us to offer sophisticated Web services at affordable rates. Our technology automates many aspects of creating, maintaining, enhancing, and marketing websites on behalf of our customers. With approximately 267,000 subscribers to our eWorks! XL, SmartClicks, and subscription-based services as of June 30, 2009, we believe we are one of the industry’s largest providers of affordable Web services and products enabling small and medium-sized businesses to have an effective online presence.

 

We have traditionally sold our Web services and products to customers identified primarily through strategic relationships with established brand name companies that have a large number of small and medium-sized business customers. We have a direct sales force that utilizes leads generated by our strategic marketing relationships to acquire new customers at our sales centers in Spokane, Washington; Atlanta, Georgia; Jacksonville, Florida; Manassas, Virginia; Norton, Virginia; Halifax, Nova Scotia; Barrie, Ontario; and Scottsdale, Arizona. Our sales force specializes in selling to small and medium-sized businesses across a wide variety of industries throughout the United States.

 

To increase our revenue and take advantage of our market opportunity, we plan to expand our subscriber base as well as increase our revenue from existing subscribers. We intend to continue to invest in hiring additional personnel, particularly in sales and marketing; developing additional services and products; adding to our infrastructure to support our growth; and expanding our operational and financial systems to manage our growing business. As we have in the past, we will continue to evaluate acquisition opportunities to increase the value and breadth of our Web services and product offerings and expand our subscriber base.

 

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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. Additionally, we do not treat a subscription as cancelled, even if the customer is not current in its payments, until either we have attempted to contact the subscriber twenty times or 60 days have passed since the most recent failed billing attempt, whichever is sooner. In any event, a subscriber’s account is cancelled if payment is not received within approximately 80 days.

 

We review this metric to evaluate whether we are performing to our business plan. An increase in net subscriber additions could signal an increase in subscription revenue, higher customer retention, and an increase in the effectiveness of our sales efforts. Similarly, a decrease in net subscriber additions could signal decreased subscription revenue, lower customer retention, and a decrease in the effectiveness of our sales efforts. Net subscriber additions above or below our business plan could have a long-term impact on our operating results due to the subscription nature of our business.

 

Monthly Turnover

 

Monthly turnover is a metric we measure each quarter, and which we define as customer cancellations in the quarter divided by the sum of the number of subscribers at the beginning of the quarter and the gross number of new subscribers added during the period, divided by three months. Customer cancellations in the quarter include cancellations from gross subscriber additions, which is why we include gross subscriber additions in the denominator. In measuring monthly turnover, we use the same conventions with respect to free trials and subscribers who are not current in their payments as described above for net subscriber additions. Monthly turnover is the key metric that allows management to evaluate whether we are retaining our existing subscribers in accordance with our business plan. An increase in monthly turnover may signal deterioration in the quality of our service, or it may signal a behavioral change in our subscriber base. Lower monthly turnover signals higher customer retention.

 

Sources of Revenue

We derive our revenue from sales of a variety of services to small and medium-sized businesses, including web design, online marketing, search engine optimization, eCommerce solutions, logo design and home contractor lead services. Leads are generated through online advertising campaigns targeting customers in need of web design, hosting or online marketing solutions, through strategic partnerships with enterprise partners, or through our corporate websites.

 

Subscription Revenue

 

We currently derive a substantial majority of our revenue from fees associated with our subscription services, which are generally sold through our eWorks! XL, SmartClicks, Visibility Online, Web.com, Renex and 1ShoppingCart.com offerings. A significant portion of our subscription contracts include the design of a five-page website, its hosting, and several additional Web services. In the case of eWorks! XL, upon the completion and initial hosting of the website, our subscription services are offered free of charge for a 30-day trial period during which the customer can cancel at any time. After the 30-day trial period has ended, the revenue is recognized on a daily basis over the life of the contract. No 30-day free trial period is offered to customers for our Visibility Online services, and revenue is recognized on a daily basis over the life of the contract. The typical subscription is a monthly contract, although terms range up to 12 months. We bill a majority of our customers on a monthly basis through their credit cards, bank accounts, or business merchant accounts.

 

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The Web.com product line subscription revenue is primarily generated from shared hosting, managed services, eCommerce services, applications hosting and domain name registrations. Revenue is recognized as the services are provided. Hosting contracts generally are for service periods ranging from one to 24 months and typically require up-front fees. These fees, including set-up fees for hosting services, are deferred and recognized ratably over the customer’s expected service period. Deferred revenues represents the liability for advance billings to customers for services not yet provided.

 

For the three months ended June 30, 2009, subscription revenue accounted for approximately 96% of our total revenue as compared to 98% for the three months ended June 30, 2008. For the six months ended June 30, 2009, subscription revenue accounted for approximately 95% of our total revenue as compared to 98% for the six months ended June 30, 2008. The number of paying subscribers to our Web services and lead generation products drives subscription revenue as well as the subscription price that we charge for these services. The number of paying subscribers is affected both by the number of new customers we acquire in a given period and by the number of existing customers we retain during that period. In the future, we expect other sources of revenue to decline as a percentage of total revenue over time.

 

Professional Services Revenue

 

We generate professional services revenue from custom website design, eCommerce store design, and Do-it-Yourself logo design. Our custom website design and eCommerce store design work is typically billed on a fixed price basis and over short periods. Our Do-It-Yourself logo design is typically billed upon the point-of-sale of the final product, which is created by the customer.

 

Other Revenue

We occasionally generate revenue from the sale of perpetual licenses for use of our patents. Other revenue consists of all fees earned from granting customers licenses to use our patents.

 

Cost of Revenue

 

Cost of Subscription Revenue

 

Cost of subscription revenue primarily consists of expenses related to marketing fees we pay to companies with which we have strategic marketing relationships as well as compensation expenses related to our Web page development staff, directory listing fees, customer support costs, domain name and search engine registration fees, allocated overhead costs, billing costs, and hosting expenses. We allocate overhead costs such as rent and utilities to all departments based on headcount. Accordingly, general overhead expenses are reflected in each cost of revenue and operating expense category. As our customer base and Web services usage grows, we intend to continue to invest additional resources in our website development and support staff.

 

Cost of Professional Services Revenue

 

Cost of professional services revenue primarily consists of compensation expenses related to our Web page development staff and allocated overhead costs. While in the near term, we expect to maintain or reduce costs in this area, in the long term, we may add additional resources in this area to support the growth in our professional services and custom design function.

 

Operating Expenses

Sales and Marketing Expense

 

Our largest direct marketing expenses are the costs associated with the online marketing channels we use to acquire and promote our services. These channels include search marketing, affiliate marketing and online partnerships. Sales costs consist primarily of salaries and related expenses for our sales and marketing staff. Sales and marketing expenses also include commissions, marketing programs, including advertising, events, corporate communications, other brand building and product marketing expenses and allocated overhead costs.

 

As market conditions improve, we plan to continue to invest in sales and marketing by increasing the number of direct sales personnel in order to add new subscription customers as well as increase sales of additional and new services and products to our existing customer base. Our investment in this area will also help us to expand our strategic marketing relationships, to build brand awareness, and to sponsor additional marketing events. Accordingly, we expect that, in the future, sales and marketing expenses will increase in absolute dollars.

 

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Research and Development Expense

 

Research and development expenses consist primarily of salaries and related expenses for our research and development staff, outsourced software development expenses, and allocated overhead costs. We have historically focused our research and development efforts on increasing the functionality of the technologies that enable our Web services and lead generation products. Our technology architecture enables us to provide all of our customers with a service based on a single version of the applications that serve each of our product offerings. As a result, we do not have to maintain multiple versions of our software, which enables us to have lower research and development expenses as a percentage of total revenue. While we have achieved cost reductions in recent periods due to our consolidation and migration activities, we expect that, in the future, research and development expenses will increase in absolute dollars as we continue to upgrade and extend our service offerings and develop new technologies.

 

General and Administrative Expense

 

General and administrative expenses consist of salaries and related expenses for executive, finance, administration, and management information systems personnel, as well as professional fees, other corporate expenses, and allocated overhead costs. While in the near term, we expect to maintain or reduce costs in this area, in the long term, we may add additional resources to support the growth of our business.

 

Depreciation and Amortization Expense

 

Depreciation and amortization expenses relate primarily to our computer equipment, software, building and other intangible assets recorded due to the acquisitions we have completed.

 

Critical Accounting Policies

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 these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, and expenses and related disclosure of contingent assets and liabilities. We review our estimates on an ongoing basis. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. While our significant accounting policies are described in more detail in Note 1 to our consolidated financial statements included in this report, we believe the following accounting policies to be critical to the judgments and estimates used in the preparation of our consolidated financial statements.

 

Revenue Recognition

 

We recognize revenue in accordance with SEC Staff Accounting Bulletin No., or SAB, 104 and other related generally accepted accounting principles.

 

We recognize revenue when all of the following conditions are satisfied: (1) there is persuasive evidence of an arrangement; (2) the service has been provided to the customer; (3) the amount of fees to be paid by the customer is fixed or determinable; and (4) the collection of our fees is probable.

 

Thus, we recognize subscription revenue on a daily basis, as services are provided. Customers are billed for the subscription on a monthly, quarterly, semi-annual, or annual basis, at the customer’s option. For all of our customers, regardless of their billing method, subscription revenue is recorded as deferred revenue in the accompanying consolidated balance sheets. As services are performed, we recognize subscription revenue on a daily basis over the applicable service period. When we provide a free trial period, we do not begin to recognize subscription revenue until the trial period has ended and the customer has been billed for the services.

 

We derive other revenue from sales of licenses to our patented technology. Such revenue is recognized upon the delivery of the license to the customer.

 

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Professional services revenue is generated from custom website design, eCommerce store design and search engine optimization services. Our professional services revenue from contracts for custom website design and eCommerce store design is recorded using a proportional performance model based on labor hours incurred. The extent of progress toward completion is measured by the labor hours incurred as a percentage of total estimated labor hours to complete. Labor hours are the most appropriate measure to allocate revenue among reporting periods, as they are the primary input to the provision of our professional services.

 

We account for our multi-element arrangements, such as in the instances where we design a custom website and separately offer other services such as hosting and marketing, in accordance with Emerging Issues Task Force Issue 00-21, Revenue Arrangements with Multiple Deliverables. We identify each element in an arrangement and assign the relative fair value to each element. The additional services provided with a custom website are recognized separately over the period for which services are performed.

 

Allowance for Doubtful Accounts

 

In accordance with our revenue recognition policy, our accounts receivable are based on customers whose payment is reasonably assured. We monitor collections from our customers and maintain an allowance for estimated credit losses based on historical experience and specific customer collection issues. While credit losses have historically been within our expectations and the provisions established in our financial statements, we cannot guarantee that we will continue to experience the same credit loss rates that we have in the past. Because we have a large number of customers, we do not believe a change in liquidity of any one customer or our inability to collect from any one customer would have a material adverse impact on our consolidated financial position.

 

We also monitor failed direct debit billing transactions and customer refunds and maintain an allowance for estimated losses based upon historical experience. These provisions to our allowance are recorded as an adjustment to revenue. While losses from these items have historically been minimal, we cannot guarantee that we will continue to experience the same loss rates that we have in the past.

 

Accounting for Stock-Based Compensation

 

We record compensation expenses for our employee and director stock-based compensation plans based upon the fair value of the award in accordance with SFAS 123(R), Share Based Payment .

 

Goodwill and Intangible Assets

 

In accordance with SFAS 142, Goodwill and Other Intangible Assets , we periodically evaluate goodwill and indefinite lived intangible assets for potential impairment. We test for the impairment of goodwill and indefinite lived intangible assets annually, 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. Other intangible assets include, among other items, customer relationships, developed technology and non-compete agreements, and they are amortized using the straight-line method over the periods benefited, which is up to eight years. Other intangible assets represent long-lived assets and are assessed for potential impairment whenever significant events or changes occur that might impact recovery of recorded costs. During the year ended December 31, 2008, we completed our annual impairment test of goodwill and other indefinite lived intangible assets. After performing the tests, we determined the carrying amount exceeded the fair value and calculated the impairment. As a result, we recorded a goodwill and intangible asset impairment charge of $102.6 million. The primary reason for the impairment charge was the decline of our stock price during 2008.

We will complete our annual impairment tests of goodwill and other indefinite lived intangible assets in the fourth quarter of 2009. In light of current market conditions and the volatility in the price of the our common stock, management and the audit committee expect to carefully analyze all relevant factors, including the current market value, legal factors, operating performance and the business climate, to evaluate whether our assets are impaired.

Accounting for Purchase of Business Combinations

 

All of our acquisitions were accounted for as purchase transactions, and the purchase price was allocated to the assets acquired and liabilities assumed based on the respective fair values. The excess of the purchase price over the fair value of net assets acquired or net liabilities assumed was allocated to goodwill. Management weighed several factors in determining the fair value of amortizable intangibles, which primarily consists of customer relationships, non-compete agreements, trade names, and developed technology, including using valuation studies as one of many tools in determining the fair value of amortizable intangibles.

 

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Provision for Income Taxes

 

We recognize deferred tax assets and liabilities on differences between the book and tax basis of assets and liabilities using currently effective tax rates. Further, deferred tax assets are recognized for the expected realization of available net operating loss carry forwards. A valuation allowance is recorded to reduce a deferred tax asset to an amount that we expect to realize in the future. We review the adequacy of the valuation allowance on an ongoing basis and recognize these benefits if a reassessment indicates that it is more likely than not that these benefits will be realized. In addition, we evaluate our tax contingencies on an ongoing basis and recognize a liability when we believe that it is probable that a liability exists and that the liability is measurable.

 

Comparison of the Results for the Three Months Ended June 30, 2009 to the Results for the Three Months Ended June 30, 2008

 

Revenue

 

		Three months ended June 30,
		2009				2008
		(unaudited)
Revenue:
Subscription		$	25,438			$	30,269
Professional services			1,037				589
Other			—				100
Total revenue		$	26,475			$	30,958

 

Total revenue for the three months ended June 30, 2009 decreased $4.5 million, or 14%, over the three months ended June 30, 2008. Total revenue during the three months ended June 30, 2009 declined primarily due to decreases in our average revenue per subscriber as compared to the same period of the prior year.

Subscription Revenue . Subscription revenue decreased 16% to $25.4 million in the three months ended June 30, 2009 from $30.3 million in the three months ended June 30, 2008. Subscription revenue decreased approximately $4.8 million primarily due to decreases in our average revenue per subscriber as compared to the prior year, which was slightly offset by additional revenue from our recent acquisition. The decrease in average revenue per subscriber was mainly due to the addition of lower revenue subscribers from our Do-It-Yourself website building and hosting products as well as a reduction in spending by our enterprise partner subscribers.

Net subscribers increased by 1,937 customers during the three months ended June 30, 2009 as compared to an increase of 1,056 during the three months ended June 30, 2008. The average monthly turnover decreased to 3.7% during the three months ended June 30, 2009 from 3.9% during the three months ended June 30, 2008.  Due to the current economic conditions and lower marketing spend, gross subscriber additions were down from 37,093 in the three months ended June 30, 2008 to 35,274 in the three months ended June 30, 2009.

Professional Services Revenue. Professional services revenue increased 76% to $1.0 million in the three months ended June 30, 2009 from $589 thousand in the three months ended June 30, 2008. Professional services revenue increased approximately $723 thousand due to the additional service offerings of eCommerce store design and logo design that were acquired as part of our recent acquisitions, which was partially offset by a decrease of $192 thousand in search engine optimization services.

Other Revenue. While we did not have other revenue during the three months ended June 30, 2009, we did have other revenue of $100 thousand during the three months ended June 30, 2008. This revenue was earned by the sale of perpetual licenses for the use of our patents.

 

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Cost of Revenue

 

		Three months ended June 30,
		2009				2008
		(unaudited)
Cost of revenue
Subscription		$	9,413			$	11,038
Professional services			575				292
Total cost of revenue		$	9,988			$	11,330

Cost of Subscription Revenue. Cost of subscription revenue decreased 15% to $9.4 million in the three months ended June 30, 2009 from $11.0 million in the three months ended June 30, 2008. During the three months ended June 30, 2009, we reduced costs of approximately $1.2 million, which was driven by the decline of our subscription revenue and slightly offset by additional expense due to the revenue associated with our recent acquisition. In addition, as a lesser percentage of our sales came from our strategic marketing relationships, fees related to these relationships decreased by $607 thousand during the three months ended June 30, 2009. Our gross margin on subscription revenue decreased slightly from 64% during the three months ended June 30, 2008 to 63% during the three months ended June 30, 2009.

 

Cost of Professional Services Revenue. Cost of professional services revenue increased 97% to $575 thousand in the three months ended June 30, 2009 from $292 thousand in the three months ended June 30, 2008. The increase in the cost was primarily the result of the additional costs of approximately $312 thousand related to the eCommerce store design revenue.

 

Operating Expenses

 

		Three months ended June 30,
		2009				2008
		(unaudited)
Operating expenses:
Sales and marketing		$	5,881			$	7,547
Research and development			2,086				2,384
General and administrative			4,789				5,398
Depreciation and amortization			3,441				3,232
Total operating expenses		$	16,197			$	18,561

 

Sales and Marketing Expenses. Sales and marketing expenses decreased 22% to $5.9 million, or 22% of total revenue, during the three months ended June 30, 2009 from $7.5 million, or 24% of total revenue, during the three months ended June 30, 2008. The decrease of $1.7 million in sales and marketing expenses was primarily the result of a reduction in online marketing spend during the quarter, as well as, a reduction in sales resources. Specifically, we had reductions in employee compensation and benefits expense of $619 thousand and marketing and advertising expense of $1.1 million.

 

Research and Development Expenses. Research and development expenses decreased 13% to $2.1 million, or 8% of total revenue, during the three months ended June 30, 2009 from $2.4 million, or 8% of total revenue, during the three months ended June 30, 2008. During the three months ended June 30, 2009, there was a decrease in employee compensation and benefits expense totaling $251 thousand, in addition to the reduction of costs associated with subcontracted labor totaling $55 thousand.

 

General and Administrative Expenses. General and administrative expenses decreased 11% to $4.8 million, or 18% of total revenue, during the three months ended June 30, 2009 from $5.4 million, or 17% of total revenue, during the three months ended June 30, 2008. During the three months ended June 30, 2009, we had reductions in employee compensation and benefits expense by $395 thousand.  In addition, due to the current market conditions, we reduced our remaining general and administrative expenses.

Depreciation and Amortization Expense. Depreciation and amortization expense increased 6% to $3.4 million, or 13% of total revenue, during the three months ended June 30, 2009 from $3.2 million, or 10% of total revenue, during the three months ended June 30, 2008. The increase in amortization and depreciation expense is a result of additional tangible and intangible assets acquired through our recent acquisitions.

 

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Net Interest Income. Net interest income decreased 78% to $43 thousand, or less than 1% of total revenue, during the three months ended June 30, 2009 from $192 thousand, or 1% of total revenue, during the three months ended June 30, 2008. The decrease in interest income was due to a reduction in the interest rates of our investment instruments.

Income tax expense. We recorded income tax expense of $978 thousand and $728 thousand in the three months ended June 30, 2009 and 2008, respectively, based upon our estimated annual effective tax rate. In accordance with SFAS 109, Accounting for Income Taxes , we reevaluated the need for a valuation allowance on our deferred tax assets as a result of cumulative profits generated in the most recent three-year period as well as other positive evidence. As a result of this evaluation, we reduced our deferred tax valuation allowance in the three months ended June 30, 2009 and 2008 and recognized tax benefits of $952 thousand and $1.3 million, respectively, which increased dilutive earnings per share by $0.04 and $0.04, respectively.  Therefore, we recognized tax expense of $26 thousand for the three months ended June 30, 2009, which includes $11 thousand in interest expense for unrecognized tax benefits. Our estimated annual effective tax rate varied from the statutory tax rate because we were able to fully offset U.S. tax expense with net operating loss carryforwards though a release of the valuation allowance.

Discontinued operations. On May 26, 2009, we sold our NetObjects Fusion software business for approximately $4.0 million. During the three months ended June 30, 2009, we received a partial payment of $750 thousand and recorded a $250 thousand receivable in connection with the sale of NetObjects Fusion. We recorded the net gain of $822 thousand in “Gain on sale of discontinued operations, net of tax”. The remaining $3.0 million in proceeds will be recorded as a gain in discontinued operations as cash payments are received. Operating results relating to NetObjects Fusion revenue and expenses for all periods presented are reported in discontinued operations. For the three months ended June 30, 2009 and 2008, the revenue generated by the NetObjects Fusion software business was $162 thousand and $1.0 million and net income was $95 thousand and $360 thousand, respectively.

Comparison of the Results for the Six Months Ended June 30, 2009 to the Results for the Six Months Ended June 30, 2008

 

Revenue

 

		Six months ended June 30,
		2009				2008
		(unaudited)
Revenue:
Subscription		$	51,456			$	60,000
Professional services			1,590				1,271
Other			1,000				100
Total revenue		$	54,046			$	61,371

 

Total revenue for the six months ended June 30, 2009 decreased $7.3 million, or 12%, over the six months ended June 30, 2008. Total revenue during the six months ended June 30, 2009 declined primarily due to decreases in our average revenue per subscriber as compared to the same period of the prior year.

Subscription Revenue . Subscription revenue decreased 14% to $51.5 million in the six months ended June 30, 2009 from $60.0 million in the six months ended June 30, 2008. Subscription revenue decreased approximately $8.5 million primarily due to decreases in our average revenue per subscriber as compared to the prior year, which was slightly offset by additional revenue from our recent acquisition. The decrease in average revenue per subscriber was mainly due to the addition of lower revenue subscribers from our Do-It-Yourself website building and hosting products as well as a reduction in spending by our enterprise partner subscribers.

Net subscribers increased by 1,764 customers during the six months ended June 30, 2009 as compared to an increase of 8,346 during the six months ended June 30, 2008. The average monthly turnover decreased to 3.8% during the six months ended June 30, 2009 from 4.0% during the six months ended June 30, 2008.  Due to the current economic conditions and lower marketing spending, gross subscriber additions were down from 82,750 in the six months ended June 30, 2008 to 70,421 in the six months ended June 30, 2009.

Professional Services Revenue. Professional services revenue increased 25% to $1.6 million in the six months ended June 30, 2009 from $1.3 million in the six months ended June 30, 2008. Professional services revenue increased approximately $887 thousand due to the additional service offerings of eCommerce store design and logo design that were acquired as part of our recent acquisitions, which was partially offset by a decrease of $389 thousand in search engine optimization services.

 

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Other Revenue. Other revenue increased 900% to $1.0 million in the six months ended June 30, 2009 from $100 thousand in the six months ended June 30, 2008. This revenue was earned by the sale of perpetual licenses for the use of our patents.

Cost of Revenue

 

		Six months ended June 30,
		2009				2008
		(unaudited)
Cost of revenue
Subscription		$	18,721			$	21,941
Professional services			876				667
Total cost of revenue		$	19,597			$	22,608

Cost of Subscription Revenue. Cost of subscription revenue decreased 15% to $18.7 million in the six months ended June 30, 2009 from $21.9 million in the six months ended June 30, 2008. During the six months ended June 30, 2009, we reduced costs of approximately $2.2 million, which was driven by the decline of our subscription revenue and slightly offset by additional expense due to the revenue associated with our recent acquisition. In addition, as a lesser percentage of our sales came from our strategic marketing relationships, fees related to these relationships decreased by $1.0 million during the six months ended June 30, 2009. As a result of these savings, our gross margin on subscription revenue increased from 63% during the six months ended June 30, 2008 to 64% during the six months ended June 30, 2009.

 

Cost of Professional Services Revenue. Cost of professional services revenue increased 31% to $876 thousand in the six months ended June 30, 2009 from $667 thousand in the six months ended June 30, 2008. The increase in the cost was primarily the result of the additional costs of approximately $312 thousand related to the eCommerce store design revenue.

 

Operating Expenses

 

		Six months ended June 30,
		2009				2008
		(unaudited)
Operating expenses:
Sales and marketing		$	11,645			$	14,953
Research and development			4,128				4,666
General and administrative			10,851				10,499
Depreciation and amortization			6,790				6,582
Total operating expenses		$	33,414			$	36,700

 

Sales and Marketing Expenses. Sales and marketing expenses decreased 22% to $11.6 million, or 22% of total revenue, during the six months ended June 30, 2009 from $15.0 million, or 24% of total revenue, during the six months ended June 30, 2008. The decrease of $3.3 million in sales and marketing expenses was primarily the result of a reduction in online marketing spending during the quarter, as well as, a reduction in sales resources. Specifically, we saw reductions in employee compensation and benefits expense by $1.1 million and marketing and advertising expense by $2.2 million.

 

Research and Development Expenses. Research and development expenses decreased 12% to $4.1 million, or 8% of total revenue, during the six months ended June 30, 2009 from $4.7 million, or 8% of total revenue, during the six months ended June 30, 2008. During the six months ended June 30, 2009, there was an overall decrease in employee compensation and benefits expense totaling $435 thousand, in addition to the reduction of costs associated with subcontracted labor totaling $118 thousand.

 

General and Administrative Expenses. General and administrative expenses increased 3% to $10.9 million, or 20% of total revenue, during the six months ended June 30, 2009 from $10.5 million, or 17% of total revenue, during the six months ended June 30, 2008. During the six months ended June 30, 2009, we had an increase in professional services expense, specifically legal expenses of $570 thousand that were primarily associated with the sale of patents, in addition to, increases in employee compensation and stock compensation of $291 thousand, of which $188 thousand is associated with our recent acquisition. In addition, due to the current market conditions, we reduced our remaining general and administrative expenses, which partially offset the increases in professional service and compensation expense.

 

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Depreciation and Amortization Expense. Depreciation and amortization expense increased 3% to $6.8 million, or 13% of total revenue, during the six months ended June 30, 2009 from $6.6 million, or 11% of total revenue, during the six months ended June 30, 2008. The increase in amortization and depreciation expense is a result of additional tangible and intangible assets acquired through our recent acquisitions.

  

Net Interest Income. Net interest income decreased 77% to $105 thousand, or less than 1% of total revenue, during the six months ended June 30, 2009 from $448 thousand, or 1% of total revenue, during the six months ended June 30, 2008. The decrease in interest income was due to a reduction in the interest rates of our investment instruments.

Income tax expense. Prior to adjustments to its deferred tax asset valuation reserves, we calculated income tax expense of $1.5 million and $1.4 million in the six months ended June 30, 2009 and 2008, respectively, based upon our estimated annual effective tax rate. In accordance with SFAS 109, Accounting for Income Taxes , we reevaluated the need for a valuation allowance on our deferred tax assets as a result of cumulative profits generated in the most recent three-year period as well as other positive evidence. As a result of this evaluation, we reduced our deferred tax valuation allowance in the six months ended June 30, 2009 and 2008 and recognized tax benefits of $1.5 million and $1.3 million, respectively, which increased dilutive earnings per share by $0.06 and $0.04, respectively.  We reduced our deferred tax valuation allowance based upon an analysis of the amount of deferred taxes that is more likely than not to be realized, which included the consideration of cumulative pretax earnings over the past three years and a short-term forecast of pretax earnings. Therefore, we recognized tax expense of $43 thousand for the six months ended June 30, 2009, which includes $11 thousand of interest expense for unrecognized tax benefits. Our estimated annual effective tax rate varied from the statutory tax rate because we were able to fully offset U.S. tax expense with net operating loss carryforwards though a release of the valuation allowance.

Discontinued operations. On May 26, 2009, we sold our NetObjects Fusion software business for approximately $4.0 million. During the six months ended June 30, 2009, we received a partial payment of $750 thousand and recorded a $250 thousand receivable in connection with the sale of NetObjects Fusion. We recorded the net gain of $822 thousand in “Gain on sale of discontinued operations, net of tax”. The remaining $3.0 million in proceeds will be recorded as a gain in discontinued operations as cash payments are received. Operating results relating to NetObjects Fusion revenue and expenses for all periods presented are reported in discontinued operations. For the six months ended June 30, 2009 and 2008, the revenue generated by the NetObjects Fusion software business was $428 thousand and $1.5 million and net income was $228 thousand and $302 thousand, respectively.

Liquidity and Capital Resources

As of June 30, 2009, we had $35.6 million of unrestricted cash and cash equivalents and $25.5 million in working capital, as compared to $34.1 million of cash and cash equivalents and $24.0 million in working capital as of December 31, 2008.

Net cash provided by operations for the six months ended June 30, 2009 was $8.1 million as compared to the net cash provided by operations of $4.0 million for the six months ended June 30, 2008. The increase of net cash provided by operations over the prior year was primarily the result of $5.0 million in net payments, made during the six months ended June 30, 2008, associated with the accrued restructuring and other accrued liabilities in connection with the Web.com acquisition less $1.0 million paid for liabilities assumed in connection with the Solid Cactus, Inc. and Solid Cactus Call Center, Inc. (collectively, “Solid Cactus”) acquisition during the six months ended June 30, 2009. The decrease of the accounts receivable and deferred revenue balances also contributed to the increase of net cash provided by operations.

 

Net cash used in investing activities in the six months ended June 30, 2009 was $3.2 million as compared to the net cash used in investing activities during the six months ended June 30, 2008 of $2.1 million. During the six months ended June 30, 2009, we acquired substantially all the assets and select liabilities of Solid Cactus for approximately $3.3 million.  Additionally, we sold our NetObjects Fusion software business and recorded net proceeds of $822 thousand in connection with the initial payment. We also invested approximately $513 thousand in property and equipment and intangible assets. During the six months ended June 30, 2008, we acquired certain assets of LogoYes.com and Design Logic, Inc. totaling approximately $4.6 million, including acquisition expenses. We received proceeds from the sales of restricted investments totaling $7.0 million and reinvested $2.5 million of those proceeds. The uninvested proceeds were transferred to a money market account and classified as unrestricted cash. In addition, we purchased $3.2 million of real property and equipment and paid off a note payable and the related $1.2 million of restricted cash was released and classified as unrestricted cash.

Net cash used in financing activities in the six months ended June 30, 2009 was $3.5 million as compared to the net cash used in financing activities during the six months ended June 30, 2009 of $360 thousand. During the six months ended June 30, 2009, we repurchased approximately one million shares of our common stock for $3.5 million and paid $165 thousand for debt obligations we assumed as part of the Solid Cactus acquisition. In addition, we received proceeds from the exercise of stock options totaling $215 thousand. During the six months ended June 30, 2008, we paid $1.1 million to satisfy debt obligations and received proceeds from the exercise of stock options totaling $780 thousand.

 

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Off-Balance Sheet Arrangements

As of June 30, 2009 and June 30, 2008, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Summary

 

Our future capital uses and requirements depend on numerous forward-looking factors. These factors include but are not limited to the following:

 

•

the costs involved in the expansion of our customer base;

 

•

the costs involved with investment in our servers, storage and network capacity;

•

the costs associated with the expansion of our domestic and international activities;

•

the costs associated with the repurchase of our common stock;

•

the costs involved with our research and development activities to upgrade and expand our service offerings; and

 

•

the extent to which we acquire or invest in other technologies and businesses.

 

We believe that our existing cash and cash equivalents will be sufficient to meet our projected operating requirements for at least the next 12 months, including our sales and marketing expenses, research and development expenses, capital expenditures, and any acquisitions or investments in complementary businesses, services, products or technologies.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk.

Foreign Currency Exchange Risk

 

Our results of operations and cash flows are subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the Euro and the Canadian Dollar. We will analyze our exposure to currency fluctuations and may engage in financial hedging techniques in the future to reduce the effect of these potential fluctuations. We have not entered into any hedging contracts since exchange rate fluctuations have had little impact on our operating results and cash flows. The majority of our subscription agreements are denominated in U.S. dollars. To date, our foreign sales have been primarily in Euros. Sales to customers domiciled outside the United States were approximately 1% and 3% of our total revenue in the three months ended June 30, 2009 and 2008, respectively. Sales to customers domiciled outside the United States were approximately 1% and 2% of our total revenue in the six months ended June 30, 2009 and 2008, respectively. Sales in Germany represented approximately 66% and 72% of our international revenue in the three months ended June 30, 2009 and 2008, respectively, and 60% and 68% in the six months ended June 30, 2009 and 2008, respectively.

 

Interest Rate Sensitivity

 

We had unrestricted cash and cash equivalents totaling $35.6 million and $34.1 million at June 30, 2009 and December 31, 2008, respectively. These amounts were invested primarily in money market funds. The unrestricted cash, cash equivalents and short-term marketable securities are held for working capital purposes. We do not enter into investments for trading or speculative purposes. Due to the short-term nature of these investments, we believe that we do not have any material exposure to changes in the fair value of our investment portfolio as a result of changes in interest rates. Declines in interest rates, however, will reduce future investment income.

 

Item 4.

Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures.

 

Based on their evaluation as of June 30, 2009, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) were effective at the reasonable assurance level to ensure that the information required to be disclosed by us in this quarterly report on Form 10-Q was recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules, and that such information is accumulated and communicated to us to allow timely decisions regarding required disclosures.

 

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Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives. Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our Company have been detected.

 

Changes in Internal controls Over Financial Reporting.

 

There have been no changes in our internal controls over financial reporting during the three months ended June 30, 2009 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 

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PART II—OTHER INFORMATION

Item 1.

Legal Proceedings.

From time to time the Company may be involved in litigation relating to claims arising out of its operations. There are several outstanding litigation matters that relate to its wholly-owned subsidiary, Web.com Holding Company, Inc., formerly Web.com, Inc. (“Web.com Holding”), including the following:

 

On August 2, 2006, Web.com Holding filed suit in the United States District Court for the Western District of Pennsylvania against Federal Insurance Company and Chubb Insurance Company of New Jersey, seeking insurance coverage and payment of litigation expenses with respect to litigation involving Web.com Holding pertaining to events in 2001. Web.com Holding also has asserted claims against Rapp Collins, a division of Omnicom Media, that are pending in state court in Pennsylvania for recovery of the same litigation expenses. These actions were consolidated in state court in Pennsylvania on September 30, 2008.

 

On June 19, 2006, Web.com Holding filed suit in the United States District Court for the Northern District of Georgia against The Go Daddy Group, Inc., seeking damages, a permanent injunction and attorney fees related to alleged infringement of four of Web.com Holdings’ patents. On January 8, 2009, the parties entered into a confidential settlement and patent cross-licensing agreement, which resolves the lawsuit. The revenue derived from the sale of the patent license is reflected in other revenue for the six months ended June 30, 2009.

The outcome of any litigation cannot be assured, and despite management’s views of the merits of any litigation, or the reasonableness of the Company’s estimates and reserves, the Company’s cash balances could nonetheless be materially affected by an adverse judgment. In accordance with SFAS 5, Accounting for Contingencies , the Company believes it has adequately reserved for the contingencies arising from the current legal matters where an outcome was deemed to be probable and the loss amount could be reasonably estimated. As such, the Company does not believe that the anticipated outcome of any current litigation will have a materially adverse impact on its financial condition, cash flows, or results of operations.  

 

Item 1A.               Risk Factors.

 

Factors That May Affect Future Operating Results

 

In addition to the risks discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” our business is subject to the risks set forth below.

Depressed general economic conditions or adverse changes in general economic conditions could adversely affect our operating results.   If economic or other factors negatively affect the small and medium-sized business sector, our customers may become unwilling or unable to purchase our Web services and products, which could cause our revenue to decline and impair our ability to operate profitably.

 

As our business has grown, we have become increasingly subject to the risks arising from adverse changes in domestic and global economic conditions. Uncertainty about future economic conditions makes it difficult for us to forecast operating results and to make decisions about future investments. For example, the direction and relative strength of the global economy has recently been increasingly uncertain due to softness in the residential real estate and mortgage markets, volatility in fuel and other energy costs, difficulties in the financial services sector and credit markets, continuing geopolitical uncertainties and other macroeconomic factors affecting spending behavior. If economic growth in the United States is slowed, or if other adverse general economic changes occur or continue, many customers may delay or reduce technology purchases or marketing spending. This could result in reductions in sales of our Web services and products, longer sales cycles, and increased price competition .

 

Our existing and target customers are small and medium-sized businesses. We believe these businesses are more likely to be significantly affected by economic downturns than larger, more established businesses. For instance, the current global financial crisis affecting the banking system and financial markets and the possibility that financial institutions may consolidate or go out of business have resulted in a tightening in the credit markets, which could limit our customers’ access to credit. Additionally, these customers often have limited discretionary funds, which they may choose to spend on items other than our Web services and products. If small and medium-sized businesses experience economic hardship , or if they behave more conservatively in light of the general economic environment , they may be unwilling or unable to expend resources to develop their online presences, which would negatively affect the overall demand for our services and products and could cause our revenue to decline.

 

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Most of our Web services are sold on a month-to-month basis, and if our customers are unable or choose not to subscribe to our Web services, our revenue may decrease.

 

Typically, our Web service offerings are sold pursuant to month-to-month subscription agreements, and our customers can generally cancel their subscriptions to our Web services at any time with little or no penalty.

 

Historically, we have experienced a high turnover rate in our customer base. For the years ended December 31, 2008 and 2007, 46% and 43%, respectively, of our subscribers who were customers at the beginning of the respective year were no longer subscribers at the end of the respective year. For the six months ended June 30, 2009 and 2008, 22% and 29%, respectively, of our subscribers who were customers at the beginning of the respective period were no longer subscribers at the end of the period. The turnover rate calculations do not include any acquisition related customer activity.

While we cannot determine with certainty why our subscription renewal rates are not higher, we believe there are a variety of factors, which have in the past led, and may in the future lead, to a decline in our subscription renewal rates. These factors include the cessation of our customers’ businesses, the overall economic environment in the United States and its impact on small and medium-sized businesses, the services and prices offered by us and our competitors, and the evolving use of the Internet by small and medium-sized businesses. If our renewal rates are low or decline for any reason, or if customers demand renewal terms less favorable to us, our revenue may decrease, which could adversely affect our stock price.

We depend on our strategic marketing relationships to identify prospective customers. The loss of several of our strategic marketing relationships, or a reduction in the referrals and leads they generate, would significantly reduce our future revenue and increase our expenses.

 

As a key part of our strategy, we have entered into agreements with a number of companies pursuant to which these parties provide us with access to their customer lists and allow us to use their names in marketing our Web services and products. Approximately 18% of our new customers in the year ended December 31, 2008 and approximately 11% of our new customers in the six months ended June 30, 2009, were identified through our strategic marketing relationships. We believe these strategic marketing relationships are critical to our business because they enable us to penetrate our target market with a minimum expenditure of resources. If these strategic marketing relationships are terminated or otherwise fail, our revenue would likely decline significantly and we could be required to devote additional resources to the sale and marketing of our Web services and products. We have no long-term contracts with these organizations, and these organizations are generally not restricted from working with our competitors. Accordingly, our success will depend upon the willingness of these organizations to continue these strategic marketing relationships.

 

To successfully execute our business plan, we must also establish new strategic marketing relationships with additional organizations that have strong relationships with small and medium-sized businesses that would enable us to identify additional prospective customers. If we are unable to diversify and extend our strategic marketing relationships, our ability to grow our business may be compromised.  

 

Our growth will be adversely affected if we cannot continue to successfully retain, hire, train, and manage our key employees, particularly in the telesales and customer service areas.

 

Our ability to successfully pursue our growth strategy will depend on our ability to attract, retain, and motivate key employees across our business. We have many key employees throughout our organization that do not have non-competition agreements and may leave to work for a competitor at any time. In particular, we are substantially dependent on our telesales and customer service employees to obtain and service new customers. Competition for such personnel and others can be intense, and there can be no assurance that we will be able to attract, integrate, or retain additional highly qualified personnel in the future. In addition, our ability to achieve significant growth in revenue will depend, in large part, on our success in effectively training sufficient personnel in these two areas. New hires require significant training and in some cases may take several months before they achieve full productivity, if they ever do. Our recent hires and planned hires may not become as productive as we would like, and we may be unable to hire sufficient numbers of qualified individuals in the future in the markets where we have our facilities. If we are not successful in retaining our existing employees, or hiring, training and integrating new employees, or if our current or future employees perform poorly, growth in the sales of our services and products may not materialize and our business will suffer.

 

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We may expand through acquisitions of, or investments in, other companies or technologies, which may result in additional dilution to our stockholders and consume resources that may be necessary to sustain our business.

 

One of our business strategies is to acquire complementary services, technologies or businesses. In connection with one or more of those transactions, we may:

 

•

issue additional equity securities that would dilute our stockholders;

 

•

use cash that we may need in the future to operate our business; and

 

•

incur debt that could have terms unfavorable to us or that we might be unable to repay.

 

Business acquisitions also involve the risk of unknown liabilities associated with the acquired business. In addition, we may not realize the anticipated benefits of any acquisition, including securing the services of key employees. Incurring unknown liabilities or the failure to realize the anticipated benefits of an acquisition could seriously harm our business.

 

We may find it difficult to integrate recent and potential future business combinations, which could disrupt our business, dilute stockholder value, and adversely affect our operating results.

 

During the course of our history, we have completed several acquisitions of other businesses, and a key element of our strategy is to continue to acquire other businesses in the future. In particular, we completed the Solid Cactus acquisition in April 2009. Integrating this recently acquired business and assets and any businesses or assets we may acquire in the future could add significant complexity to our business and additional burdens to the substantial tasks already performed by our management team. In the future, we may not be able to identify suitable acquisition candidates, and if we do, we may not be able to complete these acquisitions on acceptable terms or at all. In connection with our recent and possible future acquisitions, we may need to integrate operations that have different and unfamiliar corporate cultures. Likewise, we may need to integrate disparate technologies and Web service and product offerings, as well as multiple direct and indirect sales channels. The key personnel of the acquired company may decide not to continue to work for us. These integration efforts may not succeed or may distract our management’s attention from existing business operations. Our failure to successfully manage and integrate these current acquisitions, or any future acquisitions could seriously harm our business.

 

Accounting for acquisitions under generally accepted accounting principles could adversely affect our reported financial results.

 

Acquisitions could require us to record substantial amounts of goodwill and other intangible assets. For example, during the year ended December 31, 2008, we completed our annual impairment test of goodwill and other indefinite lived intangible assets. We performed the initial step of our impairment evaluation by comparing the fair market value of our Company, as determined by using a discounted cash flow and market approach giving equal weight to both models, to its carrying value. As the carrying amount exceeded the fair value, we performed the second step of our impairment evaluation to calculate impairment and as a result recorded a goodwill and intangible asset impairment charge of $102.6 million. The primary reason for the impairment charge was the decline of our stock price during the fourth quarter of 2008. Any future impairment of this goodwill, and the ongoing amortization of other intangible assets, could adversely affect our reported financial results.

 

After being profitable for the years ended December 31, 2005, 2006, and 2007, we were not profitable for the year ended December 31, 2008 and we may not become or stay profitable in the future.

 

Although we generated net income for the years ended December 31, 2005, 2006, and 2007 and the six months ended June 30, 2009, we have not historically been profitable, were not profitable for the year ended December 31, 2008, and may not be profitable in future periods.  As of June 30, 2009, we had an accumulated deficit of approximately $151.9 million. We expect that our expenses relating to the sale and marketing of our Web services, technology improvements and general and administrative functions, as well as the costs of operating and maintaining our technology infrastructure, will increase in the future. Accordingly, we will need to increase our revenue to be able to again achieve and, if achieved, to later maintain profitability. We may not be able to reduce in a timely manner or maintain our expenses in response to any decrease in our revenue, and our failure to do so would adversely affect our operating results and our level of profitability.

 

Our operating results are difficult to predict and fluctuations in our performance may result in volatility in the market price of our common stock.

 

Due to our limited operating history, our evolving business model, and the unpredictability of our emerging industry, our operating results are difficult to predict. We expect to experience fluctuations in our operating and financial results due to a number of factors, such as:

 

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•

our ability to retain and increase sales to existing customers, attract new customers, and satisfy our customers’ requirements;

 

•

the renewal rates for our services;

 

•

changes in our pricing policies;

 

•

the introduction of new services and products by us or our competitors;

 

•

our ability to hire, train and retain members of our sales force;

 

•

the rate of expansion and effectiveness of our sales force;

 

•

technical difficulties or interruptions in our services;

 

•

general economic conditions;

 

•

additional investment in our services or operations;

•

ability to successfully integrate acquired businesses and technologies; and

 

•

our success in maintaining and adding strategic marketing relationships.

 

These factors and others all tend to make the timing and amount of our revenue unpredictable and may lead to greater period-to-period fluctuations in revenue than we have experienced historically.

 

As a result of these factors, and in light of current global and U.S. economic conditions, we believe that our quarterly revenue and results of operations are likely to vary significantly in the future and that period-to-period comparisons of our operating results may not be meaningful. The results of one quarter may not be relied on as an indication of future performance. If our quarterly revenue or results of operations fall below the expectations of investors or securities analysts, the price of our common stock could decline substantially.

 

Our business depends in part on our ability to continue to provide value-added Web services and products, many of which we provide through agreements with third parties, and our business will be harmed if we are unable to provide these Web services and products in a cost-effective manner.

 

A key element of our strategy is to combine a variety of functionalities in our Web service offerings to provide our customers with comprehensive solutions to their online presence needs, such as Internet search optimization, local yellow pages listings, and eCommerce capability. We provide many of these services through arrangements with third parties, and our continued ability to obtain and provide these services at a low cost is central to the success of our business. For example, we currently have agreements with several service providers that enable us to provide, at a low cost, Internet yellow pages advertising. However, these agreements may be terminated on short notice, typically 60 to 90 days, and without penalty. If any of these third parties were to terminate their relationships with us, or to modify the economic terms of these arrangements, we could lose our ability to provide these services at a cost-effective price to our customers, which could cause our revenue to decline or our costs to increase.

 

We have a risk of system and Internet failures, which could harm our reputation, cause our customers to seek reimbursement for services paid for and not received, and cause our customers to seek another provider for services.

We must be able to operate the systems that manage our network around the clock without interruption. Its operations will depend upon our ability to protect its network infrastructure, equipment, and customer files against damage from human error, fire, earthquakes, hurricanes, floods, power loss, telecommunications failures, sabotage, intentional acts of vandalism and similar events. Our networks are currently subject to various points of failure. For example, a problem with one of our routers (devices that move information from one computer network to another) or switches could cause an interruption in the services that we provide to some or all of our customers. In the past, we have experienced periodic interruptions in service. We have also experienced, and in the future we may continue to experience, delays or interruptions in service as a result of the accidental or intentional actions of Internet users, current and former employees, or others. Any future interruptions could:

·

Cause customers or end users to seek damages for losses incurred;

 

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·

Require the Company to replace existing equipment or add redundant facilities;

·

Damage the Company’s reputation for reliable service;

·

Cause existing customers to cancel their contracts; or

·

Make it more difficult for the Company to attract new customers.

Our data centers are maintained by third parties.

A substantial portion of the network services and computer servers we utilize in the provision of services to customers are housed in data centers owned by other service providers. In particular, a significant number of our servers are housed in data centers in Atlanta, Georgia, and Jacksonville, Florida. We obtain Internet connectivity for those servers, and for the customers who rely on those servers, in part through direct arrangements with network service providers and in part indirectly through the owners of those data centers. We also utilize other third-party data centers in other locations. In the future, we may house other servers and hardware items in facilities owned or operated by other service providers.

 

A disruption in the ability of one of these service providers to provide service to us could cause a disruption in service to our customers. A service provider could be disrupted in its operations through a number of contingencies, including unauthorized access, computer viruses, accidental or intentional actions, electrical disruptions, and other extreme conditions. Although we believe we have taken adequate steps to protect our business through contractual arrangements with our service providers, we cannot eliminate the risk of a disruption in service resulting from the accidental or intentional disruption in service by a service provider. Any significant disruption could cause significant harm to us, including a significant loss of customers. In addition, a service provider could raise its prices or otherwise change its terms and conditions in a way that adversely affects our ability to support our customers or could result in a decrease in our financial performance.

We rely heavily on the reliability, security, and performance of our internally developed systems and operations, and any difficulties in maintaining these systems may result in service interruptions, decreased customer service, or increased expenditures.

 

The software and workflow processes that underlie our ability to deliver our Web services and products have been developed primarily by our own employees. The reliability and continuous availability of these internal systems are critical to our business, and any interruptions that result in our inability to timely deliver our Web services or products, or that materially impact the efficiency or cost with which we provide these Web services and products, would harm our reputation, profitability, and ability to conduct business. In addition, many of the software systems we currently use will need to be enhanced over time or replaced with equivalent commercial products, either of which could entail considerable effort and expense. If we fail to develop and execute reliable policies, procedures, and tools to operate our infrastructure, we could face a substantial decrease in workflow efficiency and increased costs, as well as a decline in our revenue.

 

We face intense and growing competition. If we are unable to compete successfully, our business will be seriously harmed.

 

The market for our Web services and products is competitive and has relatively low barriers to entry. Our competitors vary in size and in the variety of services they offer. We encounter competition from a wide variety of company types, including:

 

•

Website design and development service and software companies;

 

•

Internet service providers and application service providers;

 

•

Internet search engine providers;

 

•

Local business directory providers; and

 

•

Website domain name providers and hosting companies.

 

In addition, due to relatively low barriers to entry in our industry, we expect the intensity of competition to increase in the future from other established and emerging companies. Increased competition may result in price reductions, reduced gross margins, and loss of market share, any one of which could seriously harm our business. We also expect that competition will increase as a result of industry consolidations and formations of alliances among industry participants.

 

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Many of our current and potential competitors have longer operating histories, significantly greater financial, technical, marketing and other resources, greater brand recognition and, we believe, a larger installed base of customers. These competitors may be able to adapt more quickly to new or emerging technologies and changes in customer requirements. They may also be able to devote greater resources to the promotion and sale of their services and products than we can. If we fail to compete successfully against current or future competitors, our revenue could increase less than anticipated or decline, and our business could be harmed.

 

Our failure to build brand awareness quickly could compromise our ability to compete and to grow our business.

 

As a result of the anticipated increase in competition in our market, and the likelihood that some of this competition will come from companies with established brands, we believe brand name recognition and reputation will become increasingly important. Our strategy of relying significantly on third-party strategic marketing relationships to find new customers may impede our ability to build brand awareness, as our customers may wrongly believe our Web services and products are those of the parties with which we have strategic marketing relationships. If we do not continue to build brand awareness quickly, we could be placed at a competitive disadvantage to companies whose brands are more recognizable than ours.

 

If our security measures are breached, our services may be perceived as not being secure, and our business and reputation could suffer.

 

Our Web services involve the storage and transmission of our customers’ proprietary information. Although we employ data encryption processes, an intrusion detection system, and other internal control procedures to assure the security of our customers’ data, we cannot guarantee that these measures will be sufficient for this purpose. If our security measures are breached as a result of third-party action, employee error or otherwise, and as a result our customers’ data becomes available to unauthorized parties, we could incur liability and our reputation would be damaged, which could lead to the loss of current and potential customers. If we experience any breaches of our network security or sabotage, we might be required to expend significant capital and other resources to remedy, protect against or alleviate these and related problems, and we may not be able to remedy these problems in a timely manner, or at all. Because techniques used by outsiders to obtain unauthorized network access or to sabotage systems change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or implement adequate preventative measures.

 

If we cannot adapt to technological advances, our Web services and products may become obsolete and our ability to compete would be impaired.

 

Changes in our industry occur very rapidly, including changes in the way the Internet operates or is used by small and medium-sized businesses and their customers. As a result, our Web services and products could become obsolete quickly. The introduction of competing products employing new technologies and the evolution of new industry standards could render our existing products or services obsolete and unmarketable. To be successful, our Web services and products must keep pace with technological developments and evolving industry standards, address the ever-changing and increasingly sophisticated needs of our customers, and achieve market acceptance. If we are unable to develop new Web services or products, or enhancements to our Web services or products, on a timely and cost-effective basis, or if new Web services or products or enhancements do not achieve market acceptance, our business would be seriously harmed.

 

Providing Web services and products to small and medium-sized businesses designed to allow them to Internet-enable their businesses is a new and emerging market; if this market fails to develop, we will not be able to grow our business.

 

Our success depends on a significant number of small and medium-sized business outsourcing website design, hosting, and management as well as adopting other online business solutions. The market for our Web services and products is relatively new and untested. Custom website development has been the predominant method of Internet enablement, and small and medium-sized businesses may be slow to adopt our template-based Web services and products. Further, if small or medium-sized businesses determine that having an online presence is not giving their businesses an advantage, they would be less likely to purchase our Web services and products. If the market for our Web services and products fails to grow or grows more slowly than we currently anticipate, or if our Web services and products fail to achieve widespread customer acceptance, our business would be seriously harmed.

 

We are dependent on our executive officers, and the loss of any key member of this team may compromise our ability to successfully manage our business and pursue our growth strategy.

 

Our future performance depends largely on the continuing service of our executive officers and senior management team, especially those of David Brown, our Chief Executive Officer. Our executives are not contractually obligated to remain employed by us. Accordingly, any of our key employees could terminate their employment with us at any time without penalty and may go to work for one or more of our competitors after the expiration of their non-compete period. The loss of one or more of our executive officers could make it more difficult for us to pursue our business goals and could seriously harm our business.

 

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Any growth could strain our resources and our business may suffer if we fail to implement appropriate controls and procedures to manage our growth.

 

Growth in our business may place a strain on our management, administrative, and sales and marketing infrastructure. If we fail to successfully manage our growth, our business could be disrupted, and our ability to operate our business profitably could suffer. Growth in our employee base may be required to expand our customer base and to continue to develop and enhance our Web service and product offerings. To manage growth of our operations and personnel, we would need to enhance our operational, financial, and management controls and our reporting systems and procedures. This would require additional personnel and capital investments, which would increase our cost base. The growth in our fixed cost base may make it more difficult for us to reduce expenses in the short term to offset any shortfalls in revenue.

 

We may be unable to protect our intellectual property adequately or cost-effectively, which may cause us to lose market share or force us to reduce our prices.

 

Our success depends, in part, on our ability to protect and preserve the proprietary aspects of our technology, Web services, and products. If we are unable to protect our intellectual property, our competitors could use our intellectual property to market services and products similar to those offered by us, which could decrease demand for our Web services and products. We may be unable to prevent third parties from using our proprietary assets without our authorization. While we do rely on patents acquired from the Web.com acquisition, we do not currently rely on patents to protect all of our core intellectual property. To protect, control access to, and limit distribution of our intellectual property, we generally enter into confidentiality and proprietary inventions agreements with our employees, and confidentiality or license agreements with consultants, third-party developers, and customers. We also rely on copyright, trademark, and trade secret protection. However, these measures afford only limited protection and may be inadequate. Enforcing our rights to our technology could be costly, time-consuming and distracting. Additionally, others may develop non-infringing technologies that are similar or superior to ours. Any significant failure or inability to adequately protect our proprietary assets will harm our business and reduce our ability to compete.

 

If we fail to maintain an effective system of internal controls, we may not be able to accurately or timely report our financial results, which could cause our stock price to fall or result in our stock being delisted.

 

Effective internal controls are necessary for us to provide reliable and accurate financial reports. We will need to devote significant resources and time to comply with the requirements of Sarbanes-Oxley with respect to internal control over financial reporting. In addition, Section 404 under Sarbanes-Oxley requires that we assess and our auditors attest to the design and operating effectiveness of our controls over financial reporting. Our ability to comply with the annual internal control report requirement for our fiscal year ending on December 31, 2009, will depend on the effectiveness of our financial reporting and data systems and controls across our company and our operating subsidiaries. We expect these systems and controls to become increasingly complex to the extent that we integrate acquisitions and our business grows. To effectively manage this complexity, we will need to continue to improve our operational, financial, and management controls and our reporting systems and procedures. Any failure to implement required new or improved controls, or difficulties encountered in the implementation or operation of these controls, could harm our operating results or cause us to fail to meet our financial reporting obligations, which could adversely affect our business and jeopardize our listing on the NASDAQ Global Market, either of which would harm our stock price.

 

We might require additional capital to support business growth, and this capital might not be available on acceptable terms, or at all.

 

We intend to continue to make investments to support our business growth and may require additional funds to respond to business challenges, including the need to develop new services and products or enhance our existing Web services, enhance our operating infrastructure and acquire complementary businesses and technologies. Accordingly, we may need to engage in equity or debt financings to secure additional funds. Financial market disruption and general economic conditions in which the credit markets are severely constrained and the depressed equity markets may make it difficult for us   to obtain additional financing on terms favorable to us, if at all . If we raise additional funds through further issuances of equity or convertible debt securities, our existing stockholders could suffer significant dilution, and any new equity securities we issue could have rights, preferences and privileges superior to those of holders of our common stock. Any debt financing secured by us in the future could involve restrictive covenants relating to our capital raising activities and other financial and operational matters, which may make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions. If we are unable to obtain adequate financing or financing on terms satisfactory to us, when we require it, our ability to continue to support our business growth and to respond to business challenges could be significantly impaired.

 

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Provisions in our amended and restated certificate of incorporation and bylaws or under Delaware law might discourage, delay, or prevent a change of control of our company or changes in our management and, therefore, depress the trading price of our common stock.

 

Our amended and restated certificate of incorporation and bylaws contain provisions that could depress the trading price of our common stock by acting to discourage, delay, or prevent a change of control of our company or changes in our management that the stockholders of our company may deem advantageous. These provisions:

 

•

establish a classified board of directors so that not all members of our board are elected at one time;

 

•

provide that directors may only be removed for cause and only with the approval of 66  2 /3% of our stockholders;

 

•

require super-majority voting to amend some provisions in our amended and restated certificate of incorporation and bylaws;

 

•

authorize the issuance of blank check preferred stock that our board of directors could issue to increase the number of outstanding shares to discourage a takeover attempt;

 

•

prohibit stockholder action by written consent, which requires all stockholder actions to be taken at a meeting of our stockholders;

 

•

provide that the board of directors is expressly authorized to make, alter, or repeal our bylaws; and

 

•

establish advance notice requirements for nominations for elections to our board or for proposing matters that can be acted upon by stockholders at stockholder meetings.

 

Additionally, we are subject to Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any “interested” stockholder for a period of three years following the date on which the stockholder became an “interested” stockholder and which may discourage, delay, or prevent a change of control of our company.

 

If we do not integrate our services and products related to an acquisition, we may lose customers and fail to achieve our financial objectives.

Achieving the benefits of any acquisition will depend in part upon the integration of the acquisition’s services and products with those offered by us in a timely and efficient manner. To provide enhanced and more valuable services and products to our customers after, we also need to integrate our operations. This may be difficult, unpredictable, and subject to delay because our services and products would be developed, marketed and sold independently and were designed without regard to such integration. If we cannot successfully integrate our services and products and continue to provide customers with enhanced services and products after an acquisition on a timely basis, we may lose customers and our business and results of operations may suffer.

We may not realize the anticipated benefits from an acquisition.

Acquisitions involve the integration of companies that have previously operated independently. We expect that acquisitions may result in financial and operational benefits, including increased revenue, cost savings and other financial and operating benefits. We cannot be certain, however, that we will be able to realize increased revenue, cost savings or other benefits from any acquisition, or, to the extent such benefits are realized, that they are realized timely. Integration may also be difficult, unpredictable, and subject to delay because of possible cultural conflicts and different opinions on product roadmaps or other strategic matters. We may integrate or, in some cases, replace, numerous systems, including those involving management information, purchasing, accounting and finance, sales, billing, employee benefits, payroll and regulatory compliance, many of which may be dissimilar. Difficulties associated with integrating an acquisition’s service and product offering into ours, or with integrating an acquisition’s operations into ours, could have a material adverse effect on the combined company and the market price of our common stock.

 

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Charges to earnings resulting from acquisitions may adversely affect our operating results.

Under purchase accounting, we allocate the total purchase price to an acquired company’s net tangible assets, intangible assets based on their fair values as of the date of the acquisition and record the excess of the purchase price over those fair values as goodwill. Our management’s estimates of fair value are based upon assumptions believed to be reasonable but are inherently uncertain. Going forward, the following factors could result in material charges that would adversely affect our results:

•

impairment of goodwill;

•

charges for the amortization of identifiable intangible assets and for stock-based compensation;

•

accrual of newly identified pre-merger contingent liabilities that are identified subsequent to the finalization of the purchase price allocation; and

•

charges to income to eliminate certain Web.com Group pre-merger activities that duplicate those of the acquired company or to reduce our cost structure.

For example, during the year ended December 31, 2008, we completed our annual impairment test of goodwill. We performed the initial step of our impairment evaluation by comparing the fair market value of our Company, as determined by using a discounted cash flow and market approach giving equal weight to both models, to its carrying value. As the carrying amount exceeded the fair value, we performed the second step of our impairment evaluation to calculate impairment and as a result recorded a goodwill impairment charge of $102.3 million. The primary reason for the impairment charge was the decline of our stock price during the fourth quarter of 2008. We expect to incur additional costs associated with combining of acquired companies, which may be substantial. Additional costs may include costs of employee redeployment, relocation and retention, including salary increases or bonuses, accelerated amortization of deferred equity compensation and severance payments, reorganization or closure of facilities, taxes and termination of contracts that provide redundant or conflicting services. Some of these costs may have to be accounted for as expenses that would decrease Web.com Group’s net income and earnings per share for the periods in which those adjustments are made.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

Recent Sales of Unregistered Securities

During the three months ended June 30, 2009, Friedman, Billings, Ramsey Group, Inc. (“FBR”) exercised, or caused to be exercised, its warrants to purchase 21,148 shares of common stock of the Company.  The warrants were cash and net exercised by the recipients with an exercise price of $2.88.

Issuer Purchases of Equity Securities

 

On September 4, 2008, we announced that our Board of Directors authorized the repurchase of up to $20 million of the Company’s outstanding common shares over the next eighteen months. The timing, price and volume of repurchases will be based on market conditions, liquidity, relevant securities laws and other factors.  The Company may terminate the repurchase program at any time without notice.

 

The following table sets forth information about our stock repurchases for the three months ended June 30, 2009:

 

Issuer Purchases of Equity Securities

										Total number of  shares				Maximum dollar  value
		Total  number				Average				purchased as part of				of shares that may  yet
		of shares				price  paid				publicly announced				be purchased under  the
Period (1)		purchased  (1)				per share				plans or programs				plan (in thousands)  (2)
April 1, 2009 - April 30, 2009			-			$	-				-			$	10,497
May 1, 2009 - May 31, 2009			195,815				4.42				195,815				9,632
June 1, 2009 - June 30, 2009			-				-				-				9,632

(1) Based on trade date; not settlement date.

(2) On September 4, 2008, the Company announced a stock repurchase program which authorized the Company to repurchase up to $20 million of the Company's outstanding common stock over the next eighteen months.

 

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Item 3.

Defaults Upon Senior Securities.

 

Not applicable.

 

Item 4.

Submission of Matters to a Vote of Security Holders.

 

We held our Annual Meeting of Stockholders on May 6, 2009. The following is a brief description of each matter voted upon at the meeting and the number of votes cast for, withheld, or against, the number of abstentions and the number of broker non-votes with respect to each matter:

 

1.

The election of the following two directors to hold office until the 2012 Annual Meeting of Stockholders or until their successors are duly elected and have qualified:

 

Director Name		Shares voted for				Voting Authority Withheld
Hugh M. Durden			14,575,981				8,884,939
Jeffrey M. Stibel			14,027,589				9,433,331

 

2.

The ratification of the selection of Ernst & Young LLP, as our independent registered public accounting firm for the fiscal year ended December 31, 2009:

 

Shares Voted										Broker
For		Against				Abstaining				Non-Votes
23,388,740			52,570				19,610				—

 

Item 5.

Other Information.

 

Not applicable.

 

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Item 6.

Exhibits.

Exhibit No.			Description of Document
3.1			Amended and Restated Certificate of Incorporation of Web.com Group, Inc. (1)
3.2			Amended and Restated Bylaws of Web.com Group, Inc. (2)
3.3			Certificate of Ownership and Merger of Registration (3)
4.1			Reference is made to Exhibits 3.1 and 3.2
4.2			Specimen Stock Certificate. (3)
31.1			CEO Certification required by Rule 13a-14(a) or Rule 15d-14(a).
31.2			CFO Certification required by Rule 13a-14(a) or Rule 15d-14(a).
32.1			Certification required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. §1350). (4)

 

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(1)	Filed as an Exhibit the Registrant’s registration statement on Form S-1 (No. 333-124349), filed with the SEC on April 27, 2005, as amended, and incorporated herein by reference.

(2)	Filed as an Exhibit the Registrant’s current report on Form 8-K (000-51595), filed with the SEC on February 10, 2009, and incorporated herein by reference.

(3)	Filed as an Exhibit to the Registrant’s current report on Form 8-K (000-51595), filed with the SEC on October 30, 2008, and incorporated herein by reference.

(4)

The certification attached as Exhibit 32.1 accompanying this Quarterly Report on Form 10-Q, is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of Web.com Group, Inc. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Quarterly Report on Form 10-Q, irrespective of any general incorporation language contained in such filing.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

	Web.com Group, Inc.
	(Registrant)
August 5, 2009	/s/     Kevin M. Carney
Date	Kevin M. Carney Chief Financial Officer (Principal Financial and Accounting Officer)

 

 

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I NDEX OF E XHIBITS

 

Exhibit No.			Description of Document
3.1			Amended and Restated Certificate of Incorporation of Web.com Group, Inc. (1)
3.2			Amended and Restated Bylaws of Web.com Group, Inc. (2)
3.3			Certificate of ownership and Merger of Registrant. (3)
4.1			Reference is made to Exhibits 3.1 and 3.2
4.2			Specimen Stock Certificate. (3)
31.1			CEO Certification required by Rule 13a-14(a) or Rule 15d-14(a).
31.2			CFO Certification required by Rule 13a-14(a) or Rule 15d-14(a).
32.1			Certification required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. §1350). (4)

 

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(1)	Filed as an Exhibit the Registrant’s registration statement on Form S-1 (No. 333-124349), filed with the SEC on April 27, 2005, as amended, and incorporated herein by reference.

(2)	Filed as an Exhibit the Registrant’s current report on Form 8-K (000-51595), filed with the SEC on February 10, 2009, and incorporated herein by reference.

(3)	Filed as an Exhibit to the Registrant’s current report on Form 8-K (000-51595), filed with the SEC on October 30, 2008, and incorporated herein by reference.

(4)

The certification attached as Exhibits 32.1 accompanying this Quarterly Report on Form 10-Q, is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of Web.com Group, Inc. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Quarterly Report on Form 10-Q, irrespective of any general incorporation language contained in such filing.

 

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Exhibit 31.1

 

CERTIFICATION

 

I, David L. Brown, certify that:

 

1.	I have reviewed this quarterly report on Form 10-Q of Web.com Group, Inc.;

 

2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4.

The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

(a)

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

(b)

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

(c)

Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

(d)

Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5.	The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

(a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

(b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: August 5, 2009

 

By:	/s/     David L. Brown
	David L. Brown Chief Executive Officer and Chairman of the Board (Principal Executive Officer)

 

 

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Exhibit 31.2

 

CERTIFICATION

 

I, Kevin M. Carney, certify that:

 

1.	I have reviewed this quarterly report on Form 10-Q of Web.com Group, Inc.;

 

2.	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3.	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4.

The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

 

(a)

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

(b)

Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

(c)

Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

(d)

Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5.	The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

(a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which