Web.com, Inc. (WWWW) F3Q08 Earnings Call November 6, 2008 5:00 PM ET
Peter Delgrosso - Senior Vice President, Corporate Communications
David L. Brown - Chairman, Chief Executive Officer
Kevin M. Carney - Chief Financial Officer
Jeffrey M. Stibel - President
David Hilal - Friedman, Billings, Ramsey Group, Inc.
Nate Swanson - ThinkEquity
Troy Mastin - William Blair & Company, LLC
Scott Berg - ThinkEquity
Sameet Sinha - JMP Securities
Carter Malloy - Stephens
Steven Jute – RBC Capital Markets
Good day, everyone, and welcome to today’s Web.com third quarter 2008 financial results conference call. (Operator Instructions) I would now like to turn the call over to Peter Delgrosso, Senior Vice President of Corporate Communications.
Thank you, Miranda. Good afternoon and thank you for joining us today to review Web.com’s third quarter 2008 financial results. With me on the call today are David Brown, Chairman and CEO, Jeff Stibel, President, and Kevin Carney, Chief Financial Officer. After prepared remarks, we will open up the call to a question and answer session.
Please note that our remarks today contain forward-looking statements. The words anticipate, expect, may, believe, will, and similar expressions are intended to identify forward-looking statements.
These statements are based solely on our current expectations and are risks and uncertainties that can cause actual results and the timing of such results to differ materially from those projected in the forward-looking statements.
Please refer to our filings with the SEC and the risk factors contained therein including our quarterly report on Form 10-Q for the quarter ended June 30, 2008 for more information on these risks and uncertainties and our limitations that apply to our forward-looking statements.
Web.com expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements made herein. Additionally, this conference call may contain information that is deemed to be a non-GAAP financial measure. A reconciliation to the nearest GAAP financial measure is available at our website www.web.com under the Investor Relations tab. Also, please note that a webcast of today’s call will be available on our website in the IR section.
With that, I’d like to turn the call over to our Chairman and CEO, David Brown. David?
Thank you, Pete, and thank you all for joining us to review our third quarter financial results, which were consistent with our guidance from both a revenue and earnings perspective.
We have now passed the one-year mark since Web.com and Website Pros merged and the long-term earnings power of our combined company is evidenced by operating margin expansion during 2008, with the third quarter representing record non-GAAP levels.
This has come in the face of an increasingly challenging macroeconomic environment, as we discussed last quarter, which is impacting our target customer base and business from a short-term perspective. Moreover, since our last call, it is fair to say that the economic climate took an even further turn for the worse as a result of the global crisis in the financial market that accelerated during the final weeks of the September quarter.
While the near term demand outlook is pressured by the economic environment, it is important to keep in perspective the fact that Web.com has faced adverse market environments in the past, such as the bursting of the dot.com bubble in 2001 and emerged an even stronger company. The company is now significantly larger and more diversified than we were when we faced the last recessionary period and we are generating strong and increasing cash flow and profitability.
In fact, our profits today are greater than what our revenue was during the last such period. To put things into perspective, the company’s financial strength is the strongest it has ever been in the company’s eleven year history with profitability at record levels, annualized operating cash flow at record levels at approximately $25 million and growing. Operating margins at record and best in class levels of 18% plus, and expected to continue to expand. A growing cash balance of approximately $34 million and no debt.
With a strong market position in financial profiles, we believe that we are well prepared to weather the current economic crisis and have the opportunity to emerge in a stronger position for the long-term as we have in the past.
Taking a look at the summary financial results for the quarter, total revenue was $30.6 million, which was within our guidance range. From a profitability perspective, the company delivered GAAP operating income of $1.1 million, up 41% year-over-year and representing a 4% margin while non-GAAP operating income came in at $5.5 million, up over 127% year-over-year and representing a record non-GAAP operating margin of 18%. This drove GAAP net income for diluted share to $0.04 per share and non-GAAP net income per diluted share to $0.19 per share, which was also consistent with our guidance.
We generated $6.2 million in cash from operations during the quarter, up 45% year-over-year, bringing our year-to-date total to $10.2 million dollars. Excluding the paydown of accrued restructuring charges, cash flow form operations would have been approximately $7.1 million for the third quarter and $16.4 million year-to-date.
Our record operating profitability and strong cash generation are not only examples of the inherent leverage in our company’s operations, but they are reflective of a corporate culture that for over a decade has focused on running a sound, highly profitable business during up and down economic cycles.
We will continue to execute with this focus during the current challenging economic environment and in a moment I will share with you some recent actions we have taken to position us to do so.
During the third quarter, as conditions in the marketplace continue to soften, we decreased emphasis on direct marketing, but continued our opportunistic efforts to add new customers. Our strategy is still to grow organically and through acquisitions and in the third quarter we executed against this plan. We ended the third quarter with over 274,000 subscribers, which was an increase of approximately 2,700 net new subscribers during the quarter.
In addition to our multi-channel customer acquisition strategy, we followed through on an opportunistic deal, which brought in approximately 9,000 relatively low ARPU subscribers, specifically the customers we purchased came from Quetzal, an internet services company, which divested its web hosting business. The Quetzal subscribers were already utilizing our web offerings and hosting platforms, thereby significantly reducing the cost and risks normally associated with customer acquisitions.
We acquired this customer base at a historically low cost of acquisition. It is important to note that the expected return on this customer base purchase is materially greater than what we believe a comparable investment in online marketing would deliver in today’s market environment. This Quetzal purchase serves as a great example of an opportunity to monetize a significant number of subscribers on our platform in a cost efficient matter enabling Web.com to scale the higher profitability levels.
As we indicated on last quarter’s call, the more challenging economic environment was impacting our growth in three ways and that continues to be the case.
With respect to our partner channels, we have seen a continued reduction of partner-generated sales leads to our outbound sales force and contribution from our enterprise channel as well as similar low productivity from our online direct marketing programs.
Taking collectively, it’s clear that we are facing a challenging environment for growing our net subscriber editions in the short term. That said, we will not lower our standards for bring new customers on board as we are intensely focused on running a profitable business. One of the ways to bring on customers efficiently is finding the best partners to work with.
Along those lines, we were very excited to announce partnerships with Yellow Brook, Bob Villa, Merchant Circle, and PowerPay, further strengthening the progress we are making growing our online marketing and e-commerce businesses.
In addition, we have a solid pipeline of opportunities that we are pursuing with other influential partners and recently we renewed our long-standing partnership with Discover under a new two-year arrangement.
We believe Web.com is increasingly being viewed as a partner of choice as a result of our enhanced market position in scale combined with the fact that many companies are looking for ways to focus on their core competencies and find leverage in any way that they can during the current economic environment.
Acquiring subscribers from an opportunistic perspective and from companies feeling economic pressures in addition to growing our partnership channel are examples of ways that we believe Web.com can emerge from the current economic environment in an even stronger position. From a long-term perspective, we remain very positive about Web.com’s position. We continue to believe we are the early stages of a large emerging market opportunity as small and medium-sized business increasingly adopt online marketing services.
We believe that our strategy to diversify the company’s approach to the small business market, both in depth and breadth of product line and in channel diversification is unique and unmatched in the industry.
We continue to make progress in adding value for our small business customers, which is resulting in lower customer churns. Third quarter churn came in at 4%, which approximates our historical low levels and reflects the continuing progress that we are making in reducing churn by increasing the attention even in the face of a difficult economic environment.
For the near term perspective, we will continue to focus on driving efficiencies in our business, identifying cost savings with the ultimate goal of driving growth in our operating profitability in cash flow.
To that end, we are evaluating strategic alternatives for the Fusion license business as we no longer consider it core to our predominantly subscription business model.
In addition, we are implementing headcount and other expense reductions designed to reduce excess capacity. We believe there are additional opportunities for leveraging our company’s operations and we will continue to be proactive and methodical in executing our ongoing improvement strategy to further enhance our growth and earnings prospects.
During the third quarter, we announced the share repurchase program that authorizes the company to spend up to $20 million dollars over an 18-monthy period to repurchase our stock. This program is in line with our strong, ongoing commitment to enhance shareholder value and demonstrates the long-term growth belief we have in the company.
As we look ahead, we will continue to evaluate the best way to utilize the company’s balance sheet and cash flow generation in light of the environment we are operating in to determine the best use of our capital.
Even in a challenging economic environment, we believe we can achieve a 20-plus% non-GAAP operating margin and from a longer term perspective, we continue to believe that Web.com has the core assets addressing a marketing opportunity that would support at least double digit revenue growth following an improvement in the economic environment.
Among the factors that provide us confidence in this belief is the fact that we are highly diversified, growing at strong rates, and increasing in contribution. For example, our online marketing and e-commerce business units are generating strong growth and affording us new ways to monetize our customer base and develop new partnerships as a result of our success.
While these businesses comprise about a quarter of our overall business, they are growing in contribution and have achieved significant success in a relatively short amount of time.
I’d like to reemphasize the confidence we have in the future of Web.com. Our long held commitment to the small business, the most internet segment of the US economy, and our relationship focus on customer value as the way to reach this market has and will continue to serve us well. Along the way as the internet economy has evolved, we evolved into a highly diversified operation and we’ve created a business model that has many leverage points, from building scale in our operations to improving productivity in our business processes to the components of increasing customer lifetime value. All of these have played out to our benefit over the past many quarters and we expect will continue to power our progress moving forward.
I’d now like to turn the call over to Jeff for some additional commentary on both the quarter and other points of interest. Jeff?
Thank you, David. I would like to focus my comments on a couple areas of the business., including our partnerships and then conclude with how we view the short and long-term outlook for Web.com.
On prior calls, we’ve highlighted our partnership channels and described how we see them positively impacting our business. Throughout 2008, we have been extremely active and struck numerous deals with companies looking to leverage our best in class online marketing delivery infrastructure. During 2008 alone, we have signed or renewed deals with many companies, including Yellow Book, Discover, Register.com, CCA Global, SMG, PowerPay, Merchant Circle, Bob Villa, and Lenders One. This adds to our roster of existing partnerships including Rh Donnelley, DEX Media, Yahoo, LegalZoom, Microsoft and many others.
A new addition to our strategy this year was creating a business development driven channel to offer a suite of online marketing solutions to a variety of larger companies with a local retail of franchise presence. This is a top-down strategy in which we sell the Web.com value proposition to the enterprise and may push our solutions down to literally thousands of potential customers.
Over the past couple of quarters, as we have launched these programs, our partners have realized very positive early results with our online marketing program, highlighted by exceptional conversion rates. This demonstrates to us that our strategy in pursuit of this channel is valuable. We continue to work with each of our partners, but due to the macro environment, a few have temporarily paused these marketing campaigns as they evaluate the marketing budget. It is noteworthy; however, that none have cancelled. We’re continuing in our development efforts and as a result have numerous opportunities already underway in pre-launch phase.
While it is safe to say that our near-term expectation on this channel contribution is tempered in light of the current market conditions, over the long-term we see significant potential.
Additionally, over the past several weeks, we’ve announced several promising new partnerships that amplify our presence with small businesses. For example, we recently Yellow Book as a new channel partner. As a company with experience working with yellow page providers, we are very excited the potential they have to add. They’re the number one independent publisher of yellow pages and have approximately 5,000 sales reps and approximately 700,000 unique advertisers.
We are in the initial stages of ramping this promising relationship where a Yellow Book sales rep will be selling our customized website solution to their advertising customers. This new relationship provides Web.com with an opportunity for enormous reach into the local advertising market.
Two other relationships that we recently announced are with Bob Villa and Merchant Circle. Bob Villa is one of the most well-known US television personalities in authority on home improvement. Under this exclusive arrangement, Bob Villa and Web.com will offer homeowners access to home repair contractors under branded and co-branded websites. For contractors, this service provides them with a powerful regeneration solution to attract new customers in the local area and the early response with homeowners and contractors has been very positive.
Merchant Circle is the largest social network of local business owners in the country with over 600,000 local merchants and our partnership will offer these local merchants with Web.com’s marketing and website services. Merchant Circle has done a great job creating a footprint with the new SMB space and we’re now a part of that.
As many of you know, we have experience with ad and commerce business models and see value in offering customers tangible cost savings, revenue generating benefits while increasing our ability to monetize our assets. Under this thinking, we recently announced a deal with PowerPay, a provider of payment processing solutions, which are e-commerce customers have the ability to undergo a free rate analysis which could save the customer up to 25% on merchant fees. In any economy, saving 25% is a good thing. In our current economy, it’s a great thing. With Web.com, we will start earning a transaction fee for any merchants we sign up with approximately a billion dollars in e-commerce transactions facilitated annually, the opportunity to monetize this space is promising.
I’d like to finish by reiterating something that David pointed out. We are highly focused on maintaining our track record of delivering strong profitability and cash flow. Our ability to deliver is evidenced by our profit and cash flow performance year-to-date as well as our outlook for the fourth quarter. Because of the slowdown in the economy, we have already taken deliberate steps to reign in our spending. First, we pulled back on our marketing spend and expect to continue to do so as the environment dictates.
In addition, we streamlined the company to maximize profitability in cash flow. As a result of our efforts, we find ourselves high profitable, comprehensive provider of online marketing for small or medium-sized businesses with approximately $34 million in cash, no debt, annualized cash flow of approximately $25 million and growing, all positioning us to lead this market when the economy improves.
With that, let me turn it over to our Chief Financial Officer review the quarterly financials in more detail. Kevin?
Thanks, Jeff. Total revenue for the third quarter came in at $30.6 million, an increase of 72% year-over-year and a decline of 4% sequentially. Almost half of which was related to the normal decline in license revenue following the new software version launch. Our total revenue was in line with guidance provided for the quarter.
Subscription revenue was $29.2 million in the third quarter representing 95% of our total revenue, growth of 74% year-over-year basis and a decline of 3% on a sequential basis. The remaining $1.4 million dollars in revenue or 5% of total revenue for the third quarter was generated from software licenses and professional services. With over 274,000 subscribers at the end of the quarter, our ARPU was approximately $36 during the third quarter, which was down slightly from $37 in the previous two quarters as a result of our strategic purchase which occurred at the tail end of the quarter and is comprised of lower ARPU but highly profitable customers. Acting out this purchase, ARPU would have been more in line with second quarter levels.
We will continue to balance our objectives for maximizing ARPU and subscriber additions and seems to be fluctuations in these numbers on a quarter-to-quarter basis. We do not view one as a greater strategic priority over the other. The key is to manage both in a way that will drive profit growth for the company over the long term.
Our consolidated churn rate remained the 3.9% we achieved last quarter coming in at 4% for the third quarter. Our long-term trend of bringing churn down remains intact, in spite of the more difficult economic environment and can be attributed to our continued efforts of providing and demonstrating the high value of our solutions.
Turning to gross profit, we generated $19.4 million in gross profits for the third quarter representing a record gross margin of 63% down slightly from 64% in the previous quarter.
Gross margin on subscription revenue of 63.4 was down slightly from 63.8% in the previous quarter.
Turning to operating profitability, we’ll focus our discussions on non-GAAP or proforma results, because we believe that excluding the effects of non-cash and non-recurring items such as stock-based compensation, amortization of intangibles arising from business combinations, non-recurring restructuring charges and revenue of limited purchase accounting provides the best indicator of the health of our overall business and the levels of efficiency in our operating infrastructure.
On the operating expense side, non-GAAP sales and marketing came in at $7.1 million or 23.2% of revenue, essentially in line with the second quarter as a percentage of revenue, but down from 4% sequentially in total dollars. Moving forward, we expect total sales and marketing to be lower if we continue to closely our direct marketing spend to ensure that we are generating an attractive return on our investments and we begin to realize the cost savings as we move excess capacity.
Non-GAAP general and administrative expenses were approximately $3.7 million or 12% of revenue down from 14.3% in the second quarter. G&A was positively impacted by our continued cost-savings initiatives.
Non-GAAP research and development expenses came in at $2.3 million or 7.5% of revenue, down from 8.4% in the second quarter. G&A, R&D also saw continued benefits from cost-savings initiatives, but the positive effect due to the elimination of outsourced development resources associated with our Fusion product line.
During the third quarter, we recorded a restructuring charge of approximately $500,000 associated with the early termination of this outsourced relationship. During the fourth quarter, we expect to record an additional restructuring charge of approximately $350,000 associated with the headcount reduction discussed earlier.
We expect our efforts to lower our expense run rate by approximately $2.5 to $3 million on annualized basis once they have been enacted.
Our third quarter non-GAAP income from operations which excludes the effect of stock-based compensation, amortization of intangibles, non-recurring restructuring charges and revenue eliminated in purchase accounting was a record $5.5 million representing growth of 127% on a year-over-year basis and a record 18% on operating margin, up approximately 200 basis points sequentially. Based on 30.3 million shares outstanding for the quarter, we generated non-GAAP diluted EPS of $0.19 which was at the midpoint of our guidance of $0.18-$0.20.
We also appreciate that investors need to analyze our results on a GAAP basis, so we provided a full tabular reconciliation of these GAAP results and the non-GAAP results as part of the earnings release.
In summarizing, the third quarter GAAP results, gross margin was 63%, sales and marketing expense was $7.3 million, R&D expense was $2.4 million, and G&A expense was $4.6 million, leading to GAAP operating income of $1.1 million, up 41% year-over-year and representing a 4% operating margin.
Net income of $1.3 million and net income per fully diluted share of $0.04 in the third quarter 2008. The GAAP results including a reconciliation to non-GAAP results are available on our website at www.web.com under the Investor Relations section.
Turning to the balance sheet, unrestricted cash and investments were $3.6 million at the end of the third quarter, representing a increase of $2.3 million from $31.3 million at the end of the prior quarter. The increase in cash was primarily the result of positive cash from operations offset by the $2.5 million spent in the third quarter associated with the repurchase of shares under the $20 million repurchase program. This program is in line with our strong ongoing commitment to enhance shareholder value and demonstrate the long-term growth belief we have in the company.
Since this was announced, the company has purchased under the plan approximately 700,000 shares in total, with over 400,000 shares being purchased in the third quarter. As we look ahead, we will continue to evaluate the best way to manage the company’s balance sheet in cash flow generation and our actions may include among others capital preservation, M&A opportunities and repurchases of the company’s common stock. Which areas we focus on may vary quarter-to-quarter.
For the third quarter, Web.com generated $6.2 million in cash flow from operations, bringing the year-to-date total to $10.2 million, excluding the paydown of accrued restructuring charges, cash flow from operations would have been approximately $7.1 million for the third quarter and $16.5 million year-to-date.
I would now like to turn to our outlook for the fourth quarter and full year 2008. We expect total revenue in the fourth quarter 2008 in the range of $28-$30 million. Assuming a non-GAAP tax rate in the single digits and 30 million shares outstanding, we expect our non-GAAP net income per diluted share to be in the $0.20-$0.22 range in the fourth quarter. Taking our third quarter results and fourth quarter guidance into consideration, our current full year 2007 outlook is for total revenue in the $121.5 to $123.5 million dollar range and non-GAAP net income per diluted share in the range of $0.72-$0.74.
With that, we’d now like to take questions.
(Operator Instructions) We’ll hear first from David Hilal with FBR.
Phillip for David Hilal - Friedman, Billings, Ramsey Group, Inc.
Could you talk about business conditions that you’ve seen in October and compare them to September and also talk about the quality of the two customers in term of ARPU and churn.
Business conditions questions and Jeff, you can handle the two customers. There hasn’t been a dramatic change in the quality of the economic environment from late September to now. Thirdly in late September, we saw even a greater hesitation on the part of small businesses to by-services. We commented on this in our second quarter call that we were beginning to see in our gross subscriber edition line some slowness in decision making on the part of small businesses and that certainly has continued through the process.
We have not yet seen a marked increase in billing problems and cancellations and as a result of that, our customer retention efforts continued strong through this period.
With regards to the two cad accounts, we really looked at this acquisition as a customer acquisition. I men we compared this to our other marketing efforts and the fact it was equivalent or lower in many cases. These accounts are almost similar to the do-it-yourself hosting accounts versus the red design accounts. So you’re talking about lower ARPU, significantly lower churn as well. The immediate opportunity, this is a profitable acquisition for us and it made a ton of sense.
The longer term opportunity is we’d like to put the Web.com base that was acquired a year ago, we have the opportunity to now offer design and marketing services to these customers.
With respect to the enterprise channel, we had commented earlier that we were seeing some slowdown in spending amongst our enterprise channels, the new channel that we had launched, and we did continue to see that slowdown even increase during as the quarter ran on and went into the fourth quarter and we really believe this is a function of these large corporations evaluating their marketing budgets. None of them have cancelled. All of them, they’re still active programs, but they’re ratcheting back their spend as they’re evaluating the conditions in the marketplace. How bad are the conditions and how bad they might be.
So we’re evaluating that. We still think there’s great opportunity in that channel, but for now it’s moving in a slower pace than it was say in the first and second quarter.
With the stock equivalent lower…is this something you want to continue and in terms of opportunities out there, how much opportunity is there to acquire customer bases like that?
I would say this is absolutely something we want to continue. If we can acquire customers in bulk either through partnership or marketing channeled or through acquisitions, account acquisitions, we will absolutely do that if the sack is attractive and user base is a staple user base.
So to the extent that there are opportunities available, we would look at our marketing budge and allocate it where most appropriate. In terms of the opportunities that may or may not be available, I think that one of the benefits of the downturn of the economy is a lot of companies are looking inward and saying what is non-core? And for a lot of companies, hosting and website design is non-core. So we are actively looking for opportunities in that regard and this was the one that was presented to us in third quarter.
We’ll take our next question from Troy Mastin with William Blair.
Troy Mastin - William Blair & Company, LLC
Revenue line, I think at the midpoint, your guidance suggests that the fourth quarter will be down a few percentage points on a year-over-year basis and down a little bit on a sequential basis, maybe a few percentage points as well. Is that maybe a reasonable expectation in this environment given the higher marketing costs, given lower response rates, given the difficult economy, you’re going to see that kind of slippage on a sequential basis. And if so, I know it’s impossible to predict, but how long might this persist and how much of it upon the economy versus marketing costs?
First off, we anticipated this. In our second quarter call, we could see that the market was softening. We could see that our ability to acquire new subscribers would be pressured, especially if we wanted to maintain our profitability. As cost of acquiring in the online marketing channel began to go up, we made a decision to not chase that cost up that curve and we knew that would have an impact on our net subscriber growth and ultimately that’s going to have an impact. In the short term, we were absolutely convinced that as the market improves, that small businesses will begin to be more confident in their buying decisions and we’ll be able to see an acceleration in our gross subscriber ads. As you can tell, we’ve managed to maintain our customer retention. In fact, made in-roads that area, especially in the controllable part of that business.
So we’re actually fairly pleased that right now things are playing out the way we expected they might, given the last time we talked to you. The other thing that has happened here is that large corporations have already pulled back on the brakes. Small businesses are really being more cautious in their decision making, but still moving forward, and we still are seeing a significant number of small businesses by our services and in many cases by more of our services, but larger corporations as evidenced in our enterprise channel have clearly pulled the brake and so we did see a reduction there and the reduction you saw sequentially in our revenues is largely impacted by that enterprise channel being reduced from third quarter to fourth quarter.
At this point, we don’t have good visibility into where we are in the business cycle here and therefore we’re not in a position to give you much good guidance other than we do believe that we are seeing good trends in our churn. We’re continuing to see subscribers buy our products. There still is strong demand for our e-commerce and our online marketing services. So those are very promising areas for us. So we see a number of very promising areas continuing forward, even to this day and beyond that. That’s about the only visibility we have at this point.
Are there separate forces that work here? Higher marketing costs in a bad economy or are they completely linked in that the response rates have just gone down and that’s a result of the bad economy.
Troy, our decisions were conscious decisions. They were proactive decisions to lower marketing costs. If you look out there, there are other providers going after small businesses that are spending and spending a significant amount and they’re growing, but it is putting significant pressure on their operating margins, on their EBIDTA.
In large part, marketing goes hand in hand with the economy. As the economy tightens, people pull back on their spend. For us, we are going after small businesses, trying to bring them online and the market online. The bright spot is we’re incredibly successful, which is why the customers that we have are staying with us and why our churn continues to go down, but I terms of gross ad, we’ve made a conscious decision knowing that there are less and less small businesses out there in the short term, because of the economy. Knowing that, that means it will cost us more and more to acquire those subscribers to pull back on the marketing spend.
So I think it does go hand in hand. When the economy is down, I think that we will have a much better opportunity to grow at much more rapid rate.
I wanted to ask some questions about the cost items as well as going forward. So maybe I start with reductions, the planned reductions you’ve got for the fourth quarter, how should we expect those to hit your P&L in Q4 and beyond in terms of where we’ll see the cost savings in which line items.
This is Kevin. I think that generally speaking, I think we’re going to see, we talked about a couple of different things. The reduction in the outsource development, obviously you’ll see that and sales and marketing and G&A. I would say moving into the fourth quarter, you’d expect to see those numbers coming down, not every single line exactly the same, but the 10 to 15% range into the fourth quarter and then some…going into the first quarter.
That 10 to 15% is in total dollars?
Total dollars, yes.
On a sequential basis?
You talked a little bit about competitive environment, but I’m curious if there’s evidence yet that these higher costs are having an adverse effect on them yet, particularly given the weakness in the industry lately or the economy lately.
From a partnership perspective, it may be having impact. We are seeing less and less competition in the marketplace as we call on some of the major companies like Yahoo and Microsoft and some of the big, big internet providers that need our services to reach small business, we are frankly seeing very little competition in the marketplace at this point.
We’re also seeing a fair amount of sales activity and divestiture activity. So we have a lot of opportunities right now to look at to evaluate in terms of how to grow our business through that channel, but that’s all that we’ve seen at this point.
We hear next from Scott Berg - ThinkEquity.
Scott Berg - ThinkEquity
The acquisition of Quetzals of 9,000 customers, is that factored into your customer count at the end of the quarter?
Yes it is.
Scott Berg - ThinkEquity
Okay, so if I back out that number, you actually had a net decrease in customers for the quarter?
We would have had about 6,000 net increase in customers, which is what we had expected going into the quarter and our guidance reflected that.
Scott Berg - ThinkEquity
That’s what I thought. I just wanted to make sure my numbers were right.
This was a diversion of marketing that we would have spent out in the marketplace towards this acquisition.
Scott Berg - ThinkEquity
How would you say just kind of the environment in most of the new subscribers that have come in or maybe those that are purchasing products, are they buying more just the basic website services or are they buying some add-on services, whether it’s the marketing or the search engine optimization?
I think what we would say in terms of the spread of subscribers joining us, they’re joining us at even with what we’ve seen in prior quarters. There’s not been a large change in terms of the growth rates in any of our businesses over the last say three to four quarters.
What we are seeing, which I think is interesting in our online marketing and our lead space, we have seen some selling more of the same stuff to the same customer. Especially in the contractor space, we’ve have some positive successes and as that industry tightens up, the value of the leads that we can provide our contractors seems to be going up. So we are seeing an increase in spending in some limited areas. But generally, our growth in subscribers is very consistent with what we’ve seen in previous quarters.
Scott Berg - ThinkEquity
Last question is in regard to your cash level. Are you comfortable with the current cash flow or would you look at doing something different going forward and of course I know about the $20 million stock buyback program.
First off, we are comfortable with our cash levels given that we are generating strong cash flow each quarter. All things being equal and if nothing changes, of course our cash levels are going to continue to grow rapidly; however, we’ve had an ongoing and will continue to have an ongoing practice of evaluating different ways to deploy our cash. Whether it’s through buying back shares or investing in marketing and growth for the business or in acquisitions and we’re evaluating those constantly, given the market conditions, but we are very pleased with the fact that not only do we have $34 million approximately in cash, but we’re generating cash at a very nicely increasing rate, which gives us a lot of ammunition to both bolster the company now, but take advantage of opportunities that we know we will see, because we’ve already lived through one of these recessionary periods actually back seven or eight years ago and we came out of that in a similar situation as not only a strong survivor, but we were able to utilize our strength to build the company into the company it is today.
We’ll go next to Sameet Sinha - JMP Securities
Sameet Sinha - JMP Securities
When we talk to the people in industry, a number SMBs are going out of business. Employment is down on the SMB market, can you comment on that? Have you seen that in your experience, are they going out of business or what’s your experience there?
I can tell you that we measure these types of things extremely closely in our business. This is s metrics-driven business and we have not seen a marked increase in customers going out of business to this point in time. We have obviously tough economic times and we do see some modest impact in those areas, but fortunately for us we’ve been able to completely offset the effects of that with improvements in the value of our products and in our retention program, but we really haven’t seen any material increases at this point in default rates or those types of things to this point in time.
Sameet Sinha - JMP Securities
Sequentially, revenues, do you expect them to be down in fourth quarter or on a net basis…should probably be down in the fourth quarter. Can you venture a guess into 09? Fourth quarter trends hold and eventually see a couple of negative quarters, is that kind of what you’re seeing in your budget?
In our current forecast, we would expect and we indicated this in the second quarter conference call, that we expected net subscribers to be going down for at least the next few quarters as long as we were in these very difficult economic times. We figure that’s a function of our gross subscriber growth being reduced, not necessarily our churn going up. So we could expect churn to remain relatively constant and we would expect we might continue to see erosion in subscribers here marketplace begins to gain some confidence.
It’s important to note, while seeing the weaknesses on the gross subscriber count, it’s important there, because that’s where most of the cost is in terms of acquiring subscribers and it’s one of the reasons why our margins are actually expanding at this time. Once the economy rebounds, we’re going to be in a much stronger position to grow.
Sameet Sinha - JMP Securities
Can you give us a sense of the cost structure, how much of it is fixed….\
In our formal comments, we mentioned that we do believe there is additional opportunity and additional leverage in our business model. So there is a significant opportunity in 2009 for additional costs to be reduced. We’ve not outlined those yet and aren’t prepared to do those yet, but there is still significant opportunities for leverage in our business model.
We’ll go next to Carter Malloy with Stephens.
Carter Malloy - Stephens
Couple of quick questions, one on the churn rate in the quarter. Does that include the 10,000 acquired customers and if so, what would that churn rate have been?
It would include the 9,000.
Carter Malloy - Stephens
Do you have that churn rate?
I don’t have that handy.
Carter Malloy – Stephens
What percent of your new customers maybe year-to-date or for last quarter were actually coming from your online marketing efforts?
We can’t give you a percentage, Carter, but we can tell you and we’ve mentioned this previously that the online channels are a very significant contributor of subscribers. When the two companies combined, Web.com and Website Pros, one of the reasons why we wanted that combination to occur, at least the Website Pros folks wanted it to occur, is we wanted that online marketing channel and not all channels pay out for you in every environment, but it works extremely well in strong economic markets and it did. It’s still working very strongly for us now. I would say it’s more than a majority of our gross subscribers, but that’s the level of detail that we provided on at this point.
And it is also one of our fastest growing areas in the company.
Carter Malloy - Stephens
You guys are cutting back on that expenditure base, key word, competition in price going up?
No, we’re cutting back on all our marketing spend as a company. We’re still very much focused on that channel.
Carter Malloy - Stephens
Last on the Discover renewal, was that on the same terms as your…contract or any different terms there?
Same terms. Two year extension. We always have a year-to-year with them and they actually suggested to extend the agreement for two years instead of one at that rate, but no other changes.
Carter Malloy - Stephens
Just looking at the PowerPay relationship, a little confused as to how that would relate to OneShoppingCart.com. Competing or complimentary technology?
It’s very complimentary. We’re talking about merchant credit card services, which all online merchants need. So what we’re really done is now we’re providing a solution to all of our existing and new online customers, e-commerce customers. We’re giving them an opportunity to both save money and have a best in class credit card, online credit merchant processor, and really what’s beneficial for our company is not only do we help our customer, but we make money in that process.
We do roughly a billion dollars in transactions right now across our entire portfolio of small businesses. We don’t have a merchant provider right now. So we’re not getting a piece of that whatsoever. So this would be the preferred provider.
And we do have time for one more question. We’ll hear from Steven Jute with RBC Capital Markets.
Steven Jute - RBC Capital Markets
Has short CapEx outlook changed at all given the restructuring?
No it hasn’t. I think you said CapEx? I think we’ve probably spent just about all we’re going to in 2008 through the third quarter and I think as we’ve indicated in the past…about half of that for the year going forward.
At this time I’d like to turn the conference back over to our speakers for any additional or closing remarks.
David L. Brown
We want to thank you all again for joining us today on our third quarter earnings call. In the near-term, next week we’ll be presenting at Pipe Jaffrey’s Global Internet Summit in Laguna Beach, California. During the week of November 17, we’ll be presenting at the UVS Global Technology and Services Conference in New York City. If you’re planning on attending either event and would like to meet, please let us know, and as always, please contact us if you have any additional questions. Thank you all and good night.
That does conclude today’s conference call. We’d like to thank you all for your participation. Have a great day.
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