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Web.com Group Inc., (NASDAQ:WWWW)

Q3 2010 Earnings Call

November 2, 2010 05:06 pm ET

Executives

Timothy Dolan - ICR, Investor Relations

David Brown - Chairman and CEO

Kevin Carney - Chief Financial Officer

Analysts

Philip Dionisio - FBR Capital Markets

Gene Munster - Piper Jaffray

Jeff Martin - Roth Capital Partners

Stephen Ju - RBC Capital Markets

James Cakmak - Sidoti & Company

Mickey Schleien – Ladenburg

Jim Baker – B. Riley

Operator

Greetings and welcome to the Web.com Third Quarter 2010 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions)

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Timothy Dolan of ICR. Thank you, Mr. Dolan. You may begin.

Timothy Dolan

Thank you. Good afternoon. And thank you for joining us today to review Web.com's third quarter 2010 financial results. With me on the call today are David Brown, Chairman and CEO; 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 expect, believe, will, going, begin, see, plan, continue 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 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 there quarter ended June 30, 2010, for more information on these risks and uncertainties and other 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, non-GAAP financial measures will be discussed on this conference call. 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 on today's call will be available on our website in the Investor Relations section.

With that, I'd like to turn the call over to our Chairman and CEO, David Brown. David?

David Brown

Thank you, Tim. And thank you all for joining us on the call to review our third quarter 2010 results. We are pleased with the company's execution during the initial quarter combining Register.com’s operation with Web.com.

The performance of both companies was consistent with or better than our expectations leading to third quarter non-GAAP revenue and profitability that was above the high end of our guidance. Although there is still much work ahead of us, all of the strategic reasons we moved ahead with the Register.com’s acquisition have been confirmed in the first few months of joining forces.

We have plans in place and are on track to achieve our cost savings objectives. Our teams have been hard at work in identifying how we can best modify our combined company’s opportunity from a sales prospective and those opportunities appear to be as good or even better than we initially anticipated. And we are also a faster-than-required start for paying down our debt related to the acquisition which is consistent with our previously shared commitment to use the strong cash flow from the combined company to deliver the company as quickly as possible.

We believe the significant expansion in our revenue, profitability and cash flow as a result of the Register.com’s acquisition will enable Web.com to generate substantial shareholder value over the next 12 to 18 months. We believe there is further upside potential with respect to generating shareholder value as we increase our sales and marketing investments aggressively in 2011 to restore growth in our combined company’s operations.

Taking a look at our results for the quarter, I would remind you that Register.com’s operations only contributed to Web.com’s results for approximately two of the three months of the quarter. The fourth quarter will be the first time our results reflect a full quarter of contribution from Register.com.

With that said, non-GAAP revenue which excludes the 5.7 million impact of the write-down of purchased deferred revenue for the third quarter was 38.5 million above the high end of our guidance, due primarily to the acquisition closing a few days earlier than anticipated.

From a profitability perspective, we delivered adjusted EBIDTA of 7.3 million or a 19% adjusted EBIDTA margin. This contributed to non-GAAP EPS of $0.20 which was well above our guidance of $0.13 to $0.14 due primarily to realizing a lower cash tax rate than anticipated, higher than expected revenue, as well as achieving some of the plan cost synergies earlier than expected.

Finally, we generated adjusted cash flow from operations excluding non-recurring payments associated with the Register.com acquisition of 7.1 million during the third quarter which compares to 5.1 million in the same quarter last year.

From a macro perspective, the market environment during the third quarter was largely consistent with our expectations. A small business community continues to face economic challenges and it remains uncertain when recovery will begin and how quickly it might ramp. Our view is based on talking to tens of thousands of small businesses every month and it was further confirmed by the most recent NFIB report. Their index which is focused on the SMB community shared a slight improvement in September from 88.8 to 89; however, this is still well below its historical average of 98 since March of 2007.

In addition, over the next three months, 8% of the respondents plan to create new positions, which was unchanged compared to the last readings, while 16% are looking to reduce headcount which is up 3 points over the same time period.

This macro backdrop clearly presents headwinds for companies that are serving the small business community, because we cannot control this variable; we remain focused on executing the strategies that we believe will optimize Web.com’s long term growth and profitability.

If we look at Web.com’s performance over the last ten years, we have a solid track record of growing revenue through organic means and strategic acquisitions. We are confident that Web.com will re-emerge with a solid growth profile as the economic environment for small businesses improves.

A core component of our strategy to scale from a revenue profitability and cash flow perspective is our acquisition of Register.com. I would like to provide an update relative to what we have been focused on thus far and the progress that we have made starting with the integration of our operations.

Our ability to deliver against our cost savings objectives is key to our ability to leverage the Register.com acquisition and there are many different potential sources that we can and are addressing. To name a few, we have already consolidated our senior management team and we are currently focused on streamlining our back office operations, achieving efficiencies in our data centre operations and leveraging our R&D spend in areas where our product roadmaps overlap. We have a restructuring plan in place and we have already communicated with employees that will be impacted as we streamline the combined company’s operations.

As I mentioned a moment ago, we realized cost savings at a faster than planned pace during the third quarter. As a reminder, we believe that we can ultimately achieve at least $10 million in annualized expense savings. Execution across the number of areas we are reducing expenses will take several quarters to complete and we expect the level of cost savings to increase over the course of 2011.

In 2011, we expect to realize level of cost savings to be in the range of $5 million, while we will realize the full $10 million benefit of our actions in 2012. In addition to simply reducing our cost structure, we have put focus on integrating our two organizations in a way that puts our product roots and individuals in the best position to execute moving forward. In this respect, we will truly be a single organization by the end of this year.

For example, Register.com’s product roots that were focused on value added solutions are being integrated in the Web.com’s functional areas such web services, e-commerce and online marketing to name a few.

Another example is the integration of our sales organizations, so that we are able to use the combined company resources to sell the optimum mix of solutions from a corporate perspective not a Web.com or Register.com perspective.

I mentioned at the start that we believe incremental growth opportunities are as good as or even better than we originally anticipated. We are still early to be clear but we are excited about the level of idea flow that our respective organizations have been coming up with during our initial meetings as our respective organizations better learn the full capabilities of Web.com and Register.com.

We are going to slightly increase our marketing spend during the fourth quarter as we test the number of sales mix, product packaging and cross sale programs. We believe there is a tremendous opportunity to up sell Register.com’s direct customer base which numbers approximately 700,000 subscribers after adjusting for joint customers with Web.com. Many of these are prime targets for Web.com’s suite of web services and online marketing solutions.

As our history would suggest, we do not spend on marketing just to do so. We want to make sure that we are getting a solid return on our investment. We are optimistic that we will identify marketing programs with these characteristics and we currently plan to increase our marketing spend by at least 50% in 2011 with most of this increase being funded from cost savings as we integrate Register.com into Web.com.

The increased level of spending was taken into consideration in the preliminary 2011 EPS guidance that we provided and which Kevin will review in a moment. In addition, if the economic environment and growth outlook improves, there is potential to expand our marketing resources even further.

Our current plan is to begin the testing process during the fourth quarter with further scaling of our test in full launcher programs beginning in the first quarter of 2011. It will take time for programs to drive incremental business and we have a rateable revenue recognition model so it may take several quarters for the payback on our investments to be realized in our financial statements. However, what is most important is that the faster growth is reignited.

We believe the fastest near term path to restoring growth is increasing our ARPU through cross sell and up sell activities with our customer base, given it has increased from over .25 million subscribers to just under 1 million subscribers following the acquisition. In addition, another reason that our initial growth priorities are pre-focused is that, Register.com has proven its ability to increase ARPU among its lower priced subscriber base. This is how they operated their business over the last two years during the challenging economic environment and with limited ability to make new investments in their businesses.

We are now able to provide Register.com’s sizable sales organization with access to Web.com’s broad sweep of higher priced and value added solutions to cross sell and up sell. All things considered we believe we can generate returns with the lowest risk by focusing on ARPU growth in the near term.

The next priority which will likely become a more permanent aspect of our focus in the second half of 2011 and beyond is further expanding our subscriber base. We will do that via organic means as well as through strategic acquisitions. Either way, there is a cost to acquiring subscribers. It really comes down to what is the most effective use of our capital. We believe there are growth opportunities with both Web.com’s and Register.com’s flagship offerings. I am pleased to share that both our Do-It-Yourself and Do-It-For-Me web services businesses have now reached the point in which they are stable to growing. This marks the first time we can make that comment about both business segments since the economic downturn began.

In addition, our online marketing and e-commerce businesses continue to grow. We also believe there is an opportunity the core domain name service business of Register.com which targets an industry that is expected to grow in the 8% to 11% range over the course of the next several years. We believe the domestic market would represent a mid-single digit growth rate with international growing at a faster rate.

After we get our combined company growing though ARPU expansion, one of our longer term growth strategies is to restore level of growth in Register.com’s domain name business and we believe market fundamentals including the expansion of top level domains and international level domains will support our ability to do so. In addition, the fact that we have far greater resources to invest in sales and marketing is another key reason that we are confident growth can be restored in our domain name business service offerings over the median term.

Another positive development related to the Register.com acquisition is it further builds on the progress that Web.com has made in reducing our customer churn. During the third quarter, Web.com’s customer churn, before considering the impact of Register.com was maintained at an all-time low level of 2.9% per month. The addition of Register.com for the partial quarter brought that level down to 1.7%. However, if we assume Register.com was part of Web.com for the full quarter, our monthly churn would have been approximately 2%. At this level, Web.com is in good company as it relates to other high performing technology providers to the small business community.

In summary, we are pleased with the performance of Web.com and Register.com in our initial quarter together and we are especially pleased with our progress bringing our two companies together. By the end of this year, we will truly be a single operating company and we are positioned to have a very strong financial profile characterised by revenue scales and significant profitability and cash flow.

Our cost savings programs are underway and on track. Our cash flow is ramping and we are paying down our debt and our teams are hard at work identifying and testing ways to restore growth to extend the company’s long term growth track record. We believe there is tremendous unrealized value in the assets of our company and there is opportunity to significantly expand that value from a long term perspective.

With that, let me turn it over to Kevin to review the quarterly financials in more details. Kevin?

Kevin Carney

Thank you, David. Total non-GAAP revenue for the third quarter came in the $38.5 million which exclude the $5.7 million impact of the purpose accounting reduction to Register.com’s deferred revenue in the quarter.

Of non-GAAP revenue, was above the high end of $37 to $38 million guidance range with most of the upside due to the fact that Register.com acquisition closed slightly earlier than expected.

Non-GAAP subscription revenue came in at $37.8 million which compares to $24 million last quarter. The remaining $674,000 came from professional services and other revenue which compare to $821,000 last quarter. We ended the quarter with a subscriber base of approximately 974,000 subscribers on a combined basis which includes an adjustment of approximately 75,000 subscribers to avoid double counts in customers shared by Web.com and Register.com.

This adjustment aside, Web.com subscriber base was essentially flat on a sequential basis during the third quarter while Register.com’s subscriber base declined by approximately 20,000 subscribers assuming a full quarter.

Moving forward, we are going to report a consolidated subscriber total as we are running our business on a consolidated basis. It is highly likely that the overall subscriber base will continue to decline in the near term until we increase sales resources focused on stabilizing and growing the domain name services subscriber base. As David mentioned, we view ARPU as the near term driver to our revenue and that is how we plan to deploy our sales resources.

Longer term, we will increase investments targeted at stabilizing and growing our domain name subscriber base in addition to our overall subscriber base.

Web.com’s core ARPU was essentially flat on a sequential basis during the third quarter. This was the first quarter in some time that Web.com’s ARPU was stable, which we believe is encouraging and reflects many of the packaging and pricing efforts made in recent quarters. This is also consistent with how we expected the year to play out mainly ARPU stabilizing and improving in the back half of the year.

On a consolidated basis, our ARPU is approximately $20 including the stub period contribution from Register.com. More meaningful is the fact that ARPU would have been approximately $14 at Register.com’s full quarter contribution has been included. This is the comparable ARPU that we will report again from the fourth quarter and moving forward. As I have mentioned, we believe that we can restore revenue growth for our combined company in the near term by increasing ARPU.

Turning to gross profit, we generated $23.6 million in gross profit for the third quarter representing a gross margin of 61.5% which is an increase compared to 59.7% last quarter due to improvement on the Web.com’s side and the inclusion of Register.com.

Moving on to operating profitability, we will focus our discussion on non-GAAP or pro forma results, because we believe that excluding the effects of the non-cash and non-recurring items such as stock based compensation and amortization of intangibles arising from business combinations, corporate development expenses, restructuring charges and revenue and pre-paid registry fees eliminated from purchase accounting provides the best indicator of the health of our overall business and the level of efficiency of our operating infrastructure.

Our third quarter non-GAAP income from operations which exclude the impact of the just mentioned items was $6.3 million representing a 16% non-GAAP operating margins based on 26.8 million shares outstanding for the quarter, we generated non-GAAP diluted EPS of $0.20 per share which was well above the high end of our guidance at $0.13 to $0.14. Approximately $0.05 of the upsize was due to lower taxes compared to our guidance assumption.

On last quarter’s call, we indicated that we are modelling the cash tax rate percentage in the mid to high 20s but there was a possibility of a much lower cash tax rate depending upon the results of our tax analysis on the close of Register.com’s acquisition. While this portion of the upside is not driven by operation it is a positive because it enables Web.com to retain approximately $1 million of additional cash.

Adjusted EBITDA, which excludes the impact of stock based compensation, depreciation and amortization expenses, restructuring charges, corporate development expenses and the impact of the purchase accounting adjustment to Register.com deferred revenue and prepaid registry fees was $7.3 million for the third quarter of 2010, representing an adjusted EBITDA margin of 19% consistent with the year ago period.

We also appreciate the investors need to analyze our results on a GAAP basis, so we have 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 47% based on GAAP revenue, that is approximately $5.7 million less than our non-GAAP revenue due to the purchase account reduction to Register.com’s deferred revenue. GAAP sales and marketing expense was $8.3 million; R&D expense was $3 million; G&A expense was $8.1 million; depreciation and amortization was $4.7 million; and restructuring expense was $1.8 million. As a result of Register.com acquisition, the company also realized a $21.2 million tax benefit during the quarter contributing to GAAP net income of $12 million from continuing operations or $0.45 per share. The GAAP results including the reconciliation to non-GAAP results are available on our website at www.web.com under the investor relations section.

Moving to the balance sheet, unrestricted cash and investments were $17.8 million at the end of the third quarter; down from $42.8 million at the end of the second quarter. The company used $20 million in cash during the third quarter; it is part of the consideration for Register.com acquisition. In addition we used several we used several million dollars of cash early in the quarter to pay off liabilities that Web.com took on as part of the acquisition. Our intention is to maintain a cash balance in the $50 million range for the near term using cash balances that are built up above this lever to continue to reduce the debt we raised as part of the register.com acquisition.

We generated positive cash flows from operations of $7.1 dollars, excluding the pay down of the crude restructuring expenses and expenses associated with closing the Register.com acquisition. On a GAAP basis, we reported cash flows from operations of $3.5 million. We have a $109 million in debt after paying $6 million during the quarter from Register.com acquisition. Our debt is essentially carrying an effective interest rate of approximately 5%, which is at the low end of our initial target range of 5 to 5.5%. We remain committed to paying down the debt on a consistent basis and while the maturity date on our long term debt is in 2015; our goal is to pay off the debt well in advance of that date.

Now let me turn to our non-GAAP guidance for the fourth quarter of 2010.

We are currently targeting non-GAAP revenue in the range of $44 million to $45 million. We currently expect our non-GAAP net income for diluted share to be in the $0.16 to $0.17 range which assumes $27.6 million diluted shares outstanding and a non-GAAP tax rate percentage in the mid to high 20s.

Looking ahead we continue to expect cash tax rates to come down to the mid to high teen level beginning in 2011 and further down to the high single digit level in 2012 as more of our NOLs become available.

In 2013 and beyond, our current expectation is that cash taxes will start to move back up and we will provide more color on that progression of the course over the next year or two.

I would also like to reiterate some thoughts regarding our 2011 outlook that we discussed last call. First, we currently expect to realize approximately half of the $10 million cost synergy potential in 2011, as the quarterly run rate of savings will scale over the course of the year. As such exiting 2011, we will have visibility into an additional $5 million in cost savings that can be realized in 2012 as a result of our efforts in 2011.

Second, we expect cost savings realized in 2011 to contribute toward the company’s ability to deliver non-GAAP EPS in the range of a $1 per share for the year, even with a cash tax rate in the mid-to-high teen’s range being maturely higher than what Web.com had experienced in the past.

Third, we currently expect to generate adjusted EBITDA in the range of $40 million for the full year of 2011.

And finally, our goal to use the strong cash flow of our combined company to pay down approximately (1/3) of Web.com’s GAAP by the end of 2011.

In summary, we are very excited about the prospects for our combined organization and believe we have the opportunity to create substantial shareholder value as we integrate our companies to deliver strong cash flow and profitability and increase investments and growth initiatives.

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

Question-and-Answer session

Operator

(Operator Instructions) Our first question is from the line of David Hilal with FBR Capital Markets. Please go ahead.

Philip Dionisio - FBR Capital Markets

Hi, this is Philip Dionisio for David. David, given what you have seen with Register.com – I guess it has been three months since the close. What growth are you comfortable with for 2011? And when you think about the $1 of EPS that you have talked about, if you are tracking above that target would you look to increase spending? I guess the question is: If one dollar a ceiling for next year?

David Brown

Implied in our $1 EPS for 2011 is what we would call modest growth and we defined modest growth up on our previous calls as single digit percentage growth. So we are not really looking for any pickup in the economy and at this point that targeted EPS is based on very modest growth. If we were to generate more earnings than the dollar we are certainly willing to invest in additional sales and marketing kit. We have the programs available to make a rational spend. And so at this point, I think you should think that as we go to our process for identifying places to put money as long as we can get a good return of investment, we are very inclined to invest incremental earnings in sales and in growth.

Philip Dionisio - FBR Capital Markets

If we start you recovery of the SMB market, then we would expect you to increase spending on sales and marketing above and beyond what you have talked about?

David Brown

Yes. I think our current expectation is that as the market improves, mass adaption is occurring and it is important for us to ramp up our sales and marketing efforts to get in front of those customers and to increase the revenue growth of this company and so we are committed to doing that as long as it is done in a practical and reasonable way and we get a good return on investment.

Philip Dionisio - FBR Capital Markets

Okay, thank you.

Operator

Thank you. Our next question is from the line of Gene Munster with Piper Jaffray. Please go ahead.

Gene Munster - Piper Jaffray

I want to talk actually about the growth and a little bit on the previous question, too. Just things get better you said you are ramping up in sales and marketing, but you guys have a good opportunity within you presence within small business I think to add other business lines and products that are more focused on local. Have you given that much thought and I guess when you think about other growth initiatives, is there any color you can give us around future products to kind of accelerate that growth? Thank you.

David Brown

I think part of our corporate DNA is to have a very broad sweep of products and to adapt to the changing marketplace. There is certainly a lot of change going on in the internet market, in the social marketing space and the mobile space and as you said around the local space. And although it is premature to talk about all of our initiatives, I can tell you that we are very active. We have several new product initiatives that are underway, that are in the testing phase right now, that address some of these areas. Each one of them could be a business within the business in the coming years so we are very excited about those initiatives. And it is one of the reasons why we have confidence that we will be able to deploy up to 50% increase in our marketing spend and initiatives that will have good, strong return on investments because of these product initiatives.

Operator

Thank you. Our next question is from the line of Jeff Martin with Roth Capital Partners. Please go ahead.

Jeff Martin - Roth Capital Partners

Thanks. Not to labor the marketing initiatives but you had several programs that you are testing before the Register.com acquisition, are you still moving around with those same types of programs or you develop new ones? Is it a combination of that? What kind of success have you seen with some of the ones you have been trying on for two to three quarters now?

David Brown

Sure. Previous programs that we have mentioned included improving the conversion rate in our outbound and inbound sales area and we continue to see good gains in that area. I commented earlier that we are now positively growing in the DIFM and the DIY areas of (core) web.com. We also talked about our feet on the street program where we have sales people in local markets. That program continues and we are pleased with that program. It is still in the test phase and we are testing the scalability of that business model, but I would say that we are very pleased with it. And then add on top of that, I think what is exciting as part of this acquisition is that some of the new product initiatives that we have not yet talked about, we have a much, much larger base of customers that we can sell those new products into. And these are things that are very topical today in the social networking space and the mobile space. So we are very excited and very optimistic that we will be able to see deep penetrations of those products across the customer base but all of our old initiatives seem to be playing our well plus we have added a bunch of new work to the mix.

Jeff Martin - Roth Capital Partners

Okay. And then, in terms of cross selling, it’s only been two months but are you seeing any early signs of success and what is kind of in a low hanging fruit in your opinion and what are the implications on ARPU? From purely cross selling.

David Brown

Sure. I think form an ARPU implication, I think there is pretty profound opportunity here. Register.com was a domain name company principally with some value added products that were in the very low monthly price point area. We now opened up the complete Web.com box of products, which includes E-works, Visibility Online – these are all products that we have talked about in the past, as well as online marketing, eCommerce. All of those products were not – they were not available to Register.com customers previously. So, you are talking about significant opportunities to increase ARPU as the Register.com customer base adapts these products and then add to that new subscription products that we are creating in the spaces that I just mentioned earlier.

We think that there is very good opportunity to drive ARPU for the next several years in these areas and that is our first priority is to improve our capability and to achieve the benefit in those areas and then we will of course be ramping up our spending to acquire new subscribers as well because we want to have not only a good hunting ground for increasing ARPU among existing customers but we want to constantly be bringing in new customers that can also go to that same process.

Jeff Martin - Roth Capital Partners

David, what would you consider a successful cross sell rate?

David Brown

It really varies depending upon that product that you are talking about and the channels that you are using. If you are in the direct mail space it is one – it is relatively low conversion rate but can still be a very, very effective return on investments based on the spending you have all the way up to – if we are using inbound and outbound telemarketing you typically see higher conversion rates.

We talked about in the past that sales per hour in conversion rates in our business, we think we are a class leader in those areas. Some of our initial tests show us that we are seeing cross sell and up sell rates that are frankly at the very high end of our historical performance levels of any of the programs that we have done. So if you look back historically you will see our numbers in the high single digits and low teen percentage rates of conversion.

So that is what we are looking for in – you should think of this as not across an entire customer base but packets of the customer base will be attracted to certain products. You can’t think of it as a homogenous group of customers, it is a heterogeneous group of needs and so we will sell different products into different pockets of customers. And that is how we will proceed going forward.

Jeff Martin - Roth Capital Partners

Okay, great and then one final question – a simple one. What is your CapEx budget for next year?

David Brown

We have commented in the past that on a combined basis historically, if you are looking at two companies combined 3 to 5 million and I would say, with the integration efforts that we have ahead of us, probably closer to the higher end of that range in the near term and beyond the integration probably closer to low end.

Jeff Martin - Roth Capital Partners

Okay. Great, thanks.

Operator

Thank you. Our next question is from the line of Stephen Ju with RBC Capital Markets. Please, go ahead.

Stephen Ju - RBC Capital Markets

Good afternoon, guys. I am looking at the guidance for 44 to 45 million for the quarter here. If I were to hold the subscriber number (inaudible) that implies an ARPU of something like $15 versus the 14 that I believe you just set for the fourth quarter on a combined basis? So, assuming the math is correct, what gives you the confidence to have a dollar improvement in ARPU on a sequential basis and are you seeing such a pick up now? Thank you.

Kevin Carney

This is Kevin. I think there is a couple of things in play. I think one is, some of the things that Dave alluded to, up sell opportunity, we are seeing familiar signs of success there so those are certain contributors and the other would be some of my comments in the prepared remarks indicating that, within the near term, until we start redeploying marketing resources towards increasing domain name units. We would expect actually to see some near term erosion in our total subscriber base driven by the churn on the main subscriber base, so that too is going to be a driver to driving to higher ARPU metrics.

Stephen Ju - RBC Capital Markets

Understood, thank you.

Operator

Our next question is from the line of James Cakmak with Sidoti & Company. Please go ahead.

James Cakmak - Sidoti & Company

Hi. Good afternoon. Actually just going on from your comments just now Kevin, you talked about focusing on ARPU near term and then shifting it back towards customer growth – how are you thinking about balancing that and certain level of churn that you are comfortable with near term?

Kevin Carney

The way we are thinking about it is really a prioritization exercise where we are taking what we know we are good at, which is we got a large sales force that has been successfully selling, up selling and cross selling for the last several years and we are feeding them new products that they can introduce to their customer base. We think that is the – from a prioritization perspective because we had experience and success – that is the first half and we are putting a lot of our initiatives around maximizing our success in that area. At the same token, we are testing our reach into the market and increasing our spend. I think I commented, there will be a modest increase in spend as we test some things during the fourth quarter. And as those tests play out, we can quickly ramp up our marketing spend to take advantage of opportunities to acquire subscribers more quickly. And so it’s a – we think that’s a few quarters around down the road. We are quite comfortable that the ARPU increase that we will see from this cross selling and up selling will create revenue growth for the company in the near term and more than off-setting any erosion of customers and then in that short term period we’ll turn the spigot on and begin to spend more. So that is kind of how we are approaching it from a prioritization perspective. We do not expect – first off our churn, we commented that our churn is going to be in the range of 2%, plus or minus couple of tens, and as you all know it may bounce around from time to time but the trends are very positive here. They were positive in the core web.com. They have also been positive in Register.com and we are going to continue keep our focus on churn. So we expect over time the trends to be good here. And with such a large base of customers, even we begin to grow subscribers, we do not expect the effect – the early life churn effects of growth to have much of an impact on our overall churn rate, because we have such a large number in our denominator now. So, we feel pretty comfortable that the churn is a number that we basically hammered right into kind of leadership in our space and we are committed to continuing to push it in that direction.

James Cakmak - Sidoti & Company

Okay, and so a stand-alone basis the churn on Register is a no worse than it was before.

Kevin Carney

That is actually better. It has been trending profitably for the last several quarters and I would say this is the best quarter they have ever had.

James Cakmak - Sidoti & Company

Okay. And then you talked about more industry growth, the domain name business should grow 8% to 10% – 8% to 11%. Do you see that getting there within the next year or two?

Kevin Carney

Exactly, it is happening now. There is growth occurring in the domain name space and unfortunately Register was not getting its fair share of that growth because they have so cut back their marketing budget as web.com did back in 2008. So the good news from this whole exercise and this acquisition is that we have now enough money, enough profitability that we can take excess profitability and reinvest it back in sales and marketing. Our sales and marketing expenditures as a percentage of revenue are far, far below, some of our peer group companies that are growing faster than us. So it is not an accident that we are not growing as fast as them. We are not spending nearly as much as them and we are now indicating that we have the ability to invest more and we will be investing more and that will help us generate more subscriber growth in the coming quarters.

James Cakmak - Sidoti & Company

Got it. So basically now, I guess it is safe to say based on your initiatives and the way the business is churning their ARPU, we should give it as kind of troughing here in the fourth quarter.

Kevin Carney

Yes, I think that is correct. I think if it has not already troughed, it is troughing, yes.

James Cakmak - Sidoti & Company

Okay, thank you.

Operator

(Operator Instructions) Our next question is from Mickey Schleien with Ladenburg. Please go ahead.

Mickey Schleien - Ladenburg

Good afternoon. My question is related to the small business index you mentioned at the beginning of the call. I wanted to confirm whether you were referring to the optimism index or if it is another index? And do you believe that is the most accurate leading indicator for ARPU and growth or is there something else that we could look at as well?

David Brown

Well, Mickey, that National Federation of Independent Business index I was referring to is the one that you just mentioned. We monitor it, as well as our own internal metrics regarding the condition of the small business marketplace and we have a lot of metrics in our business so this is, the NFIB survey is nearly a confirming source for us. And we mentioned it only because it is hard data that has already been put out into the public markets. We have a number of internal sources from things like churn rates to things like billing failure rate, etc. All of those indicate to us that it is still a very difficult environment for small businesses. And having said that, our expectations regarding ARPU and revenue growth are really independent of the difficulty. We are assuming that the market is going to be difficult. It is not improving. Most of our expectations are based on plans and programs that we have already deployed and tested and we have seen results sufficient to make us believe that we will see growth in ARPU and growth in revenue. So we are basically having to churn it out in a very difficult market environment and we have enough time now to not only stabilize our business but see our way ahead to growth in the business.

Mickey Schleien - Ladenburg

So would you agree then that although the industry and the other indicators you look at may not imply a strong market, would you agree that it is no longer deteriorating?

David Brown

I would say it is no worse, no better. That is our current view on the market.

Mickey Schleien - Ladenburg

Okay, thank you for your time.

Operator

Our next question is from the line Jim Baker with B. Riley. Please, go ahead.

–Jim Baker – B. Riley

Hi, it looks like your fourth quarter guidance is kind of at the high end of what we could have derived from the prior full year guidance especially on the bottom line. So even setting aside some of these growth opportunities that you have hammered on, I was just wondering if you kind of discovered more synergies than expected or you are just realizing them a little faster than you maybe previously expected?

David Brown

Jim, it is a combination of several things. It is little bit of achieved cost earlier than expected but it is also a little bit more revenue than we expected. It is also a little bit more profitable revenue than we expected. As we have success in offering these new products – the Web.com products to the Register.com customers – we actually saw our gross margin move up a little bit in the quarter. So we are seeing a number of positive trends across all fronts and that is what’s giving us encouragement regarding our guidance.

–Jim Baker – B. Riley

Okay, it looks like being one with Register.com is a bright spot in the past have been its ability to execute in the international market. I am just kind wondering how you see that opportunity going forward and you know that those customers are making more or less receptive to some of Web.com’s value added services?

David Brown

Well I would it’s early on our merger and I will tell you that we haven’t fully explored all the opportunities that exists for us and international but I can also tell you that Register did have a significant presence internationally and we are maintaining that presence and we are studying it closely to see whether it would create opportunity for us down the road. But as I have already mentioned we have very disciplined approach and clear approach. We are going to integrate the two companies first, achieve the savings that we said we could achieve and improve our cross sell and up sell capabilities that we can drive our ARPU. We are then we are going to begin to scale our marketing spend to grow subscribers in the business and internationally yet another opportunity that we can look at as we accomplish those first two things.

–Jim Baker – B. Riley

Okay. Thank you. Nice work, and good luck, guys.

David Brown

Thank you.

Operator

Thank you. We have no question further questions in the queue at this time. I would like to turn the call back over to management for any closing comments.

David Brown

Thank you. Well I would like to thank everyone again for joining us. As you can tell, we are very excited about Web.com’s future and continue to believe our combined company is well-positioned to deliver non-GAAP EPS in the range of $1 per share in 2011. Equally important, we plan to simultaneously increase spend in sales and marketing to restore Web.com’s top line growth which we believe has the potential to drive further increases in share holder value. We look forward to speaking with you over the course of this quarter while we are in New York City for the Piper and Wells Fargo conferences in November and on the road with investors and as always, if you would like to speak to us in the meantime just call our Investor Relations and we can arrange a time. Thank you and good evening,

Operator

Ladies and gentlemen this concludes today’s teleconference. You may now disconnect your line at this time. Thank you for your participation.

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