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Web.com, Inc. (NASDAQ:WWWW)

Q4 2008 Earnings Call

February 10, 2009 5:00 pm ET

Executives

Peter Delgrosso – Vice President, Investor Relations

David L. Brown - Chief Executive Officer & Director

Jeffrey M. Stibel - President & Director

Kevin M. Carney - Chief Financial Officer

Analysts

David Hilal - Friedman, Billings, Ramsey & Co.

Tim Brown – Roth Capital Partners, LLC

James Cakmak– Sidoti & Company

Sameet Sinha – JMP Securities

Stephen Ju – RBC Capital Markets

Scott Berg – ThinkEquity

Operator

Welcome to today’s Web.com fourth quarter 2008 financial results conference call. As a reminder today’s call is being recorded. At this time all participants are in a listen only mode. Later we will conduct a question-and-answer session. Instructions to participate will be given at that time. I would now like to turn the call over to Pete Delgrosso, Vice President of Investor Relations.

Peter Delgrosso

Thank you for joining us today to review Web.com’s fourth quarter and full year 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. Words such as 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 September 30th, 2008 for more information on these risks and uncertainties and our limitations that apply to our forward-looking statements.

Web.com expressly disclaims any obligations 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 our webcast and 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 L. Brown

Thank you all for joining us to review our fourth quarter and full year financial results which were consistent with or better than our guidance from both a revenue and earnings perspective. In particular revenue of $29 million was at the midpoint of our guidance while continued focus on operating efficiencies and expense management enabled the company to deliver record quarterly non-GAAP earnings per share of $0.23 which exceeded the high end of our guidance.

During 2008 we successfully combined Website Pros and Web.com which resulted in accelerated earnings growth, cost savings and a diversified online marketing and web services platform. While the economy has created a headwind on our near term revenue growth the efforts we made through combining the two companies has diversified and expanded the company’s long term growth opportunities.

The highlights to the fourth quarter was continued strong profitability, margin expansion and cash flow. For the first time in the history of the company we delivered a non-GAAP operating margin of over 22% and this was a key driver to another strong quarter for cash flow from operations.

While we remain cautious along with the rest of corporate America regarding the challenging economic conditions we remain confident in Web.com’s strategy and market position. We continue to enhance our business through strategic partnerships, customer experience enhancements and new sales and marketing initiatives that we believe will help Web.com drive top line growth when the economic environment improves.

It’s notable that since our founding Web.com has an established track record of delivering consistent solid growth from a revenue, subscriber and profitability perspective. We have executed successfully through previous difficult market environments positioning the company to gain market share and enjoy prosperous growth over the long term and we continue to believe the company is well positioned to repeat this cycle as we emerge from the current market downturn.

We are proud of Web.com’s numerous positive achievements during 2008. For starters the company quickly, aggressively and efficiently integrated what was essentially a merger of equals between Website Pros and Web.com delivering over $12 million in cost savings while at the same time driving our combined company churn to historic lows.

The end result is that we now have much larger critical mass, more efficient operations and a significantly more diversified distribution strategy. These are not only important for the long term but are essential to being successful in this more difficult economic environment. Secondly we proved the scalability of our combined company and financial model.

Our non-GAAP operating margin expanded throughout the year finishing at record levels for both the fourth quarter and full year 2008. In addition the company generated approximately $24.7 million in adjusted EBITDA excluding the impact of stock based compensation, goodwill and asset impairment and restructuring charges during 2008 which represented 20% of our revenue and an increase of over 129% on a year-over-year basis.

The third key accomplishment from a longer term perspective is that we continued to renew, expand and add high quality distribution partnerships during 2008 such as Discover, Yellow Book and Register.com to name a few. These types of partnerships position Web.com for long term growth.

Related to these partnerships is the fourth key accomplishment during 2008 which was adding entirely new distribution channels to reach our target customers and establishing additional asset monetization plans.

For example we launched our enterprise channel initiative during 2008 which we believe has significant long term potential and we began to implement a monetization plan focused on payment processing to add value and reduce costs for our customers and to realize the share of the billions of online and offline dollars that are transacted by our customers.

Here again we are executing on strategies to help position the company for long term growth. The fifth milestone event in 2008 was the announcement and execution of our first authorized share repurchase program as we use our strong balance sheet and cash flow to enhance shareholder value.

Since the program’s inception Web.com has purchased approximately 9% of its outstanding stock or 2.5 million shares. Finally we are proud of the company’s execution on our strategy of building Web.com into an end to end provider of online marketing services.

While we began as a website development company many years ago Web.com now offers professionally designed and do-it-yourself web services, search engine optimization, online marketing, eCommerce, lead generation, brand identify solutions as well as solutions tailored for specific vertical markets such as homebuilding and construction.

The fastest growing segment of our overall business is our suite of solutions outside of web services. We have significantly expanded the overall market opportunity that we are addressing and equally important we believe that Web.com has a unique set of solutions and domain expertise to solve the specific needs of SNB organizations.

From a summary perspective it is clear that web.com had a number of positive achievements during 2008 all of which are important from a long term perspective. While we cannot predict what will happen with the economy there are things that we can control such as those that I just highlighted and I believe Web.com executed at a high level in 2008 considering the economic challenges that are impacting our target markets.

We ended the quarter and year with approximately 265,000 subscribers which is up slightly from 263,000 at the end of the year ago period. We believe the critical mass of our subscriber base is a highly valuable asset and that it will help the company to be successful in executing through this difficult economic time period.

Even during this time period we were able to retain and dutifully service our customers as churn matched record low levels at 3.9% for the quarter compared to 4% in the third quarter. As we enter 2009 we expect that the economic environment will remain challenging throughout the year and we will operate the business accordingly.

As such we will continue to focus on driving operational efficiencies, realizing further cost savings and seeking out additional revenue opportunities. What is also certain for 2009 is that we will remain focused on advancing our strategy of becoming an end to end provider of online marketing services to small and medium sized businesses.

Before I conclude my remarks I’d like to make a special point of thanking the management team and employees of Web.com. At over 700 strong our team is truly one of our chief competitive advantages.

From innovation in how we deliver our services to dedication in keeping our customers’ interests foremost to the collegiality and loyalty that is evident throughout our ranks I never cease to be amazed at the personal resourcefulness and good nature of my colleagues here at Web.com. It is from this team that I derive much of my enthusiasm and confidence regarding the bright future that lays ahead for Web.com.

Now I’d like to turn the call over to Jeff for some additional commentary on Web.com’s market opportunity and go to market strategy.

Jeff

Let me begin with some comments on our target markets. It is clear that the small and medium sized business community is feeling the pain of the economic slowdown. They’ve already seen the loss of jobs spreading to companies of all sizes including small and medium sized businesses.

While small businesses are operating in a highly volatile and uncertain macro environment the one thing that has not changed is the long term industry trend of small businesses moving to the web and adopting online marketing strategies and eCommerce models essentially leveraging the online channel for their offline business.

Even in the changing economic times there is little doubt that the online channel is taking market share away from traditional marketing channels and more consumers are accessing the Internet to find local goods and services. We continue to believe that we are at the early stages of this large emerging market opportunity.

Web.com’s broad and deep line of services and products coupled with the diverse and expanding distribution network is unique and unmatched in the industry. We continue to add new channels and partners and this will be a strategic priority throughout 2009. Our core web services platform and online marketing capabilities are transferable to many different industries in which businesses are looking to service the small business customer online.

This core market differentiator has the ability to add incremental opportunities for Web.com to forge more partner and channel opportunities. We have had success in this strategy to date. During 2008 alone we signed or renewed deals with many companies including Yellow Book, Discover, Register.com, CCA Global, SMG, Power Pay, Merchant Circle, Bob Vila and Lenders One.

These are in addition to partnerships such as R.H. Donnelly, Dex Media, Yahoo, Legalzoom, Microsoft and many others. As consumer confidence improves and employment and business creation picks up we believe these partnerships will help position Web.com to capture growing demand for online marketing solutions.

An important new strategy in 2008 was creating a business development channel to offer our suite of online marketing solutions to a variety of larger companies with a local retail or franchise presence. This is a top down strategy in which we will sell the Web.com value proposition to the enterprise and they will push our solutions down to literally thousands of potential customers.

We got off to a strong start in building out this new channel. We were able to quickly demonstrate our value proposition and our progress confirmed to us that this is a channel that has significant long term potential. As we discussed last quarter we have seen a few of our partners temporarily cut back or outright pause these marketing campaigns as they evaluate their overall marketing budget.

Importantly each enterprise customer has indicated that they remain committed to their partnership with Web.com. Equally as important we continue to be engaged in discussions with new partners and we are in the early launch phase with others that are looking at ways to invest in online strategies as a means to grow their businesses.

We’re also pleased with the early traction of our Yellow Book partnership. In just a few quarters this partnership has already become a productive relationship in which we offer customized stand alone websites for Yellow Book’s advertising customers. As a reminder Yellow Book is the number one independent publisher of Yellow Pages having approximately 5,000 sales reps and approximately 700,000 unique advertisers.

We are also in the early stages of implementing an ad in commerce model in which we look to monetize our collective assets which includes a patent licensing component. As way of background Web.com has a vast intellectual property portfolio of 21 issued patents with several pending. They cover core technology aspects of our business and industry.

As an aside we have been successful on this strategy in the past having struck patent license deals with several companies including Go Daddy, Register.com and [Hostilfia] to name a few.

Continuing on the theme of monetization with approximately $1 billion in eCommerce transactions facilitated annually and many billions more transacted by our customers through traditional brick and mortar processes the opportunity to monetize this space is attractive and we have already launched test campaigns and attracted customer interest.

In addition to expanding our distribution channels we continue to expand our value proposition to our customers through organic means and M&A. We did this in 2008 and you can expect to see Web.com to continue to bring to market new solutions and packages of integrated solutions during 2009.

We look forward to sharing more specifics on our plans as 2009 plays out. With that let me turn it over to our Chief Financial Officer to review the quarterly financials in more detail.

Kevin M. Carney

Total revenue for the fourth quarter came in at $29 million which was right at the midpoint of our guidance of $28 million to $30 million. Within total revenue subscription revenue came in at $28 million which was down 6% compared to the same period in the prior year. The remaining $1 million came from license fees and professional services.

With over 265,000 subscribers at the end of the quarter our ARPU was $34.62 during the fourth quarter which compares to $35.71 in the previous quarter. As we indicated last quarter we expected ARPU to be down as a result of the addition of the low ARPU subscribers we brought over from two accounts at the end of Q3. In addition the product and marketing spend by enterprise partner subscribers also impacted overall ARPU.

Based on customer feedback with that channel our current expectation is that these programs will eventually push ahead which would provide a positive impact to our ARPU other things being equal. We will continue to balance our objectives for maximizing ARPU and subscriber additions and are likely to see fluctuations in these numbers on a quarter to quarter basis.

The key is to manage both in a way that will drive profit growth for the company over the long term. As we shared today we delivered very strong profitability and cash flow in the fourth quarter. Our consolidated churn rate returned to our record low level of 3.9% during the fourth quarter which is down from 4% in the previous quarter.

Turning to gross profit we generated $18.8 million in gross profit for the fourth quarter representing a gross margin of 65% which was up from 63% last quarter. Gross margin was up as a result of a better mix of higher margin revenue and the continued benefits of our migration and consolidation activities.

Turning to operating profitability we’ll discuss our results on both a GAAP and a non-GAAP basis and there is a reconciliation table in our press release. On the operating expense side non-GAAP sales and marketing came in at $6.3 million for the quarter down from $7.1 million in the prior quarter and representing 22% of revenue.

As we shared last quarter we were targeting lower sales and marketing spends as we closely monitor our direct marketing spend to ensure that we are generating an attractive return on our investment. Non-GAAP general and administrative expenses for the quarter were approximately $3.5 million down from $3.7 million and representing 12% of revenue.

Non-GAAP research and development expenses for the quarter came in at $1.9 million down from $2.3 million and representing 7% of revenue. We saw continued benefits from cost savings initiatives plus a positive effect due to the elimination of outsourced development resources associated with our Fusion product line which we announced last quarter.

During the fourth quarter the company recorded a restructuring charge of approximately $300,000 which relates to the workforce reduction we announced last quarter designed to reduce excess capacity. We expect this action to lower our expense run rate by approximately $2.5 million to $3 million on an annualized basis in 2009.

Our fourth quarter non-GAAP income from operations which excludes the effect of stock based compensation, amortization of intangibles, nonrecurring restructuring charges, the goodwill and asset impairment and revenue eliminated in purchase accounting was a record $6.4 million representing growth of 84% on a year-over-year basis and a record 22% operating margin.

Based on 27.8 million shares outstanding for the quarter we generated non-GAAP diluted EPS of $0.23 per share which exceeded our guidance of $.020 to $0.22. You will note that we also added a discussion of adjusted EBITDA in our press release. We believe this measure will become increasingly important to evaluate over the next year or two as the company’s cash tax rate begins to increase.

Adjusted EBITDA enables an apples to apples comparison of the cash profitability of the company’s operations before non-operating items are taken into consideration. Adjusted EBITDA which excludes the impact of stock based compensation, restructuring and impairment charges was $7.2 million for the fourth quarter of 2008 an increase of 91% compared to $3.8 million for the fourth quarter of 2007.

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 our GAAP results let me first share that we elected to take an impairment charge of $103 million during the fourth quarter.

We made the determination that it was appropriate to write down the goodwill associated with previous acquisitions as a result of the change in the company’s market capitalization as well as the downturn in the economy. Our quarterly GAAP gross margin was 65%, sales and marketing expense was $6.5 million, R&D expense was $2 million and G&A expense was $4.3 million.

Including the impairment charge I just mentioned we reported a GAAP operating loss of $100 million and a GAAP net loss per fully diluted share of $3.74. 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 our summary full year results total revenue for the full year 2008 was $122.5 million an increase of 48% on a year-over-year basis driven by the combination of Web.com and Website Pros in the fourth quarter of 2007. For the full year 2008 the company reported record non-GAAP operating income of $21.8 million representing a non-GAAP operating margin of 18%.

Non-GAAP net income per diluted share was a record $0.75 for the full year 2008 representing an increase of 44% from $0.52 for the full year 2007. The company generated adjusted EBITDA excluding the impact of stock based compensation, restructuring charges and impairment charges of $24.7 million for the full year 2008 an increase of 129% compared to $10.8 million for the full year 2007.

On a GAAP basis for the full year 2008 the company reported an operating loss of $97 million and GAAP net loss per diluted share of $3.51 as a result of the $103 million goodwill and asset impairment charge I previously mentioned. Excluding the impairment charge operating income for the full year 2008 would have been $5.6 million an increase of 277% compared to $1.5 million for the full year 2007.

GAAP net income per diluted share would have been $0.21 for the full year 2008 an increase of 250% compared to $0.06 for the full year 2007. Turning to the balance sheet unrestricted cash and investments were $34.1 million at the end of the fourth quarter an increase of $500,000 compared to $33.6 million at the end of the third quarter.

The increase in cash was primarily the result of positive cash from operations offset by the $4.4 million spent in the fourth quarter associated the repurchase of shares under the previously announced share repurchase program. For the fourth quarter Web.com generated $4.8 million in cash flow from operations bringing the full year total to $15 million.

Excluding the pay down of accrued restructuring charges, cash flow from operations would have been approximately $22.3 million for the full year 2008 and $5.8 million for the fourth quarter. Now I’d like to provide some perspective on our financial outlook as we begin 2009. For the first quarter of 2009 we are targeting revenue in the range of $26 million to $27 million.

Assuming a non-GAAP tax rate in the single digits and 27 million shares outstanding we expect our non-GAAP net income per diluted share to be in the $0.14 to $0.16 range in the first quarter. As a reminder during the first quarter we typically experience a seasonal increase in operating expenses. The uncertainty related to the economic environment makes it more challenging to provide a full year revenue range.

However David and Jeff spoke to the trends we are currently seeing in our business as well as the growth initiatives we are executing against. Our expectation is for our quarterly revenue run rate to stabilize towards the end of 2009 based on increasing productivity from existing channel relationships and new initiatives to monetize our assets as well as contribution from other partnerships and direct marketing campaigns.

Because we clearly have more control over our cost structure we will continue to utilize cost control as one of our key levers in managing the business and at least in the near term we will continue to manage the business with a high priority on profitability particularly in light of the difficult economic environment.

On a full year basis we are targeting gross margins to remain fairly consistent plus or minus a few points and we expect to make further progress related to lowering our quarterly operating expense run rate. As we proceed through 2009 we plan to share our incremental thoughts on the market environment as well as our business plans and goals.

With that we’d now like to take questions. Operator if you could please begin the Q&A session.

Question-And-Answer Session

Operator

(Operator Instructions) We’ll go first to David Hilal - Friedman, Billings, Ramsey & Co.

David Hilal - Friedman, Billings, Ramsey & Co.

It was nice to see the churn come in where it did given today’s environment but I guess maybe what offset it a little bit in my mind was the gross sub-number decline which I calculated to be about $26,000. So I wanted to get some color on that.

I guess specifically, David, when you think about all the ways you acquire customers, both your partners and your different channels, which one of those are probably having the most trouble in this environment versus which ones are maybe a little bit more resilient in this environment?

David L. Brown

A specific answer to your question, when we look across all of our channels we see small business customers being very hesitant to make new buying decisions and that’s what’s affected our gross subscriber additions over the last few quarters. We haven’t seen any change in that recently.

Where we are seeing unevenness would be in some of our higher ARPU product lines. We are seeing obviously more concern and more slowness in the decision making process in some of our higher ARPU product lines. That would translate into some of the online marketing and some of the lead generation spaces where our ARPU may run into the several hundreds of dollars.

New customer acquisition in those spaces appears to be slower than it was say a year ago this time.

David Hilal - Friedman, Billings, Ramsey & Co.

Do you think churn can come down even further? I know the churn is always the highest in the early days of a customer and given that you’re signing up less new customers and you have more mature customers, usually the way that math works is that it would lower churn over time. Do you think that’ll be the case even in this environment or does that get offset?

David L. Brown

I certainly think we saw that in the fourth quarter and as we enter into the first quarter we’re continuing to see signs of that. We’re also by the way seeing benefits from having completed the migration of our do it yourself hosting accounts from many, many platforms down to two platforms.

That was completed in December and I’m very happy to say that that was a year long process and during that time we did experience higher than normal churn in that DIY, do it yourself, customer base. We expect to see that churn coming down as we move into the future and we’re continuing to see very positive trends in our do it for me customer bases.

David Hilal - Friedman, Billings, Ramsey & Co.

Now let me ask you on cost cutting, can you give us any more to do from what was previously announced and/or any need to do any more than what was previously announced?

David L. Brown

David, as we said last quarter we have an eye in the company on always trying to improve the operations of our business. It’s a constant improvement philosophy so you should expect through the course of this year for us to be looking for opportunities to reduce costs and improve our effectiveness at the same time. I guess that’s a long winded way of saying yes, you should expect to see more cost improvement throughout the course of the year.

Operator

We’ll go next to Tim Brown – Roth Capital Partners, LLC.

Tim Brown – Roth Capital Partners, LLC

Just following up on your clients’ behavior, are you seeing more of the trade down from the do it for me to the do it yourself?

David L. Brown

We’re not seeing that trend as much as we are seeing a behavior where small businesses and for that matter consumers are sitting on their hands and when faced with a buying decision we think that’s a natural part of the economic slowdown, the concern that consumers and small businesses feel about the economy and that’s translating into prolonged, longer than normal buying decision process and in some cases just reluctance to pull the trigger.

But we’re obviously still seeing a significant number of small businesses making a buying decision but we’re not seeing a big shift say from our do it for me to our DIY. We’re still having a very good balance of sales throughout the company.

Tim Brown – Roth Capital Partners, LLC

If you could comment on the SAC? It sounds like in the marketing spend it sounds the SAC is probably going up particularly in your direct channel. Can you just comment on that?

David L. Brown

I think that’s accurate. I think that given the reluctance of small businesses to buy we’re seeing our acquisition costs go up modestly but as we’ve commented before we do tend in a large part of our spending is in the online marketing arena. We do manage that area very tightly around a SAC target and we continue to maintain that discipline.

If we see opportunities to acquire more subscribers at or below that SAC target we’ll take it and we’ll of course also be very opportunistic if we were to find say through acquisition of customer or through other means where we could acquire at attractive SACs then we would take those as well.

Tim Brown – Roth Capital Partners, LLC

Did you buy any portfolios in the quarter?

David L. Brown

We did not, we did not make any acquisitions of customers during the fourth quarter.

Tim Brown – Roth Capital Partners, LLC

That’s still a strategy that’s out there?

David L. Brown

It’s still a strategy of the company. We’ve always grown both organically and using acquisitions. Where we could do acquisitions at a cost that was attractive relative to our overall cost of acquiring a subscriber and we’ll continue to use that as we move forward.

Tim Brown – Roth Capital Partners, LLC

I’m getting a net ads of a negative $9,000. Is that right?

Kevin M. Carney

Yes, about $8,600.

Tim Brown – Roth Capital Partners, LLC

Looking at the guidance for the revenue for Q1, is that accelerating, that drop or is the ARPU coming down as well?

Kevin M. Carney

I think that’s the latter. Our forecast would indicate net ads in the proximity of what you saw in the fourth quarter but I think some reduction in ARPU and David spoke to it a minute ago about gross ads seeing fewer gross ads in the higher ARPU products and the other piece would be what I think Jeff alluded to in his comments is the additional pause in the enterprise channel which is reduction of spend there that puts some pressure on ARPU.

Tim Brown – Roth Capital Partners, LLC

So you’re looking at Q1 that’s going to be a pretty similar number to Q4 then in the net ads or net loss?

Kevin M. Carney

That’s what we’re thinking at this time, yes.

Tim Brown – Roth Capital Partners, LLC

Just one quick final question on the restructuring, you said $12 million was saved. Was it saved this year, you’re on a $12 million run rate?

Kevin M. Carney

When we talk about the $12 million, it’s looking back at a pre-merger looking for the operating expense level and cost of sales frankly of the two organizations pre-merger and then looking at what we saved on an annualized basis as a result of the integration.

Tim Brown – Roth Capital Partners, LLC

That’s largely done at this point?

Kevin M. Carney

Yes.

Operator

We’ll go next to James Cakmak– Sidoti & Company

James Cakmak– Sidoti & Company

Can you provide a little bit more color on how much of the marketing cost that you’re incurring, how much of the gross ads would you say are organic versus coming from your marketing spend?

David L. Brown

In the fourth quarter all of our gross ads were organic. When you look at the breakdown and we don’t break these down specifically, our two largest channels are partnership channels where we’re marketing into a base of customers like Discover Card or our direct marketing spend which would be through search marketing, banners, pop ups or offline ads. But we don’t disclose the specifics.

James Cakmak– Sidoti & Company

On your guidance for the first quarter, I’m just quickly running the numbers and assuming you can guys can maintain gross ads in the 20,000 range, that is a pretty sharp drop in ARPU. Is that what you guys are assuming, somewhere around the $30, $31, $32 range?

Kevin M. Carney

We’re not driving specifically to that number but I think, again that is what our guidance assumes is relatively stable in terms of the net reduction in gross ads and the offset is the drop in ARPU.

James Cakmak– Sidoti & Company

How much more do you think you can scale back the selling and marketing at this point and still maintain that $25,000 gross ad?

Kevin M. Carney

I guess I would say this, we will continue to, David didn’t come at it earlier but one of the other things that we’re looking at is repurposing some of the direct marketing spend. We’re testing in areas that we haven’t historically done online marketing. So that’s something that we’re looking at.

The other opportunities to potentially scale back would be, its not something we’re saying we’re going to do at this point, but again if the trends were to deteriorate we could adjust in our outbound telemarketing in the sales and marketing line there.

David L. Brown

But I think an important way to look at this, we’re managing our marketing budget to a particular spend level and SAC level so that we can preserve our cash to be opportunistic when other opportunities to acquire accounts comes up. That could very easily be from and M&A standpoint. As you saw in the previous quarter in Q3 we were able to opportunistically pick up some very cost effective accounts that were profitable to us.

We see that as a big driver going forward and we want to make sure that we’re managing our marketing spend not just from an organic perspective but from a more holistic perspective as we look at the marketplace and the dynamics therein.

James Cakmak– Sidoti & Company

What’s the GAAP tax rate you guys think we’ll have for this year?

Kevin M. Carney

I would say the GAAP tax rate is going to be effectively, again because we have the deferred tax asset that we’re unwinding, is effectively going to be zero. We’re going to have zero provision expect for a little bit of Canadian tax. From a cash tax standpoint, we’re guiding at this point to the first quarter which would be still single digits.

James Cakmak– Sidoti & Company

Lastly, have you been buying back shares during the January, February month?

David L. Brown

We have had an active share repurchase program as we commented. We’ve acquired back about 2.5 million shares. When we reported at our last quarterly we had really just gotten the program started. So, yes we were very active in the quarter in buying back shares and we’ll continue to evaluate that program. Actually at this point having acquired back almost 9% of our outstanding shares, we’ve made significant progress in driving we think shareholder value at this point.

Operator

We’ll go next to Sameet Sinha – JMP Securities.

Sameet Sinha – JMP Securities

This is the anniversary Website Pros with Web.com, you’ve been studying the subscription base for a while now and I remember that you spoke about how cross selling, up selling, all the experiments were going on. Can you provide us any information, has that experiment been stopped because of the macro conditions or are you pushing ahead with those and maybe you could share some preliminary data with us?

David L. Brown

It’s a great question and it’s one of the things that we’re most pleased with having been combined now for a year. We’ve now got plenty of experience cross selling and up selling into the lower ARPU do it yourself customer base that we acquired. I’m really pleased to tell you that we have found that customer base to be very receptive to the online marketing and search engine optimization products that the company has to offer.

We view that frankly as the best partner. If it were a partner, it would be our very best partner in terms of its conversion performance and we’re also very fortunate that as we have worked with that base where we have found that we may not have had success at one point in time, we have found that at later points in time as the customers have been with us for longer, they are again very receptive.

So we have an ongoing program now of contacting our newfound customers and offering them different products and services and we view that now as a very valid strategy for Web.com. If we can bring in subscribers at lower ARPU, we now know that we can very effectively bring them up the value chain and increase ARPU.

Sameet Sinha – JMP Securities

You’re talking about ARPU expectations down for the next quarter. How should we think about gross margins from hereon because obviously we are seeing people sticking more to the lower price product? Should we expect gross margins to stabilize? Most of the efficiencies from the acquisition are already done I imagine. If you can shed some light on that.

Kevin M. Carney

I think we commented in my prepared remarks that we expect it to be relatively stable within a few points. One of the things that will actually, you’re correct that most of the cost saving initiative from the Web.com hosting platform consolidation we’ve seen the benefits of that through the end of 2008.

Going forward I think some of the things that will be helping us would be some of the asset monetization programs we talked about where they’re very, very high margins. I think those will help support the gross profit margins as well.

Sameet Sinha – JMP Securities

My final question, Kevin, if you look at your cost structure, you’ve indicated that you’ll continue to look at opportunities to eliminate costs, but can you quantify what’s fixed, what’s variable? That’ll give us a good insight into the cost structure.

Kevin M. Carney

I think I can more qualitatively than quantitatively respond to that. I think certainly in the cost of sales it’s largely variable. We have a very flexible model there. As you move down, we talked about the sales and marketing line, we’ve got two pieces of the equation, TPC so we can pull back the spend and sort of adjust the throttle quarter to quarter.

Outbound telemarketing, in the sales force last quarter as part of the headcount reduction we talked about we made some reductions there, as we said right sized the sales force given the environment and I think that we can continue to do that. Then maybe less so in the G&A and R&D lines but I think there’s opportunity there as well.

Operator

We’ll go next to Stephen Ju – RBC Capital Markets.

Stephen Ju – RBC Capital Markets

In terms of the competitive landscape out there especially in the direct channel, do you feel like your competitors are increasingly willing to chase that subscriber at the expense of margins at this point? Second, do you have a cap ex outlook for '09 or even the first quarter?

David L. Brown

With regards to the first question in terms of the competitive landscape, we aren’t seeing a lot of competitive pressure these days and that’s one of the bright spots particularly on the website design side of the business. We really are the big gorilla out there and we continue to try to acquire as many customers as we can.

Even on the hosting side we’re seeing a lot less pressure. That’s not say that there aren’t smaller competitors bidding up Google keywords as an example, but we tend not to play in that game. We try to stay away from the commodity side of the business. The real pressure that we’re seeing on the gross ad side is really coming from the fact that when the economy starts to constrict the natural reaction from most small business owners is to stop.

They are stopping spending while they try to get a grasp on how this economy is going to impact their business and we’re trying to run our marketing efforts in parallel with that. I’ll let Kevin address the second question.

Kevin M. Carney

In terms of cap ex, if you look back at 2008 we spent about $4.3 million and just as a reminder, about $2.4 of that was the Spokane building. So, you back that out, about $2 million and I would say that would be a very conservative number for 2009. Again, we had a fair amount of cap ex related to the integration activities of Web.com and Website Pros so I would say $2 million would be a safe number.

Stephen Ju – RBC Capital Markets

As you look at the first quarter, the linearity of it, does it tend to pick up or taper off from the beginning to the end of the quarter or are the month pretty much equal contributors in terms of the subscriber aspect.

David L. Brown

Stephen if you’re looking at really our normal seasonal patterns if you look back historically at the company you will see that we often times have a strong fourth quarter, the first quarter from an earnings perspective is lower than the fourth quarter because we have some seasonal expenses that begin, simple things like payroll taxes and other things that start up again. Then, through the course of the year our business ramps and that’s been a consistent pattern with the company for several years now with the exception of 2007 when we had some restructuring charges in the fourth quarter as a result of the merger.

So, you should expect to see as we certainly expect to see the same trend happening. We also believe that because of some partnership programs that are implementing and some asset monetization plans we do expect to see later in the year, we expect to see improvements in our earnings and in our revenues as we result of the maturing of some of those programs. So, we’ve indicated in our comments here today that although we see a continuation of the fourth quarter in to the first quarter and perhaps another quarter or so but later in the year we do expect to see some strengthening of both revenues and earnings. That would be also consistent with the normal seasonality of our business.

Stephen Ju – RBC Capital Markets

March is usually the best month of the first quarter is what you’re saying also?

David L. Brown

That’s correct, it usually is.

Operator

Your next question comes from Scott Berg – ThinkEquity.

Scott Berg – ThinkEquity

I just have two, the first is on the work force reduction done in the fourth quarter, how much was say 100% implemented during the quarter? Was all the cost work force reduction implemented or was it say about 75% of it?

David L. Brown

It was all implemented. Effectively all implemented in the quarter although we do have some expenses associated with severance payment that will run in to the first quarter but effectively all of the headcount reductions actually occurred in the quarter and we have some tag along expenses that have actually been commented on as part of the restructuring charge here.

Scott Berg – ThinkEquity

I guess my last question is on customer patterns, do you feel that the customers are coming to the site and making the conscious decision of not buying whatever product or solution that they have in mind or is it just the traffic is not being driven?

Kevin M. Carney

I would say it’s a combination of both. We’re still seeing significant traffic and by no means has our organic traffic dropped off but of course as we stop spending or we spend less on paid traffic by definition our traffic will be lower. But, what we’re seeing is people taking a longer time to make a decision so the sales cycle is longer and our expectation and assumption is not only is the sales process taking longer but in many cases the sales process is on hold. People are shopping, their browsing but not ready to make a decision, a purchase decision yet.

Operator

That concludes the question and answer session today. At this time I would like to turn the conference back over to Mr. David Brown for any additional or closing remarks.

David L. Brown

Thank you all again for joining us today on our fourth quarter earnings call. In the near term, next week we’ll be presenting at Roth Capital’s 21st Annual Growth Stock conference in Dana Point California. During the week of February 23rd we’ll be presenting at Jefferies 5th Annual Internet and Media conference in New York City. If you’re planning on attending either event and would like to meet please let us know. As always, please contact us if you have any additional questions. Thank you and goodnight.

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Source: Web.com, Inc. Q4 2008 Earnings Call Transcript
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