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EX-31.1 - EX-31.1 - LEAF GROUP LTD.dmd-20160331ex311bf790d.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

(Mark One)

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

 

For the quarterly period ended March 31, 2016

 

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) 656-6253

(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 May 2, 2016, there were 20,378,204 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 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

  

18 

 

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

  

32 

 

Item 4.

  

Controls and Procedures

  

33 

 

 

 

 

Part II 

Other Information

 

 

 

Item 1.

  

Legal Proceedings

  

34 

 

Item 1A.

  

Risk Factors

  

34 

 

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

  

34 

 

Item 3.

  

Defaults Upon Senior Securities

  

34 

 

Item 4.

  

Mine Safety Disclosures

  

34 

 

Item 5.

  

Other Information

  

34 

 

Item 6.

  

Exhibits

  

34 

 

 

  

Signatures

  

35 

 

 

 

2


 

Part I.       FINANCIAL INFORMATION

 

Item 1.      CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  

Demand Media, Inc. and Subsidiaries 

Condensed Consolidated Balance Sheets  

(In thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

    

March 31, 

    

December 31, 

 

 

 

2016

 

2015

 

Assets

 

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

30,513

 

$

38,570

 

Accounts receivable, net

 

 

8,597

 

 

10,469

 

Prepaid expenses and other current assets

 

 

4,618

 

 

4,989

 

Total current assets

 

 

43,728

 

 

54,028

 

Property and equipment, net

 

 

12,559

 

 

14,568

 

Intangible assets, net

 

 

18,307

 

 

21,332

 

Goodwill

 

 

10,358

 

 

10,358

 

Other assets

 

 

1,048

 

 

1,173

 

Total assets

 

$

86,000

 

$

101,459

 

 

 

 

 

 

 

 

 

Liabilities and Stockholders' Equity

 

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

 

Accounts payable

 

$

1,833

 

$

1,973

 

Accrued expenses and other current liabilities

 

 

11,335

 

 

15,169

 

Deferred revenue

 

 

2,378

 

 

2,933

 

Total current liabilities

 

 

15,546

 

 

20,075

 

Deferred tax liability

 

 

 —

 

 

551

 

Other liabilities

 

 

1,698

 

 

1,713

 

Commitments and contingencies (Note 7)

 

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

 

 

Common stock, $0.0001 par value. Authorized 100,000 shares; 21,089 issued and 20,287 shares outstanding at March 31, 2016 and 20,956 issued and 20,154 shares outstanding at December 31, 2015

 

 

2

 

 

2

 

Additional paid-in capital

 

 

507,147

 

 

505,603

 

Accumulated other comprehensive loss

 

 

(90)

 

 

(91)

 

Treasury stock at cost, 802 at March 31, 2016 and December 31, 2015

 

 

(30,767)

 

 

(30,767)

 

Accumulated deficit

 

 

(407,536)

 

 

(395,627)

 

Total stockholders’ equity

 

 

68,756

 

 

79,120

 

Total liabilities and stockholders’ equity

 

$

86,000

 

$

101,459

 

 

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 March 31,

 

 

    

2016

    

2015

 

Revenue:

 

 

 

 

 

 

 

Service revenue

 

$

14,505

 

$

23,225

 

Product revenue

 

 

12,464

 

 

9,985

 

Total revenue

 

 

26,969

 

 

33,210

 

Operating expenses:

 

 

 

 

 

 

 

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

 

 

8,171

 

 

10,149

 

Product costs

 

 

8,507

 

 

6,834

 

Sales and marketing

 

 

5,995

 

 

4,794

 

Product development

 

 

5,614

 

 

7,036

 

General and administrative

 

 

8,530

 

 

9,349

 

Amortization of intangible assets

 

 

3,032

 

 

4,711

 

Total operating expenses

 

 

39,849

 

 

42,873

 

Loss from operations

 

 

(12,880)

 

 

(9,663)

 

Interest income

 

 

2

 

 

180

 

Interest expense

 

 

 —

 

 

(71)

 

Other income, net

 

 

980

 

 

2,827

 

Loss from operations before income taxes

 

 

(11,898)

 

 

(6,727)

 

Income tax expense

 

 

(11)

 

 

(22)

 

Net loss

 

$

(11,909)

 

$

(6,749)

 

 

 

 

 

 

 

 

 

Loss per share

 

 

 

 

 

 

 

Net loss per share - basic and diluted

 

$

(0.59)

 

$

(0.34)

 

Weighted average number of shares - basic and diluted

 

 

20,213

 

 

19,773

 

 

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

4


 

Demand Media, Inc. and Subsidiaries 

Condensed Consolidated Statements of Comprehensive Loss 

(In thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended March 31,

 

 

    

2016

    

2015

    

Net loss

 

$

(11,909)

 

$

(6,749)

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

 

1

 

 

6

 

Comprehensive loss

 

$

(11,908)

 

$

(6,743)

 

 

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, 2015

 

20,154

 

$

2

 

$

505,603

 

$

(30,767)

 

$

(91)

 

$

(395,627)

 

$

79,120

 

Issuance of stock under employee stock awards and other, net

 

133

 

 

 —

 

 

1

 

 

 —

 

 

 —

 

 

 —

 

 

1

 

Tax withholdings related to vesting of share-based payments

 

 —

 

 

 —

 

 

(492)

 

 

 —

 

 

 —

 

 

 —

 

 

(492)

 

Stock-based compensation expense

 

 —

 

 

 —

 

 

2,035

 

 

 —

 

 

 —

 

 

 —

 

 

2,035

 

Foreign currency translation adjustment

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

1

 

 

 —

 

 

1

 

Net loss

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(11,909)

 

 

(11,909)

 

Balance at March 31, 2016

 

20,287

 

$

2

 

$

507,147

 

$

(30,767)

 

$

(90)

 

$

(407,536)

 

$

68,756

 

 

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)

 

 

 

 

 

 

 

 

 

 

 

Three months ended March 31,

 

 

    

2016

    

2015

 

Cash flows from operating activities

 

 

 

 

 

 

 

Net loss

 

$

(11,909)

 

$

(6,749)

 

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

 

5,731

 

 

7,550

 

Stock-based compensation

 

 

1,919

 

 

2,235

 

Gain on disposal of businesses and online properties

 

 

(973)

 

 

(2,908)

 

Other

 

 

(31)

 

 

 —

 

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

 

 

 

 

 

 

 

Accounts receivable, net

 

 

1,872

 

 

2,905

 

Prepaid expenses and other current assets

 

 

462

 

 

(262)

 

Other long-term assets

 

 

(12)

 

 

(38)

 

Accounts payable

 

 

(53)

 

 

(2,574)

 

Accrued expenses and other liabilities

 

 

(3,675)

 

 

(2,435)

 

Deferred revenue

 

 

(231)

 

 

(139)

 

Net cash used in operating activities

 

 

(6,900)

 

 

(2,415)

 

Cash flows from investing activities

 

 

 

 

 

 

 

Purchases of property and equipment

 

 

(1,480)

 

 

(1,772)

 

Purchases of intangible assets

 

 

(4)

 

 

(19)

 

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

 

 

650

 

 

3,831

 

Other

 

 

167

 

 

155

 

Net cash (used in) provided by investing activities

 

 

(667)

 

 

2,195

 

Cash flows from financing activities

 

 

 

 

 

 

 

Proceeds from exercises of stock options and purchases under ESPP

 

 

1

 

 

126

 

Net taxes paid on restricted stock units and options exercised

 

 

(492)

 

 

(289)

 

Other

 

 

 —

 

 

(120)

 

Net cash used in financing activities

 

 

(491)

 

 

(283)

 

Effect of foreign currency on cash and cash equivalents

 

 

1

 

 

6

 

Change in cash and cash equivalents

 

 

(8,057)

 

 

(497)

 

Cash and cash equivalents, beginning of period

 

 

38,570

 

 

47,820

 

Cash and cash equivalents, end of period

 

$

30,513

 

$

47,323

 

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 marketplaces 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 our leading owned and operated online properties that publish media content, including text articles, videos, photographs and designed visual formats. This content is published across several key categories on eHow, a do-it-yourself and how-to reference destination; Livestrong.com, a health and healthy living destination; and certain other online properties focused on specific interests. During the periods covered by this Quarterly Report on Form 10-Q, we also owned and operated Cracked, a humor site offering original and engaging comedy-driven video series, text articles and blogs. We sold our Cracked property in April 2016, as discussed further in Note 11. Additionally, our studioD business develops and executes content marketing strategies and creates custom content for third-party brands, publishers and agencies.

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”) provides artists with an online commerce platform to feature and sell their original designs on a wide variety of consumer and home décor products such as art prints, phone and tablet cases, t-shirts, and throw pillows. SaatchiArt.com (“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.

2. Basis of Presentation

The accompanying interim condensed consolidated balance sheet as of March 31, 2016, the condensed consolidated statements of operations and condensed consolidated statements of comprehensive loss for the three month periods ended March 31, 2016 and 2015, the condensed consolidated statements of cash flows for the three month periods ended March 31, 2016 and 2015 and the condensed consolidated statement of stockholders’ equity for the three month period ended March 31, 2016 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 March 31, 2016 and our results of operations for the three month periods ended March 31, 2016 and 2015 and our cash flows for the three month periods ended March 31, 2016 and 2015. The results for the three month period ended March 31, 2016 are not necessarily indicative of the results expected for the full year. The consolidated balance sheet as of December 31, 2015 has been derived from our audited financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2015.

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

8


 

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, 2015 filed with the SEC.

 

In the first quarter of 2016, we reclassified certain personnel costs, including stock-based compensation, primarily relating to individuals serving in management roles for specific businesses, from general and administrative expense to either service costs, sales and marketing or product development, to better reflect the respective functions of these individuals. Certain prior period amounts have also been reclassified to conform to the current period presentation, resulting in the following changes in our condensed consolidated statements of operations for the three months ended March 31, 2015: (i) a decrease of $1.0 million in general and administrative expense; and (ii) increases of $0.7 million in product development expense, $0.2 million in sales and marketing expense, and $0.1 million in service costs.

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; the assigned value of acquired assets and assumed liabilities in business 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.

Recent Accounting Pronouncements

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

In September 2015, the FASB issued an update to Accounting Standards Codification 805, Business Combinations: Simplifying the Accounting Measurement-Period Adjustments. This update simplifies the accounting for adjustments made to provisional amounts recognized in a business combination by eliminating the requirement to retrospectively account for those adjustments. Under this update, the adjustments are recognized in the reporting period in which the adjustment amounts are determined. This update is effective for the Company commencing in the first quarter of fiscal

9


 

year 2017 and should be applied prospectively. Early adoption is permitted. We are currently evaluating the impact of this amended guidance on our consolidated financial statements.

In November 2015, the FASB issued ASU No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. This amended guidance requires an entity to present deferred tax assets and liabilities as noncurrent in the statement of financial position. The amended guidance is effective for the Company commencing in the first quarter of fiscal 2018. Early adoption is permitted and the guidance may be applied either prospectively to all deferred tax assets and liabilities or retrospectively to all periods presented. We elected to prospectively adopt the standard effective January 1, 2016. We believe the application of the guidance simplifies and improves the usefulness of deferred tax information for users of the Company’s financial statements. No prior periods were retrospectively adjusted.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842). This update will require lease assets and lease liabilities to be recognized on the balance sheet and disclosure of key information about leasing arrangements. This guidance is effective for the Company commencing in the first quarter of fiscal 2019 and must be adopted using a modified retrospective transition, and provides for certain practical expedients. Early adoption is permitted. We are currently evaluating the impact of this standard on our consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting. This standard makes several modifications to Topic 718 related to the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. This guidance is effective for the Company commencing in the first quarter of fiscal 2017. Early adoption is permitted. We are currently evaluating the impact of this standard on our consolidated financial statements.

3. Property and Equipment

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

 

 

 

 

 

 

 

 

 

 

    

March 31, 

    

December 31,

 

 

 

2016

 

2015

 

Computers and other related equipment

 

$

8,465

 

$

16,588

 

Purchased and internally developed software

 

 

26,468

 

 

34,868

 

Furniture and fixtures

 

 

1,465

 

 

1,423

 

Leasehold improvements

 

 

6,704

 

 

7,296

 

 

 

 

43,102

 

 

60,175

 

Less accumulated depreciation

 

 

(30,543)

 

 

(45,607)

 

Property and equipment, net

 

$

12,559

 

$

14,568

 

Depreciation and software amortization expense, which includes losses on disposal of property and equipment of approximately $0.9 million and $0.3 million for the three months ended March 31, 2016 and 2015, respectively, is shown by classification below (in thousands):

 

 

 

 

 

 

 

 

 

 

 

Three months ended March 31,

 

 

    

2016

    

2015

    

Service costs

 

$

1,464

 

$

1,497

 

Sales and marketing

 

 

13

 

 

20

 

Product development

 

 

41

 

 

57

 

General and administrative

 

 

1,181

 

 

1,265

 

Total depreciation

 

$

2,699

 

$

2,839

 

 

 

 

10


 

4. Intangible Assets

Intangible assets consisted of the following (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 31, 2016

 

 

 

Gross carrying

 

Accumulated

 

Net carrying

 

 

 

amount

 

amortization

 

amount

 

Customer relationships

 

$

1,628

 

$

(1,187)

 

$

441

 

Artist relationships

 

 

11,719

 

 

(9,209)

 

 

2,510

 

Media content

 

 

93,725

 

 

(84,611)

 

 

9,114

 

Technology

 

 

5,854

 

 

(3,088)

 

 

2,766

 

Non-compete agreements

 

 

217

 

 

(179)

 

 

38

 

Trade names

 

 

7,140

 

 

(3,702)

 

 

3,438

 

 

 

$

120,283

 

$

(101,976)

 

$

18,307

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2015

 

 

 

Gross carrying

 

Accumulated

 

Net carrying

 

 

 

amount

 

amortization

 

amount

 

Customer relationships

 

$

1,628

 

$

(1,107)

 

$

521

 

Artist relationships

 

 

11,719

 

 

(8,340)

 

 

3,379

 

Media content

 

 

95,785

 

 

(85,018)

 

 

10,767

 

Technology

 

 

5,854

 

 

(2,842)

 

 

3,012

 

Non-compete agreements

 

 

217

 

 

(160)

 

 

57

 

Trade names

 

 

7,150

 

 

(3,554)

 

 

3,596

 

 

 

$

122,353

 

$

(101,021)

 

$

21,332

 

 

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

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

 

 

 

 

 

 

 

 

 

 

 

Three months ended March 31,

 

 

    

2016

    

2015

    

Service costs

 

$

1,700

 

$

2,835

 

Sales and marketing

 

 

949

 

 

1,016

 

Product development

 

 

247

 

 

701

 

General and administrative

 

 

136

 

 

159

 

Total amortization

 

$

3,032

 

$

4,711

 

Service costs include accelerated amortization charges of less than $0.1 million for the three months ended March 31, 2016 and 2015, as a result of removing certain assets from service.

5. Other Assets

 

As of March 31, 2016, we had $1.0 million of cash included in long-term assets, collateralizing a standby letter of credit associated with one of our leases.

11


 

6. Accrued Expenses and Other Current Liabilities

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

 

 

 

 

 

 

 

 

 

 

 

March 31, 

 

December 31, 

 

 

    

2016

 

2015

 

Accrued payroll and related items

 

$

3,923

 

$

5,916

 

Acquisition holdback

 

 

607

 

 

607

 

Artist payables

 

 

2,481

 

 

2,816

 

Other

 

 

4,324

 

 

5,830

 

Accrued expenses and other current liabilities

 

$

11,335

 

$

15,169

 

 

 

7. Commitments and Contingencies

Leases

We conduct our operations utilizing leased office facilities in various locations under operating leases with non-cancelable periods ending between February 2018 and February 2020.

Litigation

 

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

Taxes

From time to time, various federal, state and other jurisdictional tax authorities undertake review of us and our filings. In evaluating the exposure associated with various tax filing positions, we accrue charges for possible exposures.

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 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

8. 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 months ended March 31, 2016 and 2015 was less than $0.1 million.

12


 

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 it is more likely than not that our income tax positions and deductions will be sustained on audit and do not anticipate any material adjustments which could 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 not material. There are no material uncertain tax positions and no uncertain income tax positions were recorded during the three months ended March 31, 2016 or 2015, 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. The tax years 2008 to 2015 remain subject to examination by the Internal Revenue Service and most tax years since our incorporation are subject to examination by various state authorities.

9. 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 March 31,

 

 

    

2016

    

2015 (1)

    

Service costs

 

$

262

 

$

314

 

Sales and marketing

 

 

208

 

 

199

 

Product development

 

 

399

 

 

718

 

General and administrative

 

 

1,050

 

 

1,004

 

Total stock-based compensation

 

$

1,919

 

$

2,235

 


(1)

Certain 2015 personnel costs, including stock-based compensation, were reclassified out of general and administrative to service costs, sales and marketing and product development to conform to 2016 presentation. See Note 2 for additional information.

13


 

Award Activity

Stock Options

Stock option activity is as follows (in thousands):

 

 

 

 

 

 

Number of

 

 

    

options

 

 

 

outstanding

 

Outstanding at December 31, 2015

 

3,199

 

Options granted

 

79

 

Options exercised

 

 —

 

Options forfeited or cancelled

 

(94)

 

Outstanding at March 31, 2016

 

3,184

 

Restricted Stock Units

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

 

 

 

 

 

 

Number of

 

 

    

shares

 

Unvested at December 31, 2015

 

977

 

Granted

 

1,762

 

Vested

 

(235)

 

Forfeited

 

(63)

 

Unvested at March 31, 2016

 

2,441

 

Employee Stock Purchase Plan

 

In May 2011, we commenced our first offering under the Employee Stock Purchase Plan (“ESPP”), which allows eligible employees to purchase, through payroll deductions, a limited amount of our common stock at a 15% discount to the lower of market price as of the beginning or ending of each six-month purchase 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. We suspended the ESPP plan after the November 2015 purchase. In April 2016, the compensation committee of the board of directors approved to restart an offering under the ESPP with the commencement of the next offering period in May 2016. The ESPP provides for a 12-month offering period which is comprised of two consecutive six-month purchase periods, one from May to November and the other from November to May. A maximum of 500 shares of common stock may be purchased by each participant during each purchase period. Approximately 1.7 million shares of common stock remained authorized for issuance under the ESPP at March 31, 2016.

10. Stockholders’ Equity

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 March 31, 2016. 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 March 31, 2016, 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.

14


 

Voting Rights

Each share of common stock has the right to one vote per share.

11. Acquisitions and Dispositions

Dispositions

During the three months ended March 31, 2016, we sold one of our non-core online properties for total consideration of $1.0 million, resulting in a gain of $1.0 million, recorded in other income, net. During the three months ended March 31, 2015, we sold our Pluck social media business for $3.8 million in cash after working capital adjustments, resulting in a gain of $2.1 million.

 

On April 12, 2016, we completed the sale of substantially all of the assets relating to our Cracked business, including the Cracked.com humor website, to Scripps Media, Inc. for a cash purchase price of $39.0 million. A portion of the purchase price equal to $3.9 million was placed into escrow at closing to secure certain post-closing indemnification obligations. Any remaining portion of the escrow amount that is not subject to then-pending claims will be paid to us on the 15-month anniversary of the closing date of the sale.

 

As of March 31, 2016, we have classified the assets related to Cracked, primarily consisting of property and equipment, net and intangible assets, net, in the amount of $0.6 million as assets held-for-sale, recorded in other current assets in our condensed consolidated balance sheet. Revenues for the Cracked business were $1.6 million and $2.5 million for the three months ended March 31, 2016 and 2015, respectively. The Cracked business had a pre-tax loss of $0.9 million and pre-tax income of $0.7 million for the three months ended March 31, 2016 and 2015, respectively, not including allocations of corporate costs.

 

As a result of the sale of the Cracked business, we will recognize a gain of approximately $38.0 million, based on preliminary estimates, which may change as additional information is obtained. We expect to utilize our existing net operating losses to offset the income tax associated with the gain on sale resulting from the sale of the Cracked business. If all or a portion of our net operating loss carryforwards are subject to limitation because it is determined that we had previously experienced an “ownership change” as defined in section 382 of the Internal Revenue Code of 1986, as amended, our future cash flows could be adversely impacted due to increased tax liability.

12. 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.

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

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended March 31,

 

 

    

 

2016

    

2015

 

Content & Media

 

 

$

13,507

 

$

22,525

 

Marketplaces

 

 

 

13,462

 

 

10,685

 

Total revenue

 

 

$

26,969

 

$

33,210

 

 

15


 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended March 31,

 

 

    

 

2016

    

2015

 

Domestic

 

 

$

21,980

 

$

28,768

 

International

 

 

 

4,989

 

 

4,442

 

Total revenue

 

 

$

26,969

 

$

33,210

 

 

 

 

13. 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.

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. 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.

We have Level 1 financial assets measured at fair value consisting of money market funds in the amount of $5.0 million as of March 31, 2016 and December 31, 2015. These assets are included in cash and cash equivalents in the accompanying condensed consolidated balance sheet.

 

16


 

14. 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  March 31, 

 

 

 

2016

    

2015

    

Net loss

 

$

(11,909)

 

$

(6,749)

 

Weighted average common shares outstanding—basic and diluted

 

 

20,213

 

 

19,773

 

Net loss per share—basic and diluted

 

$

(0.59)

 

$

(0.34)

 

For the three months ended March 31, 2016 and 2015, we excluded 0.1 million shares from the calculation of diluted weighted average common shares outstanding, as their inclusion would have been antidilutive.

15. Subsequent Events

In April 2016, we completed the sale of substantially all of the assets relating to our Cracked business for total consideration of $39.0 million, of which $35.1 million was received in cash and $3.9 million was placed into escrow.

17


 

 

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, 2015 (the “2015 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 2015 Annual Report, which was filed with the SEC on March 1, 2016, and the factors described in the section entitled “Risk Factors” in Part I. Item 1A of the 2015 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 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 marketplaces properties to enable communities of creators to reach passionate audiences in large and growing lifestyle categories. In addition, our branded content creation and diverse advertising offerings help advertisers find innovative ways to engage with their customers.

Our business is comprised of two service offerings: Content & Media and Marketplaces.

18


 

Content & Media

Our Content & Media service offering includes our leading owned and operated online properties that publish media content, including text articles, videos, photographs and designed visual formats. This content is published across several key categories on eHow, a do-it-yourself and how-to reference destination; Livestrong.com, a health and healthy living destination; and certain other online properties focused on specific interests. During the periods covered by this Quarterly Report on Form 10-Q, we also owned and operated Cracked, a humor site offering original and engaging comedy-driven video series, text articles and blogs. We sold our Cracked property in April 2016, as discussed in further detail below. Additionally, our studioD business develops and executes content marketing strategies and creates custom content for third-party brands, publishers and agencies.

Our Content & Media service offering derives the majority of its revenue from the sale of advertising on our 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, 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 industry 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 online properties continue to shift from desktop to mobile, with ad unit rates for mobile generally lower than desktop. 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 online properties from direct visits, social media and search engine referrals by building high-quality products that provide a better user experience and lead to increased engagement. In order to improve the quality of our products, we have redesigned our websites; refined our content library; rationalized ad unit density; and developed a greater variety of content formats, particularly formats better suited for mobile devices. We are also working 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 continuing to optimize our ad product stack, increasing branded ad sales through direct sellers and 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.

Historically, the majority of our advertising revenue has been generated by our relationship with Google. While Google continues to be our primary ad vendor for ad monetization, in 2015 we began to significantly diversify our monetization partners and will continue to do so going forward. Google also serves as one of our primary technology platform partners in connection with 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.com (“Society6”) provides artists with an online commerce platform to feature and sell their original designs on a wide variety of consumer and home décor products such as art prints, phone and tablet cases, t-shirts and throw pillows. SaatchiArt.com (“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 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

19


 

service offering is principally dependent on the number of transactions and average revenue per transaction generated by products and services sold through our online marketplaces. We believe there are opportunities to 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, international expansion 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, marketing costs, and shipping and handling costs. During the three months ended March 31, 2016, 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.

Sale of Cracked Business

On April 12, 2016, we completed the sale of substantially all of the assets relating to our Cracked business, including the Cracked.com humor website, to Scripps Media, Inc. for a cash purchase price of $39.0 million. A portion of the purchase price equal to $3.9 million was placed into escrow at closing to secure certain post-closing indemnification obligations. Any remaining portion of the escrow amount that is not subject to then-pending claims will be paid to us on the 15-month anniversary of the closing date of the sale. Revenue for the Cracked business was $1.6 million and $2.5 million for the three months ended March 31, 2016 and 2015, respectively. The Cracked business had a pre-tax loss of $0.9 million and pre-tax income of $0.7 million for the three months ended March 31, 2016 and 2015, respectively, not including allocations of corporate costs.

Revenue

For the three months ended March 31, 2016 and 2015, we reported revenue of $27.0 million and $33.2 million, respectively. For the three months ended March 31, 2016 and 2015, Content & Media revenue accounted for 50% and 68% of our total revenue, respectively, and Marketplaces revenue accounted for 50% and 32% 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.

20


 

·

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.

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended

 

 

 

 

 

 

March 31, 

 

 

 

  

 

 

2016

 

2015

 

% Change

 

 

Content & Media Metrics(1):

 

 

 

    

 

 

    

 

    

 

Visits (in thousands)

 

 

785,979

 

 

943,438

 

(17)

%

 

Revenue per Visit

 

$

17.18

 

$

23.87

 

(28)

%

 

Marketplaces Metrics(1):

 

 

 

 

 

 

 

 

 

 

Number of Transactions

 

 

227,202

 

 

182,179

 

25

%

 

Average Revenue per Transaction

 

$

59.25

 

$

58.65

 

1

%

 

(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 primarily derived from sales of advertising and from products and services sold through our online marketplaces.

Service Revenue

Content & Media

We generate Content & Media service revenue primarily from advertisements displayed on our online properties and on certain webpages of our content channel customers’ online properties that are hosted by our content services. 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. 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

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

21


 

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 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

The terms with our shipping vendors are FOB destination and we therefore 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. 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 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 expense.

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 remain relatively flat as a percentage of product revenue.

Shipping and Handling

Shipping and handling charged to customers are recorded in service revenue or product revenue, as applicable. 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 across our 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 online properties and related mobile applications, as well as the costs to develop future product and

22


 

service offerings. We currently anticipate that our product development expenses will remain relatively flat in the near term as a percentage of revenue.

General and Administrative

General and administrative expenses consist primarily of personnel costs from our corporate 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. In the first quarter of 2016, we reclassified certain personnel costs, including stock-based compensation, primarily relating to individuals serving in management roles for specific businesses, from general and administrative expense to either service costs, sales and marketing or product development, to better reflect the respective functions of these individuals. 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. In the event of content remediation in future periods, additional accelerated amortization expense may be incurred in the periods such actions occur. We expect amortization expense related to business combinations to decrease in the near term due to fewer acquisitions as compared to prior years. 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. Goodwill is tested at the reporting unit level and as of March 31, 2016, we have two reporting units: content and media and marketplaces. As of March 31, 2016, our goodwill balance related entirely to our marketplaces reporting unit.

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 income consists primarily of interest earned on cash balances and short-term investments. We typically invest our available cash balances in money market funds and short-term United States Treasury obligations.

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.

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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 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. However, if all or a portion of our net operating loss carryforwards are subject to limitation because we experience an ownership change, our future cash flows could be adversely impacted due to increased tax liability.

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; and the recoverability of our long-lived assets, including our media portfolio; 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 2015 Annual Report. There have been no material changes to our critical accounting policies and estimates since the date of our 2015 Annual Report.

 

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Results of Operations

The following tables set forth our results of operations for the periods presented. The period-to-period comparison of financial results is not necessarily indicative of future results.

 

 

 

 

 

 

 

 

 

 

 

Three months ended March 31,

 

 

 

2016

    

2015

    

Revenue:

 

 

 

 

 

 

 

Service revenue

 

$

14,505

 

$

23,225

 

Product revenue

 

 

12,464

 

 

9,985

 

Total revenue

 

 

26,969

 

 

33,210

 

Operating expenses:

 

 

 

 

 

 

 

Service costs (exclusive of amortization of intangible assets shown separately below)(1)(2)(3)

 

 

8,171

 

 

10,149

 

Product costs

 

 

8,507

 

 

6,834

 

Sales and marketing(1)(2)(3)

 

 

5,995

 

 

4,794

 

Product development(1)(2)(3)

 

 

5,614

 

 

7,036

 

General and administrative(1)(2)(3)

 

 

8,530

 

 

9,349

 

Amortization of intangible assets

 

 

3,032

 

 

4,711

 

Total operating expenses

 

 

39,849

 

 

42,873

 

Loss from operations

 

 

(12,880)

 

 

(9,663)

 

Interest income

 

 

2

 

 

180

 

Interest expense

 

 

 —

 

 

(71)

 

Other income, net

 

 

980

 

 

2,827

 

Loss from operations before income taxes

 

 

(11,898)

 

 

(6,727)

 

Income tax expense

 

 

(11)

 

 

(22)

 

Net loss

 

$

(11,909)

 

$

(6,749)

 

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

Service costs

 

$

1,464

 

$

1,497

 

Sales and marketing

 

 

13

 

 

20

 

Product development

 

 

41

 

 

57

 

General and administrative

 

 

1,181

 

 

1,265

 

Total depreciation

 

$

2,699

 

$

2,839

 

 

 

 

 

 

 

 

 

(2) Stock-based compensation included in the above line items(3):

 

 

 

 

 

 

 

Service costs

 

$

262

 

$

314

 

Sales and marketing

 

 

208

 

 

199

 

Product development

 

 

399

 

 

718

 

General and administrative

 

 

1,050

 

 

1,004

 

Total stock-based compensation

 

$

1,919

 

$

2,235

 

 

(3)   In the first quarter of 2016, we reclassified certain personnel costs (including stock-based compensation), primarily relating to individuals serving in management roles for specific businesses, from general and administrative expense to either service costs, sales and marketing or product development, to better reflect the respective functions of these individuals. Certain prior period amounts have also been reclassified to conform to the current period presentation, resulting in the following changes in our condensed consolidated statements of operations for the three months ended March 31, 2015: (i) a decrease of $1.0 million in general and administrative expense; and (ii) increases of $0.7 million in product development expense, $0.2 million in sales and marketing expense, and $0.1 million in service costs.

 

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As a percentage of revenue:

 

 

 

 

 

 

 

 

 

 

 

Three months ended March 31,

 

 

    

    

2016

    

2015

    

Revenue: