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4-Traders Homepage  >  Equities  >  Nasdaq  >  Web.com Group Inc    WEB

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WEB COM : Management's Discussion and Analysis of Financial Condition and Results of Operations. (form 10-Q)

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11/08/2017 | 12:06pm CET

Forward Looking Statements

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

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 revenue and average revenue per subscriber is useful to investors, because they describe the operating performance of the Company. 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 and related security products, 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.

On January 31, 2017, the Company acquired DonWeb.com, a hosting and domain registration company catering to the Spanish-speaking market, located in Rosario, Argentina. The Company paid approximately $8.6 million at closing. The Company will pay the seller additional consideration of $2.0 million on January 31, 2021, present valued at $1.7 million as of the acquisition date for total consideration of $10.3 million. In addition, the agreement includes a four year earnout provision that entitles the seller up to $3.0 million contingent upon the post-acquisition business performance. The earnout provisions require the seller be employed with the Company and as such will be recorded as compensation expense. See Note 2, Business Combinations, for additional information surrounding the acquisition. 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 included $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

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subscribers. Management's Discussion and Analysis includes the results of operations and cash flows of Yodle from March 9, 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:

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 $1.2 million and $2.1 million for the three months ended September 30, 2017 and 2016, respectively. The fair market value adjustments were $4.2 million and $16.7 million for the nine months ended September 30, 2017 and 2016, 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.

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.

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 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.

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


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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

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 remain flat for the remainder of 2017, while amortization expense is expected to continue to decline as a result of certain intangible assets becoming fully amortized.

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 2016 Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 28, 2017.



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Results of Operations

Comparison of the results for the three months ended September 30, 2017 to the three months ended September 30, 2016

The operations of DonWeb.com began integrating with the existing legacy Web.com operations immediately following the closing of the acquisition on January 31, 2017. 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 or ARPU is not specifically segregated subsequent to these acquisitions, nor would it be indicative of each of the standalone entities.

The following table sets forth our key business metrics:

                                              Three months ended September 30,
                                                 2017                   2016
                                                        (unaudited)
Ending Subscribers as of September 30,          3,460,000                3,447,000
Net subscriber (reductions) additions(1)          (30,000 )                  5,000

Average revenue per user (monthly) $ 18.04 $ 18.47

(1) The net subscriber reduction during the three months ended September 30, 2017, includes a decrease of approximately 6,000 subscribers that is an adjustment to final subscriber counts related to the DonWeb.com acquisition from January 1, 2017.

Subscriber counts decreased by approximately 30,000 subscribers during the three months ended September 30, 2017, as compared to an increase of approximately 5,000 subscribers during the three months ended September 30, 2016. The decline in subscriber counts was in part driven by a shift in our sales strategy towards higher ARPU services, which results in lower new customer additions. Our rolling twelve month retention rate as of September 30, 2017 was 84.4% compared to 86.0% during the same prior year period. The retention rate was essentially flat during the third quarter of 2017 when compared sequentially to the second quarter ended June 30, 2017. Relative to our large base of domain subscribers, Yodle's products are higher churn, which we continue to view as an opportunity for improvement. In addition, the overall mix shift away from domain subscribers negatively impacted retention. During the nine months ended September 30, 2017, we continued to make progress positioning our product portfolio and aligning our sales channels to improve customer satisfaction and ultimately retention.

Revenue
                                       Three months ended September 30,
                                              2017                     2016
                                          (unaudited, in thousands)
Revenue:
Subscription                    $         186,758                   $ 188,771
Professional services and other             1,809                       1,915
Total revenue                   $         188,567                   $ 190,686

Total revenue decreased to $188.6 million in the three months ended September 30, 2017 from $190.7 million in the three months ended September 30, 2016. Total revenue for the respective 2017 and 2016 periods includes $1.2 million and $2.1 million of unfavorable impact resulting from amortizing deferred revenue. The unfavorable impact decreased $0.9 million during the three months ended September 30, 2017, compared to the same prior period. The deferred revenue resulted from acquisition fair value adjustments recorded during 2017 and 2016. The remaining $3.0 million decrease in revenue during the three months ended September 30, 2017 when compared to the same prior year period, resulted primarily from lower Yodle products revenues, as well as decreased Do-It-Yourself ("DIY") website volumes. These declines in revenue were partially offset by an increase in our vertical marketing solutions revenue and higher online marketing, lead generation and email revenues.


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Subscription Revenue. Subscription revenue decreased during the three months ended September 30, 2017, to $186.8 million from $188.8 million during the three months ended September 30, 2016. The decrease is primarily due to drivers mentioned above, excluding the $0.1 million unfavorable impact from custom design website services.

Professional Services and Other Revenue. Professional services revenue of $1.8 million was 6% lower in the three months ended September 30, 2017 down from $1.9 million for the three months ended September 30, 2016. The slight decrease was principally driven by a lower volume of custom design professional services.

Cost of Revenue and Operating Expenses

                                                           Three months ended September
                                                                       30,
                                                              2017              2016
                                                            (unaudited, in thousands)
Cost of Revenue and Operating Expenses:
Cost of revenue                                           $    59,414$   58,380
Sales and marketing                                            51,026           55,304
Technology and development                                     16,331           15,538
General and administrative                                     20,168           19,094
Restructuring expense                                             424            1,133
Asset impairment                                                    -            1,979
Depreciation and amortization                                  17,601           21,165
Total cost of revenue and operating expenses              $   164,964$  172,593

Cost of Revenue. Cost of revenue increased $1.0 million during the three months ended September 30, 2017, compared to the three months ended September 30, 2016. The increase was due to higher online marketing, email and domain related expenses, offset by a decrease in partner-related commissions, as well as declines in salaries and benefits. In addition, the inclusion of the operating costs from the DonWeb acquisition that closed on January 31, 2017 contributed to the increase in cost of revenue during the three months ended September 30, 2017 compared to the same prior year period.

Sales and Marketing Expenses. Sales and marketing expenses decreased 8% or $4.3 million to $51.0 million, or 27% of total revenue, from $55.3 million, or 29% of revenue, for the comparable periods. The decline of $3.1 million was primarily due to lower marketing expenses as we strategically focused efforts on reducing certain online, television and affiliate marketing expenses. In addition, salaries and benefits decreased $0.7 million mainly driven by lower headcount and facilities expense declined $0.8 million from exiting two of the three floors of the Yodle New York, New York office, as well as exiting the St. Lucia call center facility. Offsetting the above declines in costs were incremental costs resulting from the acquisition of DonWeb in January 2017.

Technology and Development Expenses. Technology and development expenses of $16.3 million, or 9% of total revenue, increased by $0.8 million during the three months ended September 30, 2017 from $15.5 million, or 8% of total revenue during the three months ended September 30, 2016. The increase was driven by $0.7 million of higher salaries and benefits principally driven from a decline in internally developed software projects in the comparable periods. Additionally, software maintenance and security expenses increased $0.6 million during the three months ended September 30, 2017 when compared to the same prior year period. These increases were partially offset by lower facilities expenses due to exiting the New York, New York space as noted above.

General and Administrative Expenses. General and administrative expenses increased $1.1 million to $20.2 million, or 11% of total revenue, during the three months ended September 30, 2017, as compared to $19.1 million, or 10% of total revenue during the three months ended September 30, 2016. The increase was due to $0.7 million of higher legal and corporate development expenses as well as $0.5 million of additional salaries and incentive-based benefits during the third quarter ended September 30, 2017 when compared to the same prior year period. Partly offsetting these increases was a $0.3 million decline in regulatory fees.


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Restructuring Expense. The three months ended September 30, 2017 includes a $0.4 million restructuring charge from adjusting the estimated real estate taxes on our New York office lease that was previously vacated. The three months ended September 30, 2016 included restructuring expense of $1.1 million, primarily from terminating certain Yodle employees.

Depreciation and Amortization Expense. Depreciation and amortization expense decreased $3.6 million to $17.6 million during the three months ended September 30, 2017 from $21.2 million during the three months ended September 30, 2016. Amortization expense declined as certain Network Solutions' intangible assets became fully amortized. Depreciation expense decreased by $0.4 million during the three months ended September 30, 2017 compared to the same prior year period, as certain assets acquired with the Network Solutions acquisition became fully depreciated.

Interest Expense, net. Net interest expense totaled $8.6 million and $8.3 million for the three months ended September 30, 2017 and 2016, respectively. Included in the interest expense for each of the three months ended September 30, 2017 and 2016, respectively, was $4.1million and $3.6 million, primarily from amortizing deferred financing fees and loan origination discounts. Loan interest expense, excluding amortization, decreased $0.2 million during the third quarter ended September 30, 2017, compared to the third quarter of 2016, primarily due to lower overall debt levels during the current year quarterly period ended.

Income Tax Expense. We recorded income tax expense of $6.7 million and $6.5 million during the three months ended September 30, 2017 and 2016, respectively, based upon our estimated annual effective tax rates for each year. Our estimated annual effective tax rate for 2017 and 2016 reflects the impact of net unfavorable permanent book-tax differences primarily driven by stock compensation estimated for the year and an increase in the projected year-end valuation allowance related to certain state and foreign deferred tax assets.

Comparison of the results for the nine months ended September 30, 2017 to the nine months ended September 30, 2016.

The operations of DonWeb.com began integrating with the existing legacy Web.com operations immediately following the closing of the acquisition on January 31, 2017. 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 is not specifically segregated subsequent to these acquisitions, nor would it be indicative of each of the standalone entities.

Revenue
                                      Nine months ended September 30,
                                             2017                    2016
                                         (unaudited, in thousands)
Revenue:
Subscription                    $        554,616$ 518,084
Professional services and other            5,800                      5,219
Total revenue                   $        560,416$ 523,303

Total revenue increased to $560.4 million for the nine months ended September 30, 2017 from $523.3 million for the nine months ended September 30, 2016. Total revenue includes $4.2 million and $16.7 million of unfavorable impact resulting from amortizing into revenue, deferred revenue that was recorded at fair value on the respective acquisition dates, during the nine months ended September 30, 2017 and 2016, respectively. The unfavorable impact decreased $12.5 million during the nine months ended September 30, 2017 compared to the same prior period. The remaining $24.6 million increase in revenue during the nine months ended September 30, 2017, was driven principally from the inclusion of Yodle for the entire 2017 period compared to a partial period in 2016, as well as increases in lead generation and email revenues. These increases were partially offset by a decline in DIY products, such as hosting and website presence, in addition to lower domain and domain-related product revenues.

Subscription Revenue. Subscription revenue increased during the nine months ended September 30, 2017, to $554.6 million from $518.1 million during the nine months ended September 30, 2016. The increase was primarily due to the inclusion of Yodle for the entire nine months ended September 30, 2017, compared to a partial period in 2016. In addition, subscription revenue increased due to the drivers discussed above.


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Professional Services and Other Revenue. Professional services revenue increased 11% to $5.8 million for the nine months ended September 30, 2017 from $5.2 million for the nine months ended September 30, 2016. The increase was principally driven by a higher volume of custom design professional services.

Cost of Revenue and Operating Expenses


                                                            Nine months ended September 30,
                                                                 2017                2016
                                                               (unaudited, in thousands)
Cost of Revenue and Operating Expenses:
Cost of revenue                                           $        175,863$  167,189
Sales and marketing                                                151,168          157,867
Technology and development                                          50,655           47,896
General and administrative                                          61,274           54,391
Restructuring expense                                                  736            2,047
Asset impairment                                                       143            1,979
Depreciation and amortization                                       53,435           59,351
Total cost of revenue and operating expenses              $        493,274$  490,720

Cost of Revenue. Cost of revenue increased 5% or $8.7 million during the nine months ended September 30, 2017, compared to the nine months ended September 30, 2016. The increase was primarily driven by the inclusion of a full nine months of costs associated with Yodle in 2017 compared to a partial period of activity in 2016. Additionally, we incurred $1.2 million of increased software related services and $0.7 million of higher email costs. Offsetting the increases were declines in the following: partner-related commissions of $3.4 million, hosting expenses of $1.0 million, as well as $1.1 million of lower salaries and benefits.

Sales and Marketing Expenses. Sales and marketing expenses decreased 4% to $151.2 million, or 27% of total revenue, during the nine months ended September 30, 2017 from $157.9 million, or 30% of revenue, during the nine months ended September 30, 2016. Sales and marketing expenses decreased year over year due to a decline of $17.4 million in marketing expenses, as we strategically focused efforts on reducing certain television, online and affiliate marketing programs partially offset by the inclusion of Yodle for the entire nine month period ended September 30, 2017 compared to the same prior year period and a $4.8 million increase in salaries and benefits.

Technology and Development Expenses. Technology and development expenses of $50.7 million, or 9% of total revenue, increased by $2.8 million during the nine months ended September 30, 2017, from $47.9 million, or 9% of total revenue during the nine months ended September 30, 2016. The increase in technology and development expense is principally driven by $2.6 million of higher salaries and benefits as well as an increase of $0.8 million in software and security costs during the nine months ended September 30, 2017 compared to the same prior year period. These additional costs were partially offset by lower facilities costs from exiting two floors of Yodle's New York City leased office space.

General and Administrative Expenses. General and administrative expenses increased $6.9 million to $61.3 million, or 11% of total revenue, during the nine months ended September 30, 2017, as compared to $54.4 million, or 10% of total revenue during the nine months ended September 30, 2016. The increase was due to higher general and administrative expenses resulting primarily from $7.9 million of increased incentive-based compensation, $1.0 million of higher software maintenance and $1.1 million of increased legal and accounting costs. These increases were partially offset by $2.9 million of lower corporate development costs as a result of the complexity of the Yodle acquisition in 2016.

Restructuring Expense. For the nine months ended September 30, 2017 and 2016, restructuring expense was $0.7 million and $2.0 million, respectively, primarily from terminating certain Yodle employees. The nine months ended September 30, 2017 also includes a $0.4 million lease restructuring charge from adjusting the estimated real estate taxes on our New York office space lease that was previously vacated.

Asset impairment. During the nine months ended September 30, 2017 and 2016, we recorded a $0.1 million and $2.0 million impairment charge on our domain name inventory, respectively.

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Depreciation and Amortization Expense. Depreciation and amortization expense decreased $5.9 million to $53.4 million during the nine months ended September 30, 2017 from $59.4 million during the nine months ended September 30, 2016. Amortization expense decreased by $6.3 million during the nine months ended September 30, 2017 as certain Network Solutions' intangible assets became fully amortized. Depreciation expense increased by $0.4 million during the nine months ended September 30, 2017 which is driven principally by the Yodle acquisition, partially offset by certain fixed assets becoming fully depreciated.

Interest Expense, net. Net interest expense amounted to $24.6 million and $22.5 million for the nine months ended September 30, 2017 and 2016, respectively. Included in the interest expense for the nine months ended September 30, 2017 and 2016, is $11.5 million and $10.3 million, primarily from amortizing deferred financing fees and loan origination discounts, respectively. Loan interest expense, excluding amortization, increased $0.8 million during the nine months ended September 30, 2017, compared to the nine months ended 2016, primarily due to the additional debt incurred from financing the Yodle acquisition in March 2016.

Income Tax Expense. We recorded income tax expense of $19.7 million and $8.0 million during the nine months ended September 30, 2017 and 2016, respectively, based upon our estimated annual effective tax rates for each year. Our estimated annual effective tax rate for 2017 and 2016 reflects the impact of net unfavorable permanent book-tax differences primarily driven by stock compensation estimated for the year and an increase in the projected year-end valuation allowance related to certain state and foreign deferred tax assets.

Outlook. For the fourth quarter of 2017, we expect stability in our non-GAAP revenue compared to the third quarter of 2017. For the full year, we anticipate year over year growth primarily due to a full year contribution from our Yodle acquisition. We expect to generate strong cash flow from operations, which could be used to pay down debt, repurchase common shares or fund other corporate development activities.

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,
                                                             2017                     2016
                                                              (unaudited, in thousands)
Net cash provided by operating activities             $        110,830$       89,747
Net cash used in investing activities                          (25,379 )              (322,483 )
Net cash (used in) provided by financing activities            (98,129 )               235,884
Effect of exchange rate changes on cash                            (25 )                   (36 )

Net (decrease) increase in cash and cash equivalents $ (12,703 )$ 3,112

Cash Flows

At September 30, 2017, we had $7.7 million of cash and cash equivalents and $238.5 million in negative working capital, as compared to $20.4 million of cash and cash equivalents and $209.3 million in negative working capital at December 31, 2016. The majority of the negative working capital continues to be due to significant balances of deferred revenue, partially offset by deferred expenses, which is amortized to revenue or expense rather than settled with cash. Also included in the negative working capital as of September 30, 2017 is the deferred consideration of $23.1 million, primarily resulting from the Yodle acquisition and is payable to the sellers on March 9, 2018. In addition, the current portion of long term debt increased $14.4 million to $31.3 million as of September 30, 2017. We expect cash generated from operating activities to be more than sufficient to meet our future working capital and debt servicing requirements. We have included the majority of the 2018 Notes as long-term debt based upon our intent and ability to refinance these obligations.

Net cash provided by operating activities for the nine months ended September 30, 2017 increased $21.1 million to $110.8 million, primarily driven by the higher operating cash flows stemming from the March 2016 Yodle acquisition. Included in the

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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. Also contributing to the increase in cash provided by operations during the nine months ended September 30, 2017 compared to the same prior year period, is the absence of funding $6.4 million of letters of credit for Yodle operating leases that occurred during the first quarter of 2016. Partially offsetting the increases were $4.1 million of restructuring related severance and lease payments that have been made in 2017 and an increase in cash paid for interest of $1.5 million in the nine months ended September 30, 2017 compared to the same prior period. Finally, deferred revenue was unfavorable during the nine months ended September 30, 2017 compared to the nine months ended September 30, 2016.

Net cash used in investing activities during the nine months ended September 30, 2017 was $25.4 million, as compared to $322.5 million in the nine months ended September 30, 2016. The nine months ended September 30, 2017 included a payment of $8.6 million for 100% of the outstanding shares of DonWeb.com whereas, the nine months ended September 30, 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 and $3.0 million for the acquisition of TORCHx. See Note 2, Business Combinations, for additional information surrounding these acquisitions. Capital expenditures of $16.8 million during the nine months ended September 30, 2017 decreased by $0.9 million when compared to the same period prior year. The capital expenditures during the nine months ended September 30, 2017, were primarily related to 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 used in financing activities during the nine months ended September 30, 2017, reflects an $18.9 million consideration payment made to the sellers of Yodle on March 9, 2017. The cash provided by financing activities during the nine months ended September 30, 2016 includes increases 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, 2017 and 2016, common stock repurchases of approximately 3.1 million and 1.0 million common shares totaling $76.5 million and $17.5 million, respectively, were made in connection with our stock repurchase program announced on November 5, 2014, of which for the nine months ended September 30, 2017, $74.4 million was paid to Okumus Fund Management Ltd. for 3.0 million shares. Proceeds received from the exercise of stock options increased by $9.3 million to $13.1 million in the nine months ended September 30, 2017 when compared to the same prior year period. Approximately $3.6 million and $4.2 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, 2017 and 2016, respectively. The nine months ended September 30, 2017 and 2016 included $1.9 million and $5.7 million of loan origination and lender fees, respectively in connection with the respective May 2017 amendment and March 2016 amendment to the credit agreement. We drew $49.0 million on our revolving credit facility during the nine months ended September 30, 2017; $7.0 million was drawn in anticipation of funding requirements for the consideration payment to the sellers of Yodle and subsequently repaid the amount in April 2017, while $42.0 million was drawn in the third quarter of 2017 to partially fund the repurchase of common shares, of which, $10.0 million was subsequently repaid. The beginning of the year balance on the revolving credit facility of approximately $49.3 million was converted to additional term loan in May 2017. Payments on the term loan amounted to $43.0 million and $4.9 million during the nine months ended September 30, 2017 and 2016, respectively. Payments on the revolving credit facility of $50.6 million were made during the nine months ended September 30, 2016.

Debt Covenants

The second amendment to the credit agreement dated May 18, 2017 continues 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, 2017 for purposes of the First Lien Net Leverage Ratio was approximately $414.0 million. The covenant calculations as of September 30, 2017 on a trailing 12-month basis are as follows:

                                                                    Ratio at
                                  Covenant Requirement as of      September 30,       Favorable/
Covenant Description                  September 30, 2017              2017           (Unfavorable)
Consolidated Net Debt to EBITDA      Not greater than 3.65                 2.28              1.37



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Consolidated Interest Coverage Ratio Greater than 2.00 9.47 7.47

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 September 30, 2017, there was $33.6 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

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.


•      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.


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-Q:
•      Fair value adjustment to deferred revenue. Web.com has recorded fair value
       adjustments to acquired deferred revenue in accordance with ASC 805-10-65.
       Web.com excludes the impact of these adjustments from its non-GAAP revenue
       measures, because doing so results in non-GAAP revenue which are more
       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 facilitates management's internal comparisons to
       Web.com's historical operating results.



                                       30

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                                         Web.com Group, Inc.
                             Reconciliations of GAAP to Non-GAAP Results
                              (in thousands, except for per share data)
                                             (unaudited)
                                                                Three months ended September 30,
                                                                    2017                 2016

Reconciliation of GAAP revenue to non-GAAP subscription revenue used in ARPU GAAP revenue

                                                 $       188,567$       190,686
Fair value adjustment to deferred revenue                              1,202                 2,108
  Non-GAAP revenue                                           $       189,769$       192,794
  Professional services and other revenue                             (1,809 )              (1,915 )
Non-GAAP subscription revenue used in ARPU                   $       187,960$       190,879
  Average subscribers (in thousands)                                   3,472                 3,445

ARPU (Non-GAAP subscription revenue per subscriber over 3 month period)

                                                $         18.04       $         18.47



Contractual Obligations and Commitments

We have no material changes outside the ordinary course of business to the Contractual Obligations table as presented in Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations of our 2016 Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 28, 2017.

Off-Balance Sheet Arrangements

As of September 30, 2017 and December 31, 2016, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.


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