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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 For the quarterly period ended March 31, 2012
 
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from              to             
 
Commission file number 001-35048
DEMAND MEDIA, INC.
(Exact name of registrant as specified in its charter)
Delaware
 
20-4731239
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
1299 Ocean Avenue, Suite 500
Santa Monica, CA
 
90401
(Address of principal executive offices)
 
(Zip Code)
(310) 394-6400
(Registrant’s 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 x  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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer. See definition of “accelerated filer,” “large accelerated filer” and “smaller reporting company’ in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer o
 
Accelerated filer o
 
 
 
Non-accelerated filer x
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.):  Yes o  No x
 As of May 10, 2012, there were 83,914,973 shares of the registrant’s common stock, $0.0001 par value, outstanding.

 
 




DEMAND MEDIA, INC.

INDEX TO FORM 10-Q
 
 
 
Page
Part I
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Part II
 
 
 
 
 
 
 
 
 
 


i



Part I.     FINANCIAL INFORMATION
 
Item 1.         CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Demand Media, Inc. and Subsidiaries
Consolidated Balance Sheets
(In thousands, except per share amounts) 
(unaudited)
 
December 31,
2011
 
March 31,
2012
Assets
 

 
 

Current assets
 

 
 

Cash and cash equivalents
$
86,035

 
$
95,568

Accounts receivable, net
32,665

 
32,323

Prepaid expenses and other current assets
8,656

 
7,995

Deferred registration costs
50,636

 
56,540

Total current assets
177,992

 
192,426

Deferred registration costs, less current portion
9,555

 
11,249

Deferred tax assets
42

 
1,243

Property and equipment, net
32,626

 
34,481

Intangible assets, net
111,304

 
101,864

Goodwill
256,060

 
256,060

Other assets
2,524

 
2,996

Total assets
$
590,103

 
$
600,319

Liabilities, Convertible Preferred Stock and Stockholders’ Equity
 

 
 

Current liabilities
 

 
 

Accounts payable
$
10,046

 
$
7,871

Accrued expenses and other current liabilities
33,932

 
33,706

Deferred tax liabilities
18,288

 
18,663

Deferred revenue
71,109

 
76,844

Total current liabilities
133,375

 
137,084

Deferred revenue, less current portion
14,802

 
16,540

Other liabilities
1,660

 
3,160

Total liabilities
149,837

 
156,784

Commitments and contingencies (Note 7)


 


Stockholders’ equity
 

 
 

Common Stock, $0.0001 par value. Authorized 500,000 shares; 85,946 and 83,849 shares issued, and 83,605 and 81,087 shares outstanding at December 31, 2011 and March 31, 2012, respectively
10

 
10

Additional paid-in capital
528,032

 
536,140

Accumulated other comprehensive income
59

 
53

Treasury stock at cost, 2,341 and 2,762 shares at December 31, 2011 and March 31, 2012, respectively
(17,064
)
 
(20,055
)
Accumulated deficit
(70,771
)
 
(72,613
)
Total stockholders’ equity
440,266

 
443,535

Total liabilities, convertible preferred stock and stockholders’ equity
$
590,103

 
$
600,319


The accompanying notes are an integral part of these condensed consolidated financial statements. 

1



Demand Media, Inc. and Subsidiaries

Consolidated Statements of Operations
 
(In thousands, except per share amounts)
 
(unaudited)
 
Three months ended March 31,
 
2011
 
2012
Revenue
$
79,523

 
$
86,234

Operating expenses:
 

 
 

Service costs (exclusive of amortization of intangible assets shown separately below)
37,654

 
41,262

Sales and marketing
9,583

 
10,393

Product development
9,251

 
10,124

General and administrative
17,024

 
15,395

Amortization of intangible assets
10,203

 
11,956

Total operating expenses
83,715

 
89,130

Loss from operations
(4,192
)
 
(2,896
)
Other income (expense):
 

 
 

Interest income
42

 
15

Interest expense
(162
)
 
(137
)
Other income (expense), net
(257
)
 
(19
)
Total other expense
(377
)
 
(141
)
Loss before income taxes
(4,569
)
 
(3,037
)
Income tax (expense)/benefit
(1,013
)
 
1,195

Net loss
(5,582
)
 
(1,842
)
Cumulative preferred stock dividends
(2,477
)
 

Net loss attributable to common stockholders
$
(8,059
)
 
$
(1,842
)
 
 

 
 

Basic and diluted net loss per share
$
(0.13
)
 
$
(0.02
)
Weighted average number of shares
63,759

 
82,942

 
The accompanying notes are an integral part of these condensed consolidated financial statements.

 

2



Demand Media, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income
 
(In thousands, except per share amounts)
 
(unaudited)
 
Three months ended March 31,
 
2011
 
2012
Net income/(loss)
$
(5,582
)
 
$
(1,842
)
Other comprehensive income/(loss)
 
 
 
Foreign currency translation adjustment
8

 
(6
)
Other comprehensive income/(loss)
8

 
(6
)
Comprehensive income/(loss)
$
(5,574
)
 
$
(1,848
)
 
The accompanying notes are an integral part of these condensed consolidated financial statements.


3




Demand Media, Inc. and Subsidiaries

Consolidated Statements of Stockholders’ Equity
 
(In thousands)
 
(unaudited)
 
 
Common stock
 
Additional
paid-in
capital
amount
 
Treasury Stock
 
Accumulated
other
comprehensive
income
 
Accumulated
deficit
 
Total
Stockholders’
Equity
 
Shares
 
Amount
 
 
 
 
 
Balance at December 31, 2011
83,605

 
$
10

 
$
528,032

 
$
(17,064
)
 
$
59

 
$
(70,771
)
 
$
440,266

Exercise of stock options, net
665

 

 
1,325

 

 

 

 
1,325

Stock option windfall tax benefits

 

 
(88
)
 

 

 

 
(88
)
Repurchases of common stock to be held in treasury
(421
)
 

 

 
(2,991
)
 

 

 
(2,991
)
Stock-based compensation expense

 

 
6,871

 

 

 

 
6,871

Foreign currency translation adjustment

 

 

 

 
(6
)
 

 
(6
)
Net loss

 

 

 

 

 
(1,842
)
 
(1,842
)
Balance at March 31, 2012
83,849

 
$
10

 
$
536,140

 
$
(20,055
)
 
$
53

 
$
(72,613
)
 
$
443,535

 
The accompanying notes are an integral part of these condensed consolidated financial statements.



4



Demand Media, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
 (In thousands)
 (unaudited)
 
Three months ended March 31,
 
2011
 
2012
Cash flows from operating activities
 

 
 

Net loss
$
(5,582
)
 
$
(1,842
)
Adjustments to reconcile net loss to net cash provided by operating activities
 

 
 

Depreciation and amortization
15,212

 
16,920

Deferred income taxes
542

 
(826
)
Stock-based compensation
8,836

 
7,391

Windfall tax benefit from exercises of stock options
(66
)
 

Other
379

 
(594
)
Change in operating assets and liabilities, net of effect of acquisitions
 

 
 

Accounts receivable
(4,597
)
 
416

Prepaid expenses and other current assets
(471
)
 
(957
)
Deferred registration costs
(3,410
)
 
(7,598
)
Deposits with registries
(108
)
 
680

Other assets
181

 
(585
)
Accounts payable
1,067

 
(1,929
)
Accrued expenses and other liabilities
3,516

 
(71
)
Deferred revenue
3,721

 
7,473

Net cash provided by operating activities
19,220

 
18,478

Cash flows from investing activities
 

 
 

Purchases of property and equipment
(5,084
)
 
(4,321
)
Purchases of intangible assets
(14,204
)
 
(2,703
)
Cash paid for acquisitions, net of cash acquired
(3,839
)
 
(243
)
Net cash used in investing activities
(23,127
)
 
(7,267
)
Cash flows from financing activities
 

 
 

Principal payments on capital lease obligations
(174
)
 

Proceeds from issuances of common stock (net of issuance costs of $3,192)
78,874

 

Proceeds from exercises of stock options and contributions to ESPP
851

 
2,115

Windfall tax benefit from exercises of stock options
66

 

Repurchases of common stock

 
(2,990
)
Payments of withholding tax on net exercise of stock-based awards

 
(796
)
Net cash provided by (used in) financing activities
79,617

 
(1,671
)
Effect of foreign currency on cash and cash equivalents
8

 
(7
)
Change in cash and cash equivalents
75,718

 
9,533

Cash and cash equivalents, beginning of period
32,338

 
86,035

Cash and cash equivalents, end of period
$
108,056

 
$
95,568

 
The accompanying notes are an integral part of these condensed consolidated financial statements.

5



Demand Media, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)
 
(In thousands, except per share amounts)
 
1.
Company Background and Overview
 
Demand Media, Inc., together with its consolidated subsidiaries (the “Company”) is a Delaware corporation headquartered in Santa Monica, California. The Company’s business is focused on an Internet-based model for the professional creation of content at scale, and is comprised of two distinct and complementary service offerings, Content & Media and Registrar.
 
Content & Media
 
The Company’s Content & Media service offering is engaged in creating long-lived media content, primarily consisting of text articles and videos, and delivering it along with social media and monetization tools to the Company’s owned and operated websites and network of customer websites. Content & Media services are delivered through the Company’s Content & Media platform, which includes its content creation studio, social media applications and a system of monetization tools designed to match content with advertisements in a manner that is optimized for revenue yield and end-user experience.
 
Registrar
 
The Company’s Registrar service offering provides domain name registration and related value added service subscriptions to third parties through its wholly owned subsidiary, eNom.
 
Initial Public Offering
 
In January 2011, the Company completed its initial public offering whereby it received proceeds, net of underwriters discounts but before deducting offering expenses, of $81,817 from the issuance of 5,175 shares of common stock. As a result of the initial public offering, all shares of the Company’s convertible preferred stock converted into 61,672 shares of common stock and warrants to purchase common stock or convertible preferred stock net exercised into 477 shares of common stock.
 
Reverse Stock-Split
 
In October 2010, the Company’s stockholders approved a 1-for-2 reverse stock split of its outstanding common stock, and a proportional adjustment to the existing conversion ratios for each series of preferred stock which was effected in January 2011. Accordingly, all common stock share and per share amounts for all periods presented in these consolidated financial statements and notes thereto, have been adjusted retrospectively, where applicable, to reflect this reverse split and adjustment of the preferred stock conversion ratio.


2.
Basis of Presentation and Summary of Significant Accounting Policies
 
A summary of the significant accounting policies consistently applied in the preparation of the accompanying consolidated financial statements follows.
 
Basis of Preparation
 
The accompanying interim consolidated balance sheet as of March 31, 2012, the consolidated statements of operations, statements of comprehensive income and statements of cash flows for the three month periods ended March 31, 2011 and 2012, and the consolidated statement of stockholders’ equity (deficit) for the three month period ended March 31, 2012 are unaudited. 

In the opinion of the Company’s management, the unaudited interim consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and include all adjustments, which include only normal recurring adjustments, necessary for the fair statement of the Company’s statement of financial position as of March 31, 2012 and its results of operations for the three month periods ended March 31, 2011 and 2012 and its cash flows for the three month periods ended March 31, 2011 and 2012. The results for the three month period ended March 31, 2012 are not necessarily indicative of the results expected for the full year. The consolidated balance sheet as of December 31, 2011 has been derived from the Company’s audited financial statements included in the Company’s Annual Report on Form 10-K for the year ended

6



December 31, 2011.

The interim unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”), for interim financial information and with the instructions to Securities and Exchange Commission (“SEC”) Form 10-Q and Article 10 of SEC Regulation S-X. They do not include all of the information and footnotes required by GAAP for complete financial statements. Therefore, these financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto, included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011 filed with the SEC.
 
Principles of Consolidation
 
The consolidated financial statements include the accounts of Demand Media, Inc. and its wholly owned subsidiaries. Acquisitions are included in the Company’s consolidated financial statements from the date of the acquisition. The Company’s purchase accounting resulted in all assets and liabilities of acquired businesses being recorded at their estimated fair values on the acquisition dates. All significant intercompany transactions and balances have been eliminated in consolidation.
 
Investments in affiliates over which the Company has the ability to exert significant influence, but does not control and is not the primary beneficiary of, including NameJet, LLC (“NameJet”), are accounted for using the equity method of accounting. Investments in affiliates which the Company has no ability to exert significant influence are accounted for using the cost method of accounting. The Company’s proportional shares of affiliate earnings or losses accounted for under the equity method of accounting, which are not material for all periods presented, are included in other income (expense) in the Company’s consolidated statements of operations. Affiliated companies are not material individually or in the aggregate to the Company’s financial position, results of operations or cash flows for any period presented.
 
Use of Estimates
 
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Significant items subject to such estimates and assumptions include revenue, allowance for doubtful accounts, investments in equity interests, fair value of issued and acquired stock warrants, the assigned value of acquired assets and assumed liabilities in business combinations, useful lives and impairment of property and equipment, intangible assets and goodwill, the fair value of the Company’s equity-based compensation awards, and deferred income tax assets and liabilities. Actual results could differ materially from those estimates. On an ongoing basis, the Company evaluates its estimates compared to historical experience and trends, which form the basis for making judgments about the carrying value of assets and liabilities.
 
Revenue Recognition
 
The Company recognizes revenue when four basic criteria are met: persuasive evidence of a sales arrangement exists; performance of services has occurred; the sales price is fixed or determinable; and collectability is reasonably assured. The Company considers persuasive evidence of a sales arrangement to be the receipt of a signed contract or insertion order. Collectability is assessed based on a number of factors, including transaction history with the customer and the credit worthiness of the customer. If it is determined that the collection is not reasonably assured, revenue is not recognized until collection becomes reasonably assured, which is generally upon receipt of cash. The Company records cash received in advance of revenue recognition as deferred revenue.
 
For arrangements with multiple deliverables, the Company allocates revenue to each deliverable if the delivered item(s) has value to the customer on a standalone basis and, if the arrangement includes a general right of return relative to the delivered item, delivery or performance of the undelivered item(s) is considered probable and substantially in the control of the Company.  The fair value of the selling price for a deliverable is determined using a hierarchy of (1) Company specific objective and reliable evidence, then (2) third-party evidence, then (3) best estimate of selling price.  The Company allocates any arrangement fee to each of the elements based on their relative selling prices.
 
The Company’s revenue is principally derived from the following services:

Content & Media
 
Advertising Revenue.  Advertising revenue is generated by performance-based Internet advertising, such as cost-per-click,

7



or CPC, in which an advertiser pays only when a user clicks on its advertisement that is displayed on the Company’s owned and operated websites and customer websites; fees generated by users viewing third-party website banners and text-link advertisements; fees generated by enabling customer leads or registrations for partners; and fees from referring users to, or from users making purchases on, sponsors’ websites. In determining whether an arrangement exists, the Company ensures that a binding arrangement is in place, such as a standard insertion order or a fully executed customer-specific agreement. Obligations pursuant to the Company’s advertising revenue arrangements typically include a minimum number of impressions or the satisfaction of the other performance criteria. Revenue from performance-based arrangements, including referral revenue, is recognized as the related performance criteria are met. The Company assesses whether performance criteria have been met and whether the fees are fixed or determinable based on a reconciliation of the performance criteria and an analysis of the payment terms associated with the transaction. The reconciliation of the performance criteria generally includes a comparison of third-party performance data to the contractual performance obligation and to internal or customer performance data in circumstances where that data is available.
 
When the Company enters into advertising revenue sharing arrangements where it acts as the primary obligor, the Company recognizes the underlying revenue on a gross basis. In determining whether to report revenue gross for the amount of fees received from the advertising networks, the Company assesses whether it maintains the principal relationship with the advertising network, whether it bears the credit risk and whether it has latitude in establishing prices. In circumstances where the customer acts as the primary obligor, the Company recognizes the underlying revenue on a net basis.
 
In certain cases, the Company records revenue based on available and preliminary information from third parties. Amounts collected on the related receivables may vary from reported information based upon third party refinement of estimated and reported amounts owing that occurs typically within 30 days of the period end. For the quarters ended March 31, 2011 and 2012, the difference between the amounts recognized based on preliminary information and cash collected was not material.
 
Content Revenue. Content revenue is generated through the sale or license of media content. Revenue from the sale or perpetual license of content is recognized when the content has been delivered and the contractual performance obligations has been fulfilled. Revenue from the license of content is recognized over the period of the license as content is delivered or when other related performance criteria are fulfilled.

Subscription Services and Social Media Services.  Subscription services revenue is generated through the sale of membership fees paid to access content available on certain owned and operated websites. The majority of the memberships range from 6 to 12 month terms, and renew automatically at the end of the membership term, if not previously canceled. Subscription services revenue is recognized on a straight-line basis over the membership term.
 
The Company configures, hosts, and maintains its platform social media services under private-labeled versions of software for commercial customers. The Company earns revenue from its social media services through initial set-up fees, recurring management support fees, overage fees in excess of standard usage terms, and outside consulting fees. Due to the fact that social media services customers have no contractual right to take possession of the Company’s private labeled software, the Company accounts for its social media services revenue as service arrangements, whereby social media services revenue is recognized when persuasive evidence of an arrangement exists, delivery of the service has occurred and no significant obligations remain, the selling price is fixed or determinable, and collectability is reasonably assured.

Social media service arrangements may contain multiple deliverables, including, but not limited to, single arrangements containing set-up fees, monthly support fees and overage billings, consulting services and advertising services. To the extent that consulting services have value on a standalone basis, the Company allocates revenue to each element in the multiple deliverable arrangement based upon their relative fair values.  Fair value is determined based upon the best estimate of the selling price. To date, substantially all consulting services entered into concurrent with the original social media service arrangements are not treated as separate deliverables as such services do not have value to the customer on a standalone basis. In such cases, the arrangement is treated as a single unit of accounting with the arrangement fee recognized over the term of the arrangement on a straight-line basis.  Set-up fees are recognized as revenue on a straight-line basis over the greater of the contractual or estimated customer life once monthly recurring services have commenced. The Company determines the estimated customer life based on analysis of historical attrition rates, average contractual term and renewal expectations. The Company periodically reviews the estimated customer life at least quarterly and when events or changes in circumstances, such as significant customer attrition relative to expected historical of projected future results, occur. Overage billings are recognized when delivered and at contractual rates in excess of standard usage terms.
 
Outside consulting services performed for customers that have value on a stand-alone basis are recognized as services are performed.
 

8



Registrar
 
Domain Name Registration Service Fees.  Registration fees charged to third parties in connection with new, renewed, and transferred domain name registrations are recognized on a straight-line basis over the registration term, which customarily range from one to two years but can extend to ten years. Payments received in advance of the domain name registration term are included in deferred revenue in the accompanying consolidated balance sheets. The registration term and related revenue recognition commences once the Company confirms that the requested domain name has been recorded in the appropriate registry under contractual performance standards. Associated direct and incremental costs, which principally consist of registry and Internet Corporation for Assigned Names and Numbers ("ICANN") fees, are also deferred and amortized to service costs on a straight-line basis over the registration term.
 
The Company’s wholly owned subsidiary, eNom, is an ICANN accredited registrar. Thus, the Company is the primary obligor with its reseller and retail registrant customers and is responsible for the fulfillment of its registrar services. As a result, the Company reports revenue derived from the fees it receives from resellers and retail registrant customers for registrations on a gross basis in the accompanying consolidated statements of operations. A minority of the Company’s resellers have contracted with the Company to provide billing and credit card processing services to the resellers’ retail customer base in addition to domain name registration services. Under these circumstances, the cash collected from these resellers’ retail customer base is in excess of the fixed amount per transaction that the Company charges for domain name registration services. As such, these amounts, which are collected for the benefit of the reseller, are not recognized as revenue and are recorded as a liability until remitted to the reseller on a periodic basis. Revenue from these resellers is reported on a net basis because the reseller determines the price to charge retail customers and maintains the primary customer relationship.
 
Value Added Services.  Revenue from online value added services, which includes, but is not limited to, web hosting services, email services, domain name identification protection, charges associated with alternative payment methods, and security certificates, is recognized on a straight-line basis over the period in which services are provided. Payments received in advance of services being provided are included in deferred revenue.
 
Auction Service Revenue.  Domain name auction service revenue represents fees received from selling third-party owned domains via an online bidding process primarily through NameJet, a domain name aftermarket auction company formed in October 2007 by the Company and an unrelated third party. For names sold through the auction process that are registered on the Company’s registrar platform upon sale, the Company has determined that auction revenue and related registration revenue represent separate units of accounting given the domain name has value to the customers on a standalone basis.  As a result, the Company recognizes the related registration fees on a straight-line basis over the registration term. The Company recognizes the bidding portion of auction revenue upon sale, net of payments to third parties since it is acting as an agent only.

Service Costs
 
Service costs consist primarily of fees paid to registries and ICANN associated with domain registrations, advertising revenue recognized by the Company and shared with its customers or partners as a result of its revenue-sharing arrangements, such as traffic acquisition costs and content revenue-sharing arrangements, Internet connection and co-location charges and other platform operating expenses associated with the Company’s owned and operated and customer websites, including depreciation of the systems and hardware used to build and operate the Company’s Content & Media platform and Registrar, personnel costs relating to in-house editorial, customer service, information technology and certain content production costs such as our multi-channel video deal with Youtube.

Registry fee expenses consist of payments to entities accredited by ICANN as the designated registry related to each top level domain (“TLD”). These payments are generally fixed dollar amounts per domain name registration period and are recognized on a straight-line basis over the registration term. The costs of renewal registration fee expenses for owned and operated undeveloped websites are also included in service costs. Amortization of the cost of website names and media content owned by the Company is included in amortization of intangible assets.
 
Deferred Revenue and Deferred Registration Costs
 
Deferred revenue consists substantially of amounts received from customers in advance of the Company’s performance for domain name registration services, subscription services for premium media content, social media services and online value added services. Deferred revenue is recognized as revenue on a systematic basis that is proportionate to the unexpired term of the related domain name registration, media subscription as services are rendered, over customer useful life, or online value added service period.
 

9



Deferred registration costs represent incremental direct cost paid in advance to registries, ICANN, and other third parties for domain name registrations and are recorded as a deferred cost on the balance sheets. Deferred registration costs are amortized to expense on a straight-line basis concurrently with the recognition of the related domain name registration revenue and are included in service costs.

Long-lived Assets
 
The Company evaluates the recoverability of its long-lived assets with finite useful lives for impairment when events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. Such trigger events or changes in circumstances may include: a significant decrease in the market price of a long-lived asset, a significant adverse change in the extent or manner in which a long-lived asset is being used, significant adverse change in legal factors or in the business climate, including those resulting from technology advancements in the industry, the impact of competition or other factors that could affect the value of a long-lived asset, a significant adverse deterioration in the amount of revenue or cash flows we expect to generate from an asset group, an accumulation of costs significantly in excess of the amount originally expected for the acquisition or development of a long-lived asset, current or future operating or cash flow losses that demonstrate continuing losses associated with the use of a long-lived asset, or a current expectation that, more likely than not, a long-lived asset will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. The Company performs impairment testing at the asset group level that represents the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. If events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable and the expected undiscounted future cash flows attributable to the asset group are less than the carrying amount of the asset group, an impairment loss equal to the excess of the asset’s carrying value over its fair value is recorded. Fair value is determined based upon estimated discounted future cash flows. Through March 31, 2012, the Company has identified no such impairment loss. Assets to be disposed of would be separately presented on the balance sheets and reported at the lower of their carrying amount or fair value less costs to sell, and would no longer be depreciated or amortized.
 
Google, the largest provider of search engine referrals to the majority of the Company's websites, regularly deploys changes to its search engine algorithms, which have led the Company to experience fluctuations in the total number of Google search referrals to its owned and operated and network of customer websites. In 2011, the overall impact of these changes on the Company's owned and operated websites was negative primarily due to a decline in traffic to eHow.com, the Company's largest website. From October 2011 to March 2012, and in response to the changes in search engine algorithms in 2011, the Company performed an evaluation of its existing content library to identify potential improvements in its content creation and distribution platform. As a result of this evaluation, the Company elected to remove certain content assets from service, resulting in $1,818 of accelerated amortization expense in the first quarter of 2012.

We intend to evolve and continuously improve our content creation and distribution platform and to create new content formats to meet rapidly changing consumer demand. In 2012 to date, such changes include increasing our investment in video, long-form content, images and diagrams, increasing and expanding distribution of our content to our network of customer websites, and an overall reduction in the volume of shorter-form text articles published on eHow.com. In the near term we also anticipate increased expenditures on new content formats in an effort to further enhance user engagement.
There can be no assurance that these changes or any future changes that may be implemented by the Company, by search engines to their algorithms and search methodologies, or by consumers in their web usage habits will not adversely impact the carrying value, estimated useful life or intended use of our long-lived assets. The Company will continue to monitor these changes as well as any future changes and emerging trends in search engine algorithms and methodologies, including the resulting impact that these changes may have on future operating results, the economic performance of the Company's long-lived assets and in its assessment as to whether significant changes in circumstances might provide an indication of potential impairment of the carrying value of its long-lived assets, including its media content and goodwill arising from acquisitions.

Property and equipment
 
Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Computer equipment is amortized over two to five years, software is amortized over two to three years, and furniture and fixtures are amortized over seven to ten years. Leasehold improvements are amortized straight-line over the shorter of the remaining lease term or the estimated useful lives of the improvements ranging from one to six years. Upon the sale or retirement of property or equipment, the cost and related accumulated depreciation or amortization is removed from the Company’s financial statements with the resulting gain or loss reflected in the Company’s results of operations. Repairs and maintenance costs are expensed as incurred. In the event that property and equipment is no longer in use, the Company will record a loss on disposal of the property and equipment, which is computed as

10



the net remaining value (gross amount of property and equipment less accumulated depreciation expense) of the related equipment at the date of disposal.
 
Intangibles—Undeveloped Websites
 
The Company capitalizes costs incurred to acquire and to initially register its owned and operated undeveloped websites (i.e. Uniform Resource Locators). The Company amortizes these costs over the expected useful life of the underlying undeveloped websites on a straight-line basis. The expected useful lives of the website names range from 12 months to 84 months. The Company determines the appropriate useful life by performing an analysis of expected cash flows based on historical experience with domain names of similar quality and value.
 
In order to maintain the rights to each undeveloped website acquired, the Company pays periodic renewal registration fees, which generally cover a minimum period of twelve months. The Company records renewal registration fees of website name intangible assets in deferred registration costs and recognizes the costs over the renewal registration period, which is included in service costs.
 
Intangibles—Media Content
 
The Company capitalizes the direct costs incurred to acquire its media content that is determined to embody a probable future economic benefit. Costs are recognized as finite lived intangible assets based on their acquisition cost to the Company. Direct content costs primarily represent amounts paid to unrelated third parties for completed content units, and to a lesser extent, specifically identifiable internal direct labor costs incurred to enhance the value of specific content units acquired prior to their publication. Internal costs not directly attributable to the enhancement of an individual content unit acquired are expensed as incurred. All costs incurred to deploy and publish content are expensed as incurred, including the costs for the ongoing maintenance of the Company’s websites in which the Company’s content is deployed.
 
Capitalized media content is amortized on a straight-line basis over five years, representing the Company’s estimate of the pattern that the underlying economic benefits are expected to be realized and based on its estimates of the projected cash flows from advertising revenue expected to be generated by the deployment of its content. These estimates are based on the Company’s plans and projections, comparison of the economic returns generated by its content of comparable quality and an analysis of historical cash flows generated by that content to date. Amortization of media content is included in amortization of intangible assets in the accompanying statement of operations and the acquisition costs are included in purchases of intangible assets within cash flows from investing activities in the Consolidated Statements of Cash Flows.
 
Intangibles—Acquired in Business Combinations
 
The Company performs valuations on each acquisition accounted for as a business combination and allocates the purchase price of each acquired business to its respective net tangible and intangible assets. Intangible assets acquired in business combinations include: trade names, non-compete agreements, owned website names, customer relationships, technology, media content, and content publisher relationships. The Company determines the appropriate useful life by performing an analysis of expected cash flows based on historical experience of the acquired businesses. Intangible assets are amortized over their estimated useful lives using the straight line method which approximates the pattern in which the economic benefits are consumed.
 
Goodwill
 
Goodwill represents the excess of the cost of an acquired entity over the fair value of the acquired net assets. The Company tests goodwill for impairment annually during the fourth quarter of its fiscal year or when events or circumstances change that would indicate that goodwill might be impaired. Events or circumstances which could trigger an impairment review include, but are not limited to a significant adverse change in legal factors or in the business climate, an adverse action or assessment by a regulator, unanticipated competition, a loss of key personnel, significant changes in the manner of the Company’s use of the acquired assets or the strategy for the Company’s overall business, significant negative industry or economic trends or significant underperformance relative to expected historical or projected future results of operations.
 
The testing for a potential impairment of goodwill involves a two-step process. The first step is to identify whether a potential impairment exists by comparing the estimated fair values of the Company’s reporting units with their respective book values, including goodwill. If the estimated fair value of the reporting unit exceeds book value, goodwill is considered not to be impaired and no additional steps are necessary. If, however, the fair value of the reporting unit is less than book value, then the second step is performed to determine if goodwill is impaired and to measure the amount of impairment loss, if any. The

11



amount of the impairment loss is the excess of the carrying amount of the goodwill over its implied fair value. The estimate of implied fair value of goodwill is primarily based on an estimate of the discounted cash flows expected to result from that reporting unit but may require valuations of certain internally generated and unrecognized intangible assets such as the Company’s software, technology, patents and trademarks. If the carrying amount of goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to the excess.

Business acquisitions and supplemental pro forma information

The Company did not complete any business acquisitions in the three months ended March 31, 2012.
 
Supplemental information on an unaudited pro forma basis, as if the four acquisitions completed in 2011 had been consummated as of January 1, 2011 is as follows:

 
Three months ended March 31,
 
2011
 
(unaudited)
Revenue
$
81,330

Net loss
(6,883
)

The unaudited pro forma supplemental information is based on estimates and assumptions which the Company believes are reasonable and reflects amortization of intangible assets as result of the acquisitions. The pro forma results are not necessarily indicative of the results that have been realized had the acquisitions been consolidated as of the beginning of the periods presented.

Stock-Based Compensation
 
Stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service period, which is the vesting period, on a straight-line basis. The Company uses the Black-Scholes option pricing model to determine the fair value of stock options that do not include market conditions. Stock-based awards are comprised principally of stock options, restricted stock awards (“RSA”) and restricted stock units ("RSU").

Under the Company's Employee Stock Purchase Plan (the "ESPP"), eligible officers and employees may purchase a limited amount of our common stock at a discount to the market price in accordance with the terms of the plan as described in Note 10 - Share-based Compensation Plans and Awards. The Company uses the Black-Scholes option pricing model to determine the fair value of the ESPP awards granted which is recognized straight-line over the total offering period.  
    
Some equity awards granted by the Company contain certain performance and/or market conditions. The Company recognizes compensation cost for awards with performance conditions based upon the probability of that performance condition being met, net of an estimate of pre-vesting forfeitures. Awards granted with performance and/or market conditions are amortized using the graded vesting method.
 
The effect of a market condition is reflected in the award’s fair value on the grant date. The Company uses a Monte Carlo simulation model or binomial lattice model to determine the grant date fair value of awards with market conditions. Compensation cost for an award that has a market condition is recognized as the requisite service period is fulfilled, even if the market condition is never satisfied.

Stock-based awards issued to non-employees are accounted for at fair value determined using the Black-Scholes option-pricing model. Management believes that the fair value of the stock options is more reliably measured than the fair value of the services received. The fair value of each non-employee stock-based compensation award is re-measured each period until a commitment date is reached, which is generally the vesting date.

Stock Repurchases

Under a stock repurchase plan, shares repurchased by the Company are accounted for when the transaction is settled. Repurchased shares held for future issuance are classified as treasury stock. Shares formally or constructively retired are deducted from common stock at par value and from additional paid in capital for the excess over par value. If additional paid in

12



capital has been exhausted, the excess over par value is deducted from retained earnings. Direct costs incurred to acquire the shares are included in the total cost of the repurchased shares.

Income Taxes
 
Deferred income taxes are recognized for differences between financial reporting and tax bases of assets and liabilities at the enacted statutory tax rates in effect for the years in which the temporary differences are expected to reverse. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. The Company evaluates the realizability of deferred tax assets and recognizes a valuation allowance for its deferred tax assets when it is more likely than not that a future benefit on such deferred tax assets will not be realized.
 
The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the consolidated financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement. The Company recognizes interest and penalties accrued related to unrecognized tax benefits in its income tax (benefit) provision in the accompanying statements of operations.
 
Net Loss Per Share
 
Basic loss per share is computed by dividing the net loss attributable to common stockholders by the weighted average number of common shares outstanding during the period. Net loss attributable to common stockholders is increased for cumulative preferred stock dividends earned during the period. Diluted loss per share is computed by dividing the net loss attributable to common stockholders by the weighted average common shares outstanding plus potentially dilutive common shares. Because the Company reported losses for the periods presented, all potentially dilutive common shares comprising of stock options, RSUs, stock from the employee stock purchase plan, warrants and convertible preferred stock are antidilutive.
 
RSPRs and RSUs and other restricted awards are considered outstanding common shares and included in the computation of basic earnings per share as of the date that all necessary conditions of vesting are satisfied. RSPRs and RSUs are excluded from the dilutive earnings per share calculation when their impact is antidilutive. Prior to satisfaction of all conditions of vesting, unvested RSPRs are considered contingently issuable shares and are excluded from weighted average common shares outstanding.
 
Fair Value of Financial Instruments
 
Fair value represents the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company measures its financial assets and liabilities in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.
 
Level 1—valuations for assets and liabilities traded in active exchange markets, or interest in open-end mutual funds that allow a company to sell its ownership interest back at net asset value on a daily basis. Valuations are obtained from readily available pricing sources for market transactions involving identical assets, liabilities or funds.
 
Level 2—valuations for assets and liabilities traded in less active dealer, or broker markets, such as quoted prices for similar assets or liabilities or quoted prices in markets that are not active. Level 2 includes U.S. Treasury, U.S. government and agency debt securities, and certain corporate obligations.

Valuations are usually obtained from third party pricing services for identical or comparable assets or liabilities.
 
Level 3—valuations for assets and liabilities that are derived from other valuation methodologies, such as option pricing models, discounted cash flow models and similar techniques, and not based on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities.
 
In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible as well as considers counterparty credit risk in its assessment of fair value.

13



 
The carrying amounts of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, receivables from domain name registries, registry deposits, accounts payable, accrued liabilities and customer deposits approximate fair value because of their short maturities.  The Company’s investments in marketable securities are recorded at fair value. Certain assets, including equity investments, investments held at cost, goodwill and intangible assets are also subject to measurement at fair value on a nonrecurring basis, if they are deemed to be impaired as the result of an impairment review. For the year ended December 31, 2011 and three month period ended March 31, 2012, no impairments were recorded on those assets required to be measured at fair value on a nonrecurring basis.
 
Financial assets and liabilities carried at fair value on a recurring basis were as follows:
 
December 31, 2011
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 

 
 

 
 

 
 

Cash equivalents(1)
$
54,701

 
$
15,447

 
$

 
$
70,148

Total assets at fair value
$
54,701

 
$
15,447

 
$

 
$
70,148

___________________________________
(1)Comprises money market funds which are included in Cash and cash equivalents in the accompanying balance sheet

March 31, 2012
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 

 
 

 
 

 
 

Cash equivalents(1)
$
29,715

 
$
7,447

 
$

 
$
37,162

Total assets at fair value
$
29,715

 
$
7,447

 
$

 
$
37,162

___________________________________
(1)Comprises money market funds which are included in Cash and cash equivalents in the accompanying balance sheet

    
For financial assets that utilize Level 1 and Level 2 inputs, the Company utilizes both direct and indirect observable price quotes, including quoted market prices (Level 1 inputs) or inputs that are derived principally from or corroborated by observable market data (Level 2 inputs).
 

 Recent Accounting Pronouncements 
In May 2011, the FASB issued Accounting Standards Update 2011-04, “Fair Value Measurement” (“ASU 2011-04”). The primary focus of ASU 2011-04 is the convergence of accounting requirements for fair value measurements and related financial statement disclosures under U.S. GAAP and International Financial Reporting Standards (“IFRS”). While ASU 2011-04 does not significantly change existing guidance for measuring fair value, it does require additional disclosures about fair value measurements and changes the wording of certain requirements in the guidance to achieve consistency with IFRS. ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011, and is required to be applied prospectively. There was not a material impact to the consolidated financial statements upon adoption in 2012.
In June 2011, the FASB issued Accounting Standards Update 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”). This guidance requires companies to present the components of comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. Under either method, amounts reclassified from Other Comprehensive Income ("OCI") to net income for each reporting period must be displayed as components of both net income and OCI on the face of the financial statements. The guidance does not change the items that are reported in OCI. ASU 2011-05 is effective for interim and annual periods beginning after December 15, 2011. Other than presentational changes, there was not a significant impact to the consolidated financial statements upon adoption in 2012.
In September 2011, FASB issued amendments to its accounting guidance on testing goodwill for impairment. The amendments allow entities to use a qualitative approach to test goodwill for impairment. This permits an entity to first perform a qualitative assessment to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying value. If it is concluded that this is the case, it is required to perform the currently prescribed two-step goodwill

14



impairment test. Otherwise, the two-step goodwill impairment test is not required. This guidance is effective for annual and interim goodwill impairment test performed for fiscal years beginning after December 15, 2011 and early adoption is permitted. The Company did not early adopt this guidance and does not anticipate a material impact to the consolidated financial statements upon adoption in 2012.

3.
Property and Equipment
 
Property and equipment consisted of the following:
 
 
December 31,
2011
 
March 31,
2012
Computers and other related equipment
$
33,680

 
$
36,209

Purchased and internally developed software
45,074

 
48,548

Furniture and fixtures
2,380

 
2,492

Leasehold improvements
3,368

 
3,368

 
84,502

 
90,617

Less accumulated depreciation
(51,876
)
 
(56,136
)
Property and equipment, net
$
32,626

 
$
34,481


Depreciation and software amortization expense by classification for the three months ended March 31, 2011 and 2012 is shown below:
 
 
Three months ended March 31,
 
2011
 
2012
Service costs
$
4,044

 
$
3,650

Sales and marketing
72

 
134

Product development
321

 
282

General and administrative
572

 
898

Total depreciation
$
5,009

 
$
4,964


4.
Intangible Assets
 
Intangible assets consist of the following:
 
 
December 31, 2011
 
 
 
Gross
carrying
amount
 
Accumulated
amortization
 
Net
 
Weighted
average
useful life
Owned website names
$
43,343

 
$
(35,674
)
 
$
7,669

 
3.8

Customer relationships
27,325

 
(20,257
)
 
7,068

 
5.8

Media content
130,981

 
(56,847
)
 
74,134

 
5.1

Technology
38,694

 
(24,055
)
 
14,639

 
5.8

Non-compete agreements
14,806

 
(14,513
)
 
293

 
3.3

Trade names
11,294

 
(4,652
)
 
6,642

 
14.5

Content publisher relationships
2,092

 
(1,233
)
 
859

 
5.0

 
$
268,535

 
$
(157,231
)
 
$
111,304

 
5.3


15



 
March 31, 2012
 
 
 
Gross
carrying
amount
 
Accumulated
amortization
 
Net
 
Weighted
average
useful life
Owned website names
$
43,983

 
$
(37,234
)
 
$
6,749

 
3.7

Customer relationships
27,325

 
(21,061
)
 
6,264

 
5.8

Media content
129,340

 
(61,430
)
 
67,910

 
5.1

Technology
38,694

 
(25,179
)
 
13,515

 
5.8

Non-compete agreements
14,806

 
(14,558
)
 
248

 
3.3

Trade names
11,294

 
(4,916
)
 
6,378

 
14.5

Content publisher relationships
2,092

 
(1,292
)
 
800

 
5.0

 
$
267,534

 
$
(165,670
)
 
$
101,864

 
5.3

 
Identifiable finite-lived intangible assets are amortized on a straight-line basis over their estimated useful lives.

Amortization expense by classification for the three months ended March 31, 2011 and 2012 is shown below:
 
 
 
Three months ended
 
 
March 31,
 
 
2011
 
2012
Service costs
 
$
7,776

 
$
9,920

Sales and marketing
 
828

 
710

Product development
 
1,288

 
1,068

General and administrative
 
311

 
258

Total amortization
 
$
10,203

 
$
11,956

 

5.
Goodwill
     
The following table presents the changes in the Company’s goodwill balance:

Balance at December 31, 2010
$
224,920

Goodwill arising from acquisitions
31,140

Balance at December 31, 2011
256,060

Goodwill arising from acquisitions

Balance at March 31, 2012
$
256,060

 
Goodwill in 2011 arose from four acquisitions completed in that year. There were no business acquisitions during the three months ended March 31, 2012.
        
The Company's most recent annual impairment analysis was performed in the fourth quarter of the year ended December 31, 2011 and indicated that the fair value of each of its three reporting units significantly exceeded the carrying amount of the respective reporting unit's book value of goodwill at that time.

6.
Other Balance Sheets Items
 
Accounts receivable consisted of the following:
 

16



 
December 31,
2011
 
March 31,
2012
Accounts receivable—trade
$
29,695

 
$
28,586

Receivables from registries
2,970

 
3,737

Accounts receivable, net
$
32,665

 
$
32,323

 
Accrued expenses and other liabilities consisted of the following:
 
 
December 31,
2011
 
March 31,
2012
Accrued payroll and related items
$
10,562

 
$
12,581

Domain owners’ royalties payable
1,336

 
1,087

Commissions payable
2,894

 
2,936

Customer deposits
7,898

 
6,156

Other
11,242

 
10,946

Accrued expenses and other liabilities
$
33,932

 
$
33,706


7.
Commitments and Contingencies
 
Leases
 
The Company conducts its operations utilizing leased office facilities in various locations and leases certain equipment under non-cancellable operating and capital leases. The Company’s leases expire between July 2012 and February 2017.
 
Litigation
 
In April 2011, the Company and eleven other defendants were named in a patent infringement lawsuit filed in the U.S. District Court, Eastern District of Texas.  The plaintiff filed and served a complaint making several claims related to a method for displaying advertising on the Internet.  In May 2011, the Company filed its response to the complaint, denying all liability, and is in the process of discussing a resolution with the plaintiff.  The Company intends to vigorously defend its position and does not expect to incur a material loss in respect of this matter.

From time to time, the Company is a party to other various litigation matters incidental to the conduct of its business. There is no pending or threatened legal proceeding to which Company is a party that, in our opinion, is likely to have a material adverse effect on the Company’s future financial results.
 
Taxes
 
From time to time, various federal, state and other jurisdictional tax authorities undertake review of the Company and its filings. In evaluating the exposure associated with various tax filing positions, the Company accrues charges for possible exposures. The Company believes any adjustments that may ultimately be required as a result of any of these reviews will not be material to its consolidated financial statements.

Domain Name Agreement

In April 2011, the Company entered an agreement to provide domain name registration services and manage certain domain names owned and operated by a customer over a twenty seven month term (the "Domain Agreement").  In conjunction with the Domain Agreement, the Company committed to purchase at least $175 of expired domain names every calendar quarter or a total of $1,575 over the term of the agreement.  The contract can be terminated by either the Company or the counter party providing notice at least 60 days prior to the end of each annual renewal period.  The aggregate value of expired domain names purchased by the Company from inception through March 31, 2012 was $861.

gTLD Commitment

The Internet Corporation for Assigned Names and Numbers, or ICANN has approved a framework for the significant

17



expansion of the number of generic Top Level Domain ("gTLDs") in 2012. The Company has entered into various agreements with third-parties in respect of its gTLD initiative, and has committed to invest approximately $18,000 in connection with its gTLD initiative at March 31, 2012.

Indemnifications
 
In its normal course of business, the Company has made certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. Those indemnities include intellectual property indemnities to the Company’s customers, indemnities to directors and officers of the Company to the maximum extent permitted under the laws of the State of Delaware and indemnifications related to the Company’s lease agreements. In addition, the Company’s advertiser and distribution partner agreements contain certain indemnification provisions which are generally consistent with those prevalent in the Company’s industry. The Company has not incurred significant obligations under indemnification provisions historically and does not expect to incur significant obligations in the future. Accordingly, the Company has not recorded any liability for these indemnities, commitments and guarantees in the accompanying balance sheets.
 
8.
Income Taxes
 
During the three months ended March 31, 2012, we recorded an income tax benefit of $1.2 million compared to an expense of $1.0 million during the same period in 2011, representing a movement of $2.2 million. The movement was primarily due to a benefit from the change in California apportionment methodology during the quarter ended March 31, 2012. Adoption of this change reduced our effective state tax rate compared to the prior period.
    
The Company’s effective tax rate differs from the statutory rate primarily as a result of state taxes, foreign taxes, nondeductible stock option expenses and changes in the Company’s valuation allowance.

The Company reduces the deferred tax asset resulting from future tax benefits by a valuation allowance if, based on the weight of the available evidence it is more likely than not that some portion or all of these deferred taxes will not be realized. The timing of the reversal of deferred tax liabilities associated with tax deductible goodwill is not certain and thus not available to assure the realization of deferred tax assets. Due to the limitation associated with deferred tax liabilities from tax deductible goodwill, the Company has deferred tax assets in excess of deferred tax liabilities before application of a valuation allowance for the periods presented. As the Company has no history of generating book income, the ultimate future realization of these excess deferred tax assets is not more likely than not and thus subject to a valuation allowance. Accordingly, the Company has established a valuation allowance against its deferred tax assets.
The Company is subject to the accounting guidance for uncertain income tax positions. The Company believes that its income tax positions and deductions will be sustained on audit and does not anticipate any adjustments that will result in a material adverse effect on the Company's financial condition, results of operations, or cash flow. The Company acquired an $84 uncertain tax position as a result of a business acquisition during 2011. 
The Company's policy for recording interest and penalties associated with audits and uncertain tax positions is to record such items as a component of income tax expense, and amounts recognized to date are insignificant.  No uncertain income tax positions were recorded during 2011 or 2012 other than the acquired uncertain tax position, and the Company does not expect its uncertain tax position to change during the next twelve months. The Company files a U.S. federal and many state tax returns. The tax years 2007 to 2010 remain subject to examination by the IRS and all tax years since the Company's incorporation are subject to examination by various state authorities.
9.
Related Party Transactions
 
The Company’s Chairman and Chief Executive Officer and certain members of the board of directors are on the board of directors of The FRS Company (“FRS”). The Company recognized approximately $254 and $10 in revenue from FRS for advertising and creative services during the three months ended March 31, 2011 and 2012, respectively. As of December 31, 2011 and March 31, 2012, the Company’s receivable balance due from FRS was $45 and $54, respectively.  The creative services agreement was terminated by the parties effective May 31, 2011.
     
10. Share-based Compensation Plans and Awards
 
Valuation of Stock Option Awards
 

18



The following table presents the weighted-average assumptions used to estimate the fair values of the stock options granted in the periods presented:
 
 
 
Three months ended
 
 
March 31,
 
 
2011
 
2012
Expected life (in years)
 
5.78

 
NA

Risk-free interest rate
 
2.00
%
 
NA

Expected volatility
 
56
%
 
NA

Expected dividend yield
 
%
 
NA

Weighted-average estimated fair value of options granted during the period
 
$
9.24

 

 
The Company did not grant any stock options to employees during the three months ended March 31, 2012.

Stock Options
 
Stock option activity (in thousands, except share and per share data) for the three months ended March 31, 2012 is as follows:
 
 
 
Number of
options
outstanding
 
Weighted
average
exercise
price
 
Weighted
average
remaining
contractual
term
(in years)
 
Aggregate
intrinsic
value
Outstanding at December 31, 2011
16,654

 
$
13.21

 
7.53

 
$
17,480

Options granted
 

 

 
 
 
 
Options exercised
 
(443
)
 
3.03

 
 
 
 
Options forfeited or canceled
(640
)
 
13.14

 
 
 


Outstanding at March 31, 2012
15,571

 
$
13.50

 
7.07

 
$
18,452

Exercisable at March 31, 2012
7,934

 
$
6.55

 
6.02

 
$
17,336

Vested and expected to vest after March 31, 2012
13,966

 
$
12.58

 
6.94

 
$
18,227

 
The pre-tax aggregate intrinsic value of outstanding and exercisable stock options is calculated as the difference between the exercise price of the underlying awards and the closing stock price of $7.25 of the Company’s common stock on March 31, 2012 for all awards where that stock price exceeds the exercise price.  Options expected to vest reflect an estimated forfeiture rate.
 
The following table summarizes additional information concerning outstanding and exercisable options at March 31, 2012:
 

19



Range of Exercise
Prices
 
Number
Outstanding
 
Weighted
Average
Remaining
Contractual
Term
(in years)
 
Weighted
Average
Exercise
Price
 
Number
Exercisable
 
Weighted
Average
Exercise
Price
$0.00 - 3.60
 
2,959

 
5.33

 
$
2.28

 
2,772

 
$
2.22

$3.61 - 7.20
 
1,732

 
5.61

 
$
5.08

 
1,479

 
$
4.96

$7.21 - 10.80
 
4,471

 
7.12

 
$
9.07

 
3,028

 
$
9.16

$10.81 - 14.40
 
274

 
7.78

 
$
13.27

 
120

 
$
13.28

$14.41 - 18.00
 
2,628

 
8.15

 
$
17.43

 
515

 
$
16.97

$18.01 - 21.60
 
57

 
7.99

 
$
21.38

 
20

 
$
21.34

$21.61 - 25.20
 
1,150

 
8.35

 
$
24.00

 

 

$28.81 - 32.40
 
1,150

 
8.35

 
$
30.00

 

 

$32.41 - 36.00
 
1,150

 
8.35

 
$
36.00

 

 

 
 
15,571

 
7.07

 
$
13.50

 
7,934

 
$
6.55


The total grant date fair value of stock options vested during the three months ended March 31, 2011 and 2012 was $3,481 and $2,594, respectively.  The aggregate intrinsic value of all options exercised during the three months ended March 31, 2011 and 2012 was $6,108 and $1,855 respectively.
 
As of March 31, 2012, there was $30,525 of unrecognized stock-based compensation expense related to the non-vested portion of stock options, which is expected to be recognized over a weighted average period of 3.3 years.  To the extent that the forfeiture rate is different from that anticipated, stock-based compensation expense related to these awards will be different.
 
Restricted stock awards and restricted stock units
 
The following table summarizes the activity of RSUs and other restricted shares for the three months ended March 31, 2012 is as follows:
 
 
Shares
 
Weighted
average
grant date
fair value
Unvested at December 31, 2011
3,606

 
$
12.19

Granted
158

 
6.34

Vested
(321
)
 
12.95

Forfeited
(187
)
 
14.17

Unvested at March 31, 2012
3,256

 
$
11.71

 
As of March 31, 2012, there was approximately $30,206 of unrecognized compensation cost related to employee non-vested RSUs and restricted shares.  The amount is expected to be recognized over a weighted average period of 3.0 years.  To the extent that the forfeiture rate is different from that anticipated, stock-based compensation expense related to these awards will be different.

The Company has granted equity awards to consultants whereby up to 125 shares of common stock will be awarded upon the fulfillment of certain performance conditions before July 31, 2012. No vesting will occur if the performance conditions are not fulfilled before July 31, 2012. The Company will recognize stock-based compensation expense for the fair value of any equity issued under this grant, which will be measured at the date that the performance condition is fulfilled.
 
Employee Stock Purchase Plan
 
In May 2011, the Company commenced its first offering under the Demand Media, Inc. 2010 Employee Stock Purchase Plan (the “ESPP”), which allows eligible employees to purchase a limited amount of the Company's common stock at a 15% discount to the market price through payroll deductions. Participants can authorize payroll deductions for amounts up to the lesser of 15% of their qualifying wages or the statutory limit under the U.S. Internal Revenue Code. The ESPP provides for up

20



to four concurrent offering periods of twenty-four, eighteen, twelve and six-month durations, which correspondingly have four, three, two and one, six-month purchase periods, respectively.  A maximum of one thousand two hundred and fifty shares of common stock may be purchased by each participant at six-month intervals during each purchase period within an offering. The fair value of the ESPP options granted is determined using a Black-Scholes model and is amortized over the life of the 24-month offering period of the ESPP. The Black-Scholes model included an assumption for expected volatility of between 34% and 43% for each of the four purchase periods. During the three months ended March 31, 2012, the Company recognized an expense of $582 in relation to the ESPP and there were 9,749 shares of common stock remaining authorized for issuance under the ESPP at March 31, 2012. As of March 31, 2012, there was approximately $3,200 of unrecognized compensation cost related to the ESPP which is expected to be recognized on a straight-line basis over the remainder of the offering period.

LIVESTRONG.com Warrants
 
In January 2008, the Company entered into a license agreement with the Lance Armstrong Foundation, Inc. (the “License Agreement”). The Lance Armstrong Foundation (“LAF”) is a non-profit organization dedicated to uniting people to fight cancer.  In consideration for the License Agreement, the Company issued warrants to purchase an aggregate of 312 shares of the Company's common stock at an exercise price of $12.00 per share to the LAF (the “LAF Warrant”). The LAF Warrant was automatically net exercised upon the closing date of the Company's IPO and as a result the Company issued 184 shares of common stock to LAF in January 2011.

BEI Warrant
 
In June 2010, the Company entered into a website development, endorsement and license agreement with Bankable Enterprises, Inc. (“BEI”) (the “BEI Agreement”). BEI is wholly owned by Tyra Banks (“Ms. Banks”), a business woman and celebrity.
 
Under the terms of the BEI Agreement, which commenced on July 1, 2010 and ends on July 1, 2014, Ms. Banks provides certain services and endorsement rights to the Company, and licenses to the Company certain intellectual property. The Company used this intellectual property to build an owned and operated website on beauty and fashion, typeF.com, which was launched during the three months ended March 31, 2011. As consideration for Ms. Banks’ services, the Company issued a fully-vested four-year warrant to purchase 375 shares of the Company’s common stock at an exercise price of $12.00 per share. The warrant terminates on the earlier of (i) June 30, 2014 or (ii) the closing of a change of control (as defined). In addition, BEI will receive certain royalties on advertising revenue in excess of certain minimum royalty thresholds (as defined).
 
Stock-based Compensation Expense
 
Stock-based compensation expense related to all employee and non-employee stock-based awards was as follows:
 
 
Three months ended March 31,
 
 
2011
 
2012
Stock-based compensation included in
 
 
 
 
Service costs
 
$
237

 
$
708

Sales and marketing
 
900

 
1,536

Product development
 
1,116

 
1,688

General and administrative
 
6,674

 
3,459

Total stock-based compensation included in net loss
 
8,927

 
7,391

 
Stock-based compensation expense in the three months ended March 31, 2011 includes $5,051 related to 1,625 performance and market-based stock options and 1,000 RSPR awards granted to certain executive officers in prior years that vested in 2011 on the fulfillment of certain market and performance conditions: the completion of the Company’s initial public offering and the meeting of an average closing price of the Company’s stock for a stipulated period of time.
 
11. Stockholders' Equity
 
Stock Repurchases
Under the stock repurchase plan announced on August 19, 2011 and increased on February 8, 2012, the Company is authorized to repurchase up to $50,000 of its common stock from time to time. During the three months ended March 31,

21



2012, the Company repurchased 421 shares at an average price of $7.09 per share for an aggregate amount of $2,990. As of March 31, 2012, approximately $30 million of the stock repurchase authorization remained. The timing and actual number of shares repurchased will depend on various factors including price, corporate and regulatory requirements, debt covenant requirements, alternative investment opportunities and other market conditions.
Shares repurchased by the Company are accounted for when the transaction is settled. As of March 31, 2012, there were no unsettled share repurchases. Shares repurchased and retired are deducted from common stock for par value and from additional paid in capital for the excess over par value. Direct costs incurred to acquire the shares are included in the total cost of the shares.
Other
    Each share of common stock has the right to one vote per share. Each restricted stock purchase right has the right to one vote per share and the right to receive dividends or other distributions paid or made with respect to common shares, subject to restrictions for continued employment service.
    
12.
Business Segments
 
The Company operates in one operating segment. The Company’s chief operating decision maker (“CODM”) manages the Company’s operations on a consolidated basis for purposes of evaluating financial performance and allocating resources. The CODM reviews separate revenue information for its Content & Media and Registrar offerings. All other financial information is reviewed by the CODM on a consolidated basis. All of the Company’s principal operations and decision- making functions are located in the United States. Revenue generated outside of the United States is not material for any of the periods presented.
 
Revenue derived from the Company’s Content & Media and Registrar Services is as follows
 
 
 
Three months ended
 
 
March 31,
 
 
2011
 
2012
Content & Media revenue
 
 

 
 
Owned & operated
 
$
40,524

 
$
39,348

Network
 
11,328

 
14,615

Total Content & Media revenue
 
51,852

 
53,963

Registrar revenue
 
27,671

 
32,271

Total Revenue
 
$
79,523

 
$
86,234


13. Net Loss Per Share
 
The following table sets forth the computation of basic and diluted net loss per share of common stock: 
 
 
Three months ended
 
 
March 31,
 
 
2011
 
2012
Numerator:
 
 

 
 

Net loss
 
$
(5,582
)
 
$
(1,842
)
Cumulative preferred stock dividends
 
(2,477
)
 

Net loss attributable to common stockholders
 
$
(8,059
)
 
$
(1,842
)
Denominator:
 
 

 
 

Weighted average common shares outstanding
 
64,595

 
83,445

Weighted average unvested restricted stock awards
 
(836
)
 
(503
)
Weighted average common shares outstanding—basic
 
63,759

 
82,942

Dilutive effect of stock options, warrants and convertible preferred stock
 

 

Weighted average common shares outstanding—diluted
 
63,759

 
82,942

Net loss per share—basic and diluted
 
$
(0.13
)
 
$
(0.02
)

22



 
As of each period end, the following common equivalent shares were excluded from the calculation of the Company’s net loss per share as their inclusion would have been antidilutive:
 
 
March 31,
 
2011
 
2012
Stock options
18,915

 
15,571

Unvested RSUs
278

 
3,256

Common Stock Warrants
375

 
375

ESPP shares

 
876

 

14. Subsequent Events
 
During the period from April 1, 2012 to May 10, 2012, the Company issued 2,284 restricted stock units as part of employee compensation.
In April 2012, the Company invested approximately $18,000 in connection with its generic Top Level Domain ("gTLD") initiative.


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

Forward Looking Statements
 
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our 2011 Annual Report on Form 10-K.
 
This Quarterly Report on Form 10-Q contains forward-looking statements. All statements other than statements of historical facts contained in this Quarterly Report on Form 10-Q, including statements regarding our future results of operations and financial position, business strategy and plans and our objectives for future operations, are forward-looking statements. The words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect” and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our estimates of our financial results and our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy, short term and long-term business operations and objectives, and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in the section entitled “Risk Factors” in Part II Item 1A of this Quarterly Report on Form 10-Q. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this Quarterly Report on Form 10-Q may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.
 
You should not rely upon forward-looking statements as predictions of future events. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee that the future results, levels of activity, performance or events and circumstances reflected in the forward-looking statements will be achieved or occur. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. We undertake no obligation to update publicly any forward-looking statements for any reason after the date of this Quarterly Report on Form 10-Q to conform these statements to actual results or to changes in our expectations.
 
You should read this Quarterly Report on Form 10-Q and the documents that we reference in this Quarterly Report on Form 10-Q and have filed with the Securities and Exchange Commission (the “SEC”) with the understanding that our actual future results, levels of activity, performance and events and circumstances may be materially different from what we expect.
 
As used herein, “Demand Media,” “the Company,” “our,” “we,” or “us” and similar terms include Demand Media, Inc. and its subsidiaries, unless the context indicates otherwise.
 
“Demand Media” and other trademarks of ours appearing in this report are our property. This report contains additional trade names and trademarks of other companies. We do not intend our use or display of other companies’ trade names or trademarks to imply an endorsement or sponsorship of us by such companies, or any relationship with any of these companies.
 
Overview
 
We are a leader in an Internet-based model for the professional creation and distribution of high-quality, commercially valuable, long-lived content at scale. Our business is comprised of two distinct and complementary service offerings: Content & Media and Registrar. Our Content & Media offering is engaged in creating media content, primarily consisting of text articles and videos, and delivering it along with our social media and monetization tools to our owned and operated websites and to our network of customer websites. Our Content & Media service offering also includes a number of websites primarily containing advertising listings, which we refer to as undeveloped websites. Our Registrar is the world’s largest wholesale registrar of Internet domain names and the world’s second largest registrar overall, based on the number of names under management, and provides domain name registration and related value-added services.

Our principal operations and decision-making functions are located in the United States. We report our financial results as one operating segment, with two distinct service offerings. Our operating results are regularly reviewed by our chief operating decision maker on a consolidated basis, principally to make decisions about how we allocate our resources and to measure our consolidated operating performance. Together, our service offerings provide us with proprietary data that enable commercially valuable, long-lived content production at scale combined with broad distribution and targeted monetization capabilities. We

24



currently generate the vast majority of our Content & Media revenue through the sale of advertising, and to a lesser extent through subscriptions to our social media applications and licensing and sales of select content and service offerings. Substantially all of our Registrar revenue is derived from domain name registration and related value-added service subscriptions. Our chief operating decision maker regularly reviews revenue for each of our Content & Media and Registrar service offerings in order to gain more depth and understanding of the key business metrics driving our business. Accordingly, we report Content & Media and Registrar revenue separately.
 
In January 2011, we completed our initial public offering and received proceeds, net of underwriters discounts but before deducting offering expenses, of $81.8 million from the issuance of 5.2 million shares of common stock. As a result of the initial public offering, all shares of our convertible preferred stock converted into 61.7 million shares of common stock and warrants to purchase common stock or convertible preferred stock net exercised into 0.5 million shares of common stock.

For the three months ended March 31, 2011 and 2012, we reported revenue of $79.5 million and $86.2 million, respectively.  For the three months ended March 31, 2011 and 2012, our Content & Media offering accounted for 65% and 63% of our total revenue, respectively, and our Registrar service accounted for 35% and 37% of our total revenue, respectively.
 
Key Business Metrics
 
We regularly review a number of business metrics, including the following key metrics, to evaluate our business, measure the performance of our business model, identify trends impacting our business, determine resource allocations, formulate financial projections and make strategic business decisions. Measures which we believe are the primary indicators of our performance are as follows:
 
Content & Media Metrics
 
 page views:  We define page views as the total number of web pages viewed across (1) our owned and operated websites and/or (2) our network of customer websites, to the extent that the viewed customer web pages host the Company's monetization, social media and/or content services. Page views are primarily tracked through internal systems, such as our Omniture web analytics tool, contain estimates for our customer websites using our social media tools and may use data compiled from certain customer websites. We periodically review and refine our methodology for monitoring, gathering, and counting page views in an effort to improve the accuracy of our measure.

RPM:  We define RPM as Content & Media revenue per one thousand page views.

                          
Registrar Metrics
 
domain:  We define a domain as an individual domain name paid for by a third-party customer where the domain name is managed through our Registrar service offering. Beginning July 1, 2011, the number of net new domains has been adjusted to include only new registered domains added to our platform for which we have recognized revenue. This metric does not include any of the company’s owned and operated websites.
 
 average revenue per domain:  We calculate average revenue per domain by dividing Registrar revenues for a period by the average number of domains registered in that period. The average number of domains is the simple average of the number of domains at the beginning and end of the period. Average revenue per domain for partial year periods is annualized.
 
The following table sets forth additional performance highlights of key business metrics for the periods presented:

25



 
Three months ended March 31,
 
2011
 
2012
 
% Change
Content & Media Metrics (1)
 

 
 

 
 

Owned & operated
 

 
 

 
 

Page views (in millions)
2,582

 
3,142

 
22
 %
RPM
$
15.69

 
$
12.52

 
(20
)%
Network of customer websites
 
 
 
 
 
Page views (in millions)
3,766

 
4,722

 
25
 %
RPM
$
3.01

 
$
3.10

 
3
 %
RPM ex-TAC
$
2.16

 
$
2.38

 
10
 %
Registrar Metrics (1)
 
 
 
 
 
End of Period # of Domains (2) (in millions)
11.4

 
13.3

 
16
 %
Average Revenue per Domain (2)
$
9.88

 
$
9.94

 
1
 %
 
___________________________________
(1) 
For a discussion of these period to period changes in the number of page views, RPM, end of period domains and average revenue per domain and how they impacted our financial results, see “Results of Operations” below.
(2) 
Beginning July 1, 2011, the number of net new domains has been adjusted to include only new registered domains added to our platform for which we have recognized revenue. Excluding the impact of this change, end of period domains at March 31, 2012 would have increased 20% and average revenue per domain during the three months ended March 31, 2012 would have decreased 4% compared to the corresponding prior-year period.


Opportunities, Challenges and Risks

To date, we have derived the majority of our revenue through the sale of advertising in connection with our Content & Media service offering and through domain name registration subscriptions in our Registrar service offering. Our advertising revenue is primarily generated by advertising networks, which include both performance based Internet advertising, such as cost-per-click where an advertiser pays only when a user clicks on its advertisement, and display Internet advertising where an advertiser pays when the advertising is displayed. For the three months ended March 31, 2012, the majority of our advertising revenue was generated by our relationship with Google. We deliver online advertisements provided by Google on our owned and operated websites as well as on certain of our customer websites where we share a portion of the advertising revenue. For each of the three months ended March 31, 2011 and 2012 approximately 36% of our total consolidated revenue was derived from our advertising arrangements with Google. Google maintains the direct relationships with the advertisers and provides us with cost-per-click and display advertising services.
 
Our historical growth in Content & Media revenue has principally come from growth in RPMs and page views due to both the increased volume of commercially valuable content published on our owned and operated websites as well as an increase in the number of visitors to our existing content. To a lesser extent, Content & Media revenue growth has resulted from the publishing of our content on our network of customer websites and from utilizing our social media tools on certain of these sites. We believe that there are opportunities to grow our revenue and our page views by creating and publishing more content in a greater variety of formats on our owned and operated sites as well as by increasing our distribution to and expanding our network of customer websites. We also believe there is long term revenue growth opportunity from improving advertising yields to several of our owned and network websites and from introducing innovative new products.
 
We believe that there is an opportunity to further grow our Content & Media service offering by publishing and distributing our content to an increased number of distribution outlets. For example, we launched our premium multi-channel YouTube initiative in December 2011, and we currently have arrangements with a number of third-party customers to distribute and license our content on their websites. We also expanded distribution to our network of customer websites via our recent acquisition of IndieClick and believe that IndieClick's innovative product offerings provide us an opportunity to increase revenue.

Google, the largest provider of search engine referrals to the majority of the Company's websites, regularly deploys changes to its search engine algorithms, which have led the Company to experience fluctuations in the total number of Google search referrals to its owned and operated and network of customer websites. Other search engines may deploy similar changes. In 2011, the overall impact of these changes on the Company's owned and operated websites was negative primarily

26



due to a decline in traffic to eHow.com, the Company's largest website. From October 2011 to March 2012, and in response to the changes in search engine algorithms in 2011, the Company performed an evaluation of its existing content library to identify potential improvements in its content creation and distribution platform. As a result of this evaluation, the Company elected to remove certain content assets from service, resulting in $1,818 of accelerated amortization expense in the first quarter of 2012.

We intend to evolve and continuously improve our content creation and distribution platform and to create new content formats to meet rapidly changing consumer demand. In 2012 to date, such changes include increasing our investment in video and long-form content, images and diagrams, increasing and expanding distribution of our content to our network of customer websites, and an overall reduction in the volume of shorter-form text articles published on eHow.com. In the near term, we anticipate increased expenditures in new content formats designed to further enhance user engagement. These potential changes to our content creation platform could increase our per unit content creation costs, including costs associated with our community of creative professionals, potentially resulting in higher service costs as a percentage of revenue if the changes are unsuccessful in generating additional revenue. While we enact such improvements to our content creation and distribution platform, we have begun and expect to maintain a reduced level of overall investment in media content in 2012 when compared to 2010 and 2011.
    
There can be no assurance that these or any future changes that may be implemented by the Company, by search engines to their algorithms and search methodologies, or by consumers in their web usage habits will not adversely impact the carrying value, estimated useful life or intended use of our long-lived assets. The Company will continue to monitor these changes as well as any future changes and emerging trends in search engine algorithms and methodologies, including the resulting impact that these changes may have on future operating results, the economic performance of the Company's long-lived assets and in its assessment as to whether significant changes in circumstances might provide an indication of potential impairment of the carrying value of its long-lived assets, including its media content and goodwill arising from acquisitions.
The growth in our Registrar revenue is dependent upon our ability to attract and retain customers to our Registrar platform through competitive pricing on domain registrations and value added services.  Beginning in the first quarter of 2010 and extending through the first quarter of 2011, we added several customers with large volumes of domains to our Registrar platform.  This resulted in fluctuations in our average revenue per domain over these periods, from which we only recognized revenue on a portion of these domain names while deferring revenue recognition on the remainder.   Beginning July 1, 2011, we adjusted the number of net new domains to include only new registered domains added to our platform for which we have recognized revenue.  Excluding the impact of this change, end of period domains at March 31, 2012 would have increased 20% and average revenue per domain during the period ended March 31, 2012 would have decreased 4%, each compared to the corresponding prior-year period.  In the near term, we anticipate our average revenue per domain to continue to fluctuate as a result of the large volume customers added in 2011 and certain registry price increases in early 2012.  Due in part to the higher mix of large volume customers in 2012 as compared to 2011, we also expect that the associated service costs as a percentage of revenue will increase when compared to our historical results.
    
The Internet Corporation for Assigned Names and Numbers, or ICANN, has approved a framework for the significant expansion of the number of generic Top Level Domain ("gTLDs") in 2012 ("the New gTLD Program"). We believe that such expansion, once completed, will result in an increase in the number of domains registered on our platform in 2013.  In addition, we believe that the New gTLD Program could also provide us with new revenue opportunities commencing in 2013, which include operating the back-end infrastructure for new gTLD registries and/or owning one or more gTLDs in our own right.  In connection with our gTLD initiative under the New gTLD Program, we also expect to incur up to $4 million of formation expenses in 2012 and have committed $18 million of capital investment. The net amount of our capital investment could be higher or lower as the New gTLD Program progresses.

Our service costs, the largest component of our operating expenses, can vary from period to period, particularly as a percentage of revenue, based upon the mix of the underlying Content & Media and Registrar services revenues we generate. In the near term, we expect that the period-over-period growth in our Content & Media revenue will exceed the growth in our Registrar revenue, which would typically provide for higher operating margins. We expect that service costs will increase in 2012 compared to 2011 in line with revenue growth and also due to our new premium multi-channel initiative with YouTube as well the impact of our acquisition of IndieClick. We believe that these factors, together with costs associated with our investment in new business initiatives in 2012, including our preparation for new gTLDs becoming available for registration in 2013, will result in our operating margin in the remainder of 2012 being generally consistent with 2011.

Our content studio identifies and creates online text articles and videos through a community of freelance creative professionals and is core to our business strategy and long-term growth initiatives. Historically, we have made substantial investments in our platform to support our expanding community of freelance creative professionals and the growth of our

27



content production and distribution and expect to continue to make such investments. As we develop new content formats, we may not be able to attract and retain qualified creative professionals to produce such new content at scale, which may adversely impact our ability to execute against emerging business opportunities or retain existing content creators.
 
For the three months ended March 31, 2012, more than 90% of our revenue has been derived from websites and customers located in the United States. While our content is primarily targeted towards English-speaking users in the United States today, we believe that there is an opportunity in the longer term for us to create content targeted to users outside of the United States and thereby increase our revenue generated from countries outside of the United States. We plan to further expand our operations internationally to address this opportunity, including through our recent acquisition of a Latin American language content creation company in July 2011 and building on the recent launch of eHow en Español and eHow Brasil. As we expand our business internationally, we may incur additional expenses associated with this growth initiative.

Basis of Presentation
Revenue
 
Our revenue is derived from our Content & Media and Registrar service offerings.
 
Content & Media Revenue
 
We currently generate substantially all of our Content & Media revenue through the sale of advertising, and to a lesser extent through subscriptions to our social media applications and select content and service offerings. Articles and videos, each of which we refer to as a content unit, generate revenue both directly and indirectly. Direct revenue is that directly attributable to a content unit, such as advertisements, including sponsored advertising links, display advertisements and in-text advertisements, on the same webpage on which the content is displayed. Indirect revenue is also derived primarily by our content library, but is not directly attributable to a specific content unit. Indirect revenue includes advertising revenue generated on our owned and operated websites’ home pages (e.g., home page of eHow), on topic category webpages (e.g., home and garden category page), on user generated article pages that feature content that was not acquired through our proprietary content acquisition process, and subscription revenue. Our revenue generating advertising arrangements, for both our owned and operated websites and our network of customer websites, include cost-per-click performance-based advertising; display advertisements where revenue is dependent upon the number of page views; and lead generating advertisements where revenue is dependent upon users registering for, or purchasing or demonstrating interest in, advertisers’ products and services. We generate revenue from advertisements displayed alongside our content offered to consumers across a broad range of topics and categories on our owned and operated websites and on certain customer websites. Our advertising revenue also includes revenue derived from cost-per-click advertising links we place on undeveloped websites owned both by us, which we acquire and sell on a regular basis, and certain of our customers. To a lesser extent, we also generate revenue from our subscription-based offerings, which include our social media applications deployed on our network of customer websites and subscriptions to premium content or services offered on certain of our owned and operated websites.
 
Where we enter into revenue sharing arrangements with our customers, such as those relating to IndieClick and our undeveloped customer websites, and when we are considered the primary obligor, we report the underlying revenue on a gross basis in our consolidated statements of operations, and record these revenue-sharing payments to our customers as traffic acquisition costs, or TAC, which are included in service costs. In circumstances where we distribute our content on third-party websites and the customer acts as the primary obligor we recognize revenue on a net basis.
 
Registrar Revenue
 
Our Registrar revenue is principally comprised of registration fees charged to resellers and consumers in connection with new, renewed and transferred domain name registrations. In addition, our Registrar also generates revenue from the sale of other value-added services that are designed to help our customers easily build, enhance and protect their domains, including security services, e-mail accounts and web-hosting. Finally, we generate revenue from fees related to auction services we provide to facilitate the selling of third-party owned domains. Our Registrar revenue varies based upon the number of domains registered, the rates we charge our customers and our ability to sell value-added services. We market our Registrar wholesale services under our eNom brand, and our retail registration services under the eNomCentral brand, among others.

Operating Expenses
 
Operating expenses consist of service costs, sales and marketing, product development, general and administrative, and amortization of intangible assets. Included in our operating expenses are stock based compensation and depreciation expenses associated with our capital expenditures.

28



 
Service Costs
 
Service costs consist of: fees paid to registries and ICANN associated with domain registrations; advertising revenue recognized by us and shared with others as a result of our revenue-sharing arrangements, such as TAC and content creator revenue-sharing arrangements; Internet connection and co-location charges and other platform operating expenses including depreciation of the systems and hardware used to build and operate our Content & Media platform and Registrar; personnel costs related to in-house editorial, customer service and information technology; and certain content production costs such as our new premium multi-channel video deal with YouTube. We anticipate that content production costs will comprise a higher proportion of total service costs in 2012 than prior years as we increase our production of non-algorithm based content under the new premium multi-channel video initiative with YouTube and create and test new content formats. Our service costs are dependent on a number of factors, including the number of page views generated across our platform and the volume of domain registrations and value-added services supported by our Registrar. In the near term and consistent with historical trends, we expect that the period-over-period growth in our Content & Media revenue will exceed the growth in our Registrar revenue, and as a result, we expect our overall service costs as a percentage of our total revenue to continue to decrease when compared to our historical results.  However, we do expect that the new premium multi-channel initiative with the production of video for YouTube, an increase in advertising revenue through third-party publishers resulting from our acquisition of IndieClick and higher overall registration costs due to registry price increases in 2012 together with costs associated with our investment in new business initiatives in 2012 (including our preparation for new gTLDs becoming available for registration in 2013) will result in higher service costs when compared to historical results.

 Sales and Marketing
 
Sales and marketing expenses consist primarily of sales and marketing personnel costs, sales support, public relations, advertising and promotional expenditures. Fluctuations in our sales and marketing expenses are generally the result of our efforts to support the growth in our Content & Media service, including expenses required to support the expansion of our direct advertising sales force. We currently anticipate that our sales and marketing expenses will continue to increase and will increase in the near term as a percent of revenue as we continue to build our sales and marketing organizations to support the growth of our business.
 
Product Development
 
Product development expenses consist primarily of expenses incurred in our software engineering, product development and web design activities and related personnel costs. Fluctuations in our product development expenses are generally the result of hiring personnel to support and develop our platform, including the costs to further develop our content algorithms, our owned and operated websites and future product and service offerings of our Registrar. We currently anticipate that our product development expenses will increase as we continue to hire more product development personnel and further develop our products and offerings to support the growth of our business, but remain flat as a percentage of revenue compared to 2011.

General and Administrative
 
General and administrative expenses consist primarily of personnel costs from our executive, legal, finance, human resources and information technology organizations and facilities related expenditures, as well as third party professional fees, insurance and bad debt expenses. Professional fees are largely comprised of outside legal, audit and information technology consulting. During the three months ended March 31, 2011 and 2012, our allowance for doubtful accounts and bad debt expense were not significant and we expect that this trend will continue in the near term. However, as we grow our revenue from direct advertising sales, which tend to have longer collection cycles, our allowance for doubtful accounts may increase, which may lead to increased bad debt expense. As we continue to expand our business and incur additional expenses associated with being a publicly traded company, we anticipate general and administrative expenses will increase in the near term, but at a lesser rate than our projected revenue growth. Specifically, we expect that we will incur additional general and administrative expenses to provide insurance for our directors and officers and to comply with the regulatory and listing exchange requirements.
 
Amortization of Intangibles
 
We capitalize certain costs allocated to the purchase price of certain identifiable intangible assets acquired in connection with business combinations, to acquire content that our models show embody probable economic benefit, and to acquire undeveloped websites, including initial registration costs. We amortize these costs on a straight-line basis over the related expected useful lives of these assets, which have a weighted average useful life of approximately 5.3 years on a combined basis

29



as of March 31, 2012. We estimate our capitalized content to have a weighted average useful life of 5.1 years as of March 31, 2012. The Company determines the appropriate useful life of intangible assets by performing an analysis of expected cash flows based on its historical experience of intangible assets of similar quality and value. We expect amortization expense to decrease in the near term as we intend to reduce our investment in content intangible assets as compared to the prior year.  Amortization as percentage of revenue will depend upon a variety of factors, such as the amounts and mix of our investments in content and identifiable intangible assets acquired in business combinations.
 
Stock-based Compensation
 
Included in our operating expenses are expenses associated with stock-based compensation, which are allocated and included in service costs, sales and marketing, product development and general and administrative expenses. Stock-based compensation expense is largely comprised of costs associated with stock options and restricted stock units granted to employees, restricted stock issued to employees and expenses relating to our Employee Stock Purchase Plan.

We record the fair value of these equity-based awards and expense at their cost ratably over related vesting periods. In addition, stock-based compensation expense includes the cost of warrants to purchase common and preferred stock issued to certain non-employees.  In addition, during the first quarter of 2011, we recognized approximately $5.0 million in additional stock-based compensation expense related to awards granted to certain executive officers in prior years to acquire approximately 2.6 million of our shares that vested in that quarter upon meeting an average closing price of our stock for a stipulated period of time subsequent to our initial public offering.
 
As of March 31, 2012, we had approximately $60.7 million of unrecognized employee related stock-based compensation, net of estimated forfeitures, that we expect to recognize over a weighted average period of approximately 3.2 years.  In addition we also had approximately $3.2 million of unrecognized compensation expense related to our Employee Stock Purchase Plan that we expect to recognize on a straight-line basis through the second quarter of 2013. Stock-based compensation expense is expected to increase in 2012 compared to 2011 as a result of our existing unrecognized stock-based compensation and as we issue additional stock-based awards to continue to attract and retain employees and non-employee directors.
 
Interest Expense
 
Interest expense principally consists of interest on outstanding debt and amortization of debt issuance costs associated with our revolving credit facility. As of March 31, 2012 no principal balance was outstanding under the revolving credit facility.
 
Interest Income
 
Interest income consists of interest earned on cash balances and short-term investments. We typically invest our available cash balances in money market funds, short-term United States Treasury obligations and commercial paper.
 
Other Income (Expense), Net
 
Other income (expense), net consists primarily of transaction gains and losses on foreign currency-denominated assets and liabilities and changes in the value of certain long term investments and, prior to our initial public offering, changes in the fair value of our preferred stock warrant liability. We expect our transaction gains and losses will vary depending upon movements in underlying currency exchange rates, and could become more significant when we expand internationally. Our preferred stock warrants were net exercised for common stock upon our initial public offering in January 2011 and thus we no longer record changes in the value of the warrant subsequent to that date.
 
Provision for Income Taxes
 
Since our inception, we have been subject to income taxes principally in the United States, and certain other countries where we have legal presence, including the United Kingdom, the Netherlands, Canada, Sweden and beginning in 2011, Ireland and Argentina. We anticipate that as we expand our operations outside the United States, we will become subject to taxation based on the foreign statutory rates and our effective tax rate could fluctuate accordingly.
 
Income taxes are computed using the asset and liability method, under which deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.


30



     We currently believe that based on the available information, it is more likely than not that our deferred tax assets will not be realized, and accordingly we have taken a full valuation allowance against all of our United States deferred tax assets. As of December 31, 2011, we had approximately $54 million of federal and $12 million of state operating loss carry-forwards available to offset future taxable income which expire in varying amounts beginning in 2020 for federal and 2013 for state purposes if unused. Federal and state laws impose substantial restrictions on the utilization of net operating loss and tax credit carry-forwards in the event of an “ownership change,” as defined in Section 382 of the Internal Revenue Code of 1986, as amended, or the Internal Revenue Code. Currently, we do not expect the utilization of our net operating loss and tax credit carry-forwards in the near term to be materially affected as no significant limitations are expected to be placed on these carry-forwards as a result of our previous ownership changes. If an ownership change is deemed to have occurred as a result of our initial public offering, potential near term utilization of these assets could be reduced.

 
Critical Accounting Policies and Estimates
 
Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates.
 
We believe that the assumptions and estimates associated with our revenue recognition, accounts receivable and allowance for doubtful accounts, capitalization and useful lives associated with our intangible assets, including our internal software and website development and content costs, income taxes, stock-based compensation and the recoverability of our goodwill and long-lived assets have the greatest potential impact on our consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates and have discussed those in our 2011 Annual Report on Form 10-K. There have been no material changes to our critical accounting policies and estimates since the date of our 2011 Annual Report on Form 10-K.
 

31



Results of Operations
 
The following tables set forth our results of operations for the periods presented. The period-to-period comparison of financial results is not necessarily indicative of future results.
 
 
Three months ended
 
March 31,
 
2011
 
2012
 
(In thousands)
Revenue
$
79,523

 
$
86,234

Operating expenses(1)(2):
 

 
 

Service costs (exclusive of amortization of intangible assets)
37,654

 
41,262

Sales and marketing
9,583

 
10,393

Product development
9,251

 
10,124

General and administrative
17,024

 
15,395

Amortization of intangible assets
10,203

 
11,956

Total operating expenses
83,715

 
89,130

Loss from operations
(4,192
)
 
(2,896
)
Other income (expense)
 

 
 

Interest income
42

 
15

Interest expense
(162
)
 
(137
)
Other income (expense), net
(257
)
 
(19
)
Total other expense
(377
)
 
(141
)
Loss before income taxes
(4,569
)
 
(3,037
)
Income tax (expense)/benefit
(1,013
)
 
1,195

Net loss
(5,582
)
 
(1,842
)
Cumulative preferred stock dividends
(2,477
)
 

Net loss attributable to common shareholders
$
(8,059
)
 
$
(1,842
)
 
(1) 
Depreciation expense included in the above line items:
 
Service costs
$
4,044

 
$
3,650

Sales and marketing
72

 
134

Product development
321

 
282

General and administrative
572

 
898

Total depreciation expense
$
5,009

 
$
4,964


 
(2) 
 Stock-based compensation included in the above line items:
 
Service costs
$
237

 
$
708

Sales and marketing
900

 
1,536

Product development
1,116

 
1,688

General and administrative
6,674

 
3,459

Total stock-based compensation
$
8,927

 
$
7,391






32



As a percentage of revenue:
 
 
Three Months ended
 
March 31,
 
2011
 
2012
Revenue
100.0
 %
 
100.0
 %
Operating expenses:

 

Service costs (exclusive of amortization of intangible assets)
47.3
 %
 
47.8
 %
Sales and marketing
12.1
 %
 
12.1
 %
Product development
11.6
 %
 
11.7
 %
General and administrative
21.4
 %
 
17.9
 %
Amortization of intangible assets
12.8
 %
 
13.9
 %
Total operating expenses
105.3
 %
 
103.4
 %
Loss from operations
(5.3
)%
 
(3.4
)%
Other income (expense)

 

Interest income
0.1
 %
 
 %
Interest expense
(0.2
)%
 
(0.2
)%
Other income (expense), net
(0.3
)%
 
 %
Total other expense
(0.5
)%
 
(0.2
)%
Loss before income taxes
(5.7
)%
 
(3.5
)%
Income tax (expense)/benefit
(1.3
)%
 
1.4
 %
Net Loss
(7.0
)%
 
(2.1
)%
 
Revenue
 
Revenue by service line were as follows:
 
 
Three months ended March 31,
 
2011
 
2012
 
% Change
 
(In thousands)
Content & Media:
 

 
 

 
 

Owned and operated websites
$
40,524

 
$
39,348

 
(3
)%
Network of customer websites
11,328

 
14,615

 
29
 %
Total Content & Media
51,852

 
53,963

 
4
 %
Registrar
27,671

 
32,271

 
17
 %
Total revenue
$
79,523

 
$
86,234

 
8
 %
 
Content & Media Revenue from Owned and Operated Websites
 
Content & Media revenue from our owned and operated websites decreased by $1.2 million, or (3)%, to $39.3 million for the three months ended March 31, 2012, as compared to $40.5 million for the same period in 2011. The decrease was primarily due to a decrease in RPMs partially offset by an increase in page views. Page views on our owned and operated websites increased by 22%, from 2,582 million page views in the three months ended March 31, 2011 to 3,142 million page views in the three months ended March 31, 2012. RPMs on our owned and operated websites decreased by (20)%, from $15.69 in the three months ended March 31, 2011 to $12.52 in the three months ended March 31, 2012.

The page view increase included the impact of a website product enhancement we implemented in the second quarter of 2011 with respect to the presentation of image-rich content on certain of the Company's owned and operated sites, which did not impact advertising impressions. Excluding the impact of such change, we estimate that during the three months ended March 31, 2012, page views would have increased approximately 5% and RPMs would have decreased (8)%, compared to the corresponding prior year period. The remaining increase in underlying page views was due primarily to increased publishing

33



of our platform content on our owned and operated websites. The underlying decrease in RPMs was primarily attributable to a higher mix of page views from Cracked.com and LIVESTRONG.com than eHow.com as those sites typically generate lower RPMs than eHow.com. This impact was partially offset by an increase in RPMs on the monetization of our undeveloped websites.

Content & Media Revenue from Network of Customer Websites
 
Content & Media revenue from our network of customer websites for the three months ended March 31, 2012 increased by $3.3 million, or 29%, to $14.6 million, as compared to $11.3 million in the same period in 2011. The increase was largely due to revenue from our YouTube channels as well as growth in overall page views and RPMs. Page views on our network of customer websites increased by 956 million or 25%, from 3,766 million page views in the three months ended March 31, 2011, to 4,722 million pages viewed in the three months ended March 31, 2012. The increase in page views was due primarily to the acquisition of IndieClick in August 2011, which contributed 1,619 million page views during the first quarter of 2012, which was partially offset by a decline in page views associated with our Pluck customer base. RPMs increased 3% from $3.01 in the three months ended March 31, 2011 to $3.10 in the three months ended March 31, 2012. The increase in RPMs was primarily due to YouTube channel revenue and lower page views from our lower yield social media customers partially offset by IndieClick which typically averages lower RPMs.

Registrar Revenue
 
Registrar revenue for the three months ended March 31, 2012 increased $4.6 million, or 17%, to $32.3 million compared to $27.7 million for the same period in 2011. The increase was largely due to an increased number of new domain registrations and domain renewal registrations in 2012 compared to 2011, as well as a smaller increase in our average revenue per domain. The number of domain registrations increased 1.9 million, or 16%, to 13.3 million during the three months ended March 31, 2012 as compared to 11.4 million in the same period in 2011. Our average revenue per domain increased slightly by $0.06, or 1%, to $9.94 during the three months ended March 31, 2012 from $9.88 in the same period in 2011 due in part to an increase in value added services revenue as compared to 2011.

Beginning July 1, 2011, the number of net new domains has been adjusted to include only new registered domains added to our platform for which we have recognized revenue. Excluding the impact of this change, end of period domains at March 31, 2012 would have increased 20% compared to the corresponding prior-year period and average revenue per domain during the three months ended March 31, 2012 would have decreased 4% compared to the corresponding prior-year period.

Cost and Expenses
 
Operating costs and expenses were as follows:
 
 
Three months ended March 31,
 
2011
 
2012
 
%  Change
 
(In thousands)
Service costs (exclusive of amortization of intangible assets)
$
37,654

 
$
41,262

 
10
 %
Sales and marketing
9,583

 
10,393

 
8
 %
Product development
9,251

 
10,124

 
9
 %
General and administrative
17,024

 
15,395

 
(10
)%
Amortization of intangible assets
10,203

 
11,956

 
17
 %
 
Service Costs
 
Service costs for the three months ended March 31, 2012 increased by approximately $3.6 million, or 10%, to $41.3 million compared to $37.7 million in the same period in 2011. The increase was primarily due to a $3.5 million increase in domain registry fees associated with our growth in domain registrations and related revenue over the same period, a $1.1 million increase in certain costs associated with the continuous improvement of our content and distribution platform, new content formats and content published on our premium multi-channel YouTube initiative, a $0.3 million increase in personnel and related costs including stock-based compensation and a $0.3 million increase in related information technology expense to support growth in our business. These factors were partially offset by a $1.1 million decrease in publisher payout expense following the phase-out of eHow's writer compensation program in the first quarter of 2011 and a $0.4 million decrease in

34



depreciation expense of technology assets purchased in the prior and current periods required to manage our Internet traffic, data centers, advertising transactions, domain registrations and new products and services. As a percentage of revenues, service costs (exclusive of amortization of intangible assets) increased 50 basis points to 47.8% for the three months ended March 31, 2012 from 47.3% during the same period in 2011.

Sales and Marketing
 
Sales and marketing expenses increased 8%, or $0.8 million, to $10.4 million for the three months ended March 31, 2012 from $9.6 million for the same period in 2011. The increase was primarily due an increase in personnel related costs, including stock-based compensation expense, due to additional headcount growth in our direct advertising sales team, partially offset by a decrease in external marketing expense. As a percentage of revenue, sales and marketing expense was 12.1% during the three months ended March 31, 2012 and 2011.
 
Product Development
 
Product development expenses increased by $0.9 million, or 9%, to $10.1 million during the three months ended March 31, 2012 compared to $9.3 million in the same period in 2011. The increase was largely due to approximately $0.5 million increase in personnel and related costs including stock-based compensation expense, net of internal costs capitalized as internal software development. The remaining increase was largely attributable to additional consulting and associated costs of $0.5 million incurred to develop new and innovative products to support the growth in our business. As a percentage of revenue, product development expenses increased 10 basis points to 11.7% during the three months ended March 31, 2012 compared to 11.6% during the same period in 2011.

General and Administrative
 
General and administrative expenses decreased by $1.6 million, or (10)%, to $15.4 million during the three months ended March 31, 2012 compared to $17.0 million in the same period in 2011. The decrease was primarily due to a $2.7 million decrease in personnel related costs, including stock-based compensation expense, due to incremental expense from additional headcount to support the growth of our business, offset by the occurrence of a one-time charge of $4.6m in the first quarter of 2011 related to certain stock awards vesting on specified conditions attached to our IPO during that period. Additional factors included a $0.6 million increase in professional fees, a $0.3 million increase in facilities and rent related expense for additional office space, and additional depreciation expense of $0.3 million, all to support the growth in our business. As a percentage of revenue, general and administrative costs decreased 350 basis points to 17.9% during the three months ended March 31, 2012 compared to 21.4% during the same period in 2011.
 
Amortization of Intangibles
 
Amortization expense for the three months ended March 31, 2012 increased by $1.8 million, or 17%, to $12.0 million compared to $10.2 million in the same period in 2011. The increase was primarily due to $1.8 million of accelerated amortization expense resulting from our election to remove certain content assets from service in the first quarter of 2012 in conjunction with improvements to our content creation and distribution platform and incremental amortization expense of $0.4 million in the period arising from four acquisitions in 2011. Offsetting this was an overall decrease of $0.4 million in the amortization of certain intangible assets primarily acquired via acquisitions prior to 2011 that are now fully amortized.  As a percentage of revenue, amortization of intangible assets decreased 110 basis points to 13.9% during the three months ended March 31, 2012 compared to 12.8% during the same period in 2011 as the result of the increase in revenue and the factors listed above.

Interest Income
 
Interest income for the three months ended March 31, 2012 changed by less than $0.1 million compared to the same period in 2011.

Interest Expense
 
Interest expense for the three months ended March 31, 2012 changed by less than $0.1 million compared to the same period in 2011.
 
Other Income (Expense), Net
 

35



Other income (expense), net for the three months ended March 31, 2012 decreased by $0.2 million compared to the same period in 2011 primarily a result of certain preferred stock warrants that converted into common stock and were recorded at fair value in the quarter ending March 31, 2011 in conjunction with our IPO.
 
Income Tax (Benefit) Provision
 
During the three months ended March 31, 2012, we recorded an income tax benefit of $1.2 million compared to an expense of $1.0 million during the same period in 2011, representing a movement of $2.2 million. The movement was primarily due to a benefit from the change in California apportionment methodology during the quarter ended March 31, 2012. Adoption of this change reduced our effective state tax rate compared to the prior period.
 
Non-GAAP Financial Measures
 

To provide investors and others with additional information regarding our financial results, we have disclosed in the table below the following non-GAAP financial measures: adjusted earnings before interest, taxes, depreciation and amortization amortization expense, or Adjusted EBITDA, and revenue less traffic acquisition costs, or Revenue ex-TAC. We have provided a reconciliation of our non-GAAP financial measures to the most directly comparable GAAP financial measures. Our non-GAAP Adjusted EBITDA financial measure differs from GAAP net income in that it excludes certain expenses such as depreciation, amortization, stock-based compensation, as well as the financial impact of acquisition and realignment costs, the formation expenses directly related to our generic Top Level Domain ("gTLD") initiative and any gains or losses on certain asset sales or dispositions. Acquisition and realignment costs include such items, when applicable, as (1) non-cash GAAP purchase accounting adjustments for certain deferred revenue and costs, (2) legal, accounting and other professional fees directly attributable to acquisition activity, and (3) integration and employee severance payments attributable to acquisition or corporate realignment activities. Our non-GAAP Revenue ex-TAC financial measure differs from GAAP revenue as it reflects our consolidated revenues net of our traffic acquisition costs. Adjusted EBITDA and Revenue ex-TAC are frequently used by securities analysts, investors and others as a common financial measure of our operating performance.
These non-GAAP financial measures are the primary measures used by our management and board of directors to understand and evaluate our financial performance and operating trends, including period to period comparisons, to prepare and approve our annual budget and to develop short and long term operational plans. Additionally, Adjusted EBITDA is the primary measure used by the compensation committee of our board of directors to establish the target for and ultimately fund our annual employee bonus pool for all bonus eligible employees. We also frequently use Adjusted EBITDA in our discussions with investors, commercial bankers and other users of our financial statements.
 
Management believes these non-GAAP financial measures reflect our ongoing business in a manner that allows for meaningful period to period comparisons and analysis of trends. In particular, the exclusion of certain expenses in calculating Adjusted EBITDA can provide a useful measure for period to period comparisons of our business’ underlying recurring revenue and operating costs which is focused more closely on the current costs necessary to utilize previously acquired long-lived assets. In addition, we believe that it can be useful to exclude certain non-cash charges because the amount of such expenses is the result of long-term investment decisions in previous periods rather than day-to-day operating decisions. For example, due to the long-lived nature of our media content, revenue generated from our content assets in a given period bears little relationship to the amount of our investment in content in that same period. Accordingly, we believe that content acquisition costs represent a discretionary long-term capital investment decision undertaken by management at a point in time. This investment decision is clearly distinguishable from other ongoing business activities, and its discretionary nature and long term impact differentiate it from specific period transactions, decisions regarding day-to-day operations, and activities that would have immediate performance consequences if materially changed, deferred or terminated.
 
We believe that Revenue ex-TAC is a meaningful measure of operating performance because it is frequently used for internal managerial purposes and helps facilitate a more complete period to period understanding of factors and trends affecting our underlying revenue performance.
 
Accordingly, we believe that these non-GAAP financial measures provide useful information to investors and others in understanding and evaluating our consolidated revenue and operating results in the same manner as our management and in comparing financial results across accounting periods and to those of our peer companies.

The following table presents a reconciliation of Revenue ex-TAC and Adjusted EBITDA for each of the periods presented:
 

36



 
Three months ended
 
March 31,
 
2011
 
2012
 
(In thousands)
Non-GAAP Financial Measures:
 

 
 

Content & Media revenue
$
51,852

 
$
53,963

Registrar revenue
27,671

 
32,271

Less: traffic acquisition costs (TAC)(1)
(3,190
)
 
(3,379
)
Total revenue ex-TAC
$
76,333

 
$
82,855

 
 
 
 
Net loss
$
(5,582
)
 
$
(1,842
)
Add:
 
 
 
Income tax expense/(benefit)
1,013

 
(1,195
)
Interest and other expense, net
377

 
141

Depreciation and amortization(2)
15,212

 
16,920

Stock-based compensation(3)
8,927

 
7,391

Acquisition and realignment costs(4)
133

 
61

gTLD expense(5)

 
429

Adjusted EBITDA
$
20,080

 
$
21,905


___________________________________
(1) 
Represents revenue-sharing payments made to our network customers from advertising revenue generated from such customers’ websites.
(2) 
Amortization expense for the three months ended March 31, 2012 includes $1.8 million of accelerated non-cash amortization expense associated with the removal of certain content intangible assets from service in that period.
(3) 
Represents the fair value of stock-based awards and certain warrants to purchase our stock included in our GAAP results of operations. Stock-based compensation expense for the three months ended March 31, 2011 included $5.1 million of non-recurring expense related to awards granted to certain executive officers in prior years that vested in that period on the fulfillment of certain market and performance conditions attached to our IPO.
(4) 
Acquisition and realignment costs include non-cash purchase accounting adjustments, acquisition-related integration expenses and professional fees and employee severance payments from corporate realignment activities.
(5) 
Comprises formation expenses directly related to our gTLDs initiative that is not expected to generate associated revenue in 2012.
 
The use of non-GAAP financial measures has certain limitations because they do not reflect all items of income and expense that affect our operations. We compensate for these limitations by reconciling the non-GAAP financial measures to the most comparable GAAP financial measures. These non-GAAP financial measures should be considered in addition to, not as a substitute for, measures prepared in accordance with GAAP. Further, these non-GAAP measures may differ from the non-GAAP information used by other companies, including peer companies, and therefore comparability may be limited. We encourage investors and others to review our financial information in its entirety and not rely on a single financial measure.

Liquidity and Capital Resources
 
As of March 31, 2012, our principal sources of liquidity were our cash and cash equivalents in the amount of $95.6 million, which primarily are invested in money market funds, and our $105 million revolving credit facility with a syndicate of commercial banks. We completed our initial public offering on January 31, 2011 and received proceeds, net of underwriting discounts but before deducting offering expenses, of $81.8 million from the issuance of 5.2 million shares of common stock.
 
Historically, we have principally financed our operations from the issuance of stock, net cash provided by our operating activities and borrowings under our revolving credit facility. Our cash flows from operating activities are significantly affected by our cash-based investments in operations, including working capital, and corporate infrastructure to support our ability to generate revenue and conduct operations through cost of services, product development, sales and marketing and general and administrative activities. Cash used in investing activities has historically been, and is expected to be, significantly impacted by our upfront investments in content and also reflects our ongoing investments in our platform, company infrastructure and

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equipment for both service offerings and the net sales and purchases of our marketable securities. We have recently commenced an evaluation of changes to improve our content creation and distribution platform, through a number of initiatives including creating new content formats to meet rapidly changing consumer demand. Such changes may include increasing our investment in premium video long-form content, images and diagrams, increasing and expanding distribution of our content to our network of customer websites, and an overall reduction in the volume of shorter-form text articles published on eHow.com. In the near term, we also anticipate increased expenditures on new content formats designed to further enhance user engagement. Actions to implement such changes are undertaken only to the extent that we believe that their collective impact would improve the consumer experience on our owned and operated websites and/or increase the future overall revenue generated from our existing portfolio of media content. While we assess such improvements to our content creation and distribution platform, we have begun and expect to maintain a reduced level of overall investment in media content when compared to historical levels.
 
Since our inception through March 31, 2012 we also used significant cash to make strategic acquisitions to further grow our business, including those detailed in our 2011 Annual Report on Form 10-K. We may make further acquisitions in the future.
We announced a $25 million stock repurchase plan on August 19, 2011 which was further increased on February 8, 2012 to $50 million. Under the plan, the Company is authorized to repurchase up to $50 million of its common stock from time to time in open market purchases or in negotiated transactions. During the three months ended March 31, 2012, we repurchased 0.4 million shares at an average price of $7.09 per share for an aggregate amount of $3 million. The timing and actual number of shares repurchased will depend on various factors including price, corporate and regulatory requirements, debt covenant requirements, alternative investment opportunities and other market conditions.

In connection with our gTLD initiative under the New gTLD Program, we also expect to incur up to $4 million of formation expenses in 2012 and have committed $18 million of capital investment. The net amount of our capital investment could be higher or lower as the New gTLD Program progresses.

We entered into a credit agreement (the “Credit Agreement”) with a syndicate of commercial banks in August, 2011. The Credit Agreement provides for a $105 million, five year revolving credit facility, with the right (subject to certain conditions) to increase such facility by up to $75 million in the aggregate. The syndicate of commercial banks under the Credit Agreement have no obligation to fund any increase in the size of the facility. The Credit Agreement contains customary events of default and affirmative and negative covenants and restrictions, including certain financial maintenance covenants such as a maximum total net leverage ratio and a minimum fixed charge ratio. As of March 31, 2012, no principal balance was outstanding and approximately $98 million was available for borrowing under the Credit Agreement, after deducting the face amount of outstanding standby letters of credit, and we were in compliance with all covenants.
In the future, we may utilize commercial financings, bonds, debentures, lines of credit and term loans with a syndicate of commercial banks or other bank syndicates for general corporate purposes, including acquisitions and investing in our intangible assets, platform and technologies.

We expect that our existing cash and cash equivalents, our $105 million revolving credit facility and our cash flows from operating activities will be sufficient to fund our operations for at least the next 24 months. However, we may need to raise additional funds through the issuance of equity, equity-related or debt securities or through additional credit facilities to fund our growing operations, invest in content and make potential acquisitions.
 
The following table sets forth our major sources and (uses) of cash for each period as set forth below:
 
 
Three months ended March 31,
 
2011
 
2012
 
(In thousands)
Net cash provided by operating activities
$
19,220

 
$
18,478

Net cash used in investing activities
(23,127
)
 
(7,267
)
Net cash provided by (used in) financing activities
79,617

 
(1,671
)
 




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Cash Flow from Operating Activities
 
Three months ended March 31, 2012
 
Net cash inflows from our operating activities of $18.5 million primarily resulted from improved operating performance. Our net loss during the period was $(1.8) million, which included non-cash charges of $22.9 million such as depreciation, amortization, stock-based compensation and deferred taxes. The remainder of our sources of net cash flow from operating activities was from changes in our working capital, including accounts receivable, deposits with registries and deferred revenue of $8.6 million, offset by changes in prepaid expenses and other assets, deferred registrations costs and accounts payable of $11.1 million. The increases in our deferred revenue and deferred registry costs were primarily due to growth in our Registrar service during the period. The increase in accounts payable is reflective of significant amounts due to certain vendors at the close of 2011.
 
Three months ended March 31, 2011
 
Net cash inflows from our operating activities of $19.2 million primarily resulted from improved operating performance. Our net loss during the period was $(5.6) million, which included non-cash charges of $24.9 million such as depreciation, amortization, stock-based compensation and deferred taxes. The remainder of our sources of net cash inflows was from changes in our working capital, including deferred revenue and accrued expenses of $7.2 million, offset by net cash outflows from deferred registry fees and accounts receivable of $8.0 million. The increases in our deferred revenue and deferred registry fees were primarily due to growth in our Registrar service during the period. The increase in accrued expenses is reflective of significant amounts due to certain vendors and our employees. The increase in our accounts receivable reflects growth in advertising revenue from our platform including higher balances from brand advertising sales.
 
Cash Flow from Investing Activities
 
Three months ended March 31, 2011 and 2012
 
Net cash used in investing activities was $7.3 million and $23.1 million during the three months ended March 31, 2012 and 2011, respectively. Cash used in investing activities during the three months ended March 31, 2012 and 2011 included investments in our intangible assets of $2.7 million and $14.2 million, respectively, investments in our property and equipment of $4.3 million and $5.1 million respectively, which included internally developed software as well $0.2 million of deferred consideration relating to business acquisitions in 2011. Cash flows from investing activities during the three months ended March 31, 2011 also included $3.8 million related to acquisitions.
 
Cash invested in purchases of intangible assets and property and equipment, including internally developed software, was largely to support the growth of our business and infrastructure during these periods.  The reduction in our investment in intangible assets is related to the evaluation of changes to improve our content creation and distribution platform, through a number of initiatives including creating new content formats to meet rapidly changing consumer demand. Such changes may include increasing our investment in premium video and long-form content, increasing and expanding distribution of our content to our network of customer websites, and an overall reduction in the volume of shorter-form text articles published on eHow.com. In the near term, we also anticipate increased expenditures in non-algorithmic content such as premium video and longer-form or photo-centric content designed to further enhance user engagement. Actions to implement such changes are undertaken only to the extent that we believe that their collective impact would improve the consumer experience on our owned and operated websites and/or increase the future overall revenue generated from our existing portfolio of media content. While we assess such improvements to our content creation and distribution platform, we have begun and expect to maintain a reduced level of overall investment in media content when compared to historical levels.

Cash Flow from Financing Activities
 
Three months ended March 31, 2011 and 2012
 
Net cash provided by (used in) financing activities was $(1.7) million and $79.6 million during the three months ended March 31, 2012 and 2011, respectively.  Cash used in financing activities during the three months ended March 31, 2012 was primarily driven by the repurchase of $3.0 million of common stock and proceeds of $2.1million from exercise of stock options and contributions to its ESPP offset by $0.7 million of payments of withholding tax on net exercise of certain employee stock-based awards. Cash provided by financing activities in the three months ended March 31, 2011 included $78.9 million in net proceeds from our IPO in that period, net of issuance costs as well at proceeds of $0.9m from exercise of stock options.
 

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From time to time, we expect to receive cash from the exercise of employee stock options in our common stock. Proceeds from the exercise of employee stock options will vary from period to period based upon, among other factors, fluctuations in the market value of our common stock relative to the exercise price of such stock options.
 

Off Balance Sheet Arrangements
 
As of March 31, 2012, we did not have any off balance sheet arrangements.
 
Capital Expenditures
 
For the three months ended March 31, 2011 and 2012, we used $5.1 million and $4.3 million in cash to fund capital expenditures to create internally developed software and purchase equipment. We currently anticipate making further capital expenditures of between $10 million and $20 million during the remainder of the year ending December 31, 2012.

 
Item 3.                            QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
We are exposed to market risks in the ordinary course of our business. These risks primarily include interest rate, foreign exchange, inflation, and concentration of credit risk. To reduce and manage these risks, we assess the financial condition of our large advertising network providers, large direct advertisers and their agencies, large Registrar resellers and other large customers when we enter into or amend agreements with them and limit credit risk by collecting in advance when possible and setting and adjusting credit limits where we deem appropriate. In addition, our recent investment strategy has been to invest in high credit quality financial instruments, which are highly liquid, are readily convertible into cash and that mature within three months from the date of purchase.
 
Foreign Currency Exchange Risk
 
While relatively small, we have operations and generate revenue from sources outside the United States. We have foreign currency risks related to our revenue being denominated in currencies other than the U.S. dollar, principally in the Euro and British Pound Sterling and a relatively smaller percentage of our expenses being denominated in such currencies. We do not believe movements in the foreign currencies in which we transact will significantly affect future net earnings or losses. Foreign currency risk can be quantified by estimating the change in cash flows resulting from a hypothetical 10% adverse change in foreign exchange rates. We believe such a change would not currently have a material impact on our results of operations. However, as our international operations grow, our risks associated with fluctuation in currency rates will become greater, and we intend to continue to assess our approach to managing this risk.

Inflation Risk
 
We do not believe that inflation has had a material effect on our business, financial condition or results of operations. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, financial condition and results of operations.
 
Concentrations of Credit Risk
 
As of March 31, 2012, our cash and cash equivalents were maintained primarily with four major U.S. financial institutions and two foreign banks. We also maintained cash balances with one Internet payment processor. Deposits with these institutions at times exceed the federally insured limits, which potentially subject us to concentration of credit risk. Historically, we have not experienced any losses related to these balances and believe that there is minimal risk of expected future losses. However, there can be no assurance that there will not be losses on these deposits.
 
As of December 31, 2011 and March 31, 2012, components of our consolidated accounts receivable balance comprising more than 10%:
 
 
December 31, 2011
 
March 31,
2012
Google, Inc.
27
%
 
33
%
 

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Item 4.        CONTROLS AND PROCEDURES
 
Disclosure Controls and Procedures
 
The Company maintains disclosure controls and procedures designed to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. In accordance with Rule 13a-15(b) of the Exchange Act, as of the end of the period covered by this Quarterly Report on Form 10-Q, an evaluation was carried out under the supervision and with the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of its disclosure controls and procedures. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures, as of the end of the period covered by this Quarterly Report on Form 10-Q, were effective to provide reasonable assurance that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
 
Changes in Internal Control over Financial Reporting
 
There has been no change in the Company’s internal control over financial reporting during the Company’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.


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PART II
 
OTHER INFORMATION
 
Item 1.        LEGAL PROCEEDINGS
 
In April 2011, the Company and eleven other defendants were named in a patent infringement lawsuit filed in the U.S. District Court, Eastern District of Texas.  The plaintiff filed and served a complaint making several claims related to a method for displaying advertising on the Internet.  In May 2011, the Company filed its response to the complaint, denying all liability, and is in the process of discussing a resolution with the plaintiff.  The Company intends to vigorously defend its position and does not expect to incur a material loss in respect of this matter.

From time to time, the Company is a party to other various litigation matters incidental to the conduct of its business. There is no pending or threatened legal proceeding to which Company is a party that, in our opinion, is likely to have a material adverse effect on the Company’s future financial results.

Item 1A.     RISK FACTORS
 
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should consider carefully the risks and uncertainties described below, which could materially adversely affect our business, financial condition and results of operations.
 
Risks Relating to our Content & Media Service Offering
 

We are dependent upon certain material agreements with Google for a significant portion of our revenue. A termination of these agreements, or a failure to renew them on favorable terms, would adversely affect our business.
 
We have an extensive relationship with Google and a significant portion of our revenue is derived from cost-per-click performance-based advertising provided by Google. For each of the three months ended ended March 31, 2011 and 2012, we derived approximately 36% of our total revenue from our various advertising and content arrangements with Google. We use Google for cost-per-click advertising and cost-per-impression advertising on our owned and operated websites and on our network of customer websites, and receive a portion of the revenue generated by advertisements provided by Google on those websites. Our Google advertising agreement for our developed websites, such as eHow, expires in the third quarter of 2014. Our Google advertising agreement for our undeveloped websites expires in the second quarter of 2012. In addition, we also utilize Google's DoubleClick ad-serving platform to deliver advertisements to our developed websites, which arrangement expires in the third quarter of 2014, and have another revenue-sharing agreement with respect to revenue generated by our content posted on Google's YouTube, which expires in the fourth quarter of 2012. In the fourth quarter of 2011, we entered into a premium multi-channel initiative with Google in connection with the production of premium videos for YouTube, and we expect this initiative will generate significant revenue throughout 2012. Google, however, has termination rights in these agreements with us, including the right to terminate before the expiration of the terms upon the occurrence of certain events, including if our content violates the rights of third parties and other breaches of contractual provisions, a number of which are broadly defined. There can be no assurance that our agreements with Google will be extended or renewed after their respective expirations or that we will be able to extend or renew our agreements with Google on terms and conditions favorable to us. If our agreements with Google, in particular the cost-per-click agreement for our developed websites, are terminated we may not be able to enter into agreements with alternative third-party advertisement providers or ad-serving platforms on acceptable terms or on a timely basis or both. Any termination of our relationships with Google, and any extension or renewal after the initial term of such agreements on terms and conditions less favorable to us would have a material adverse effect on our business, financial condition and results of operations.

Our advertising agreements with Google may not continue to generate levels of revenue commensurate with what we have achieved during past periods. Our ability to generate online advertising revenue from Google depends on its assessment of the quality and performance characteristics of Internet traffic resulting from online advertisements on our owned and operated websites and on our network of customer websites as well as other components of our relationship with Google's advertising technology platforms. We have no control over any of these quality assessments or over Google's advertising technology platforms. Google may from time to time change its existing, or establish new, methodologies and metrics for valuing the quality of Internet traffic and delivering cost-per-click advertisements. Any changes in these methodologies, metrics and advertising technology platforms could decrease the amount of revenue that we generate from online advertisements. Since most of our agreements with Google contain exclusivity provisions, we are prevented from using other providers of services

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similar to those provided by Google. In addition, Google may at any time change or suspend the nature of the service that it provides to online advertisers and the catalog of advertisers from which online advertisements are sourced. These types of changes or suspensions would adversely impact our ability to generate revenue from cost-per-click advertising. Any change in the type of services that Google provides to us could have a material adverse effect on our business, financial condition and results of operations.
 
If we are unable to continue to drive and retain visitors to our owned and operated websites and to our customer websites by offering high-quality, engaging and commercially valuable content at scale in a cost-effective manner, our business, financial condition and results of operations could be adversely affected.
 
The primary method that we use to attract traffic to our owned and operated websites and to our customer websites and convert these visitors into repeat users and customers is the content created by our freelance creative professionals. How successful we are in these efforts depends, in part, upon our continued ability to create and distribute high-quality, commercially valuable content at scale in a cost-effective manner that connects consumers with the formats and types of content that meets their specific interests and enables them to share and interact with the content and supporting communities. We may not be able to create the variety and types of content in a cost-effective manner or that meets rapidly changing consumer demand in a timely manner, if at all. Any such failure to do so could adversely affect user and customer experiences and reduce traffic driven to our owned and operated websites and to our customer websites through which we distribute our content, which would adversely affect our business, revenue, financial condition and results of operations.
 
One effort we employ to create and distribute our content in a cost-effective manner is our proprietary technology and algorithms which are designed to predict consumer demand and return on investment. Our proprietary technology and algorithms have a limited history, and as a result the ultimate returns on our investment in content creation are difficult to predict, and may not be sustained in future periods at the same level as in past periods. Furthermore, our proprietary technology and algorithms are dependent on analyzing existing Internet search traffic data, and our analysis may be impaired by changes in Internet traffic or search engines' methodologies which we do not have any control over. The failure of our proprietary technology and algorithms to accurately identify new content topics and formats, at scale, as well as the failure to create or effectively distribute new content would have an adverse impact on our business, revenue, financial condition and results of operations.
 
Google, the largest provider of search engine referrals to the majority of the Company's websites, regularly deploys changes to its search engine algorithms, which have led the Company to experience fluctuations in the total number of Google search referrals to its owned and operated and network of customer websites. In 2011, the overall impact of these changes on the Company's owned and operated websites was negative primarily due to a decline in traffic to eHow.com, the Company's largest website. From October 2011 to March 2012, and in response to the changes in search engine algorithms in 2011, the Company performed an evaluation of its existing content library to identify potential improvements in its content creation and distribution platform. We intend to evolve and continuously improve our content creation and distribution platform and to create new content formats to meet rapidly changing consumer demand. In 2012 to date, such changes include increasing our investment in video and long-form content, increasing and expanding distribution of our content to our network of customer websites, and an overall reduction in the volume of shorter-form text articles published on eHow.com. There can be no assurance that these changes or any future changes will be successfully implemented.

Another method we employ to attract and acquire new, and retain existing, users and customers is commonly referred to as search engine optimization, or SEO. SEO involves developing websites to rank well in search engine results. Our ability to successfully manage SEO efforts across our owned and operated websites and our customer websites is dependent on our timely and effective modification of SEO practices implemented in response to periodic changes in search engine algorithms and methodologies and changes in search query trends. Our failure to successfully manage our SEO strategy could result in a substantial decrease in traffic to our owned and operated websites and to our customer websites through which we distribute our content, which would result in substantial decreases in conversion rates and repeat business, as well as increased costs if we were to replace free traffic with paid traffic. Any or all of these results would adversely affect our business, revenue, financial condition and results of operations.
 
Even if we succeed in driving traffic to our owned and operated websites and to our customer websites, neither we nor our advertisers and customers may be able to monetize this traffic or otherwise retain consumers. Our failure to do so could result in decreases in customers and related advertising revenue, which would have an adverse effect on our business, revenue, financial condition and results of operations.
 



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If Internet search engines' methodologies are modified, traffic to our owned and operated websites and to our customers' websites and corresponding consumer origination volumes could decline.
 
We depend in part on various Internet search engines, such as Google, Bing, Yahoo!, and other search engines to direct a significant amount of traffic to our owned and operated websites. For three months ended March 31, 2012, approximately 38% of the page view traffic directed to our owned and operated websites came directly from these Internet search engines (and a majority of the traffic from search engines came from Google), according to our internal data. Our ability to maintain the number of visitors directed to our owned and operated websites and to our customers' websites through which we distribute our content by search engines is not entirely within our control. Some of our owned and operated websites and our customers' websites have experienced fluctuations in search result rankings and we cannot provide assurance that similar fluctuations may not continue to occur in the future.
 
Changes in the methodologies or algorithms used by Google or other search engines to display results could cause our owned and operated websites or our customers' websites to receive less favorable placements or be removed from the search results.  Internet search engines could decide that content on our owned and operated websites and on our customers' websites, including content that is created by our freelance creative professionals, is unacceptable or violates their corporate policies.
 
Google, the largest provider of search engine referrals to the majority of the Company's websites, regularly deploys changes to its search engine algorithms, which have led the Company to experience fluctuations in the total number of Google search referrals to its owned and operated and network of customer websites. In 2011, the overall impact of these changes on the Company's owned and operated websites was negative primarily due to a decline in traffic to eHow.com, the Company's largest website.

There cannot be any assurance as to whether these changes or any future changes that may be made by Google or any other search engines might further impact our content and media business. Any reduction in the number of users directed to our owned and operated websites and to our customers' websites would likely negatively affect our ability to earn revenue. If traffic on our owned and operated websites and on our customers' websites declines, we may also need to resort to more costly sources to replace lost traffic, and such increased expense could adversely affect our business, revenue, cash flows, financial condition and results of operations.
 
We base our capital allocation decisions primarily on our analysis of the predicted internal rate of return on content. If the estimates and assumptions we use in calculating internal rate of return on content are inaccurate, our capital may be inefficiently allocated. If we fail to appropriately allocate our capital, our growth rate and financial results will be adversely affected.
 
We invest in content and content formats based on our calculation of the internal rate of return on previously published content cohorts for which we believe we have sufficient data. For purposes of these calculations, a content cohort is typically defined as all of the content we publish in a particular quarter. We calculate the internal rate of return on a cohort of content as the annual discount rate that, when applied to the advertising revenue, less certain direct ongoing costs, generated from the cohort over a period of time, produces an amount equal to the initial investment in that cohort. Our calculations are based on certain material estimates and assumptions that may not be accurate. Accordingly, the calculation of internal rate of return may not be reflective of our actual returns. The material estimates and assumptions upon which we rely include estimates about portions of the costs to create content and the revenue allocated to that content. We make estimates regarding when revenue for each cohort will be received. Our internal rate of return calculations are highly dependent on the timing of this revenue, with revenue earned earlier resulting in greater internal rates of return than the same amount of revenue earned in subsequent periods.
 
We use more estimates and assumptions to calculate the internal rate of return on video content because our systems and processes to collect historical data on video content are less robust. As a result, our data on video content may be less reliable. If our estimates and calculations do not accurately reflect the costs or revenue associated with our content, the actual internal rate of return of a cohort may be more or less than our estimated internal rate of return for such cohort. In such an event, we may misallocate capital and our growth, revenue, financial condition and results of operations could be negatively impacted.
 
We face significant competition to our Content & Media service offering, which we expect will continue to intensify, and we may not be able to maintain or improve our competitive position or market share.
 
We operate in highly competitive and still developing markets. We compete for advertisers and customers on the basis of a number of factors including return on marketing expenditures, price of our offerings, and ability to deliver large volumes or precise types of customer traffic. This competition could make it more difficult for us to provide value to our consumers, our

44



advertisers and our freelance creative professionals and result in increased pricing pressure, reduced profit margins, increased sales and marketing expenses, decreased website traffic and failure to increase, or the loss of, market share, any of which would likely seriously harm our business, revenue, financial condition and results of operations. There can be no assurance that we will be able to compete successfully against current or future competitors.
 
We face intense competition from a wide range of competitors, including online marketing and media companies, social media outlets, integrated social media platforms and other specialist and enthusiast websites. Our current principal competitors include:
 
Online Marketing and Media Companies.  We compete with other Internet marketing and media companies, such as AOL, About.com and various startup companies as well as leading online media companies such as Yahoo!, for online marketing budgets. Most of these competitors compete with us across several areas of consumer interest, such as do-it-yourself, health, home and garden, beauty and fashion, golf, outdoors and humor.

Social Media Outlets. We compete with social media outlets such as Facebook, Twitter and Google+, where brands and advertisers are focusing a significant portion of their online advertising spend in order to connect with their customers.
 
Integrated Social Media Applications.  We compete with various software technology competitors, such as Jive Software, in the integrated social media space where we offer our social media applications.

Specialized and Enthusiast Websites.  We compete with companies that provide specialized consumer information websites, particularly in the do-it-yourself, health, home and garden, beauty and fashion, golf, outdoors and humor categories, as well as enthusiast websites in specific categories, including message boards, blogs and other enthusiast websites maintained by individuals and other Internet companies.

Distributed Content Creation Platforms.  We compete with companies that employ a content creation model with aspects similar to our platform, such as the use of freelance creative professionals.
 
We may be subject to increased competition with any of these types of businesses in the future to the extent that they seek to devote increased resources to more directly address the online market for the professional creation of commercially valuable content at scale. For example, if Google chose to compete more directly with us, we may face the prospect of the loss of business or other adverse financial consequences given that Google possesses a significantly greater consumer base, financial resources, distribution channels and patent portfolio. In addition, should Google decide to directly compete with us in areas such as content creation, it may decide for competitive reasons to terminate or not renew our commercial agreements and, in such an event, we may experience a rapid decline in our revenue from the loss of our source for cost-per-click advertising on our owned and operated websites and on our network of customer websites. In addition, Google's access to more comprehensive data regarding user search queries through its search algorithms would give it a significant competitive advantage over everyone in the industry, including us. If this data is used competitively by Google, sold to online publishers or given away for free, our business may face increased competition from companies, including Google, with substantially greater resources, brand recognition and established market presence.
 
In addition to Google, many of our current and other potential competitors enjoy substantial competitive advantages, such as greater name recognition, longer operating histories, substantially greater financial, technical and other resources and, in some cases, the ability to combine their online marketing products with traditional offline media such as newspapers or magazines. These companies may use these advantages to offer products and services similar to ours at a lower price, develop different products to compete with our current offerings and respond more quickly and effectively than we can to new or changing opportunities, technologies, standards or customer requirements. For example, both AOL and Yahoo! may have access to proprietary search data which could be utilized to assist them in their content creation processes. In addition, many of our current and potential competitors have established marketing relationships with and access to larger customer bases. As the markets for online and social media expand, we expect new competitors, business models and solutions to emerge, some of which may be superior to ours. Even if our platform is more effective than the products and services offered by our competitors, potential customers might adopt competitive products and services in lieu of using our services. For all of these reasons, we may not be able to compete successfully against our current and potential competitors.
 
Our Content & Media service offering primarily generates its revenue from advertising, and the reduction in spending by or loss of advertisers could seriously harm our business.
 
We generated 55% and 49% of our revenue for three months ended March 31, 2011 and 2012, respectively, from

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advertising. One component of our platform that we use to generate advertiser interest in our content is our system of monetization tools, which is designed to match content with advertisements in a manner that maximizes revenue yield and end-user experience. Advertisers will not continue to do business with us if their investment in advertising with us does not generate sales leads, and ultimately customers, or if we do not deliver their advertisements in an appropriate and effective manner. The failure of our yield-optimized monetization technology to effectively match advertisements with our content in a manner that results in increased revenue for our advertisers would have an adverse impact on our ability to maintain or increase our revenue from advertising.
 
We rely on third-party ad-providers, such as Google, to provide advertisements on our owned and operated websites and on our network of customer websites. Even if our content is effectively matched with such ad content, we cannot assure our current advertisers will fulfill their obligations under their existing contracts, continue to provide advertisements beyond the terms of their existing contracts or enter into any additional contracts. If any of our advertisers, but in particular Google, decided not to continue advertising on our owned and operated websites and on our network of customer websites, we could experience a rapid decline in our revenue over a relatively short period of time.
 
In addition, our customers who receive a portion of the revenue generated from advertisements matched with our content displayed on their websites, may not continue to do business with us if our content does not generate increased revenue for them. If we are unable to remain competitive and provide value to advertisers they may stop placing advertisements with us or with our network of customer websites, which would negatively harm our business, revenue, financial condition and results of operations.

Furthermore, brands and advertisers are increasingly focusing a portion of their online advertising budgets on social media outlets such as Facebook. If this trend were to continue and we were unable to offer a competitive or similar advertising opportunity, this could adversely impact our ability to maintain or increase our revenue from advertising.

Lastly, we believe that advertising spending on the Internet, as in traditional media, fluctuates significantly as a result of a variety of factors, many of which are outside of our control. These factors include:
 
variations in expenditures by advertisers due to budgetary constraints;
 
the cancellation or delay of projects by advertisers;
 
the cyclical and discretionary nature of advertising spending;
 
general economic conditions, as well as economic conditions specific to the Internet and online and offline media industry; and
 
the occurrence of extraordinary events, such as natural disasters, international or domestic terrorist attacks or armed conflict.
 
If we are unable to generate advertising revenue due to factors outside of our control, then our business, financial condition and results of operations would be adversely affected.
 
Since the success of our Content & Media service offering has been closely tied to the success of eHow, if eHow's performance falters it could have a material adverse effect on our business, financial condition, and operations.
 
For three months ended March 31, 2011 and 2012, Demand Media generated approximately 35% and 28%, respectively, of our revenue from eHow. No other individual site was responsible for more than 10% of our revenue in these periods. In addition, most of the content that we published during these periods was published to eHow.
 
eHow depends on various Internet search engines to direct traffic to the site. For three months ended March 31, 2012, approximately 46% of eHow's page view traffic came from Google searches. The traffic directed to eHow and in turn the performance of the content created for and distributed on eHow may be adversely impacted by a number of factors related to Internet search engines, including the following: any further changes in search engine algorithms or methodologies similar to those recently implemented by Google, which changes had a negative effect on search referral traffic to eHow and a reduction in page views on eHow; our failure to properly manage SEO efforts for eHow; our failure to prevent internal technical issues that disrupt traffic to eHow; or reduced reliance by Internet users on search engines to locate relevant content. Additionally, we have already produced a significant amount of content that is housed on eHow and it may become difficult for us to continue to identify topics and produce content with the same level of broad consumer appeal as the content we have produced up to this

46



point. A material adverse effect on eHow could result in a material adverse effect to Demand Media and its business, financial condition, and results of operations.
 
Poor perception of our brands, business or industry could harm our reputation and adversely affect our business, financial condition and results of operations.
 
Our business is dependent on attracting a large number of visitors to our owned and operated websites and our network of customer websites and providing leads and clicks to our advertisers and customers, which depends in part on our reputation within the industry and with our customers. Because our business is transforming traditional content creation models and is therefore not easily understood by casual observers, our brands, business and reputation are vulnerable to poor perception. For example, perception that the quality of our content may not be the same or better than that of other published Internet content, even though baseless, can damage our reputation. We are frequently the subject of unflattering reports in the media about our business and our model. While disruptive businesses are often criticized early on in their life cycles, we believe we are more frequently targeted than most because of the nature of the business we are disrupting-namely the traditional print and publication media as well as popular Internet publishing methods such as blogging. Any damage to our reputation could harm our ability to attract and retain advertisers, customers and freelance creative professionals who create a majority of our content, which would materially adversely affect our results of operations, financial condition and business. Furthermore, certain of our owned and operated websites, such as LIVESTRONG.com and eHow, as well as some of the content we produce for our network of customer websites, are associated with high-profile experts to enhance the websites' brand recognition and credibility. In addition, any adverse news reports, negative publicity or other alienation of all or a segment of our consumer base relating to these high-profile experts would reflect poorly on our brands and could have an adverse effect on our business.
 
We rely primarily on creative professionals for a majority of our online content. We may not be able to attract or retain sufficient creative professionals to generate content on a scale or of a quality sufficient to grow our business. As we do not control those persons or the source of content, we are at risk of being unable to generate interesting and attractive features and other material content.
 
We rely primarily on freelance creative professionals for the content that we distribute through our owned and operated websites and our network of customer websites. We may not be able to attract or retain sufficient qualified and experienced creative professionals to generate content on a scale or of a quality sufficient to grow our business. For example, our premium video initiatives may require the engagement of producers, contributors, talent, editors and filmmakers with a specialized skill set, and there is no assurance that we will be able to engage such specialists in a cost-effective manner or at all. Furthermore, as we develop new content formats to meet changing consumer demand, we may not offer the volume of traditional content assignments that our creative professionals have grown accustomed to, and some of our creative professionals may seek assignments elsewhere or otherwise stop producing content for us. In addition, our competitors may attempt to attract members of our freelance creative professional community by offering compensation that we are unable to match. We believe that over the past four years our ability to attract and retain creative professionals has benefited from the weak overall labor market and from the difficulties and resulting layoffs occurring in traditional media, particularly newspapers. We are uncertain whether this combination of circumstances is likely to continue and any change to the economy or the media jobs market may make it more difficult for us to attract and retain freelance creative professionals. While each of our freelance creative professionals are screened through our pre-qualification process, we cannot guarantee that the content created by our creative professionals will be of sufficient quality to attract users to our owned and operated websites and to our network of customer websites. In addition, in the vast majority of cases we have no written agreements with these persons which obligate them to create articles or videos beyond the one article or video that they elect to create at any particular time and have no ability to control their future performance. As a result, we cannot guarantee that our freelance creative professionals will continue to contribute content to us for further distribution through our owned and operated websites and our network of customer websites or that the content that is created and distributed will be sufficient to sustain our current growth rates. In the event that these creative professionals decrease their contributions of such content, we are unable to attract or retain qualified creative professionals or if the quality of such contributions is not sufficiently attractive to our advertisers or to drive traffic to our owned and operated websites and to our network of customer websites, we may incur substantial costs in procuring suitable replacement content, which could have a negative impact on our business, revenue and financial condition.
 
We may not be successful in developing premium video content and other new content formats, which may limit our future growth and have a negative effect on our business, revenue, financial condition and results of operations.

One potential area of growth for us is in the development of new content formats such as premium video for distribution through our owned and operated websites and our network of customer websites. We recently entered into a multi-channel, premium video sponsorship relationship with YouTube, and we are investing in our content creation studio capabilities to increase our capacity to produce premium video content and other non-video longer-form and high quality content formats. We

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have limited experience in developing premium video content and other types of new content formats. We cannot be certain that we will be successful in producing new content formats or that our new content formats will gain market acceptance. Our inability to expand our content offerings may limit our future growth and have a negative effect on our business, revenue, financial condition and results of operations.

The loss of third-party data providers could significantly diminish the value of our services and cause us to lose customers and revenue.
 
We collect data regarding consumer search queries from a variety of sources. When a user accesses one of our owned and operated websites, we may have access to certain data associated with the source and specific nature of the visit to our website. We also license consumer search query data from third parties. Our Content & Media algorithms utilize this data to help us determine what content consumers are seeking, if that content is valuable to advertisers and whether we can cost-effectively produce this content. Some of these third-party consumer search data agreements are for perpetual licenses of a discrete amount of data and generally do not provide for updates of the data licensed. There can be no assurances that we will be able to enter into agreements with these third parties to license additional data on the same or similar terms, if at all. If we are not able to enter into agreements with these providers, we may not be able to enter into agreements with alternative third-party consumer search data providers on acceptable terms or on a timely basis or both. Any termination of our relationships with these consumer search data providers, or any entry into new agreements on terms and conditions less favorable to us, could limit the effectiveness of our content creation process, which would have a material adverse effect on our business, financial condition and results of operations. In addition, new laws or changes to existing laws in this area may prevent or restrict our use of this data. In such event, the value of our algorithms and our ability to determine what consumers are seeking could be significantly diminished.
 
If we are unable to attract new customers for our social media applications products or to retain our existing customers, our revenue could be lower than expected and our operating results may suffer.

Our enterprise-class social media tools allow websites to add feature-rich applications, such as user profiles, comments, forums, reviews, blogs, photo and video sharing, media galleries, groups and messaging offered through our social media application product suite. We also provide social media services by powering live events with social engagement tools. In addition to adding new customers for our social media products, to increase our revenue, we must sell additional social media products to existing customers and encourage existing customers to maintain or increase their usage levels. If our existing and prospective customers do not perceive our social media products to be of sufficiently high quality, we may not be able to retain our current customers or attract new customers. We sell our social media products pursuant to service agreements that are generally one to two years in length. Our customers have no obligation to renew their contracts for our products after the expiration of their initial commitment period, and these agreements may not be renewed at the same or higher level of service, if at all. In addition, these agreements generally require us to keep our product suite operational with minimal service interruptions and to provide limited credits to media customers in the event that we are unable to maintain these service levels. To date, service level credits have not been significant. Moreover, under some circumstances, some of our customers have the right to cancel their service agreements prior to the expiration of the terms of their agreements, including the right to cancel if our social media product suite suffers repeated service interruptions. If we are unable to attract new customers for our social media products, our existing customers do not renew or terminate their agreements for our social media products or we are required to provide service level credits in the future as a result of the operational failure of our social media products, then our operating results could be harmed.
 
Wireless devices and mobile phones are increasingly being used to access the Internet, and our online marketing services may not be as effective when accessed through these devices, which could cause harm to our business.
 
The number of people who access the Internet through devices other than personal computers has increased substantially in the last few years. In general our Content & Media services were designed for persons accessing the Internet on a desktop or laptop computer. The smaller screens, lower resolution graphics and less convenient typing capabilities of these devices may make it more difficult for visitors to respond to our offerings. In addition, mobile advertising yields are currently frequently lower than those on other devices. We must also ensure that our licensing arrangements with third-party content providers allow us to make this content available on these devices. If we cannot effectively make our content, products and services available on these devices, fewer consumers may access and use our content, products and services. Also, if our services continue to be less effective or economically attractive for customers seeking to engage in advertising through these devices and this segment of Internet traffic grows at the expense of traditional computer Internet access, we will experience difficulty attracting website visitors and attracting and retaining customers and our operating results and business will be harmed.
 
We are dependent upon the quality of traffic in our network to provide value to online advertisers, and any failure in our

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quality control could have a material adverse effect on the value of our websites to our third-party advertisement distribution providers and online advertisers and adversely affect our revenue.

We use technology and processes to monitor the quality of, and to identify any anomalous metrics associated with, the Internet traffic that we deliver to online advertisers and our network of customer websites. These metrics may be indicative of low quality clicks such as non-human processes, including robots, spiders or other software; the mechanical automation of clicking; and other types of invalid clicks or click fraud. Even with such monitoring in place, there is a risk that a certain amount of low-quality traffic, or traffic that is deemed to be invalid by online advertisers, will be delivered to such online advertisers. As a result, we may be required to credit future amounts owed to us by our advertisers. Furthermore, low-quality or invalid traffic may be detrimental to our relationships with third-party advertisement distribution providers and online advertisers, and could adversely affect our revenue.
 
The expansion of our owned and operated websites into new areas of consumer interest, products, services and technologies subjects us to additional business, legal, financial and competitive risks.
 
An important element of our business strategy is to grow our network of owned and operated websites to cover new areas of consumer interest, expand into new business lines and develop additional services, products and technologies. In directing our focus into new areas, we face numerous risks and challenges, including increased capital requirements, long development cycles, new competitors and the requirement to develop new strategic relationships. We cannot assure you that our strategy will result in increased net sales or net income. Furthermore, growth into new areas may require changes to our existing business model and cost structure, modifications to our infrastructure and exposure to new regulatory and legal risks, any of which may require expertise in areas in which we have little or no experience. If we cannot generate revenue as a result of our expansion into new areas that are greater than the cost of such expansion, our operating results could be harmed.
 
As a creator and a distributor of Internet content, we face potential liability and expenses for legal claims based on the nature and content of the materials that we create or distribute, or that are accessible via our owned and operated websites and our network of customer websites. If we are required to pay damages or expenses in connection with these legal claims, our operating results and business may be harmed.
 
We rely on the work product of freelance creative professionals to create original content for our owned and operated websites and for our network of customer websites and for use in our marketing messages. As a creator and distributor of original content and third-party provided content, we face potential liability based on a variety of theories, including defamation, negligence, unlawful practice of a licensed profession, copyright or trademark infringement or other legal theories based on the nature, creation or distribution of this information, and under various laws, including the Lanham Act and the Copyright Act. We may also be exposed to similar liability in connection with content that we do not create but that is posted to our owned and operated websites and to our network of customer websites by users and other third parties through forums, comments, personas and other social media features. In addition, it is also possible that visitors to our owned and operated websites and to our network of customer websites could make claims against us for losses incurred in reliance upon information provided on our owned and operated websites or our network of customer websites. These claims, whether brought in the United States or abroad, could divert management time and attention away from our business and result in significant costs to investigate and defend, regardless of the merit of these claims. If we become subject to these or similar types of claims and are not successful in our defense, we may be forced to pay substantial damages. While we run our content through a rigorous quality control process, including an automated plagiarism program, there is no guarantee that we will avoid future liability and potential expenses for legal claims based on the content of the materials that we create or distribute. Should the content distributed through our owned and operated websites and our network of customer websites violate the intellectual property rights of others or otherwise give rise to claims against us, we could be subject to substantial liability, which could have a negative impact on our business, revenue and financial condition.

We may face liability in connection with our undeveloped owned and operated websites and our customers' undeveloped websites whose domain names may be identical or similar to another party's trademark or the name of a living or deceased person.

A number of our owned and operated websites and our network of customer websites are undeveloped or minimally developed properties that primarily contain advertising listings and links. As part of our registration process, we perform searches, analysis and screenings to determine if the domain names of our owned and operated websites in combination with the advertisements displayed on those sites violate the trademark or other rights owned by third parties. Despite these efforts, we may inadvertently register the domain names of properties that are identical or similar to another party's trademark or the name of a living or deceased person. Moreover, our efforts are inherently limited due to the fact that the advertisements displayed on our undeveloped websites are delivered by third parties and the advertisements may vary over time or based on

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the location of the viewer. We may face primary or secondary liability in the United States under the Anticybersquatting Consumer Protection Act or under general theories of trademark infringement or dilution, unfair competition or under rights of publicity with respect to the domain names used for our owned and operated websites. If we fail to comply with these laws and regulations, we could be exposed to claims for damages, financial penalties and reputational harm, which could increase our costs of operations, reduce our profits or cause us to forgo opportunities that would otherwise support our growth.
 
We may not succeed in establishing our businesses internationally, which may limit our future growth.
 
One potential area of growth for us is in the international markets. We have launched a site in the United Kingdom, recently launched a beta version of eHow en Español (a Spanish language site that targets both the U.S. Hispanic market, as well as the larger Spanish-speaking market worldwide) and are exploring launches in certain other countries. We have also been investing in translation capabilities for our technologies. We recently acquired a Spanish language content creation business platform located in Argentina. Operating internationally, where we have limited experience, exposes us to additional risks and operating costs. We cannot be certain that we will be successful in introducing or marketing our services internationally or that our services will gain market acceptance or that growth in commercial use of the Internet internationally will continue. There are risks inherent in conducting business in international markets, including the need to localize our products and services to foreign customers' preferences and customs, difficulties in managing operations due to language barriers, distance, staffing and cultural differences, application of foreign laws and regulations to us, tariffs and other trade barriers, fluctuations in currency exchange rates, establishing management systems and infrastructures, reduced protection for intellectual property rights in some countries, changes in foreign political and economic conditions, and potentially adverse tax consequences. Our inability to expand and market our products and services internationally may have a negative effect on our business, revenue, financial condition and results of operations.
 

Risks Relating to our Registrar Service Offering
 
 
We face significant competition to our Registrar service offering, which we expect will continue to intensify. We may not be able to maintain or improve our competitive position or market share.
 
We face significant competition from existing registrars and from new registrars that continue to enter the market. ICANN currently has approximately 1,000 registrars to register domain names in one or more of the generic top level domains, or gTLDs, that it oversees. There are relatively few barriers to entry in this market, so as this market continues to develop we expect the number of competitors to increase. The continued entry into the domain name registration market of competitive registrars and unaccredited entities that act as resellers for registrars, and the rapid growth of some competitive registrars and resellers that have already entered the market, may make it difficult for us to maintain our current market share.
 
The anticipated introduction of new gTLDs by ICANN (the "New gTLD Program") could substantially change the domain name industry in unexpected ways. If we do not properly manage our response to the change in business environment, it could adversely impact our competitive position or market share.

The market for domain name registration and other related web-based services is intensely competitive and rapidly evolving. We expect competition to increase from existing competitors as well as from new market entrants. Most of our existing competitors are expanding the variety of services that they offer. These competitors include, among others, domain name registrars, website design firms, website hosting companies, Internet service providers, Internet portals and search engine companies, including GoDaddy, Network Solutions, Tucows, Microsoft and Yahoo!. Some of these competitors have greater resources, more brand recognition and consumer awareness, greater international scope, larger customer bases and larger bases of existing customers than we do. As a result, we may not be able to compete successfully against them in future periods.

In addition, these and other large competitors, in an attempt to gain market share, may offer aggressive price discounts on the services they offer. These pricing pressures may require us to match these discounts in order to remain competitive, which would reduce our margins, or cause us to lose customers who decide to purchase the discounted service offerings of our competitors. As a result of these factors, in the future it may become increasingly difficult for us to compete successfully.
 
If our customers do not renew their domain name registrations or if they transfer their existing registrations to our competitors and we fail to replace their business, our business would be adversely affected.
 
Our success depends in large part on our customers' renewals of their domain name registrations. Registrar revenue, which is closely tied to domain name registrations represented approximately 35% and 37% of total revenue in three months ended

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March 31, 2011 and 2012, respectively. Our customer renewal rate for expiring domain name registrations was approximately 74% and 79% in three months ended March 31, 2011 and 2012, respectively. If we are unable to maintain or increase our overall renewal rates for domain name registrations or if any decrease in our renewal rates, including due to transfers, is not offset by increases in new customer growth rates, our customer base and our revenue would likely decrease. This would also reduce the number of domain name registration customers to whom we could market our other higher-margin services, thereby further potentially impacting our revenue and profitability, driving up our customer acquisition costs and harming our operating results. Since our strategy is to expand the number of services we provide to our customers, any decline in renewals of domain name registrations not offset by new domain name registrations would likely have an adverse effect on our business, revenue, financial condition and results of operations.
 
Regulation could reduce the value of Internet domain names or negatively impact the Internet domain name acquisition process, which could significantly impair the value attributable to our acquisitions of Internet domain names.
 
The acquisition of expiring domain names for development, undeveloped website commercialization, sale or other uses, involves the registration of thousands of Internet domain names, both with registries in the United States and internationally. We have and intend to continue to acquire previously-owned Internet domain names that have expired and that, following the period of permitted redemption by their prior owners, have been made available for registration. The acquisition of Internet domain names generally is governed by regulatory bodies. The regulation of Internet domain names in the United States and in foreign countries is subject to change. Regulatory bodies could establish additional requirements for previously-owned Internet domain names or modify the requirements for holding Internet domain names. As a result, we might not acquire or maintain names that contribute to our financial results in the same manner as we currently do. A failure to acquire or maintain such Internet domain names could adversely affect our business, revenue, financial condition and results of operations.
 
We could face liability, or our corporate image might be impaired, as a result of the activities of our customers or the content of their websites.
 
Our role as a registrar of domain names and a provider of website hosting services may subject us to potential liability for illegal activities by our customers on their websites. For example, we were named as a party to a lawsuit that has subsequently been dismissed in which a group registered a domain name through our registrar and proceeded to fill the site with content that was allegedly defamatory to another business whose name is similar to the domain name. We have also been criticized in the past for not being more proactive in policing online pharmacies acting in violation of U.S. laws. We provide an automated service that enables users to register domain names and populate websites with content. We do not monitor or review, nor does our accreditation agreement with ICANN require that we monitor or review, the appropriateness of the domain names we register for our customers or the content of our network of customer websites, and we have no control over the activities in which our customers engage. While we have policies in place to terminate domain names or to take other appropriate action if presented with a court order, governmental injunction or evidence of illegal conduct from law enforcement or a trusted industry partner, we have in the past been publicly criticized for not being more proactive in this area by consumer watchdogs and we may encounter similar criticism in the future. This criticism could harm our reputation. Conversely, were we to terminate a domain name registration in the absence of legal compulsion or clear evidence of illegal conduct from a legitimate source, we could be criticized for prematurely and improperly terminating a domain name registered by a customer. In addition, despite the policies we have in place to terminate domain name registrations or to take other appropriate actions, customers could nonetheless engage in prohibited activities.
 
Several bodies of law may be deemed to apply to us with respect to various customer activities. Because we operate in a relatively new and rapidly evolving industry, and since this field is characterized by rapid changes in technology and in new and growing illegal activity, these bodies of laws are constantly evolving. Some of the laws that apply to us with respect to customer activity include the following:
 
The Communications Decency Act of 1996, or CDA, generally protects online service providers, such as Demand Media, from liability for certain activities of their customers, such as posting of defamatory or obscene content, unless the online service provider is participating in the unlawful conduct. Notwithstanding the general protections from liability under the CDA, we may nonetheless be forced to defend ourselves from claims of liability covered by the CDA, resulting in an increased cost of doing business.

The Digital Millennium Copyright Act of 1998, or DMCA, provides recourse for owners of copyrighted material who believe that their rights under U.S. copyright law have been infringed on the Internet. Under this statute, we generally are not liable for infringing content posted by third parties. However, if we receive a proper notice from a copyright owner alleging infringement of its protected works by web pages for which we provide hosting services, and we fail to expeditiously remove or disable access to the allegedly infringing material, fail to post and enforce a

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digital rights management policy or a policy to terminate accounts of repeat infringers, or otherwise fail to meet the requirements of the safe harbor under the statute, the owner may seek to impose liability on us.
 
Although established statutory law and case law in these areas to date generally have shielded us from liability for customer activities, court rulings in pending or future litigation may serve to narrow the scope of protection afforded us under these laws. In addition, laws governing these activities are unsettled in many international jurisdictions, or may prove difficult or impossible for us to comply with in some international jurisdictions. Also, notwithstanding the exculpatory language of these bodies of law, we may be embroiled in complaints and lawsuits which, even if ultimately resolved in our favor, add cost to our doing business and may divert management's time and attention. Finally, other existing bodies of law, including the criminal laws of various states, may be deemed to apply or new statutes or regulations may be adopted in the future, any of which could expose us to further liability and increase our costs of doing business.

We may face liability or become involved in disputes over registration of domain names and control over websites.
 
As a domain name registrar, we regularly become involved in disputes over registration of domain names. Most of these disputes arise as a result of a third party registering a domain name that is identical or similar to another party's trademark or the name of a living person. These disputes are typically resolved through the Uniform Domain-Name Dispute-Resolution Policy, or UDRP, ICANN's administrative process for domain name dispute resolution, or less frequently through litigation under the Anticybersquatting Consumer Protection Act, or ACPA, or under general theories of trademark infringement or dilution. The UDRP generally does not impose liability on registrars, and the ACPA provides that registrars may not be held liable for registering or maintaining a domain name absent a showing of bad faith intent to profit or reckless disregard of a court order by the registrars. However, we may face liability if we fail to comply in a timely manner with procedural requirements under these rules. In addition, these processes typically require at least limited involvement by us, and therefore increase our cost of doing business. The volume of domain name registration disputes may increase in the future as the overall number of registered domain names increases.
 
Domain name registrars also face potential tort law liability for their role in wrongful transfers of domain names. The safeguards and procedures we have adopted may not be successful in insulating us against liability from such claims in the future. In addition, we face potential liability for other forms of “domain name hijacking,” including misappropriation by third parties of our network of customer domain names and attempts by third parties to operate websites on these domain names or to extort the customer whose domain name and website were misappropriated. Furthermore, our risk of incurring liability for a security breach on a customer website would increase if the security breach were to occur following our sale to a customer of an SSL certificate that proved ineffectual in preventing it. Finally, we are exposed to potential liability as a result of our private domain name registration service, wherein we become the domain name registrant, on a proxy basis, on behalf of our customers. While we have a policy of providing the underlying Whois information and reserve the right to cancel privacy services on domain names giving rise to domain name disputes including when we receive reasonable evidence of an actionable harm, the safeguards we have in place may not be sufficient to avoid liability in the future, which could increase our costs of doing business.
 
We may experience unforeseen liabilities in connection with our acquisition of Internet domain names or arising out of third-party domain names included in our distribution network, which could negatively impact our financial results.
 
We have acquired and intend to continue to acquire in the future additional previously-owned Internet domain names. While we have a policy against acquiring domain names that infringe on third-party intellectual property rights, including trademarks or confusingly similar business names, in some cases, these acquired names may have trademark significance that is not readily apparent to us or is not identified by us in the bulk purchasing process. As a result we may face demands by third-party trademark owners asserting infringement or dilution of their rights and seeking transfer of acquired Internet domain names under the UDRP administered by ICANN or actions under the ACPA. Additionally, we display paid listings on third-party domain names and third-party websites that are part of our distribution network, which also could subject us to a wide variety of civil claims including intellectual property infringement.
 
We intend to review each claim or demand which may arise from time to time on a case-by-case basis with the assistance of counsel and we intend to transfer any rights acquired by us to any party that has demonstrated a valid prior right or claim. We cannot, however, guarantee that we will be able to resolve these disputes without litigation. The potential violation of third-party intellectual property rights and potential causes of action under consumer protection laws may subject us to unforeseen liabilities including injunctions and judgments for money damages.

Our failure to register, maintain, secure, transfer or renew the domain names that we process on behalf of our customers or to provide our other services to our customers without interruption could subject us to additional expenses, claims of loss or

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negative publicity that have a material adverse effect on our business.
 
Clerical errors and system and process failures made by us may result in inaccurate and incomplete information in our database of domain names and in our failure to properly register or to maintain, secure, transfer or renew the registration of domain names that we process on behalf of our customers. In addition, any errors of this type might result in the interruption of our other services. Our failure to properly register or to maintain, secure, transfer or renew the registration of our customers' domain names or to provide our other services without interruption, even if we are not at fault, might result in our incurring significant expenses and might subject us to claims of loss or to negative publicity, which could harm our business, revenue, financial condition and results of operations.
 
Governmental and regulatory policies or claims concerning the domain name registration system, and industry reactions to those policies or claims, may cause instability in the industry, disrupt our domain name registration business and negatively impact our business.
 
ICANN is a private sector, not for profit corporation formed in 1998 for the express purposes of overseeing a number of Internet related tasks previously performed directly on behalf of the U.S. government, including managing the domain name registration system. ICANN has been subject to strict scrutiny by the public and by the United States government. For example, in the United States, Congress has held hearings to evaluate ICANN's selection process for new top level domains. In addition, ICANN faces significant questions regarding its financial viability and efficacy as a private sector entity. ICANN may continue to evolve both its long term structure and mission to address perceived shortcomings such as a lack of accountability to the public and a failure to maintain a diverse representation of interests on its board of directors. We continue to face the risks that:

the U.S. or any other government may reassess its decision to introduce competition into, or ICANN's role in overseeing, the domain name registration market;
 
the Internet community or the U.S. Department of Commerce or U.S. Congress may refuse to recognize ICANN's authority or support its policies, which could create instability in the domain name registration system;
 
some of ICANN's policies and practices, and the policies and practices adopted by registries and registrars, could be found to conflict with the laws of one or more jurisdictions;
 
the terms of the Registrar Accreditation Agreement, under which we are accredited as a registrar, could change in ways that are disadvantageous to us or under certain circumstances could be terminated by ICANN preventing us from operating our Registrar;
 
ICANN and, under their registry agreements, VeriSign and other registries may impose increased fees received for each ICANN accredited registrar and/or domain name registration managed by those registries;
 
international regulatory or governing bodies, such as the International Telecommunications Union or the European Union, may gain increased influence over the management and regulation of the domain name registration system, leading to increased regulation in areas such as taxation and privacy;
 
ICANN or any registries may implement policy changes that would impact our ability to run our current business practices throughout the various stages of the lifecycle of a domain name; and
 
foreign constituents may succeed in their efforts to have domain name registration removed from a U.S. based entity and placed in the hands of an international cooperative.

If any of these events occur, they could create instability in the domain name registration system. These events could also disrupt or suspend portions of our domain name registration solution, which would result in reduced revenue.
 
The relevant domain name registry and the ICANN regulatory body impose a charge upon each registrar for the administration of each domain name registration. If these fees increase, it would have a significant impact upon our operating results.
 
Each registry typically imposes a fee in association with the registration of each domain name. For example, VeriSign, the registry for .com, presently charges a $7.85 fee for each .com registration after a recently enacted 7% fee increase. ICANN charges a $0.18 fee for each domain name registered in the generic top level domains, or gTLDs, that fall within its purview. We have no control over these agencies and cannot predict when they may increase their respective fees. In terms of the

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registry agreement between ICANN and VeriSign that was approved by the U.S. Department of Commerce on November 30, 2006, VeriSign will continue as the exclusive registry for the .com gTLD through at least November 30, 2012. The recently announced 7% fee increase is the final fee increase authorized under the current registry agreement for the .com TLD. The increase in these fees either must be included in the prices we charge to our service providers, imposed as a surcharge or absorbed by us. If we absorb such cost increases or if surcharges act as a deterrent to registration, we may find that our profits are adversely impacted by these third-party fees.
 
We intend to participate in ICANN's New gTLD Program, which may present us with unique operational and other risks. If we are unsuccessful in managing these risks, our business, financial condition and results of operations could be adversely affected.

We are pursuing certain opportunities in connection with ICANN's New gTLD Program, which would include operating the back-end infrastructure for new gTLD registries and/or owning and operating one or more of our own gTLDs. We currently have no operating experience providing back-end registry services to existing registries or acting as an owner and operator of domain name registries for gTLD strings. Our participation in the New gTLD Program would involve us in new and complex processes with respect to the application and awarding of gTLD strings by ICANN, as well as require us to rely upon, negotiate and collaborate with independent third parties. In addition, we would compete with other established and more experienced operators in these proposed service offerings. If we are unsuccessful in managing these risks, our business, financial condition and results of operations could be adversely affected.

We may lose all or some of our investment under our gTLD initiative in connection with the New gTLD Program, which could adversely affect our business, financial condition and results of operations.

We have invested approximately $18 million in connection with our gTLD initiative to pursue the opportunity to be a registry operator of new gTLDs under ICANN's New gTLD Program.  There can be no assurances that we will be successful in acquiring gTLDs or that we will be granted the right to be a registry operator by ICANN.  If we are unsuccessful, we may lose all or some of our investment under our gTLD initiative in connection with the New gTLD Program, which could adversely affect our business, financial condition and results of operation.

As the number of available domain names with commercial value diminishes over time, our domain name registration revenue and our overall business could be adversely impacted.
 
As the number of domain registrations increases and the number of available domain names with commercial value diminishes over time, and if it is perceived that the more desirable domain names are generally unavailable, fewer Internet users might register domain names with us. If this occurs, it could have an adverse effect on our domain name registration revenue and our overall business. 

Risks Relating to our Company
 

We have a history of operating losses and may not be able to operate profitably or sustain positive cash flow in future periods.
 
We were founded in 2006 and have a limited operating history. We have had a net loss in every year since inception. As of March 31, 2012, we had an accumulated deficit of approximately $72.6 million and we may incur net operating losses in the future. Moreover, our cash flows from operating activities in the future may not be sufficient to fund our desired level of investments in the production of content and the purchase of property and equipment, domain names and other intangible assets. Our business strategy contemplates making continued investments and expenditures in our content creation and distribution platform as well as the development and launch of new products and services. In addition, as a public company, we have incurred and will continue to incur significant legal, accounting and other expenses that we did not incur as a private company. Our ability to generate net income in the future will depend in large part on our ability to generate and sustain substantially increased revenue levels, while continuing to control our expenses. We may incur significant losses in the future for a number of reasons, including those discussed in other risk factors and factors that we cannot foresee. Our inability to generate net income and sufficient positive cash flows would materially and adversely affect our business, revenue, financial condition and results of operations.
 
We expect a number of factors to cause our operating results to fluctuate on a quarterly and annual basis, which may make it difficult to predict our future performance.
 

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Our revenue and operating results could vary significantly from quarter-to-quarter and year-to-year and may fail to match our past performance because of a variety of factors, many of which are outside of our control. In particular, our operating expenses are fixed and variable and, to the extent variable, less flexible to manage period-to-period, especially in the short-term. For example, our ability to manage our expenses in the near term period-to-period is affected by our sales and marketing expenses to refer traffic to or promote our owned and operated websites, generally a variable expense which can be managed based on operating performance in the near term. This expense has historically represented a relatively small percentage of our operating expenses. In addition, comparing our operating results on a period-to-period basis may not be meaningful. In addition to other risk factors discussed in this section, factors that may contribute to the variability of our quarterly and annual results include:
 
lower than anticipated levels of traffic to our owned and operated websites and to our customers' websites;
 
our ability to generate revenue from traffic to our owned and operated websites and to our network of customer websites;
 
failure of our content to generate sufficient or expected revenue during its estimated useful life to recover its unamortized creation costs, which may result in increased amortization expenses associated with, among other things, a decrease in the estimated useful life of our content, an impairment charge associated with our existing content, or expensing future content acquisition costs as incurred;

creation of content in the future that may have a shorter estimated useful life as compared to our current portfolio of content, or which we license exclusively to third parties for periods that are less than the estimated useful life of our existing content, which may result in, among other things, increased content amortization expenses or the expensing of future content acquisition costs as incurred;
 
our ability to continue to create and develop content and content formats that attract users to our owned and operated websites and to our network of customer websites that distribute our content;
 
our ability to expand our existing distribution network to include emerging and alternative channels, including complementary social media platforms such as Facebook, Google+ and Twitter, dedicated applications for mobile platforms such as the iPhone, Blackberry and Android operating systems, and new types of devices used to access the Internet such as tablet computers ;

our ability to identify acquisition targets and successfully integrate acquired businesses into our operations;
 
our ability to attract and retain sufficient qualified and experienced freelance creative professionals to generate content formats on a scale sufficient to grow our business, as we continue to evolve the formats of content that we produce;
 
our ability to effectively manage our freelance creative professionals, direct advertising sales force, in-house personnel and operations;
 
a reduction in the number of domain names under management or in the rate at which this number grows, due to slow growth or contraction in our markets, lower renewal rates or other factors;
 
reductions in the percentage of our domain name registration customers who purchase additional services from us;
 
timing of and revenue recognition for large sales transactions such as significant new contracts for branded advertising;
 
the mix of services sold in a particular period between our Registrar and our Content & Media service offerings;
 
changes in our pricing policies or those of our competitors, changes in domain name fees charged to us by Internet registries or the Internet Corporation for Assigned Names and Numbers, or ICANN, or other competitive pressures on our prices;

our ability to identify, develop and successfully launch new products and services;

the timing and success of new services and technology enhancements introduced by our competitors, which could impact both new customer growth and renewal rates;

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the entry of new competitors in our markets;
 
our ability to keep our platform, domain name registration services and our owned and operated websites operational at a reasonable cost and without service interruptions;
 
increased product development expenses relating to the development of new services;
 
the amount and timing of operating costs and capital expenditures related to the maintenance and expansion of our services, operations and infrastructure;
 
changes in generally accepted accounting principles;
 
our focus on long-term goals over short-term results;
 
federal, state or foreign regulation affecting our business; and
 
weakness or uncertainty in general economic or industry conditions.
 
It is possible that in one or more future quarters, due to any of the factors listed above, a combination of those factors or other reasons, our operating results may be below our expectations and the expectations of public market analysts and investors. In that event, the price of our shares of common stock could decline substantially.
 
Changes in our business model or external developments in our industry could negatively impact our operating margins.
 
Our operating margins may experience downward pressure as a result of increasing competition and increased expenditures for many aspects of our business, including expenses related to content creation. For example, historically, we have focused on the creation of shorter-form text articles or standard videos for our owned and operated websites, including "how to" articles for eHow. However, as we increase the number of longer-form or "feature" articles or premium videos or choose to create other forms of content formats, and in turn reduce our investment in the shorter-form types of content, our operating margins may suffer as these other forms of content may be more expensive to create and the corresponding return on investment, if any, could be reduced. In addition, we intend to enter into additional revenue sharing arrangements with our customers which could cause our operating margins to experience downward pressure if a greater percentage of our revenue comes from advertisements placed on our network of customer websites compared to advertisements placed on our owned and operated websites. Additionally, the percentage of advertising fees that we pay to our customers may increase, which would reduce the margin we earn on revenue generated from those customers.
 
Our historic revenue growth rate may not be sustainable.
 
Our revenue increased rapidly in each of the fiscal years ended December 31, 2008 through December 31, 2011. We may not be able to sustain our revenue growth rate in future periods and you should not rely on the revenue growth of any prior quarterly or annual period as an indication of our future performance. If our future growth fails to meet investor or analyst expectations, it could have a materially negative effect on our stock price. If our growth rate were to decline significantly or become negative, it would adversely affect our business, financial condition and results of operations.

If we do not effectively manage our growth, our operating performance will suffer and we may lose consumers, advertisers, customers and freelance creative professionals.
 
We have experienced rapid growth in our operations since our founding in 2006, and we may experience continued growth in our business, both through internal growth and potential acquisitions. For example, our employee headcount grew from approximately 475 to over 600 in the three years ended December 31, 2011. This overall growth has placed, and will continue to place, significant demands on our management and our operational and financial infrastructure. In particular, continued growth may make it more difficult for us to accomplish the following:
 
successfully scale our technology and infrastructure to support a larger business;
 
continue to grow our platform at scale and distribute through our new and existing properties while successfully monetizing our content;
 

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maintain our standing with key advertisers as well as Internet search companies and our network of customer websites;
 
maintain our customer service standards;
 
develop and improve our operational, financial and management controls and maintain adequate reporting systems and procedures;
 
acquire and integrate websites and other businesses;
 
successfully expand our footprint in our existing areas of consumer interest and enter new areas of consumer interest; and
 
respond effectively to competition and potential negative effects of competition on profit margins.
 
In addition, our personnel, systems, procedures and controls may be inadequate to support our current and future operations. The improvements required to manage our growth will require us to make significant expenditures, expand, train and manage our employee base and allocate valuable management resources. If we fail to effectively manage our growth, our operating performance will suffer and we may lose our advertisers, customers and key personnel.
 
If we do not continue to innovate and provide products and services that are useful to our customers, we may not remain competitive, and our revenue and operating results could suffer.
 
Our success depends on our ability to innovate and provide products and services useful to our customers in both our Content & Media and Registrar service offerings. Our competitors are constantly developing innovations in content creation and distribution as well as in domain name registration and related services, such as web hosting, email and website creation solutions. As a result, we must continue to invest significant resources in product development in order to maintain and enhance our existing products and services and introduce new products and services that deliver a sufficient return on investment and that our customers can easily and effectively use. If we are unable to provide quality products and services, we may lose consumers, advertisers, customers and freelance creative professionals, and our revenue and operating results would suffer. Our operating results would also suffer if our innovations are not responsive to the needs of our customers and our advertisers, are not appropriately timed with market opportunities or are not effectively brought to market.

Our industry is undergoing rapid change, and our business model is also evolving, which makes it difficult to evaluate our current business and future prospects.
We derive a significant portion of our revenue from the sale of advertising on the Internet, which is an evolving industry that has undergone rapid and dramatic changes in industry standards, consumer and customer demands and advertising trends. In addition, our business model is also evolving and is distinct from many other companies in our industry, and it may not lead to long-term growth or success. For example, the ways in which online advertisements are delivered are rapidly changing and an increasing percentage of advertisements are being delivered through social media websites and platforms as opposed to traditional portals or content websites. If advertisers determine that their yields on such social media sites significantly outstrip their return on other types of websites, such as our owned and operated websites, our business and operating results could be adversely impacted. We need to continually evolve our services and the way we deliver them in order to keep up with such changes to remain relevant to our customers, and we may not be able to do so quickly, cost-effectively or at all.
We have made and may make additional acquisitions that could entail significant execution, integration and operational risks.

We have made numerous acquisitions in the past, including four in 2011, and our future growth may depend, in part, on acquisitions of complementary websites, businesses, solutions or technologies rather than internal development. We may continue to make acquisitions in the future to increase the scope of our business domestically and internationally. The identification of suitable acquisition candidates can be difficult, time-consuming and costly, and we may not be able to successfully complete identified acquisitions. If we are unable to identify suitable future acquisition opportunities, reach agreement with such parties or obtain the financing necessary to make such acquisitions, we could lose market share to competitors who are able to make such acquisitions. This loss of market share could negatively impact our business, revenue and future growth.

Furthermore, even if we successfully complete an acquisition, we may not be able to successfully assimilate and integrate

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the websites, business, technologies, solutions, personnel or operations of the company that we acquired, particularly if key personnel of an acquired company decide not to work for us. In addition, we may incur indebtedness to complete an acquisition, which would increase our costs and impose operational limitations, or issue equity securities, which would dilute our stockholders' ownership and could adversely affect the price of our common stock. We may also unknowingly inherit liabilities from previous or future acquisitions that arise after the acquisition and are not adequately covered by indemnities.

We may have difficulty scaling and adapting our existing technology and network infrastructure to accommodate increased traffic and technology advances or changing business requirements, which could lead to the loss of consumers, advertisers, customers and freelance creative professionals, and cause us to incur expenses to make architectural changes.
 
To be successful, our network infrastructure has to perform well and be reliable. The greater the user traffic and the greater the complexity of our products and services, the more computing power we will need. In the future, we may spend substantial amounts to purchase or lease data centers and equipment, upgrade our technology and network infrastructure to handle increased traffic on our owned and operated websites and roll out new products and services. This expansion could be expensive and complex and could result in inefficiencies or operational failures. If we do not implement this expansion successfully, or if we experience inefficiencies and operational failures during its implementation, the quality of our products and services and our users' experience could decline. This could damage our reputation and lead us to lose current and potential consumers, advertisers, customers and freelance creative professionals. The costs associated with these adjustments to our architecture could harm our operating results. Cost increases, loss of traffic or failure to accommodate new technologies or changing business requirements could harm our business, revenue and financial condition.
If the security measures for our systems are breached, or if our products or services are subject to attacks that degrade or deny the ability of administrators, developers, users and customers to maintain or access them, our systems, products and services may be perceived as not being secure.  If any such events occur, users, customers, advertisers and publishers may curtail or stop using our products and services, and we may incur significant legal and financial exposure, all of which could have a negative impact on our business, financial condition and results of operations.

Some of our systems, products and services involve the storage and transmission of information regarding our users, customers, and our advertising and publishing partners, and security breaches could expose us to a risk of loss of this information, litigation, and potential liability. Our security measures may be breached due to the actions of outside parties, employee error, malfeasance, or otherwise, and, as a result, an unauthorized party may obtain access to this information. Additionally, outside parties may attempt to fraudulently induce employees, users, or customers to disclose sensitive information in order to gain access to our systems and the stored data therein. Any such breach or unauthorized access could result in significant legal and financial exposure, damage to our reputation, and a loss of confidence in the security of our systems, products and services that could potentially have an adverse effect on our business, financial condition and results of operations. Because the techniques used to obtain unauthorized access, disable or degrade service, or sabotage systems change frequently and often are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures. If an actual or perceived breach of our security occurs, the market perception of the effectiveness of our security measures could be harmed and we could lose users, customers, advertisers or publishers.

If we do not adequately protect our intellectual property rights, our competitive position and business may suffer.
Our intellectual property, consisting of trade secrets, trademarks, copyrights and patents, is, in the aggregate, important to our business. We rely on a combination of trade secret, trademark, copyright and patent laws in the United States and other jurisdictions together with confidentiality agreements and technical measures to protect our proprietary rights. We rely more heavily on trade secret protection than patent protection. To protect our trade secrets, we control access to our proprietary systems and technology and enter into confidentiality and invention assignment agreements with our employees and consultants and confidentiality agreements with other third parties. Effective trade secret, copyright, trademark and patent protection may not be available in all countries where we currently operate or in which we may operate in the future. In addition, because of the relatively high cost we would experience in registering all of our copyrights with the United States Copyright Office, we generally do not register the copyrights associated with our content. We cannot guarantee that:
our intellectual property rights will provide competitive advantages to us;
our ability to assert our intellectual property rights against potential competitors or to settle current or future disputes will not be limited by our agreements with third parties;
our intellectual property rights will be enforced in jurisdictions where competition may be intense or where legal protection may be weak;
any of the patents, trademarks, copyrights, trade secrets or other intellectual property rights that we presently

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employ in our business will not lapse or be invalidated, circumvented, challenged or abandoned;
competitors will not design around our protected systems and technology; or
we will not lose the ability to assert our intellectual property rights against others.

Policing unauthorized use of our proprietary rights can be difficult and costly. In addition, it may be necessary to enforce or protect our intellectual property rights through litigation or to defend litigation brought against us, which could result in substantial costs and diversion of resources and management attention and could adversely affect our business, even if we are successful on the merits.
We rely on technology infrastructure and a failure to update or maintain this technology infrastructure could adversely affect our business.
 
Significant portions of our content, products and services are dependent on technology infrastructure that was developed over multiple years. Updating and replacing our technology infrastructure may be challenging to implement and manage, may take time to test and deploy, may cause us to incur substantial costs and may cause us to suffer data loss or delays or interruptions in service. For example, we have suffered a number of server outages at our data center facilities, which resulted from certain failures that triggered data center wide outages and disrupted critical technology and infrastructure service capabilities. These events impacted service to some of our significant media properties, including eHow, as well our proprietary online content production studio, and eNom customers. As a result of these data center outages, we have recently developed initiatives to create automatic backup capacity at an alternate facility for our top revenue generating services to address similar scenarios in the future.  However, there can be no assurance that our efforts to develop sufficient backup and redundant services will be successful or that we can prevent similar outages in the future. Delays or interruptions in our service may cause our consumers, advertisers, customers and freelance creative professionals to become dissatisfied with our offerings and could adversely affect our business. Failure to update our technology infrastructure as new technologies become available may also put us in a weaker position relative to a number of our key competitors. Competitors with newer technology infrastructure may have greater flexibility and be in a position to respond more quickly than us to new opportunities, which may impact our competitive position in certain markets and adversely affect our business.
 
We are currently expanding and improving our information technology systems. If these implementations are not successful, our business and operations could be disrupted and our operating results could suffer.
 
In 2010, we deployed the first phase of our enterprise reporting system, Oracle Applications ERP and Platform, to assist the management of our financial data and reporting, and to automate certain business wide processes and internal controls. Since then, we have started to implement additional build-outs, customizations and/or applications associated with this system that require significant management time, support and cost. Moreover, there are inherent risks associated with developing, improving and expanding information systems. We cannot be sure that the expansion of any of our systems, including our Oracle system, will be fully or effectively implemented on a timely basis, if at all. If we do not successfully implement informational systems on a timely basis or at all, our operations may be disrupted and or our operating results could suffer. In addition, any new information system deployments may not operate as we expect them to, and we may be required to expend significant resources to correct problems or find alternative sources for performing these functions.

The interruption or failure of our information technology and communications systems, or those of third parties that we rely upon, may adversely affect our business, operating results and financial condition.
The availability of our products and services depends on the continuing operation of our information technology and communications systems. Any damage to or failure of our systems, or those of third parties that we rely upon (co-location providers for data servers, storage devices, and network access) could result in interruptions in our service, which could reduce our revenue and profits, and damage our brand. Our systems are also vulnerable to damage or interruption from earthquakes, terrorist attacks, floods, fires, power loss, telecommunications failures, computer viruses or other attempts to harm our systems. We, and in particular our Registrar, have experienced an increasing number of computer distributed denial of service attacks which have forced us to shut down certain of our websites, including eNom.com. We have implemented certain defenses against these attacks, but we may continue to be subject to such attacks, and future denial of service attacks may cause all or portions of our websites to become unavailable. In addition, some of our data centers are located in areas with a high risk of major earthquakes. Our data centers are also subject to break-ins, sabotage and intentional acts of vandalism, and to potential disruptions if the operators of these facilities have financial difficulties. Some of our systems are not fully redundant, and our disaster recovery planning is currently underdeveloped and does not account for all eventualities. The occurrence of a natural disaster, a decision to close a facility we are using without adequate notice for financial reasons or other unanticipated problems at our data centers could result in lengthy interruptions in our service.

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Furthermore, third‑party service providers may experience an interruption in operations or cease operations for any reason. If we are unable to agree on satisfactory terms for continued data center hosting relationships, we would be forced to enter into a relationship with other service providers or assume hosting responsibilities ourselves. If we are forced to switch hosting facilities, we may not be successful in finding an alternative service provider on acceptable terms or in hosting the computer servers ourselves. We may also be limited in our remedies against these providers in the event of a failure of service. We also rely on third‑party providers for components of our technology platform, such as hardware and software providers. A failure or limitation of service or available capacity by any of these third‑party providers could adversely affect our business, revenue, financial condition and results of operations.

Changes in regulations or user concerns regarding privacy and protection of user data, or any failure to comply with such laws, could diminish the value of our services and cause us to lose customers and revenue.
 
When a user visits our websites or certain pages of our customers' websites, we use technologies, including “cookies,” to collect information related to the user, such as the user's Internet Protocol, or IP, address, demographic information, and history of the user's interactions with content or advertisements previously delivered by us. The information that we collect about users helps us deliver appropriate content and targeted advertising to the user. A variety of federal, state and international laws and regulations govern the collection, use, retention, sharing and security of data that we receive from and about our users. The existing privacy-related laws and regulations are evolving and subject to potentially differing interpretations. We post privacy policies on all of our owned and operated websites which set forth our policies and practices related to the collection and use of consumer data. Any failure, or perceived failure, by us to comply with our posted privacy policies or with industry standards or laws or regulations could result in a loss of consumer confidence in us, or result in actions against us by governmental entities or others, all of which could potentially cause us to lose consumers and revenues.
 
In addition, various federal, state and foreign legislative and regulatory bodies may expand current or enact new laws regarding privacy matters. Recent developments related to “instant personalization” and similar technologies potentially allow us and other publishers access to even broader and more detailed information about users. These developments have led to greater scrutiny of industry data collection practices by regulators and privacy advocates. New laws may be enacted, new industry self-regulation may be promulgated, or existing laws may be amended or re-interpreted, in a manner which limits our ability to analyze user data. If our access to user data is limited through legislation or any industry development, we may be unable to provide effective technologies and services to customers and we may lose customers and revenue. 

We depend on key personnel to operate our business, and if we are unable to retain our current personnel or hire additional personnel, our ability to develop and successfully market our business could be harmed.
We believe that our future success is highly dependent on the contributions of our executive officers, in particular the contributions of our Chairman and Chief Executive Officer, Richard M. Rosenblatt, as well as our ability to attract and retain highly skilled managerial, sales, technical, engineering and finance personnel. We do not maintain “key person” life insurance policies for our Chief Executive Officer or any of our executive officers. Qualified individuals, including engineers, are in high demand, and we may incur significant costs to attract and retain them. All of our officers and other employees are at-will employees, which means they may terminate their employment relationship with us at any time, and their knowledge of our business and industry would be extremely difficult to replace. If we are unable to attract and retain our executive officers and key employees, our business, operating results and financial condition will be harmed.
Volatility or lack of performance in our stock price may also affect our ability to attract employees and retain our key employees. Our executive officers have become, or will soon become, vested in a substantial amount of stock or stock options. Employees may be more likely to leave us if the shares they own have significantly appreciated in value relative to the original purchase prices of the shares or if the exercise prices of the stock options that they hold are significantly above the market price of our common stock. In addition, employees may be more inclined to leave us if the exercise prices on their stock options that they hold are significantly below the market price of our common stock.
Impairment in the carrying value of goodwill or long-lived assets, including our media content, could negatively impact our consolidated results of operations and net worth.
Goodwill represents the excess of cost of an acquired entity over the fair value of the acquired net assets. Goodwill is not amortized, but is reviewed for impairment at least annually or more frequently if impairment indicators are present. In general, long-lived assets, including our media content, are only reviewed for impairment if impairment indicators are present. In assessing goodwill and long-lived assets for impairment, we make significant estimates and assumptions, including estimates and assumptions about market penetration, anticipated growth rates and risk-adjusted discount rates based on our budgets, business plans, economic projections, anticipated future cash flows and industry data. Some of the estimates and assumptions

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used by management have a high degree of subjectivity and require significant judgment on the part of management. Changes in estimates and assumptions in the context of our impairment testing may have a material impact on us, and any potential impairment charges could substantially affect our financial results in the periods of such charges.
New tax treatment of companies engaged in Internet commerce may adversely affect the commercial use of our marketing services and our financial results.

Due to the global nature of the Internet, it is possible that, although our services and the Internet transmissions related to them typically originate in California, Texas, Illinois, Virginia and the Netherlands, governments of other states or foreign countries might attempt to regulate our transmissions or levy sales, income or other taxes relating to our activities. Tax authorities at the international, federal, state and local levels are currently reviewing the appropriate treatment of companies engaged in Internet commerce. New or revised international, federal, state or local tax regulations may subject us or our customers to additional sales, income and other taxes. We cannot predict the effect of current attempts to impose sales, income or other taxes on commerce over the Internet. New or revised taxes and, in particular, sales taxes, would likely increase the cost of doing business online and decrease the attractiveness of advertising and selling goods and services over the Internet. New taxes could also create significant increases in internal costs necessary to capture data, and collect and remit taxes. Any of these events could have an adverse effect on our business and results of operations.

Third parties may sue us for intellectual property infringement or misappropriation which, if successful, could require us to pay significant damages or curtail our offerings.
        We cannot be certain that our internally-developed or acquired systems and technologies do not and will not infringe the intellectual property rights of others. In addition, we license content, software and other intellectual property rights from third parties and may be subject to claims of infringement or misappropriation if such parties do not possess the necessary intellectual property rights to the products or services they license to us. We have in the past and may in the future be subject to legal proceedings and claims that we have infringed the patent or other intellectual property rights of a third party. These claims sometimes involve patent holding companies or other patent owners who have no relevant product revenue and against whom our own patents may provide little or no deterrence. In addition, third parties may in the future assert intellectual property infringement claims against our customers, which we have agreed in certain circumstances to indemnify and defend against such claims. Any intellectual property-related infringement or misappropriation claims, whether or not meritorious, could result in costly litigation and could divert management resources and attention. Moreover, should we be found liable for infringement or misappropriation, we may be required to enter into licensing agreements, if available on acceptable terms or at all, pay substantial damages or limit or curtail our systems and technologies. Also, any successful lawsuit against us could subject us to the invalidation of our proprietary rights. Moreover, we may need to redesign some of our systems and technologies to avoid future infringement liability. Any of the foregoing could prevent us from competing effectively and increase our costs.

Certain U.S. and foreign laws could subject us to claims or otherwise harm our business.
We are subject to a variety of laws in the U.S. and abroad that may subject us to claims or other remedies. Our failure to comply with applicable laws may subject us to additional liabilities, which could adversely affect our business, financial condition and results of operations. Laws and regulations that are particularly relevant to our business address:
privacy;
freedom of expression;
information security;
pricing, fees and taxes;
content and the distribution of content, including liability for user reliance on such content;
intellectual property rights, including secondary liability for infringement by others;
taxation;
domain name registration; and
online advertising and marketing, including email marketing and unsolicited commercial email.

Many applicable laws were adopted prior to the advent of the Internet and do not contemplate or address the unique issues of the Internet. Moreover, the applicability and scope of the laws that do address the Internet remain uncertain. For example, the laws relating to the liability of providers of online services are evolving. Claims have been either threatened or filed against us under both U.S. and foreign laws for defamation, copyright infringement, patent infringement, privacy violations, cybersquatting and trademark infringement. In the future, claims may also be alleged against us based on tort claims and other theories based on our content, products and services or content generated by our users.


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We receive, process and store large amounts of personal data of users on our owned and operated websites and from our freelance creative professionals. Our privacy and data security policies govern the collection, use, sharing, disclosure and protection of this data. The storing, sharing, use, disclosure and protection of personal information and user data are subject to federal, state and international privacy laws, the purpose of which is to protect the privacy of personal information that is collected, processed and transmitted in or from the governing jurisdiction. If requirements regarding the manner in which certain personal information and other user data are processed and stored change significantly, our business may be adversely affected, impacting our financial condition and results of operations. In addition, we may be exposed to potential liabilities as a result of differing views on the level of privacy required for consumer and other user data we collect. We may also need to expend significant resources to protect against security breaches, including encrypting personal information, or remedy breaches after they occur, including notifying each person whose personal data may have been compromised. Our failure or the failure of various third‑party vendors and service providers to comply with applicable privacy policies or applicable laws and regulations or any compromise of security that results in the unauthorized release of personal information or other user data could adversely affect our business, revenue, financial condition and results of operations.

Our business operations in countries outside the United States are subject to a number of United States federal laws and regulations, including restrictions imposed by the Foreign Corrupt Practices Act, or FCPA, as well as trade sanctions administered by the Office of Foreign Assets Control, or OFAC, and the Commerce Department. The FCPA is intended to prohibit bribery of foreign officials or parties and requires public companies in the United States to keep books and records that accurately and fairly reflect those companies' transactions. OFAC and the Commerce Department administer and enforce economic and trade sanctions based on U.S. foreign policy and national security goals against targeted foreign states, organizations and individuals.

If we fail to comply with these laws and regulations, we could be exposed to claims for damages, financial penalties, reputational harm, incarceration of our employees or restrictions on our operations, which could increase our costs of operations, reduce our profits or cause us to forgo opportunities that would otherwise support our growth.

A reclassification of our freelance creative professionals from independent contractors to employees by tax authorities could require us to pay retroactive taxes and penalties and significantly increase our cost of operations.
We contract with freelance creative professionals as independent contractors to create the substantial majority of the content for our owned and operated websites and for our network of customer websites. Because we consider our freelance creative professionals with whom we contract to be independent contractors, as opposed to employees, we do not withhold federal or state income or other employment related taxes, make federal or state unemployment tax or Federal Insurance Contributions Act payments, or provide workers' compensation insurance with respect to such freelance creative professionals. Our contracts with our independent contractor freelance creative professionals obligate these freelance creative professionals to pay these taxes. The classification of freelance creative professionals as independent contractors depends on the facts and circumstances of the relationship. In the event of a determination by federal or state taxing authorities that the freelance creative professionals engaged as independent contractors are employees, we may be adversely affected and subject to retroactive taxes and penalties. In addition, if it was determined that our content creators were employees, the costs associated with content creation would increase significantly and our financial results would be adversely affected.

We are subject to risks related to credit card payments we accept. If we fail to be in compliance with applicable credit card rules and regulations, we may incur additional fees, fines and ultimately the revocation of the right to accept credit card payments, which would have a material adverse effect on our business, financial condition or results of operations.
Many of the customers of our Content & Media and Registrar service offerings pay amounts owed to us using a credit card or debit card. For credit and debit card payments, we pay interchange and other fees, which may increase over time and raise our operating expenses and adversely affect our net income. We are also subject to payment card association operating rules, certification requirements and rules governing electronic funds transfers, which could change or be reinterpreted to make it difficult or impossible for us to comply. We believe we are compliant in all material respects with the Payment Card Industry Data Security Standard, which incorporates Visa's Cardholder Information Security Program and MasterCard's Site Data Protection standard. However, there is no guarantee that we will maintain such compliance or that compliance will prevent illegal or improper use of our payment system. If we fail to comply with these rules or requirements, we may be subject to fines and higher transaction fees and lose our ability to accept credit and debit card payments from our customers. A failure to adequately control fraudulent credit card transactions would result in significantly higher credit card-related costs and could have a material adverse effect on our business, revenue, financial condition and results of operations.
Our revolving credit facility with a syndicate of commercial banks contains financial and other restrictive covenants which, if breached, could result in the acceleration of any outstanding indebtedness we may have under the facility.

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Our revolving credit facility with a syndicate of commercial banks contains financial covenants that require, among other things, that we maintain a minimum fixed charge coverage ratio, a maximum net senior leverage ratio and a maximum net total leverage ratio. In addition, our revolving credit facility contains covenants restricting our ability to, among other things:
    incur additional debt or incur or permit to exist certain liens;
    pay dividends or make other distributions or payments on capital stock;
    make investments and acquisitions;
    enter into transactions with affiliates; and
    transfer or sell our assets.

These covenants could adversely affect our ability to finance our future operations or capital needs or to pursue available business opportunities, including acquisitions. A breach of any of these covenants could result in a default and acceleration of our indebtedness. Furthermore, if the syndicate of commercial banks is unwilling to waive certain covenants, we may be forced to amend our revolving or replace credit facility on terms less favorable than current terms or enter into new financing arrangements. As of December 31, 2011, we had no indebtedness outstanding under this facility, but had standby letters of credit of approximately $7.0 million outstanding.


Risks Relating to Owning Our Common Stock
 
 
An active, liquid and orderly market for our common stock may not be sustained, and the trading price of our common stock is likely to be volatile.
 
An active trading market for our common stock may not be sustained, which could depress the market price of our common stock. The trading price of our common stock has been, and is likely to be highly volatile and could be subject to wide fluctuations in response to various factors, some of which are beyond our control. For example, since shares of our common stock were sold in our initial public offering in January 2011 at a price of $17.00 per share, our closing stock price has ranged from $5.62 to $24.57 through May 10, 2012. In addition to the factors discussed in this “Risk Factors” section and elsewhere in this Quarterly Report on Form 10-Q, these factors include:
 
our operating performance and the operating performance of similar companies;
 
the overall performance of the equity markets;
 
the number of shares of our common stock publicly owned and available for trading;
 
threatened or actual litigation;
 
changes in laws or regulations relating to our solutions;
 
changes in methodologies or algorithms used by search engines and their impact on search referral traffic;
 
any major change in our board of directors or management;
 
publication of research reports about us or our industry or changes in recommendations or withdrawal of research coverage by securities analysts;
 
publication of third-party reports that inaccurately assess the performance of our business or certain operating metrics such as search referral traffic, the ranking of our content in search engine results or page view trends;
 
large volumes of sales of our shares of common stock by existing stockholders; and
 
general political and economic conditions.

In addition, the stock market in general, and the market for Internet-related companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Securities class action litigation has often been instituted against companies following periods of volatility in the overall market and in the market price of a company's securities. This litigation, if instituted against us, could result in very

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substantial costs, divert our management's attention and resources and harm our business, operating results and financial condition. In addition, the recent distress in the financial markets has also resulted in extreme volatility in security prices.
 
The large number of shares eligible for public sale or subject to rights requiring us to register them for public sale could depress the market price of our common stock.
 
The market price of our common stock could decline as a result of sales of a large number of shares of our common stock in the market, and the perception that these sales could occur may also depress the market price of our common stock. As of May 10, 2012, we had 83,914,973 shares of common stock outstanding.
 
Certain stockholders owning a majority of our outstanding shares are party to a stockholders agreement that entitles them to require us to register shares of our common stock owned by them for public sale in the United States, subject to the restrictions of Rule 144. In addition, certain shareholders, including investors in our preferred stock that converted into common stock as well as current and former employees, are eligible to resell shares of common stock under Rule 144 and Rule 701 without registering such stock with the SEC.
 
In addition, we have registered approximately 44 million shares reserved for future issuance under our equity compensation plans and agreements. Subject to the satisfaction of applicable exercise periods, vesting requirements and, in certain cases, performance conditions, the shares of common stock issued upon exercise of outstanding options, vesting of future awards or pursuant to purchases under our employee stock purchase plan will be available for immediate resale in the United States in the open market.
 
Sales of our common stock as restrictions end or pursuant to registration rights may make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate. These sales also could cause our stock price to fall and make it more difficult for shareholders to sell shares of our common stock.
 
We also have previously and may in the future issue shares of our common stock from time to time as consideration for acquisitions and investments. If any such acquisition or investment is significant, the number of shares that we may issue may in turn be significant. In addition, we may also grant registration rights covering those shares in connection with any such acquisitions and investments.
Our recently announced stock repurchase program may be suspended or terminated at any time, which may result in a decrease in the trading price of our common stock.

We recently announced a stock repurchase program approved by our board of directors whereby we are authorized to repurchase shares of our common stock. Such purchases may be limited, suspended, or terminated at any time without prior notice. There can be no assurance that we will buy additional shares of our common stock under our stock repurchase program or that any future repurchases will have a positive impact on the trading price of our common stock or earnings per share. Important factors that could cause us to limit, suspend or terminate our stock repurchase program include, among others, unfavorable market conditions, the trading price of our common stock, the nature of other investment or strategic opportunities presented to us from time to time, the rate of dilution of our equity compensation programs and the availability of adequate funds, our ability to make appropriate, timely, and beneficial decisions as to when, how, and whether to purchase shares under the stock repurchase program,. If we limit, suspend or terminate our stock repurchase program, our stock price may be negatively affected.

As a public company, we are subject to compliance initiatives that will require substantial time from our management and result in significantly increased costs that may adversely affect our operating results and financial condition.

The Sarbanes-Oxley Act of 2002, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, as well as other rules implemented by the SEC and the New York Stock Exchange, impose various requirements on public companies, including requiring changes in corporate governance practices. These and proposed corporate governance laws and regulations under consideration may further increase our compliance costs. If compliance with these various legal and regulatory requirements diverts our management's attention from other business concerns, it could have a material adverse effect on our business, financial condition and results of operations.    We also expect that these laws and regulations may make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage than used to be available. As a result, it may be more difficult for us to attract and retain qualified individuals to serve on our board of directors, on committees of our board of directors, or as executive officers.

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We are required to make an assessment of the effectiveness of our internal controls over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002. Further, our independent registered public accounting firm has been engaged to express an opinion on the effectiveness of our internal controls over financial reporting for our financial year ending December 31, 2012. Section 404 requires us to perform system and process evaluation and testing of our internal controls over financial reporting to allow management and our independent registered public accounting firm to report on the effectiveness of our internal controls over financial reporting for each fiscal year. Our testing, or the subsequent testing by our independent registered public accounting firm, may reveal deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses. If we are unable to comply with the requirements of Section 404, management may not be able to assess whether our internal controls over financial reporting are effective, which may subject us to adverse regulatory consequences and could result in a negative reaction in the financial markets due to a loss of confidence in the reliability of our financial statements. In addition, if we fail to maintain effective controls and procedures, we may be unable to provide the required financial information in a timely and reliable manner or otherwise comply with the standards applicable to us as a public company. Any failure by us to provide the required financial information in a timely reliable manner could materially and adversely impact our financial condition and the trading price of our securities. In addition, we may incur additional expenses and commitment of management's time in connection with further assessments of our compliance with the requirements of Section 404, which could materially increase our operating expenses and adversely impact our operating results.

If securities or industry analysts publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.
 
The trading market for our common stock will depend in part on the research and reports that securities or industry analysts publish about us or our business. If one or more of the analysts who cover us downgrade our stock or publish inaccurate or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, demand for our stock could decrease, which might cause our stock price and trading volume to decline.
 
We do not anticipate paying cash dividends, and accordingly, stockholders must rely on stock appreciation for any return on their investment.
 
The terms of our credit agreement currently prohibit us from paying cash dividends on our common stock. In addition, we do not anticipate paying cash dividends in the future. As a result, only appreciation of the price of our common stock, which may never occur, will provide a return to stockholders. Investors seeking cash dividends should not invest in our common stock.
 
Our management has broad discretion over the use of the proceeds we received in our initial public offering and might not apply the proceeds in ways that increase the value of our common stock.
 
Our management will continue to have broad discretion to use the net proceeds to us from our initial public offering. Our management might not apply the net proceeds from our initial public offering in ways that increase the value of our common stock. We expect that we will use the net proceeds of our initial public offering for investments in content, international expansion, working capital, product development, sales and marketing activities, general and administrative matters and capital expenditures. We have not otherwise allocated the net proceeds from our initial public offering for any specific purposes. In addition, as discussed under “-Risks Relating to our Company-We have made and may make additional acquisitions that could entail significant execution, integration and operational risks,” we may consider making acquisitions in the future to increase the scope of our business domestically and internationally. Until we use the net proceeds to us from our initial public offering, we have invested them, principally in marketable securities with maturities of less than one year, including but not limited to commercial paper, money market instruments, and Treasury bills, and these investments may not yield a favorable rate of return. If we do not invest or apply the net proceeds from our initial public offering in ways that enhance stockholder value, we may fail to achieve expected financial results, which could cause our stock price to decline.
 
Certain provisions in our charter documents and Delaware law could discourage takeover attempts and lead to management entrenchment.
 
Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that could have the effect of delaying or preventing changes in control or changes in our management without the consent of our board of directors, including, among other things:
 
a classified board of directors with three-year staggered terms, which may delay the ability of stockholders to change

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the membership of a majority of our board of directors;

no cumulative voting in the election of directors, which limits the ability of minority stockholders to elect director candidates;
 
the ability of our board of directors to determine to issue shares of preferred stock and to determine the price and other terms of those shares, including preferences and voting rights, without stockholder approval, which could be used to significantly dilute the ownership of a hostile acquiror;
 
the exclusive right of our board of directors to elect a director to fill a vacancy created by the expansion of our board of directors or the resignation, death or removal of a director, which prevents stockholders from being able to fill vacancies on our board of directors;
 
a prohibition on stockholder action by written consent, which forces stockholder action to be taken at an annual or special meeting of our stockholders;
 
the requirement that a special meeting of stockholders may be called only by the chairman of our board of directors, the Chief Executive Officer, the president (in absence of a Chief Executive Officer) or our board of directors, which may delay the ability of our stockholders to force consideration of a proposal or to take action, including the removal of directors;
 
the requirement for the affirmative vote of holders of at least 662/3% of the voting power of all of the then outstanding shares of the voting stock, voting together as a single class, to amend the provisions of our amended and restated certificate of incorporation relating to the issuance of preferred stock and management of our business or our amended and restated bylaws, which may inhibit the ability of an acquiror from amending our certificate of incorporation or bylaws to facilitate a hostile acquisition;
 
the ability of our board of directors, by majority vote, to amend the bylaws, which may allow our board of directors to take additional actions to prevent a hostile acquisition and inhibit the ability of an acquiror from amending the bylaws to facilitate a hostile acquisition; and
 
advance notice procedures that stockholders must comply with in order to nominate candidates to our board of directors or to propose matters to be acted upon at a stockholders' meeting, which may discourage or deter a potential acquiror from conducting a solicitation of proxies to elect the acquiror's own slate of directors or otherwise attempting to obtain control of us.
 
We are also subject to certain anti-takeover provisions under Delaware law. Under Delaware law, a corporation may not, in general, engage in a business combination with any holder of 15% or more of its capital stock unless the holder has held the stock for three years or, among other things, our board of directors has approved the transaction.

Item 2.        UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Use of Proceeds from Registered Securities
 
On January 25, 2011, registration statements on Form S-1 (File No. 333-168612 and File No. 333-171868) relating to our initial public offering of our common stock were declared effective by the SEC. An aggregate of 10,235,000 shares of our common stock were registered under the registration statements, of which 4,500,000 shares were sold by us, 4,400,000 shares were sold by the selling stockholders identified in the registration statements and 1,335,000 shares were sold by the selling stockholders and us in connection with the underwriters' exercise of their option to purchase additional shares, at an initial public offering price of $17.00 per share. The aggregate offering price for the shares registered and sold by us was approximately $88.0 million and the aggregate offering price for the shares registered and sold by the selling stockholders was approximately $86.0 million. The initial public offering closed on January 31, 2011 and, as a result, we received net proceeds of approximately $81.8 million, after deducting the underwriting discount but before deducting offering expenses and the selling stockholders received net proceeds of approximately $80.0 million, after deducting the underwriting discount of approximately $6.0 million. The Company did not receive any proceeds from the sale of shares by the selling stockholders.
 
No offering expenses were paid directly or indirectly to any of our directors or officers (or their associates) or persons owning ten percent or more of any class of our equity securities or to any other affiliates.
 

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The net offering proceeds have been invested in cash and cash equivalents. We have used the net offering proceeds for investments in media content, international expansion efforts, working capital, product development, sales and marketing activities, general and administrative matters, capital expenditures and to fund the acquisitions of Altcaster, EmergingCast, RSS Graffiti and IndieClick Media Group.

Repurchases of our Common Stock

The following provides information regarding our repurchases of our common stock during the quarter ended March 31, 2012:
 
Period
Total Number
of
Shares
Purchased
 
Average
Price Paid
per Share
 
Total Number of Shares
Purchased as Part of
Publicly Announced
Plans or Programs
 
Approximate Dollar Value of
Shares that May Yet Be
Purchased Under the
Plans or Programs
January 1 - January 31, 2012
421,490

 
7.16
 
 
421,490

 
$ [-]
February 1 - February 29, 2012
-

 
-
 
 
-

 
[-]
March 1 - March 31, 2012
18,478

(1) 
7.32
 
 
-

 
[-]
Total
439,968

 
7.16
 
 
421,490

 
[-]

(1) 
Consists entirely of shares of common stock surrendered by participants under our Amended and Restated 2006 Equity Incentive Plan as payment of applicable withholding taxes due upon the vesting of restricted stock awards. Shares so surrendered by the participants are surrendered pursuant to the terms of the plan and the applicable award agreements and are not pursuant to publicly announced share repurchase authorizations.

As previously disclosed in a current report on Form 8-K filed on August 22, 2011, our Board of Directors approved a stock repurchase program effective as of August 19, 2011 to repurchase up to $25.0 million of our outstanding common stock as share price, market conditions and other factors warrant.  In addition, as previously disclosed in a current report on Form 8-K filed on February 16, 2012, our Board of Directors approved a $25.0 million increase to this previously approved stock repurchase program, for an aggregate amount of $50.0 million of repurchases under the program. Under the stock repurchase program, we have cumulatively repurchased a total of approximately 2.7 million shares at a total cost of $20.1 million through March 31, 2012. The stock repurchase program does not require us to purchase a specific number of shares and may be modified, suspended or terminated at any time.  See “Liquidity and Capital Resources” in Part I, Item 2 of this report for further discussion of our share repurchases.

Our revolving credit facility limits our ability to make cash distributions with respect to our equity interests, such as redemptions, cash dividends and share repurchases, based on a defined leverage ratio. See "Liquidity and Capital Resources" in Part 1, Item 2 of this report for further discussion of our long-term debt. 

Item 3.        DEFAULTS UPON SENIOR SECURITIES
 
None.
 
Item 4.        Mine Safety Disclosures
 
Not applicable.
 
Item 5.         OTHER INFORMATION
 
None.
 
Item 6.        EXHIBITS
 

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Exhibit No
 
Description of Exhibit
31.1
 
Certification of the Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
 
Certification of the Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
 
Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
 
Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS
 
XBRL Instance Document*
101.SCH
 
XBRL Taxonomy Extension Schema Document*
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document*
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document*
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document*
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document*
 
 
* Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

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SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
DEMAND MEDIA, INC.
 
 
 
By:
/s/ Richard M. Rosenblatt
 
Name:
Richard M. Rosenblatt
 
Title:
Chairman and
Chief Executive Officer
 
 
 
 
 
 
 
By:
/s/ Charles S. Hilliard
 
Name:
Charles S. Hilliard
 
Title:
President and Chief Financial Officer
 
Date:  May 11, 2012


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Exhibit Index
 
Exhibit No
 
Description of Exhibit
31.1
 
Certification of the Chief Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
 
Certification of the Chief Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1
 
Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2
 
Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS
 
XBRL Instance Document*
101.SCH
 
XBRL Taxonomy Extension Schema Document*
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document*
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document*
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document*
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document*
 
 
* Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.


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