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EX-31.2 - EX-31.2 - LEAF GROUP LTD.lfgr-20170930ex312fcf78a.htm
EX-31.1 - EX-31.1 - LEAF GROUP LTD.lfgr-20170930ex311102e93.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 September 30, 2017

 

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

 


 

LEAF GROUP LTD.

(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,” “smaller reporting company” and “emerging growth 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

 

 

 

 

 

 

Emerging Growth Company

 

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    

 

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 31, 2017, there were 20,840,754 shares of the registrant’s common stock, $0.0001 par value, outstanding.

 


 

LEAF GROUP LTD.

INDEX TO FORM 10-Q

 

 

 

 

 

 

 

  

 

  

Page

Part I 

Financial Information

  

 

 

Item 1.

  

Condensed Consolidated Financial Statements (Unaudited)

  

1

 

 

  

Condensed Consolidated Balance Sheets

  

1

 

 

  

Condensed Consolidated Statements of Operations

  

2

 

 

  

Condensed Consolidated Statements of Comprehensive Income (Loss)  

  

3

 

 

  

Condensed Consolidated Statements of Stockholders’ Equity

  

4

 

 

  

Condensed Consolidated Statements of Cash Flows

  

5

 

 

  

Notes to the Condensed Consolidated Financial Statements

  

6

 

Item 2.

  

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

  

19

 

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

  

37

 

Item 4.

  

Controls and Procedures

  

38

 

 

 

 

Part II 

Other Information

 

 

 

Item 1.

  

Legal Proceedings

  

39

 

Item 1A.

  

Risk Factors

  

39

 

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

  

39

 

Item 3.

  

Defaults Upon Senior Securities

  

39

 

Item 4.

  

Mine Safety Disclosures

  

39

 

Item 5.

  

Other Information

  

39

 

Item 6.

  

Exhibits

  

39

 

 

  

Signatures

  

41

 

 

 


 

Part I.       FINANCIAL INFORMATION

 

Item 1.      CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  

Leaf Group Ltd. and Subsidiaries 

Condensed Consolidated Balance Sheets  

(In thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

    

September 30, 

    

December 31, 

 

 

2017

 

2016

Assets

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

Cash and cash equivalents

 

$

33,039

 

$

50,864

Accounts receivable, net

 

 

7,089

 

 

6,849

Prepaid expenses and other current assets

 

 

2,420

 

 

8,139

Total current assets

 

 

42,548

 

 

65,852

Property and equipment, net

 

 

11,833

 

 

11,503

Intangible assets, net

 

 

11,559

 

 

11,273

Goodwill

 

 

17,146

 

 

11,167

Other assets

 

 

1,308

 

 

1,457

Total assets

 

$

84,394

 

$

101,252

 

 

 

 

 

 

 

Liabilities and Stockholders' Equity

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

Accounts payable

 

$

2,710

 

$

2,451

Accrued expenses and other current liabilities

 

 

14,764

 

 

15,017

Deferred revenue

 

 

1,971

 

 

2,180

Total current liabilities

 

 

19,445

 

 

19,648

Deferred tax liability

 

 

176

 

 

108

Other liabilities

 

 

3,322

 

 

1,746

Total liabilities

 

 

22,943

 

 

21,502

Commitments and contingencies (Note 7)

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

 

Common stock, $0.0001 par value. Authorized 100,000 shares; 22,473 issued and 20,818 shares outstanding at September 30, 2017 and 21,407 issued and 19,763 shares outstanding at December 31, 2016

 

 

 2

 

 

 2

Additional paid-in capital

 

 

520,620

 

 

513,139

Treasury stock at cost, 1,655 at September 30, 2017 and 1,644 at December 31, 2016

 

 

(35,706)

 

 

(35,641)

Accumulated other comprehensive loss

 

 

(27)

 

 

(112)

Accumulated deficit

 

 

(423,438)

 

 

(397,638)

Total stockholders’ equity

 

 

61,451

 

 

79,750

Total liabilities and stockholders’ equity

 

$

84,394

 

$

101,252

 

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


1

 


 

Leaf Group Ltd. and Subsidiaries 

Condensed Consolidated Statements of Operations  

(In thousands, except per share amounts)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended September 30, 

 

Nine months ended September 30, 

 

    

2017

    

2016

    

2017

    

2016

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

Product revenue

 

$

20,908

 

$

15,371

 

$

50,841

 

$

39,840

Service revenue

 

 

12,552

 

 

12,688

 

 

38,422

 

 

39,623

Total revenue

 

 

33,460

 

 

28,059

 

 

89,263

 

 

79,463

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

15,385

 

 

9,791

 

 

37,456

 

 

26,588

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

 

 

4,993

 

 

5,370

 

 

15,881

 

 

19,887

Sales and marketing

 

 

6,973

 

 

6,031

 

 

20,893

 

 

19,610

Product development

 

 

4,558

 

 

4,652

 

 

14,337

 

 

15,614

General and administrative

 

 

7,056

 

 

7,498

 

 

21,933

 

 

23,450

Amortization of intangible assets

 

 

1,313

 

 

3,100

 

 

4,547

 

 

9,246

Total operating expenses

 

 

40,278

 

 

36,442

 

 

115,047

 

 

114,395

Loss from operations

 

 

(6,818)

 

 

(8,383)

 

 

(25,784)

 

 

(34,932)

Interest income

 

 

66

 

 

35

 

 

148

 

 

60

Interest expense

 

 

(2)

 

 

(2)

 

 

(5)

 

 

(2)

Other (expense) income, net

 

 

(6)

 

 

(31)

 

 

(9)

 

 

39,131

(Loss) income before income taxes

 

 

(6,760)

 

 

(8,381)

 

 

(25,650)

 

 

4,257

Income tax (expense) benefit

 

 

(57)

 

 

32

 

 

(150)

 

 

(48)

Net (loss) income

 

$

(6,817)

 

$

(8,349)

 

$

(25,800)

 

$

4,209

 

 

 

 

 

 

 

 

 

 

 

 

 

Net (loss) income per share

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

(0.33)

 

$

(0.41)

 

$

(1.27)

 

$

0.21

Diluted

 

$

(0.33)

 

$

(0.41)

 

$

(1.27)

 

$

0.21

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

20,745

 

 

20,236

 

 

20,363

 

 

20,279

Diluted

 

 

20,745

 

 

20,236

 

 

20,363

 

 

20,511

 

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


2

 


 

Leaf Group Ltd. and Subsidiaries 

Condensed Consolidated Statements of Comprehensive Income (Loss)

(In thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended September 30, 

 

Nine months ended September 30, 

 

    

2017

    

2016

    

2017

    

2016

Net (loss) income

 

$

(6,817)

 

$

(8,349)

 

$

(25,800)

 

$

4,209

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

Change in foreign currency translation adjustment

 

 

26

 

 

 3

 

 

85

 

 

 1

Comprehensive (loss) income

 

$

(6,791)

 

$

(8,346)

 

$

(25,715)

 

$

4,210

 

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


3

 


 

Leaf Group Ltd. 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, 2016

 

19,763

 

$

 2

 

$

513,139

 

$

(35,641)

 

$

(112)

 

$

(397,638)

 

$

79,750

 

Issuance of stock under employee stock awards and other

 

850

 

 

 —

 

 

1,941

 

 

 —

 

 

 —

 

 

 —

 

 

1,941

 

Repurchases of common stock to be held in treasury

 

(10)

 

 

 —

 

 

 —

 

 

(65)

 

 

 —

 

 

 —

 

 

(65)

 

Issuance of common stock for acquisition

 

215

 

 

 —

 

 

1,603

 

 

 —

 

 

 —

 

 

 —

 

 

1,603

 

Tax withholdings related to vesting of share-based payments

 

 —

 

 

 —

 

 

(2,761)

 

 

 —

 

 

 —

 

 

 —

 

 

(2,761)

 

Stock-based compensation expense

 

 —

 

 

 —

 

 

6,698

 

 

 —

 

 

 —

 

 

 —

 

 

6,698

 

Foreign currency translation adjustment

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

85

 

 

 —

 

 

85

 

Net loss

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(25,800)

 

 

(25,800)

 

Balance at September 30, 2017

 

20,818

 

$

 2

 

$

520,620

 

$

(35,706)

 

$

(27)

 

$

(423,438)

 

$

61,451

 

 

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


4

 


 

Leaf Group Ltd. and Subsidiaries 

Condensed Consolidated Statements of Cash Flows  

(In thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

Nine months ended September 30, 

 

    

2017

    

2016

Cash flows from operating activities

 

 

 

 

 

 

Net (loss) income

 

$

(25,800)

 

$

4,209

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

 

 

 

 

 

 

Depreciation and amortization

 

 

8,815

 

 

15,035

Deferred income taxes

 

 

68

 

 

(33)

Stock-based compensation

 

 

6,426

 

 

6,118

Gain on disposal of businesses and online properties

 

 

 —

 

 

(39,149)

Other

 

 

(44)

 

 

10

Change in operating assets and liabilities, net of effect of acquisitions and disposals:

 

 

 

 

 

 

Accounts receivable, net

 

 

319

 

 

3,231

Prepaid expenses and other current assets

 

 

1,021

 

 

(180)

Other long-term assets

 

 

25

 

 

48

Accounts payable

 

 

(548)

 

 

(372)

Accrued expenses and other liabilities

 

 

(1,557)

 

 

(2,730)

Deferred revenue

 

 

(236)

 

 

335

Net cash used in operating activities

 

 

(11,511)

 

 

(13,478)

Cash flows from investing activities

 

 

 

 

 

 

Purchases of property and equipment

 

 

(3,718)

 

 

(3,743)

Purchases of intangible assets

 

 

(235)

 

 

(120)

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

 

 

4,285

 

 

36,100

Cash paid for acquisitions, net of cash acquired

 

 

(6,304)

 

 

(1,413)

Restricted deposits

 

 

742

 

 

136

Other

 

 

 6

 

 

78

Net cash (used in) provided by investing activities

 

 

(5,224)

 

 

31,038

Cash flows from financing activities

 

 

 

 

 

 

Proceeds from exercises of stock options and purchases under ESPP

 

 

1,941

 

 

226

Repurchases of common stock

 

 

(65)

 

 

(3,515)

Taxes paid on net share settlements of restricted stock units

 

 

(2,761)

 

 

(1,132)

Cash paid for acquisition holdback

 

 

(119)

 

 

 —

Other

 

 

(49)

 

 

(15)

Net cash used in financing activities

 

 

(1,053)

 

 

(4,436)

Effect of foreign currency on cash and cash equivalents

 

 

(37)

 

 

(2)

Change in cash and cash equivalents

 

 

(17,825)

 

 

13,122

Cash and cash equivalents, beginning of period

 

 

50,864

 

 

38,570

Cash and cash equivalents, end of period

 

$

33,039

 

$

51,692

 

 

 

 

 

 

 

Supplemental disclosure of cash flows

 

 

 

 

 

 

Stock issued for acquisitions

 

$

1,603

 

$

 —

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


5

 


 

 

Leaf Group Ltd. and Subsidiaries 

Notes to Condensed Consolidated Financial Statements  

(Unaudited)

1. Company Background and Overview

Leaf Group Ltd. (“Leaf Group” 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 marketplaces and media properties to enable communities of creators to reach passionate audiences in large and growing lifestyle categories. Our business is comprised of two segments: Marketplaces and Media.

Marketplaces

Through our Marketplaces segment, we operate 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 an array of consumer products in the home décor, accessories, and apparel categories. In May 2017, we acquired Deny Designs, a print-on-demand home décor brand with in-house manufacturing capacity, and both wholesale and direct-to-consumer channels, complementing our Society6 business. 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 with a curated environment in which to exhibit and sell their work directly to consumers around the world. The Other Art Fair is a leading London-based art fair for discovering emerging artists that complements our Saatchi Art marketplace.  

Media

Our Media segment includes our leading owned and operated media properties that publish content, including videos, articles, and designed visual formats on various category-specific properties with distinct editorial voices. Our media properties include Livestrong.com, a health and healthy living destination; eHow, a do-it-yourself reference destination; and over 40 other media properties focused on specific editorial categories or interests that we either own and operate or host and operate for our partners. Beginning in the third quarter of 2016, we launched several category-specific properties, leveraging topics and certain content from eHow and our content library. We have focused on creating new high-quality content and building strong followings for these media brands by working with a curated network of contributors and influencers. Our Media segment also includes our content publishing studio, through which we create content for third-party publishers and brands.

2. Basis of Presentation

The accompanying interim condensed consolidated balance sheet as of September 30, 2017, the condensed consolidated statements of operations and condensed consolidated statements of comprehensive (loss) income for the three and nine months ended September 30, 2017 and 2016, the condensed consolidated statements of cash flows for the nine months ended September 30, 2017 and 2016 and the condensed consolidated statement of stockholders’ equity for the nine months ended September 30, 2017 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, 2017, our results of operations for the three and nine months ended September 30, 2017 and 2016, and our cash flows for the nine months ended September 30, 2017 and 2016. The results for the three and nine months ended September 30, 2017 are not necessarily indicative of the results expected for the full year. The consolidated balance sheet as of December 31, 2016 has been derived from our audited financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2016.

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


6

 


 

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, 2016 filed with the SEC.

Principles of Consolidation

The consolidated financial statements include the accounts of Leaf Group 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 in the United States 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.

Revenue Recognition

Product Revenue

During the first quarter of 2017, we revised the shipping terms for Society6 to reflect the transfer of title and risk of loss upon shipment and began recognizing revenue upon the shipment of fulfilled orders. We recognize product revenue from sales of Society6 products when the title and risk of loss transfers to the customer, net of sales allowances and estimated returns based on historical experience. The impact as a result of this change was not material for the three months ended September 30, 2017. The impact as a result of this change was an increase in product revenue of approximately $0.9 million for the nine months ended September 30, 2017. Such amounts would have been otherwise recorded as deferred revenue at the end of the period.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606), which will supersede nearly all existing revenue recognition guidance under 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 guidance is effective for the Company commencing in the first quarter of fiscal year 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. The Company is continuing to evaluate the impact of adopting the new revenue standard and, at this time, does not believe such adoption will have a material effect on the consolidated financial statements. To date, the Company has performed an initial assessment for each of the Company’s material revenue streams. In addition, the Company has determined it is expected to utilize various practical expedients allowed under the guidance, such as the application of the guidance only to contracts that are not completed as of the date of the initial application and certain other practical expedients applicable to contracts with a duration of one year or less. The Company anticipates it will complete its process of adopting this new accounting standard in the fourth quarter of 2017. Although the impact is not expected to be material, the Company expects to record any adoption adjustments associated with this standard in the first quarter of fiscal year 2018 using the modified retrospective method with the cumulative effect recognized as of the date of adoption. Upon adoption of the guidance, the Company also expects to expand disclosures regarding its contracts and revenue types.

In February 2016, the FASB issued ASU 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 year 2019 and must be adopted using a modified retrospective transition, and provides


7

 


 

for certain practical expedients. Early adoption is permitted. The Company is currently evaluating the impact of this standard on the consolidated financial statements.

In March 2016, the FASB issued ASU 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. The Company adopted the guidance in the first quarter of fiscal year 2017. The Company elected to continue the estimation of forfeitures for its equity instruments. The new guidance requires excess tax benefits and tax deficiencies to be recorded in the income statement when the awards vest or are settled. Due to the Company’s net operating loss carryforwards and full valuation allowance, the adoption of the guidance did not have an impact to the Company’s retained earnings upon adoption. The presentation requirements for cash flows related to employee taxes paid for withheld shares had no impact to any of the periods presented in our consolidated cash flows statements as these cash flows have historically been presented as a financing activity. The guidance did not have a material impact to the Company’s consolidated financial statements.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 provides guidance on how certain cash receipts and cash payments are to be presented and classified in the statement of cash flows. ASU 2016-15 is effective for annual and interim periods beginning after December 15, 2017. Early adoption is permitted. ASU 2016-15 is effective for the Company beginning in fiscal 2018. The Company is evaluating the impact of the adoption of this guidance on the consolidated financial statements and does not expect the impact to be material.

In November 2016, the FASB issued ASU 2016-18, Restricted Cash, which requires amounts generally described as restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the total beginning and ending amounts for the periods shown on the statement of cash flows. ASU 2016-18 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. ASU 2016-18 will be applied using a retrospective transition method to each period presented and early adoption is permitted. ASU 2016-18 is effective for the Company beginning in fiscal 2018. The Company is evaluating the impact of the adoption of this guidance on the consolidated financial statements. As of September 30, 2017, the Company has a restricted cash balance of $1.0 million collateralizing a standby letter of credit associated with the lease of the headquarters office. The Company's practice has historically been to present changes to the account as restricted deposits in the statement of cash flows. Upon adoption of this guidance, the Company expects that the presentation of the beginning and ending amounts of cash on the statement of cash flows will change to include the balance of restricted cash.

In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other (Topic 350). This standard simplifies the subsequent measurement of goodwill by removing the second step of the two-step impairment test. The amendment requires an entity to perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit's fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The amendment should be applied on a prospective basis. ASU 2017-04 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company is currently evaluating the impact of this standard on the consolidated financial statements.

In May 2017, the FASB issued ASU 2017-09, Scope of Modification Accounting. ASU 2017-09 clarifies when changes to the terms or conditions of a share-based payment award must be accounted for as modifications. The new guidance will reduce diversity in practice and result in fewer changes to the terms of an award being accounted for as modifications. Under ASU 2017-09, an entity will not apply modification accounting to a share-based payment award if the award’s fair value, vesting conditions and classification as an equity or liability instrument are the same immediately before and after the change. ASU 2017-09 will be applied prospectively to awards modified on or after the adoption date. The guidance is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted. ASU 2017-09 is effective for the Company beginning in fiscal 2018. The Company is evaluating the impact of the adoption of this guidance on the consolidated financial statements but does not expect it to have a material impact.

 


8

 


 

3. Property and Equipment

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

 

 

 

 

 

 

 

 

    

September 30, 

    

December 31, 

 

 

2017

 

2016

Computers and other related equipment

 

$

9,509

 

$

8,656

Purchased and internally developed software

 

 

28,279

 

 

27,601

Furniture and fixtures

 

 

1,500

 

 

1,472

Leasehold improvements

 

 

6,784

 

 

6,694

Machinery and related equipment

 

 

297

 

 

 —

 

 

 

46,369

 

 

44,423

Less accumulated depreciation

 

 

(34,536)

 

 

(32,920)

Property and equipment, net

 

$

11,833

 

$

11,503

 

Depreciation and software amortization expense, which includes losses on disposal of property and equipment of less than $0.1 million for each of the three months ended September 30, 2017 and 2016, respectively, and less than $0.1 million and $1.2 million for the nine months ended September 30, 2017 and 2016, respectively, is shown by classification below (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended September 30, 

 

Nine months ended September 30, 

 

    

2017

    

2016

    

2017

    

2016

Product costs

 

$

16

 

$

 —

 

$

31

 

$

 —

Service costs

 

 

725

 

 

603

 

 

2,174

 

 

2,931

Sales and marketing

 

 

 9

 

 

12

 

 

27

 

 

38

Product development

 

 

22

 

 

32

 

 

68

 

 

105

General and administrative

 

 

664

 

 

700

 

 

1,968

 

 

2,715

Total depreciation

 

$

1,436

 

$

1,347

 

$

4,268

 

$

5,789

 

4. Goodwill and Intangible Assets

The following table presents the changes in our goodwill balance (in thousands):

 

 

 

 

Balance at December 31, 2016

    

$

11,167

Acquisitions

 

 

5,906

Foreign currency impact

 

 

73

Balance at September 30, 2017

 

$

17,146

We recorded $5.9 million of goodwill in connection with the acquisition of Deny Designs in May 2017.  Refer to Note 11 for additional information. As of September 30, 2017, we have two reporting units, marketplaces and media, and our goodwill balance related entirely to our marketplaces reporting unit.

Intangible assets consisted of the following (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

September 30, 2017

 

 

Gross carrying

 

Accumulated

 

Net carrying

 

 

amount

 

amortization

 

amount

Customer relationships

 

$

2,853

 

$

(1,558)

 

$

1,295

Artist relationships

 

 

12,233

 

 

(10,570)

 

 

1,663

Media content

 

 

91,396

 

 

(89,704)

 

 

1,692

Technology

 

 

6,204

 

 

(4,458)

 

 

1,746

Non-compete agreements

 

 

25

 

 

(18)

 

 

 7

Trade names

 

 

9,885

 

 

(4,729)

 

 

5,156

 

 

$

122,596

 

$

(111,037)

 

$

11,559

 


9

 


 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2016

 

 

Gross carrying

 

Accumulated

 

Net carrying

 

 

amount

 

amortization

 

amount

Customer relationships

 

$

1,453

 

$

(1,252)

 

$

201

Artist relationships

 

 

11,916

 

 

(10,337)

 

 

1,579

Media content

 

 

91,616

 

 

(87,604)

 

 

4,012

Technology

 

 

5,654

 

 

(3,649)

 

 

2,005

Non-compete agreements

 

 

25

 

 

(11)

 

 

14

Trade names

 

 

7,539

 

 

(4,077)

 

 

3,462

 

 

$

118,203

 

$

(106,930)

 

$

11,273

 

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 September 30, 

 

Nine months ended September 30, 

 

    

2017

    

2016

    

2017

    

2016

Service costs

 

$

626

 

$

2,424

 

$

2,685

 

$

5,910

Sales and marketing

 

 

194

 

 

281

 

 

533

 

 

2,178

Product development

 

 

294

 

 

247

 

 

809

 

 

740

General and administrative

 

 

199

 

 

148

 

 

520

 

 

418

Total amortization

 

$

1,313

 

$

3,100

 

$

4,547

 

$

9,246

Service costs include accelerated amortization charges of less than $0.1 million and $1.2 million for the three months ended September 30, 2017 and 2016, respectively, and $0.7 million and $1.7 million for the nine months ended September 30, 2017 and 2016, respectively, as a result of removing certain assets from service.

5. Other Assets

 

As of September 30, 2017 and 2016, we had cash collateralizing a standby letter of credit associated with the lease of our headquarters office of approximately $0.8 million and $1.0 million, respectively, included in long-term assets.

6. Accrued Expenses and Other Liabilities

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

 

 

 

 

 

 

 

 

 

 

September 30, 

 

December 31, 

 

    

2017

 

2016

Accrued payroll and related items

 

$

3,701

 

$

4,239

Artist payables

 

 

4,114

 

 

3,982

Accrued product costs

 

 

1,158

 

 

1,566

Accrued marketing

 

 

1,375

 

 

1,456

Contingent liabilities

 

 

1,071

 

 

 —

Other

 

 

3,345

 

 

3,774

Accrued expenses and other current liabilities

 

$

14,764

 

$

15,017


10

 


 

Other long-term liabilities consisted of the following (in thousands):

 

 

 

 

 

 

 

 

 

September 30, 

 

December 31, 

 

    

2017

 

2016

Accrued rent

 

$

1,415

 

$

1,503

Contingent liabilities

 

 

1,821

 

 

 —

Other

 

 

86

 

 

243

Other liabilities

 

$

3,322

 

$

1,746

As part of the acquisition of Deny Designs, as described in Note 11, contingent consideration of up to $3.6 million is payable annually in three equal installments on the first through third anniversary of the closing date. The contingent consideration is valued at $2.8 million as of the acquisition date based on time value, discount rate, and the estimated probability of achieving the contingent criteria related to the ongoing development of new products for sale, as specified in the purchase agreement. Such amounts will be adjusted at each subsequent period based on probability of achievement until settlement of such liability. Adjustments to the liability will be recorded to income or expense in our condensed statement of operations. The fair value adjustment to the liability for the three and nine months ended September 30, 2017 was not material. The estimated amount payable upon the first year anniversary is included in accrued expenses and other current liabilities, and estimated amounts payable upon the second and third anniversaries are included in other liabilities in our condensed consolidated balance sheets.

 

During the nine months ended September 30, 2016, we recognized severance costs of $1.7 million in connection with targeted headcount reductions, primarily as a result of actions taken in June 2016 to streamline our content publishing studio and better integrate this business into our broader Media segment. These severance costs related to our Media segment and were recognized in the condensed consolidated statements of operations as follows: $0.7 million in sales and marketing costs, $0.6 million in product development costs, $0.3 million in service costs, and $0.1 million in general and administrative costs. Severance amounts related to these actions were fully paid as of September 30, 2016.

 

 

7. Commitments and Contingencies

Leases

We conduct our operations utilizing leased office facilities in various locations under operating leases, and as of September 30, 2017, these leases have non-cancelable periods ending between February 2018 and October 2021.

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 reviews of the Company and its filings. In evaluating the exposure associated with various tax filing positions, we accrue charges for possible exposures. We believe any adjustments that may ultimately be required as a result of any of these reviews will not be material to our consolidated financial statements.

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 or contractual commitments. These indemnities include intellectual property indemnities to our customers and partners, 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


11

 


 

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

Income tax (expense) benefit for each of the three month periods ended September 30, 2017 and 2016 was less than $0.1 million. Income tax expense for the nine month periods ended September 30, 2017 and 2016 was $0.2 million and less than $0.1 million, respectively.

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. 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.

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 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.

The Company adopted the new accounting guidance that simplifies several aspects of the accounting for share-based payments as of January 1, 2017. The new standard requires income tax benefits and deficiencies to be recognized as income tax expense or benefit in the income statement and the tax effects of exercised or vested awards should be treated as discrete items in the reporting period in which they occur. Upon adoption, the Company recorded approximately $7.3 million of net deferred tax assets related to net operating losses, along with a corresponding valuation allowance as of January 1, 2017, such that there is no net impact to our deferred tax assets or income tax expense. The adoption of the new standard did not have an impact on the consolidated financial statements.

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 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 nine months ended September 30, 2017 or 2016, and we do not expect our uncertain tax position to change materially during the next twelve months.

We file tax returns in the United States, at both the federal and state level, and in several foreign jurisdictions. Due to net operating loss carryforwards, our tax returns are open to examination by the Internal Revenue Service and state jurisdictions for all years since inception.


12

 


 

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 September 30, 

 

Nine months ended September 30, 

 

    

2017

    

2016

    

2017

    

2016

Service costs

 

$

155

 

$

142

 

$

453

 

$

1,054

Sales and marketing

 

 

209

 

 

145

 

 

586

 

 

586

Product development

 

 

475

 

 

290

 

 

1,352

 

 

1,206

General and administrative

 

 

1,343

 

 

1,103

 

 

4,035

 

 

3,272

Total stock-based compensation

 

$

2,182

 

$

1,680

 

$

6,426

 

$

6,118

Award Activity

Stock Options

Stock option activity is as follows (in thousands):

 

 

 

 

 

Number of

 

    

options

 

 

outstanding

Outstanding at December 31, 2016

 

2,856

Options granted

 

37

Options exercised

 

(315)

Options forfeited or cancelled

 

(300)

Outstanding at September 30, 2017

 

2,278

Restricted Stock Units

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

 

 

 

 

 

Number of

 

    

shares

Unvested at December 31, 2016

 

1,941

Granted

 

1,492

Vested

 

(882)

Forfeited

 

(478)

Unvested at September 30, 2017

 

2,073

 

 


13

 


 

10. Stockholders’ Equity

Stock Repurchases

Under our stock repurchase plan, as amended in February 2012, we are authorized to repurchase up to $50.0 million of our common stock from time to time. During the year ended December 31, 2016, we re-initiated purchases of our common stock under the stock repurchase plan and repurchased approximately 844,000 shares at an average price of $5.74 per share for an aggregate amount of approximately $4.9 million. Repurchases of approximately 10,000 shares were initiated in the fourth quarter of 2016 but settled in the first quarter of 2017 for an aggregate amount of less than $0.1 million. We have not initiated any repurchases of our common stock during the nine months ended September 30, 2017 and are not currently making repurchases. As of September 30, 2017, approximately $14.3 million remained available under the repurchase plan, and we may continue to make stock repurchases from time to time in the future. The timing and actual number of shares repurchased will depend on various factors including price, corporate and regulatory requirements, alternative investment opportunities and other market conditions.

Shares repurchased by us are accounted for when the transaction is settled. As of September 30, 2017, 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.

11. Acquisitions and Dispositions

Acquisitions

Nine months ended September 30, 2017

On May 1, 2017, we completed the acquisition of certain assets and the assumption of certain liabilities of Deny Designs, a print-on-demand home décor brand with in-house manufacturing capacity, and both wholesale and direct-to-consumer channels, for total consideration of $12.0 million. The purchase price consists of cash of approximately $6.7 million paid at closing, approximately 215,000 shares of Leaf Group common stock valued at approximately $1.7 million issued in a private placement, and contingent consideration of $3.6 million, payable annually in three equal installments on the first through third anniversary of the closing date, subject to reduction in certain circumstances. A portion of the contingent consideration will secure post-closing indemnification obligations of the seller and/or post-closing working capital adjustments to the purchase price. The business will operate as a part of our Marketplaces segment, complementing our Society6 business.

The total fair value of the purchase price for the acquisition including cash paid at closing, fair value of common stock issued and contingent consideration approximated $11.2 million and was allocated to Deny Designs’ tangible and intangible assets acquired and liabilities assumed, based on their estimated fair values as of May 1, 2017, the closing date of the acquisition. The excess of the purchase price over the net assets and liabilities acquired was recorded as goodwill. The acquisition is included in our condensed consolidated financial statements as of the closing date of the acquisition, which was May 1, 2017. During the three months ended September 30, 2017, the valuation of the fair value of tangible and intangible assets acquired and liabilities assumed was finalized. The resulting adjustments recorded to the provisional fair value amounts was not material for the three months ended September 30, 2017 and has been reflected in the condensed consolidated financial statements.

 

The following table summarizes the allocation of the purchase price for Deny Designs (in thousands):

 

 

 

 

 

Goodwill

    

$

5,906

Trademark

 

 

2,300

Customer relationships

 

 

1,400

Artist relationships

 

 

300

Technology

 

 

550

Other assets and liabilities assumed

 

 

705

Total

 

$

11,161

 

The trademark, customer relationships, artist relationships, and technology we acquired have estimated useful lives of ten years, five years, three years, and three years, respectively. The estimated weighted average useful life of the intangible assets we acquired in total is


14

 


 

seven years. Goodwill is primarily derived from our ability to generate synergies with Deny Designs’ products and services with our other marketplaces. The goodwill will be included as part of our marketplaces reporting unit and is expected to be deductible for tax purposes.

 

Contingent consideration is valued at $2.8 million as of the acquisition date based on time value, discount rate, and the estimated probability of achieving the contingent criteria related to the ongoing development of new products for sale, as specified in the purchase agreement. The minimum and maximum amount payable for each of the three years is $0.3 million and $1.2 million, respectively. Such amounts will be adjusted at each subsequent period based on probability of achievement until settlement of such liability. Adjustments to the liability will be recorded to income or expense in our condensed statement of operations. The contingent consideration liability is included in accrued expenses and other long-term liabilities in our condensed consolidated balance sheets.

 

Supplemental Pro forma Information (unaudited)

 

Supplemental information on an unaudited pro forma basis, as if the acquisition had been consummated as of January 1, 2016, is as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended September 30, 

 

Nine months ended September 30, 

 

 

2017

    

2016

    

2017

    

2016

Revenue

 

$

33,460

 

$

30,527

 

$

91,845

 

$

85,637