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Executives

Peter Delgrosso - Senior Vice President, Corporate Communications

David L. Brown – Chairman, Chief Executive Officer

Kevin M. Carney – Chief Financial Officer

Jeffrey M. Stibel – President

Analysts

David Hilal - Friedman, Billings, Ramsey Group, Inc.

Nate Swanson – ThinkEquity Partners LLC

Troy Mastin - William Blair & Company, LLC

Tim Brown - Roth Capital Partners, LLC

James Cakmak - Sidoti & Co

Analyst for Sameet Sinha - JMP Securities

Web.com (WWWW) Q2 2008 Earnings Call August 4, 2008 5:00 PM ET

Operator

Welcome to today’s Web.com second quarter 2008 financial results conference call. (Operator Instructions) I would now like to turn the call over to Peter Delgrosso, Senior Vice President, Corporate Communications.

Peter Delgrosso

Thank you for joining us today to review Web.com’s second 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 the call to a question and answer session.

Please note that our remarks today container 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 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 Securities and Exchange Commission and the risk factors contained therein including our quarterly report on Form 10-Q for the quarter ended March 31, 2008 as filed with the SEC on May 12, 2008 for more information on these risks and uncertainties and limitations that apply to our forward-looking statements.

Web.com expressly disclaims any obligation or undertaking to release publically any updates or revisions to any forward-looking statements contained herein. Additionally, this conference call may contain information that is deemed to 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 Investor Relations section.

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

David L. Brown

The company’s financial performance in the second quarter was solid. Both revenue and earnings were at the top of our guidance with earnings growth benefitting from continued growth in operating margin expansion. We performed well in what has been a challenging macroeconomic environment. That said, as I will discuss later on this call, there were signs in the quarter that provide us with concern about the impact of the economy on our core customer base and business in the short-term.

With three full quarters under our belt as a combined company, we feel very good about the progress of our integration and we believe that we have clearly demonstrated the operating leverage potential of the combined Web.com model that we committed to when we closed the merger.

We continue to prove that we can successfully integrate companies into our model delivering long-term expansion of the business. Our focus is steadfast in creating a company that is poised for long-term earnings growth and market share gains.

Taking a look at the summary financial results for the quarter: total revenue was $32 million which was at the top of our revenue guidance. Revenue was driven by continued growth across our business units as well as the launch of the latest version of NetObjects Fusion which drove increased software sales consistent with what we had seen during past launches.

Our Enterprise channel made an initial current contribution in the second quarter and we expect this channel to begin ramping in the second half of 2008 and even more so in 2009 as more partners are launched.

From a profitability perspective, quarterly GAAP operating margin came in at 4% and the company delivered a record non-GAAP operating margin of 16% which is up from 15% last quarter and up from 11% in the year-ago quarter. This drove non-GAAP net income for diluted share to $0.18 per share which was at the top of our guidance range and up 50% year-over-year.

It’s worth mentioning that the second quarter represents the twelfth consecutive quarter that Web.com has reported profitability that was in line or better than our expectations. We have a proven history over our eleven years as an Internet company of driving profitability and cash flow for our shareholders during both periods of robust economic growth and more challenging time periods. We will continue to execute with this focus which is important in light of the current economic environment.

During the second quarter, we added approximately 1,100 net new subscribers which is respectable but down from the level we added in the previous two quarters as a result of fewer gross subscriber additions. As I mentioned at the outset, there were a number of signs that the economic environment was impacting our target market and business and during the latter half of the quarter, we began to see some specific signs within our business.

First, partner-generated sales leads to our outbound tel-sales force declined during the second quarter. This impacted our DISM website products and our leads products which are two of our traditionally high businesses.

Second, our online direct marketing programs were not as productive as our historical averages. This caused us to reevaluate our near-term investments in this higher-volume lower-RPU channels to maintain our targeted costs of customer acquisitions which caused us to reevaluate and lower spending late in the quarter and into Q3. Put simply, we will not spend at increasing rates to grow the business if it significantly sacrifices profitability and total net lifetime value.

Finally, we saw a modest delay in the rollout of some of the new Enterprise partner programs which pushes out contribution previously anticipated in our forecast. We continue to be optimistic about our Enterprise channel but this timing adjustment has a short-term contribution impact.

After weighing these factors and the overall state of the environment, we are confident that we will execute through this challenging time period but still believe that it’s prudent to adjust our near-term outlook based on the uncertainty in the economy and its impact on our target market. As such, we are adjusting our 2008 revenue outlook to a range of $124-$125 million and our non-GAAP net income for diluted share outlook to a range of $0.73-$0.76.

We continue to expect the company to drive strong and expanding margins, cash flow and profitability. In no way, does our near-term adjustment on the top line reflect our long-term outlook for the business. We continue to believe we are at the early stages of a large emerging market opportunity as small and medium-sized businesses increasingly adopt online services.

There are several factors that provide us with optimism that Web.com will take advantage of this opportunity. First is the fact that we are improving the leverage that is inherent in our company’s business model. Only three-quarters since the combination of Website Pros and Web.com, we are driving record growth in operating margins and we expect to exit this year with our non-GAAP operating margin at best in class 20+ percentage levels, even in light of the economic downturn. This is a significant acceleration toward our long-term target operating model.

Second, 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. At the same time, we continue to invest in expanding our channels into the market giving us more opportunities to reach the huge small-business marketplace and add value.

Third, we continue to make progress in adding value for our small-business customers which is resulting in continuing improvement in our customer churn, a metric which is important to a healthy subscription business. To that end, second quarter churn came in at a record low 3.9%, the first time that we have broken through the important psychological 4% level. We will continue to be focused on driving value to our customers and to driving our customer churn even lower.

Finally, we are still at the early stages of a very exciting new sales channel initiative. We have made a concerted effort to ramp our Enterprise channel in which we partner with large corporations, agencies or parent companies to create a local, online marketing presence for their various locations, franchises or affiliate members throughout the country. The Enterprise channel is something we discussed previously and during Q2, we began to formerly launch specific campaigns which involved extensive planning, development, and ultimately execution creating high value and high RP online market solutions on a local level. This is a channel that was nonexistent at the beginning of this year but it is one that we believe will contribute significantly from a long-term perspective. Jeff will provide more details on the progress of our Enterprise strategies in a moment.

Consistent with our strategy of providing our customers with more value-added solutions, we made a small but strategic asset purchase at the end of the second quarter that I would like to highlight. The product is LogoYes and it is a logo and brand design technology platform that fits in very well with our value proposition for small businesses. LogoYes is a pioneer in the logo design and brand identity face and provides customers with the ability to create a logo and brand identities that can be used online or to create professional grade print products including logos, stationary, business cards and brochures to name a few.

While the acquisition’s initial revenue and earnings contribution is not material, we believe LogoYes is an excellent fit with our business model as it brings a value-add, higher RPU service of upwards of $99 that we can offer to our customer base. In addition, LogoYes has a long large existing customer base that we can cross-sell our broad suite of online marketing solutions to.

In closing, as we move through 2008, we remain committed to delivering strong profitability and from a long-term perspective, we believe our strategic growth initiative positions Web.com to gain market share and emerge as a much stronger diversified company. I’ll now turn the call over to Jeff for some additional commentary on both the quarter and other points of interest. Jeff?

Jeffrey M. Stibel

As David pointed out, we believe our business is being impact by the state of the U.S. economy as small businesses are beginning to scrutinize their spend more. As a result, we’ve made changes throughout our business to maximize the earnings potential of Web.com during this time so we can emerge stronger when the economy begins to recover.

As evidence, you can see our earnings guidance was largely intact in spite of the adjusted revenue outlook. This points to a variable model and our ability to control costs in difficult times.

On a percentage and dollar basis, we actually intend to increase our margins proportionately throughout 2008. Historically, the small-business economy has demonstrated resiliency and often grown in light of the downturn in the economy. We’re seeing starts and stops in this phenomenon even during these more difficult times, we are taking this conservative and prudent approach to guidance as we manage the business.

As David touched upon the major highlights of the quarter and Kevin will drill into more detail, I wanted to spend some time on a subject that investors have been asking us about as we disclosed it roughly a quarter ago, The Enterprise channel.

We see this channel as an important long-term catalyst that will position us for continue profitability and long-term growth. This business development driven channel had been in the works for a number of quarters. Recently, we have begun to implement and launch new programs under this channel designed to offer our suite of online marketing solutions to a variety of larger companies with a local, retail, or franchise presence throughout the United States.

Specifically, we commented on two initial partners under this program, SMG and CCA Global. We discussed CCA in the past so I wanted to provide some detail on what we are doing with SMG.

SMG is a major marketing agency that works with several Fortune 500 companies. Under this arrangement, we are working with SMG to customize our technology solutions to their specific clients’ online marketing needs. We’re still somewhat limited in the details we can share at this moment due to the NDAs that we have in place. However, we can say we are optimistic about the potential we see based on our work to date with one of SMG’s clients in particular which has the potential to literally reach thousands of local sites that can each benefit from Web.com’s online marketing solutions.

In general, we expect partners in the Enterprise channel to deliver significantly higher RPU than our additional business development channel with the potential to bring in several hundred to several thousand units. Again, an extremely high RPU level.

The solutions created with our Enterprise channel partners are customized with extremely high scalability enabling us to grow as the program develops. As such, our goal is to continue to expand this channel by adding in other suitable partners with the same criteria to driving scaling revenue and subscriber growth. We believe this channel has the potential to refuel our net new subscriber additions as well as increase our efforts to ramp over time.

Furthermore, while we are conservatively modeling the near-term impact of this new channel in large part due to current economic conditions, we do believe the channel will become a meaningful contributor to our business in 2009, which is remarkable given the fact that it literally started from zero just a few months back. In general, David and I remain optimistic about the business and the continued diversification of our go-to-market strategy provide considerable upside.

As we move through 2008, we will continue to focus on delivering strong profitability. In doing so, we’ll be opportunistic with less marketing expense but consistent on what we believe the market can deliver. We’ll also look to grow the business in corporate development positioning the company for greater revenue growth.

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

Kevin M. Carney

Total revenue for the second quarter came in at $32 million, an increase of 84% year-over-year and 4% sequentially. Subscription revenue was $30.3 million in the second quarter representing 95% of our total revenue, a growth of 89% year-over-year basis and up 2% on a sequential basis. The growth in our subscription revenue continues to be driven by new subscriber additions and lowered customer churn. The remaining $1.7 million or 5% of total revenue for the second quarter was generated from a bump in software licenses and professional services which was benefitted by the launch of NetObjects Fusion 11.

Specifically, the end of the quarter was approximately 271,000 subscribers representing an increase of approximately 1,100 net subscribers from the end of the previous quarter. During the second quarter, RPU, or average revenue per user, was roughly inline with the first quarter at $37. RPU remains stable even though coming into the quarter we had indicated that it might be another quarter or two before we achieved RPU stability.

Our consolidated churn rate was a record 3.9% for the quarter which compares to a churn rate of 4.1% in the previous quarter. This decrease in churn can be attributable to our continued effort of providing and demonstrating the high value of our solutions.

Turning to gross profit, we generated $20.5 million in gross profit for the second quarter representing a record gross margin of 64% up 80 basis points from 53.2% in the previous quarter. Gross margin on subscription revenue was 63.8, which was up 20 basis points from 63.6% in the previous quarter.

Turning to operating profitability, we’ll focus our discussion 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 on our operating infrastructure.

On the operating expense side, non-GAAP sales and marketing came in at $7.4 million or 23.1% of revenue, down from 23.5% in the first quarter. We will continue to monitor our direct marketing spend closely through the end of the year, especially given the more difficult economic environment to assure that we are generating an attractive return on our investments.

Non-GAAP general and administrative expenses were approximately $4.6 million or 14.3% of revenue down from 14.8% in the fourth quarter however, inline in absolute dollars. As Dave has mentioned, we will continue to focus on the operating leverage of the business which we anticipate will continue to lower costs and our G&A line throughout 2008.

Non-GAAP research and development expenses came in at $2.7 million or 8.4% of revenue, up approximately $100,000 quarter-over-quarter. The slight increase was attributable to the efforts associated with the release of NetObjects Fusin 11 in the quarter.

Our second 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 $5.2 million representing growth of 157% on a year-over-year basis and a record 16% on operating margin. Based on 30.5 million shares outstanding for the quarter, we generated non-GAAP diluted EPS of $0.18 which was at the top of our guidance of $0.16-$0.18.

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 summary, the company reported a GAAP net income of $2.2 million and net income per fully diluted share of $0.07 in the second quarter 2008 compared with GAAP net income of $500,000 and $0.03 per share, respectively, in the year-ago period. GAAP net income for the second quarter 2008 included a $600,000 net tax benefit or $0.02 per diluted share resulting from a $1.3 million reduction in the company’s deferred tax asset evaluation reserve.

The GAAP results including the 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 $31.2 million under the second quarter, representing a decrease from approximately $33.6 million in the prior quarter. Cash was down quarter-over-quarter due to the LogoYes purchase, the paydown of accrued restructuring charges from the Web.com and Website Pros merger, and equipment and furniture expenditures. For the second quarter, Web.com increased its operating cash flow to a record $6.4 million, up from $3 million sequentially which excludes the paydown of accrued restructuring charges in both periods.

I would now like to turn to our outlook for the third quarter and full year 2008 which as David mentioned earlier has been adjusted to reflect the more challenging macroeconomic environment that we are facing. We expect total revenue in the third quarter 2008 in the range of $30.5-$31.5 million. Assuming a non-GAAP tax rate in the single digits and 30.7 million shares outstanding, we expect our non-GAAP net income per diluted share to be in the $0.18-$0.20 range in the third quarter.

For the annual 2008 outlook, as David mentioned earlier, we are revising our guidance for total revenue and non-GAAP net income for diluted share and now anticipate total revenue to be in the $124-$125 million range and non-GAAP net income per diluted share in the $0.73-$0.76 range.

With that, we’d now like to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from David Hilal with Friedman, Billings, Ramsey.

David Hilal - Friedman, Billings, Ramsey Group, Inc.

First, Kevin on the guidance, I was hoping you could give a little more detail on the subscription line. I guess what I want to understand is it looks like subscription revenue can possible be down sequentially and if that is a possibility, I’d like to understand how that can be.

Kevin M. Carney

I think in terms of our guidance and our outlook for the balance of the year, there are really, I guess I would say to get to your question, three different areas where we’ve seen adjustments on the outlook. Specifically on your question to the subscription line, David and Jeff both mentioned in the prepared remarks, we’ve seen and planned for a delay from some of the rollouts from the revenue of the Enterprise initiative which we have obviously factored into our earlier outlook of a speedier ramp there. So that’s certainly contributing to the reduction in terms of our outlook on subscription revenue. The other would be what we’ve alluded to in terms of the reduction that we saw in our gross subscriber additions during the quarter.

So there’s really two factors at play here. One is, I would say, the inefficiency of our marketing spend as we see as a result of the economic environment and the reduction we saw of gross subscriber additions during the second quarter carrying forward in terms of our balance for the rest of the year. The other factor would be, as we mentioned, as a result, we’ve planned for a reduction in our online marketing spend because at the levels we’re spending, we’re acquiring customers on an unprofitable basis. So we’ve decided not to do that.

David Hilal - Friedman, Billings, Ramsey Group, Inc.

Let me ask it differently, because I understand the outlook has been lowered. When I say lowered, I’m talking up relative to Q2, but the aggregate dollar amount being down in Q3 from Q2. I guess the only way that can happen is if you have less subscribers that you currently have but I guess is that a possible scenario you’re suggesting with your guidance.

Kevin M. Carney

Yes, I think, the simple answer is yes. I think with the comments I just made about resulting growth subscriber additions and assuming we don’t see anything significant happening in terms of churn, it’s certainly a possibility in regards to our guidance for the year. You asked specifically about subscription, but it is worth noting in terms of the revised outlook for the balance of the year, we also adjusted our outlook for Fusion in the third and fourth quarter. That probably accounts for about 10% of our revised outlook.

David Hilal - Friedman, Billings, Ramsey Group, Inc.

On the CapEx side, it looks like CapEx was up quite a bit in Q2 and the highest level I can remember. I think when we talked about it 90 days ago, that was not in the cards. What happened to drive CapEx up for the quarter?

Kevin M. Carney

Really, two things. We did make some additional investment in terms of computer hardware which I would say is more inline with what you’ve seen in prior quarters. In addition to that, we made some investments that I had commented in my remarks in capital expenditures in terms of furniture and equipment for an expansion of our operations here in Jacksonville. That’s the balance of what you see there.

David Hilal - Friedman, Billings, Ramsey Group, Inc.

I wanted to dive into the Enterprise channel. You talked about that being delayed a little bit. Why is it being delayed and can you give us a rough estimate in terms of your initial expectations? Is it 30, 60, 90 days type of delay? So why and how much longer?

Jeffrey M. Stibel

It really is dependent on the partner themselves and in a couple of cases, we saw partners pulling back on their resources, whether it be layoffs, whether it be employee head shifting, and that pushed things further out. In other cases, just level launch compounded another one launching. In each of the cases, we are on track for all of the partners that we initially signed up have signed up more and continue to make progress. I think you’re right in a way you characterize this and I think you’re looking for a specific answer. We’re 30, 60 or 90 days off depending on the partner. We have now launched with CCA as we said, SMG, in both cases we’re in a number of different companies within those portfolios. We have another company, Register.com, that has launched previously, that has continued to make very good progress in there. We are continuing to make in-roads with other companies as well. For a variety of reasons, each of those were delayed.

Operator

We’ll take our next question from Nate Swanson with ThinkEquity.

Nate Swanson – ThinkEquity Partners LLC

I guess I would like to get an idea of the sequential movement on the subscription revenue side. I’m wondering in terms of your churn, it was a very good number this quarter, how does that trend during the quarter and I guess what have you seen in the month of July and your expectations for Q3? How does that play into the subscription revenue line?

David L. Brown

On churn, we had a very strong churn quarter and it was very strong throughout the quarter. In fact, building on the very last month of the quarter was our strongest month. That has carried on into the third quarter, at least the beginning of it. So we’re again very optimistic we’re going to be able to continue to drive churn down. It’s not rocket science for us. It’s a function of continuing to add value and help our small-business customers grow their businesses. As we do, we’re getting, we’re really working on that part of the churn curve that is the controllable part. The part where the customer understands the value they’re receiving, they appreciate it compared to their other options. There’s not much we can do about customers going out of business. So I think our achievement here driving down to 3.9% is even more notable given the fact that in difficult economic times, you would expect business closure to increase. We’ve been able to overcome that and we think we’ll be able to overcome that in the coming months and quarters.

Jeffrey M. Stibel

Nate to your point on the question, I think what that indicates is where we’re seeing weaknesses on our gross additions and that is part economic and part our reaction to seeing the effect of the economy and pulling back on our marketing spend. You’re really seeing this on the top-line growth which is why we’re able to control for profitability because that’s where the variable piece of our business is. We’re actually pulling back on that spend somewhat. When you look within the trends, we are seeing more small businesses as an example going out of business. We’re able to counter that with at least enough churn numbers with some of the things that we have done since this merger that have shown tremendous progress. As David pointed to, continue to show a strength on our ability to maintain and reduce our churn level. So we really are seeing the impact on the gross subscriber adds.

Nate Swanson – ThinkEquity Partners LLC

Are you seeing any reduction in RPU as customers renew or maybe they’d elect to subscribe to lower price points?

David L. Brown

Actually RPU was a bright spot for the quarter. We had expected RPU to continue drift down for at least another quarter or two but instead we were able to stabilize it. We actually are seeing signs that our RPU is strengthening in certain parts of our business, certainly in our CISM web services business, we’ve seen some modest improvements. RPU, we think now, as stabilized and over time, we can begin to push that up over time.

Nate Swanson – ThinkEquity Partners LLC

You mentioned that the partner-generated leads were weaker this quarter. What percentage of your customers came in and direct versus indirect? How do you feel about your ability to optimize your marketing programs in terms of just understanding of the pricing of those packages versus what you’re seeing more broadly from an economic perspective?

David L. Brown

I can comment on a few things, Nate. We don’t typically provide specifics on a percentage of our business that comes from partners or not from partners. I think we said previously that a majority of our business is direct but the partnership channel is still very significant to us, especially in our DIFM, in our higher RP business. So when we see weaker leads grow, it can have an impact on our gross subscriber additions and ultimately net subscriber additions. What I think is very meaningful though, is that we have been able to raise our productivity.

We continue to improve our productivity in the business, in all areas of the business. That’s one of the reasons why you see despite lower gross subscriber additions, you see us improving profitabilities, pretty much across the board. We’re very optimistic. We’re very confident in our ability to drive profitability throughout the rest of this year regardless of the circumstances. Again, we’ve had to take the lessons at the end of the second quarter and the absence of any new information about an improvement in the economic environment, we’ve had to plan and forecast using those very conservative measures that we saw at the very tail end of the second quarter. So there are some potential upsides that I should outline for you.

For instance, just as we said we’d lowered our marketing spend because our costs of acquisition went above our target levels, yet we find that our costs of acquisition comes down to more historical levels, we’re absolutely committed to increasing our marketing spend back to traditional levels. You’ll see our gross subscriber additions accelerate, but we do run a balanced business where we look at both profit and growth.

In addition, we have some very significant business opportunities that have been on our plate and are in our planning horizon but for a variety of reasons have moved out in time. These involved adding significant numbers of new subscribers to the company. We’ve alluded to it in the past but because of, we think the economic uncertainty, even our partners are reprioritizing what’s most important to them at the time and that has an impact on us. As those things come along, we expect to continue to see those significant additions of subscribers. It just may not be as early as we originally planned

Nate Swanson – ThinkEquity Partners LLC

If you can just touch on the platform migration and the impact that that had on churn this quarter. How far through the migration do you think you are at this point?

Jeffrey M. Stibel

We’ve made considerable progress and I think as we said in the last earnings report, we actually accelerated that in Q1. I think what you’re seeing is lower churn, in particularly on those migrated customers as a result of that because they’re on a stronger, more stable platform. We’re seeing increased margins as a result of that effort. We are now well-through the period that we thought we were going to be through. We are actually ahead of schedule. We still have every expectation that we’ll hit our goal of being complete by the end of this year.

Operator

We’ll go next to Troy Mastin with William Blair.

Troy Mastin - William Blair & Company, LLC

I want to understand a little bit more about the Enterprise partner channel and the success you’re seeing there in acquiring new customers, and to isolate where you’re seeing challenges and to make sure it’s in the non-partner channel. Is that the case what you referenced in terms of not meeting your objectives in the quarter? That was non-partners and new customer acquisitions, is that correct?

Jeffrey M. Stibel

Troy, I think there were two questions and that second one was are we seeing weakness on the partner side versus direct marketing. I think what we’re saying is we’re seeing this in both. Both leads driven by partners are slowing, even though our efficiency made up for that to some extent. In terms of our direct marketing spend; we have also been pulling back. Does that answer that part of the question, Troy?

Troy Mastin - William Blair & Company, LLC

Yes, I guess I’m focusing more on the cost. I’m assuming what’s happening here is your cost is requiring new customers has gone up in your direct marketing channel. That’s another question that I have, is that purely response-driven or is that also price-driven? But then I want to understand if that is also happening in the partner channel because I think what you’re saying about partners is they’re taking longer to get onboard and that’s one of the reasons you took them on as well. So I guess there’s three or four questions in there.

Jeffrey M. Stibel

So in terms of our subscriber acquisition costs for direct marketing, that’s correct, we are seeing subscriber acquisition costs go up. As a result, we have pulled back on marketing budget which is pulling back on that subscriber acquisition cost. We will spend up to a point of diminishing return and towards the tail end of Q2 and into Q3; we’ve seen us reaching that at a lower spend level. We will continue to maximize our marketing budget against the strong acquisitions costs that feel are prudent.

Troy Mastin - William Blair & Company, LLC

To be clear there, is that purely driven by lower response rates or has costs of acquisition gone up in terms of higher media expenses?

Jeffrey M. Stibel

It is a function of both. You are seeing this largely in the industry with costs of acquiring customers on Google and on some of the secondary search providers such as Yahoo!, Microsoft, all going up. It is in part because a lot of those search providers are consolidating and in part because you’re seeing just deeper competition in that channel. So we’re seeing that in some areas and in other areas, we’re seeing lower subscriber acquisition costs which is the affiliate channels but that’s offset by the fact that we’re selling more in those search markets.

Troy Mastin - William Blair & Company, LLC

On the partner side, to be clear, you’re having problems in both areas, bringing the new partners up to speed or getting the contracts signed, or whatever the slowdown may be, as well as what similar things you may be seeing the direct marketing channel in which it’s costing more to bring those new customers on board.

Jeffrey M. Stibel

The partner side is a little bit different. It’s not the cost on the partner side. It’s the fact that for existing partners, to some extent, they have less customers that they are able to send to us. They are seeing slowdowns in some cases in their business. So they are seeing slowdowns in terms of the channels that are driving subscribers to us. With regards to the Enterprise channel, the new channel where we are signing new deals, what we’re seeing is a slowdown in terms of the launch schedule. So this is basically a delay in terms of the revenue in subscriber growth that we still believe is going to materialize.

Troy Mastin - William Blair & Company, LLC

I wanted to get a little more detail on the acquisition you made in the quarter. I would assume that was the vast majority of the cash outflow that showed up on the cash flow statement for acquisitions. Is that correct?

David L. Brown

Yes,

Troy Mastin - William Blair & Company, LLC

I was going to ask for you to tell us a little bit more about LogoYes in terms of where it fits in your business, if it’s a pure up-sell similar to Web.com, and you mentioned business cards is one thing that they do, I’m curious if they have any sort of an offering of a lead-generation model where they offer some sort of free business cards to grab a new customer?

David L. Brown

LogoYes has been a partner of ours for a number of years and it is a do-it-yourself. It is a software technology that allows a small business or consumer to create a logo for themselves using some technology and some design assets that have been laid out in a database or we can use it internally for a do-it-for-me solution for customers that don’t want to go through the steps to create their own logos. We can do that for them. The beauty of this is it fits perfectly into our website creation business because oftentimes one of the first things that a customer is looking for is a logo for their business. As they begin to create and they begin to think about their offline and online marketing, they’re looking for a way to brand themselves. We know have acquired a branding solution that we can offer to our customers. We can first use it in their online presence and importantly for us, in expanding our business, we can also offer to them for offline purposes. So we can provide them with business cards, with brochures. We do have some marketing alliances already established that will allow us to enter those offline businesses just as we’re in the online business. It’s also a very nicely priced product. It’s not expensive, to have an initial lower-priced product at $99, you can get a very first-class logo which is unique to your business. Our pricing can go up from there depending on whether we’re providing different types of images for offline purposes or whether we’re actually creating the logo for the customer themselves.

Troy Mastin - William Blair & Company, LLC

Do they offer any free services?

David L. Brown

They don’t offer any free services. This is a paid service. It is available on the Internet for a short time. We are already implementing it into our entire process for all of our customers. You’ll see us put some marketing muscle behind it in the marketplace as well.

Troy Mastin - William Blair & Company, LLC

I assume there were no left related billing issues in the quarter. Just a quick update there. I think your exposure is minuscule now. Just wanted to confirm that’s still the case.

Kevin M. Carney

That’s still the case. There’s nothing to report this quarter.

Operator

Next, we’ll go to Tim Brown with Roth Capital.

Tim Brown - Roth Capital Partners, LLC

First on LogoYes, were there any revenues on the last twelve months at all?

Kevin M. Carney

In the quarter, there was about less than $35,000 in revenue.

David L. Brown

It was just really a technology acquisition.

Tim Brown - Roth Capital Partners, LLC

On the Enterprise channel, I just had a few other questions. If you look at SMG and CCA, and what they’ve done to date, can you give us; I guess their feedback, and maybe how they are looking at the success of using Website Pros’ services at this point? Are there any metrics that they’re using and what has been the response so far?

Jeffrey M. Stibel

Again, Tim, we’re really in the early stages. These just launched and you have to remember they launch first at corporate and then they get pushed down to the franchises, the stores, or the advertisers themselves. So we don’t have any specific feedback as of yet that would be interesting. I think to note, in terms of how they track performance. We actually work together to determine how we do that. We are really focused on the metric of lead generation for these stores.

Whether you’re talking about CCA and their flooring stores, or SMG and their partners and advertisers, what we’re really trying to do is drive traffic in principally offline stores. So we’re looking at lead generation either through phone, fax or through e-mail. So we’re buying on a cost-per-click basis through principally Yahoo!, Google, Microsoft. What we’re doing is we’re trying to see is the click to lead conversion ratio and what the cost of that lead and ultimately that acquisition really is. What we have felt at this point now for the partners that we launched, the ones we announced and the ones that we haven’t, is a system that allows us not to just track back the clicks conversions of leads, but actually the sales. We also have feedback mechanisms built into this.

Tim Brown - Roth Capital Partners, LLC

I know this is a hard one to answer but you said they push it out, is this something that they communicated to you that in the beginning of 2009, they are going to start to ramp this up? Is there any time frame at all?

Jeffrey M. Stibel

No, actually to the contrary. In both of those cases, we’ve already launched. So we launched with one or more of their partners. It’s just a function of getting more of those partners into the system than most stores within each of those partnerships. That’s a function of having technology resources on both sides, marketing resources on both sides and market out to those stores, and ultimately sales resources to go and close the deal. So we’re seeing in various instances across that channel, it is just a bottleneck in competing for resources. So I think in all cases, everyone has that same sense of urgency. It’s just a matter of timing and prioritizing. We’re seeing it in those channels, we’re also seeing it with some other Web.com deals such as the Register.com deal where we have migrations that have taken place and are going to continue to take place but they are being deferred again because of resource concerns.

Tim Brown - Roth Capital Partners, LLC

When you say that, you’re talking about the clients or Web.com, the resource constraints?

Jeffrey M. Stibel

Principally the client.

Tim Brown - Roth Capital Partners, LLC

The other question I had was the upselling to Web.com customers. Where is that now at this point, especially the visibility online?

David L. Brown

It’s a bright spot. It has been and continues to be a bright spot in this whole business model that we built with Web.com. We’ve had tremendous success. We’ve really only reached the tip of the iceberg in terms of the opportunity and the number of customers we reached. We’re continuing to crawl into the base, continuing to get smarter about what we should be selling to those customers and about how to upsell and for that matter, even you, the products and services of the DYI or DIFM to save customer churn. I would say this continues to be a bright spot. This is an area that had good head room for us but again, we’re still early in the game, having only reached the tip of the iceberg in terms of touching customers.

Tim Brown - Roth Capital Partners, LLC

Have you seen any pressure on pricing at all, through some of the higher RPU products?

David L. Brown

We haven’t seen any pressure on pricing in any of the areas of the business. Again, it’s one of the things I commented on where we expected to see continued possible dilution in RPU because of the mixing of the DIY product mixed with the DIFM. We’ve actually been able to, the price has actually moved up so it’s now overcome that dilution a little bit earlier than we expected. So we’ve been pleased with that and we expect continued progress in that area.

Jeffrey M. Stibel

Tim, of course, with the slowdown in gross adds, it’s natural to assume, and it’s correct, that there is some pressure in an external environment but when you look at what we’re doing, we have limited resources as well. It costs us nothing to market to our existing base. What we’re seeing is once we get a customer in the door and show them the value of the first three or four months that they can receive, they tend to want more of our services, more of our products. It’s why we did this LogoYes deal. It’s why we’re having such length in success offselling the Web.com base. It’s why when we see these economic times starting to hit us on a subscriber acquisition cost basis, we’re turning our sales force inward for upselling our own base. We’re seeing some very strong success and progress there.

Tim Brown - Roth Capital Partners, LLC

Can you give us your thoughts on buying back stock at these levels?

David L. Brown

It’s absolutely something that is under consideration here. We’ve been looking at it very carefully and it’s one of the options that are available to the company in the use of equity capital.

Operator

We’ll go next to James Cakmak with Sidoti & Co.

James Cakmak - Sidoti & Co

On the net new subscriber growth for the quarter, can you just comment a little bit about which product areas you really saw that growth from?

Jeffrey M. Stibel

It would probably be easier to look at that from a growth standpoint not a net. I think when you look at it; the mix wasn’t any different than it has been before. We see it principally from web services and marketing services, and web services tend to contribute a little bit more because they’re an entry point of our funnel. We look towards marketing services to upsell.

James Cakmak - Sidoti & Co

As far as the Enterprise channel goes, how much for the revised 2008 outlook, how much of the guidance is factored in from the Enterprise channel?

Jeffrey M. Stibel

We don’t break out specifically the Enterprise channel but I think what Kevin spoke to was in terms of the reduction in revenue, it pulled the Enterprise channel down in line to account for roughly 30% of that $10 million reduction in revenue.

James Cakmak - Sidoti & Co

Do you anticipate any headcount reductions from the sales force over the near-term?

David L. Brown

Obviously, we have a series of planned integration efforts throughout the rest of this year and there may be some headcount reduction where functions are being combined but relative to our sales headcount, we don’t see reduction. In fact, that’s an area that has opportunities where it warrants we’re going to add to our sales force throughout the rest of this year and into the near future. Our plan currently calls for that.

James Cakmak - Sidoti & Co

Just to be completely clear on the timing of when you feel you began to experience the impact of the economic weakness. You had commented it was somewhere along the latter half of the second quarter. Is that correct?

David L. Brown

Very late in the quarter.

Operator

Your final question comes from Analyst for Sameet Sinha with JMP Securities.

Analyst for Sameet Sinha - JMP Securities

First of all, as it relates to RPU, you indicated that we could be looking at being stabilized at a $37 level and previously it looks to becoming down as you assign lower RPU from legacy Web.com customers. My question is, if gross customer adds were to accelerate, is there another leg down on RPU or do you think that it’s more a product of upselling taking a fact that it’s driving higher RPU than to lower gross customer adds?

David L. Brown

The answer to your question unfortunately is complicated because it depends upon the mix of subscriber growth and other activities going on such as the rolling out of our Enterprise channel. As we commented earlier, Enterprise channel customers tend to come on at significantly higher RPU than we’ve seen in the past. So depending upon the actual timings of when we’re inaugurating a new partnership and bringing on Enterprise customers versus a ramping up say of a migration or an acceleration of DIY customers, those two could offset or there could be an imbalance one way or the other. So it’s hard for us to predict that right now. We’ve commented in the past that we would expect RPU to generally be flat or to be going up except when we have very significant DIY growth subscriber’s acquisitions. We do think there’s a possibility that we’ll see some of that in the coming quarter and as we see it, we’ll note that to the marketplace.

Analyst for Sameet Sinha - JMP Securities

Along the lines of the Enterprise channel, you talked about constraints with some of your partners. That channel ramps in the back half of the year and into 2009. If you see significant traction there, would you need to increase your capacity in terms of prep files or calendar campaign management?

David L. Brown

Not significantly. Certainly not in a way that would impact our margins, if that’s what you’re asking. Randy, not in such a way that it would delay our ability to proceed.

Operator

At this time, I would like to turn the program over to David Brown for any additional or closing comments.

David L. Brown

We want to thank you all again for joining us today on our second quarter earnings call. In the near-term, on August 6, Jeff will be presenting at RBC Capital Markets 2008 Technology Conference in San Francisco. If you’re planning on attending this event and would like to meet, please let us know. As always, please feel free to contact us if you have any additional questions. Thank you and good night.

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Source: Web.com Q2 2008 Earnings Call Transcript
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