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EX-32.1 - EX-32.1 - LEAF GROUP LTD.dmd-20150630ex321f36374.htm

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 June 30, 2015

 

OR

 

¨

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.)

 

 

 

1655 26th Street
Santa Monica, CA

 

90404

(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   No  

 

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   No  

 

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

 

  

Accelerated filer

 

 

 

 

 

 

 

 

Non-accelerated filer

 

  (Do not check if a smaller reporting company)

  

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   No  

As of July 31, 2015, there were 20,005,774 shares of the registrant’s common stock, $0.0001 par value, outstanding.

 

 

 


 

DEMAND MEDIA, INC.

INDEX TO FORM 10-Q

 

 

 

 

 

 

 

  

 

  

Page

Part I 

Financial Information

  

 

 

Item 1.

  

Condensed Consolidated Financial Statements (Unaudited)

  

 

 

  

Condensed Consolidated Balance Sheets

  

 

 

  

Condensed Consolidated Statements of Operations

  

 

 

  

Condensed Consolidated Statements of Comprehensive Income (Loss)

  

 

 

  

Condensed Consolidated Statements of Stockholders’ Equity

  

 

 

  

Condensed Consolidated Statements of Cash Flows

  

 

 

  

Notes to the Condensed Consolidated Financial Statements

  

 

Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  

26 

 

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

  

41 

 

Item 4.

  

Controls and Procedures

  

42 

Part II 

Other Information

 

 

 

Item 1.

  

Legal Proceedings

  

43 

 

Item 1A.

  

Risk Factors

  

43 

 

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

  

44 

 

Item 3.

  

Defaults Upon Senior Securities

  

44 

 

Item 4.

  

Mine Safety Disclosures

  

44 

 

Item 5.

  

Other Information

  

44 

 

Item 6.

  

Exhibits

  

45 

 

 

  

Signatures

  

47 

 

 

 

2


 

Part I.       FINANCIAL INFORMATION

 

Item 1.      CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  

Demand Media, Inc. and Subsidiaries 

Condensed Consolidated Balance Sheets  

(In thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

    

June 30, 

    

December 31, 

 

 

 

2015

 

2014

 

Assets

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

42,292

 

$

47,820

 

Accounts receivable, net

 

 

10,570

 

 

14,504

 

Prepaid expenses and other current assets

 

 

7,863

 

 

7,447

 

Total current assets

 

 

60,725

 

 

69,771

 

Property and equipment, net

 

 

18,752

 

 

22,836

 

Intangible assets, net

 

 

28,607

 

 

40,535

 

Goodwill

 

 

10,358

 

 

10,358

 

Other assets

 

 

5,872

 

 

6,055

 

Total assets

 

$

124,314

 

$

149,555

 

Liabilities and Stockholders' Equity

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

Accounts payable

 

$

824

 

$

4,762

 

Accrued expenses and other current liabilities

 

 

20,765

 

 

24,225

 

Deferred revenue

 

 

2,767

 

 

3,569

 

Total current liabilities

 

 

24,356

 

 

32,556

 

Deferred tax liability

 

 

372

 

 

334

 

Other liabilities

 

 

1,712

 

 

1,823

 

Commitments and contingencies (Note 8)

 

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

 

 

Common stock, $0.0001 par value. Authorized 100,000 shares; 20,685 issued and 19,883 shares outstanding at June 30, 2015 and 20,543 issued and 19,741 shares outstanding at December 31, 2014

 

 

2

 

 

2

 

Additional paid-in capital

 

 

502,007

 

 

497,809

 

Accumulated other comprehensive loss

 

 

(85)

 

 

(76)

 

Treasury stock at cost, 802 at June 30, 2015 and December 31, 2014, respectively

 

 

(30,767)

 

 

(30,767)

 

Accumulated deficit

 

 

(373,283)

 

 

(352,126)

 

Total stockholders’ equity

 

 

97,874

 

 

114,842

 

Total liabilities and stockholders’ equity

 

$

124,314

 

$

149,555

 

 

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

3


 

Demand Media, Inc. and Subsidiaries 

Condensed Consolidated Statements of Operations  

(In thousands, except per share amounts)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended  June 30, 

 

Six months ended June 30, 

 

 

    

2015

    

2014

    

2015

    

2014

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

Service revenue

 

$

20,067

 

$

36,397

 

$

43,292

 

$

74,661

 

Product revenue

 

 

9,701

 

 

6,680

 

 

19,686

 

 

13,472

 

Total revenue

 

 

29,768

 

 

43,077

 

 

62,978

 

 

88,133

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

9,534

 

 

11,274

 

 

19,537

 

 

21,942

 

Product costs

 

 

6,768

 

 

5,046

 

 

13,602

 

 

10,001

 

Sales and marketing

 

 

4,768

 

 

4,592

 

 

9,373

 

 

10,723

 

Product development

 

 

6,045

 

 

6,948

 

 

12,403

 

 

14,171

 

General and administrative

 

 

9,955

 

 

12,555

 

 

20,317

 

 

24,404

 

Amortization of intangible assets

 

 

7,225

 

 

7,877

 

 

11,936

 

 

17,815

 

Total operating expenses

 

 

44,295

 

 

48,292

 

 

87,168

 

 

99,056

 

Loss from operations

 

 

(14,527)

 

 

(5,215)

 

 

(24,190)

 

 

(10,923)

 

Interest income (expense), net

 

 

110

 

 

(934)

 

 

219

 

 

(1,704)

 

Other income (expense), net

 

 

19

 

 

(23)

 

 

2,846

 

 

(46)

 

Loss from continuing operations before income taxes

 

 

(14,398)

 

 

(6,172)

 

 

(21,125)

 

 

(12,673)

 

Income tax expense

 

 

(10)

 

 

(269)

 

 

(32)

 

 

(2,714)

 

Net loss from continuing operations

 

 

(14,408)

 

 

(6,441)

 

 

(21,157)

 

 

(15,387)

 

Net loss from discontinued operations

 

 

 —

 

 

(7,892)

 

 

 —

 

 

(9,902)

 

Net loss

 

$

(14,408)

 

$

(14,333)

 

$

(21,157)

 

$

(25,289)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per share - basic and diluted

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss from continuing operations

 

$

(0.73)

 

$

(0.35)

 

$

(1.07)

 

$

(0.84)

 

Net loss from discontinued operations

 

 

 —

 

 

(0.43)

 

 

 —

 

 

(0.54)

 

Net loss

 

$

(0.73)

 

$

(0.78)

 

$

(1.07)

 

$

(1.38)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares - basic and diluted

 

 

19,841

 

 

18,286

 

 

19,807

 

 

18,229

 

 

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

4


 

Demand Media, Inc. and Subsidiaries 

Condensed Consolidated Statements of Comprehensive Income (Loss)  

(In thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended  June 30, 

 

Six months ended June 30, 

 

 

    

2015

    

2014

    

2015

    

2014

 

Net loss

 

$

(14,408)

 

$

(14,333)

 

$

(21,157)

 

$

(25,289)

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

 

(15)

 

 

(28)

 

 

(9)

 

 

(50)

 

Realized gain on marketable securities available-for-sale, net of tax expense of $344

 

 

 —

 

 

 —

 

 

 —

 

 

(562)

 

Other comprehensive income (loss), net of tax:

 

 

(15)

 

 

(28)

 

 

(9)

 

 

(612)

 

Comprehensive income (loss)

 

$

(14,423)

 

$

(14,361)

 

$

(21,166)

 

$

(25,901)

 

 

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

5


 

Demand Media, Inc. and Subsidiaries

Condensed Consolidated Statements of Stockholders’ Equity  

(In thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Additional

 

 

 

 

other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

paid-in

 

 

 

 

comprehensive

 

 

 

 

Total

 

 

 

Common stock

 

capital

 

Treasury

 

income

 

Accumulated

 

stockholders’

 

 

    

Shares

    

Amount

    

amount

    

Stock

    

(loss)

    

deficit

    

equity

 

Balance at December 31, 2014

 

19,741

 

$

2

 

$

497,809

 

$

(30,767)

 

$

(76)

 

$

(352,126)

 

$

114,842

 

Issuance of stock under employee stock awards and other, net

 

142

 

 

 —

 

 

263

 

 

 —

 

 

 —

 

 

 —

 

 

263

 

Stock-based compensation expense

 

 —

 

 

 —

 

 

3,935

 

 

 —

 

 

 —

 

 

 —

 

 

3,935

 

Foreign currency translation adjustment

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(9)

 

 

 —

 

 

(9)

 

Net loss

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(21,157)

 

 

(21,157)

 

Balance at June 30, 2015

 

19,883

 

$

2

 

$

502,007

 

$

(30,767)

 

$

(85)

 

$

(373,283)

 

$

97,874

 

 

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

6


 

Demand Media, Inc. and Subsidiaries 

Condensed Consolidated Statements of Cash Flows  

(In thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

Six months ended June 30, 

 

 

    

2015

    

2014

 

Cash flows from operating activities

 

 

 

 

 

 

 

Net loss

 

$

(21,157)

 

$

(25,289)

 

Adjustments to reconcile net loss to net cash provided by operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

 

17,209

 

 

31,922

 

Deferred income taxes

 

 

 —

 

 

4,601

 

Stock-based compensation

 

 

4,124

 

 

10,631

 

Gain on disposal of businesses

 

 

(2,908)

 

 

 —

 

Gain on other assets, net

 

 

 —

 

 

(5,747)

 

Other

 

 

199

 

 

(1,447)

 

Change in operating assets and liabilities, net of effect of acquisition:

 

 

 

 

 

 

 

Accounts receivable, net

 

 

4,360

 

 

4,891

 

Prepaid expenses and other current assets

 

 

(394)

 

 

(793)

 

Deferred registration costs

 

 

 —

 

 

(8,957)

 

Deposits with registries

 

 

 —

 

 

294

 

Other long-term assets

 

 

(132)

 

 

(674)

 

Accounts payable

 

 

(3,858)

 

 

(2,887)

 

Accrued expenses and other liabilities

 

 

(3,903)

 

 

(127)

 

Deferred revenue

 

 

(149)

 

 

11,724

 

Net cash (used in) provided by operating activities

 

 

(6,609)

 

 

18,142

 

Cash flows from investing activities

 

 

 

 

 

 

 

Purchases of property and equipment

 

 

(2,586)

 

 

(5,910)

 

Purchases of intangible assets

 

 

(56)

 

 

(4,314)

 

Payments for gTLD applications

 

 

 —

 

 

(11,460)

 

Proceeds from gTLD withdrawals, net

 

 

 —

 

 

6,105

 

Cash received from disposal of business, net of cash disposed

 

 

3,831

 

 

 —

 

Other

 

 

205

 

 

1,291

 

Net cash provided by (used in) investing activities

 

 

1,394

 

 

(14,288)

 

Cash flows from financing activities

 

 

 

 

 

 

 

Long-term debt repayments, net

 

 

 —

 

 

(22,500)

 

Proceeds from exercises of stock options and contributions to ESPP

 

 

248

 

 

252

 

Net taxes paid on RSUs and options exercised

 

 

(440)

 

 

(1,646)

 

Cash paid for acquisition holdback

 

 

 —

 

 

(1,542)

 

Other

 

 

(112)

 

 

(296)

 

Net cash used in financing activities

 

 

(304)

 

 

(25,732)

 

Effect of foreign currency on cash and cash equivalents

 

 

(9)

 

 

(45)

 

Change in cash and cash equivalents

 

 

(5,528)

 

 

(21,923)

 

Cash and cash equivalents, beginning of period

 

 

47,820

 

 

153,511

 

Cash and cash equivalents, end of period

 

$

42,292

 

$

131,588

 

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

7


 

Demand Media, Inc. and Subsidiaries 

Notes to Condensed Consolidated Financial Statements  

(Unaudited)

1. Company Background and Overview

Demand Media, Inc. (“Demand Media” and, together with its consolidated subsidiaries, the “Company,” “our,” “we,” or “us”) is a Delaware corporation headquartered in Santa Monica, California. We are a diversified Internet company that builds platforms across our media and marketplace properties to enable communities of creators to reach passionate audiences in large and growing lifestyle categories. Our business is comprised of two service offerings, Content & Media and Marketplaces.

On August 1, 2014, we completed the separation of Rightside Group, Ltd. (“Rightside”) from Demand Media, Inc., resulting in two independent, publicly traded companies (hereinafter referred to as the “Separation”). Following the Separation, Rightside operates our former domain name services business, while we continue to own and operate our Content & Media and Marketplaces businesses. The Separation was structured as a pro rata tax-free dividend involving the distribution of all outstanding shares of Rightside common stock to holders of Demand Media common stock as of the August 1, 2014 record date (the “Distribution”). Immediately following the Distribution, we completed a 1-for-5 reverse stock split with respect to all of our outstanding shares of common stock, including shares held in treasury, which is reflected retrospectively throughout the consolidated financial statements.

Content & Media

Our Content & Media service offering includes a leading content creation platform that produces high-quality content in text, video, photography and designed visual formats. This content is published to our leading owned and operated online properties across several key categories on eHow.com, a how-to reference destination, and Livestrong.com, a health and healthy living destination, as well as to online properties operated by our customers. We also own and operate Cracked.com, a humor site offering original and engaging comedy-driven video series, text articles and blogs created through a collaborative process among our in-house editorial staff, comedians and a community of website enthusiasts. Additionally, our studioD business develops and executes custom content marketing strategies for third-party brands, publishers and advertisers.

Marketplaces

Through our Marketplaces service offering, we operate two leading artist marketplaces where large communities of artists can market and sell their original artwork or original designs printed on a wide variety of products. Society6.com (“Society6”), which we acquired in June 2013, provides artists with an online commerce platform to feature and sell their original images or designs on consumer products such as art prints, phone and tablet cases, t-shirts and throw pillows. Saatchi Online, Inc., which operates SaatchiArt.com (“Saatchi Art”) and which we acquired in August 2014, is an online art gallery featuring a wide selection of original paintings, drawings, sculptures and photography that provides a global community of artists a curated environment in which to exhibit and sell their work directly to consumers around the world.

8


 

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 condensed consolidated financial statements follows.

Basis of Presentation

The accompanying interim condensed consolidated balance sheet as of June 30, 2015, the condensed consolidated statements of operations and condensed consolidated statements of comprehensive income (loss) for the three and six month periods ended June 30, 2015 and 2014, the condensed consolidated statements of cash flows for the six month periods ended June 30, 2015 and 2014 and the condensed consolidated statement of stockholders’ equity for the six month period ended June 30, 2015 are unaudited.

In the opinion of management, the unaudited interim condensed 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 our statement of financial position as of June 30, 2015 and our results of operations for the six month periods ended June 30, 2015 and 2014 and our cash flows for the six month periods ended June 30, 2015 and 2014. The results for the three month period ended June 30, 2015 are not necessarily indicative of the results expected for the full year. The consolidated balance sheet as of December 31, 2014 has been derived from our audited financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2014.

The interim unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States, for interim financial information and with the instructions from the U.S. Securities and Exchange Commission (“SEC”) for Quarterly Reports on Form 10-Q and Article 10 of Regulation S-X. They do not include all of the information and footnotes required by GAAP for complete financial statements. Therefore, these condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2014 filed with the SEC.

The common stock share information and related per share amounts included in our condensed consolidated financial statements have been adjusted retroactively for all periods presented to reflect the 1-for-5 reverse stock split with respect to all of our outstanding shares of common stock, including shares held in treasury, that was effected on August 1, 2014.

The financial results of Rightside are presented as discontinued operations in our condensed consolidated statements of operations for the three and six month periods ended June 30, 2014. For additional information relating to our previous domain name services business, please refer to our Annual Report on Form 10-K for the year ended December 31, 2013.

Principles of Consolidation

The consolidated financial statements include the accounts of Demand Media and its wholly owned subsidiaries. Acquisitions are included in our consolidated financial statements from the date of the acquisition. Our 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.

Use of Estimates

The preparation of the consolidated financial statements in conformity with GAAP 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; the assigned value of acquired assets and assumed liabilities in business

9


 

combinations; useful lives and impairment of property and equipment, intangible assets, goodwill and other assets; the fair value of equity-based compensation awards; and deferred income tax assets and liabilities. Actual results could differ materially from those estimates. On an ongoing basis, we evaluate our estimates compared to historical experience and trends, which form the basis for making judgments about the carrying value of our assets and liabilities.

Investments in Equity Interests

We account for investments in companies that we do not control or account for under the equity method of accounting using either the fair value or the cost method of accounting, as applicable. Investments in equity securities are carried at fair value if the fair value of the security is readily determinable. Equity investments carried at fair value are classified as marketable securities available-for-sale. Realized gains and losses for marketable securities available-for-sale are included in other income (expense), net in our consolidated statements of operations. Unrealized gains and losses, net of taxes, on marketable securities available-for-sale are included in our consolidated financial statements as a component of other comprehensive income (loss) and accumulated other comprehensive income (loss) (“AOCI”), until realized.

Investments in companies that we do not control or account for under the equity method of accounting, and for which we do not have readily determinable fair values, are accounted for using the cost method of accounting. Cost method investments are originally recorded at cost. In determining whether other-than-temporary impairment exists for these equity securities, management considers: (1) the length of time and the extent to which the fair value has been less than the cost, (2) the financial condition and near-term prospects of the issuer and (3) our intent and ability to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

The cost of marketable securities sold is based upon the specific accounting method used. Any realized gains or losses on the sale of equity investments are reflected as a component of interest income or expense. During the first quarter of 2014, we sold certain marketable securities available-for-sale, resulting in a reclassification from other comprehensive income of $0.9 million of unrealized gains on marketable securities, which is currently recorded in discontinued operations. The sale of these marketable securities resulted in total realized gains of $1.4 million, which is included in discontinued operations.

We classify marketable securities as current or non-current based upon whether such assets are reasonably expected to be realized in cash or sold or consumed during the normal operating cycle of the business.

Revenue Recognition

We recognize 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. We consider persuasive evidence of a sales arrangement to be the receipt of a signed contract. Collectability is assessed based on a number of factors, including transaction history and the creditworthiness of a customer. If it is determined that collection is not reasonably assured, revenue is not recognized until collection becomes reasonably assured, which is generally upon receipt of cash. We record cash received in advance of revenue recognition as deferred revenue.

For arrangements with multiple deliverables, we allocate 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 our control. 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. We allocate any arrangement fee to each of the elements based on their relative selling prices.

10


 

Our revenue is principally derived from the following services and products:

Service Revenue

Content & Media

Advertising Revenue. We generate revenue from advertisements displayed alongside our content on our online properties and certain of our customers’ online properties. Articles, videos and other forms of content generate advertising revenue from a diverse mix of advertising methods including performance-based cost-per-click advertising, in which an advertiser pays only when a visitor clicks on an advertisement; display advertisements, where revenue is dependent upon the number of advertising impressions delivered; and sponsored content or advertising links. In determining whether an arrangement exists, we ensure that a binding arrangement is in place, such as a standard insertion order or a fully executed customer-specific agreement. Obligations pursuant to our advertising revenue arrangements typically include a minimum number of impressions or the satisfaction of other performance criteria. Revenue from performance-based arrangements is recognized as the related performance criteria are met. We assess 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.

At times we enter into revenue-sharing arrangements with our customers, and if we are considered the primary obligor, we report the underlying revenue on a gross basis in our consolidated statements of operations and record the revenue-sharing payments to our customers in service costs.

Social Media Services. Prior to the sale of our Pluck social media business in February 2015, we configured, hosted, and maintained our platform for social media services under private-labeled versions of software for commercial customers. We earned revenue from our social media services through recurring management support fees, overage fees in excess of standard usage terms, outside consulting fees and initial set-up fees. Due to the fact that social media services customers had no contractual right to take possession of our private-labeled software, we accounted for our social media services revenue as service arrangements. Social media services revenue was recognized when persuasive evidence of an arrangement existed, delivery of the service had occurred and no significant obligations remained, the selling price was fixed or determinable, and collectability was reasonably assured. In February 2015, we sold our Pluck social media business and we no longer provide any social media services. The consideration we received for Pluck was a $3.8 million cash payment after working capital adjustments, resulting in a gain of $2.9 million, which is recorded in other income (expense), net.

Content Sales and Licensing Revenue. We also generate revenue from the sale or license of media content, including the creation and distribution of content for third party brands, publishers and advertisers through our studioD business. Revenue from the sale or perpetual license of media content is recognized when the content has been delivered and the contractual performance obligations have been fulfilled. Revenue from the non-perpetual license of media content is recognized over the period of the license as content is delivered or when other related performance criteria are fulfilled. In circumstances where we distribute our content on third-party properties and the customer acts as the primary obligor, we recognize revenue on a net basis.

Marketplaces

Art Commissions Revenue. We generate service revenue from commissions we receive from facilitating the sale of original art by artists to customers through Saatchi Art. We recognize service revenue arising from the sale of original art net of amounts paid to the artist because we are not the primary obligor in the transaction, we do not have inventory risk, and we do not establish the prices for the art sold. We also recognize this service revenue net of any sales allowances. Revenue is recognized after the original art has been delivered and the return period has expired. Payments received in advance of delivery and completion of the return period are included in deferred revenue in the accompanying condensed consolidated balance sheets. We periodically provide incentive offers to customers to encourage purchases, including percentage discounts off current purchases, free shipping and other offers. Value-added

11


 

taxes (“VAT’), sales tax and other taxes are not included in revenue because we are a pass-through conduit for collecting and remitting any such taxes.

Product Revenue

We recognize product revenue from sales of Society6 products upon delivery, net of estimated returns based on historical experience. We recognize product revenue from the sale of prints through Saatchi Art when the prints are delivered and the return period has expired. Payments received in advance of delivery and, with respect to the Saatchi Art prints, prior to completion of the return period are included in deferred revenue in the accompanying condensed consolidated balance sheets. Revenue is recorded at the gross amount due to the following factors: we are the primary obligor in a transaction, we have inventory and credit risk, and we have latitude in establishing prices and selecting suppliers. Product revenue is recognized net of sales allowances and return allowances. We periodically provide incentive offers to customers to encourage purchases, including percentage discounts off current purchases, free shipping and other offers. VAT, sales tax and other taxes are not included in revenue, as we are a pass-through conduit for collecting and remitting any such taxes.

Service Costs

Service costs consist of payments relating to our 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 creation and distribution platform; expenses related to creating, rewriting, or auditing certain content units; and personnel costs relating to in-house editorial, customer service and information technology. Service costs also include payments to our customers pursuant to revenue-sharing arrangements where we are the primary obligor.

Product Costs

Product costs consist of outsourced product manufacturing costs, artist royalties and personnel costs.

Shipping and Handling

Shipping and handling charged to customers is recorded in service revenue or product revenue. Associated costs are recorded in service costs or product costs.

Deferred Revenue

Deferred revenue consists of amounts received from customers before we have met all four criteria for the recognition of revenue. Deferred revenue includes payments received from sales of our products on Society6 prior to delivery of such products; payments made for original art and prints sold via Saatchi Art that are collected prior to the completion of the return period; and amounts received from customers of our previous social media services in advance of our performance of such services. Deferred revenue for social media services was recognized as revenue on a systematic basis proportionate to the services that had been rendered.

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 three years, software is amortized over two to three years, and furniture and fixtures are amortized over five 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 ten years. Upon the sale or retirement of property or equipment, the cost and related accumulated depreciation or amortization is removed from our financial statements with the resulting gain or loss reflected in our results of operations. Repairs and maintenance costs are expensed as incurred. In the event that property and equipment is no longer in use, we will record a loss on disposal of the property and equipment, which is computed as the difference between the sales price, if any, and the net remaining value (gross amount of property and equipment less accumulated depreciation expense) of the related equipment at the date of disposal.

12


 

Intangible Assets—Media Content

We capitalize the direct costs incurred to develop media content that is determined to have a probable future economic benefit. Costs are recognized as finite-lived intangible assets based on their acquisition cost to us. 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 prior to their publication. Internal costs not directly attributable to the enhancement of an individual content unit are expensed as incurred. All costs incurred to deploy and publish content are expensed as incurred, including the costs incurred for the ongoing maintenance of our owned and operated properties on which our content is published.

Capitalized media content is amortized on a straight-line basis over its useful life, which is typically five years, representing our estimate of when the underlying economic benefits are expected to be realized and based on our estimates of the projected cash flows from advertising revenue expected to be generated by the deployment of such content. These estimates are based on our plans and projections, comparison of the economic returns generated by content of comparable quality and an analysis of historical cash flows generated by such content to date. Amortization of media content is included in amortization of intangible assets in the accompanying condensed consolidated statements of operations and the acquisition costs are included in purchases of intangible assets within cash flows from investing activities in the accompanying condensed consolidated statements of cash flows.

Google, Yahoo! and Bing, the largest providers of search engine referrals to our online properties, regularly deploy changes to their search engine algorithms. To date, the overall impact of these changes on search referrals to our owned and operated online properties has been negative, primarily due to a decline in traffic to eHow.com. In response to changes in search engine algorithms since 2011, we have performed evaluations of our existing content library to identify potential improvements in our content creation and distribution platform. As a result of these evaluations, we elected to remove certain content units from our content library, resulting in $21.4 million of related accelerated amortization expense since 2011, including $3.3 million of accelerated amortization expense in the three months ended June 30, 2015. We continue to perform evaluations of our content library on an ongoing basis and may remove additional content, which could result in additional accelerated amortization expense in the periods such actions occur.

Intangible Assets—Acquired in Business Combinations

We perform valuations of assets acquired and liabilities assumed on each acquisition accounted for as a business combination and allocate the purchase price of each acquired business to our respective net tangible and intangible assets. Acquired intangible assets include: trade names, non-compete agreements, owned website names, artist relationships, customer relationships, technology, media content, and content publisher relationships. We determine 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.

Long-lived Assets

We evaluate the recoverability of our long-lived tangible and intangible 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 to the extent or manner in which a long-lived asset is being used, a 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. We perform 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

13


 

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. Assets to be disposed of are separately presented on the balance sheets and reported at the lower of their carrying amount or fair value less estimated costs to sell, and are no longer depreciated or amortized.

Goodwill

Goodwill represents the excess of the cost of an acquired entity over the fair value of the acquired net assets. Goodwill is tested for impairment annually during the fourth quarter of our fiscal year or when events or circumstances change in a manner that indicates goodwill might be impaired. Events or circumstances that 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 our use of the acquired assets or the strategy for our overall business, significant negative industry or economic trends, a decline in our stock price leading to an extended period when our market capitalization is less than the book value of our net assets or significant underperformance relative to expected historical or projected future results of operations.

Goodwill is tested for impairment at the reporting unit level, which is one level below or the same as an operating segment. As of June 30, 2015, we determined that we have two reporting units. When testing goodwill for impairment, we first perform a qualitative assessment to determine whether it is necessary to perform step one of a two-step goodwill impairment test for each reporting unit. We are required to perform step one only if we conclude that it is more likely than not that a reporting unit’s fair value is less than the carrying value of its assets. Should this be the case, the first step of the two-step process is to identify whether a potential impairment exists by comparing the estimated fair values of our reporting units with their respective carrying values, including goodwill. If the estimated fair value of a reporting unit exceeds the carrying value, goodwill is not considered to be impaired and no additional steps are necessary. If, however, the estimated fair value of a reporting unit is less than its carrying value, then a second step is performed to measure the amount of the impairment, if any. The amount of the impairment is the excess of the carrying value of the goodwill over its implied fair value. The 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 our software, technology, patents and trademarks.

Since acquiring Saatchi Art in August 2014, we have continued to integrate and develop our marketplaces platforms. During the second quarter of 2015, we made certain changes to our management structure below our chief operating decision maker and, as a result of these changes, we determined that Society6 from the content & media reporting unit should be combined with the Saatchi Art reporting unit to create a marketplaces reporting unit. A change in reporting units requires that goodwill be tested for impairment. Therefore, we performed an interim assessment of impairment of goodwill for the Saatchi Art reporting unit during the second quarter of 2015, which resulted in no impairment.

Stock-Based Compensation

We measure and recognize compensation expense for all stock-based payment awards made to employees, non-employees and directors based on the grant date fair values of the awards. The fair value of restricted stock units (“RSUs”) is measured based on the fair market value of the underlying stock on the date of grant. The fair value of stock options with service based vesting conditions is estimated using the Black-Scholes-Merton option pricing model. The fair value of premium-priced stock options with service based vesting conditions is estimated using the Hull-White model. We recognize stock-based compensation expense on a straight-line basis (net of estimated forfeitures) over the requisite service period. Stock-based compensation expense is classified in the consolidated statement of operations based on the department to which the related employee provides service.

The Black-Scholes-Merton and Hull-White option pricing models require management to make assumptions and to apply judgment in determining the fair value of our awards. The most significant assumptions and judgments include the expected volatility, expected term of the award and estimated forfeiture rates. We estimated the expected volatility of our awards from the historical volatility of selected public companies with comparable characteristics to Demand Media,

14


 

including similarity in size, lines of business, market capitalization, revenue and financial leverage. The weighted average expected life of options was calculated using the simplified method as prescribed under guidance by the SEC. The risk-free interest rate is based on the implied yield currently available on U.S. Treasury notes with terms approximately equal to the expected life of the option. The expected dividend rate is zero as we currently have no history or expectation of paying cash dividends on our common stock. The forfeiture rate is established based on applicable historical forfeiture patterns adjusted for any expected changes in future periods.

We use the Black-Scholes-Merton option pricing model to determine the fair value of shares issued pursuant to the Demand Media, Inc. 2010 Employee Stock Purchase Plan (“ESPP”), and we recognize the fair value straight-line over the total offering period.

Stock Repurchases

Under a stock repurchase plan, shares repurchased by us 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 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. We evaluate the realizability of deferred tax assets and recognize a valuation allowance for our deferred tax assets when it is more likely than not that a future benefit on such deferred tax assets will not be realized.

We recognize 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. We recognize interest and penalties accrued related to unrecognized tax benefits in our income tax expense (benefit) provision in the accompanying condensed consolidated statements of operations.

Net Income (Loss) Per Share

Basic net income (loss) per share is computed by dividing the net income (loss) attributable to common stockholders by the weighted average number of common shares outstanding during the period. Net income (loss) attributable to common stockholders is increased for any cumulative preferred stock dividends earned during the period. Diluted net income (loss) per share is computed by dividing the net income (loss) attributable to common stockholders by the weighted average common shares outstanding plus potentially dilutive common shares. RSUs and other restricted awards are considered outstanding common shares and included in the computation of basic income (loss) per share as of the date that all necessary conditions of vesting are satisfied. RSUs, stock options and stock issued pursuant to the ESPP are excluded from the diluted net income (loss) per share calculation when their impact is antidilutive.

15


 

Fair Value of Financial Instruments

We report certain financial assets and liabilities at their carrying amounts. The carrying amounts of our financial instruments, including cash and cash equivalents, accounts receivable, restricted cash, accounts payable, accrued liabilities and customer deposits approximate fair value because of their short maturities. For our term loans and revolving loan facility, which were repaid in full in November 2014, the carrying amounts approximated fair value because they bore interest at variable rates that approximate fair value. Our 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.

Assets Held-For-Sale

We report a business as held-for-sale when management has approved or received approval to sell the business and is committed to a formal plan, the business is available for immediate sale, the business is being actively marketed, the sale is probable and anticipated to occur during the ensuing year and certain other specified criteria are met. A business classified as held-for-sale is recorded at the lower of its carrying amount or estimated fair value less cost to sell. If the carrying amount of the business exceeds its estimated fair value, a loss is recognized. Depreciation is not recorded on long-lived assets of a business classified as held-for-sale. Assets and liabilities related to a business classified as held-for-sale are segregated in the condensed consolidated balance sheet and major classes are separately disclosed in the notes to the condensed consolidated financial statements commencing in the period in which the business is classified as held-for-sale.

Discontinued Operations

 

We report the results of operations of a business as discontinued operations if the disposal of a component represents a strategic shift that has (or will have) a major effect on an entity’s operations and financial results. The results of discontinued operations are reported in net income (loss) from discontinued operations in the consolidated statements of operations for current and prior periods commencing in the period in which the business meets the criteria of a discontinued operation, and include any gain or loss recognized on closing or adjustment of the carrying amount to fair value, less cost to sell.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers, which will supersede nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of the guidance is that an entity should recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. Further, the guidance requires improved disclosures to help users of financial statements better understand the nature, amount, timing and uncertainty of revenue that is recognized.

The original effective date for ASU 2014-09 would have required us to adopt this standard beginning in the first quarter of 2017. In July 2015, the FASB voted to amend ASU 2014-09 by approving a one-year deferral of the effective date as well as providing the option to early adopt the standard on the original effective date. Accordingly, we may adopt the standard in the first quarter of 2018. The new revenue standard may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of adoption. We are currently evaluating the timing of its adoption and the impact of adopting the new revenue standard on our consolidated financial statements.

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3. Property and Equipment

Property and equipment consisted of the following (in thousands):

 

 

 

 

 

 

 

 

 

 

    

June 30, 

    

December 31,

 

 

 

2015

 

2014

 

Computers and other related equipment

 

$

27,139

 

$

28,776

 

Purchased and internally developed software

 

 

43,127

 

 

48,875

 

Furniture and fixtures

 

 

1,891

 

 

3,004

 

Leasehold improvements

 

 

7,559

 

 

7,591

 

 

 

 

79,716

 

 

88,246

 

Less accumulated depreciation

 

 

(60,964)

 

 

(65,410)

 

Property and equipment, net

 

$

18,752

 

$

22,836

 

Depreciation and software amortization expense, which includes losses on disposal of property and equipment of approximately  $0.3 million and $0.1 million for the three months ended June 30, 2015 and 2014, respectively, and $0.6 million and $1.0 million for the six months ended June 30, 2015, and 2014, respectively, is shown by classification below (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended  June 30, 

 

Six months ended June 30, 

 

 

    

2015

    

2014

    

2015

    

2014

 

Service costs

 

$

1,125

 

$

1,710

 

$

2,622

 

$

3,564

 

Sales and marketing

 

 

17

 

 

40

 

 

37

 

 

78

 

Product development

 

 

50

 

 

118

 

 

107

 

 

247

 

General and administrative

 

 

1,242

 

 

1,185

 

 

2,507

 

 

2,516

 

Discontinued operations

 

 

 —

 

 

1,679

 

 

 —

 

 

4,103

 

Total depreciation

 

$

2,434

 

$

4,732

 

$

5,273

 

$

10,508

 

 

 

 

4. Intangible Assets

Intangible assets consisted of the following (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2015

 

 

 

Gross carrying

 

Accumulated

 

Net carrying

 

 

 

amount

 

amortization

 

amount

 

Customer relationships

 

$

7,100

 

$

(6,418)

 

$

682

 

Artist relationships

 

 

11,719

 

 

(6,603)

 

 

5,116

 

Media content

 

 

102,064

 

 

(87,469)

 

 

14,595

 

Technology

 

 

5,875

 

 

(2,382)

 

 

3,493

 

Non-compete agreements

 

 

192

 

 

(125)

 

 

67

 

Trade names

 

 

8,360

 

 

(3,706)

 

 

4,654

 

Content publisher relationships

 

 

2,092

 

 

(2,092)

 

 

 —

 

 

 

$

137,402

 

$

(108,795)

 

$

28,607

 

 

 

17


 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2014

 

 

 

Gross carrying

 

Accumulated

 

Net carrying

 

 

 

amount

 

amortization

 

amount

 

Customer relationships

 

$

9,569

 

$

(8,730)

 

$

839

 

Artist relationships

 

 

11,719

 

 

(4,796)

 

 

6,923

 

Media content

 

 

103,415

 

 

(80,249)

 

 

23,166

 

Technology

 

 

27,770

 

 

(23,293)

 

 

4,477

 

Non-compete agreements

 

 

253

 

 

(146)

 

 

107

 

Trade names

 

 

10,478

 

 

(5,467)

 

 

5,011

 

Content publisher relationships

 

 

2,092

 

 

(2,080)

 

 

12

 

 

 

$

165,296

 

$

(124,761)

 

$

40,535

 

Identifiable finite-lived intangible assets are amortized on a straight-line basis over their estimated useful lives commencing on the date that the asset is available for its intended use.

Total amortization expense for the periods  shown below includes (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended  June 30, 

 

Six months ended June 30, 

 

 

    

2015

    

2014

    

2015

    

2014

 

Service costs

 

$

5,879

 

$

5,858

 

$

8,714

 

$

12,070

 

Sales and marketing

 

 

949

 

 

835

 

 

1,965

 

 

2,987

 

Product development

 

 

246

 

 

1,009

 

 

947

 

 

2,195

 

General and administrative

 

 

151

 

 

175

 

 

310

 

 

563

 

Discontinued operations

 

 

 —

 

 

1,908

 

 

 —

 

 

3,599

 

Total amortization

 

$

7,225

 

$

9,785

 

$

11,936

 

$

21,414

 

Service costs include accelerated amortization charges of $3.3 million and $0.1 million for the three months ended June 30, 2015 and 2014, respectively, and $3.3 million and $1.6 million, for the six months ended June 30, 2015 and 2014, respectively, as a result of removing certain assets from service.

 

5. Other Assets

Other assets consisted of the following (in thousands):

 

 

 

 

 

 

 

 

 

 

    

June 30, 

 

December 31, 

 

 

 

2015

 

2014

 

Long-term portion of promissory note

 

$

4,701

 

$

4,505

 

Other

 

 

1,171

 

 

1,550

 

Other assets

 

$

5,872

 

$

6,055

 

 

 

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6. Other Balance Sheet Items

 

Accrued expenses and other current liabilities consisted of the following (in thousands):

 

 

 

 

 

 

 

 

 

 

 

June 30, 

 

December 31, 

 

 

    

2015

 

2014

 

Accrued payroll and related items

 

$

4,098

 

$

4,291

 

Acquisition holdback

 

 

8,525

 

 

8,958

 

Artist payables

 

 

1,790

 

 

2,250

 

Other

 

 

6,352

 

 

8,726

 

Accrued expenses and other current liabilities

 

$

20,765

 

$

24,225

 

In July 2015, we paid $7.4 million in cash and issued 122,638 shares of our common stock to the sellers of Society6 in connection with the expiration of the holdback period.

 

7. Debt

In November 2014, we repaid all amounts outstanding under our credit agreement, dated August 29, 2013, with Silicon Valley Bank, as administrative agent, and the lenders and other agents party thereto (the “Credit Agreement”) and terminated the Credit Agreement and the related Guarantee and Collateral Agreement. The Credit Agreement had provided for a $100.0 million senior secured term loan facility and a $125.0 million senior secured revolving loan facility. Under the Credit Agreement, loans bore interest, at our option, at an annual rate based on LIBOR or a base rate. Loans based on LIBOR bore interest at a rate between LIBOR plus 2.00% and LIBOR plus 3.00%, depending on our consolidated leverage ratio. Loans based on the base rate bore interest at the base rate plus an applicable margin of 1.00% or 2.00%, depending on our consolidated leverage ratio. We were also required to pay a commitment fee between 0.20% and 0.40% per annum, depending on our consolidated leverage ratio, on the undrawn portion available under the credit facility.

 

In connection with entering into the Credit Agreement in August 2013, we incurred debt issuance costs of $1.9 million. Debt issuance costs are capitalized and amortized into interest expense over the term of the underlying debt. During the three and the six months ended June 30, 2014 we amortized $0.2 million and $0.3 million, respectively, of deferred debt issuance costs. Due to the repayment in full of all amounts under the credit facility in November 2014, there were no amortized deferred debt issuance costs during 2015.

8. Commitments and Contingencies

Leases

We conduct our operations utilizing leased office facilities in various locations and lease certain equipment under non-cancelable operating and capital leases. Our leases expire between December 2017 and February 2020.

Litigation

 

On November 5, 2014, Charles Saatchi filed a lawsuit against our wholly owned subsidiary, Saatchi Online, Inc. (“Saatchi Art”), in the High Court of Justice, Chancery Division (United Kingdom) relating to an intellectual property licensing agreement (the “IP Agreement”) between Charles Saatchi and Saatchi Art, dated February 18, 2010 (the “UK Action”). Mr. Saatchi alleged that Saatchi Art committed a repudiatory breach of the IP Agreement and sought a permanent injunction restricting Saatchi Art from continuing to use the “Saatchi” name, a declaration that the IP Agreement has been validly terminated, a disgorgement of any profits derived from Saatchi Art’s use of the name since the alleged termination date and unspecified monetary damages.

 

19


 

On December 30, 2014, Charles Saatchi and Robert Norton, common stockholders of Saatchi Art prior to its acquisition by Demand Media, filed a lawsuit in the Delaware Chancery Court against certain former directors, officers and preferred stockholders of Saatchi Art, and Saatchi Art itself, alleging that, in connection with Demand Media’s acquisition of Saatchi Art, such directors, officers and preferred stockholders breached their fiduciary duties to the common stockholders and that the preferred stockholders and Saatchi Art violated a Saatchi Art voting agreement by breaching the implied covenant of good faith and fair dealing (the “Delaware Action” and, together with the UK Action, the “Actions”). The complaint sought rescissory damages, a constructive trust over the acquisition proceeds, disgorgement of all profits related thereto, and unspecified compensatory damages, costs and fees.

 

On July 29, 2015, Saatchi Art, for itself and on behalf of the other defendants in the Delaware Action, entered into a settlement agreement (the “Settlement Agreement”) with Charles Saatchi and Robert Norton to settle all disputes relating to the Actions. The Settlement Agreement results in the complete resolution of the Actions to the mutual satisfaction of the parties. Under the terms of the Settlement Agreement, the IP Agreement regarding the use of the “Saatchi” name in connection with the Saatchi Art business remains in full force and effect. Based on the terms of the Settlement Agreement, we recorded an expense of $250,000 with respect to the settlement of the Delaware Action on our consolidated statement of operations for the three and six months ended June 30, 2015, which is net of amounts to be recovered from an insurance policy and the escrow account established to cover indemnification obligations of the selling stockholders under the Saatchi Art merger agreement.

In addition, from time to time we are a party to various legal matters incidental to the conduct of our businesses. Certain of our outstanding legal matters include speculative claims for indeterminate amounts of damages. We record a liability when we believe that it is probable that a loss has been incurred and the amount can be reasonably estimated. Based on our current knowledge, we do not believe that there is a reasonable possibility that the final outcome of the pending or threatened legal proceedings to which we are a party, either individually or in the aggregate, will have a material adverse effect on our future financial results. However, the outcome of such legal matters is subject to significant uncertainties.

Taxes

From time to time, various federal, state and other jurisdictional tax authorities undertake review of us and our filings. In evaluating the exposure associated with various tax filing positions, we accrue charges for possible exposures. The IRS completed the audit of our 2012 tax return with no adjustments.

Indemnification

In the normal course of business, we have provided certain indemnities, commitments and guarantees under which we may be required to make payments in relation to certain transactions. These indemnities include intellectual property indemnities to our customers, indemnities to our directors and officers to the maximum extent permitted under the laws of the State of Delaware, indemnifications related to our lease agreements and indemnifications to sellers or buyers in connection with acquisitions and dispositions, respectively. In addition, our advertiser and distribution partner agreements contain certain indemnification provisions which are generally consistent with those prevalent in our industry. We have not incurred significant obligations under indemnification provisions historically and do not expect to incur significant obligations in the future. Accordingly, we have not recorded any liability for these indemnities, commitments and guarantees in the accompanying condensed consolidated balance sheets. 

9. Income Taxes

Our effective tax rate differs from the statutory rate primarily as a result of state taxes, foreign taxes, nondeductible stock option expenses and changes in our valuation allowance.

Income tax expense for the six months ended June 30, 2015, decreased by $2.7 million primarily due to the impairment of goodwill which allowed for the reversal of the deferred tax liability related to the tax amortization of goodwill and a full valuation allowance. 

20


 

We reduce our deferred tax assets 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, we have deferred tax assets in excess of deferred tax liabilities before application of a valuation allowance for the periods presented. As we have insufficient history of generating book income, the ultimate future realization of these excess deferred tax assets is not more likely than not and is thus subject to a valuation allowance. Accordingly, we have established a full valuation allowance against our deferred tax assets.

We are subject to the accounting guidance for uncertain income tax positions. We believe that our income tax positions and deductions will be sustained on audit and do not anticipate any adjustments will result in a material adverse effect on our financial condition, results of operations, or cash flow. We acquired a $0.1 million uncertain tax position as a result of a business acquisition during 2011.

Our 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 the six months ended June 30, 2015 or 2014 other than the acquired uncertain tax position, and we do not expect our uncertain tax position to change materially during the next twelve months. We file a U.S. federal and many state tax returns as well as tax returns in multiple foreign jurisdictions. All tax years since our incorporation remain subject to examination by the IRS and various state authorities. The IRS completed the audit of our 2012 tax return with no adjustments.

10. Employee Benefit Plan

We have a defined contribution plan (the “401(k) Plan”) under Section 401(k) of the Internal Revenue Code of 1986, as amended covering all full-time employees who meet certain eligibility requirements. Eligible employees may defer up to 90% of their pre-tax eligible compensation, up to the annual maximum allowed by the IRS. Under the 401(k) Plan, we may, but are not obligated to, match a portion of the employee contributions up to a defined maximum. During the six months ended June 30, 2015 and 2014, we incurred approximately $0.6 million and $1.1 million, respectively, in employer contributions under the 401(k) Plan, and we expect to incur approximately $0.6 million for the remainder of the current fiscal year. 

11. Stock-based Compensation Plans and Awards

Stock-based Compensation Expense

Stock-based compensation expense related to all employee and non-employee stock-based awards recognized in the condensed consolidated statements of operations was as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended  June 30, 

 

Six months ended June 30, 

 

 

    

2015

    

2014

    

2015

    

2014

 

Service costs

 

$

310

 

$

407

 

$

624

 

$

696

 

Sales and marketing

 

 

129

 

 

180

 

 

310

 

 

333

 

Product development

 

 

458

 

 

850

 

 

927

 

 

1,535

 

General and administrative

 

 

992

 

 

2,832

 

 

2,263

 

 

5,469

 

Discontinued operations

 

 

 —

 

 

1,095

 

 

 —

 

 

2,598

 

Total stock-based compensation

 

$

1,889

 

$

5,364

 

$

4,124

 

$

10,631

 

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Award Activity

Stock Options

Stock option activity is as follows (in thousands):

 

 

 

 

 

 

 

Number of

 

 

    

options

 

 

 

outstanding

 

Outstanding at December 31, 2014

 

3,473

 

Options granted

 

807

 

Options exercised

 

(8)

 

Options forfeited or cancelled

 

(807)

 

Outstanding at June 30, 2015

 

3,465

 

Restricted Stock Units

Restricted stock unit activity is as follows (in thousands):

 

 

 

 

 

 

 

Number of

 

 

    

Shares

 

Unvested at December 31, 2014

 

857

 

Granted

 

808

 

Vested

 

(139)

 

Forfeited

 

(311)

 

Unvested at June 30, 2015

 

1,215

 

Employee Stock Purchase Plan

 

In 2010, we established our ESPP, which allows eligible employees to purchase, through payroll deductions, a limited amount of our common stock at a discounted price. The ESPP provides up to a 24-month offering period which is comprised of four consecutive six-month purchase periods commencing in May and November. We commenced our first offering period in May 2011 and our most recent offering period in November 2014. Under the ESPP, participants can purchase our common stock at a 15% discount to the lower of our common stock’s market price as of the beginning or ending of the relevant offering period. 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. A maximum of 750 shares of common stock may be purchased by each participant during each purchase period. The fair value of the shares issued pursuant to the ESPP is determined using a Black-Scholes-Merton model and is amortized over the remaining life of the 24-month offering period of the ESPP. The Black-Scholes-Merton model included an assumption for expected volatility of between 58% and 60% for each of the four purchase periods during the current offering period. During the six months ended June 30, 2015, we recognized $0.1 million of expense in relation to the ESPP and approximately 1.7 million shares of common stock remained authorized for issuance under the ESPP at June 30, 2015. As of June 30, 2015, there was approximately $0.5 million of unrecognized compensation expense related to the ESPP which is expected to be recognized on a straight-line basis over the remainder of the current offering period.

12. Stockholders’ Equity

Reverse Stock Split

On August 1, 2014, immediately following the Distribution, we enacted a 1-for-5 reverse stock split with respect to all of our outstanding shares of common stock, including shares held in treasury, which is reflected retrospectively throughout the condensed consolidated financial statements.

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Stock Repurchases

Under our February 8, 2012 stock repurchase plan, as amended, we are authorized to repurchase up to $50.0 million of our common stock from time to time. Since April 2013, we have not repurchased any shares of common stock. Approximately $19.2 million remains available under the repurchase plan at June 30, 2015. 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 us are accounted for when the transaction is settled. As of June 30, 2015, there were no unsettled share repurchases. The par value of shares repurchased and retired is deducted from common stock and any excess over par value is deducted from additional paid in capital. Direct costs incurred to repurchase 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.

13. Business Segments

We operate in one operating segment. Our chief operating decision maker (the “CODM”) manages our operations on a consolidated basis for purposes of evaluating financial performance and allocating resources. The CODM reviews separate revenue information for the Content & Media and Marketplace offerings. All other financial information is reviewed by the CODM on a consolidated basis. All of our principal operations and assets are located in the United States.

Revenue derived from our Content & Media and Marketplaces service offerings is as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended  June 30, 

 

Six months ended June 30, 

 

 

    

 

2015

    

2014

    

2015

    

2014

 

Content & Media

 

 

$

19,261

 

$

36,461

 

$

41,786

 

$

74,787

 

Marketplaces

 

 

 

10,507

 

 

6,616

 

 

21,192

 

 

13,346

 

Total revenue

 

 

$

29,768

 

$

43,077

 

$

62,978

 

$

88,133

 

 

Revenue by geographic region, as determined based on the location of our customers or anticipated destination of use, was as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended  June 30, 

 

Six months ended June 30, 

 

 

    

 

2015

    

2014

    

2015

    

2014

 

Domestic

 

 

$

25,357

 

$

38,483

 

$

54,125

 

$

78,979

 

International

 

 

 

4,411

 

 

4,594

 

 

8,853

 

 

9,154

 

Total revenue

 

 

$

29,768

 

$

43,077

 

$

62,978

 

$

88,133

 

 

 

14. Fair Value

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. We measure our 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.

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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, we utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible and consider counterparty credit risk in our assessment of fair value.

For financial assets that utilize Level 1 and Level 2 inputs, we utilize 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). For financial assets that utilize Level 3 inputs, we derive the fair value based on company assumptions and information obtained from brokers based on the indicated market values.

We report certain financial assets and liabilities at their carrying amounts. The carrying amounts of our financial instruments, which include cash and cash equivalents, accounts receivable, restricted cash, accounts payable, accrued liabilities and customer deposits, approximate fair value because of their short maturities. The carrying amount for amounts that were outstanding under our terminated credit facility approximates fair value because the loans bore interest at variable rates that approximated fair value. Our 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.

Financial assets measured at fair value on a recurring basis were as follows (in thousands):