Web.com Group, Inc.
WEB.COM GROUP, INC. (Form: 10-Q, Received: 11/08/2016 10:54:12)


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________________  
FORM 10-Q
________________________   
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2016
 
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                 to                
 
Commission File Number: 000-51595
________________________ 
Web.com Group, Inc.
(Exact name of registrant as specified in its charter)
________________________  
Delaware
94-3327894
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
12808 Gran Bay Parkway, West, Jacksonville, FL
32258
(Address of principal executive offices)
(Zip Code)
 
(904) 680-6600
(Registrant’s telephone number, including area code)
 
(Former name, former address and former fiscal year, if changed since last report)
________________________ 
  
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ý   Yes    ¨   No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ý   Yes    ¨   No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. 
Large accelerated filer x
Accelerated filer ¨
Non-accelerated filer ¨
Smaller reporting company ¨
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨   Yes    ý   No 

Common Stock, par value $0.001 per share, outstanding as of November 1, 2016 : 50,856,638




Web.com Group, Inc.
 
Quarterly Report on Form 10-Q
 
For the Quarterly Period ended September 30, 2016
 
Index
 
Part I
 
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
Item 3.
 
 
 
 
 
 
 
Item 4.
 
 
 
 
 
 
 
Part II
 
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
Item 1A.
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
Item 3.
 
 
 
 
 
 
 
Item 4.
 
 
 
 
 
 
 
Item 5.
 
 
 
 
 
 
 
Item 6.
 
 
 
 
 
 
 
 
 

2



PART I — FINANCIAL INFORMATION

Item 1. Financial Statements.

  Web.com Group, Inc.
 
Consolidated Statements of Comprehensive Income
(in thousands, except per share amounts)
(unaudited)  
 
Three months ended September 30,
 
Nine months ended September 30,
 
2016
 
2015
 
2016
 
2015
 
 
 
 
 
 
 
 
Revenue
$
190,686

 
$
136,821

 
$
523,303

 
$
405,141

 
 
 
 
 
 
 
 

Cost of revenue (exclusive of depreciation and amortization, shown separately below)
58,380

 
45,412

 
167,189

 
139,319

 
 
 
 
 
 
 
 
Gross profit
132,306

 
91,409

 
356,114

 
265,822

 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 

 
 
 
 
 
 
 
 
Sales and marketing
55,304

 
35,033

 
157,867

 
106,392

Technology and development
15,538

 
9,062

 
47,896

 
26,019

General and administrative
19,094

 
16,735

 
54,391

 
48,819

Restructuring expense
1,133

 

 
2,047

 
335

Asset impairment
1,979

 

 
1,979

 

Depreciation and amortization
21,165

 
13,846

 
59,351

 
41,439

Total operating expenses
114,213

 
74,676

 
323,531

 
223,004

 
 
 
 
 
 
 
 
Income from operations
18,093

 
16,733

 
32,583

 
42,818


 
 
 
 
 
 
 
Interest expense, net
(8,270
)
 
(4,966
)
 
(22,530
)
 
(15,398
)
Net income before income taxes
9,823

 
11,767

 
10,053

 
27,420

Income tax expense
(6,477
)
 
(5,673
)
 
(7,976
)
 
(14,437
)
Net income
$
3,346

 
$
6,094

 
$
2,077

 
$
12,983

 
 
 
 
 
 
 
 
Other comprehensive income:
 
 
 
 
 

 
 

Foreign currency translation adjustments
(198
)
 
(524
)
 
(1,405
)
 
(434
)
Unrealized (loss) gain on investments, net of tax

 
(30
)
 
29

 
(29
)
Total comprehensive income
$
3,148

 
$
5,540

 
$
701

 
$
12,520

 
See accompanying notes to consolidated financial statements

Certain reclassifications have been made to the previously presented financial statements to conform with the current presentation


3




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

 
 

Net income per basic common share
 
$
0.07

 
$
0.12

 
$
0.04

 
$
0.26

Diluted earnings per share:
 
 
 
 
 
 

 
 

Net income per diluted common share
 
$
0.07

 
$
0.12

 
$
0.04

 
$
0.25

 
 
 
 
 
 
 
 
 
Basic weighted average common shares outstanding
 
49,221

 
50,035

 
49,296

 
50,420

Diluted weighted average common shares outstanding
 
50,771

 
52,312

 
50,970

 
52,477

 
See accompanying notes to consolidated financial statements


4




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

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
21,818

 
$
18,706

Accounts receivable, net of allowance of $1,647 and $1,815, respectively
20,110

 
12,892

Prepaid expenses
15,008

 
8,151

Deferred expenses
60,941

 
59,400

Other current assets
1,777

 
4,380

Total current assets
119,654

 
103,529

 
 
 
 
Property and equipment, net
61,764

 
41,963

Deferred expenses
49,556

 
50,113

Goodwill
869,401

 
639,145

Intangible assets, net
433,104

 
318,107

Other assets
11,718

 
4,482

Total assets
$
1,545,197

 
$
1,157,339

 
 
 
 
Liabilities and stockholders' equity
 

 
 
Current liabilities:
 

 
 

Accounts payable
$
21,468

 
$
9,974

Accrued expenses
15,060

 
13,303

Accrued compensation and benefits
16,522

 
13,765

Deferred revenue
236,500

 
219,187

Current portion of debt
14,429

 
11,169

Deferred consideration
18,616

 

Other liabilities
4,045

 
3,802

Total current liabilities
326,640

 
271,200

 
 
 
 
Deferred revenue
195,628

 
191,426

Long-term debt
671,410

 
411,409

Deferred tax liabilities
81,700

 
37,840

Other long-term liabilities
31,302

 
7,287

Total liabilities
1,306,680

 
919,162

 
 
 
 
Stockholders' equity:
 

 
 

Common stock, $0.001 par value per share: 150,000,000 shares authorized, 50,835,511 and 50,683,717 shares issued and outstanding at September 30, 2016 and December 31, 2015, respectively
51

 
51

Additional paid-in capital
573,698

 
565,648

Treasury stock at cost, 2,547,427 shares as of September 30, 2016 and 2,120,944 shares as of December 31, 2015
(53,161
)
 
(44,750
)
Accumulated other comprehensive loss
(3,524
)
 
(2,148
)
Accumulated deficit
(278,547
)
 
(280,624
)
Total stockholders' equity
238,517

 
238,177

Total liabilities and stockholders' equity
$
1,545,197

 
$
1,157,339

See accompanying notes to consolidated financial statements

5



Web.com Group, Inc.
 Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
 
Nine months ended September 30,
 
2016
 
2015
Cash flows from operating activities
 

 
 

Net income
$
2,077

 
$
12,983

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Depreciation and amortization
59,351

 
41,439

Stock based compensation
15,208

 
15,251

Deferred income taxes
6,208

 
13,458

Amortization of debt discounts and issuance costs
10,315

 
8,492

Asset impairment
1,979

 

Changes in operating assets and liabilities:
 

 
 

Accounts receivable, net
(2,532
)
 
3,761

Prepaid expenses and other assets
(10,567
)
 
(1,425
)
Deferred expenses
(983
)
 
2,781

Accounts payable
88

 
(2,867
)
Accrued expenses and other liabilities
(2,105
)
 
2,028

Accrued compensation and benefits
(2,306
)
 
7,402

Deferred revenue
13,014

 
9,267

Net cash provided by operating activities
89,747

 
112,570

Cash flows from investing activities
 

 
 

Business acquisitions
(303,262
)
 
(1,330
)
Capital expenditures
(17,674
)
 
(11,157
)
Other
(1,547
)
 

Net cash used in investing activities
(322,483
)
 
(12,487
)
Cash flows from financing activities
 

 
 

Stock issuance costs
(22
)
 
(82
)
Common stock repurchased
(4,246
)
 
(2,302
)
Payments of long-term debt
(55,500
)
 
(67,500
)
Proceeds from exercise of stock options
3,816

 
6,642

Proceeds from borrowings on long-term debt
200,000

 

Proceeds from borrowings on revolving credit facility
115,000

 

Debt issuance costs
(5,700
)
 

Common stock purchases under stock repurchase plan
(17,464
)
 
(40,930
)
Net cash provided by (used in) financing activities
235,884

 
(104,172
)
 
 
 
 
Effect of exchange rate changes on cash
(36
)
 
(3
)
 
 
 
 
Net increase (decrease) in cash and cash equivalents
3,112

 
(4,092
)
Cash and cash equivalents, beginning of period
18,706

 
22,485

Cash and cash equivalents, end of period
$
21,818

 
$
18,393

Supplemental cash flow information
 

 
 

Interest paid
$
12,221

 
$
7,649

Income tax paid
$
2,787

 
$
1,520

See accompanying notes to consolidated financial statements

6



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

1. The Company and Summary of Significant Accounting Policies
 
Description of Company
 
Web.com Group, Inc. ("Web.com" or "the Company") provides a full range of Internet services to small businesses to help them compete and succeed online. Web.com meets the needs of small businesses anywhere along their lifecycle with affordable, subscription-based solutions including domains, hosting, website design and management, search engine optimization, online marketing campaigns, local sales leads, social media, mobile products and eCommerce solutions. For more information about the Company, please visit http://www.web.com. The information obtained on or accessible through the Company's website is not incorporated into this Quarterly Report on Form 10-Q and you may not consider it a part of this Quarterly Report on Form 10-Q.
The Company has reviewed the criteria of Accounting Standards Codification ("ASC") 280-10, Segment Reporting, and has determined that the Company is comprised of only one segment, web services and products.
In March 2016, the Company completed the acquisition of 100% of the outstanding shares of Yodle, Inc., a Delaware corporation, ("Yodle"), for approximately $341.3 million , which includes $40.9 million of deferred consideration. Yodle is a leading provider of cloud based local marketing solutions for small businesses with approximately 1,400 employees and 53,000 subscribers. See Note 2, Business Combinations , for additional information surrounding the acquisition.

Basis of Presentation
 
The accompanying consolidated balance sheet as of September 30, 2016 , the consolidated statements of comprehensive income for the three and nine months ended September 30, 2016 and 2015 , the consolidated statements of cash flows for the nine months ended September 30, 2016 and 2015 , and the related notes to the consolidated financial statements are unaudited.
 
The unaudited consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements for the year ended December 31, 2015 , except that certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or excluded as permitted.
 
In the opinion of management, the unaudited consolidated financial statements include all adjustments of a normal recurring nature necessary for the fair presentation of the Company’s financial position as of September 30, 2016 , the Company’s results of operations for the three and nine months ended September 30, 2016 and 2015 , and the cash flows for the nine months ended September 30, 2016 and 2015 . The Company's financial position as of September 30, 2016 includes the assets and liabilities of Yodle and the results of operations and cash flows from March 9, 2016 to September 30, 2016 . The results of operations for the three and nine months ended September 30, 2016 , are not necessarily indicative of the results to be expected for the year ending December 31, 2016 .

Pursuant to the rules and regulations of the SEC, certain information and disclosures normally included in the notes to the annual financial statements prepared in accordance with U.S. generally accepted accounting principles ("GAAP") have been omitted from these interim financial statements. The Company suggests that these financial statements be read in conjunction with the audited financial statements and the notes included in the Company's most recent annual report on Form 10-K filed with the SEC on February 26, 2016, and any subsequently filed current reports on Form 8-K.

Reclassification of Expenses and Correction of Immaterial Accounting Error

Reclassification of Expenses

In an effort to report operating expenses in a manner more in line with functional areas and to simplify the related accounting, the Company has changed its classification of certain information technology related operating expenses from general and administrative expenses to technology and development expenses. This reclassification was applied retrospectively to all periods presented. The Company also reclassified customer support costs previously included in cost of revenue to sales and marketing on a prospective basis.

7



    
Correction of Immaterial Accounting Error

The Company's policy is to report costs associated with the data centers and systems infrastructure that support the products developed by its technology personnel ("infrastructure costs") in technology and development expense. The Company identified certain infrastructure costs that had been recorded to cost of revenue and elected to correct the historical presentation of these expenses. To correct this immaterial error, the costs have been recorded in technology and development expenses for all periods presented.

It is also the Company’s policy to allocate rent expense based on headcount to the appropriate financial statement line item classification. The Company identified certain rent expenses associated with the Yodle acquisition were not appropriately allocated by financial statement line item out of general and administrative expense during the six months ended June 30, 2016. To correct this immaterial error, the costs have been recorded using the proper allocation method to cost of sales, sales and marketing expenses, and technology and development expenses for the six months ended June 30, 2106.
    
Adjustments to Presentation

The above mentioned changes had no cumulative effect on the presentation of the consolidated statements of comprehensive income, consolidated balance sheet, or consolidated statements of cash flows. The effects of the aforementioned error correction and accounting classification change to the September 30, 2015 unaudited consolidated statements of comprehensive income are as follows (in thousands):
 
Three months ended September 30, 2015
 
Nine months ended September 30, 2015
 
As Previously Reported
Change in Accounting Classification
Effect of Error Correction
As Adjusted
 
As Previously Reported
Change in Accounting Classification
Effect of Error Correction
As Adjusted
Cost of revenue
$
46,410


(998
)
$
45,412

 
$
142,214


(2,895
)
$
139,319

Gross profit
$
90,411


998

$
91,409

 
$
262,927


2,895

$
265,822

Technology and Development
$
6,043

2,021

998

$
9,062

 
$
17,703

5,421

2,895

$
26,019

General and Administrative
$
18,756

(2,021
)

$
16,735

 
$
54,240

(5,421
)

$
48,819

Total operating expenses
$
73,678


998

$
74,676

 
$
220,109


2,895

$
223,004


The effects of the aforementioned error corrections and accounting classification change that is included in the nine months ended September 30, 2016 are shown below (in thousands). The three months ended September 30, 2016 correctly reflect these items.
 
Six months ended June 30, 2016
 
As Previously Reported
Change in Accounting Classification
Effect of Error Corrections
As Adjusted
Cost of revenue
$
110,826


(2,017
)
$
108,809

Gross profit
$
221,790


2,017

$
223,807

Sales and marketing
$
100,459


2,103

$
102,562

Technology and development
$
24,611

4,636

3,111

$
32,358

General and Administrative
$
43,129

(4,636
)
(3,197
)
$
35,296

Total operating expenses
$
207,299


2,017

$
209,316


Use of Estimates
 
The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the

8



date of the financial statements and reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Sources of Revenue
Subscription Revenue
The Company currently derives a substantial majority of its revenue from fees associated with our subscription services, which generally include web services, online marketing, eCommerce, and domain name registration offerings. We bill a majority of our customers in advance and recognize revenue on a daily basis over the life of the contract.
Professional Services and Other Revenue  
The Company also generates professional services revenue from custom website design, eCommerce store design and support services. Custom website design and eCommerce store design work is typically billed on a fixed-price basis and over very short periods. Generally, revenue is recognized when the service has been completed.  

Cost of Revenue  
Cost of revenue consists of expenses related to compensation of our web page development staff, domain name registration costs, directory listing fees, eCommerce store design, online marketing costs for services provided, billing costs, hosting expenses, and allocated occupancy overhead costs. The Company allocates occupancy overhead costs such as rent and utilities to all departments based on headcount. Accordingly, general overhead expenses are reflected in each cost of revenue and operating expense category.

Operating Expenses  
Sales and Marketing Expense
The Company's direct marketing expenses include the costs associated with the online marketing channels used to promote our services and acquire customers. These channels include search marketing, affiliate marketing, direct television advertising and partnerships. Sales and marketing costs consist primarily of compensation and related expenses for our sales and marketing staff as well as our customer support staff and allocated occupancy overhead costs. Sales and marketing expenses also include marketing programs, such as advertising, corporate sponsorships and other corporate events and communications.
 
Technology and development
Technology and development represents costs associated with creation, development and distribution of our products and websites. Technology and development expenses primarily consist of headcount-related costs associated with the design, development, deployment, testing, operation, enhancement of our products and costs associated with the data centers and all systems infrastructure costs supporting those products as well as all administrative platforms and allocated occupancy overhead costs.

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

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

New Accounting Standards

Recently Adopted Accounting Standards

In September 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2015-16, Business Combinations (Topic 805), Simplifying the Accounting for Measurement-Period Adjustments . The new standard requires an entity recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The standard also requires that the acquirer record, in the

9



same period's financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provision amounts, calculated as if the accounting had been completed at the acquisition date. For public companies, ASU 2015-16 is effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. ASU 2015-16 was adopted during the first quarter ended March 31, 2016 and there was no effect on the Company's consolidated financial statements and footnote disclosures.

Accounting Standards Issued Not Yet Adopted

In May 2014, the FASB and International Accounting Standards Board ("IASB") issued ASU 2014-09 Revenue from Contracts with Customers (Topic 606), a converged standard on revenue recognition which supersedes previous revenue recognition guidance. Some of the main areas of transition to the new standard include, among others, transfer of control (revenue is recognized when a customer obtains control of a good or service), allocation of transaction price is based on relative standalone selling price (entities that sell multiple goods or services in a single arrangement must allocate the consideration to each of those goods or services), contract costs (entities sometimes incur costs, such as sales commissions or mobilization activities, to obtain or fulfill a contract), and disclosures (extensive disclosures are required to provide greater insight into both revenue that has been recognized, and revenue that is expected to be recognized in the future from existing contracts). In August 2015, the FASB issued ASU 2015-14 Revenue from Contracts with Customers (Topic 606), Deferral of the Effective Date , which defers the effective date of the new standard by one year, resulting in the new standard being effective for fiscal years, and interim periods within those years, beginning after December 15, 2017 with early adoption as of the original effective date permitted. The Company will use one of two methods of adoption: (i) retrospective to each prior reporting period presented, with the option to elect certain practical expedients as defined within the standard; or (ii) retrospective with the cumulative effect of initially applying the standard recognized at the date of initial application inclusive of certain additional disclosures. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers: Principal versus Agent Considerations (Reporting Revenue Gross versus Net) . In April 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing . Also, in May 2016, the FASB issued ASU 2016-12, Revenue from Contracts with Customers: Narrow-Scope Improvements and Practical Expedients . These standards clarify the guidance in ASU 2014-09 and have the same effective date as the original standard. The Company is currently evaluating the impact that the adoption of ASU 2014-09, ASU 2016-08, ASU 2016-10 and ASU 2016-12 will have on our consolidated financial statements.
In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40): Disclosure of Uncertainties About an Entity's Ability to Continue as a Going Concern, which is new guidance related to the disclosures around going concern. The new standard provides guidance around management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. The new standard is effective for the annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. Early adoption is permitted. The adoption of this standard is not expected to have an impact on our consolidated financial statements or disclosures.
In January 2016, the FASB issued ASU 2016-01, Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities , which addresses certain aspects of the recognition, measurement, presentation and disclosure of financial instruments. The amendment will be effective for the Company beginning January 1, 2018 and the adoption of this standard is not expected to have an impact on our consolidated financial statements or disclosures.
In February 2016, the FASB issued ASU 2016-02, Leases , which requires lessees to recognize on the balance sheet a right-of-use asset, representing their right to use the underlying asset for the lease term, and a lease liability for all leases with terms greater than 12 months. The guidance also requires qualitative and quantitative disclosures designed to assess the amount, timing and uncertainty of cash flows arising from leases. The standard requires the use of a modified retrospective transition approach, which includes a number of optional practical expedients that entities may elect to apply. ASU 2016-02 is effective for the Company beginning January 1, 2019 and we are currently evaluating the impact that ASU 2016-02 will have on our consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation: Improvements to Employee Share-Based Payment Accounting . The standard is intended to simplify several areas of accounting for share-based compensation arrangements, including the income tax impact, classification on the statement of cash flows and forfeitures. ASU 2016-09 is effective for the Company on January 1, 2017 and the Company is currently evaluating the impact that ASU 2016-09 will have on our consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, addressing eight specific cash flow issues in an effort to reduce diversity in practice. The amended guidance

10



is effective for fiscal years beginning after December 31, 2017, and for interim periods within those years. Early adoption is permitted. The Company is currently evaluating the impact that ASU 2016-15 will have on our consolidated financial statements.
2. Business Combinations
Acquisition of Yodle
On March 9, 2016, the Company executed an Agreement and Plan of Merger (the "Merger Agreement) with Yodle, Inc., a Delaware corporation ("Yodle"), and Shareholder Representative Services, LLC, a Colorado limited liability company. The Company acquired 100% of the outstanding shares of Yodle, Inc. and paid approximately $300.3 million adjusted for, among other things, Yodle's cash and outstanding debt and transaction related expenses. The Company will pay an additional $18.9 million and $22.0 million on the first and second anniversary dates of the closing, respectively, subject to adjustments as described in the Merger Agreement. Finally, the Company converted out of the money stock options held by employees of Yodle to Web.com options, which resulted in additional consideration of $2.3 million , for total consideration of $341.3 million . In addition to the consideration, the Company incurred approximately $3.9 million of acquisition-related transaction expenses which are reflected in the General and Administrative line item of the Consolidated Statement of Comprehensive Income for during the nine months ended September 30, 2016 .
The Company has accounted for the acquisition of Yodle using the acquisition method as required in Accounting Standards Codification 805, Business Combinations ("ASC 805"). As such, preliminary fair values have been assigned to the assets acquired and liabilities assumed and the excess of the total purchase price over the fair value of the net assets acquired is recorded as goodwill. The Company, with the assistance of independent valuation professionals, has also performed preliminary estimates of the fair value of certain intangible assets. The goodwill recorded from this acquisition represents business benefits the Company anticipates realizing from acquiring a leader in value added digital marketing solutions that further solidifies our position as a leading national provider in this space. In addition, Yodle has vertically focused solutions that help small businesses attract new business and retain existing customers through cloud based marketing platforms. Finally, the Company also expects to benefit from synergies from eliminating duplicate operational and administrative expenditures, where feasible. The goodwill from the acquisition is not deductible for tax purposes.
The Company is still reviewing information surrounding intangible assets, property, plant and equipment values, certain assets and liabilities, accrued expenses, deferred revenue and income taxes. These items may result in changes to the Company's preliminary purchase price allocation through the first quarter of 2017. The adjustments made to the purchase price allocation through September 30, 2016 were primarily due to refinement of inputs used to calculate the fair value of the customer relationship, developed technology and the domain/trade name intangible assets. As a result of these adjustments to the fair value of the definite-lived intangible assets, the amortization expense during the three months ended September 30, 2016 was reduced by $0.8 million . The following table summarizes the Company's preliminary purchase price allocation based on the fair values of the assets acquired and liabilities assumed (in thousands):
 
 
As of March 31, 2016
Adjustments
As of September 30, 2016
 
Tangible current assets
$
7,709

$
(241
)
$
7,468

 
Property plant and equipment
18,157

32

18,189

 
Developed technology
72,500

19,330

91,830

 
Trademarks / trade names
32,500

(4,510
)
27,990

 
Customer relationships
67,500

(32,730
)
34,770

 
Other non current assets
277


277

 
Goodwill
218,530

10,380

228,910

 
Current liabilities
(22,308
)
(247
)
(22,555
)
 
Deferred revenue
(8,709
)

(8,709
)
 
Deferred tax liability
(43,532
)
6,878

(36,654
)
 
Other long term liabilities
(245
)

(245
)
 
Purchase price consideration
$
342,379

$
(1,108
)
$
341,271

 
 
 
 
 

The preliminary customer relationships and developed technology intangible assets will be amortized over 6.2 years and 5.9 years , respectively. The trademarks and trade names are indefinite life intangible assets and are not amortized.
 
The operations of Yodle have been incorporated with the existing Web.com Group Inc. operations subsequent to the transaction closing. As such, the determination of operating income and net income is not readily available nor would it be indicative of the standalone entity if presented.

11




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

Pro Forma Condensed Consolidated Results of Operations

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

The Company has adjusted the results of operations to reflect the impact of amortizing into revenue, deferred revenue that was recorded at fair value. In addition, interest expense and amortization of intangible assets were adjusted to reflect the cost of the March 9, 2016 debt issued to finance the acquisition and the fair value of the intangible assets on the acquisition date, respectively.

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

 
 
 
 
 
Nine months ended September 30, 2016
Revenue
 
 
 
 
$
563,272

Net loss
 
 
 
 
$
(1,557
)
 
 
 
 
 
 
Basic net loss per share
 
 
 
 
$
(0.03
)
 
 
 
 
 
 
Diluted net loss per share
 
 
 
 
$
(0.03
)
 
 
 
 
 
 
Basic weighted-average common shares outstanding
 
 
 
 
49,221

Diluted weighted-average common shares outstanding
 
 
 
 
49,221

 
 
 
 
 
 
 
 
 
Three months ended September 30, 2015
 
Nine months ended September 30, 2015
Revenue
 
 
$
189,536

 
$
548,706

 
 
 
 
 
 
Net loss
 
 
$
(36
)
 
$
(16,615
)
 
 
 
 
 
 
Basic net loss per share
 
 
$

 
$
(0.33
)
 
 
 
 
 
 
Diluted net loss per share
 
 
$

 
$
(0.33
)
 
 
 
 
 
 
Basic weighted-average common shares outstanding
 
 
50,035

 
50,420

Diluted weighted-average common shares outstanding
 
 
50,035

 
50,420


Acquisition of TORCHx

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


12



The Company has accounted for the acquisition of TORCHx using the acquisition method as required in Accounting Standards Codification 805, Business Combinations ("ASC 805"). As such, preliminary fair values have been assigned to the assets acquired and liabilities assumed and the excess of the total purchase price over the fair value of the net assets acquired is recorded as goodwill. The Company has estimated the fair value of certain intangible assets. The goodwill recorded from this acquisition represents business benefits the Company anticipates realizing from optimizing resources and cross-sale opportunities. The goodwill from the acquisition is deductible for tax purposes.

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

Assets and liabilities acquired are as follows (in thousands):

        
 
Tangible current assets
$
21

 
Developed technology-7 year useful life
1,790

 
Customer relationships-4 year useful life
360

 
Goodwill
2,262

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


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

During the first quarter of 2015 and 2016, the Company issued equity awards with performance, service and market conditions. These awards are included in basic shares outstanding once all criteria have been met and the shares have vested. Prior to the end of the vesting period, the number of contingently issuable shares included in diluted EPS is based on the number of shares, if any, that would be issuable under the terms of the arrangement if the end of the reporting period were the end of the contingency period, using the treasury stock method and assuming the result would be dilutive. As of September 30, 2016 , neither of the underlying conditions for either of the remaining tranches of the 2015 and 2016 awards have been met. Therefore, no incremental common shares from this award have been included. See Note 10, Stock-Based Compensation and Stockholders' Equity , for additional information on this award.

During the three months ended September 30, 2016 and 2015, 3.6 million and 1.5 million share-based awards, respectively, have been excluded from the calculation of diluted common shares because including those securities would have been anti-dilutive. During the nine months ended September 30, 2016 and 2015, 3.7 million and 1.7 million share-based awards, respectively, have been excluded from the calculation of diluted common shares because including those securities would have been anti-dilutive.

The Company's potentially dilutive shares also include incremental shares issuable upon the conversion of the Company's Senior Convertible Notes due August 15, 2018 ("2018 Notes"). See Note 6, Long-term Debt , for additional information regarding the 2018 Notes. Upon conversion or maturity of the 2018 Notes, the Company may settle the notes with either cash, shares of its common stock or a combination of cash and shares of its common stock, at its election. The Company has adopted a current policy to settle the principal amount in cash and any excess conversion value in shares of our common stock. Because the principal amount of the 2018 Notes will be settled in cash upon conversion, only the conversion spread relating to the 2018 Notes is included in our calculation of diluted net income per common share. When the market price of the Company's stock exceeds the conversion price, as applicable, it will include, in the diluted net income per common share calculation, the effect of the additional shares that may be issued upon conversion using the treasury stock method. There were no incremental common shares from the 2018 Notes that were included in the calculation of diluted shares because the Company's average price of its common stock did not exceed the conversion price during the three and nine months ended September 30, 2016 and 2015.

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


13



 
 
 
Three months ended September 30,
 
Nine months ended September 30,
 
 
 
2016
 
2015
 
2016
 
2015
Net income
 
 
$
3,346

 
$
6,094

 
$
2,077

 
$
12,983

 
 
 
 
 
 
 
 
 
 
Basic weighted average common shares outstanding
 
 
49,221

 
50,035

 
49,296

 
50,420

Dilutive effect of stock options
 
 
1,281

 
1,907

 
1,347

 
1,704

Dilutive effect of restricted shares
 
 
269

 
370

 
327

 
353

Dilutive effect of performance shares
 
 

 

 

 

Dilutive effect of the assumed conversion of the 2018 Notes
 
 

 

 

 

Diluted weighted average common shares outstanding
 
 
50,771

 
52,312

 
50,970

 
52,477

 
 
 
 
 
 
 
 
 
 
Net income per basic common share
 
 
$
0.07

 
$
0.12

 
0.04

 
0.26

 
 
 
 
 
 
 
 
 
 
Net income per diluted common share
 
 
$
0.07

 
$
0.12

 
$
0.04

 
$
0.25


4. Goodwill and Intangible Assets
 
In accordance with ASC 350, the Company reviews goodwill and other indefinite-lived intangible asset balances for impairment on an annual basis and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of goodwill or indefinite-lived intangible assets below its carrying amount. As of December 31, 2015 , the Company completed its annual impairment test of goodwill and other indefinite-lived intangible assets and determined that there was no impairment. There were no indicators of impairment during the nine months ended September 30, 2016 .

During the nine months ended September 30, 2016, the Company purchased $1.5 million for registrar credentials. These credentials were recorded as other intangible assets and are being amortized over 24 months.

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

 
$
741,858

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

 
639,564

Goodwill acquired during the period- Scoot

 
11

Goodwill acquired during the period- Yodle- Note 2, Business Combinations
228,910

 

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

 

Foreign currency translation adjustments (1)
(916
)
 
(430
)
Goodwill balance at end of period, net *
$
869,401

 
$
639,145

   
* Gross goodwill balances were $971.7 million as of September 30, 2016 and $741.4 million as of December 31, 2015 . These include accumulated impairment losses of $102.3 million .

(1) The foreign currency translation adjustments are from translating the goodwill acquired from the July 2014 Scoot acquisition at the current balance sheet date.






14



The Company’s intangible assets are summarized as follows (in thousands): 
 
September 30, 2016
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net
 
Weighted-average Remaining Amortization Period in Years
Indefinite-lived intangible assets:
 

 
 

 
 
 
 
Domain/Trade names
$
159,921

 
$

 
$
159,921

 
 
Definite-lived intangible assets:


 


 


 
 
Customer relationships
324,470

 
(149,735
)
 
174,735

 
6.7
Developed technology
286,391

 
(190,643
)
 
95,748

 
5.0
Other
7,804

 
(5,104
)
 
2,700

 
1.6
   Total *
$
778,586

 
$
(345,482
)
 
$
433,104

 
 
 
 
 
 
 
 
 
* Cumulative foreign currency translation adjustments, reflecting the movement in currencies, decreased total intangible assets by approximately $0.7 million as of September 30, 2016 .

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

 
 

 
 
 
 
Domain/Trade names
$
132,228

 
$

 
$
132,228

 
 
Definite-lived intangible assets:


 


 


 
 
Customer relationships
289,710

 
(128,212
)
 
161,498

 
7.6
Developed technology
193,020

 
(169,819
)
 
23,201

 
2.1
Other
6,027

 
(4,847
)
 
1,180

 
2.4
   Total *
$
620,985

 
$
(302,878
)
 
$
318,107

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

The weighted-average amortization period for the amortizable intangible assets remaining as of September 30, 2016 is approximately 6.1 years. Total amortization expense was $15.5 million and $9.8 million for the three months ended September 30, 2016 and 2015, respectively. Amortization expense was $43.6 million and $29.5 million for the nine months ended September 30, 2016 and 2015, respectively.
 
As of September 30, 2016 , the amortization expense for the remainder of the year ended December 31, 2016, and the next five years and thereafter is as follows (in thousands):
2016 (remainder of year)
$
14,272

2017
50,033

2018
45,696

2019
41,970

2020
39,747

2021
37,922

Thereafter
43,543

Total
$
273,183


15



5. Related Party Transactions
Effective February 6, 2015, the Company elected Mr. John A. Giuliani to serve on its Board of Directors. Mr. Giuliani served as President, Chief Executive Officer and Director of Conversant, a subsidiary of Alliance Data Systems Corporation, a personalized digital marketing platform. The Company incurred $0.1 million and $0.2 million of expense related to services provided by Conversant during the three months ended September 30, 2016 and 2015, respectively. During the nine months ended September 30, 2016 and 2015, respectively, the Company incurred $0.5 million and $0.7 million of expense related to services provided by Conversant.
6. Long Term Debt

16



 
1% Senior Convertible Notes due August 15, 2018

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

The Company may not redeem the 2018 Notes prior to August 20, 2016 . On or after August 20, 2016, the Company may redeem for cash any or all of the 2018 Notes, at its option, if the last reported sale price of its common stock exceeds 130% of the applicable conversion price on each applicable trading day as defined by the indenture. The redemption price will equal 100% of the principal amount of the 2018 Notes to be redeemed, plus accrued and unpaid interest to, but not including, the redemption date. Holders of the 2018 Notes may also convert their notes at any time prior to May 15, 2018 if the sale price of the Company's common stock exceeds 130% of the applicable conversion price on each applicable trading day as defined by the indenture.

In addition, holders may also convert their 2018 Notes any time prior to May 15, 2018 , (i) if during the five business days after any five consecutive trading day period in which the trading price of the 2018 Notes was less than 98% of the product of the last reported sale price of the Company's common stock and the conversion rate, (ii) if the Company calls the 2018 Notes for redemption; or (iii) upon the occurrence of specified corporate events.

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

The Company determined that the embedded conversion option in the 2018 Notes is not required to be separately accounted for as a derivative under ASC 815, Derivatives and Hedging . The 2018 Notes are within the scope of ASC 470, Topic 20, Debt with Conversion and Other Options, which requires the Company to separate a liability component and an equity component from the proceeds received. The carrying amount of the liability component at the time of the transaction of $204.4 million was calculated by measuring the fair value of a similar debt instrument that does not have an associated equity component. The fair value of the liability component was subtracted from the initial proceeds and the remaining amount of $47.8 million was recorded as the equity component. The excess of the principal amount of the liability component over its carrying amount will be amortized to interest expense over the expected life of 5 years using the effective interest method.
 
Upon conversion or maturity of the 2018 Notes, the Company may settle the notes with either cash, shares of its common stock or a combination of cash and shares of its common stock, at its election. The Company has adopted a current policy to settle the $258.8 million of principal amount in cash and any excess conversion value in shares of its common stock. Because the principal amount of the 2018 Notes will be settled in cash upon conversion, only the conversion spread relating to the 2018 Notes may be included in the Company's calculation of diluted net income per common share. When the market price of the Company's stock exceeds the conversion price, it will include, in the diluted net income per common share calculation, the effect of the additional shares that may be issued upon conversion using the treasury stock method. As such, the 2018 Notes have no impact on diluted net income per common share until the price of the Company's common stock exceeds the conversion price (approximately $35.00 per common share) of the 2018 Notes.
 
As of September 30, 2016 and December 31, 2015 , the carrying value of the debt and equity component was $236.3 million and $47.8 million and $228.0 million and $47.8 million , respectively. The unamortized debt discount of $22.4 million as of September 30, 2016 will be amortized over the remaining life of 1.9 years using the effective interest method.

Credit Agreement

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

17




The Amended Credit Agreement provides for (i) $390.0 million of five -year secured term loans, replacing and refinancing $190.0 million of secured term loans outstanding under the Existing Credit Agreement and providing for an additional $200.0 million of secured term loans (the "Term Loan") and (ii) a five-year secured revolving credit facility that provides up to $150 million of revolving loans (the "Revolving Credit Facility"), which replaces the revolving credit facility under the Existing Credit Agreement. On the Closing Date, the Company used the proceeds of the Term Loan and borrowed $115.0 million of loans under the Revolving Credit Facility, together with cash on hand, to complete the Acquisition.

The Term Loan and loans under the Revolving Credit Facility initially bear interest at a rate equal to either, at the Company’s option, the LIBOR rate plus an applicable margin equal to 3.00% per annum, or the prime lending rate plus an applicable margin equal to 2.00% per annum. The applicable margins for the Term Loan and loans under the Revolving Credit Facility are subject to reduction or increase based upon the Company’s consolidated first lien net leverage ratio as of the end of each fiscal quarter. Effective August 2016, the Company's interest rate on these loans was reduced to the LIBOR rate plus the applicable margin of 2.50% per an num as a result of reaching certain financial covenant ratios. The Company must also pay (i) a commitment fee of 0.45% per annum on the actual daily amount by which the revolving credit commitment exceeds then-outstanding usage under the Revolving Credit Facility, also subject to reduction or increase based upon the Company’s consolidated first lien net leverage ratio, (ii) a letter of credit fee equal to the applicable margin that applies to LIBOR loans under the Revolving Credit Facility and (iii) a fronting fee of 0.125% per annum, calculated on the daily amount available to be drawn under each letter of credit issued under the Revolving Credit Facility.
The Company is permitted to make voluntary prepayments with respect to the Revolving Credit Facility and the Term Loan at any time without payment of a premium. The Company is required to make mandatory prepayments of the Term Loan with (i) net cash proceeds from certain asset sales (subject to reinvestment rights) and (ii) net cash proceeds from certain issuances of debt. The Company is also required to maintain certain financial ratios under the Credit Agreement and there are customary covenants that limit the incurrence of debt, the payment of dividends, the disposition of assets, and making of certain payments. Substantially all of the Company's and certain of its domestic subsidiaries' tangible and intangible assets are pledged as collateral under the Credit Agreement.
The refinancing was accounted for as a modification of the Existing Credit Agreement. As a result, the $5.7 million of additional loan origination discounts and bank arranger fees were capitalized during the first quarter ended March 31, 2016 in connection with the refinancing. Third party fees related to the Amendment were expensed as incurred.
The Company has $76.3 million of available borrowings under the Revolving Credit Facility as of September 30, 2016 .
Outstanding long-term debt and the interest rates in effect at September 30, 2016 and December 31, 2015 consist of the following (in thousands):
 
September 30,
2016
 
December 31,
2015
Revolving Credit Facility maturing 2021, 3.02%, based on LIBOR plus 2.50%, less unamortized discount of $2,351 at September 30, 2016, effective rate of 3.76%
$
69,524

 
$
3,437

Term Loan due 2021, 3.02%, based on LIBOR plus 2.50%, less unamortized discount of $5,153 at September 30, 2016, effective rate of 3.81%
379,972

 
191,109

Senior Convertible Notes, maturing 2018, 1.00%, less unamortized discount of $22,407 at September 30, 2016, effective rate of 5.88%
236,343

 
228,032

Total Outstanding Debt
685,839

 
422,578

Less: Current Portion of Long-Term Debt
(14,429
)
 
(11,169
)
Long-Term Portion
$
671,410

 
$
411,409

 
Debt discount and issuance costs
 
The Company recorded $3.6 million and $2.9 million of expense from amortizing debt issuance and discount costs during each of the three months ended September 30, 2016 and 2015 , respectively. During the nine months ended September 30, 2016 and 2015, $10.3 million and $8.5 million of amortization expense was recorded, respectively.
 
Total estimated principal payments due for the next five years as of September 30, 2016 are as follows:   
Year 1
$
14,625

Year 2
283,125


18



Year 3
34,125

Year 4
39,000

Year 5
344,875

Total principal payments
$
715,750


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

7. Accumulated Other Comprehensive Loss

The components of accumulated other comprehensive loss were as follows (in thousands):
 
September 30, 2016
 
December 31, 2015
Foreign currency translation adjustments
$
(3,524
)
 
$
(2,119
)
Unrealized loss on investments

 
(29
)
    Total accumulated other comprehensive loss
$
(3,524
)
 
$
(2,148
)
 
 
 
 

8. Fair Value
 
The Company defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company applies the following fair value hierarchy, which prioritizes the inputs used to measure fair value into three levels as follows:
 
Level 1 -Quoted prices in active markets for identical assets or liabilities.
 
Level 2 -Observable inputs other than quoted prices in active markets for identical assets and liabilities, quoted prices for identical or similar assets or liabilities in inactive markets, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
 
Level 3 -Inputs that are generally unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability.
 
The Company has financial assets and liabilities that are not required to be remeasured to fair value on a recurring basis. The carrying value of the Company’s cash and cash equivalents, accounts receivable, accounts payable, deferred consideration and accrued expenses approximates fair market value as of September 30, 2016 and December 31, 2015 due to the short maturity of these items. As of September 30, 2016 , the fair value and carrying value of the Company’s 2018 Notes totaled $245.7 million and $236.3 million , respectively. As of December 31, 2015 , the fair value and carrying value of the Company's 2018 Notes was $ 243.2 million and $228.0 million , respectively. The fair value of the 2018 Notes, including the equity component, was calculated by taking the quoted market price for the instruments multiplied by the principal amount. This is based on a Level 2 fair value hierarchy calculation obtained from quoted market prices for the Company’s long-term debt instruments that may not be actively traded at each respective period end. The Revolving Credit Facility and Term Loan that were amended on February 11, 2016, are variable rate debt instruments indexed to 1-Month LIBOR that resets monthly and the fair value approximates the carrying value as of September 30, 2016 and December 31, 2015. See Note 6, Long-term Debt , for additional information surrounding the amendment.

9. Income Taxes

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

The Company recorded income tax expense of $6.5 million and $5.7 million during the three months ended September 30, 2016 and 2015 , and $8.0 million and $14.4 million during the nine months ended September 30, 2016 and 2015 respectively,
based upon the estimated annual effective tax rates for each year. The estimated annual effective tax rate for 2016 reflects the impact of net unfavorable permanent book-tax differences estimated for the year and an increase in the projected year-end valuation allowance related to certain state and foreign deferred tax assets. The estimated annual effective tax rate for 2015 reflected the estimated increase in the Company's projected year-end valuation allowance related to the projected increase in non-reversing deferred tax liabilities, and reduced by forecasted pre-tax income for the year.

10. Stock-Based Compensation and Stockholders' Equity
 
The Company records compensation expense for employee and director stock-based compensation plans based upon the fair value of the award in accordance with ASC 718, Compensation-Stock Compensation .
Equity Incentive Plans
The Company has the 2014 Equity Incentive Plan for the issuance of stock-based compensation, including but not limited to, common stock options and restricted shares to employees. In addition, the Company’s plan provides for grants of non-statutory stock options and restricted shares awards (“RSA’s”) to non-employee directors. The Company issues shares out of treasury stock, if available, otherwise new shares of common stock are issued upon the exercise of stock options and the granting of restricted shares. During the nine months ended September 30, 2016, the aggregate number of shares of common stock that may be issued pursuant to the 2014 Equity Incentive Plan was increased by 4 million additional shares.
Incentive stock options and non-statutory stock options issued generally vest ratably over three to four years, are contingent upon continued service and expire ten years from the grant date. Restricted share awards generally vest 25 percent each year over a four year period.
The Board of Directors or a committee thereof, administers all of the equity incentive plans and establishes the terms of options granted, including the exercise price, the number of shares subject to individual option awards and the vesting period of options, within the limits set forth in the plans. Options have a maximum term of 10 years and vest as determined by the Board of Directors.
The Company has additional equity incentive plans that are established in conjunction with its acquisitions. These plans are considered one-time, inducement awards of incentive stock options, non-statutory stock options and restricted shares. Once the inducement awards are granted, no additional shares, including forfeitures and cancellations, are available for future grant under these plans.
Yodle Equity Grants
In connection with the March 2016 Yodle acquisition, the Company granted 0.3 million restricted shares that vest annually over a four year period and 0.3 million stock options of which 25 percent vest one year from the date of grant and the remaining 75 percent vest monthly over a three year period for a total of four years.
In addition, the Company converted unvested and out of the money existing Yodle stock options to 1.3 million stock options of the Company in connection with the March 9, 2016 acquisition of Yodle. The total value of the converted stock options is approximately $8.3 million . Approximately $2.3 million has been recorded as additional consideration representing the vesting that occurred prior to the closing of the acquisition. The remaining $6.0 million will be amortized to stock compensation expense over the remaining service period of approximately 3 years.
Performance Shares
During the first quarter of 2015 and 2016, the Compensation Committee of the Board of Directors approved performance share equity awards. The targeted number of shares under a 100 percent payout scenario for each of the 2015 and 2016 awards are 0.2 million common shares over the three year vesting periods, with one-third vesting each year. The actual number of shares that may be earned and issued, if any, may range from 0-200% of the target number of shares granted. The range is based upon (1) the number of shares earned based upon the over achievement or under achievement of the financial measures for the annual performance period and (2) the number of shares earned being adjusted higher or lower depending on the performance of the Company's total shareholder return, compared against the Company's peer group.
Compensation expense related to the performance share stock plan for the three and nine months ended September 30, 2016 was approximately $0.3 million and $0.8 million , respectively. This represented the remaining expense for the first tranche of the 2015 award as well as the estimated expense for the 2016 performance period. The Company recorded $0.3 million and $0.6 million of compensation expense for the performance shares during the three and nine months ended September 30, 2015, respectively. The 2015 tranche of the performance share award resulted in a payout of 159% of the target shares, or approximately 92 thousand shares. During the nine months ended September 30, 2016 , approximately 37 thousand shares totaling $0.7 million , were withheld by the Company for minimum income tax withholding requirements.
Stock Options


19



Compensation costs related to the Company’s stock option plans were $ 2.5 million for each of the three months ended September 30, 2016 and 2015 . Compensation costs for the nine months ended September 30, 2016 and 2015, $7.2 million and $8.1 million , respectively. During the three months ended September 30, 2016 and 2015 , 0.5 million and 0.2 million common shares were issued for options exercised, respectively. During each of the nine months ended September 30, 2016 and 2015, 0.6 million common shares were issued for options exercised.
 
Restricted Stock
 
Compensation expense related to restricted stock plans for the three months ended September 30, 2016 and 2015 , was approximately $2.2 million and $2.3 million , respectively. Compensation expense for the nine months ended September 30, 2016 and 2015 was $7.3 million and $6.5 million , respectively. During the nine months ended September 30, 2016 and 2015 , approximately 0.2 million and 0.1 million shares totaling approximately $3.5 million and $2.3 million , respectively, were withheld by the Company for minimum income tax withholding requirements. During the three months ended September 30, 2016 and 2015, 0.2 million and 35 thousand restricted common shares were granted, respectively. During the nine months ended September 30, 2016 and 2015 0.8 million and 0.5 million restricted common shares were granted, respectively. This excludes the Yodle restricted stock awards that were discussed above.

Stock Repurchases

On November 5, 2014 , the Company's Board of Directors authorized a share repurchase program of up to $100.0 million of the Company's common stock. This program, according to its terms, will expire on December 31, 2016 .
The aggregate amount remaining available for repurchase under this program was $21.1 million at September 30, 2016 . Repurchases under the repurchase programs may take place in the open market or in privately negotiated transactions, including structured and derivative transactions such as accelerated share repurchase transactions, and may be made under a Rule 10b5-1 plan. During the three months ended September 30, 2016 and 2015, the Company repurchased approximately 32 thousand and 0.5 million common shares, respectively. The total amount repurchased during the three months ended September 30, 2016 and 2015, was $0.6 million and $11.0 million , respectively. During the nine months ended September 30, 2016 and 2015, 1.0 million and 2.0 million common shares were repurchased for $17.5 million and $40.9 million , respectively.
In October 2016, the Company's Board of Directors authorized that the share repurchase program of the Company's outstanding securities be extended through December 31, 2018 and be increased by an additional $100.0 million .
11. Commitments and Contingencies
 
Standby Letters of Credit

The Company utilizes letters of credit to back certain payment obligations relating to its facility operating leases. The Company had approximately $ 7.6 million in standby letters of credit as of September 30, 2016 , $ 1.9 million of which were issued under the Revolving Credit Facility. The letters of credit increased approximately $5.6 million during the nine months ended September 30, 2016 , primarily to fulfill requirements under Yodle operating leases.

Legal Proceedings

From time to time, the Company and its subsidiaries receive inquiries from foreign, federal, state and local regulatory authorities or are named as defendants in various investigations, inquires or legal actions that are incidental to our business and arise out of or are related to claims made in connection with our marketing practices, customer and vendor contracts and employment related disputes. We believe that the resolution of these investigations, inquiries or legal actions will not have a material adverse effect on our financial position, marketing practices or results of operations. There were no material legal proceedings for which a loss was reasonably possible or estimable at September 30, 2016 .

12. Restructuring Costs

The Company incurred $1.1 million and $2.0 million of restructuring costs for severance expenses and software contract termination costs related to the Yodle acquisition during the three and nine months ended September 30, 2016, respectively.

13. Asset Impairment

The Company recorded a $2.0 million asset impairment charge related to domain name inventory during the three and nine months ended September 30, 2016.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Forward Looking Statements
 

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This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the “safe harbor” provisions created by those sections. Forward-looking statements are based on our management’s beliefs and assumptions and on information currently available to our management. All statements other than statements of historical facts are “forward-looking statements” for purposes of these provisions, including any projections or earnings. In some cases, you can identify forward-looking statements by terms such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “should,” “will,” “would” and similar expressions intended to identify forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors, which may cause our actual results, performance, time frames or achievements to be materially different from any future results, performance, time frames or achievements expressed or implied by the forward-looking statements. We discuss many of these risks, uncertainties and other factors in this Quarterly Report on Form 10-Q in greater detail under the heading “Risk Factors.” Given these risks, uncertainties and other factors, you should not place undue reliance on these forward-looking statements. Also, these forward-looking statements represent our estimates and assumptions only as of the date of this filing. You should read this Quarterly Report on Form 10-Q completely and with the understanding that our actual future results may be materially different from what we expect. We hereby qualify our forward-looking statements by these cautionary statements. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.
 
Safe Harbor
 
In the following discussion and analysis of results of operations and financial condition, certain financial measures may be considered “non-GAAP financial measures” under Securities and Exchange Commission rules. These rules require supplemental explanation and reconciliation, which is provided in this Quarterly Report on Form 10-Q.

We believe presenting non-GAAP net income attributable to common stockholders, non-GAAP net income per share attributable to common stockholders and non-GAAP operating income measures are useful to investors, because they describe the operating performance of the Company, excluding some recurring charges that are included in the most directly comparable measures calculated and presented in accordance with GAAP. We use these non-GAAP measures as important indicators of our past performance and in planning and forecasting performance in future periods. The non-GAAP financial information we present may not be comparable to similarly-titled financial measures used by other companies, and investors should not consider non-GAAP financial measures in isolation from, or in substitution for, financial information presented in compliance with GAAP.

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

In March 2016, the Company completed the acquisition of 100% of the outstanding shares of Yodle, Inc., a Delaware corporation, ("Yodle"), for approximately $341.3 million , which includes $40.9 million of deferred consideration. Yodle is a leading provider of cloud based local marketing solutions for small businesses with approximately 1,400 employees and 53,000 subscribers. Management's Discussion and Analysis includes the results of operations and cash flows of Yodle from March 9, 2016 through September 30, 2016 . See Note 2, Business Combinations , for additional information surrounding the acquisition.   
Key Business Metrics
 
Management periodically reviews certain key business metrics to evaluate the effectiveness of our operational strategies, allocate resources and maximize the financial performance of our business. These key business metrics include:
 
Net Subscriber Additions
We define total subscribers as the approximate number of subscribers that, as of the end of a period, are identified as subscribing to our products on a paid basis.  A unique subscriber with subscriptions of more than one brand or with more than

21



one distinct billing relationship or product subscription with us, are counted as one subscriber.  Total subscribers for a period reflects adjustments to add or subtract subscribers as we integrate acquisitions and/or are otherwise able to identify subscribers that meet, or do not meet, this definition of total subscribers.

We maintain and grow our subscriber base through a combination of adding new subscribers and retaining existing subscribers. We define net subscriber additions in a particular period as the gross number of new subscribers added during the period, less subscriber cancellations during the period. For this purpose, we only count as new subscribers those customers whose subscriptions have extended beyond the free trial period, if applicable.

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

Customer Retention Rate (Retention Rate)

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

Average Revenue per User (Subscriber)
 
Monthly average revenue per user, or ARPU, is a metric we measure on a quarterly basis. We define ARPU as quarterly non-GAAP subscription revenue divided by the average of the number of subscribers at the beginning of the quarter and the number of subscribers at the end of the quarter, divided by the measurement period in months. We exclude from subscription revenue the impact of the fair value adjustments to deferred revenue resulting from acquisition-related write downs. The fair market value adjustments were $ 2.1 million and $ 3.5 million for the three months ended September 30, 2016 and 2015 , respectively. The fair market value adjustments were $16.7 million and $12.9 million for the nine months ended September 30, 2016 and 2015, respectively. ARPU is the key metric that allows management to evaluate the impact on monthly revenue from product pricing, product sales mix trends, and up-sell/cross-sell effectiveness.
 
Sources of Revenue
 
Subscription Revenue

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

Cost of Revenue
 
Cost of revenue consists of expenses related to compensation of our web page development staff, domain name registration costs, directory listing fees, eCommerce store design, online marketing costs for services provided, billing costs, hosting expenses, and allocated occupancy overhead costs. The Company allocates occupancy overhead costs such as rent and utilities to all departments based on headcount. Accordingly, general overhead expenses are reflected in each cost of revenue and operating expense category.
 
Operating Expenses

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

Sales and Marketing Expense
 
The Company's direct marketing expenses include the costs associated with the online marketing channels used to promote our services and acquire customers. These channels include search marketing, affiliate marketing, direct television advertising and partnerships. Sales and marketing costs consist primarily of compensation and related expenses for our sales and marketing staff as well as our customer support staff and allocated occupancy overhead costs. Sales and marketing expenses also include marketing programs, such as advertising, corporate sponsorships and other corporate events and communications.
 
We plan to continue to invest in sales and marketing to add new subscription customers, and increase sales of additional and new services and products to our existing customer base. We also plan to continue investing in direct response television and radio advertising. We have invested a portion of our incremental marketing budget in branding activities such as the umbrella sponsorship of the Web.com Tour and other sports marketing activities.
Technology and development
Technology and development represents costs associated with creation, development and distribution of our products and websites. Technology and development expenses primarily consist of headcount-related costs associated with the design, development, deployment, testing, operation, enhancement of our products and costs associated with the data centers and all systems infrastructure costs supporting those products as well as all administrative platforms and allocated occupancy overhead costs.

General and Administrative Expense

General and administrative expenses consist of compensation and related expenses for executive, finance, and administration, as well as professional fees, corporate development costs, other corporate expenses, and allocated occupancy overhead costs.
 
Depreciation and Amortization Expense
 
Depreciation and amortization expenses relate primarily to our intangible assets recorded due to the acquisitions we have completed, as well as depreciation expense from computer and other equipment, internally developed software, furniture and fixtures, and building and improvement expenditures. Depreciation is expected to increase as we continue to increase our efforts for internally developed software projects as well as from the fixed assets acquired in connection with the Yodle acquisition. Amortization expense is expected to continue to increase during the remainder of 2016 from the amortization of intangible assets acquired from the Yodle acquisition when compared to prior year periods.

Critical Accounting Policies and Estimates
 
Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements requires us to make estimates, assumptions and judgments that affect our assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. We base these estimates and assumptions on historical data and trends, current fact patterns, expectations and other sources of information we believe are reasonable. Actual results may differ from these estimates. For a full description of our critical accounting policies, see Item 7 — Management's Discussion and Analysis of Financial Condition and Results of Operations in our 2015 Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 26, 2016.


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


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Included in the three and nine months ended September 30, 2015 are adjustments for the correction of an immaterial error in the classification of infrastructure costs, which were previously classified within the cost of revenue financial statement line item but have been reclassified to technology and development. In addition, in an effort to report operating expenses in a manner more in line with functional areas and to simplify the related accounting, the Company has changed its classification of certain information technology related operating expenses from general and administrative expenses to technology and development expenses. This reclassification was applied retrospectively to all periods presented. The Company also reclassified customer support costs previously included in cost of revenue to sales and marketing on a prospective basis.
See Note 1, The Company and Summary of Significant Accounting Policies, for a summary of the changes reflected herein.

The following table sets forth our key business metrics:  
 
Three months ended September 30,
 
2016 (1)
 
2015
 
(unaudited)
Ending Subscribers as of September 30,
3,447,000

 
3,331,000

Net subscriber additions
5,000

 
15,000

Average revenue per user (monthly)
$
18.47

 
$
13.90

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

Net organic subscribers increased by approximately 5,000 subscribers during the three months ended September 30, 2016 , as compared to an increase of approximately 15,000 subscribers during the three months ended September 30, 2015 . The increase in our subscriber count is primarily due to marketing and customer service efforts in prior periods, as well as during the quarter ended September 30, 2016 . Our rolling twelve month retention rate (1) as of September 30, 2016 was 86.0% compared to 87.6% during the same prior year period. The inclusion of Yodle had a modestly unfavorable impact on our retention metric.  Relative to our large base of domain subscribers Yodle’s products are higher churn, which we view as an opportunity for improvement. During the third quarter we made progress positioning our product portfolio and aligning our sales channels to improve customer satisfaction and ultimately retention. 

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

 
 

Subscription
$
188,771

 
$
135,020

Professional services and other
1,915

 
1,801

Total revenue
$
190,686

 
$
136,821

 
Total revenue increased to $ 190.7 million in the three months ended September 30, 2016 up from $ 136.8 million in the three months ended September 30, 2015 . Total revenue includes $2.1 million and $3.5 million of unfavorable impact resulting from amortizing into revenue, deferred revenue that was recorded at fair value at the acquisition date during the three months ended September 30, 2016 and 2015, respectively. The unfavorable impact decreased $1.4 million during the three months ended September 30, 2016 , compared to the same prior period. The remaining $52.4 million increase in revenue during the three months ended September 30, 2016 , is driven principally by the acquisition of Yodle, in addition to increased Do-It-For-Me website and premium website revenues as well as email-related revenue. These increases were partially offset by a decline in Do-It-Yourself products, such as hosting and website presence, in addition to lower domain and domain-related product revenues.

Subscription Revenue . Subscription revenue increased during the three months ended September 30, 2016 , to $188.8 million up from $135.0 million during the three months ended September 30, 2015 . The increase is primarily due to the acquisition of Yodle in March of 2016 in addition to the impact of the other revenue drivers discussed above.
 

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Professional Services and Other Revenue. Professional services revenue was 6% higher at $1.9 million in the three months ended September 30, 2016 up from $1.8 million for the three months ended September 30, 2015 . The increase was principally driven by a slightly higher volume of custom design professional services.

Cost of Revenue
 
Three months ended September 30,
 
2016
 
2015
 
(unaudited, in thousands)
Cost of revenue
$
58,380

 
$
45,412

 
Cost of Revenue. Cost of revenue increased 29% or $13.0 million during the three months ended September 30, 2016 , compared to the three months ended September 30, 2015 . A majority of the increase was due to the costs associated with the additional revenue due to the Yodle acquisition that closed in March 2016. In addition, online marketing expenses increased by $1.2 million during the three months ended September 30, 2016 when compared to the same prior year period.

Our gross margin was 69% during the three months ended September 30, 2016 up from 67% during the same prior year period due to the inclusion of higher margin Yodle products. Excluding the $ 2.1 million and $ 3.5 million effect of the adjustment related to the fair value of acquired deferred revenue for the three months ended September 30, 2016 and 2015 , respectively, non-GAAP gross margin was 70% and 68% for the three months ended September 30, 2016 and 2015, respectively.
 
Operating Expenses
 
 
Three months ended September 30,
 
2016
 
2015
 
(unaudited, in thousands)
Operating Expenses:
 

 
 

Sales and marketing
$
55,304

 
$
35,033

Technology and development
15,538

 
9,062

General and administrative
19,094

 
16,735

Restructuring expense
1,133

 

Asset impairment
1,979

 

Depreciation and amortization
21,165

 
13,846

Total operating expenses
$
114,213

 
$
74,676

 
Sales and Marketing Expenses. Sales and marketing expenses increased 58% to $55.3 million and were 29% of total revenue during the three months ended September 30, 2016 , up from $35.0 million , which was approximately 26% of revenue during the three months ended September 30, 2015 . Sales and marketing expenses increased approximately $20.3 million during the three months ended September 30, 2016 compared to the same prior year period primarily due to the acquisition of Yodle in March 2016. In addition, compensation and benefits expense, increased $2.1 million during the three months ended September 30, 2016 when compared to the same prior year period. The increases were offset by $2.6 million of overall lower general marketing expenses, primarily from direct response television advertising and $0.6 million of decreased call center expenses.
 
Technology and Development Expenses. Technology and development expenses of $ 15.5 million , or 8% of total revenue, increased by $6.5 million during the three months ended September 30, 2016 , from $9.1 million , or 7% of total revenue during the three months ended September 30, 2015 . The increase was primarily from the technology expenses related from the acquisition of Yodle in March 2016. Compensation and benefits expense also increased by $2.3 million during the quarter ended September 30, 2016.

General and Administrative Expenses. General and administrative expenses increased $2.4 million to $19.1 million , or 10% of total revenue, during the three months ended September 30, 2016 , as compared to $16.7 million , or 12% of total revenue during the three months ended September 30, 2015 . The increase was due to higher general and administrative expenses resulting from the Yodle acquisition, offset by a $1.6 million decline in compensation and benefits. In addition, software maintenance expense increased by $0.4 million during the three months ended September 30, 2016 when compared to the same prior year period.

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Restructuring Expense. Restructuring expense of $1.1 million included approximately $0.8 million of severance benefits resulting from terminating certain Yodle employees and from $0.3 million of contract termination costs.

Asset impairment . During the three months ended September 30, 2016, we recorded a $2.0 million impairment charge on our domain name inventory.

Depreciation and Amortization Expense. Depreciation and amortization expense increased $7.3 million to $21.2 million during the three months ended September 30, 2016 , compared to $13.8 million during the three months ended September 30, 2015 . Amortization expense increased by $5.6 million primarily from the intangible assets acquired as part of the Yodle acquisition. In addition, depreciation expense increased by $1.7 million during the three months ended September 30, 2016 , $1.0 million of which, is from depreciating assets acquired from the Yodle acquisition. The remaining $0.7 million increase is primarily from a higher volume of internally developed software projects that were placed into service.
 
Interest Expense, net. Net interest expense totaled $8.3 million and $5.0 million for the three months ended September 30, 2016 and 2015 , respectively. Included in the interest expense for each of the three months ended September 30, 2016 and 2015 , is $3.6 million and $2.9 million of deferred financing fee and loan origination discount amortization, respectively. Loan interest expense, excluding amortization, increased $2.5 million during the third quarter ended September 30, 2016 , compared to the third quarter of 2015 , primarily due to the higher debt levels from the additional debt incurred and slightly higher interest rates in effect from financing the Yodle acquisition. Interest expense during the quarter ended September 30, 2016, includes a 0.5% decrease in the term loan and revolver interest rate, effective mid-August of 2016, resulting from favorable debt covenant results.

Income Tax Expense. We recorded income tax expense of $6.5 million and $5.7 million during the three months ended September 30, 2016 and 2015 , respectively, based upon our estimated annual effective tax rates for each year. Our estimated annual effective tax rate for 2016 reflects the impact of net unfavorable permanent book-tax differences estimated for the year and an increase in the projected year-end valuation allowance related to certain state and foreign deferred tax assets. The estimated annual effective tax rate for 2015 reflected the estimated increase in the Company’s projected year-end valuation allowance related to the projected increase in non-reversing deferred tax liabilities, and reduced by forecasted pre-tax income for the year.
 
Results of Operations
 
Comparison of the results for the nine months ended September 30, 2016 and for the nine months ended September 30, 2015 .
 
The following table sets forth our key business metrics: 

 
Nine months ended September 30,
 
2016 (1)
 
 
2015
 
 
(unaudited)
Ending subscribers September 30,
3,447,000
 
 
 
3,331,000
 
 
Net subscriber additions
95,000
 
 
 
55,000
 
 
Average revenue per user (monthly)
$
17.41

 
 
$
13.86

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

As part of the acquisition of Yodle, we acquired approximately 53,000 subscribers in March 2016. In addition, net organic subscribers increased by approximately 95,000 subscribers during the nine months ended September 30, 2016, as compared to an increase of approximately 55,000 subscribers during the nine months ended September 30, 2015. The increase in subscribers is primarily due to marketing and customer service efforts in prior periods, as well as during the quarter ended September 30, 2016 . Our rolling twelve month retention rate as of September 30, 2016 was 86.0% compared to 87.6% during the same prior year period. The inclusion of Yodle had a modestly unfavorable impact on our retention metric.  Relative to our large base of domain subscribers Yodle’s products are higher churn, which we view as an opportunity for improvement. During the third quarter we made progress positioning our product portfolio and aligning our sales channels to improve customer satisfaction and ultimately retention. 


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Revenue

 
Nine months ended September 30,
 
2016
 
 
2015
 
 
(unaudited, in thousands)
Revenue:
 
 
 
 
 
 
 
Subscription
$
518,084

 
 
$
399,166

 
Professional services and other
5,219
 
 
 
5,975
 
 
Total revenue
$
523,303

 
 
$
405,141

 
 
Total revenue increased 29% to $523.3 million in the nine months ended September 30, 2016 , from $405.1 million in the nine months ended September 30, 2015 . The acquisition of Yodle in March 2016 contributed to the majority of the increase in revenue during the nine months ended September 30, 2016. Total revenue during the nine months ended September 30, 2016 and 2015 , includes the unfavorable impact of $16.7 million and $12.9 million , respectively, from amortizing into revenue, deferred revenue that was recorded at fair value at the acquisition date. The unfavorable impact increased $3.8 million during the nine months ended September 30, 2016 primarily from deferred revenue acquired from the March 2016 acquisition of Yodle. Additionally, revenues increased during the nine months ended September 30, 2016 compared to the same prior year period principally driven by increased Do-It-For-Me website and premium website revenues, as well as ecommerce, online marketing and email revenues. The increases were partly offset by decreases in domain-related revenues, hosting, advertising and Do-It-Yourself website revenues.
 
Subscription Revenue . Subscription revenue increased 30% during the nine months ended September 30, 2016 to $518.1 million from $399.2 million during the nine months ended September 30, 2015 . The increase is due to the overall revenue drivers discussed above.
 
Professional Services and Other Revenue. Professional services revenue of $5.2 million decreased $0.8 million from $6.0 million during the nine months ended September 30, 2016 due to a lower volume of custom design professional services.

Cost of Revenue 

 
Nine months ended September 30,
 
2016
 
 
2015
 
 
(unaudited, in thousands)
Cost of revenue
$
167,189

 
 
$
139,319

 
 
Cost of Revenue. Cost of revenue increased 20% or $27.9 million during the nine months ended September 30, 2016 compared to the nine months ended September 30, 2015 . The acquisition of Yodle was the primary driver for the higher cost of revenue during the nine months ended September 30, 2016. Compensation and benefits decreased $0.8 million during the nine months ended September 30, 2016. In addition, general and online marketing costs increased $1.2 million during the nine months ended September 30, 2016 compared to the same prior year period, while domain registration costs decreased $2.9 million.
 
Our gross margin of 68% during the nine months ended September 30, 2016 increased from 66% during the nine months ended September 30, 2015 primarily from the higher margin Yodle product offerings. Excluding the $16.7 million and $12.9 million effect of the adjustment related to the fair value of acquired deferred revenue for the nine months ended September 30, 2016 and 2015 , respectively, non-GAAP gross margin increased from 67% to 69% during the nine months ended September 30, 2016 compared to the same prior year period.
 
Operating Expenses 
 
Nine months ended September 30,
 
2016
 
 
2015
 
 
(unaudited, in thousands)

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Operating Expenses:
 
 
 
 
 
 
 
Sales and marketing
$
157,867

 
 
$
106,392

 
Technology and development
 
47,896

 
 
 
26,019

 
General and administrative
 
54,391

 
 
 
48,819

 
Restructuring expense
 
2,047

 
 
 
335

 
Asset impairment
 
1,979

 
 
 

 
Depreciation and amortization
 
59,351

 
 
 
41,439

 
Total operating expenses
$
323,531

 
 
$
223,004

 
 
Sales and Marketing Expenses. Sales and marketing expenses increased 48% from $106.4 million or 26% of revenue during the nine months ended September 30, 2015 to $157.9 million or 30% of revenue during the nine months ended September 30, 2016 . The $51.5 million increase was driven principally from the additional expenses from the Yodle acquisition. In addition, total compensation and benefits increased $6.6 million during the nine months ended September 30, 2016 when compared to the same prior year period. In addition, online marketing expenses and call center costs decreased $4.5 million and $1.5 million, respectively.
 
Technology and Development Expenses. Technology and development expenses increased 84% to $47.9 million , or 9% of total revenue, during the nine months ended September 30, 2016 up from $26.0 million , or 6% of total revenue during the nine months ended September 30, 2015. The increase was driven by the March 2016 acquisition of Yodle. In addition, there was $5.9 million of higher compensation and benefits expense during the nine months ended September 30, 2016 when compared to the same prior year period. Data, software and networking support related costs increased $1.4 million during the year to date period ended September 30, 2016 compared to the same prior year period.
 
General and Administrative Expenses. General and administrative expenses increased 11% to $54.4 million , or 10% of total revenue, during the nine months ended September 30, 2016 , up from $48.8 million or 12% of total revenue during the nine months ended September 30, 2015 . Total general and administrative expenses increased $5.6 million primarily due to the acquisition of Yodle during the nine months ended September 30, 2016 . Compensation and benefits decreased $5.6 million during the year to date period ended September 30, 2016 compared to the same prior year period. In addition, acquisition-related closing costs of about $3.9 million contributed to the higher general and administrative costs, while bad debt expense declined $1.3 million during the nine months ended September 30, 2016 .

Restructuring Expense. Restructuring expense of $2.0 million included approximately $1.6 million of severance benefits resulting from terminating certain Yodle employees and from $0.5 million of contract termination costs.
 
Asset impairment . During the nine months ended September 30, 2016, we recorded a $2.0 million impairment charge on our domain name inventory.

Depreciation and Amortization Expense. Depreciation and amortization expense increased to $59.4 million during the nine months ended September 30, 2016 from $41.4 million during the nine months ended September 30, 2015 . Amortization expense is $14.1 million higher during the nine months ended September 30, 2016 primarily from amortizing the intangible assets that were acquired from the March 2016 Yodle acquisition. Depreciation expense was also up $3.8 million during the nine months ended September 30, 2016 when compared to the same prior year period, also from the assets acquired from Yodle in addition to higher internally developed software projects that continue to be placed in service.
 
Interest Expense, net. Net interest expense totaled $22.5 million and $15.4 million for the nine months ended September 30, 2016 and 2015, respectively. Included in interest expense during the nine months ended September 30, 2016 and 2015 was $10.3 million and $8.5 million of amortization of debt issuance costs, respectively. Excluding amortization, interest expense increased from $6.9 million to $12.3 million during the nine months ended September 30, 2015 and 2016, respectively. The increase was driven from the higher debt levels and slightly higher interest rates resulting from the financing of the Yodle acquisition. Interest expense during the nine months ended September 30, 2016, includes a 0.5% decrease in the term loan and revolver interest rate, effective mid-August of 2016, resulting from favorable debt covenant results.

Income Tax Expense. We recorded an income tax expense of $8.0 million and $14.4 million during the nine months ended September 30, 2016 and 2015, respectively, based upon our estimated annual effective tax rates for each year. Our estimated annual effective tax rate for 2016 reflects the impact of net unfavorable permanent book-tax differences estimated for the year and an increase in the projected year-end valuation allowance related to certain state and foreign deferred tax assets. The estimated annual effective tax rate for 2015 reflected the estimated increase in the Company’s projected year-end valuation

28



allowance related to the projected increase in non-reversing deferred tax liabilities, and reduced by forecasted pre-tax income for the year.

Outlook. For 2016, we expect a meaningful increase in our revenue due to the acquisition of Yodle, which closed in the first quarter of 2016. We continue to expect year over year revenue growth in our value added digital marketing solutions, offset by declines in Do-It-Yourself and domain product lines.  As we are decreasing our investment in sales and marketing in certain sales channels as we focus on the Yodle integration, we expect some softness in our value added digital marketing solutions revenue in the 4 th quarter. We expect to generate strong free cash flow which will be used to pay down debt and repurchase common shares.

Liquidity and Capital Resources
 
The following table summarizes total cash flows for operating, investing and financing activities for the nine months ended September 30, (in thousands):   
 
Nine months ended September 30,
 
2016
 
2015
 
(unaudited, in thousands)
Net cash provided by operating activities
$
89,747

 
$
112,570

Net cash used in investing activities
(322,483
)
 
(12,487
)
Net cash provided by (used in) financing activities
235,884

 
(104,172
)
Effect of exchange rate changes on cash
(36
)
 
(3
)
Increase (decrease) in cash and cash equivalents
$
3,112

 
$
(4,092
)
 
Cash Flows

As of September 30, 2016 , we had $ 21.8 million of cash and cash equivalents and $ 207.0 million in negative working capital, as compared to $ 18.7 million of cash and cash equivalents and $ 167.7 million in negative working capital as of December 31, 2015 . The unfavorable change in working capital is primarily due to increases in deferred revenue, deferred consideration and accounts payable, primarily resulting from the March 2016 acquisition of Yodle. Prepaid expenses and accounts receivable are also higher when compared to December 31, 2015 primarily from the assets and liabilities of Yodle that were acquired in March of 2016. The deferred consideration in current liabilities, also resulting from the Yodle acquisition, is payable to the sellers on March 9, 2017. The majority of the negative working capital continues to be due to significant balances of deferred revenue, partially offset by deferred expenses, which get amortized to revenue or expense rather than settled with cash. We expect cash generated from operating activities to be more than sufficient to meet our future working capital and debt servicing requirements.

Net cash provided by operations for the nine months ended September 30, 2016 decreased $22.8 million to $89.7 million down from the nine months ended September 30, 2015 . Included in the cash provided by operating activities is $3.9 million of acquisition-related transaction costs that were paid during the nine months ended September 30, 2016 as well as about $0.9 million of restructuring related severance payments that have been made. In addition, cash paid for interest is $4.6 million higher than in the nine months ended September 30, 2015. The working capital changes also reflect the requirement to fund $5.6 million of letters of credit that are restricted by operating leases of Yodle. The annual performance bonuses paid in the nine months ended September 30, 2016 were higher than amounts paid for the same prior year period. Finally, accounts receivable timing and accrued expense payments were also unfavorable during the nine months ended September 30, 2016 due primarily to the Yodle acquisition.

Net cash used in investing activities during the nine months ended September 30, 2016 was $ 322.5 million , as compared to $12.5 million in the nine months ended September 30, 2015 . The quarter ended March 31, 2016 included a $300.3 million payment for the acquisition of 100% of the outstanding shares of Yodle, Inc., a leader in value added digital marketing solutions that further solidifies our position as a leading national provider in this space. In addition, on May 31, 2016, we purchased the assets of TORCHx, Inc. a Florida corporation for $4.4 million, of which $3.0 million was paid at closing with the remaining $1.5 million payable on November 30, 2017. See Note 2, Business Combinations , for additional information surrounding these acquisitions. Also included in cash used in investing activities for the nine months ended September 30, 2016 is $1.5 million in payments for domain registrar credentials that were acquired during the period. Capital expenditures increased by $6.5 million during the nine months ended September 30, 2016 due to major capital investments that have been

29



made on our next generation website builder tool, building new operational functionality that supports the consolidation of customer transactions and billing platforms, as well as, the development of a lead traffic and advertising spend value reporting platform.

Net cash provided by financing activities during the nine months ended September 30, 2016 , reflects the increase in long term debt from our amended credit agreement to fund the acquisition of Yodle Inc., on March 9, 2016. During the nine months ended September 30, 2016 , common stock repurchases of approximately 1.0 million common shares totaling $17.5 million were made in connection with our stock repurchase program announced on November 5, 2014. Proceeds received from the exercise of stock options decreased by $2.8 million to $ 3.8 million in the nine months ended September 30, 2016 when compared to the same prior year period. Approximately $ 4.2 million and $2.3 million of cash was used to pay employee minimum tax withholding requirements in lieu of receiving common shares during the nine months ended September 30, 2016 and 2015 , respectively. The nine months ended September 30, 2016 included $5.7 million of loan origination and arrangement fees in connection with the March 2016 amendment to the credit agreement. See Note 6, Long Term Debt , for additional information surrounding the amendment.

Debt Covenants

The amendment to the credit agreement entered into on February 11, 2016 with an effective date of March 9, 2016, continue to require that we not exceed a maximum first lien net leverage ratio and that we maintain a minimum consolidated cash interest expense to consolidated EBITDA coverage ratio as set forth in the table below. The first lien net leverage ratio is defined as the total of the outstanding consolidated first lien debt minus up to $50.0 million of unrestricted cash and cash equivalents, divided by consolidated EBITDA. The consolidated interest coverage ratio is defined as consolidated EBITDA divided by consolidated cash interest expense. Consolidated EBITDA is defined as consolidated net income before (among other things) interest expense, income tax expense, depreciation and amortization, impairment charges, restructuring costs, changes in deferred revenue and deferred expenses, stock-based compensation expense, non-cash losses, acquisition-related costs and includes the benefit of annualized synergies due to the Yodle acquisition.

Outstanding debt as of September 30, 2016 for purposes of the First Lien Net Leverage Ratio was approximately $435.2 million . The covenant calculations as of September 30, 2016 on a trailing 12-month basis are as follows:

Covenant Description
 
Covenant Requirement as of 
September 30, 2016
 
Ratio at September 30, 2016
 
Favorable/
(Unfavorable)
Consolidated Net Debt to EBITDA
 
Not greater than 3.25
 
2.28

 
0.97

Consolidated Interest Coverage Ratio
 
Greater than 2.00
 
10.02

 
8.02

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

Stock Repurchase Plan

In October 2014, our Board of Directors authorized a plan for the repurchase of up to $100.0 million of our outstanding common shares through December 31, 2016. In October 2016, our Board of Directors approved an increase in our current stock repurchase plan by $100 million and extended the expiration date of the outstanding available shares to December 31, 2018. Therefore, as of November 3, 2016, there was $121.0 million available for repurchase under this program.
 
The timing, price and volume of repurchases will be based on market conditions, restrictions under applicable securities laws and other factors. The repurchase program does not require us to repurchase any specific number of shares, and we may terminate the repurchase program at any time.

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

New Accounting Standards


30



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

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

We believe presenting non-GAAP measures is useful to investors because it describes the operating performance of the company, excluding some recurring charges that are included in the most directly comparable measures calculated and presented in accordance with GAAP. Our management uses these non-GAAP measures as important indicators of the Company's past performance and in planning and forecasting performance in future periods. The non-GAAP financial information we present may not be comparable to similarly-titled financial measures used by other companies, and investors should not consider non-GAAP financial measures in isolation from, or in substitution for, financial information presented in compliance with GAAP. You are encouraged to review the reconciliation of non-GAAP financial measures to GAAP financial measures included in this Quarterly Report on Form 10-Q.
Relative to each of the non-GAAP measures Web.com presents, management further sets forth its rationale as follows:
Non-GAAP Revenue . Web.com excludes from non-GAAP revenue the impact of the fair value adjustment to amortized deferred revenue because management believes that excluding such measures helps management and investors better understand the Company's revenue trends.
Non-GAAP Operating Income and Non-GAAP Operating Margin . Web.com excludes from non-GAAP operating income and non-GAAP operating margin, amortization of intangibles, asset impairment, fair value adjustment to deferred revenue and deferred expense, restructuring expenses, corporate development expenses, and stock-based compensation charges, because management believes that adjusting for such measures helps management and investors better understand the Company's operating activities.
Non-GAAP Net Income and Non-GAAP Net Income Per Basic and Diluted Share . Web.com excludes from non-GAAP net income and non-GAAP net income per basic and diluted share amortization of intangibles, asset impairment, income tax provision, fair value adjustment to deferred revenue and deferred expense, restructuring expenses, corporate development expenses, amortization of debt discounts and fees, and stock-based compensation, and includes estimated cash income tax payments, because management believes that adjusting for such measures helps management and investors better understand the Company's operating activities.
Adjusted EBITDA and Adjusted EBITDA Margin . Web.com excludes from adjusted EBITDA and adjusted EBITDA margin depreciation and amortization expense, asset impairment, income tax provision, interest expense, interest income, stock-based compensation, fair value adjustments to deferred revenue and deferred expense, corporate development expenses and restructuring expenses, because management believes that excluding such items helps investors better understand the Company's operating activities.
Non-GAAP Gross Profit and Non-GAAP Gross Margin . Web.com excludes from non-GAAP gross profit and non-GAAP gross margin, fair value adjustment to deferred revenue and deferred expense, and stock based compensation charges, because management believes that adjusting for such measures helps management and investors better understand the Company's operating activities.
Free Cash Flow. Free cash flow is a non-GAAP financial measure that Web.com uses and defines as net cash provided by operating activities less capital expenditures. The Company considers free cash flow to be a liquidity measure which provides useful information to management and investors about the amount of cash generated by the business after the acquisition of property and equipment, which can then be used for investment opportunities.
In respect of the foregoing, Web.com provides the following supplemental information to provide additional context for the use and consideration of the non-GAAP financial measures used in this quarterly report Form 10-K:
Stock-based compensation . These expenses consist of expenses for employee stock options and employee awards under Accounting Standards Codification ("ASC") 718-10. While stock-based compensation expense calculated in accordance with ASC 718-10 constitutes an ongoing and recurring expense, such expense is excluded from non-GAAP results because such expense is not used by management to assess the core profitability of the Company's business operations. Web.com further believes these measures are useful to investors in that they allow for greater transparency to certain line items in the Company's financial statements. In addition, when management performs internal comparisons to Web.com's historical

31



operating results and compares the Company's operating results to the Company's competitors, management excludes this item from various non-GAAP measures.
Asset impairment. Web.com has recorded expenses related to asset impairment and excludes the impact of these expenses from its non-GAAP measures, because such expense is not used by management to assess the core profitability of the Company's business operations.
Amortization of intangibles . Web.com incurs amortization of acquired intangibles under ASC 805-10-65. Acquired intangibles primarily consist of customer relationships, customer lists, non-compete agreements, trade names, and developed technology. Web.com expects to amortize for accounting purposes the fair value of the acquired intangibles based on the pattern in which the economic benefits of the intangible assets will be consumed as revenue is generated. Although the intangible assets generate revenue, the Company believes the non-GAAP financial measures excluding this item provide meaningful supplemental information regarding the Company's operational performance. In addition, when management performs internal comparisons to Web.com's historical operating results and compares the Company's operating results to the Company's competitors, management excludes this item from various non-GAAP measures.
Depreciation expense . Web.com records depreciation expense associated with its fixed assets. Although its fixed assets generate revenue for Web.com, the item is excluded because management believes certain non-GAAP financial measures excluding this item provide meaningful supplemental information regarding the Company's operational performance. In addition, when management performs internal comparisons to Web.com's historical operating results and compares the Company's operating results to the Company's competitors, management excludes this item from various non-GAAP measures.
Amortization of debt discounts and fees . Web.com incurs amortization expense related to debt discounts and deferred financing fees. The difference between the effective interest expense and the coupon interest expense (i.e. debt discount), as well as, amortized deferred financing fees are excluded because Web.com believes the non-GAAP measures excluding these items provide meaningful supplemental information regarding the Company's operational performance. In addition, when management performs internal comparisons to Web.com's historical operating results and compares the Company's operating results to the Company's competitors, management excludes this item from various non-GAAP measures.
Restructuring expense . Web.com has recorded restructuring expenses and excludes the impact of these expenses from its non-GAAP measures, because such expense is not used by management to assess the core profitability of the Company's business operations.
Income tax expense . Due to the magnitude of Web.com's historical net operating losses and related deferred tax asset, the Company excludes income tax from its non-GAAP measures primarily because it is not indicative of the actual tax to be paid by the Company and therefore is not reflective of ongoing operating results. The Company believes that excluding this item provides meaningful supplemental information regarding the Company's operational performance and facilitates management's internal comparisons to the Company's historical operating results and comparisons to the Company's competitors' operating results. The Company includes the estimated tax that the Company expects to pay for operations during the periods presented.
Fair value adjustment to deferred revenue and deferred expense . Web.com has recorded a fair value adjustment to acquired deferred revenue and deferred expense in accordance with ASC 805-10-65. Web.com excludes the impact of these adjustments from its non-GAAP measures, because doing so results in non-GAAP revenue and non-GAAP net income which are reflective of ongoing operating results and more comparable to historical operating results, since the majority of the Company's revenue is recurring subscription revenue. Excluding the fair value adjustment to deferred revenue and deferred expense therefore facilitates management's internal comparisons to Web.com's historical operating results.
Corporate development expenses . Web.com incurred expenses relating to acquisitions and the successful integration of acquisitions. Web.com excludes the impact of these expenses from its non-GAAP measures, because such expense is not used by management to assess the core profitability of the Company's business operations.
Monthly average revenue per user, or ARPU . ARPU is a metric the Company measures on a quarterly basis. The Company defines ARPU as quarterly non-GAAP subscription revenue divided by the average of the number of subscribers at the beginning of the quarter and the number of subscribers at the end of the quarter, divided by three months. The Company excludes from subscription revenue the impact of the fair value adjustments to deferred revenue resulting from acquisition-related write downs.
The following table presents our non-GAAP measures for the periods indicated (in thousands, except for per share data and percentages):
Web.com Group, Inc.
Reconciliations of GAAP to Non-GAAP Results

32



(in thousands, except for per share data)
(unaudited)


 


Three months ended September 30,
 
Nine months ended September 30,

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

 

 

 

GAAP revenue
$
190,686

 
$
136,821

 
$
523,303

 
$
405,141

   Fair value adjustment to deferred revenue
2,108

 
3,547

 
16,704

 
12,892

Non-GAAP revenue
$
192,794

 
$
140,368

 
$
540,007

 
$
418,033



 

 

 

Reconciliation of GAAP net income to non-GAAP net income

 

 

 

GAAP net income
$
3,346

 
$
6,094

 
$
2,077

 
$
12,983

   Amortization of intangibles
15,461

 
9,827

 
43,608

 
29,466

   Asset impairment
1,979

 

 
1,979

 

   Stock based compensation
5,008

 
5,067

 
15,208

 
15,251

   Income tax expense
6,477

 
5,673

 
7,976

 
14,437

   Restructuring expense
1,133

 

 
2,047

 
335

   Corporate development
57

 

 
3,925

 
597

   Amortization of debt discounts and fees
3,631

 
2,872

 
10,315

 
8,492

   Cash income tax expense
(850
)
 
(725
)
 
(1,905
)
 
(1,512
)
   Fair value adjustment to deferred revenue
2,108

 
3,547

 
16,704

 
12,892

   Fair value adjustment to deferred expense
80

 
147

 
232

 
504

Non-GAAP net income
$
38,430

 
$
32,502

 
$
102,166

 
$
93,445



 

 

 

Diluted weighted average shares

 

 

 

Diluted shares:

 

 

 

   Basic weighted average common shares
49,221

 
50,035

 
49,296

 
50,420

   Diluted stock options
1,281

 
1,907

 
1,347

 
1,704

   Diluted restricted stock
269

 
370

 
327

 
353

Total diluted weighted average common shares
50,771

 
52,312

 
50,970

 
52,477

 
 
 
 
 
 
 
 

Three months ended September 30,
 
Nine months ended September 30,
Reconciliation of GAAP net income per diluted share to non-GAAP net income per diluted share
2016
 
2015
 
2016
 
2015
GAAP net income per diluted share
$
0.07

 
$
0.12

 
$
0.04

 
$
0.25

   Diluted equity

 

 

 

   Amortization of intangibles
0.31

 
0.18

 
0.85

 
0.55

   Asset impairment
0.04

 

 
0.04

 

   Stock based compensation
0.10

 
0.10

 
0.30

 
0.29

   Income tax expense
0.13

 
0.11

 
0.16

 
0.28

   Restructuring expense
0.02

</