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EX-10.2 - EX-10.2 - LEAF GROUP LTD.dmd-20150930ex10204a33c.htm
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EX-32.2 - EX-32.2 - LEAF GROUP LTD.dmd-20150930ex32213aab8.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 September 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 October 30, 2015, there were 20,073,259 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

  

27 

 

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

  

43 

 

Item 4.

  

Controls and Procedures

  

44 

Part II 

Other Information

 

 

 

Item 1.

  

Legal Proceedings

  

45 

 

Item 1A.

  

Risk Factors

  

45 

 

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

  

47 

 

Item 3.

  

Defaults Upon Senior Securities

  

47 

 

Item 4.

  

Mine Safety Disclosures

  

47 

 

Item 5.

  

Other Information

  

47 

 

Item 6.

  

Exhibits

  

48 

 

 

  

Signatures

  

49 

 

 

 

2


 

Part I.       FINANCIAL INFORMATION

 

Item 1.      CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  

Demand Media, Inc. and Subsidiaries 

Condensed Consolidated Balance Sheets  

(In thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

    

September 30, 

    

December 31, 

 

 

 

2015

 

2014

 

Assets

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

37,942

 

$

47,820

 

Accounts receivable, net

 

 

9,618

 

 

14,504

 

Prepaid expenses and other current assets

 

 

4,954

 

 

7,447

 

Total current assets

 

 

52,514

 

 

69,771

 

Property and equipment, net

 

 

15,516

 

 

22,836

 

Intangible assets, net

 

 

24,935

 

 

40,535

 

Goodwill

 

 

10,358

 

 

10,358

 

Other assets

 

 

1,205

 

 

6,055

 

Total assets

 

$

104,528

 

$

149,555

 

Liabilities and Stockholders' Equity

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

Accounts payable

 

$

1,149

 

$

4,762

 

Accrued expenses and other current liabilities

 

 

12,765

 

 

24,225

 

Deferred revenue

 

 

2,978

 

 

3,569

 

Total current liabilities

 

 

16,892

 

 

32,556

 

Deferred tax liability

 

 

316

 

 

334

 

Other liabilities

 

 

1,704

 

 

1,823

 

Commitments and contingencies (Note 8)

 

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

 

 

Common stock, $0.0001 par value. Authorized 100,000 shares; 20,872 issued and 20,070 shares outstanding at September 30, 2015 and 20,543 issued and 19,741 shares outstanding at December 31, 2014

 

 

2

 

 

2

 

Additional paid-in capital

 

 

503,543

 

 

497,809

 

Accumulated other comprehensive loss

 

 

(74)

 

 

(76)

 

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

 

 

(30,767)

 

 

(30,767)

 

Accumulated deficit

 

 

(387,088)

 

 

(352,126)

 

Total stockholders’ equity

 

 

85,616

 

 

114,842

 

Total liabilities and stockholders’ equity

 

$

104,528

 

$

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  September 30, 

 

Nine months ended September 30, 

 

 

    

2015

    

2014

    

2015

    

2014

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

Service revenue

 

$

16,755

 

$

33,712

 

$

60,047

 

$

108,373

 

Product revenue

 

 

11,750

 

 

7,603

 

 

31,436

 

 

21,075

 

Total revenue

 

 

28,505

 

 

41,315

 

 

91,483

 

 

129,448

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

9,566

 

 

11,256

 

 

29,103

 

 

33,198

 

Product costs

 

 

7,638

 

 

5,506

 

 

21,240

 

 

15,507

 

Sales and marketing

 

 

5,424

 

 

4,699

 

 

14,797

 

 

15,422

 

Product development

 

 

6,520

 

 

7,050

 

 

18,923

 

 

21,221

 

General and administrative

 

 

9,883

 

 

12,464

 

 

30,200

 

 

36,868

 

Goodwill impairment charge

 

 

 —

 

 

232,270

 

 

 —

 

 

232,270

 

Amortization of intangible assets

 

 

3,441

 

 

7,388

 

 

15,377

 

 

25,203

 

Total operating expenses

 

 

42,472

 

 

280,633

 

 

129,640

 

 

379,689

 

Loss from operations

 

 

(13,967)

 

 

(239,318)

 

 

(38,157)

 

 

(250,241)

 

Interest income (expense), net

 

 

(3)

 

 

(627)

 

 

216

 

 

(2,331)

 

Other income, net

 

 

178

 

 

782

 

 

3,024

 

 

736

 

Loss from continuing operations before income taxes

 

 

(13,792)

 

 

(239,163)

 

 

(34,917)

 

 

(251,836)

 

Income tax (expense) benefit

 

 

(13)

 

 

16,631

 

 

(45)

 

 

13,917

 

Net loss from continuing operations

 

 

(13,805)

 

 

(222,532)

 

 

(34,962)

 

 

(237,919)

 

Net loss from discontinued operations

 

 

 —

 

 

(1,306)

 

 

 —

 

 

(11,208)

 

Net loss

 

$

(13,805)

 

$

(223,838)

 

$

(34,962)

 

$

(249,127)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings (Loss) per share - basic and diluted

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss from continuing operations

 

$

(0.69)

 

$

(11.62)

 

$

(1.76)

 

$

(12.90)

 

Net loss from discontinued operations

 

 

 —

 

 

(0.07)

 

 

 —

 

 

(0.60)

 

Net loss per share

 

$

(0.69)

 

$

(11.69)

 

$

(1.76)

 

$

(13.50)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares - basic and diluted

 

 

20,021

 

 

19,151

 

 

19,879

 

 

18,450

 

 

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  September 30, 

 

Nine months ended September 30, 

 

 

    

2015

    

2014

    

2015

    

2014

 

Net loss

 

$

(13,805)

 

$

(223,838)

 

$

(34,962)

 

$

(249,127)

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

 

11

 

 

(41)

 

 

2

 

 

(91)

 

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

 

 

 —

 

 

 —

 

 

 —

 

 

(562)

 

Other comprehensive income (loss), net of tax:

 

 

11

 

 

(41)

 

 

2

 

 

(653)

 

Comprehensive loss

 

$

(13,794)

 

$

(223,879)

 

$

(34,960)

 

$

(249,780)

 

 

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

 

329

 

 

 —

 

 

263

 

 

 —

 

 

 —

 

 

 —

 

 

263

 

Stock-based compensation expense

 

 —

 

 

 —

 

 

5,471

 

 

 —

 

 

 —

 

 

 —

 

 

5,471

 

Foreign currency translation adjustment

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

2

 

 

 —

 

 

2

 

Net loss

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(34,962)

 

 

(34,962)

 

Balance at September 30, 2015

 

20,070

 

$

2

 

$

503,543

 

$

(30,767)

 

$

(74)

 

$

(387,088)

 

$

85,616

 

 

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)

 

 

 

 

 

 

 

 

 

 

 

 

Nine months ended September 30, 

 

 

    

2015

    

2014

 

Cash flows from operating activities

 

 

 

 

 

 

 

Net loss

 

$

(34,962)

 

$

(249,127)

 

Adjustments to reconcile net loss to net cash (used in) provided by operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

 

24,364

 

 

43,356

 

Deferred income taxes

 

 

 —

 

 

(13,625)

 

Stock-based compensation

 

 

5,683

 

 

15,364

 

Goodwill impairment charge

 

 

 —

 

 

232,270

 

Gain on disposal of businesses and properties

 

 

(3,105)

 

 

(795)

 

Gain on other assets, net

 

 

 —

 

 

(5,745)

 

Other

 

 

(76)

 

 

(1,638)

 

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

 

 

 

 

 

 

 

Accounts receivable, net

 

 

4,712

 

 

7,402

 

Prepaid expenses and other current assets

 

 

550

 

 

(1,650)

 

Deferred registration costs

 

 

 —

 

 

(8,876)

 

Deposits with registries

 

 

 —

 

 

(259)

 

Other long-term assets

 

 

(140)

 

 

(557)

 

Accounts payable

 

 

(3,572)

 

 

(5,153)

 

Accrued expenses and other liabilities

 

 

(3,367)

 

 

(472)

 

Deferred revenue

 

 

164

 

 

12,296

 

Net cash (used in) provided by operating activities

 

 

(9,749)

 

 

22,791

 

Cash flows from investing activities

 

 

 

 

 

 

 

Purchases of property and equipment

 

 

(3,590)

 

 

(7,597)

 

Purchases of intangible assets

 

 

(64)

 

 

(5,406)

 

Payments for gTLD applications

 

 

 —

 

 

(15,829)

 

Proceeds from gTLD withdrawals, net

 

 

 —

 

 

6,105

 

Cash received from disposal of businesses and properties, net of cash disposed

 

 

4,766

 

 

13,696

 

Cash received from early repayment of promissory note

 

 

5,100

 

 

 —

 

Cash received from disposition holdback

 

 

998

 

 

 —

 

Cash paid for acquisitions, net of cash acquired

 

 

(58)

 

 

(2,240)

 

Restricted deposits

 

 

671

 

 

(1,700)

 

Other

 

 

76

 

 

996

 

Net cash provided by (used in) investing activities

 

 

7,899

 

 

(11,975)

 

Cash flows from financing activities

 

 

 

 

 

 

 

Long-term debt repayments, net

 

 

 —

 

 

(22,500)

 

Proceeds from exercises of stock options and contributions to ESPP

 

 

215

 

 

343

 

Net taxes paid on RSUs and options exercised

 

 

(563)

 

 

(2,236)

 

Cash paid for acquisition holdback

 

 

(7,561)

 

 

(1,942)

 

Cash distribution related to spin-off

 

 

 —

 

 

(24,145)

 

Other

 

 

(121)

 

 

(529)

 

Net cash used in financing activities

 

 

(8,030)

 

 

(51,009)

 

Effect of foreign currency on cash and cash equivalents

 

 

2

 

 

(87)

 

Change in cash and cash equivalents

 

 

(9,878)

 

 

(40,280)

 

Cash and cash equivalents, beginning of period

 

 

47,820

 

 

153,511

 

Cash and cash equivalents, end of period

 

$

37,942

 

$

113,231

 

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 leading owned and operated online properties that publish content in text, video, photography and designed visual formats. This content is published across several key categories on eHow.com, a how-to reference and do-it-yourself destination, Livestrong.com, a health and healthy living destination, and certain niche properties focused on specific interests. 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, and LEAFtv, a lifestyle resource for women that produces high-quality, short-form how-to videos covering stylish living, food and fashion. Additionally, our studioD business develops and executes content marketing strategies and creates custom content for third-party brands, agencies and publishers.

Marketplaces

Through our Marketplaces service offering, we operate two leading art and design marketplaces where large communities of artists can market and sell their original artwork or their 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. SaatchiArt.com (“Saatchi Art”), 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 September 30, 2015, the condensed consolidated statements of operations and condensed consolidated statements of comprehensive income (loss) for the three and nine month periods ended September 30, 2015 and 2014, the condensed consolidated statements of cash flows for the nine month periods ended September 30, 2015 and 2014 and the condensed consolidated statement of stockholders’ equity for the nine month period ended September 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 September 30, 2015 and our results of operations for the nine month periods ended September 30, 2015 and 2014 and our cash flows for the nine month periods ended September 30, 2015 and 2014. The results for the three month period ended September 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 relevant 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 nine month periods ended September 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. 

 

Results of Adjustments

 During the three months ended September 30, 2015, we identified through our internal processes that our property and equipment, net was overstated because certain capitalized internally developed software costs had not been placed into service and certain write offs were not identified on a timely basis. The adjustment is not considered material to any of our prior period or current period consolidated financial statements. As such, during the three months ended September 30, 2015, we recorded an out of period adjustment which increased depreciation by $0.6 million, decreased “Other income, net” by $0.5 million and decreased “Property and equipment, net” by $1.1 million. The condensed consolidated statements of operations and comprehensive income for the three and nine months ended September 30, 2015,  the condensed consolidated balance sheet as of September 30, 2015 and the condensed consolidated statement of cash flows for the nine months ended September 30, 2015 reflect the above adjustments.

In the fourth quarter of 2014, we determined that certain gTLD transactions, primarily related to deposits made for gTLD auctions just prior to the spin-off of Rightside, had been misclassified in our consolidated statement of cash flows for the nine months ended September 30, 2014. These cash flows were improperly recorded as a change in "Accounts Receivable" within operating activities instead of being classified as "Payments for gTLD applications" within investing activities. For the third quarter of 2014, this classification error resulted in our net cash provided by operating activities being understated by $3.4 million and net cash used in investing activities being understated by the same amount. This classification error relates entirely to activities of our discontinued operations. We assessed the materiality of this error in accordance with SEC Staff Accounting Bulletin No. 99 and concluded that the error was not material to the consolidated financial statements taken as a whole. As such, we have corrected this error in preparing the consolidated statement of cash flows for the nine months ended September 30, 2014, as presented herein.

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, 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 now 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.

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We classify marketable securities as current or non-current based upon whether such assets are reasonably expected to be realized in cash, 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.

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; native advertisements, which are advertisements created to match the form and function of the platform on which they appear; 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, 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 $2.4 million, which is recorded in other income, net.

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Content Sales and Licensing Revenue. We generate revenue from the sale or license of media content, including the creation and distribution of content for third party brands, publishers and agencies 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 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. Product revenue for Society6 is recognized net of sales allowances and return allowances. We recognize product revenue from the sale of prints through Saatchi Art when the prints are delivered and the return period has expired. Product revenue for Saatchi Art is recognized after the return period has lapsed, net of estimated sales allowances and estimated future returns. 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. Product 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. 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 product revenue because 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.

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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.

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. 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 approximately $3.3 million of accelerated amortization expense in the nine months ended September 30, 2015. We continue to perform evaluations of our content library on an ongoing basis and may remove additional content in the future, which could result in additional accelerated amortization expense in the periods such actions occur.

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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 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 September 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

14


 

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, which had previously been included in our 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 and determined an impairment did not exist.  

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, 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.

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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.

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 loans under our previous credit 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 and investments held at cost, 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

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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 not adopt the standard until 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.

3. Property and Equipment

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

 

 

 

 

 

 

 

 

 

 

    

September 30, 

    

December 31,

 

 

 

2015

 

2014

 

Computers and other related equipment

 

$

17,464

 

$

28,776

 

Purchased and internally developed software

 

 

37,694

 

 

48,875

 

Furniture and fixtures

 

 

1,388

 

 

3,004

 

Leasehold improvements

 

 

7,297

 

 

7,591

 

 

 

 

63,843

 

 

88,246

 

Less accumulated depreciation

 

 

(48,327)

 

 

(65,410)

 

Property and equipment, net

 

$

15,516

 

$

22,836

 

Depreciation and software amortization expense, which includes losses on disposal of property and equipment of approximately $1.1 million and $0.2 million for the three months ended September 30, 2015 and 2014, respectively, and $1.7 million and $1.1 million for the nine months ended September 30, 2015, and 2014, respectively, is shown by classification below (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended  September 30, 

 

Nine months ended September 30, 

 

 

    

2015

    

2014

    

2015

    

2014

 

Service costs

 

$

2,041

 

$

1,559

 

$

4,663

 

$

5,123

 

Sales and marketing

 

 

15

 

 

37

 

 

52

 

 

115

 

Product development

 

 

47

 

 

135

 

 

154

 

 

382

 

General and administrative

 

 

1,611

 

 

1,112

 

 

4,118

 

 

3,628

 

Discontinued operations

 

 

 —

 

 

559

 

 

 —

 

 

4,662

 

Total depreciation

 

$

3,714

 

$

3,402

 

$

8,987

 

$

13,910

 

 

 

 

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4. Intangible Assets

Intangible assets consisted of the following (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2015

 

 

 

Gross carrying

 

Accumulated

 

Net carrying

 

 

 

amount

 

amortization

 

amount

 

Customer relationships

 

$

4,893

 

$

(4,292)

 

$

601

 

Artist relationships

 

 

11,719

 

 

(7,472)

 

 

4,247

 

Media content

 

 

97,569

 

 

(84,855)

 

 

12,714

 

Technology

 

 

5,887

 

 

(2,628)

 

 

3,259

 

Non-compete agreements

 

 

217

 

 

(142)

 

 

75

 

Trade names

 

 

7,667

 

 

(3,628)

 

 

4,039

 

Content publisher relationships

 

 

1,616

 

 

(1,616)

 

 

 —

 

 

 

$

129,568

 

$

(104,633)

 

$

24,935

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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.

During the three months ended September 30, 2015, we sold certain non-core online properties within our Demand Vertical Network. We received total consideration of $0.9 million for these properties and related acquired intangible assets, resulting in a gain of $0.7 million, which is recorded in other income, net.

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended  September 30, 

 

Nine months ended September 30, 

 

 

    

2015

    

2014

    

2015

    

2014

 

Service costs

 

$

1,969

 

$

5,419

 

$

10,683

 

$

17,489

 

Sales and marketing

 

 

949

 

 

841

 

 

2,914

 

 

3,828

 

Product development

 

 

246

 

 

989

 

 

1,193

 

 

3,184

 

General and administrative

 

 

277

 

 

138

 

 

587

 

 

701

 

Discontinued operations

 

 

 —

 

 

645

 

 

 —

 

 

4,244

 

Total amortization

 

$

3,441

 

$

8,032

 

$

15,377

 

$

29,446

 

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

 

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5. Other Assets

Other assets consisted of the following (in thousands):

 

 

 

 

 

 

 

 

 

 

    

September 30, 

 

December 31, 

 

 

 

2015

 

2014

 

Long-term portion of promissory note

 

$

 —

 

$

4,505

 

Other

 

 

1,205

 

 

1,550

 

Other assets

 

$

1,205

 

$

6,055

 

 

 

During the three months ended September 30, 2015, we received a  payment of $5.1 million, plus accrued and unpaid interest, on the promissory note that we received as part of the consideration for the sale of our CoveritLive business in July 2014. This promissory note had a principal amount of $5.6 million and was originally due in full by July 2016. The early repayment of $5.1 million, plus accrued and unpaid interest, satisfied all amounts owed to us under the promissory note and the promissory note was discharged. The discount from the carrying value of the promissory note was approximately $0.1 million, which was recorded as interest income (expense), net.

 

6. Accrued Expenses and Other Current Liabilities

 

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

 

 

 

 

 

 

 

 

 

 

 

September 30, 

 

December 31, 

 

 

    

2015

 

2014

 

Accrued payroll and related items

 

$

5,131

 

$

4,291

 

Acquisition holdback

 

 

607

 

 

8,958

 

Artist payables

 

 

1,842

 

 

2,250

 

Other

 

 

5,185

 

 

8,726

 

Accrued expenses and other current liabilities

 

$

12,765

 

$

24,225

 

In July 2015, as part of the consideration for our purchase of Society6, we paid $7.4 million in cash and issued 122,638 shares of our common stock to the sellers of Society6 upon the expiration of the holdback period.

During the three months ended September 30, 2015, we recognized severance costs of $1.8 million in connection with certain workforce reduction actions that occurred throughout the period.  Severance costs for the three months ended September 30, 2015 were recognized in the condensed consolidated statements of operations as follows: $0.8 million in product development costs, $0.5 million in service costs, $0.4 million in general and administrative costs, and $0.1 million in sales and marketing costs. As of September 30, 2015, there was $0.6 million of accrued severance included in accrued expenses and other current liabilities in the condensed consolidated balance sheet.  An additional $0.5 million of retention and severance costs will be expensed over the applicable retention periods, which extend through the first quarter of 2016.  Changes to the severance accrual during the nine months ended September 30, 2015 are as follows (in thousands):

 

 

 

 

 

Balance at December 31, 2014

 

$

-

New charges

 

 

1,830

Cash payments

 

 

(1,252)

Balance at September 30, 2015

 

$

578

 

 

7. Debt

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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 nine months ended September 30, 2014 we amortized $0.1 million and $0.4 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 February 2016 and February 2020.  

Litigation

 

On November 5, 2014, Charles Saatchi filed a lawsuit against our wholly owned subsidiary, Saatchi Online, Inc. (“Saatchi Online”), 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 Online, dated February 18, 2010 (the “UK Action”). Mr. Saatchi had alleged that Saatchi Online committed a repudiatory breach of the IP Agreement and had sought, among other things, a permanent injunction restricting Saatchi Online from continuing to use the “Saatchi” name.

 

On December 30, 2014, Charles Saatchi and Robert Norton, common stockholders of Saatchi Online 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 Online, and Saatchi Online itself, alleging that, in connection with Demand Media’s acquisition of Saatchi Online, such directors, officers and preferred stockholders breached their fiduciary duties to the common stockholders and that the preferred stockholders and Saatchi Online violated a Saatchi Online voting agreement by breaching the implied covenant of good faith and fair dealing (the “Delaware Action” and, together with the UK Action, the “Actions”).

 

On July 29, 2015, Saatchi Online, 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 resolved the Actions to the mutual satisfaction of the parties. Under the terms of the Settlement Agreement, we are permitted to use the Saatchi name in connection with operating the Saatchi Art business. In connection with entering into the Settlement Agreement, we contributed $250,000 towards the settlement of the Delaware Action, which was paid in August 2015. This amount was net of amounts reimbursed to us from an insurance policy and the escrow account established to cover indemnification obligations of the selling stockholders under the Saatchi Online 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

20


 

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.

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, content creation 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 three and nine months ended September 30, 2015 was less than $0.1 million as compared to an income tax benefit for the three and nine months ended September 30, 2014 of $16.7 million and $13.9 million, respectively. The difference between the 2014 and the 2015 periods was the result of the impairment of goodwill in the three and nine months ended September 30, 2014, which allowed for the reversal of the deferred tax liability related to the tax amortization of goodwill and a full valuation allowance. 

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.

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 nine months ended September 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.

21


 

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 nine months ended September 30, 2015 and 2014, we incurred approximately $0.8 million and $1.4 million, respectively, in employer contributions under the 401(k) Plan, and we expect to incur approximately $0.3 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  September 30, 

 

Nine months ended September 30, 

 

 

    

2015

    

2014

    

2015

    

2014

 

Service costs

 

$

182

 

$

451

 

$

806

 

$

1,147

 

Sales and marketing

 

 

122

 

 

178

 

 

432

 

 

511

 

Product development

 

 

350

 

 

832

 

 

1,277

 

 

2,367

 

General and administrative

 

 

905

 

 

2,921

 

 

3,168

 

 

8,390

 

Discontinued operations

 

 

 —

 

 

351

 

 

 —

 

 

2,949

 

Total stock-based compensation

 

$

1,559

 

$

4,733

 

$

5,683

 

$

15,364

 

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

 

884

 

Options exercised

 

(8)

 

Options forfeited or cancelled

 

(1,162)

 

Outstanding at September 30, 2015

 

3,187

 

Restricted Stock Units

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

 

 

 

 

 

 

 

Number of

 

 

    

Shares

 

Unvested at December 31, 2014

 

857

 

Granted

 

926

 

Vested

 

(226)

 

Forfeited

 

(525)

 

Unvested at September 30, 2015

 

1,032

 

22


 

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 nine months ended September 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 September 30, 2015. As of September 30, 2015, there was approximately $0.3 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.

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 remained available under the repurchase plan at September 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 September 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.

Voting Rights

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 service 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.

23


 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended  September 30, 

 

Nine months ended September 30, 

 

 

    

 

2015

    

2014

    

2015

    

2014

 

Content & Media

 

 

$

15,881

 

$

33,566

 

$

57,667

 

$

108,353

 

Marketplaces

 

 

 

12,624

 

 

7,749

 

 

33,816

 

 

21,095

 

Total revenue

 

 

$

28,505

 

$

41,315

 

$

91,483

 

$

129,448

 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended  September 30, 

 

Nine months ended September 30, 

 

 

    

 

2015

    

2014

    

2015

    

2014

 

Domestic

 

 

$

24,621

 

$

37,291

 

$

79,054

 

$

116,269

 

International

 

 

 

3,884

 

 

4,024

 

 

12,429

 

 

13,179

 

Total revenue

 

 

$

28,505

 

$

41,315

 

$

91,483

 

$

129,448

 

 

 

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. 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.

24


 

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):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at September 30, 2015

 

 

    

Level 1

    

Level 2

    

Level 3

    

Total

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash equivalents (1)

 

$

5,006

 

$

 —

 

$

 —

 

$

5,006

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2014

 

 

    

Level 1

    

Level 2

    

Level 3

    

Total

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash equivalents (1)

 

$

5,000

 

$

 —

 

$

 —

 

$

5,000

 

Promissory note

 

 

 —

 

 

 —

 

 

4,946

 

 

4,946

 

 

 

$

5,000

 

$

 —

 

$

4,946

 

$

9,946

 


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

During the three months ended September 30, 2015, we received a payment of $5.1 million, plus accrued and unpaid interest, on the promissory note that we received as part of the consideration for the sale of our CoveritLive business in July 2014. This promissory note had a principal amount of $5.6 million and was originally due in full by July 2016. The early repayment of $5.1 million, plus accrued and unpaid interest, satisfied all amounts owed to us under the promissory note and the promissory note was discharged. The discount from the carrying value of the promissory note was approximately $0.1 million, which was recorded as interest income (expense), net.

 

25


 

15. Net Loss Per Share

The following table sets forth the computation of basic and diluted net loss per share of common stock (in thousands, except per share data):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended  September 30, 

 

Nine months ended September 30, 

 

 

 

2015

    

2014

    

2015

    

2014

 

Net loss from continuing operations

    

$

(13,805)

    

$

(222,532)

    

$

(34,962)

    

$

(237,919)

 

Net loss from discontinued operations

 

 

 —

 

 

(1,306)

 

 

 —

 

 

(11,208)

 

Net loss

 

$

(13,805)

 

$

(223,838)

 

$

(34,962)

 

$

(249,127)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

 

20,021

 

 

19,151

 

 

19,879

 

 

18,454

 

Weighted average unvested restricted stock awards

 

 

 —

 

 

 —

 

 

 —

 

 

(4)

 

Weighted average common shares outstanding—basic and diluted

 

 

20,021

 

 

19,151

 

 

19,879

 

 

18,450

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings (Loss) per share—basic and diluted

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss from continuing operations

 

$

(0.69)

 

$

(11.62)

 

$

(1.76)

 

$

(12.90)

 

Net loss from discontinued operations

 

 

 —

 

 

(0.07)

 

 

 —

 

 

(0.60)

 

Net loss per share

 

$

(0.69)

 

$

(11.69)

 

$

(1.76)

 

$

(13.50)

 

For the three months ended September 30, 2015 and 2014, we excluded 0.2 million and 0.1 million shares, respectively, and for the nine months ended September 30, 2015 and 2014, we excluded 0.1 million and 0.3 million shares, respectively, from the calculation of diluted weighted average common shares outstanding, as their inclusion would have been antidilutive.

16. Discontinued Operations

On August 1, 2014, we completed the Separation of Rightside from Demand Media. As a result of the Separation, the financial results of Rightside are presented as discontinued operations in our consolidated statements of operations for the three and nine months ended September 30, 2014. Following the Separation, the following activity in our statement of operations was reclassified from continuing operations to discontinued operations:

 

 

 

 

 

 

 

 

 

 

Three months ended 

 

Nine months ended

 

    

September 30, 2014

    

September 30, 2014

Service revenue

 

$

16,336

 

$

107,721

Operating expenses:

 

 

 

 

 

 

Service costs

 

 

14,085

 

 

92,588

Sales and marketing

 

 

627

 

 

5,632

Product and development

 

 

1,046

 

 

8,203

General and administrative

 

 

2,775

 

 

14,819

Amortization of intangible assets

 

 

683

 

 

4,243

Total operating expenses

 

 

19,216

 

 

125,485

Operating loss

 

 

(2,880)

 

 

(17,764)

Other income (expense), net

 

 

(25)

 

 

7,017

Loss before income taxes

 

 

(2,905)

 

$

(10,747)

Income tax (expense) benefit

 

 

1,599

 

 

(461)

Net loss

 

$

(1,306)

 

$

(11,208)

 

 

26


 

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

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.

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 Annual Report on Form 10-K for the year ended December 31, 2014 (the “2014 Annual Report”). 

Forward Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. 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,” “predict,” “plan” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements are so identified. You should not rely upon forward-looking statements as guarantees of future performance. 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 discussed below and elsewhere in this Quarterly Report on Form 10-Q, as well as those discussed in other documents we file with the Securities and Exchange Commission (the “SEC”), including our 2014 Annual Report, which was filed with the SEC on March 16, 2015, and the factors described in the section entitled “Risk Factors” in Part I. Item 1A of the 2014 Annual Report. 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. We undertake no obligation to revise or update any forward-looking statements for any reason after the date of this Quarterly Report on Form 10-Q, except as required by law.

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.

Overview

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.

Content & Media

Our Content & Media service offering includes leading owned and operated online properties that publish content in text, video, photography and designed visual formats. This content is published across several key categories on

27


 

eHow.com, a how-to reference and do-it-yourself destination, Livestrong.com, a health and healthy living destination, and certain niche properties focused on specific interests. 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, and LEAFtv, a lifestyle resource for women that produces high-quality, short-form how-to videos covering stylish living, food and fashion. Additionally, our studioD business develops and executes content marketing strategies and creates custom content for third-party brands, agencies and publishers.

Our Content & Media service offering derives the majority of its revenue from the sale of advertising on our owned and operated online properties. Our advertising revenue is principally dependent on the number of visits to our properties and the corresponding ad unit rates.  Since 2011, the total number of visits to our properties, particularly eHow.com, has substantially declined due to lower search engine referrals resulting from ongoing changes to search engine algorithms by Google, Yahoo! and Bing, as well as our decision to remove low quality and duplicative content.  We have also experienced lower ad monetization due to declines in cost-per-click ad rates and our decision to reduce the number of ads per page on certain articles. In addition, visits across our owned and operated online properties continue to shift from desktop to mobile, with ad unit rates for mobile generally lower than desktop. As a result of these declines in traffic and ad monetization, our revenue derived from eHow for the three months ended September 30, 2015 dropped to 15% of our total revenue, as compared to 44% for the three months ended September 30, 2014, after giving effect to the Separation. Future changes to search engine algorithms that negatively impact the volume of referral traffic, declines in ad unit rates, or increased availability of ad blocking software, particularly on mobile devices, could result in a material adverse effect to our business and results of operations.

We believe that there are opportunities to increase the number of visits to our properties, both from direct visits by users and search engine referrals, by building high-quality products that provide a better user experience and lead to increased engagement on our online properties. We have recently focused our efforts on redesigning our websites; refining our content library; rationalizing ad unit density; and developing a greater variety of content formats, particularly formats better suited for mobile devices. We have also recently started a new initiative with a network of contributors and influencers to create more authoritative and engaging content. These changes could negatively impact revenue and increase our operating expenses in the near term, but we believe that by providing consumers with an improved user and content experience, we will be able to increase the number of visits and revenue in a sustained fashion over the long-term. We also believe there are opportunities to increase our advertising revenue by optimizing our ad product stack and increasing branded ad sales by offering more innovative products such as native advertisements and sponsored ad placements. However, if the overall ad unit rates we receive continue to decline, we could experience lower advertising revenue even if the number of visits to our properties increases. 

The majority of our advertising revenue currently is, and historically has been, generated by our relationship with Google. Google also serves as one of the principal technology platform partners for our programmatic ad sales offering. Any change in the type of services that Google provides to us, or to the terms of our agreements with Google, could adversely impact our results of operations.

Marketplaces

Through our Marketplaces service offering, we operate two leading art and design marketplaces where large communities of artists can market and sell their original artwork or their original designs printed on a wide variety of products. Society6 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 Art 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.

Our Marketplaces service offering generates revenue from the sale of products and services through our online art and design marketplaces.  On Society6, revenue is generated from the sale of print-on-demand products. Saatchi Art primarily generates revenue through commissions on the final sale price of original works of art. Our Marketplaces service offering is principally dependent on the number of transactions and average revenue per transaction generated by

28


 

products and services sold through our online marketplaces, both of which increased for the nine months ended September 30, 2015 as compared to the prior year period. We believe there are opportunities to further increase the number of transactions and the average revenue per transaction by attracting new visitors to our marketplaces via diverse online and offline marketing, improving conversion of visitors to purchasing customers, continuing to introduce new products, and offering product bundling and other promotions.

The revenue generated by our Marketplaces service offering has higher costs associated with it as compared to our Content & Media service offering due to variable product costs, including outsourced product manufacturing costs, artist royalties, and shipping and handling costs. During the nine months ended September 30, 2015, a higher percentage of our total revenue was generated by our Marketplaces service offering as compared to the prior year period. If our revenue sources continue to shift from our Content & Media service offering to our Marketplaces service offering, our total costs relative to our revenue will be negatively impacted.

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. The financial results of Rightside are presented as discontinued operations in our condensed consolidated statements of operations for the three and nine months ended September 30, 2014. Unless it is disclosed, all financial results represent continuing operations.

For the nine months ended September 30, 2015 and 2014, we reported revenue of $91.5 million and $129.4 million, respectively. For the nine months ended September 30, 2015 and 2014, Content & Media revenue accounted for 63% and 84% of our total revenue, respectively, and Marketplaces revenue accounted for 37% and 16% 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

·

Visits:  We define visits as the total number of times users access our content across (a) one of our owned and operated online properties and/or (b) one of our customers’ online properties, to the extent that the visited customer web pages are hosted by our content services. In each case, breaks of access of at least 30 minutes constitute a unique visit.

·

Revenue per visit (“RPV”): We define RPV as Content & Media revenue per one thousand visits.

Marketplaces Metrics

·

Number of transactions: We define transactions as the total number of successfully completed transactions during the applicable period.

·

Average revenue per transaction: We calculate average revenue per transaction by dividing Marketplaces revenue for a period by the number of transactions in that period.

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The following table sets forth our key business metrics for the periods presented:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

 

 

 

Nine months ended

 

 

 

 

 

September 30, 

 

 

 

  

September 30, 

 

 

 

 

 

2015

 

2014

 

% Change

 

 

2015

 

2014

 

% Change

 

Content & Media Metrics(1):

 

 

 

    

 

 

    

 

    

 

 

 

    

 

 

    

 

 

Visits (in thousands)

 

 

780,990 

 

 

1,051,912 

 

(26)

%

 

 

2,621,274

 

 

3,053,302

 

(14)

%

Revenue per Visit

 

$

20.33 

 

$

31.91 

 

(36)

%

 

$

22.00

 

$

35.49

 

(38)

%

Marketplaces Metrics(1):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Number of Transactions

 

 

203,768 

 

 

143,024 

 

42 

%

 

 

569,817

 

 

408,248

 

40 

%  

Average Revenue per Transaction

 

$

61.95 

 

$

54.18 

 

14 

%

 

$

59.35

 

$

51.67

 

15 

%  

(1)

For a discussion of these period-to-period changes in the number of visits, RPV, number of transactions and average revenue per transaction and how they impacted our financial results, see “Results of Operations” below.

Basis of Presentation

Revenue

Our revenue is derived from sales of advertising and from products and services sold through our online marketplaces and other offerings.

Service Revenue

Content & Media

We generate Content & Media service revenue primarily from advertisements displayed 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; native advertisements, which are advertisements created to match the form and function of the platform on which they appear; sponsored content; or advertising links. 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.

We also generate Content & Media service revenue from the sale or license of media content, including the creation and distribution of content for third-party brands, publishers and agencies through our studioD business. 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. In addition, we previously provided social media services and generated Content & Media service revenue from recurring management support fees, overage fees in excess of standard usage terms, outside consulting fees and initial set-up fees. As of February 2015, we no longer provide social media services.

Marketplaces

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 consolidated balance sheets. We periodically provide incentive offers to customers to encourage purchases, including percentage discounts off

30


 

current purchases, free shipping and other offers. Value-added taxes (“VAT”), sales tax and other taxes are not included in Marketplaces service 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. Product revenue for Society6 is recognized net of sales allowances and return allowances. We recognize product revenue from the sale of prints through Saatchi Art when the prints are delivered and the return period has expired. Product revenue for Saatchi Art is recognized after the return period has lapsed, net of estimated sales allowances and estimated future returns. 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. Product 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. 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 product revenue because 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 related 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. In the near term, we expect service costs to decrease as a percentage of revenue primarily as a result of lower personnel and information technology expenses.

Product Costs

Product costs consist of outsourced product manufacturing costs, artist royalties, and personnel costs. In the near term, we expect our product costs to increase as our product revenue continues to grow.

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.

Sales and Marketing

Sales and marketing expenses consist primarily of sales and marketing personnel costs, sales support, public relations, advertising, marketing and general promotional expenditures. Fluctuations in our sales and marketing expenses are generally the result of our efforts to drive growth in our product and service offerings. We currently anticipate that our sales and marketing expenses will increase in the near term as a percentage of revenue as we grow our marketing activities to support our studioD and Marketplaces offerings.

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 platforms, including the costs to improve our owned and operated websites and related mobile applications, as well as the costs to develop future product and service offerings. We currently anticipate that our product development expenses will remain relatively flat in the near term as a percentage of revenue.

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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 and insurance. Professional fees are largely comprised of outside legal, audit and information technology consulting. We currently anticipate that general and administrative expenses will decrease in the near term as a percentage of revenue due to managed reduction of expenses.

Amortization of Intangible Assets

We capitalize certain costs (i) allocated to the purchase price of certain identifiable intangible assets acquired in connection with business combinations and (ii) incurred to develop media content that is determined to have a probable economic benefit. We amortize these costs on a straight-line basis over the related expected useful lives of these assets. We determine the appropriate useful life of intangible assets by performing an analysis of expected cash flows based on our historical experience of intangible assets of similar quality and value. We expect amortization expense related to business combinations to decrease in the near term due to fewer acquisitions as compared to prior years. Remediation of our content in future periods could result in additional accelerated amortization expense related to capitalized media content in the periods such actions occur. Amortization as a 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.

Goodwill

We test goodwill for impairment in the fourth quarter of each year unless there are interim indicators that suggest that it is more likely than not that goodwill may be impaired. 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, which had previously been included in our 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 and determined an impairment did not exist.

Stock-based Compensation

Included in 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, restricted stock units and restricted stock granted to employees, directors and non-employees, and expenses relating to our Employee Stock Purchase Plan. We record the fair value of these equity-based awards and expenses at their cost ratably over related vesting periods.

Interest Income (Expense), Net

Interest expense principally consists of interest on outstanding debt and amortization of any debt issuance costs. Our previous credit facility was fully repaid in November 2014, resulting in lower interest expense in the third quarter of 2015 than in the prior year period. We expect interest expense to decrease overall in 2015 because we currently have no debt outstanding. Interest income generally consists of interest earned on cash balances and short-term investments. Interest income also included interest earned on the promissory note that we received as part of the consideration for our sale of CoveritLive prior to the early repayment of the promissory note in the third quarter of 2015.  We typically invest our available cash balances in money market funds and short-term United States Treasury obligations.

32


 

Other Income, Net

Other income, net consists primarily of transaction gains and losses on foreign currency-denominated assets and liabilities and gains or losses on sales of businesses. We expect these gains and losses will vary depending upon movements in underlying currency exchange rates and whether we dispose of any businesses.

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 or had a legal presence, including the United Kingdom, the Netherlands, Canada, Australia and Argentina. We may in the future become subject to taxation in additional countries 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.

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 federal and certain state and foreign deferred tax assets. 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 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.

Critical Accounting Policies and Estimates

Our condensed consolidated financial statements are prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States. The preparation of our condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, 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; goodwill; capitalization and useful lives associated with our intangible assets; income taxes; stock-based compensation; the recoverability of our long-lived assets, including our media portfolio; and discontinued operations have the greatest potential impact on our condensed consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates and have discussed these in our 2014 Annual Report. There have been no material changes to our critical accounting policies and estimates since the date of our 2014 Annual Report. The following discussion includes any specific activity related to these accounting policies and estimates for the nine months ended September 30, 2015, as well as any additional accounting policies and estimates that had a significant impact on our consolidated financial statements for the nine months ended September 30, 2015.

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 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.

 

33


 

On August 1, 2014, we completed the Separation of Rightside from Demand Media, resulting in two independent, publicly traded companies. 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 financial results of Rightside are presented as discontinued operations in our condensed consolidated statements of operations for the three and nine months ended September 30, 2014. The following activity in our condensed consolidated statements of operations was reclassified from continuing operations to discontinued operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended 

 

Nine months ended

 

    

September 30, 2014

    

September 30, 2014

Service revenue

 

$

16,336

 

$

107,721

Operating expenses:

 

 

 

 

 

 

Service costs

 

 

14,085

 

 

92,588

Sales and marketing

 

 

627

 

 

5,632

Product and development

 

 

1,046

 

 

8,203

General and administrative

 

 

2,775

 

 

14,819

Amortization of intangible assets

 

 

683

 

 

4,243

Total operating expenses

 

 

19,216

 

 

125,485

Operating loss

 

 

(2,880)

 

 

(17,764)

Other income (expense), net

 

 

(25)

 

 

7,017

Loss before income taxes

 

 

(2,905)

 

$

(10,747)

Income tax (expense) benefit

 

 

1,599

 

 

(461)

Net loss

 

$

(1,306)

 

$

(11,208)

 

34


 

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  September 30, 

 

Nine months ended September 30, 

 

 

 

2015

    

2014

    

2015

    

2014

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

Service revenue

 

$

16,755

 

$

33,712

 

$

60,047

 

$

108,373

 

Product revenue

 

 

11,750

 

 

7,603

 

 

31,436

 

 

21,075

 

Total revenue

 

 

28,505

 

 

41,315

 

 

91,483

 

 

129,448

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Service costs (exclusive of amortization of intangible assets shown separately below)(1)(2)

 

 

9,566

 

 

11,256

 

 

29,103

 

 

33,198

 

Product costs

 

 

7,638

 

 

5,506

 

 

21,240

 

 

15,507

 

Sales and marketing(1)(2)

 

 

5,424

 

 

4,699

 

 

14,797

 

 

15,422

 

Product development(1)(2)

 

 

6,520

 

 

7,050

 

 

18,923

 

 

21,221

 

General and administrative(1)(2)

 

 

9,883

 

 

12,464

 

 

30,200

 

 

36,868

 

Goodwill impairment charge

 

 

 —

 

 

232,270

 

 

 —

 

 

232,270

 

Amortization of intangible assets

 

 

3,441

 

 

7,388

 

 

15,377

 

 

25,203

 

Total operating expenses

 

 

42,472

 

 

280,633

 

 

129,640

 

 

379,689

 

Loss from operations

 

 

(13,967)

 

 

(239,318)

 

 

(38,157)

 

 

(250,241)

 

Interest income (expense), net

 

 

(3)

 

 

(627)

 

 

216

 

 

(2,331)

 

Other income, net

 

 

178

 

 

782

 

 

3,024

 

 

736

 

Loss from continuing operations before income taxes

 

 

(13,792)

 

 

(239,163)

 

 

(34,917)

 

 

(251,836)

 

Income tax (expense) benefit

 

 

(13)

 

 

16,631

 

 

(45)

 

 

13,917

 

Net loss from continuing operations

 

 

(13,805)

 

 

(222,532)

 

 

(34,962)

 

 

(237,919)

 

Net loss from discontinued operations(1)(2)

 

 

 —

 

 

(1,306)

 

 

 —

 

 

(11,208)

 

Net loss

 

$

(13,805)

 

$

(223,838)

 

$

(34,962)

 

$

(249,127)

 

__________________

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1) Depreciation expense included in the above line items:

 

 

 

 

 

 

 

 

 

 

 

 

 

Service costs

 

$

2,041

 

$

1,559

 

$

4,663

 

$

5,123

 

Sales and marketing

 

 

15

 

 

37

 

 

52

 

 

115

 

Product development

 

 

47

 

 

135

 

 

154

 

 

382

 

General and administrative

 

 

1,611

 

 

1,112

 

 

4,118

 

 

3,628

 

Discontinued operations

 

 

 —

 

 

559

 

 

 —

 

 

4,662

 

Total depreciation

 

$

3,714

 

$

3,402

 

$

8,987

 

$

13,910

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(2) Stock-based compensation included in the above line items:

 

 

 

 

 

 

 

 

 

 

 

 

 

Service costs

 

$

182

 

$

451

 

$

806

 

$

1,147

 

Sales and marketing

 

 

122

 

 

178

 

 

432

 

 

511

 

Product development

 

 

350

 

 

832

 

 

1,277

 

 

2,367

 

General and administrative

 

 

905

 

 

2,921

 

 

3,168

 

 

8,390

 

Discontinued operations

 

 

 —

 

 

351

 

 

 —

 

 

2,949

 

Total stock-based compensation

 

$

1,559

 

$

4,733

 

$

5,683

 

$

15,364

 

35


 

As a percentage of revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended  September 30, 

 

Nine months ended September 30, 

 

 

    

2015

    

2014

    

2015

    

2014

 

Revenue:

 

 

 

 

 

 

 

 

 

Service revenue

 

58.8

%  

81.6

%  

65.6

%  

83.7

%  

Product revenue

 

41.2

%  

18.4

%  

34.4

%  

16.3

%  

Total revenue

 

100.0

%  

100.0

%  

100.0

%  

100.0

%  

Operating expenses:

 

 

 

 

 

 

 

 

 

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

 

33.6

%  

27.2

%  

31.8

%  

25.6

%  

Product costs

 

26.8

%  

13.3

%  

23.2

%  

12.0

%  

Sales and marketing

 

19.0

%  

11.4

%  

16.2

%  

11.9

%  

Product development

 

22.9

%  

17.1

%  

20.7

%  

16.4

%  

General and administrative

 

34.7

%  

30.2

%  

33.0

%  

28.5

%  

Goodwill impairment charge

 

 —

%  

562.1

%  

 —

%  

179.4

%  

Amortization of intangible assets

 

12.0

%  

17.9

%  

16.8

%  

19.4

%  

Total operating expenses

 

149.0

%  

679.2

%  

141.7

%  

293.2

%  

Loss from operations

 

(49.0)

%

(579.2)

%

(41.7)

%

(193.2)

%

Interest income (expense), net

 

 —

%

(1.5)

%

0.2

%

(1.9)

%

Other income, net

 

0.6

%  

1.9

%  

3.3

%  

0.6

%  

Loss from continuing operations before income taxes

 

(48.4)

%

(578.8)

%

(38.2)

%

(194.5)

%

Income tax (expense) benefit

 

 —

%  

40.3

%

 —

%  

10.7

%

Net loss from continuing operations

 

(48.4)

%

(538.5)

%

(38.2)

%

(183.8)

%

Net loss from discontinued operations

 

 —

%

(3.2)

%

 —

%

(8.7)

%

Net loss

 

(48.4)

%

(541.7)

%

(38.2)

%

(192.5)

%

Revenue

Revenue by service offering was as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

 

 

 

Nine months ended

 

 

 

 

 

 

September 30, 

 

 

 

 

September 30, 

 

 

 

 

 

    

2015

    

2014

    

% Change

    

 

2015

    

2014

    

% Change

 

 

Content & Media

 

$

15,881

 

$

33,566

 

(53)

%

     

$

57,667

 

$

108,353

 

(47)

%

   

Marketplaces

 

 

12,624

 

 

7,749

 

63

%

 

 

33,816

 

 

21,095

 

60

%

 

Total revenue

 

$

28,505

 

$

41,315

 

(31)

%

 

$

91,483

 

$

129,448

 

(29)

%

 

Content & Media Revenue

Content & Media revenue decreased by $17.7 million, a 53% decline to $15.9 million for the three months ended September 30, 2015, as compared to $33.6 million for the same period in 2014. Visits decreased by 26%  to  781 million visits in the three months ended September 30, 2015 from 1,052 million visits in the three months ended September 30, 2014 driven by significant declines in desktop visits across our online properties, in part due to management’s decision to remove certain content units on some of our properties. These declines were partially offset by significant mobile visit growth on some of our online properties. RPV decreased by 36%, to $20.33 in the three months ended September 30, 2015 from $31.91 in the three months ended September 30, 2014, primarily due to lower ad monetization yields from our cost-per-click advertising, reducing the number of ads per page on certain articles and the impact from selling our Pluck social media business.

Content & Media revenue decreased by $50.7 million, a 47% decline to $57.7 million for the nine months ended September 30, 2015, as compared to $108.4 million for the same period in 2014. Visits decreased by 14% to

36


 

2,621 million visits in the nine months ended September 30, 2015 from 3,053 million visits in the nine months ended September 30, 2014 driven by significant declines in desktop visits across most of our online properties, in part due to our decision to remove certain content units from some of our properties. These declines were partially offset by significant mobile visit growth across most of our online properties. RPV decreased by 38%, to $22.00 in the nine months ended September 30, 2015 from $35.49 in the nine months ended September 30, 2014, primarily due to lower ad monetization yields from our cost-per-click advertising, a  reduction in higher yielding direct sold display advertising, reducing the number of ads per page on certain articles,  and the impact from selling our CoveritLive and Pluck social media businesses.

Marketplaces Revenue

Marketplaces revenue increased by $4.9 million, a 63% increase to $12.6 million for the three months ended September 30, 2015, as compared to $7.7 million for the same period in 2014. The number of transactions increased 42% to 203,768 in the three months ended September 30, 2015 from 143,024 in the 2014 period, primarily as a result of new product introductions, increased conversion of visits to purchases and traffic growth on Society6. Marketplaces average revenue per transaction increased by 14% year-over-year, from $54.18 to $61.95, driven primarily by a shift towards higher priced items on Society6, as well as the addition of Saatchi Art, which has significantly higher average revenue per transaction.

Marketplaces revenue increased by $12.7 million, a  60% increase to $33.8 million for the nine months ended September 30, 2015, as compared to $21.1 million for the same period in 2014. The number of transactions increased 40% to 569,817 in the nine months ended September 30, 2015 from 408,248 in the 2014 period, primarily as a result of new product introductions, increased conversion of visits to purchases and traffic growth on Society6. Marketplaces average revenue per transaction increased by 15% year-over-year, from $51.67 to $59.35, driven primarily by a shift towards higher priced items on Society6, as well as the addition of Saatchi Art, which has significantly higher average revenue per transaction.

Costs and Expenses

Operating costs and expenses were as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

 

 

 

Nine months ended

 

 

 

 

 

 

September 30, 

 

 

 

 

September 30, 

 

 

 

 

 

 

2015

 

2014

 

% Change

 

 

2015

 

2014

 

% Change

 

 

Service costs (exclusive of amortization of intangible assets)

 

$

9,566

 

$

11,256

 

(15)

%

   

$

29,103

 

$

33,198

 

(12)

%

   

Product costs

 

 

7,638

 

 

5,506

 

39

%

 

 

21,240

 

 

15,507

 

37

%

 

Sales and marketing

 

 

5,424

 

 

4,699

 

15

%

 

 

14,797

 

 

15,422

 

(4)

%

 

Product development

 

 

6,520

 

 

7,050

 

(8)

%

 

 

18,923

 

 

21,221

 

(11)

%

 

General and administrative

 

 

9,883

 

 

12,464

 

(21)

%

 

 

30,200

 

 

36,868

 

(18)

%

 

Goodwill impairment charge

 

 

 —

 

 

232,270

 

(100)

%

 

 

 —

 

 

232,270

 

(100)

%

 

Amortization of intangible assets

 

 

3,441

 

 

7,388

 

(53)

%

 

 

15,377

 

 

25,203

 

(39)

%

 

Service Costs

Service costs for the three months ended September 30, 2015 decreased by approximately $1.7 million, or 15%, to $9.6 million compared to $11.3 million for the same period in 2014. The decrease was primarily due to decreases of $0.5 million in content renovation costs, $0.5 million in information technology expense, $0.5 million in personnel and related costs, $0.4 million in traffic acquisition costs, $0.2 million in ad serving costs, and $0.2 million in consulting fees. These decreases were partially offset by an increase of $0.5 million in depreciation expense.

Service costs for the nine months ended September 30, 2015 decreased by approximately $4.1 million, or 12%, to $29.1 million compared to $33.2 million in the same period in 2014. The decrease was primarily due to decreases of $1.3

37


 

million in information technology expense, $1.2 million in personnel and related costs, $0.8 million in traffic acquisition costs, $0.5 million in depreciation expense, $0.5 million in ad serving costs, $0.5 million in consulting fees, $0.2 million in new content expense, and $0.1 million in content renovation costs. These decreases were partially offset by an increase of $1.1 million in Saatchi Art service costs.

Product Costs

Product costs for the three months ended September 30, 2015 increased by approximately $2.1 million, or 39%, to $7.6 million, as compared to $5.5 million in the same period in 2014. The increase was primarily due to increased costs related to the higher volume of products sold on Society6.

Product costs for the nine months ended September 30, 2015 increased by approximately $5.7 million, or 37%, to $21.2 million, as compared to $15.5 million in the same period in 2014. The increase was primarily due to increased costs related to the higher volume of products sold on Society6.

Sales and Marketing

Sales and marketing expenses increased by approximately $0.7 million, or 15%, to $5.4 million for the three months ended September 30, 2015 from $4.7 million for the same period in 2014. The increase was primarily driven by an increase of $0.8 million in marketing activities primarily for our marketplaces businesses, partially offset by a decrease of $0.1 million in consulting fees.

Sales and marketing expenses decreased by approximately $0.6 million, or 4%, to $14.8 million for the nine months ended September 30, 2015 from $15.4 million for the same period in 2014. The decrease was primarily driven by (i) a net decrease of $1.8 million in personnel and related costs primarily due to our reduction in direct advertising sales and the sale of Pluck, which was partially offset by investment in studioD personnel, and (ii) a decrease of $0.5 million in consulting fees. These decreases were partially offset by a net increase of $1.7 million in marketing expenses driven by increases in marketing activities for our marketplaces businesses partially offset by lower marketing activities for our content and media properties.

Product Development

Product development expenses decreased by approximately $0.5 million, or 8%, to $6.5 million during the three months ended September 30, 2015 compared to $7.1 million in the same period in 2014, primarily driven by (i) a net decrease of $0.4 million in personnel and related costs due to the sale of Pluck and headcount reductions, partially offset by increases in personnel and related costs resulting from the acquisition of Saatchi Art, and (ii) a decrease of $0.1 million in depreciation expense.

Product development expenses decreased by approximately $2.3 million, or 11%, to $18.9 million during the nine months ended September 30, 2015 compared to $21.2 million in the same period in 2014, primarily driven by (i) a  net decrease of $2.1 million in personnel and related costs due to the sale of Pluck and headcount reductions, partially offset by increases in personnel and related costs resulting from the acquisition of Saatchi Art, and (ii) a decrease of $0.2 million in depreciation expense. These decreases were partially offset by an increase of $0.1 million in dues and subscription expense.

General and Administrative

General and administrative expenses decreased by approximately $2.6 million, or 21%, to $9.9 million during the three months ended September 30, 2015 compared to $12.5 million in the same period in 2014. The decrease was primarily due to decreases of $2.8 million in personnel and related costs primarily resulting from lower stock-based compensation, $0.6 million in acquisition costs, $0.2 million in loss on sale, $0.1 million in legal and audit fees, and $0.1 million in facilities and related costs. These decreases were partially offset by increases of $0.7 million in realignment costs and $0.5 million in depreciation expense.

38


 

General and administrative expenses decreased by approximately $6.7 million, or 18%, to $30.2 million during the nine months ended September 30, 2015 compared to $36.9 million in the same period in 2014. The decrease was primarily due to decreases of $6.8 million in personnel and related costs primarily resulting from lower stock-based compensation and headcount reductions, $1.4 million in legal and audit fees, $0.5 million in facilities and related costs, and $0.2 million in loss on sale. These decreases were partially offset by increases of $0.8 million in acquisition costs, $0.7 million in realignment costs, and $0.5 million in depreciation expense.

Severance Costs

As more fully described herein and in the related notes to the accompanying unaudited condensed financial statements, in the three months ended September 30, 2015, we implemented a number of initiatives to improve operating efficiency, including targeted reductions in force in areas where our business model shifted throughout the period. For the three months ended September 30, 2015, we incurred $1.8 million in severance costs primarily related to certain workforce reduction actions that occurred throughout the period. Severance costs include severance pay, the provision of certain extended employee benefits and employer taxes. As of September 30, 2015, there was $0.6 million of accrued severance included in accrued expenses and other current liabilities in the condensed consolidated balance sheet. We will incur additional retention and severance costs currently estimated to be $0.5 million over the applicable retention periods, which extend through the first quarter of 2016.

Goodwill Impairment Charge

During the three and nine months ended September 30, 2014, we recorded a pretax impairment charge of $232.3 million on the carrying value of our goodwill based on the results of an interim assessment of impairment of the goodwill in our content and media reporting unit due to a decline in our cash flow forecast as well as a sustained decline in our market capitalization.  We did not record any impairment charges during the corresponding 2015 period.

Amortization of Intangible Assets  

Amortization expense for the three months ended September 30, 2015 decreased by approximately $3.9 million, or 53%, to $3.4 million compared to $7.4 million in the same period in 2014. The decrease was primarily due to the removal of certain content units from our media properties in the fourth quarter of 2014 and the disposition of certain intangible assets in connection with the sales of our Pluck business in the first quarter of 2015 and our Creativebug and CoveritLive businesses in the third quarter of 2014. 

Amortization expense for the nine months ended September 30, 2015 decreased by approximately $9.8 million, or 39%, to $15.4 million compared to $25.2 million in the same period in 2014. The decrease was primarily due to the removal of certain content units from our media properties in the fourth quarter of 2014 and the disposition of certain intangible assets in connection with the sales of our Pluck business in the first quarter of 2015 and our Creativebug and CoveritLive businesses in the third quarter of 2014. The decrease was partially offset by an increase in accelerated amortization expense in the 2015 period as compared to the 2014 period related to our content takedowns.

Interest Income (Expense), Net

Net interest expense was less than $0.1 million for the three months ended September 30, 2015. Net interest income was approximately $0.2 million for the nine months ended September 30, 2015, primarily related to interest income paid to us on the promissory note we received as part of the consideration for our sale of CoveritLive in July 2014. Net interest expense was $0.6 million and $2.3 million for the three and nine months ended September 30, 2014, respectively, primarily due to interest paid on debt outstanding under our former credit facility. 

Other Income, Net

Net other income for the three months ended September 30, 2015 decreased by $0.6 million, or 77%, to $0.2 million compared to $0.8 million in the same period in 2014. The decrease was primarily due to higher gains on sale related to dispositions of online properties during the 2014 period as compared to the 2015 period.

39


 

Net other income for the nine months ended September 30, 2015 increased by $2.3 million to $3.0 million compared to $0.7 million in the same period in 2014. The increase was primarily due to the gain on sale of our Pluck business.

Income Tax Benefit (Expense)

Income tax expense for the three and nine months ended September 30, 2015 was less than $0.1 million. Income tax benefit for the three and nine months ended September 30, 2014 was $16.6 million and $13.9 million, respectively. The difference between the 2015 and 2014 periods was primarily due to the impact from the impairment of goodwill during the third quarter of 2014, which allowed for the reversal of the deferred tax liability related to the tax amortization of goodwill and a full valuation allowance as compared to the same period in 2014. As of September 30, 2015, we recorded a full valuation allowance against any deferred tax asset generated by operating loss; therefore, no income tax benefit was recorded for the three and nine months ended September 30, 2015.

Non-GAAP Financial Measures

To provide investors and others with additional information regarding our financial results, we have disclosed in the table below adjusted earnings before interest, taxes, depreciation and amortization expense, or Adjusted EBITDA. We have provided a reconciliation of this non-GAAP financial measure to net income (loss), the most directly comparable GAAP financial measure. Our Adjusted EBITDA financial measure differs from GAAP net income (loss) in that it excludes net income (loss) from discontinued operations, as well as net interest expense, income tax expense (benefit), and certain other non-cash or non-recurring items impacting net income (loss) from time to time, principally comprised of depreciation and amortization and stock-based compensation. 

Adjusted EBITDA is one of 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, because it excludes certain expenses that management believes are not indicative of our core operating results. Management believes that the exclusion of these expenses provides a useful measure for period-to-period comparisons of our underlying recurring revenue and operating costs that is focused more closely on the current costs necessary to utilize previously acquired long-lived assets and reflects our ongoing business in a manner that allows for meaningful analysis of trends. In addition, management believes that excluding certain non-cash charges can be useful because the amount of such expenses is the result of long-term investment decisions in previous periods rather than day-to-day operating decisions. Adjusted EBITDA is also one of the primary measures management uses to prepare and update our short and long term financial and operational plan and to evaluate investment decisions. We also frequently use Adjusted EBITDA in our discussions with investors, commercial bankers and other users of our financial statements.

Accordingly, we believe that Adjusted EBITDA provides 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. However, 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 non-GAAP financial measures to the most comparable GAAP financial measures. Further, non-GAAP financial measures do not have standardized meanings, and therefore other companies, including peer companies, may use the same or similarly named measures but exclude different items or use different computations, so comparability may be limited. Non-GAAP financial measures should be considered in addition to, and not as a substitute for, measures prepared in accordance with GAAP. We encourage investors and others to review our financial information in its entirety and not rely on a single financial measure.

The following table presents a reconciliation of Adjusted EBITDA for each of the periods presented (in thousands):

40


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended  September 30, 

 

Nine months ended September 30, 

 

 

 

2015

    

2014

 

2015

    

2014

 

Net loss

 

$

(13,805)

 

$

(223,838)

    

$

(34,962)

 

$

(249,127)

 

Less: Net loss from discontinued operations, net of taxes

 

 

 —

 

 

1,306

 

 

 —

 

 

11,208

 

Net loss from continuing operations

 

 

(13,805)

 

 

(222,532)

 

 

(34,962)

 

 

(237,919)

 

Add (deduct):

 

 

 

 

 

 

 

 

 

 

 

 

 

Income tax (benefit) expense

 

 

13

 

 

(16,631)

 

 

45

 

 

(13,917)

 

Interest and other (income) expense, net

 

 

(175)

 

 

(155)

 

 

(3,240)

 

 

1,595

 

Depreciation and amortization(1)

 

 

7,155

 

 

10,230

 

 

24,364

 

 

34,450

 

Stock-based compensation(2)

 

 

1,559

 

 

4,382

 

 

5,683

 

 

12,415

 

Goodwill impairment charge

 

 

 —

 

 

232,270

 

 

 —

 

 

232,270

 

Acquisition and realignment costs(3)

 

 

1,606

 

 

570

 

 

2,162

 

 

1,891

 

Adjusted EBITDA

 

$

(3,647)

 

$

8,134

 

$

(5,948)

 

$

30,785

 


(1)

Represents depreciation expense of our long-lived tangible assets and amortization expense of our finite-lived intangible assets, including amortization expense related to our investment in media content assets, included in our GAAP results of operations.

(2)

Represents the fair value of stock-based awards granted to employees as included in our GAAP results of operations.

(3)

Represents such items, when applicable, as (a) legal, accounting and other professional fees directly attributable to acquisition or corporate realignment activities, (b) employee severance and other payments attributable to acquisition or corporate realignment activities, and (c) expenditures related to the separation of Demand Media into two distinct publicly traded companies.

Liquidity and Capital Resources

As of September 30, 2015, we had $37.9 million of cash and cash equivalents. Our principal sources of liquidity are our cash and cash equivalents, as well as the cash we generate from our operations. Historically, we have principally financed our operations from the issuance of stock, net cash provided by our operating activities and borrowings under our previous credit facilities. In November 2014, we repaid all outstanding amounts under our previous credit facility and terminated that facility, and we do not currently have an available line of credit. We believe that our existing cash and cash equivalents and our cash flows from operating activities will be sufficient to fund our operations for at least the next 12 months. However, in order to fund our operations, make potential acquisitions, pursue new business opportunities and invest in our existing businesses, platforms and technologies, we may need to raise additional funds by entering into a new credit facility, selling certain assets or issuing equity, equity-related or debt securities. Our shelf registration statement previously filed with the SEC expired in October 2015.

Since our inception, we have used significant cash to make strategic acquisitions to grow our business, including the acquisitions of Society6 in June 2013 and Saatchi Art in August 2014. A portion of the purchase price for Society6 was held back by us to secure any post-closing indemnification obligations and/or post-closing adjustments to the purchase price, and in July 2015, we paid $7.4 million in cash and issued an additional 122,638 shares of our common stock to the sellers of Society6 following the expiration of the indemnification holdback period. We have also generated cash since July 2014 by disposing of certain businesses. In July 2014, we sold our Creativebug business for $10.0 million in cash, $1.0 million of which was initially held in escrow and released to us in July 2015. In July 2014, we also sold our CoveritLive social media business for $4.5 million in cash and a promissory note with a principal amount of $5.6 million, originally due in full by July 2016. In September 2015, we agreed to an early repayment of the promissory note and received  $5.1 million in cash, plus accrued and unpaid interest, which satisfied all amounts owed to us under the promissory note.  In addition, in February 2015 we sold our Pluck social media business for $3.8 million in cash after working capital adjustments, and in the third quarter of 2015, we sold certain non-core websites that were part of our Demand Vertical Network for a total of $0.9 million. We may make further acquisitions and dispositions in the future.

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.

41


 

Cash used in investing activities has historically been, and is expected to be, impacted by our ongoing investments in our properties, company infrastructure and equipment. The following table sets forth our major sources and (uses) of cash for each of the periods presented (in thousands):

 

 

 

 

 

 

 

 

 

 

 

Nine months ended September 30, 

 

 

 

2015

    

2014

 

Net cash (used in) provided by operating activities

 

$

(9,749)

 

$

22,791

 

Net cash provided by (used in) investing activities

 

$

7,899

 

$

(11,975)

 

Net cash used in financing activities

 

$

(8,030)

 

$

(51,009)

 

Cash Flows from Operating Activities

Nine months ended September 30, 2015 

Net cash used in our operating activities during the nine months ended September 30, 2015 was $9.8 million. Our net loss during the period was $35.0 million, which included non-cash charges of $30.0 million related to depreciation, amortization and stock-based compensation, partially offset by a  gain on disposal of business and online properties of $3.2 million. The remainder of net cash used in operating activities was from changes in our working capital, including changes in accounts payable, accrued expenses and other liabilities, and other long-term assets of $7.1 million, offset in part by changes in accounts receivable, prepaid expenses and other current assets, and deferred revenue of $5.4 million. The decreases in accrued expenses and other liabilities and accounts payable were primarily due to the timing of payments and collections.

Nine months ended September 30, 2014

Net cash inflows from our operating activities for the nine months ended September 30, 2014 was $22.8 million. Our net loss during the period was $249.1 million, which included a  $232.3 million non-cash, pretax impairment charge in the third quarter of 2014 and non-cash charges of $45.1 million for depreciation, amortization, stock-based compensation and deferred taxes, partially offset by $8.2 million from non-cash gains from disposal of businesses, other assets and other. The remainder of the change in our net cash flow from operating activities was from changes in our working capital, primarily driven by a $16.7 million decrease in cash resulting from changes in deferred registrations costs, prepaid and other assets, other long-term assets and accounts payable and accrued expenses, as well as a $19.7 million increase in cash from changes in deferred revenue and accounts receivable. The increases in our deferred revenue and deferred registry costs were primarily due to growth in our former domain name business during the period, while the change in our accounts receivable, accounts payable and accrued expenses was primarily due to the timing of payments and collections.

Cash Flows from Investing Activities

Nine months ended September 30, 2015 and 2014

Net cash provided by investing activities was $7.9 million during the nine months ended September 30, 2015, compared to net cash used in investing activities of $12.0 million during the same period in 2014. Cash flows from investing activities for the nine months ended September 30, 2015 consisted of cash inflows of $5.1 million from a promissory note, $4.8 million from the sales of our Pluck business and certain online properties within our Demand Vertical Network, and $1.0 million of cash received from  a holdback related to a prior year disposition, partially offset by investments in property and equipment of $3.6 million, which included internally developed software. Cash flows from investing activities for the nine months ended September 30, 2014 included cash used for investments in our property and equipment of $7.6 million, which included internally developed software, and investments in intangible assets of $5.4 million. Cash outflows in 2014 also included $15.8 million related to investments in certain generic Top Level Domain (“gTLD”) applications in connection with our former domain name business and $3.9 million in business acquisitions and restricted cash deposits, partially offset by cash inflows of $13.7 million from the sales of businesses, net of cash disposed and $6.1 million from the withdrawals of our interest in certain gTLD applications relating to our former domain name business.

42


 

Cash Flows from Financing Activities

Nine months ended September 30, 2015 and 2014 

Net cash used in financing activities was $8.0 million and $51.0 million during the nine months ended September 30, 2015 and 2014, respectively. Cash used in financing activities for the nine months ended September 30, 2015, primarily consists of $7.6 million of cash paid for acquisition holdbacks from prior year acquisitions and $0.6 million of costs related to net taxes paid on exercises of employee stock options and vesting of restricted stock units. Cash used in financing activities during the nine months ended September 30, 2014, was primarily driven by repayments on our credit facility of $22.5 million, holdback payments of $1.9 million for prior year acquisitions and payments of withholding tax on net settlement of certain employee stock-based awards of $2.2 million. In August 2014, we capitalized Rightside with $24.1 million in connection with the Separation.

Off Balance Sheet Arrangements

As of September 30, 2015, we did not have any off balance sheet arrangements.

Capital Expenditures

For the nine months ended September 30, 2015 and 2014, we used $3.6 million and $7.6 million, respectively, in cash to fund capital expenditures to create internally developed software and purchase property and equipment. The decrease is primarily due to lower expenditures related to internally developed software and lower capital expenditures relating to the registry infrastructure for our former domain name business. We currently anticipate making capital expenditures of between $0.5 million and $1.0 million during the remainder of the year ending December 31, 2015.

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 currency 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, 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, readily convertible into cash and 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 exchange 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 that movements in the foreign currencies in which we transact will significantly affect future net earnings or losses. Foreign currency exchange risk can be quantified by estimating the change in cash flows resulting from a hypothetical 10% adverse change in foreign exchange rates. We do not believe that such a change would currently have a material impact on our results of operations. However, if our international operations grow, our risks associated with fluctuations 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.

43


 

Concentrations of Credit Risk

As of September 30, 2015, our cash and cash equivalents were maintained primarily with five major U.S. financial institutions and three foreign banks. We also maintained cash balances with two Internet payment processors. 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.

Components of our consolidated accounts receivable balance comprising more than 10% were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

    

September 30, 2015

    

December 31, 2014

 

Google, Inc.

 

30

42

 

 

 

Item 4.       CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

We maintain disclosure controls and procedures designed to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934, as amended (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 our management, including our principal executive officer and principal financial officer, of the effectiveness of our disclosure controls and procedures. Based on that evaluation, our principal executive officer and principal financial officer concluded that our 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 us in reports that we file or submit 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 our management, including the principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

There has been no change in our internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

44


 

PART II

OTHER INFORMATION  

Item  1.      LEGAL PROCEEDINGS

 

On November 5, 2014, Charles Saatchi filed a lawsuit against our wholly owned subsidiary, Saatchi Online, Inc. (“Saatchi Online”), 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 Online, dated February 18, 2010 (the “UK Action”). Mr. Saatchi had alleged that Saatchi Online committed a repudiatory breach of the IP Agreement and had sought a permanent injunction restricting Saatchi Online from continuing to use the “Saatchi” name, a declaration that the IP Agreement had been validly terminated, a disgorgement of any profits derived from Saatchi Online’s use of the name since the alleged termination date and unspecified monetary damages. 

 

On December 30, 2014, Charles Saatchi and Robert Norton, common stockholders of Saatchi Online 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 Online, and Saatchi Online itself, alleging that, in connection with Demand Media’s acquisition of Saatchi Online, such directors, officers and preferred stockholders breached their fiduciary duties to the common stockholders and that the preferred stockholders and Saatchi Online violated a Saatchi Online 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 Online, 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 resolved the Actions to the mutual satisfaction of the parties. Under the terms of the Settlement Agreement, we are permitted to use of the “Saatchi” name in connection with operating the Saatchi Art business.  In connection with entering into the Settlement Agreement, we contributed $250,000 towards the settlement of the Delaware Action, which was paid in August 2015. This amount was net of amounts reimbursed to us from an insurance policy and the escrow account established to cover indemnification obligations of the selling stockholders under the Saatchi Online 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.

 

Item 1A.RISK FACTORS

There are certain risks and uncertainties in our business that could cause our actual results to differ materially from those anticipated.  A detailed discussion of our risk factors was included in Part I, Item 1A, “Risk Factors” of our 2014 Annual Report, which is available at www.sec.gov and at ir.demandmedia.com.  These risk factors should be read carefully in connection with evaluating our business and in connection with the forward-looking statements and other information contained in this Quarterly Report on Form 10-Q. Any of the risks described in the 2014 Annual Report could materially affect our business, financial condition and/or future results.  The risk factors described in the 2014 Annual Report are not the only risks facing us. Additional risks and uncertainties not currently known to us, or that are currently deemed to be immaterial, could also materially adversely affect our business, financial condition and/or future results. Except as set forth below, there have been no material changes to the risk factors set forth in the 2014 Annual Report. 

45


 

We generate the majority of our Content & Media revenue from advertising.  A reduction in advertising revenue, including as a result of lower ad unit rates, increased availability of ad blocking software, lower online advertising spend, a loss of advertisers or lower advertising yields, could seriously harm our business, financial condition and results of operations.

We currently generate the majority of our revenue from advertisements displayed on our online properties and certain of our customers’ online properties. For the nine months ended September 30, 2015 and the years ended December 31, 2014 and 2013, after giving effect to the Separation, we generated 57%, 70% and 83%, respectively, of our total revenue from advertising, and we expect to continue to derive the majority of our Content & Media revenue from advertising. We have experienced declines in ad unit rates for both desktop and mobile since 2014, resulting in lower advertising revenue, and any further reductions in ad unit rates would negatively impact our financial results. In addition, software developers have been increasing the availability of ad blocking software, particularly on mobile devices.  Increased adoption of ad blocking software by users could reduce our advertising revenue and negatively impact our financial results.

We also believe that advertising spend 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 cyclical and discretionary nature of advertising spending, including the perceived impact of campaign strategies; general economic conditions, as well as economic conditions specific to the Internet and media industry; and the occurrence of extraordinary events, such as natural disasters or terrorist attacks. Additionally, brands and advertisers are increasingly focusing a portion of their online advertising budgets on social media outlets such as Facebook, Twitter and Pinterest, as well as on native and sponsored advertising campaigns. If this trend continues and we are unable to offer competitive or similarly valued advertising opportunities on our online properties, our revenue from advertising could be adversely impacted. An inability to maintain or increase our advertising revenue would have a material adverse effect on our business, financial condition and results of operations.

Additionally, our advertising strategy is currently focused on programmatic offerings that utilize various advertising network exchanges, including exchanges operated by Google and Rubicon, to manage our ad stack. Operating on a programmatic basis requires us to actively manage the sale of our owned and operated inventory on these exchanges. Although we had shifted our advertising strategy away from direct sales in early 2014, we have recently decided to implement direct sales channels again to improve our branded advertising sales, particularly with respect to native and sponsored ad campaigns. An inability to successfully manage our ad stack, including the programmatic process and our direct sales team, could have a material adverse effect on our business, financial condition and results of operations.

In addition, one component of our platform that we use to generate advertiser interest is our system of monetization tools, which is designed to match content with advertisements in a manner that optimizes revenue yield and end-user experience. Advertising providers and advertisers will stop placing advertisements on our owned and operated online properties or our customers’ online properties if their investments do 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 advertisers would have an adverse impact on our ability to maintain or increase our revenue from advertising. If any of our advertisers or advertising providers, and in particular Google, decides not to continue advertising on, or providing advertisements to, our owned and operated online properties or our customers’ online properties, or modifies its advertising policies in a manner that could negatively impact yield, we could experience a rapid decline in our revenue over a relatively short period of time.

 

46


 

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

Unregistered Sales of Equity Securities

          In June 2013, we acquired 100% of the issued and outstanding membership interests of Society6, LLC, a Delaware limited liability company, from the holders of the membership interests (collectively, the “Sellers”). We held back a portion of the purchase price (both cash and stock) for two years in order to secure post-closing indemnification obligations of the Sellers and/or post-closing adjustments to the purchase price. In connection with the expiration of the indemnification holdback period, we issued 122,638 shares of our common stock to the Sellers on July 13, 2015. The shares were issued in a private placement exempt from the registration requirements of the Securities Act of 1933, as amended (the “Securities Act”), in reliance on the exemptions set forth in Section 4(a)(2) of the Securities Act and Rule 506 promulgated thereunder.

Repurchases of our Common Stock

We did not repurchase any of our common stock during the three months ended September 30, 2015.

Item 3.      DEFAULTS UPON SENIOR SECURITIES  

None.

Item 4.       MINE SAFETY DISCLOSURES  

Not applicable.

Item 5.       OTHER INFORMATION  

None.

47


 

Item 6.       EXHIBITS  

 

 

 

 

Exhibit No

     

Description of Exhibit

 

 

 

2.1

 

Asset Purchase Agreement, dated as of July 9, 2014, by and among Demand Media, Inc., a Delaware corporation; CB Acquisition, LLC, a Delaware limited liability company; and Otter Media Holdings, LLC, a Delaware limited liability company (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed with the SEC on July 14, 2014).

 

 

 

2.2

 

Separation and Distribution Agreement between Demand Media, Inc. and Rightside Group, Ltd., dated as of August 1, 2014 (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed with the SEC on August 7, 2014).

 

 

 

2.3

 

Agreement and Plan of Merger, dated as of August 8, 2014, by and among Demand Media, Inc., Gallery Merger Sub, Inc., a Delaware corporation, Saatchi Online, Inc. and Shareholder Representative Services LLC, as the stockholder representative (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed with the SEC on August 11, 2014).

 

 

 

3.1

 

Amended and Restated Certificate of Incorporation of Demand Media, Inc., as amended effective August 1, 2014 (incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-3 filed with the SEC on August 29, 2014).

 

 

 

3.2

 

Amended and Restated Bylaws of Demand Media, Inc. (incorporated by reference to Exhibit 3.02 to the Company’s Annual Report on Form 10-K filed with the SEC on March 1, 2011).

 

 

 

4.1

 

Form of Demand Media, Inc. Common Stock Certificate (incorporated by reference to Exhibit 4.1 to the Company’s Quarterly Report on Form 10-Q filed with the SEC on November 10, 2014).

 

 

 

10.1     

 

Form of Demand Media, Inc. 2010 Incentive Award Plan Stock Option Grant Notice and Stock Option Agreement, as amended.

 

 

 

10.2     

 

Form of Demand Media Inc. 2010 Incentive Award Plan Restricted Stock Unit Award Grant Notice and Restricted Stock Unit Award Agreement, as amended.

 

 

 

31.1 

  

Certification of the Principal 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 Principal 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 Principal 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 Principal 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

 

 

 

 

Indicates management contract or compensatory plan, contract or arrangement.

 

 

48


 

 

 

 

 

 

 

 

 

 

 

 

 

 

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/ Sean Moriarty

 

Name:

 Sean Moriarty

 

Title:

 Chief Executive Officer

 (Principal Executive Officer)

 

 

 

 

 

 

 

By:

/s/ Rachel Glaser

 

Name:

 Rachel Glaser

 

Title:

 Chief Financial Officer

 (Principal Financial Officer)

 

Date: November 5, 2015

 

 

49


 

Exhibit Index

 

 

 

 

Exhibit No

     

Description of Exhibit

 

 

 

2.1

 

Asset Purchase Agreement, dated as of July 9, 2014, by and among Demand Media, Inc., a Delaware corporation; CB Acquisition, LLC, a Delaware limited liability company; and Otter Media Holdings, LLC, a Delaware limited liability company (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed with the SEC on July 14, 2014).

 

 

 

2.2

 

Separation and Distribution Agreement between Demand Media, Inc. and Rightside Group, Ltd., dated as of August 1, 2014 (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed with the SEC on August 7, 2014).

 

 

 

2.3

 

Agreement and Plan of Merger, dated as of August 8, 2014, by and among Demand Media, Inc., Gallery Merger Sub, Inc., a Delaware corporation, Saatchi Online, Inc. and Shareholder Representative Services LLC, as the stockholder representative (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed with the SEC on August 11, 2014).

 

 

 

3.1

 

Amended and Restated Certificate of Incorporation of Demand Media, Inc., as amended effective August 1, 2014 (incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-3 filed with the SEC on August 29, 2014).

 

 

 

3.2

 

Amended and Restated Bylaws of Demand Media, Inc. (incorporated by reference to Exhibit 3.02 to the Company’s Annual Report on Form 10-K filed with the SEC on March 1, 2011)

4.1

 

Form of Demand Media, Inc. Common Stock Certificate (incorporated by reference to Exhibit 4.1 to the Company’s Quarterly Report on Form 10-Q filed with the SEC on November 10, 2014).

 

 

 

10.1  

 

Form of Demand Media, Inc. 2010 Incentive Award Plan Stock Option Grant Notice and Stock Option Agreement, as amended.

 

 

 

10.2  

 

Form of Demand Media Inc. 2010 Incentive Award Plan Restricted Stock Unit Award Grant Notice and Restricted Stock Unit Award Agreement, as amended.

 

 

 

31.1

 

Certification of the Principal 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 Principal 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 Principal 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 Principal 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

 

 

 

 

Indicates management contract or compensatory plan, contract or arrangement.

 

 

50