UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 001-34518

Ancestry.com Inc.

(Exact name of registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)		26-1235962 (I.R.S. Employer Identification Number)
360 West 4800 North Provo, Utah (Address of principal executive offices)		84604 (Zip Code)

(801) 705-7000
(Registrants’ telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

As of October 19, 2010, there were 44,518,170 shares of the registrant’s common stock, par value $0.001, outstanding.

 

 

Ancestry.com Inc.

Table of Contents

		Page
Part I. Financial Information
Item 1. Condensed Consolidated Financial Statements (unaudited)
Condensed Consolidated Balance Sheets as of September 30, 2010 and December 31, 2009			3
Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2010 and 2009			4
Condensed Consolidated Statements of Cash Flows for the Three and Nine Months Ended September 30, 2010 and 2009			5
Notes to Condensed Consolidated Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			12
Item 3. Quantitative and Qualitative Disclosures About Market Risk			26
Item 4. Controls and Procedures			26
Part II. Other Information
Item 1. Legal Proceedings			27
Item 1A. Risk Factors			27
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			43
Item 6. Exhibits			44
Signatures			45
Exhibit Index			46
Exhibit 4.1
Exhibit 4.2
Exhibit 10.1
Exhibit 10.2
Exhibit 10.3
Exhibit 10.4
Exhibit 10.5
Exhibit 10.6
Exhibit 10.7
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1

PART I. FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

ANCESTRY.COM INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

		September 30,				December 31,
		2010				2009
		(unaudited)
		(In thousands)
ASSETS
Current assets:
Cash and cash equivalents		$	64,085			$	66,941
Restricted cash			2,441				2,181
Short-term investments			16,004				33,331
Accounts receivable, net of allowances of $355 and $472 at September 30, 2010 and December 31, 2009, respectively			4,398				5,860
Income tax receivable			2,912				2,017
Deferred income taxes			1,572				8,797
Prepaid expenses and other current assets			4,972				5,380
Total current assets			96,384				124,507
Property and equipment, net			19,378				19,430
Content database costs, net			55,301				49,650
Intangible assets, net			33,107				41,484
Goodwill			290,356				285,466
Other assets			1,402				2,811
Total assets		$	495,928			$	523,348
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	8,857			$	6,877
Accrued expenses			27,401				18,850
Escrow liability			2,029				1,763
Deferred revenues			90,583				69,711
Current portion of long-term debt			—				28,416
Total current liabilities			128,870				125,617
Long-term debt, less current portion			—				71,609
Deferred income taxes			24,728				30,117
Other long-term liabilities			1,834				1,115
Total liabilities			155,432				228,458
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $0.001 par value; 5,000 shares authorized; no shares issued and outstanding			—				—
Common stock, $0.001 par value; 175,000 shares authorized; 44,402 and 42,416 shares issued and outstanding at September 30, 2010 and December 31, 2009, respectively			44				42
Additional paid-in capital			293,263				272,513
Accumulated other comprehensive income (loss)			519				(41	)
Retained earnings			46,670				22,376
Total stockholders’ equity			340,496				294,890
Total liabilities and stockholders’ equity		$	495,928			$	523,348

See accompanying notes to condensed consolidated financial statements

ANCESTRY.COM INC

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2010				2009				2010				2009
		(unaudited)
		(In thousands, except per share data)
Revenues:
Subscription revenues		$	74,239			$	52,603			$	204,343			$	152,506
Product and other revenues			5,076				4,384				13,853				12,287
Total revenues			79,315				56,987				218,196				164,793
Costs of revenues:
Cost of subscription revenues			11,267				10,033				33,996				29,755
Cost of product and other revenues			1,155				1,389				3,929				4,213
Total cost of revenues			12,422				11,422				37,925				33,968
Gross profit			66,893				45,565				180,271				130,825
Operating expenses:
Technology and development			10,528				9,142				30,447				26,690
Marketing and advertising			24,125				14,240				71,061				44,226
General and administrative			9,141				10,229				24,915				24,569
Amortization of acquired intangible assets			3,791				4,052				11,149				12,165
Total operating expenses			47,585				37,663				137,572				107,650
Income from operations			19,308				7,902				42,699				23,175
Other income (expense):
Interest expense			(2,187	)			(1,428	)			(4,896	)			(4,784	)
Interest income			201				48				340				746
Other income, net			401				4				398				14
Income before income taxes			17,723				6,526				38,541				19,151
Income tax expense			(5,914	)			(2,485	)			(14,247	)			(6,927	)
Net income		$	11,809			$	4,041			$	24,294			$	12,224
Net income per common share:
Basic		$	0.27			$	0.11			$	0.56			$	0.32
Diluted		$	0.24			$	0.10			$	0.50			$	0.30
Weighted average common shares outstanding
Basic			43,984				38,327				43,075				38,283
Diluted			48,774				41,059				48,186				40,096

See accompanying notes to condensed consolidated financial statements

ANCESTRY.COM INC

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2010				2009				2010				2009
		(unaudited)
		(In thousands)
Operating activities:
Net income		$	11,809			$	4,041			$	24,294			$	12,224
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation			2,751				2,762				8,355				8,092
Amortization of content			1,900				1,753				5,564				5,182
Amortization of acquired intangible assets			3,791				4,052				11,149				12,164
Amortization of deferred financing costs			1,539				220				2,368				613
Deferred income taxes			3,627				615				990				(1,271	)
Stock-based compensation expense			1,275				1,462				3,541				4,265
Changes in operating assets and liabilities:
Accounts receivable			561				1,011				1,496				974
Restricted cash			(94	)			85				(144	)			888
Other assets			(1,343	)			(1,324	)			627				(2,288	)
Income tax receivable			(2,439	)			(201	)			(895	)			2,683
Accounts payable and accrued expenses			9,501				(524	)			17,569				(459	)
Excess tax benefits from stock-based compensation			(4,071	)			(6	)			(7,641	)			(29	)
Deferred revenues			475				26				19,563				8,672
Other long-term liabilities			719				—				719				26
Net cash provided by operating activities			30,001				13,972				87,555				51,736
Investing activities:
Capitalization of content database costs			(3,393	)			(2,183	)			(8,534	)			(5,855	)
Purchases of property and equipment			(4,269	)			(1,415	)			(7,897	)			(7,566	)
Acquisitions of businesses, net of cash acquired			(8,147	)			—				(8,147	)			—
Purchases of short-term investments			—				—				(7,193	)			—
Proceeds from sale and maturity of short-term investments			14,527				—				24,564				—
Proceeds from settlement of forward contract			366				—				366				—
Net cash used in investing activities			(916	)			(3,598	)			(6,841	)			(13,421	)
Financing activities:
Proceeds from exercise of stock options			4,442				5				9,514				559
Principal payments on debt			(76,230	)			(2,405	)			(100,025	)			(18,331	)
Deferred financing costs from issuance of credit facility			(733	)			—				(733	)			—
Excess tax benefits from stock-based compensation			4,071				6				7,641				29
Repurchase of common stock			—				—				—				(100	)
Net cash used in financing activities			(68,450	)			(2,394	)			(83,603	)			(17,843	)
Effect of changes in foreign currency exchange rates on cash and cash equivalents			33				—				33				—
Net increase (decrease) in cash and cash equivalents			(39,332	)			7,980				(2,856	)			20,472
Cash and cash equivalents at beginning of period			103,417				52,613				66,941				40,121
Cash and cash equivalents at end of period		$	64,085			$	60,593			$	64,085			$	60,593
Supplemental disclosures of cash flow information:
Cash paid for interest		$	1,051			$	1,208			$	2,528			$	6,624
Cash paid for income taxes			164				4,029				6,345				8,985
Supplemental disclosures of noncash investing and financing activities:
Unrealized gain (loss) on short-term investments			(4	)			—				44				—
Capitalization of stock-based compensation			3				2				6				3

See accompanying notes to condensed consolidated financial statements

ANCESTRY.COM INC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

1. NATURE OF OPERATIONS

Ancestry.com Inc. (the “company” or “Ancestry”) is an online family history resource that derives revenues from providing access to digitized historical records on a subscription basis. The company also offers other products including software and self-publishing products.

Basis of Presentation

The condensed consolidated financial statements include the accounts of the company and its wholly owned subsidiaries and a variable interest entity (“VIE”). All significant intercompany accounts and transactions have been eliminated in consolidation.

The accompanying condensed consolidated balance sheet as of September 30, 2010 and the condensed consolidated statements of operations and condensed consolidated statements of cash flows for the three and nine months ended September 30, 2010 and 2009 are unaudited. These unaudited interim condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) on the same basis as the audited consolidated financial statements and in the opinion of management, reflect all adjustments (all of which are considered of normal recurring nature) considered necessary to present fairly the company’s financial position, results of its operations and cash flows for the three and nine months ended September 30, 2010 and 2009. The results of operations for the three and nine months ended September 30, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010. These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in the company’s 2009 Annual Report on Form 10-K (the “2009 Annual Report”) filed with the Securities and Exchange Commission on February 26, 2010.

The preparation of interim condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported and disclosed in the financial statements and accompanying notes. Actual results could differ materially from these estimates.

Certain prior period amounts have been reclassified to conform to current year presentation. These reclassifications did not have a significant impact on the condensed consolidated financial statements.

Recent accounting pronouncements

In June 2009, the Financial Accounting Standards Board (“FASB”) issued amended standards for determining whether to consolidate a VIE. These new standards amend the evaluation criteria to identify the primary beneficiary of a VIE and require ongoing reassessment of whether an enterprise is the primary beneficiary of the VIE. These standards were effective for the company beginning in the first quarter of 2010. The company has concluded that it is the primary beneficiary of a VIE and therefore has consolidated the financial statements of the VIE into the financial statements of the company. The VIE is not significant to the financial position, results of operations, or cash flows of the consolidated company. The adoption of the new standards did not have an impact on the company’s consolidated financial position, results of operations or cash flows.

2. CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS

Cash, cash equivalents and short-term investments consisted of the following (in thousands):

		September 30,				December 31,
		2010				2009
Cash		$	9,928			$	5,159
Cash equivalents:
Money market funds			54,157				61,782
Total cash and cash equivalents		$	64,085			$	66,941
Short-term investments:
U.S. agency securities		$	16,004			$	33,331

Gross unrealized gains and losses on short-term investments were not significant at September 30, 2010 and December 31, 2009. As of September 30, 2010, the company had U.S. agency securities totaling $13.0 million in an unrealized gain position. The company also had U.S. agency securities totaling $3.0 million in an unrealized loss position, which had been in a loss position for less than one year, and are not considered to be other than temporary losses. As of December 31, 2009, all U.S. agency securities were in an unrealized loss position and had been in a loss position for less than one year. The company designates all short-term investments as available-for-sale. As of September 30, 2010 and December 31, 2009, the company did not hold any investments with original maturities greater than one year from the date of purchase.

Cash equivalents and short-term investments are measured at fair value. Fair value is based on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In order to increase consistency and comparability in fair value measurements, the accounting guidance establishes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three broad levels. These levels, in order of highest priority to lowest priority, are described below:

Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities.

Level 2: Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.

Level 3: Unobservable inputs are used when little or no market data is available.

The company’s cash equivalents and short-term investments at September 30, 2010 and December 31, 2009 were all classified within Level 1. There were no movements between fair value measurement levels of the company’s cash equivalents and short-term investments during the nine months ended September 30, 2010.

The carrying amounts reported in the financial statements for accounts receivable and accounts payable approximate their fair values because of the short-term maturities of these financial instruments. The carrying value of long-term debt approximated fair values based on interest rates currently available to the company for debt with similar terms at December 31, 2009. At September 30, 2010, the company had no long-term debt outstanding.

In connection with the acquisition of Genline AB discussed below, the company entered into a forward contract to purchase 53 million Swedish kronor. The company did not qualify the contract for hedge accounting and therefore the fair value gains and losses on the contract were recorded in net income. In July 2010, the forward contract was settled resulting in a gain of $0.4 million.

3. BUSINESS ACQUISITIONS

On July 15, 2010, the company acquired Genline AB (“Genline”), the owner and operator of the Swedish family history Web site Genline.se, based in Stockholm, Sweden for $7.2 million in cash consideration. The Genline acquisition increased the company’s presence in the Swedish market and provides existing customers with access to millions of Swedish records. The acquisition of Genline was not material to the company’s financial position or results of operations.

On August 6, 2010, the company acquired ProGenealogists, Inc. (“ProGenealogists”), which specializes in genealogical, forensic and family history research, for $1.1 million in cash consideration. The acquisition of ProGenealogists provides the company with a genealogy research team for internal projects and allows customers access to expert genealogists to assist them in their research. The ProGenealogists acquisition was not material to the company’s financial position or results of operations.

4. NET INCOME PER COMMON SHARE

Basic net income per common share is computed using the weighted-average number of outstanding shares of common stock during the period. Diluted net income per common share is computed using the weighted-average number of outstanding shares of common stock and, when dilutive, potential common shares outstanding during the period. Potential common shares consist primarily of incremental shares issuable upon the assumed exercise of stock-based awards to purchase common stock using the treasury stock method. The computation of diluted net income per share for the three months ended September 30, 2010 and 2009 excludes stock-based awards to acquire 0.5 million and 1.2 million shares, respectively, as their impact was anti-dilutive. The computation of diluted net income per common share for the nine months ended September 30, 2010 and 2009 excludes stock-based awards to acquire 0.6 million and 2.2 million shares, respectively, as their impact was anti-dilutive.

A reconciliation of the numerator and the denominator used in the calculation of basic and diluted net income per common share is as follows (in thousands, except per share amounts):

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2010				2009				2010				2009
Basic net income per common share:
Net income		$	11,809			$	4,041			$	24,294			$	12,224
Shares used in computation:
Weighted-average common shares outstanding			43,984				38,327				43,075				38,283
Basic net income per common share		$	0.27			$	0.11			$	0.56			$	0.32
Diluted net income per common share:
Net income		$	11,809			$	4,041			$	24,294			$	12,224
Shares used in computation:
Weighted-average common shares outstanding			43,984				38,327				43,075				38,283
Dilutive stock-based awards			4,790				2,732				5,111				1,813
Weighted-average number of diluted common shares			48,774				41,059				48,186				40,096
Diluted net income per common share		$	0.24			$	0.10			$	0.50			$	0.30

5. COMPREHENSIVE INCOME

Other comprehensive income consists of changes in unrealized gains and losses on available-for-sale securities and changes in foreign currency translation adjustments. The components of comprehensive income were as follows (in thousands):

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2010				2009				2010				2009
Net income		$	11,809			$	4,041			$	24,294			$	12,224
Other comprehensive income:
Changes in unrealized gain (loss) on available for sale securities, net			(4	)			—				44				—
Changes in foreign currency translation adjustments			516				—				516				—
Comprehensive income		$	12,321			$	4,041			$	24,854			$	12,224

6. LONG-TERM DEBT

On September 9, 2010, the company terminated and paid in full the remaining $76.2 million of debt then outstanding. On December 5, 2007, the company entered into a secured credit facility with a number of financial institutions for borrowings of up to $150.0 million. These borrowings included a term loan of $140.0 million (the “Term Loan”) and a revolving commitment of up to $10.0 million (the “Revolving Loans”), both of which were to mature on December 5, 2012. No amounts were outstanding under the Revolving Loans as of December 31, 2009 or during 2010. Debt financing costs of $3.9 million were incurred in connection with the Term Loan. These costs were deferred in other long-term assets on the balance sheet and were amortized to interest expense over the period of the Term Loan. The remaining unamortized debt financing costs of $1.3 million were charged to interest expense upon termination.

In connection with the payoff of the Term Loan, on September 9, 2010 the company entered into a three-year $100.0 million principal amount senior secured revolving credit facility with Bank of America, N.A., as administrative agent, and certain other financial institutions (the “Credit Facility”). The Credit Facility includes a $5.0 million sublimit for the issuance of letters of credit and a $7.0 million sublimit for swingline loans and has a maturity date of September 9, 2013. The Credit Facility is secured by a first-priority security interest in all of the capital stock of the company’s wholly-owned domestic subsidiaries and 65% of the capital stock of the company’s material foreign subsidiaries as well as the currently owned and hereafter acquired real and personal property assets of the company and its wholly-owned domestic subsidiaries. Borrowings under the Credit Facility may be used to finance the on-going working capital needs of the company and its subsidiaries and for general corporate purposes, including permitted business acquisitions and capital expenditures. As of September 30, 2010, the company has not borrowed against the Credit Facility.

The Credit Facility contains financial and other covenants, including but not limited to, limitations on indebtedness, liens, mergers, asset sales, dividends and other payments in respect of equity interests, capital expenditures, investments and affiliate transactions (subject to qualifications and baskets), as well as the maintenance of a minimum fixed charge coverage ratio and a maximum senior secured leverage ratio. A violation of these covenants or the occurrence of certain other events could result in a default permitting the termination of the lenders’ commitments under the Credit Facility and/or the acceleration of any loan amounts then outstanding. The company was in compliance with all financial and other covenants at September 30, 2010.

Under the terms of the Credit Facility, the company may elect that the loans comprising each borrowing bear interest generally at a rate equal to (i) LIBOR plus a margin that fluctuates between 1.50% and 2.00%, as determined by the company’s Consolidated Leverage Ratio (as defined in the Credit Facility) as set forth in the company’s most recently delivered compliance certificate or (ii) the Base Rate (defined as a rate equal to the highest of (a) the Federal Funds Rate plus 0.50%, (b) the Bank of America prime rate and (c) the Eurodollar rate plus 1.00%), plus a margin that fluctuates between 0.50% and 1.00%, as determined by the company’s Consolidated Leverage Ratio as set forth in its most recently delivered compliance certificate (the “Base Rate Applicable Margin”). Each swingline loan will bear interest at the Base Rate plus the Base Rate Applicable Margin. In addition, the company will pay a commitment fee of 0.40% on any unused portions of the facility and a letter of credit fee that fluctuates between 1.50% and 2.00%, as determined by the company’s Consolidated Leverage Ratio as set forth in its most recently delivered compliance certificate.

Debt financing costs of $0.7 million were incurred in connection with the Credit Facility. These costs are deferred in other long-term assets on the balance sheet and are being amortized to interest expense over the period of the Credit Facility. At September 30, 2010, the unamortized debt financing costs were $0.7 million.

7. STOCK-BASED AWARDS

In July 2009, the Board of Directors approved the 2009 Stock Incentive Plan (the “2009 Plan”), which provides for the grant of stock options and other stock-based awards, including restricted stock units, to employees, directors and consultants. As of September 30, 2010, 2,957,138 stock-based awards were available to be granted under the 2009 Plan. The company has also granted stock options under previously approved plans: the 1998 Stock Option Plan (the “1998 Plan”), the Executive Stock Plan (“ESP”), the 2004 Stock Option Plan (the “2004 Plan”) and the Generations Holding, Inc. Stock Purchase and Option Plan (the “2008 Plan”). The company does not intend to grant additional stock awards under the 1998 Plan, ESP, 2004 Plan or 2008 Plan.

Stock Options

Stock option awards granted generally vest over four years and have a term not greater than ten years from the date of grant. A summary of stock option activity of all the plans for the nine months ended September 30, 2010 is as follows:

						Weighted
						Average
		Number of				Exercise
		Shares				Price
Outstanding at December 31, 2009			10,373,290			$	5.29
Granted			417,250				17.99
Exercised			(1,985,136	)			4.82
Canceled			(198,653	)			6.16
Outstanding at September 30, 2010			8,606,751				5.99
Exercisable at September 30, 2010			5,710,713				4.96
Vested and expected to vest			8,512,176				5.96

As of September 30, 2010, the company had $8.1 million of total unrecognized compensation expense, net of estimated forfeitures, related to stock options. The unrecognized compensation expense is expected to be recognized over a weighted average remaining period of 2.5 years. The weighted average remaining contractual life of options outstanding at September 30, 2010 was 6.6 years. The total intrinsic values of options outstanding and options exercisable as of September 30, 2010 were $144.3 million and $101.6 million, respectively. The total intrinsic value of options exercised during the nine months ended September 30, 2010 was $27.0 million.

The company estimates the fair value of each option on the date of grant using the Black-Scholes option-pricing model. The weighted average grant date fair values of options granted during the nine months ended September 30, 2010 and 2009 were $6.00 and $2.99, respectively. The following weighted average assumptions were used to value option grants.

		Nine Months Ended
		September 30,
		2010				2009
Expected volatility			40	%			50	%
Expected term (in years)			4.0				4.2
Weighted average risk-free interest rate			1.7	%			1.9	%
Weighted average fair value of the underlying common stock		$	17.99			$	6.80
Expected dividends			—				—

Restricted Stock Units

During the nine months ended September 30, 2010, the company also issued restricted stock units representing the right to receive one share of the company’s common stock under the 2009 Plan. Restricted stock unit awards generally vest over four years. The following table summarizes restricted stock unit activity.

						Weighted
						Average
		Number of				Grant Date
		Units				Fair Value
Restricted stock units outstanding at December 31, 2009			—			$	—
Granted			456,198				17.87
Vested			(450	)			18.20
Forfeited			(6,167	)			16.40
Restricted stock units outstanding at September 30, 2010			449,581				17.89

As of September 30, 2010 the company had $6.2 million of total unrecognized compensation expense, net of estimated forfeitures related to restricted stock units. The unrecognized compensation expense is expected to be recognized over a weighted average period of 3.8 years.

Stock-Based Compensation Expense

The following table summarizes stock-based compensation expense included in the statement of operations (in thousands):

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2010				2009				2010				2009
Cost of subscription revenues		$	57			$	17			$	134			$	78
Technology and development			550				388				1,437				1,223
Marketing and advertising			204				104				390				273
General and administrative			464				953				1,580				2,691
Total stock-based compensation expense		$	1,275			$	1,462			$	3,541			$	4,265

8. INCOME TAXES

The company is subject to income taxes in the U.S. and foreign jurisdictions. Significant judgment is required in evaluating the company’s uncertain tax positions and determining its provision for income taxes. The company’s total gross unrecognized tax benefits as of September 30, 2010 and December 31, 2009 were $1.0 million and $0.6 million, respectively. The gross uncertain tax positions, if recognized by the company, would affect the company’s effective income tax rate.

9. COMMITMENTS AND CONTINGENCIES

From time to time, the company is a party to or otherwise involved in legal proceedings or other legal matters that arise in the ordinary course of business or otherwise. While the company’s management does not believe that any pending legal claim or proceeding will be resolved in a manner that would have a material adverse effect on the company’s business, the company cannot assure the ultimate outcome of any legal proceeding or contingency in which the company is or may become involved.

10. SUBSEQUENT EVENTS

On September 22, 2010, the company entered into an agreement to acquire iArchives, Inc., a leading digitization services provider that also operates Footnote.com, a leading American history Web site and on October 20, 2010, the company completed the acquisition. The purchase price was approximately $31.6 million, consisting of the issuance of approximately 1.022 million shares of Ancestry.com common stock valued at approximately $24.6 million, based on the closing price on October 20, 2010, and approximately $7.0 million of cash consideration. The acquisition is expected to provide Ancestry.com with a complementary consumer brand, expanded content offerings, and enhanced digitization and image-viewing technologies.

The company announced a share repurchase program, under which the company may spend up to $25.0 million to repurchase shares of its common stock, depending on market conditions, the price of the company’s common stock and other factors. The share repurchase program is intended in part to offset the issuance of common stock as a result of the iArchives acquisition.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements relating to future events and future performance. All statements other than those that are purely historical may be forward-looking statements. We may, in some cases, use words such as “project,” “believe,” “anticipate,” “continue,” “plan,” “expect,” “estimate,” “intend,” “should,” “would,” “could,” “potentially,” “will” or “may,” or other words that convey uncertainty of future events or outcomes to identify these forward-looking statements. Forward-looking statements in this Quarterly Report include statements about:

•		our future financial performance, including our revenues, cost of revenues, operating expenses and ability to sustain profitability;
•		our rate of revenue and expense growth;
•		the pool of our potential subscribers;
•		our ability to attract and retain subscribers;
•		our ability to manage growth;
•		our ability to generate additional revenues on a cost-effective basis;
•		our ability to acquire content and make it available online;
•		our ability to enhance the subscribers’ experience and provide value;
•		our success with respect to any future business acquisitions;
•		our international expansion plans;
•		our ability to adequately manage costs and control margins and trends;
•		our investments in technology and the success of our promotional programs and new products;
•		our development of brand awareness;
•		our ability to retain and hire necessary employees;
•		our competitive position;
•		our liquidity and working capital requirements and the availability of cash and credit;
•		the seasonality of our business;
•		the impact of external market forces; and
•		the impact of claims or litigation.

Although we believe that the assumptions underlying the forward-looking statements are reasonable, we cannot guarantee future results, level of activity, performance or achievements. There are a number of important factors that could cause actual results to differ materially from the results anticipated by these forward-looking statements. These important factors include those that we discuss in this Quarterly Report under the captions “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Risk Factors” and elsewhere. You should read these factors and the other cautionary statements made in this Quarterly Report as being applicable to all related forward-looking statements wherever they appear in this Quarterly Report. If one or more of these factors materialize, or if any underlying assumptions prove incorrect, our actual results, performance or achievements may vary materially from any future results, performance or achievements expressed or implied by these forward-looking statements. All subsequent written or spoken forward-looking statements attributable to our company or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. The forward-looking statements included in this Quarterly Report are made only as of the date of this Quarterly Report, and we undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

Overview

Ancestry.com is the world’s largest online family history resource, with nearly 1.4 million paying subscribers around the world as of September 30, 2010. We have been a leader in the family history market for over 20 years and have helped pioneer the market for online family history research. We believe that most people have a fundamental desire to understand who they are and from where they came, and that anyone interested in discovering, preserving and sharing their family history is a potential user of Ancestry.com. We strive to make our service valuable to individuals ranging from the most committed family historians to those taking their first steps towards satisfying their curiosity about their family stories.

The foundation of our service is an extensive and unique collection of billions of historical records that we have digitized, indexed and put online over the past 14 years. Our subscribers use our proprietary online platform, extensive digital historical record collection, and easy-to-use technology to research their family histories, build their family trees, collaborate with other subscribers, upload their own records and publish and share their stories with their families. We offer our service on a subscription basis, typically annually or monthly. These subscribers are our primary source of revenue. We charge each subscriber for their subscription at the commencement of their subscription period and at each renewal date. Although monthly subscribers have become an increasing proportion of our subscribers, the annual commitments of a majority of our subscribers enhance management’s near-term visibility on our revenues and provide working capital benefits, which we believe enable us to more effectively manage the growth of our business. We provide ongoing value to our subscribers by regularly adding new historical content, enhancing our Web sites with new tools and features and enabling greater collaboration among our users through the growth of our global community.

Our goal is to remain the leading online resource for family history and to grow our subscriber base in the United States and around the world by offering a superior value proposition to anyone interested in learning more about their family history. We have focused on, and will continue to focus on, retaining our loyal base of existing subscribers, on acquiring new subscribers and on expanding the market to new consumers. We believe our previous investments in technology and content have provided us a foundation for a scalable business model that will help us to increase our margins over the long term and effectively manage our costs as our business grows. However, we expect to continue to devote substantial resources and funds to improving our technologies and product offerings and acquiring new and relevant content and talent, and expanding the awareness of our brand and category through global marketing, any of which may adversely affect our margin expansion in the near term.

The following discussion and analysis is based upon and should be read in conjunction with the Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report as well as the Consolidated Financial Statements and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2009 (the “2009 Annual Report”).

Recent Developments

Genline Acquisition

On July 15, 2010, we acquired Genline AB, owner and operator of the Swedish family history Web site Genline.se, for approximately $7.2 million in cash consideration. The Genline acquisition increased our presence in the Swedish market and provides our customers with access to millions of Swedish records. The acquisition of Genline was not material to our financial position or results of operations.

ProGenealogists Acquisition

On August 6, 2010, we acquired ProGenealogists, Inc., for approximately $1.1 million in cash consideration. ProGenealogists is a leading professional genealogy research firm that specializes in genealogical, forensic and family history research. We believe the acquisition of ProGenealogists provides us with a premier genealogy research team for internal projects and gives our customers access to expert genealogists to assist them in their research. The ProGenealogists acquisition was not material to our financial position or results of operations.

New Credit Facility

On September 9, 2010, we terminated and paid in full the $76.2 million outstanding under our previous credit facility from cash on hand including the proceeds from our initial public offering. Also on September 9, 2010, in connection with the payoff of the previous credit facility, we entered into a new three-year $100.0 million principal amount senior secured revolving credit facility with Bank of America, N.A., as administrative agent, and certain other financial institutions. The new credit facility includes a $5.0 million sublimit for the issuance of letters of credit and a $7.0 million sublimit for swingline loans. As of November 1, 2010, we have not drawn any funds under the new credit facility.

Interest under the new credit facility is variable generally based on LIBOR or the base rate (defined as the highest of (a) the Federal Funds Rate plus 0.50%, (b) the Bank of America prime rate and (c) the Eurodollar rate plus 1.00%), plus a margin based on our consolidated leverage ratio. Each swingline loan will bear interest at the base rate plus a margin.

The new credit facility matures September 9, 2013 and is secured by a first-priority security interest in all of the capital stock of our wholly owned domestic subsidiaries and 65% of the capital stock of our material foreign subsidiaries as well as our currently owned and hereafter acquired real and personal property assets, as well as those of our wholly owned domestic subsidiaries. Borrowings under the new credit facility may be used to finance our on-going working capital needs and those of our subsidiaries and for general corporate purposes, including permitted business acquisitions and capital expenditures.

The new credit facility contains financial and other covenants, including but not limited to, limitations on indebtedness, liens, mergers, asset sales, dividends and other payments in respect of equity interests, capital expenditures, investments and affiliate transactions (subject to qualifications and baskets), as well as a minimum fixed charge coverage ratio and a maximum senior secured leverage ratio. A violation of these covenants or the occurrence of certain other events could result in a default permitting the termination of the lenders’ commitments under the credit facility and/or the acceleration of any loan amounts then outstanding. We were in compliance with all financial and other covenants at September 30, 2010. Note 6 to our condensed consolidated financial statements describes further the terms of the new credit facility.

iArchives Acquisition

On September 22, 2010, we entered into an agreement to acquire iArchives, Inc. (“iArchives”), a leading digitization service provider that also operates Footnote.com, a leading American history Web site, and on October 20, 2010 we completed the acquisition. The purchase price was approximately $31.6 million, consisting of the issuance of approximately 1.022 million shares of our common stock (valued at approximately $24.6 million, based on the closing price on October 20, 2010) and approximately $7.0 million of cash consideration. We believe that the acquisition will provide Ancestry.com with a complementary consumer brand, expanded content offerings, and enhanced digitization and image-viewing technologies.

Share Repurchase Program

On September 23, 2010, we announced a share repurchase program, under which we may spend up to $25.0 million to repurchase shares of our common stock, depending on market conditions, the stock price and other factors. The share repurchase program is intended in part to offset the issuance of shares of our common stock as a result of the iArchives acquisition.

Key Business Metrics

Our management regularly reviews a number of financial and operating metrics, including the following key operating metrics to evaluate our business, determine the allocation of resources, make decisions regarding corporate strategies and evaluate forward-looking projections. The following key operating metrics reflect data with respect to the Ancestry.com Web sites and exclude our other subscription-based Web sites, such as myfamily.com, Genline.se, Genealogy.com and Footnote.com:

•		Total subscribers. A subscriber is an individual who pays for renewable access to one of our Ancestry.com Web sites. Total subscribers is defined as the number of subscribers at the end of the quarter.
•		Gross subscriber additions. A gross subscriber addition is a new customer who purchases a subscription to one of our Ancestry Web sites, net of any refunds or returns.

•		Monthly churn. Monthly churn is a measure representing the number of subscribers that cancel in the quarter divided by the sum of beginning subscribers and gross subscriber additions during the quarter. To arrive at monthly churn, we divide the result by three. Management uses this measure to determine the health of our subscriber base.
•		Subscriber acquisition cost. Subscriber acquisition cost is external marketing and advertising expense, divided by gross subscriber additions in the quarter. Management uses this metric to determine the efficiency of our marketing and advertising programs in acquiring new subscribers.
•		Average monthly revenue per subscriber. Average monthly revenue per subscriber is total subscription revenues earned in the quarter from subscriptions to one of the Ancestry.com Web sites divided by the average number of subscribers in the quarter, divided by three. The average number of subscribers for the quarter is calculated by taking the average of the beginning and ending number of subscribers for the quarter.

Because we recognize subscription revenues ratably over the subscription period, a concentration of renewals in the first half of the year generally has not resulted in a material seasonal impact on our revenues, but may result in a seasonal effect on one or more of the key business metrics described above.

Performance Highlights

The following represents our performance highlights for Q3 2010, Q2 2010 and Q3 2009:

		Three Months Ended
		September 30,				June 30,				September 30,
		2010				2010				2009
Total subscribers at end of quarter			1,376,974				1,310,562				1,028,180
Gross subscriber additions			251,738				290,589				159,795
Monthly churn			4.0	%			4.3	%			3.6	%
Subscriber acquisition cost		$	81.58			$	74.04			$	70.55
Average monthly revenue per subscriber		$	17.75			$	18.02			$	16.48

For Q3 2010, our gross subscriber additions decreased as compared to Q2 2010 and increased as compared to Q3 2009, reflecting the continued success of marketing programs on the quarter and the difficult sequential comparison due to strong subscriber additions from the airing of “Who Do You Think You Are?” early in Q2 2010.

For Q3 2010, our monthly churn decreased as compared to Q2 2010 and increased as compared to Q3 2009. The changes in churn are influenced by the growth in subscriber additions and an increase in the proportion of monthly subscriptions to annual subscriptions during 2010. New subscribers, i.e., those who have been subscribers for less than 100 days, tend to churn at a higher rate than the average subscriber. The number of new subscribers in Q3 2010, as a percent of total subscribers, was slightly lower than that of Q2 2010 and higher than that of Q3 2009. These factors contributed to a decrease in churn for Q3 2010 as compared to Q2 2010 and an increase in churn in Q3 2010 as compared to Q3 2009.

For Q3 2010, our subscriber acquisition cost increased as compared to Q2 2010 and Q3 2009. The increases were due to the growth in marketing expenses exceeding the growth in gross subscriber additions. Marketing expenses increased primarily due to additional television marketing in both domestic and international markets, which generally has a higher subscriber acquisition cost than other marketing channels.

For Q3 2010, our average monthly revenue per subscriber decreased as compared to Q2 2010 primarily due to the timing of Q2 2010 revenue recognition attributable to gross subscriber additions related to “Who Do You Think You Are?” Because the majority of the Q1 2010 gross subscriber additions related to the television show was added in the second half of March, we did not recognize a significant portion of revenue related to these subscribers until Q2 2010. For Q3 2010, our average monthly revenue increased as compared to Q3 2009 due to both an increase in the proportion of monthly subscriptions to annual subscriptions and an increase in the proportion of premium packages to basic packages.

Components of Condensed Consolidated Statements of Operations

Revenues

Subscription revenues. We derive subscription revenues primarily from providing access to our services via our various Ancestry.com Web sites. Subscription revenues are recognized ratably over the subscription period, which consist primarily of annual and monthly subscriptions, net of estimated cancellations. We typically charge each subscriber’s credit card for their subscription at the commencement of their subscription period and at each renewal date (whether annual or monthly), unless they cancel their subscription before the renewal date. The amount of unrecognized revenues is recorded in deferred revenue.

A majority of our subscription revenues is derived from subscribers in the United States. We attribute subscription revenues by country based on the billing address of the subscriber, regardless of the Web site to which the person subscribes. The following presents subscription revenue by geographic region (in thousands):

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2010				2009				2010				2009
United States		$	56,275			$	39,489			$	154,790			$	114,968
United Kingdom			10,320				8,729				30,001				25,147
All other countries			7,644				4,385				19,552				12,391
Total subscription revenues		$	74,239			$	52,603			$	204,343			$	152,506

Product and other revenues. Product and other revenues include sales of desktop software (Family Tree Maker), physical delivery of vital records products (birth, marriage and death certificates), DNA testing (Ancestry.com DNA), advertising and other products and services. Revenues related to these products are recognized upon shipment of product or fulfillment of services, as applicable.

Cost of Revenues

Cost of subscription revenues. Cost of subscription revenues consists of amortization of our database content costs, depreciation expense on Web servers and equipment, credit card processing fees, Web hosting costs, royalty costs on certain content licensed from others and personnel-related costs for database content support and subscriber services personnel.

Cost of product and other revenues. Cost of product and other revenues consists of our direct costs to purchase the products, shipping costs, credit card processing fees, personnel-related costs of warehouse personnel, warehouse storage costs and royalties on products licensed from others. In 2010, we changed the distribution arrangement for our retail Family Tree Maker software product to a royalty-based model, which eliminated our costs of product revenues for retail copies sold.

Personnel-related costs for each category of cost of revenues and operating expenses include salaries, bonuses, stock-based compensation, employer payroll taxes and employee benefit costs.

Operating Expenses

Technology and development. Technology and development expenses consist of personnel-related costs incurred in product development, maintenance and testing of our Web sites, enhancing our record search and linking technologies, developing solutions for new product lines, internal information systems and infrastructure, third-party development, and other internal-use software systems. Our development costs are primarily based in the United States and are primarily devoted to providing accessibility to content and tools for individuals to do family history research.

Marketing and advertising. Marketing and advertising expenses consist primarily of direct expenses related to television and online advertising and personnel-related expenses.

General and administrative. General and administrative expenses consist principally of personnel-related expenses for our executive, finance, legal, human resources and other administrative personnel, as well as outside services costs, consisting primarily of consultants, legal and accounting fees, and other general corporate expenses. We expect that in Q4 2010, general and administrative costs will continue to increase in absolute dollars.

Amortization of acquired intangible assets. Amortization of acquired intangible assets is the amortization expense associated with subscriber relationships and contracts, core technologies, and intangible assets, including trademarks and tradenames. Subscriber relationships and contracts are amortized based on the expected annual turnover rate, or rate of attrition, of the subscribers that approximates our monthly churn, resulting in an accelerated basis of amortization. We believe that recognizing amortization expense in this pattern better matches the amortization expense with the revenue generated from these subscribers. In Q3 2010, as a result of our business acquisitions, we increased the fair value associated with acquired intangible assets. As such, we expect that amortization of acquired intangible assets will increase in Q4 2010.

Other Income (Expense) and Income Tax Expense

Interest expense. Interest expense includes the interest expense associated with our long-term debt and amortization of deferred financing costs. Our interest expense varies based on the level of debt outstanding and changes in interest rates.

Interest income. Interest income includes interest earned on cash and cash equivalents and short-term investments.

Income tax expense. Income tax expense consists of federal and state income taxes in the United States and income taxes in certain foreign jurisdictions.

Results of Operations

The following table sets forth our condensed consolidated statements of operations as a percentage of revenues for the three and nine months ended September 30, 2010 and 2009. The information contained in the table below should be read in conjunction with our condensed consolidated financial statements and the related notes.

		Three Months Ended								Nine Months Ended
		September 30,				September 30,				September 30,				September 30,
		2010				2009				2010				2009
Revenues:
Subscription revenues			93.6	%			92.3	%			93.7	%			92.5	%
Product and other revenues			6.4				7.7				6.3				7.5
Total revenues			100.0				100.0				100.0				100.0
Costs of revenues:
Cost of subscription revenues			14.2				17.6				15.6				18.0
Cost of product and other revenues			1.5				2.4				1.8				2.6
Total cost of revenues			15.7				20.0				17.4				20.6
Gross profit			84.3				80.0				82.6				79.4
Operating expenses:
Technology and development			13.3				16.0				13.9				16.2
Marketing and advertising			30.4				25.0				32.6				26.8
General and administrative			11.5				18.0				11.4				14.9
Amortization of acquired intangible assets			4.8				7.1				5.1				7.4
Total operating expenses			60.0				66.1				63.0				65.3
Income from operations			24.3				13.9				19.6				14.1
Other income (expense):
Interest expense			(2.8	)			(2.5	)			(2.2	)			(2.9	)
Interest income			0.3				0.1				0.1				0.4
Other income, net			0.5				—				0.2				—
Income before income taxes			22.3				11.5				17.7				11.6
Income tax expense			(7.4	)			(4.4	)			(6.6	)			(4.2	)
Net income			14.9				7.1				11.1				7.4

Revenues, Cost of Revenues and Gross Profit

		Three Months Ended												Nine Months Ended
		September 30,												September 30,
		2010				2009				% Change				2010				2009				% Change
		(In thousands)												(In thousands)
Revenues:
Subscription revenues		$	74,239			$	52,603				41.1	%		$	204,343			$	152,506				34.0	%
Product and other revenues			5,076				4,384				15.8				13,853				12,287				12.7
Total revenues			79,315				56,987				39.2				218,196				164,793				32.4
Cost of revenues:
Cost of subscription revenues			11,267				10,033				12.3				33,996				29,755				14.3
Cost of product and other revenues			1,155				1,389				(16.8	)			3,929				4,213				(6.7	)
Total cost of revenues			12,422				11,422				8.8				37,925				33,968				11.6
Gross profit		$	66,893			$	45,565				46.8			$	180,271			$	130,825				37.8
Gross profit percentage			84.3	%			80.0	%							82.6	%			79.4	%

Subscription revenues

For Q3 2010, our subscription revenues increased $21.6 million as compared to Q3 2009. The increase was primarily the result of an increase in the number of total subscribers, as well as an increase in average monthly revenue per subscriber on our Ancestry.com Web sites. Average monthly revenue per subscriber increased due to both an increase in the proportion of monthly subscriptions to annual subscriptions, and an increase in the proportion of premium packages to basic packages. During Q3 2010, changes in foreign currency exchange rates did not have a significant impact on subscription revenues.

For the nine months ended September 30, 2010, our subscription revenues increased $51.8 million as compared to the nine months ended September 30, 2009. The increase was driven by the same factors that influenced the three month results.

Product and other revenues

For Q3 2010, product and other revenues increased $0.7 million as compared to Q3 2009. For the nine months ended September 30, 2010, product and other revenues increased $1.6 million as compared to the nine months ended September 30, 2009. The increases were primarily due to increased revenues related to our Family Tree Maker software, vital records products, and DNA testing.

Cost of subscription revenues

For Q3 2010, our cost of subscription revenues increased $1.2 million as compared to Q3 2009. The increase was primarily due to a $0.5 million increase in credit card processing fees reflecting higher transaction volumes as a result of increased total subscribers, a $0.3 million increase in personnel-related costs attributable to additional Web operations personnel and a $0.2 million increase in Web hosting costs attributable to greater user traffic volumes.

For the nine months ended September 30, 2010, our cost of subscription revenues increased $4.2 million as compared to the nine months ended September 30, 2009. The increase was primarily due to a $1.5 million increase in personnel-related costs attributable to additional Web operations personnel, a $1.4 million increase in credit card processing fees reflecting higher transaction volumes as a result of increased total subscribers, a $0.7 million increase in Web hosting costs attributable to greater user traffic volumes and a $0.4 million increase in content amortization.

Cost of product and other revenues

Cost of product and other revenues decreased slightly between Q3 2010 and Q3 2009 as well as between the nine months ended September 30, 2010 and the nine months ended September 30, 2009 despite increases in product and other revenues during the same periods in 2010. The decreases were primarily due to the change in our Family Tree Maker distribution arrangement in 2010.

Operating Expenses

		Three Months Ended												Nine Months Ended
		September 30,												September 30,
		2010				2009				% Change				2010				2009				% Change
		(In thousands)												(In thousands)
Operating expenses:
Technology and development		$	10,528			$	9,142				15.2	%		$	30,447			$	26,690				14.1	%
Marketing and advertising			24,125				14,240				69.4				71,061				44,226				60.7
General and administrative			9,141				10,229				(10.6	)			24,915				24,569				1.4
Amortization of acquired intangible assets			3,791				4,052				(6.4	)			11,149				12,165				(8.4	)
Total operating expenses		$	47,585			$	37,663				26.3			$	137,572			$	107,650				27.8

Technology and development

For Q3 2010, our technology and development expenses increased $1.4 million as compared to Q3 2009. For the nine months ended September 30, 2010, our technology and development expenses increased $3.8 million as compared to the nine months ended September 30, 2009. The increases were primarily the result of increases in personnel-related expenses reflecting increases in the number of technology and development personnel.

Marketing and advertising

For Q3 2010, our marketing and advertising expenses increased $9.9 million as compared to Q3 2009. For the nine months ended September 30, 2010, our marketing and advertising expenses increased $26.8 million as compared to the nine months ended September 30, 2009. The increases were due to increased television and online advertising in both the domestic and international markets.

General and administrative

For Q3 2010, our general and administrative expenses decreased $1.1 million as compared to Q3 2009. Excluding the settlement of a claim related to a content index in Q3 2009 of $2.3 million, general and administrative expenses increased primarily due to an increase of $1.2 million in outside services costs primarily related to business acquisition activities incurred in Q3 2010.

For the nine months ended September 30, 2010, our general and administrative expenses remained relatively flat as compared to the nine months ended September 30, 2009. Excluding the settlement of a claim related to a content index in Q3 2009 of $2.3 million, general and administrative expenses increased primarily due to an increase of $1.9 million in outside services costs primarily related to business acquisition activities and costs associated with operating as a public company. In addition, we had a $0.5 million change in position from foreign currency gains in the nine months ended September 30, 2009 to losses in the nine months ended September 30, 2010.

Amortization of acquired intangible assets

For Q3 2010, amortization of acquired intangible assets decreased $0.3 million as compared to Q3 2009. For the nine months ended September 30, 2010, amortization of acquired intangible assets decreased $1.0 million as compared to the nine months ended September 30, 2009. The decreases were due to decreased amortization of our subscriber relationship intangible assets, which are amortized on an accelerated basis.

Other Income (Expense) and Income Tax Expense

		Three Months Ended												Nine Months Ended
		September 30,												September 30,
		2010				2009				% Change				2010				2009				% Change
		(In thousands)												(In thousands)
Other income (expense):
Interest expense		$	(2,187	)		$	(1,428	)			53.2	%		$	(4,896	)		$	(4,784	)			2.3	%
Interest income			201				48				318.8				340				746				(54.4	)
Other income, net			401				4			NM					398				14			NM
Income tax expense			(5,914	)			(2,485	)			138.0				(14,247	)			(6,927	)			105.7
Other data:
Effective tax rate			33.4	%			38.1	%							37.0	%			36.2	%

Interest expense

For Q3 2010, interest expense increased $0.8 million as compared to Q3 2009. This was primarily due to the acceleration of $1.3 million of deferred financing costs related to our long-term debt that was paid in full in September 2010. This increase was partially offset by a decrease of $0.5 million in interest expense on our long-term debt as a result of a lower average outstanding balance for Q3 2010 as compared to Q3 2009.

For the nine months ended September 30, 2010, interest expense remained relatively flat as compared to the nine months ended September 30, 2009. Interest expense decreased $1.6 million as a result of our carrying a lower average debt balance throughout the nine months ended September 30, 2010 as compared to the nine months ended September 30, 2009. However, this decrease was offset by an increase in interest expense due to the acceleration of $1.3 million of deferred financing costs related to our long-term debt that was paid in full in September 2010.

Interest income

For Q3 2010, interest income remained relatively flat as compared to Q3 2009.

For the nine months ended September 30, 2010, interest income decreased $0.4 million as compared to the nine months ended September 30, 2009. The prior year benefited from $0.5 million earned on an income tax refund received in the second quarter of 2009.

Other income, net

For Q3 2010 and the nine months ended September 30, 2010, other income increased $0.4 million as compared to Q3 2009 and the nine months ended September 30, 2009. The increases were primarily due to the settlement of a forward contract for Swedish kronor related to the acquisition of Genline, which resulted in a gain of $0.4 million in Q3 2010.

Income tax expense

For Q3 2010, our effective income tax rate of 33.4% differed from the federal statutory rate of 35% principally due to state income taxes of 0.7%, foreign income taxes of 0.5% as a result of net operating losses in foreign jurisdictions for which no income tax benefit has been recognized, research and development tax credits of (2.8)%, net tax deductions related to stock-based compensation expenses of (1.2)% and other items of 1.2%.

For Q3 2009 our effective income tax rate of 38.1% differed from the federal statutory rate of 35% primarily due to state income taxes of 1.8%, foreign income taxes of 1.8% as a result of net operating losses in foreign jurisdictions for which no income tax benefit has been recognized, non-deductible stock-based compensation expenses of 2.4% and other items of (2.9)%.

For the nine months ended September 30, 2010, our effective income tax rate of 37.0% differed from the federal statutory rate of 35% principally due to state income taxes of 1.5%, foreign income taxes of 0.7% as a result of net operating losses in foreign jurisdictions for which no income tax benefit has been recognized, research and development tax credits of (1.3)% and other items of 1.1%.

For the nine months ended September 30, 2009, our effective tax rate of 36.2% differed from the federal statutory rate of 35% principally due to state income taxes of 1.8%, changes in the state tax apportionment factors resulting from enacted legislation of (5.5)%, foreign income taxes of 1.4% and other items of 3.5%.

Other Financial Data

In addition to our results determined under U.S. generally accepted accounting principles (“GAAP”) discussed above, we believe adjusted EBITDA and free cash flow are useful to investors in evaluating our operating performance because securities analysts use adjusted EBITDA and free cash flow as supplemental measures to evaluate the overall operating performance of companies. For the three months and nine months ended September 30, 2010 and 2009, our net income, adjusted EBITDA and free cash flow were as follows:

		Three Months Ended												Nine Months Ended
		September 30,												September 30,
		2010				2009				% Change				2010				2009				% Change
		(In thousands)												(In thousands)
Net Income		$	11,809			$	4,041				192.2	%		$	24,294			$	12,224				98.7	%
Adjusted EBITDA(1)			29,025				17,931				61.9				71,308				52,878				34.9
Free cash flow(2)			20,148				9,096				121.5				46,004				23,848				92.9

(1)		Adjusted EBITDA. We define adjusted EBITDA as net income (loss) plus net interest expense; income tax expense; non-cash charges including depreciation, amortization, impairment of intangible assets and stock-based compensation expense; and other (income) expense.
(2)		Free cash flow. We define free cash flow as net income plus net interest expense; income tax expense; non-cash charges including depreciation, amortization, impairment of intangible assets and stock-based compensation expense; and other (income) expense; minus capitalization of content database costs, capital expenditures and cash paid for income taxes and interest.

Adjusted EBITDA and free cash flow are financial data that are not calculated in accordance with GAAP. The table below in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” provides a reconciliation of these non-GAAP financial measures to net income, the most directly comparable financial measure calculated and presented in accordance with GAAP. We prepare adjusted EBITDA and free cash flow to eliminate the impact of items that we do not consider indicative of our core operating performance. We encourage you to evaluate these adjustments and the reasons we consider them appropriate, as well as the material limitations of non-GAAP measures.

Our management uses adjusted EBITDA and free cash flow as measures of operating performance; for planning purposes, including the preparation of our annual operating budget; to allocate resources to enhance the financial performance of our business; to evaluate the effectiveness of our business strategies; to provide consistency and comparability with past financial performance; to facilitate a comparison of our results with those of other companies; and in communications with our board of directors concerning our financial performance. We also use adjusted EBITDA and have used free cash flow as factors when determining management’s incentive compensation.

Management believes that the use of adjusted EBITDA and free cash flow provides consistency and comparability with our past financial performance, facilitates period to period comparisons of operations, and also facilitates comparisons with other peer companies, many of which use similar non-GAAP financial measures to supplement their GAAP results. Management believes that it is useful to exclude non-cash charges such as depreciation, amortization and stock-based compensation from adjusted EBITDA and free cash flow because (i) the amount of such non-cash expenses in any specific period may not directly correlate to the underlying performance of our business operations and (ii) such expenses can vary significantly between periods as a result of new acquisitions, full amortization of previously acquired tangible and intangible assets or the timing of new stock-based awards, as the case may be.

Although adjusted EBITDA and free cash flow are frequently used by investors and securities analysts in their evaluations of companies, adjusted EBITDA and free cash flow each have limitations as an analytical tool, and you should not consider them in isolation or as a substitute for analysis of our results of operations as reported under GAAP. Some of these limitations are:

•		adjusted EBITDA and free cash flow do not reflect our future requirements for contractual commitments and adjusted EBITDA does not reflect our cash expenditures or future requirements for capital expenditures;
•		adjusted EBITDA and free cash flow do not reflect changes in, or cash requirements for, our working capital;

•		adjusted EBITDA does not reflect interest income or interest expense;
•		adjusted EBITDA does not reflect cash requirements for income taxes;
•		adjusted EBITDA and free cash flow do not reflect the non-cash component of employee compensation;
•		although depreciation and amortization are non-cash charges, the assets being depreciated or amortized will often have to be replaced in the future, and adjusted EBITDA does not reflect any cash requirements for these replacements;
•		other companies in our industry may calculate adjusted EBITDA or free cash flow or similarly titled measures differently than we do, limiting their usefulness as comparative measures.

The following table presents a reconciliation of our adjusted EBITDA and free cash flow to net income, the most comparable GAAP financial measure, for each of the periods identified.

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2010				2009				2010				2009
		(In thousands)
Reconciliation of adjusted EBITDA and free cash flow to net income:
Net income		$	11,809			$	4,041			$	24,294			$	12,224
Interest expense, net			1,986				1,380				4,556				4,038
Income tax expense			5,914				2,485				14,247				6,927
Depreciation expense			2,751				2,762				8,355				8,092
Amortization expense			5,691				5,805				16,713				17,346
Stock-based compensation			1,275				1,462				3,541				4,265
Other income, net			(401	)			(4	)			(398	)			(14	)
Adjusted EBITDA		$	29,025			$	17,931			$	71,308			$	52,878
Capitalization of content database costs			(3,393	)			(2,183	)			(8,534	)			(5,855	)
Capital expenditures			(4,269	)			(1,415	)			(7,897	)			(7,566	)
Cash paid for interest			(1,051	)			(1,208	)			(2,528	)			(6,624	)
Cash paid for income taxes			(164	)			(4,029	)			(6,345	)			(8,985	)
Free cash flow		$	20,148			$	9,096			$	46,004			$	23,848

Liquidity and Capital Resources

As of September 30, 2010, we had $180.1 million of total liquidity, comprised of $64.1 million in cash and cash equivalents, $16.0 million in short-term investments and the ability to borrow $100.0 million under our new revolving credit facility. Cash and cash equivalents are comprised of high quality investments including money market funds. Short-term investments are classified as available-for-sale and are held in high quality investments including U.S. government agency securities with maturities less than a year. Note 2 of the accompanying notes to our condensed consolidated financial statements describes further the composition of our cash and cash equivalents and short-term investments. Note 6 to our condensed consolidated financial statements describes further the terms of our new revolving credit facility.

On September 9, 2010, we terminated and paid in full the $76.2 million outstanding under our previous credit facility from cash on hand, including the proceeds from our initial public offering. Also on September 9, 2010, in connection with the payoff of the previous credit facility, we entered into a new three-year $100.0 million principal amount senior secured revolving credit facility with Bank of America, N.A., as administrative agent, and certain other financial institutions. Our new revolving credit facility includes a $5.0 million sublimit for the issuance of letters of credit and a $7.0 million sublimit for swingline loans. As of September 30, 2010, we have not drawn any funds under the new credit facility.

In December 2007, Spectrum Equity Investors contributed cash and equity with an aggregate value of $138.6 million and we entered into a credit facility that included a $140.0 million term loan as part of a larger transaction, which we refer to as the Spectrum investment. On November 4, 2009, we commenced our initial public offering and completed the offering on November 10, 2009. We received net proceeds of $47.8 million from the offering, after deducting the underwriting discounts and commissions and offering expenses payable by us. Except for our initial public offering, we have funded our operations primarily from cash flows from operations during the last five years which has satisfied all of our cash requirements.

Our primary uses of cash include operating costs such as personnel-related expenses, marketing and advertising, payments related to long-term debt, capital expenditures related to equipment and database content costs, business acquisitions, expansion of new markets and businesses, and Web hosting costs. Our future capital requirements may vary materially from those now planned and will depend on many factors, including:

•		the development of new services;
•		market acceptance of our services;
•		the levels of advertising and promotion required to retain and acquire subscribers;
•		the launch of additional services and improvement of our competitive position in the marketplace;
•		the level of new content acquisition required to retain and acquire subscribers;
•		the expansion of our development and marketing organizations;
•		our engaging in potential business acquisitions;
•		our ability to integrate and operate acquired businesses;
•		future potential stock repurchases by us;
•		the building of infrastructure necessary to support our growth; and
•		our relationships with subscribers and vendors.

We have experienced increases in our expenditures in connection with the growth in our operations and personnel, and we anticipate that our expenditures will continue to increase in the future. We expect cash on hand, internally generated cash flow and available credit from our new credit facility will provide adequate funds for operating and recurring cash needs ( e.g., working capital and capital expenditures) for at least the next 12 months.

Summary cash flow information for cash and cash equivalents and short-term investments for Q3 2010 and Q3 2009 and the nine months ended September 30, 2010 and 2009 is set forth below. For the purpose of this cash flow analysis, we have included our highly liquid short-term investments, which we believe we can readily convert to cash on a short-term basis. We consider cash, cash equivalents and short-term investments in evaluating our overall cash position.

		Three Months Ended												Nine Months Ended
		September 30,												September 30,
		2010				2009				% Change				2010				2009				% Change
		(In thousands)												(In thousands)
Net cash and cash equivalents and short-term investments provided by (used in):
Operating activities		$	30,001			$	13,972				115	%		$	87,555			$	51,736				69	%
Investing activities			(15,447	)			(3,598	)			329				(24,168	)			(13,421	)			80
Financing activities			(68,450	)			(2,394	)		NM					(83,603	)			(17,843	)			369
Effect of changes in foreign currency exchange rates on cash and cash equivalents			33				—			NM					33				—			NM
Increase (Decrease) in cash and cash equivalents and short-term investments		$	(53,863	)		$	7,980			575				$	(20,183	)		$	20,472				(199	)