filings.toolsItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read together with our audited financial statements and related notes included in "Financial Statements and Supplementary Data." Some of the information contained in this discussion and analysis, including information with respect to our plans and strategies for our business, includes forward-looking statements involving significant risks and uncertainties. As a result of many factors, such as those set forth in "Risk Factors," our actual results may differ materially from the results described in, or implied by, these forward-looking statements.
This section of the Form 10-K generally discusses 2019 and 2018 items and year-to-year comparisons between 2019 and 2018. Discussions of 2017 items and year-to-year comparisons between 2018 and 2017 that are not included in this Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2018, and are incorporated by reference herein and considered part of this Form 10-K only to the extent referenced.
(Throughout this discussion and analysis, dollars are in millions, excluding ARPU, and shares are in thousands.)
Overview
We are the global market leader in domain registration. Securing a domain is usually the first step to creating a digital identity and our domain products can often serve as the starting point in our customer relationships. As of December 31, 2019, approximately 90% of our customers had purchased a domain from us and we had 79.6 million domains under management. Based on information reported in VeriSign's Domain Name Industry Brief, we had over 22% of the world's domains registered as of September 30, 2019.
We also offer hosting, presence and business applications products and services (products) enhancing our value proposition to our customers by enabling them to create, manage and syndicate their digital identities. While these products are often purchased in conjunction with, or subsequent to, an initial domain registration, they may also be the starting points in our customer relationships. As we have grown, our hosting, presence and business applications products have become increasingly important parts of our business, constituting approximately 55% of total revenue in 2019.
Financial Highlights
Below are our key financial highlights for 2019, with comparisons to 2018.
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Total revenue of $2,988.1 million, an increase of 12.3%, or approximately 13.7% on a constant currency basis(1).
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International revenue of $1,008.5 million, an increase of 7.7%, or approximately 11.4% on a constant currency basis(1).
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Total bookings(2) of $3,401.2 million, an increase of 12.9%, or approximately 14.3% on a constant currency basis(1).
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Net income of $138.4 million.
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Total customers increased 4.1% to 19.3 million.
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ARPU increased 6.6% to $158.
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Net cash provided by operating activities of $723.4 million, an increase of 29.2%.
(1) Discussion of constant currency is set forth in "Quantitative and Qualitative Disclosures about Market Risk."
(2) A reconciliation of total bookings to total revenue, its most directly comparable GAAP financial measure, is set forth in "Selected Financial Data—Reconciliation of Bookings."
Our Financial Model
We have developed a stable and predictable business model driven by efficient customer acquisition, high customer retention rates and increasing lifetime spend. We grew our total customers from 17.3 million as of December 31, 2017 to 19.3 million as of December 31, 2019, through a combination of our industry leading products built on a single cloud platform, brand advertising, direct marketing efforts, customer referrals and world-class customer care. In each of the five years ended December 31, 2019, our customer retention rate exceeded 85%, and in 2019, our retention rate for customers who had been with us for over three years was approximately 92%. We believe the breadth and depth of our product offerings and the high quality and responsiveness of our Customer Care team build strong relationships with our customers and are key to our high level of customer retention.
We generate bookings and revenue from sales of product subscriptions, including domain products, hosting and presence products and business applications, as described below. We offer our product subscriptions on a variety of terms, which average one year, but can range from monthly to multi-annual terms of up to ten years depending on the product. We monitor total bookings as we typically collect payment at the time of sale and recognize revenue ratably over the term of our customer contracts. Accordingly, we believe total bookings is an indicator of the expected growth in our revenue and the operating performance of our business. See "Selected Financial Data—Reconciliation of Bookings" for a reconciliation of total revenue to total bookings.
Domains. We generated 45% of our 2019 total revenue from the sale of domain products, primarily from domain registrations and renewals, domain add-ons such as privacy and aftermarket sales. Total revenue from domain products grew at a CAGR of 13.4% over the three years ended December 31, 2019.
Hosting and Presence. We generated 38% of our 2019 total revenue from the sale of hosting and presence products, primarily from a variety of website hosting products, website building products, security products and e-commerce products. These products generally have higher margins than conventional domain registrations. Total revenue from hosting and presence products grew at a CAGR of 18.4% over the three years ended December 31, 2019.
Business Applications. We generated 17% of our 2019 total revenue from the sale of business applications products, primarily from productivity tools such as domain-specific email accounts, which generally also have higher margins than conventional domain registrations. Total revenue from business applications products grew at a CAGR of 28.3% over the three years ended December 31, 2019.
Revenue derived from each of our product categories has increased in each of the last three years, with our hosting, presence and business applications products growing faster in recent periods. This mix shift has favorably impacted our margins.
In each of the five years ended December 31, 2019, greater than 85% of our total revenue, excluding the impact of purchase accounting, was generated by customers who were also customers in the prior year. To track our growth and the stability of our customer base, we monitor, among other things, revenue, retention rates and ARPU generated by our annual customer cohorts over time, as well as corresponding marketing and advertising spend. We define an annual customer cohort to include each customer who first became a customer during a calendar year. For example, in 2014, we acquired 2.9 million customers, who we collectively refer to as our 2014 cohort, and spent $165 million in marketing and advertising expenses. By the end of 2019, the 2014 cohort had generated an aggregate of $1,266 million of total bookings and we expect this cohort will continue to generate bookings and revenue in the future. For the five years ended December 31, 2019, the average annual bookings retention rate of the 2014 cohort was approximately 93%. To calculate a cohort's bookings retention rate, we compare the number of active customers within a specific cohort as of the end of the current year to the number of customers that were in the cohort in the year of acquisition. Over this period, ARPU, excluding the impact of purchase accounting, for the 2014 cohort grew from $79 in 2015 to $163 in 2019, representing a CAGR of 20%. We selected the 2014 cohort for this analysis because we believe it is representative of the spending patterns and revenue impact of our other cohorts. We believe our cohort analysis is important to illustrate the long-term value of our customers.
Key Metrics
As described in "Selected Financial Data," we monitor the following key metrics to help us evaluate our business and assess operational performance. These operational measures are supplemental to our GAAP results and we believe they are useful in evaluating our business. A reconciliation of total bookings to total revenue, its most directly comparable GAAP financial measure, is set forth in "Selected Financial Data—Reconciliation of Bookings."
| Year Ended December 31, | |||||||||||||||||||||||||||||
| 2019 | 2018 | 2017 | |||||||||||||||||||||||||||
| (unaudited) | |||||||||||||||||||||||||||||
| Total bookings | $ | 3,401.2 | $ | 3,011.5 | $ | 2,618.2 | |||||||||||||||||||||||
| Total customers at period end (in thousands) | 19,274 | 18,518 | 17,339 | ||||||||||||||||||||||||||
| Average revenue per user | $ | 158 | $ | 148 | $ | 139 |
Total bookings. The 12.9% increase in total bookings in 2019 was primarily driven by an increase in total customers and domains under management, increased aftermarket domain sales and broadened customer adoption of non-domain products, partially offset by the impact of movements in foreign currency exchange rates.
Total customers. The 4.1% increase in total customers in 2019 primarily resulted from our increased international presence, our ongoing marketing and advertising initiatives and our enhanced and expanded product offerings.
Average revenue per user. The 6.6% increase in ARPU in 2019 was primarily due to broadened customer adoption of our products resulting in increased customer spend combined with a full year of revenue from our July 2018 acquisition of Main Street Hub (MSH).
Results of Operations
The following table sets forth our results of operations for the periods presented and as a percentage of our total revenue for those periods. The period-to-period comparison of financial results is not necessarily indicative of future results.
| Year Ended December 31, | |||||||||||||||||||||||||||||||||||||||||||||||
| 2019 | 2018 | 2017 | |||||||||||||||||||||||||||||||||||||||||||||
| $ | % of Total Revenue | $ | % of Total Revenue | $ | % of Total Revenue | ||||||||||||||||||||||||||||||||||||||||||
| Revenue: | |||||||||||||||||||||||||||||||||||||||||||||||
| Domains | $ | 1,351.6 | 45.2 | % | $ | 1,220.3 | 45.9 | % | $ | 1,057.2 | 47.4 | % | |||||||||||||||||||||||||||||||||||
| Hosting and presence | 1,126.5 | 37.7 | % | 1,017.6 | 38.2 | % | 847.9 | 38.0 | % | ||||||||||||||||||||||||||||||||||||||
| Business applications | 510.0 | 17.1 | % | 422.2 | 15.9 | % | 326.8 | 14.6 | % | ||||||||||||||||||||||||||||||||||||||
| Total revenue | 2,988.1 | 100.0 | % | 2,660.1 | 100.0 | % | 2,231.9 | 100.0 | % | ||||||||||||||||||||||||||||||||||||||
| Costs and operating expenses: | |||||||||||||||||||||||||||||||||||||||||||||||
| Cost of revenue (excluding depreciation and amortization) | 1,026.8 | 34.3 | % | 893.9 | 33.6 | % | 775.5 | 34.7 | % | ||||||||||||||||||||||||||||||||||||||
| Technology and development | 492.6 | 16.5 | % | 434.0 | 16.3 | % | 355.8 | 15.9 | % | ||||||||||||||||||||||||||||||||||||||
| Marketing and advertising | 345.6 | 11.6 | % | 291.4 | 11.0 | % | 253.2 | 11.3 | % | ||||||||||||||||||||||||||||||||||||||
| Customer care | 348.7 | 11.7 | % | 323.1 | 12.1 | % | 292.3 | 13.1 | % | ||||||||||||||||||||||||||||||||||||||
| General and administrative | 362.1 | 12.1 | % | 334.0 | 12.6 | % | 282.4 | 12.8 | % | ||||||||||||||||||||||||||||||||||||||
| Depreciation and amortization | 209.7 | 7.0 | % | 234.1 | 8.8 | % | 205.8 | 9.2 | % | ||||||||||||||||||||||||||||||||||||||
| Total costs and operating expenses | 2,785.5 | 93.2 | % | 2,510.5 | 94.4 | % | 2,165.0 | 97.0 | % | ||||||||||||||||||||||||||||||||||||||
| Operating income | 202.6 | 6.8 | % | 149.6 | 5.6 | % | 66.9 | 3.0 | % | ||||||||||||||||||||||||||||||||||||||
| Interest expense | (92.1) | (3.1) | % | (98.4) | (3.7) | % | (83.0) | (3.7) | % | ||||||||||||||||||||||||||||||||||||||
| Loss on debt extinguishment | (14.8) | (0.5) | % | — | — | % | (7.3) | (0.3) | % | ||||||||||||||||||||||||||||||||||||||
| Tax receivable agreements liability adjustment | 8.7 | 0.3 | % | 14.9 | 0.6 | % | 123.2 | 5.5 | % | ||||||||||||||||||||||||||||||||||||||
| Other income (expense), net | 22.0 | 0.7 | % | 6.9 | 0.3 | % | 7.0 | 0.3 | % | ||||||||||||||||||||||||||||||||||||||
| Income from continuing operations before income taxes | 126.4 | 4.2 | % | 73.0 | 2.8 | % | 106.8 | 4.8 | % | ||||||||||||||||||||||||||||||||||||||
| Benefit for income taxes | 12.0 | 0.4 | % | 9.0 | 0.3 | % | 18.9 | 0.8 | % | ||||||||||||||||||||||||||||||||||||||
| Income from continuing operations | 138.4 | 4.6 | % | 82.0 | 3.1 | % | 125.7 | 5.6 | % | ||||||||||||||||||||||||||||||||||||||
| Income from discontinued operations, net of income taxes | — | — | % | — | — | % | 14.1 | 0.6 | % | ||||||||||||||||||||||||||||||||||||||
| Net income | 138.4 | 4.6 | % | 82.0 | 3.1 | % | 139.8 | 6.2 | % | ||||||||||||||||||||||||||||||||||||||
| Less: net income attributable to non-controlling interests | 1.4 | — | % | 4.9 | 0.2 | % | 3.4 | 0.1 | % | ||||||||||||||||||||||||||||||||||||||
| Net income attributable to GoDaddy Inc. | $ | 137.0 | 4.6 | % | $ | 77.1 | 2.9 | % | $ | 136.4 | 6.1 | % | |||||||||||||||||||||||||||||||||||
Comparison of 2019 and 2018
Revenue
We generate substantially all of our revenue from sales of subscriptions, including domain registrations and renewals, hosting and presence products and business applications. Our subscription terms average one year, but can range from monthly terms to multi-annual terms of up to ten years depending on the product. We generally collect the full amount of subscription fees at the time of sale, while revenue is recognized over the period in which the performance obligations are satisfied, which is generally over the contract term. Revenue is presented net of refunds, and we maintain a reserve to provide for refunds granted to customers.
Domains revenue primarily consists of revenue from the sale of domain registration subscriptions, domain add-ons and aftermarket domain sales. Domain registrations provide a customer with the exclusive use of a domain during the applicable contract term. After the contract term expires, unless renewed, the customer can no longer access the domain.
Hosting and presence revenue primarily consists of revenue from the sale of subscriptions for our website hosting products, website building products, website security products and online visibility products.
Business applications revenue primarily consists of revenue from the sale of subscriptions for third-party productivity applications, email accounts, email marketing tools and telephony solutions.
The following table presents our revenue for the periods indicated:
| Year Ended December 31, | 2019 to 2018 | 2018 to 2017 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2019 | 2018 | 2017 | $ change | % change | $ change | % change | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Domains | $ | 1,351.6 | $ | 1,220.3 | $ | 1,057.2 | $ | 131.3 | 11 | % | $ | 163.1 | 15 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Hosting and presence | 1,126.5 | 1,017.6 | 847.9 | 108.9 | 11 | % | 169.7 | 20 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Business applications | 510.0 | 422.2 | 326.8 | 87.8 | 21 | % | 95.4 | 29 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Total revenue | $ | 2,988.1 | $ | 2,660.1 | $ | 2,231.9 | $ | 328.0 | 12 | % | $ | 428.2 | 19 | % |
The 12.3% increase in total revenue was driven by growth in total customers and ARPU as well as having a full year of revenue from MSH in 2019, partially offset by the impact of movements in foreign currency exchange rates. The increase in customers impacted each of our revenue lines, as the additional customers purchased subscriptions across our product portfolio.
Domains. The 10.8% increase in domains revenue was primarily driven by the increase in domains under management from 77.6 million as of December 31, 2018 to 79.6 million as of December 31, 2019, increased aftermarket domain sales and international growth.
Hosting and presence. The 10.7% increase in hosting and presence revenue was primarily driven by increased revenue from our website building and website security products as well as our acquisition of MSH.
Business applications. The 20.8% increase in business applications was primarily driven by increased customer adoption of our email, productivity and telephony solutions.
Costs and Operating Expenses
Cost of revenue
Costs of revenue are the direct costs we incur in connection with selling an incremental product to our customers. Substantially all cost of revenue relates to domain registration fees paid to the various domain registries, payment processing fees, third-party commissions and licensing fees for third-party productivity applications. Similar to our billing practices, we pay domain costs at the time of purchase for the life of each subscription, but recognize the costs of service ratably over the term of our customer contracts. The terms of registry pricing are established by agreements between registries and registrars, and can vary significantly depending on the TLD. We expect cost of revenue to increase in absolute dollars in future periods as we expand our domains business, increase our sales of third-party productivity applications, increase our customer base and expand our international presence. Cost of revenue may increase or decrease as a percentage of total revenue, depending on the mix of products sold in a particular period.
| Year Ended December 31, | 2019 to 2018 | 2018 to 2017 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2019 | 2018 | 2017 | $ change | % change | $ change | % change | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Cost of revenue | $ | 1,026.8 | $ | 893.9 | $ | 775.5 | $ | 132.9 | 15 | % | $ | 118.4 | 15 | % |
The 14.9% increase in cost of revenue was primarily attributable to higher domain costs driven by the increase in domains under management and increased aftermarket domain sales, increased software licensing fees resulting from higher sales of email and productivity solutions and increased payment processing fees resulting from our bookings growth.
Technology and development
Technology and development expenses represent the costs associated with the creation, development and distribution of our products and websites. These expenses primarily consist of personnel costs associated with the design, development, deployment, testing, operation and enhancement of our products, as well as costs associated with the data centers and systems infrastructure supporting those products, excluding depreciation expense. We expect technology and development expense to increase in absolute dollars as we continue to enhance existing products, develop new products and migrate our infrastructure to a cloud-based third-party provider. Technology and development expenses may increase or decrease as a percentage of total revenue depending on our level of investment in additional personnel and the pace of our infrastructure transition. Our investments in additional technology and development expenses are made to enhance our integrated technology infrastructure and to support our new and enhanced product offerings and the overall growth of our business.
| Year Ended December 31, | 2019 to 2018 | 2018 to 2017 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2019 | 2018 | 2017 | $ change | % change | $ change | % change | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Technology and development | $ | 492.6 | $ | 434.0 | $ | 355.8 | $ | 58.6 | 14 | % | $ | 78.2 | 22 | % |
Excluding the impact of the $7.2 million equity-based compensation correction discussed in Note 7 to our financial statements, technology and development expenses increased 15.2%, primarily attributable to increased compensation-related costs driven by higher average headcount associated with our continued product development and increased software costs related to the growth of our business.
Marketing and advertising
Marketing and advertising expenses represent the costs associated with attracting and acquiring customers, primarily consisting of fees paid to third parties for marketing and advertising campaigns across a variety of channels. These expenses also include personnel costs and affiliate program commissions. We expect marketing and advertising expenses to fluctuate both in absolute dollars and as a percentage of total revenue depending on both the mix of internal and external marketing resources used and the size and scope of our future campaigns.
| Year Ended December 31, | 2019 to 2018 | 2018 to 2017 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2019 | 2018 | 2017 | $ change | % change | $ change | % change | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Marketing and advertising | $ | 345.6 | $ | 291.4 | $ | 253.2 | $ | 54.2 | 19 | % | $ | 38.2 | 15 | % |
The 18.6% increase in marketing and advertising expenses was primarily attributable to increased discretionary advertising spend and compensation-related costs driven by higher average headcount associated with continued growth of our business.
Customer care
Customer care expenses represent the costs to guide and service our customers, primarily consisting of personnel costs. We expect these expenses to increase in absolute dollars in the future as we expand our domestic and international Customer Care teams due to increases in total customers and increases in the number of interactions we have with our customers. We expect customer care expenses to fluctuate as a percentage of total revenue depending on the level of personnel required to support the continued growth of our business.
| Year Ended December 31, | 2019 to 2018 | 2018 to 2017 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2019 | 2018 | 2017 | $ change | % change | $ change | % change | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Customer care | $ | 348.7 | $ | 323.1 | $ | 292.3 | $ | 25.6 | 8 | % | $ | 30.8 | 11 | % |
The 7.9% increase in customer care expenses was primarily driven by increased costs associated with the continued expansion of our international third-party Customer Care locations, the continued growth of our business, our acquisition of MSH and an increased level of customer interactions.
General and administrative
General and administrative expenses primarily consist of personnel costs for our administrative functions, professional service fees, office rent for all locations, all employee travel expenses, acquisition-related expenses and other general costs. We expect general and administrative expenses to increase in absolute dollars in the future as a result of our overall growth, increased personnel costs and public company expenses.
| Year Ended December 31, | 2019 to 2018 | 2018 to 2017 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2019 | 2018 | 2017 | $ change | % change | $ change | % change | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| General and administrative | $ | 362.1 | $ | 334.0 | $ | 282.4 | $ | 28.1 | 8 | % | $ | 51.6 | 18 | % |
Excluding the impact of the $6.1 million equity-based compensation correction and the $18.1 million legal settlement accrual discussed in Note 7 and Note 13 to our financial statements, respectively, general and administrative expenses increased 4.8%, primarily due to increased compensation-related costs driven by increased average headcount associated with the continued growth of our business and our acquisition of MSH, partially offset by lower acquisition-related expenses.
Depreciation and amortization
Depreciation and amortization expenses consist of charges relating to the depreciation of the property and equipment used in our operations and the amortization of acquired intangible assets. Depreciation and amortization may increase or decrease in absolute dollars in future periods depending on our future level of capital investments in hardware and other equipment as well as amortization expense associated with future acquisitions.
| Year Ended December 31, | 2019 to 2018 | 2018 to 2017 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2019 | 2018 | 2017 | $ change | % change | $ change | % change | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Depreciation and amortization | $ | 209.7 | $ | 234.1 | $ | 205.8 | $ | (24.4) | (10) | % | $ | 28.3 | 14 | % |
The 10.4% decrease in depreciation and amortization expenses was primarily driven by intangible assets that became fully amortized during 2019.
Interest expense
| Year Ended December 31, | 2019 to 2018 | 2018 to 2017 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2019 | 2018 | 2017 | $ change | % change | $ change | % change | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Interest expense | $ | 92.1 | $ | 98.4 | $ | 83.0 | $ | (6.3) | (6) | % | $ | 15.4 | 19 | % |
There was no material change in interest expense.
Loss on debt extinguishment
In 2019, we recognized a loss on debt extinguishment of $14.8 million, primarily related to the $600.0 million partial prepayment of our existing Term Loans with the proceeds of the issuance of the Senior Notes. See Note 10 to our financial statements for additional discussion.
Liquidity and Capital Resources
Overview
Our principal sources of liquidity have been cash flow generated from operations, long-term debt borrowings and stock option exercises. Our principal uses of cash have been to fund operations, acquisitions and capital expenditures, as well as make interest payments and mandatory principal payments on our long-term debt and repurchase shares of our Class A common stock.
In general, we seek to deploy our capital in a systematically prioritized manner focusing first on requirements for operations, then on growth investments, and finally on equity holder returns. Our strategy is to deploy capital from any potential source, whether debt, equity or internally generated cash, depending on the adequacy and availability of the source of capital and which source may be used most efficiently and at the lowest cost at such time. Therefore, while cash from operations is our primary source of operating liquidity and we believe our internally-generated cash flows are sufficient to support our day-to-day operations, we may use a variety of capital sources to fund our needs for less predictable investment decisions such as strategic acquisitions and share repurchases.
We have incurred significant long-term debt, as described below, to fund acquisitions and for our working capital needs. As a result of our debt, we are limited as to how we conduct our business and we may be unable to raise additional debt or equity financing or limited in the amount we are able to raise to compete effectively or to take advantage of new business opportunities, strategic acquisitions or share repurchases. However, the restrictions under our debt agreements are subject to a number of qualifications and may be amended with the consent of the lenders and the holders of the Senior Notes, as applicable.
We believe our existing cash and cash equivalents and internally-generated cash flows will be sufficient to meet our anticipated operating cash needs for at least the next 12 months. However, our future capital requirements will depend on many factors including our growth rate, the timing and extent of spending to support domestic and international development efforts, continued brand development and advertising spend, the expansion of Customer Care and general and administrative activities, the introduction of new and enhanced product offerings, the costs to support new and replacement capital equipment, the completion of strategic acquisitions or share repurchases. Should we pursue additional strategic acquisitions or share repurchases, we may need to raise additional capital, which may be in the form of additional long-term debt or equity financings.
Credit Facility and Senior Notes
Our credit facility, which matures on February 15, 2024, consists of term loans and a revolving credit loan. In June 2019, we issued the unsecured 5.25% Senior Notes in an aggregate principal amount of $600.0 million. The full principal of the Senior Notes is payable at maturity on December 1, 2027, subject to earlier repurchase or redemption, as described in the indenture governing the Senior Notes. The proceeds from the issuance of the Senior Notes were used to prepay $600.0 million in aggregate principal amount of term loans. Concurrent with the issuance of the Senior Notes, we amended our credit facility to increase the borrowing capacity of the revolving credit loan to $600.0 million and reduce its interest rate margins. See further discussion of our debt agreements in Note 10 to our financial statements.
Our debt agreements contain covenants restricting, among other things, our ability, or the ability of our subsidiaries, to incur indebtedness, issue certain types of equity, incur liens, enter into fundamental changes including mergers and consolidations, sell assets, make restricted payments including dividends, distributions and investments, prepay junior indebtedness and engage in operations other than in connection with acting as a holding company, subject to customary exceptions. As of December 31, 2019, we were in compliance with all such covenants and had no amounts drawn on the revolving credit loan.
As further discussed in Note 11 to our financial statements, we have hedged a portion of our long-term debt through the use of cross-currency and interest rate swap derivative instruments. These instruments help us manage and mitigate our risk of exposure to changes in foreign currency exchange rates and interest rates. See "Quantitative and Qualitative Disclosures About Market Risk" for additional discussion of our hedging activities.
Tax Receivable Agreements
As described in "Critical Accounting Policies and Estimates—Payable to Related Parties Pursuant to the TRAs," we are a party to five TRAs. As of December 31, 2019, the liability under the TRAs was $175.3 million, as described in Note 16 to our financial statements. We currently do not expect to begin making payments related to the existing liability under the TRAs until 2023. We may record additional liabilities under the TRAs as our estimates of the future utilization of the tax attributes, NOLs and other tax benefits change.
Because we are a holding company with no operations, we rely on Desert Newco to provide us with funds necessary to meet any financial obligations. If we do not have sufficient funds to pay TRA, tax or other liabilities or to fund our operations (as a result of Desert Newco's inability to make distributions to us due to various limitations and restrictions or as a result of the acceleration of our obligations under the TRAs), we may have to borrow funds and thus our liquidity and financial condition could be materially and adversely affected.
Share Repurchase Programs
Our Board has authorized two separate $500.0 million share repurchase programs, as described in Note 6 to our financial statements. During 2019, we repurchased a total of 7,125 shares of our Class A common stock in the open market under these programs, which were retired upon repurchase for an aggregate purchase price of $458.6 million, including commissions. As of December 31, 2019, we have $541.4 million available to make additional repurchases under these programs.
Subsequent Events
In February 2020, we entered into agreements for two acquisitions with an aggregate purchase price of approximately $196.9 million, of which $149.1 million has been paid in cash. The remaining $47.8 million will be paid upon receipt of certain regulatory approvals and satisfaction of other customary closing conditions as well as upon the expiration of the contractual holdback period.
Cash Flows
The following table summarizes our cash flows for the periods indicated:
| Year Ended December 31, | |||||||||||||||||||||||||||||||||||||||||
| 2019 | 2018 | 2017 | |||||||||||||||||||||||||||||||||||||||
| Net cash provided by operating activities | $ | 723.4 | $ | 559.8 | $ | 475.6 | |||||||||||||||||||||||||||||||||||
| Net cash used in investing activities | (135.3) | (254.8) | (1,570.1) | ||||||||||||||||||||||||||||||||||||||
| Net cash provided by (used in) financing activities | (456.9) | 47.0 | 1,107.5 | ||||||||||||||||||||||||||||||||||||||
| Effect of exchange rate changes on cash and cash equivalents | (0.8) | (2.3) | 3.6 | ||||||||||||||||||||||||||||||||||||||
| Net increase in cash and cash equivalents | $ | 130.4 | $ | 349.7 | $ | 16.6 |
Operating Activities
Our primary source of cash from operating activities has been cash collections from our customers. We expect cash inflows from operating activities to be primarily affected by increases in total bookings. Our primary uses of cash from operating activities have been for domain registration costs paid to registries, software licensing fees related to third-party email and productivity solutions, personnel costs, discretionary marketing and advertising costs, technology and development costs and interest payments. We expect cash outflows from operating activities to be affected by the timing of payments we make to registries and increases in personnel and other operating costs as we continue to grow our business and increase our international presence.
Net cash provided by operating activities increased $163.6 million from $559.8 million in 2018 to $723.4 million in 2019, primarily driven by our bookings growth as well as increased interest income.
Investing Activities
Our investing activities primarily consist of strategic acquisitions and purchases of property and equipment to support the overall growth of our business and our increased international presence. We expect our investing cash flows to be affected by the timing of payments we make for capital expenditures and the strategic acquisition or other growth opportunities we decide to pursue.
Net cash used in investing activities decreased $119.5 million from $254.8 million in 2018 to $135.3 million in 2019, primarily due to a $106.9 million decrease in business acquisitions.
Financing Activities
Our financing activities primarily consist of long-term debt borrowings, the repayment of principal on long-term debt, stock option exercises and share repurchases.
Net cash from financing activities decreased $503.9 million from $47.0 million provided in 2018 to $456.9 million used in 2019, primarily resulting from $458.6 million of share repurchases in 2019, a $44.4 million increase in acquisition contingent consideration payments and $13.2 million of financing-related costs paid in 2019.
Deferred Revenue
See Note 8 to our financial statements for details regarding the expected future recognition of deferred revenue as of December 31, 2019.
Contractual Obligations
The following table summarizes our material contractual obligations and commitments as of December 31, 2019:
| Payments due by period | |||||||||||||||||||||||||||||||||||||||||
| 1 year | 2-3 years | 4-5 years | 5+ years | ||||||||||||||||||||||||||||||||||||||
| Long-term debt, including current maturities(1) | $ | 25.0 | $ | 50.0 | $ | 1,757.3 | $ | 600.0 | |||||||||||||||||||||||||||||||||
| Interest on long-term debt(2) | 95.5 | 188.0 | 131.8 | 94.5 | |||||||||||||||||||||||||||||||||||||
| Operating leases(3) | 50.6 | 78.0 | 49.9 | 110.0 | |||||||||||||||||||||||||||||||||||||
| Service agreements(4) | 48.9 | 96.5 | 35.1 | 0.3 | |||||||||||||||||||||||||||||||||||||
| TRA payments(5) | — | — | 36.3 | 139.0 | |||||||||||||||||||||||||||||||||||||
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(1) See Note 10 to our financial statements for information regarding the terms of our long-term debt agreements.
(2) Interest on long-term debt excludes both the amortization of deferred debt issuance costs and original issue discount and the expected benefits associated with our interest rate swap. Interest on our variable rate debt is calculated using the rate in effect at December 31, 2019.
(3) See Note 12 to our financial statements for information regarding our operating lease commitments. The amounts include the imputed interest component of our operating lease liabilities.
(4) See Note 13 to our financial statements for information regarding our service agreement commitments.
(5) Reflects the estimated timing of TRA payments as of December 31, 2019. Such payments could be due later than estimated depending on the timing of our use of the underlying tax attributes. As of December 31, 2019, we have recorded a liability of $175.3 million payable to the related parties under the TRAs, reflecting limitations on the use of the favorable tax attributes due to limitations of taxable income. The estimated amounts payable under the TRAs do not include the up to $1,579.3 million of additional liabilities we may record in the future if utilization of such tax attributes becomes more-likely-than-not. See "Risk Factors-Risks Related to Our Company and Our Organizational Structure" and Note 16 to our financial statements for additional information regarding our liability under the TRAs.
Off-Balance Sheet Arrangements
As of December 31, 2019 and 2018, we had no off-balance sheet arrangements that had, or which are reasonably likely to have, a material effect on our financial statements.
Critical Accounting Policies and Estimates
We prepare our financial statements in accordance with GAAP, and in doing so, we make estimates, assumptions and judgments affecting the reported amounts of assets, liabilities, revenues and expenses, as well as the related disclosure of contingent assets and liabilities. We base our estimates, assumptions and judgments on historical experience and on various other factors we believe to be reasonable under the circumstances, and we evaluate these estimates, assumptions and judgments on an ongoing basis. Different assumptions and judgments would change the estimates used in the preparation of our financial statements, which, in turn, could change our results from those reported. We refer to estimates, assumptions and judgments of this type as our critical accounting policies and estimates, which we discuss further below. We review our critical accounting policies and estimates with the audit and finance committee of our board of directors on an annual basis.
See Note 2 to our financial statements for a summary of our significant accounting policies.
Revenue Recognition
We recognize revenue when control of the promised products is transferred to our customers, in an amount reflecting the consideration we expect to be entitled to in exchange for those products. Payments received in advance of our performance are recorded as deferred revenue. Revenue is recognized net of allowances for returns and applicable transaction-based taxes collected from customers.
We generally sell our products with a right of return, which we account for as variable consideration when estimating the amount of revenue to recognize. Refunds are estimated at contract inception using the expected value method based on historical refund experience and updated each reporting period as additional information becomes available. Refunds result in a reduced amount of revenue recognized over the contract term of the applicable product compared to the amount originally expected. Our annual refund rate has ranged from 6.4% to 6.9% of total bookings from 2017 to 2019.
We may sell multiple products to customers at the same time. For example, we may design a customer website and separately offer other products such as hosting and a SSL certificate, or a customer may combine a domain registration with other products such as private registration or email. Judgment may be required in determining whether products are considered distinct performance obligations that should be accounted for separately or as one combined performance obligation. The majority of our revenue arrangements consist of multiple performance obligations, with revenue recognized over the period in which each performance obligation is satisfied, which is generally over the contract term.
For arrangements with multiple performance obligations, we allocate revenue to each distinct performance obligation based on its relative stand-alone selling price (SSP). Our process for determining SSP requires judgment and considers multiple factors that may vary over time depending upon the unique facts and circumstances related to each performance obligation. We determine SSP based on prices charged to customers for individual products, taking into consideration factors including historical and expected discounting practices, the size, volume and term length of transactions, customer demographics, the geographic areas in which our products are sold and our overall go-to-market strategy.
We sell our products directly to customers and also through a network of resellers. In certain cases, we act as a reseller of products provided by others. The determination of gross or net revenue recognition is reviewed on a product-by-product basis and is dependent on whether we act as principal or agent in the transaction.
See Notes 2 and 8 to our financial statements for additional information regarding revenue recognition and deferred revenue.
Equity-Based Compensation
We grant stock options, restricted stock units (RSUs) and performance-based awards (PSUs) to our employees and independent directors, which are accounted for using the fair value method. Options are granted at exercise prices equal to the fair market value of our Class A common stock as reported on the NYSE on the date of grant. We measure and recognize compensation expense for such awards based on their accounting grant date fair values. RSUs and PSUs are measured based on the fair market value of the underlying common stock on their respective accounting grant dates. For options, the fair value is estimated using the Black-Scholes option-pricing model, which requires management to make assumptions and apply judgment in determining such value.
The most significant judgments include estimating the expected option term, expected stock price volatility and risk-free interest rates. The assumptions we use represent management's best estimates. If factors change and different assumptions are used, our equity-based compensation expense could be materially different in the future.
We also estimate a forfeiture rate for our awards, which is based on an analysis of historical forfeitures. We evaluate the appropriateness of our estimate based on actual forfeiture experience, analysis of employee turnover and other factors. Changes in our estimated forfeiture rate can have a significant impact on our equity-based compensation expense since the cumulative effect of adjusting this rate is recognized in the period in which the estimate is changed. If a revised forfeiture rate were to increase, a resulting decrease in previously-recognized expense would be recorded. If a revised forfeiture rate were to decrease, a resulting increase in previously-recognized expense would be recorded.
On a quarterly basis, we estimate when and if PSUs will be earned. Expense is recognized only for awards considered probable of being earned. The accounting grant date fair value of each award ultimately expected to vest is recognized as compensation expense, net of estimated forfeitures, over the requisite service period.
We will continue to use judgment in evaluating these assumptions on a prospective basis. As we accumulate additional data related to our awards, we may refine our estimates, which could materially impact future expense.
See Notes 2 and 7 to our financial statements for additional information regarding equity-based compensation.
Business Combinations
We include the results of operations of acquired businesses in our financial statements as of the respective dates of acquisition. Accounting for business combinations requires us to make significant estimates and assumptions, especially at the acquisition date, with respect to tangible and intangible assets acquired, liabilities assumed and pre-acquisition contingencies. The purchase price, including estimates of the fair value of contingent consideration when applicable, is allocated to the tangible and intangible assets acquired and the liabilities assumed based on their estimated fair values on the respective acquisition dates, with the excess recorded as goodwill. Critical estimates used in valuing certain acquired intangible assets include, but are not limited to, future expected cash flows (primarily from customer relationships and developed technology) and discount rates.
Our contingent consideration liabilities, which relate to future earn-out payments associated with our acquisitions, are generally valued using discounted cash flow valuation methods. Critical estimates used in valuing contingent consideration liabilities include estimated operating results scenarios for the applicable performance periods, probability weightings assigned to operating results scenarios and discount rates.
We use our best estimates and assumptions to determine acquisition-date fair values. These estimates are inherently uncertain and subject to refinement. We continue to collect information and reevaluate our preliminary estimates and assumptions and record any qualifying measurement period adjustments to goodwill. Contingent consideration is adjusted to fair value in subsequent periods as an increase or decrease in general and administrative expenses.
See Notes 2 and 3 to our financial statements for additional information regarding business combinations.
Goodwill and Indefinite-Lived Intangible Assets
We make estimates, assumptions and judgments when valuing goodwill and other intangible assets in connection with the initial purchase price allocations of our acquisitions, as well as when evaluating the recoverability of our goodwill and other intangible assets on an ongoing basis. We assess our goodwill and indefinite-lived intangible assets for impairment at least annually during the fourth quarter. We will also perform an assessment at other times if and when events or changes in circumstances indicate the carrying value of these assets may not be recoverable.
We perform our impairment assessment based on qualitative analysis, which includes considering various factors including macroeconomic conditions, industry and market conditions and our historical and projected operating results. If, based on our qualitative analysis, we were to determine it is more-likely-than-not the fair value of our single reporting unit is less than its carrying amount, we would record an impairment loss for the amount equal to such excess.
Our qualitative analyses during 2019, 2018 and 2017 did not indicate any impairment, and accordingly, none was recorded. As of December 31, 2019, we believe such assets are recoverable; however, there can be no assurances these assets will not be impaired in future periods. Any future impairment charges could adversely impact our results of operations.
See Notes 2 and 5 to our financial statements for additional information regarding goodwill and indefinite-lived intangible assets.
Income Taxes
We are subject to U.S. federal, state and foreign income taxes with respect to our allocable share of any taxable income or loss of Desert Newco, as well as any stand-alone income or loss we generate. Significant judgment is required in determining our provision or benefit for income taxes and in evaluating uncertain tax positions.
We account for income taxes under the asset and liability method, which requires the recognition of DTAs and DTLs for the expected future tax consequences of events included in our financial statements. Under this method, we determine DTAs and DTLs on the basis of the differences between the financial statements and tax bases of assets and liabilities by using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on DTAs and DTLs is recognized in income in the period in which the enactment date occurs.
We recognize DTAs to the extent we believe these assets are more-likely-than-not to be realized. In making such a determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax planning strategies and recent results of operations.
We recognize tax benefits from uncertain tax positions only if it is more-likely-than-not the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. The tax benefits recognized from such positions are measured based on the largest benefit having a greater than 50% likelihood of being realized.
See Notes 2 and 15 to our financial statements for additional information regarding income taxes.
Payable to Related Parties Pursuant to the TRAs
We are a party to five TRAs. Under four of these agreements, we are generally required to pay to certain pre-IPO owners approximately 85% of the amount of calculated tax savings, if any, we are deemed to realize (as described below) as a result of (1) any existing tax attributes associated with LLC Units acquired in the pre-IPO organizational transactions, the benefit of which is allocable to us as a result of such transactions (including the allocable share of Desert Newco's existing tax basis in its assets), (2) NOLs available as a result of such transactions and (3) tax benefits related to imputed interest.
Under the fifth of these agreements, we are generally required to pay our other pre-IPO owners approximately 85% of the amount of the calculated tax savings, if any, we are deemed to realize (as described below) as a result of (1) any step-up in tax basis created as a result of exchanges of their LLC Units (together with the corresponding shares of Class B common stock) for shares of our Class A common stock, (2) any existing tax attributes associated with their LLC Units, the benefit of which is allocable to us as a result of such exchanges (including the allocable share of Desert Newco's existing tax basis in its assets), (3) tax benefits related to imputed interest and (4) payments under the TRA.
The TRAs allow our pre-IPO owners to transfer their rights under the TRAs to third parties, who would then succeed to all rights under the TRAs. In the event of such a transfer, we would be required to make the payments described above to the new TRA parties.
When LLC Units are exchanged, we receive certain tax attributes, including the original basis adjustments (the OBAs) created from the original acquisition of the LLC Units plus any anticipated basis adjustments. The OBAs entitle us to the depreciation and amortization previously allocable to the original owner of such units. The anticipated basis adjustments will increase, for tax purposes, our depreciation and amortization deductions. To the extent these deductions are used to reduce our taxable income, thereby resulting in actual tax savings, we will be required to pay the original owners approximately 85% of such savings, which is recorded as an additional liability under the TRAs. This increase in tax basis also creates additional DTAs and may also decrease gains, or increase losses, on future dispositions of certain assets to the extent tax basis is allocated to those assets.
For purposes of calculating the income tax savings we are deemed to realize under the TRAs, we will calculate the federal income tax savings using the actual applicable U.S. federal income tax rate and will calculate the state and local income tax savings using 5% for the assumed combined state and local tax rate, which represents an approximation of our combined state and local income tax rate, net of federal income tax benefits.
The term of the TRAs commenced in 2015 upon the completion of our IPO and will continue until all such tax benefits have been utilized or expire, unless we exercise our rights to terminate the agreements or payments under the agreements are accelerated in the event we materially breach any of our material obligations under the agreements.
As a results of certain pre-IPO reorganization transactions, we received certain tax attributes, including the OBAs and NOL carryforwards, from certain of our pre-IPO owners, which entitle us to the depreciation and amortization previously allocable to such parties. These deductions are allowed prior to the utilization of any NOL or tax credit carryforwards against income taxes.
Based on current projections of taxable income, and before deduction of any specially allocated depreciation and amortization, we anticipate having enough taxable income to utilize a portion of these specially allocated deductions related to the OBAs. Accordingly, as of December 31, 2019, our liability under the TRAs was $175.3 million.
The projection of future taxable income involves significant judgment. Actual taxable income may differ from our estimates, which could significantly impact the liability under the TRAs. We have determined it is more-likely-than-not we will be unable to utilize all of our DTAs subject to TRAs; therefore, we have not recorded a liability under the TRAs related to the tax savings we may realize from the utilization of NOL carryforwards and the amortization related to basis adjustments created by exchanges of LLC Units. If utilization of these DTAs becomes more-likely-than-not in the future, at such time, we will record
liabilities under the TRAs of up to an additional $1,140.9 million as a result of basis adjustments under the Internal Revenue Code and up to an additional $438.4 million related to the utilization of NOL and credit carryforwards, which will be recorded through charges to our statements of operations. However, if the tax attributes are not utilized in future years, it is reasonably possible no amounts would be paid under the TRAs. In this scenario, the reduction of the liability under the TRAs would result in a benefit to our statements of operations.
See Notes 2 and 16 to our financial statements for additional information regarding the payable to related parties pursuant to the TRAs.
The TRAs are subject to a number of risks and uncertainties. For a description of these risks, see "Risk Factors—Risks Related to Our Company and Our Organizational Structure."
Indirect Taxes
We are subject to indirect taxation in some, but not all, of the various states and foreign jurisdictions in which we and our subsidiaries conduct business. Laws and regulations attempting to subject communications and commerce conducted over the Internet to various indirect taxes are becoming more prevalent, both in the U.S. and internationally, and may impose additional burdens on us in the future. Increased regulation could negatively affect our business directly, as well as the businesses of our customers. Taxing authorities may impose indirect taxes on the Internet-related revenue we generate based on regulations currently being applied to similar, but not directly comparable, industries. There are many transactions and calculations where the ultimate indirect tax determination is uncertain. In addition, domestic and international indirect taxation laws, or interpretations thereof, are subject to change.
The calculation of our reserve for indirect taxes involves significant management estimates and is based on an ongoing analysis of our business activities, revenues subject to indirect taxes and applicable regulations. Although we believe our indirect tax estimates and associated liabilities are reasonable, the final determination of indirect tax audits, litigation or settlements could be materially different than the amounts established for indirect tax contingencies.
See Note 13 to our financial statements for additional information regarding indirect taxes.
Loss Contingencies
We are subject to the possibility of various loss contingencies arising from uncertain and unresolved matters in the ordinary course of business and from events or actions by others having the potential to result in a future loss. Such contingencies may include, but are not limited to, intellectual property claims, putative class actions, commercial and consumer protection claims, labor and employment claims, breach of contract claims, regulatory proceedings, product service level commitments and losses resulting from other events and developments. We consider the likelihood of loss, the impairment of an asset or the incurrence of a liability, as well as our ability to reasonably estimate the amount of loss, in determining loss contingencies.
When a loss is considered probable and reasonably estimable, we record a liability in the amount of our best estimate for the ultimate loss. When there appears to be a range of possible costs with equal likelihood, a liability is recorded based on the low-end of such range. However, the likelihood of a loss with respect to a particular contingency is often difficult to predict and determining a meaningful estimate of the loss or a range of loss may not be practicable based on the information available and the potential effect of future events and decisions by third parties impacting the ultimate resolution of the contingency. It is also not uncommon for such matters to be resolved over many years, during which time relevant developments and new information must be continuously evaluated to determine both the likelihood of potential loss and whether it is possible to reasonably estimate a range of possible loss. When a loss is probable but a reasonable estimate cannot be made, disclosure is provided. Disclosure is also provided when it is reasonably possible a loss will be incurred or when it is reasonably possible the amount of a loss will exceed the recorded amounts.
We regularly review all contingencies to determine whether the likelihood of loss has changed and to assess whether a reasonable estimate of the loss or range of loss can be made. Development of a meaningful estimate of loss, or a range of potential loss, is complex when the outcome is directly dependent on negotiations with, or decisions by, third parties such as regulatory agencies, court systems in various jurisdictions and other interested parties. Such factors bear directly on whether it is possible to reasonably estimate a range of potential loss and boundaries of high and low estimates. Until the final resolution of such matters, there may be an exposure to loss in excess of the amounts recorded, and such amounts could be material. Should any of our
estimates and assumptions change or prove to have been incorrect, it could have a material impact on our business, operating results or financial condition.
See Note 13 to our financial statements for additional information regarding loss contingencies.
Recent Accounting Pronouncements
For information regarding recent accounting pronouncements, see Note 2 to our financial statements.
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