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EX-32.2 - EX-32.2 - LEAF GROUP LTD.lfgr-20180630ex322897b27.htm
EX-32.1 - EX-32.1 - LEAF GROUP LTD.lfgr-20180630ex3211f959c.htm
EX-31.2 - EX-31.2 - LEAF GROUP LTD.lfgr-20180630ex312635bcf.htm
EX-31.1 - EX-31.1 - LEAF GROUP LTD.lfgr-20180630ex31160bb6c.htm
EX-2.1 - EX-2.1 - LEAF GROUP LTD.lfgr-20180630ex2177536e0.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 June 30, 2018

 

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 July 25, 2018, there were 25,026,664 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

  

20

 

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

  

35

 

Item 4.

  

Controls and Procedures

  

36

 

 

 

 

Part II 

Other Information

 

 

 

Item 1.

  

Legal Proceedings

  

37

 

Item 1A.

  

Risk Factors

  

37

 

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

  

37

 

Item 3.

  

Defaults Upon Senior Securities

  

37

 

Item 4.

  

Mine Safety Disclosures

  

37

 

Item 5.

  

Other Information

  

37

 

Item 6.

  

Exhibits

  

37

 

 

  

Signatures

  

39

 

 

 


 

Part I.       FINANCIAL INFORMATION

 

Item 1.      CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)  

Leaf Group Ltd. and Subsidiaries 

Condensed Consolidated Balance Sheets  

(In thousands)

(Unaudited)

 

 

 

 

 

 

 

 

 

    

June 30, 

    

December 31, 

 

 

2018

 

2017

Assets

 

 

 

 

 

 

Current assets

 

 

 

 

 

 

Cash and cash equivalents

 

$

31,952

 

$

31,344

Accounts receivable, net

 

 

11,234

 

 

8,663

Prepaid expenses and other current assets

 

 

3,011

 

 

2,741

Total current assets

 

 

46,197

 

 

42,748

Property and equipment, net

 

 

12,451

 

 

11,665

Intangible assets, net

 

 

8,470

 

 

10,431

Goodwill

 

 

27,028

 

 

17,152

Other assets

 

 

1,181

 

 

1,246

Total assets

 

$

95,327

 

$

83,242

 

 

 

 

 

 

 

Liabilities and Stockholders' Equity

 

 

 

 

 

 

Current liabilities

 

 

 

 

 

 

Accounts payable

 

$

1,468

 

$

1,980

Accrued expenses and other current liabilities

 

 

15,675

 

 

17,182

Deferred revenue

 

 

2,623

 

 

2,064

Total current liabilities

 

 

19,766

 

 

21,226

Deferred tax liability

 

 

51

 

 

40

Other liabilities

 

 

2,353

 

 

3,456

Total liabilities

 

 

22,170

 

 

24,722

Commitments and contingencies (Note 7)

 

 

 

 

 

 

Stockholders’ equity

 

 

 

 

 

 

Common stock, $0.0001 par value. Authorized 100,000 shares; 26,635 and 24,980 shares issued and outstanding at June 30, 2018 and 22,686 and 21,031 shares issued and outstanding at December 31, 2017

 

 

 2

 

 

 2

Additional paid-in capital

 

 

549,895

 

 

523,012

Treasury stock at cost, 1,655 shares at June 30, 2018 and December 31, 2017

 

 

(35,706)

 

 

(35,706)

Accumulated other comprehensive income (loss)

 

 

(45)

 

 

(17)

Accumulated deficit

 

 

(440,989)

 

 

(428,771)

Total stockholders’ equity

 

 

73,157

 

 

58,520

Total liabilities and stockholders’ equity

 

$

95,327

 

$

83,242

 

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 June 30, 

 

Six months ended June 30, 

 

 

    

2018

    

2017

    

2018

    

2017

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

Product revenue

 

$

17,192

 

$

15,349

 

$

35,644

 

$

29,933

 

Service revenue

 

 

17,129

 

 

13,216

 

 

32,424

 

 

25,870

 

Total revenue

 

 

34,321

 

 

28,565

 

 

68,068

 

 

55,803

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

 

12,464

 

 

11,538

 

 

25,801

 

 

22,072

 

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

 

 

6,561

 

 

5,098

 

 

12,848

 

 

10,888

 

Sales and marketing

 

 

7,859

 

 

7,196

 

 

14,848

 

 

13,920

 

Product development

 

 

5,095

 

 

5,029

 

 

9,805

 

 

9,779

 

General and administrative

 

 

7,661

 

 

7,225

 

 

14,969

 

 

14,878

 

Amortization of intangible assets

 

 

956

 

 

1,396

 

 

1,982

 

 

3,233

 

Total operating expenses

 

 

40,596

 

 

37,482

 

 

80,253

 

 

74,770

 

Loss from operations

 

 

(6,275)

 

 

(8,917)

 

 

(12,185)

 

 

(18,967)

 

Interest income

 

 

30

 

 

39

 

 

48

 

 

82

 

Interest expense

 

 

(1)

 

 

(1)

 

 

(2)

 

 

(3)

 

Other (expense) income, net

 

 

(25)

 

 

(6)

 

 

(33)

 

 

(3)

 

Loss before income taxes

 

 

(6,271)

 

 

(8,885)

 

 

(12,172)

 

 

(18,891)

 

Income tax expense

 

 

(22)

 

 

(80)

 

 

(46)

 

 

(92)

 

Net loss

 

$

(6,293)

 

$

(8,965)

 

$

(12,218)

 

$

(18,983)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss per share - basic and diluted

 

$

(0.25)

 

$

(0.44)

 

 

(0.51)

 

 

(0.94)

 

Weighted average number of shares - basic and diluted

 

 

24,854

 

 

20,392

 

 

23,910

 

 

20,169

 

 

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 June 30, 

 

Six months ended June 30, 

 

    

2018

    

2017

    

2018

    

2017

Net loss

 

$

(6,293)

 

$

(8,965)

 

$

(12,218)

 

$

(18,983)

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

Change in foreign currency translation adjustment

 

 

(80)

 

 

45

 

 

(28)

 

 

59

Comprehensive loss

 

$

(6,373)

 

$

(8,920)

 

$

(12,246)

 

$

(18,924)

 

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, 2017

 

21,031

 

$

 2

 

$

523,012

 

$

(35,706)

 

$

(17)

 

$

(428,771)

 

$

58,520

 

Issuance of stock under employee stock awards and other

 

576

 

 

 —

 

 

629

 

 

 —

 

 

 —

 

 

 —

 

 

629

 

Tax withholdings related to vesting of share-based payments

 

 —

 

 

 —

 

 

(2,268)

 

 

 —

 

 

 —

 

 

 —

 

 

(2,268)

 

Stock-based compensation expense

 

 —

 

 

 —

 

 

5,155

 

 

 —

 

 

 —

 

 

 —

 

 

5,155

 

Issuance of common stock in connection with follow-on public offering, net of offering costs

 

3,373

 

 

 —

 

 

23,367

 

 

 —

 

 

 —

 

 

 —

 

 

23,367

 

Foreign currency translation adjustment

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(28)

 

 

 —

 

 

(28)

 

Net loss

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(12,218)

 

 

(12,218)

 

Balance at June 30, 2018

 

24,980

 

$

 2

 

$

549,895

 

$

(35,706)

 

$

(45)

 

$

(440,989)

 

$

73,157

 

 

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)

 

 

 

 

 

 

 

 

 

 

Six months ended June 30, 

 

 

    

2018

    

2017

 

Cash flows from operating activities

 

 

 

 

 

 

 

Net loss

 

$

(12,218)

 

$

(18,983)

 

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

 

 

 

 

 

 

 

Depreciation and amortization

 

 

4,901

 

 

6,066

 

Deferred income taxes

 

 

10

 

 

 9

 

Stock-based compensation

 

 

4,884

 

 

4,244

 

Other

 

 

54

 

 

(48)

 

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

 

 

 

 

 

 

 

Accounts receivable, net

 

 

 4

 

 

415

 

Prepaid expenses and other current assets

 

 

21

 

 

1,215

 

Other long-term assets

 

 

79

 

 

(32)

 

Accounts payable

 

 

(883)

 

 

(1,200)

 

Accrued expenses and other liabilities

 

 

(2,679)

 

 

(3,019)

 

Deferred revenue

 

 

(574)

 

 

(450)

 

Net cash used in operating activities

 

 

(6,401)

 

 

(11,783)

 

Cash flows from investing activities

 

 

 

 

 

 

 

Purchases of property and equipment

 

 

(3,501)

 

 

(2,238)

 

Purchases of intangible assets

 

 

(29)

 

 

(121)

 

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

 

 

 —

 

 

385

 

Cash paid for acquisitions, net of cash acquired

 

 

(10,349)

 

 

(6,304)

 

Restricted deposits

 

 

 —

 

 

606

 

Other

 

 

 —

 

 

 3

 

Net cash used in investing activities

 

 

(13,879)

 

 

(7,669)

 

Cash flows from financing activities

 

 

 

 

 

 

 

Proceeds from exercises of stock options and purchases under ESPP

 

 

629

 

 

1,525

 

Repurchases of common stock

 

 

 —

 

 

(65)

 

Proceeds from issuance of common stock

 

 

23,367

 

 

 —

 

Taxes paid on net share settlements of restricted stock units

 

 

(2,268)

 

 

(2,367)

 

Cash paid for acquisition holdback

 

 

 —

 

 

(119)

 

Cash paid for contingent consideration liability

 

 

(905)

 

 

 —

 

Other

 

 

(34)

 

 

(32)

 

Net cash provided by (used in) financing activities

 

 

20,789

 

 

(1,058)

 

Effect of foreign currency on cash, cash equivalents and restricted cash

 

 

(3)

 

 

(21)

 

Change in cash, cash equivalents and restricted cash

 

 

506

 

 

(20,531)

 

Cash, cash equivalents and restricted cash, beginning of period

 

 

32,300

 

 

51,957

 

Cash, cash equivalents and restricted cash, end of period

 

$

32,806

 

$

31,426

 

 

 

 

 

 

 

 

 

Reconciliation of cash, cash equivalents and restricted cash

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

31,952

 

$

30,470

 

Restricted cash included in other current assets

 

 

136

 

 

136

 

Restricted cash included in other long-term assets

 

 

718

 

 

820

 

Total cash, cash equivalents and restricted cash shown in the statement of cash flows

 

$

32,806

 

$

31,426

 

 

 

 

 

 

 

 

 

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 consumer internet company that builds enduring, creator-driven brands that reach passionate audiences in large and growing lifestyle categories, including art and design, fitness and wellness, and home and décor, amongst others.

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 and designers can market and sell their original art and designs printed on a wide variety of products. Our made-to-order marketplaces, consisting of our Society6.com (“Society6”) and Deny Designs brands, provide artists and designers with an online commerce platform to feature and sell their original art and designs on an array of consumer products primarily in the home décor category. Our fine art marketplace, Saatchi Art, inclusive of SaatchiArt.com and its art fair event brand, The Other Art Fair (collectively, “Saatchi Art”), is a leading fine art marketplace where a global community of artists exhibit and sell their original artwork directly to consumers through a curated online gallery or in-person at art fairs hosted in the United Kingdom, Australia, and the United States. Saatchi Art’s online art gallery features a wide selection of original paintings, drawings, sculptures and photography.  

Media

Our Media segment includes our leading owned and operated media properties that publish content, including videos, articles and other content formats, on various category-specific properties with distinct editorial voices. Our media properties include Livestrong.com, a fitness, health and wellness destination; Hunker, a home and space inspiration destination; Cuteness.com, an online community for pet owners and animal lovers; and over 50 other media properties focused on specific categories or interests that we either own and operate or host and operate for our partners. In addition, our portfolio of media properties includes Well+Good, a leading wellness destination and brand, which we acquired in June 2018. Well+Good will operate together with our Livestrong.com media property in the fitness and wellness category.

2. Basis of Presentation

The accompanying interim condensed consolidated balance sheet as of June 30, 2018, the condensed consolidated statements of operations and condensed consolidated statements of comprehensive (loss) income for the three and six months ended June 30, 2018 and 2017, the condensed consolidated statements of cash flows for the six months ended June 30, 2018 and 2017 and the condensed consolidated statement of stockholders’ equity for the six months ended June 30, 2018 are unaudited.

In the opinion of management, the unaudited interim condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and include all adjustments, which include only normal recurring adjustments, necessary for the fair statement of our statement of financial position as of June 30, 2018, our results of operations for the three and six months ended June 30, 2018 and 2017, and our cash flows for the six months ended June 30, 2018 and 2017. The results for the three and six months ended June 30, 2018 are not necessarily indicative of the results expected for the full year. The consolidated balance sheet as of December 31, 2017 has been derived from our audited financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2017.

The interim unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”), 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, 2017 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 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 ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which supersedes 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 new revenue standard may be applied retrospectively to each prior period presented or modified retrospectively with the cumulative effect recognized as of the date of adoption. The Company adopted the guidance in the first quarter of fiscal year 2018 using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. The cumulative impact of adopting Topic 606 was immaterial and no adjustments to the opening balance of retained earnings were recorded. There was no impact to revenues for the three and six months ended June 30, 2018 as a result of applying Topic 606.

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 for certain practical expedients. Early adoption is permitted. The Company expects that substantially all of its operating lease commitments with terms greater than 12 months will be subject to the new guidance and will be recognized as operating lease liabilities and right-of-use assets upon adoption. The Company is currently continuing to evaluate and quantify the impact of the new leases standard on the Company’s consolidated financial statements and anticipates the adoption of ASU 2016-02 will have a material impact on the consolidated balance sheets. The Company does not expect the adoption of this standard to have a material impact on the recognition, measurement or presentation of lease expenses within the Company’s consolidated statements of operations or cash flows.

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. The Company adopted the guidance in the first quarter of fiscal year 2018. The guidance did not have a material impact on the Company’s consolidated financial statements.

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. The Company adopted the guidance in the first quarter of fiscal year 2018. ASU 2016-18 has been adopted using a retrospective transition method to each period presented. As of June 30, 2018 and 2017, the Company has a restricted


7

 


 

cash balance of $0.9 million and $1.0 million, respectively, collateralizing a standby letter of credit associated with the lease of the headquarters office. Beginning in the first quarter of fiscal year 2018, the presentation of the beginning and ending amounts of cash on the Company’s statement of cash flows includes the restricted cash for each period presented.

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. The Company adopted the guidance in the first quarter of fiscal year 2018. The guidance did not have a material impact to the Company’s consolidated financial statements.

In February 2018, the FASB issued ASU No. 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income (Subtopic 220), which permits a reclassification from accumulated other comprehensive income (loss) to retained earnings of the stranded tax effects resulting from application of the new corporate tax rate of 21% enacted in the Tax Cuts and Jobs Act. ASU 2018-02 is effective for interim and annual periods beginning after December 15, 2018, and early adoption is permitted. The Company is currently evaluating the impact of this standard on the consolidated financial statements, however the adoption of this standard is not expected to have a material impact on the consolidated financial statements.

 

3. Revenue Recognition

Adoption of ASC Topic 606, Revenue from Contracts with Customers

 

On January 1, 2018, we adopted Topic 606, Revenue from Contracts with Customers, using the modified retrospective method applied to those contracts that were not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts are not adjusted and continue to be reported in accordance with our historic accounting under Topic 605.

 

The cumulative impact of adopting Topic 606 was immaterial and no adjustments to the opening balance of retained earnings were recorded. There was no impact to revenues for the three and six months ended June 30, 2018 as a result of applying Topic 606.

Revenue

 

Revenues are recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services.

Our contracts with customers may include multiple performance obligations. For such arrangements, we allocate the transaction price to each performance obligation based on the estimated standalone selling prices of the promised good or service. We allocate any arrangement fee or other incentive or promotional offers to each of the elements based on their relative selling prices.  

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

Product Revenue

Marketplaces

We recognize product revenue from sales of products when we transfer control of promised goods to our customers in an amount that reflects the consideration to which we expect to be entitled to in exchange for those goods. In determining the amount of consideration we expect to be entitled to, we take into account sales allowances, estimated returns based on historical experience and any incentive offers periodically provided to customers to encourage purchases, including percentage discounts off current purchases, free shipping and promotional other offers. Product revenue is recorded at the gross amount due to the following factors: we are the principal in a transaction and obtain control of the goods before they are transferred to the customer. Value-added taxes (“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.  


8

 


 

Service Revenue

Marketplaces

We generate Marketplaces service revenue from commissions we receive from facilitating the sale of original art by artists to customers through Saatchi Art. We also generate Marketplaces service revenue from various sources relating to Saatchi Art’s The Other Art Fair, including commissions from the sale of original art, fees paid by artists for stands at the fairs and sponsorship opportunities and generally recognize fair related service revenue upon completion of each fair. We recognize service revenue arising from the sale of original art net of amounts paid to the artist because we are not the principal in the transaction and we do not obtain control over the original art. Revenue is recognized when we transfer control of the promised service, which is after the original art has been delivered and the return period has expired. We periodically provide incentive offers to Saatchi Art customers to encourage purchases, including percentage discounts off current purchases, free shipping and other promotional offers. 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.

Media

Advertising Revenue. We generate Media service revenue primarily from advertisements displayed on our online media properties and on certain webpages of our partners’ media 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 display advertisements, where revenue is dependent upon the number of advertising impressions delivered; performance-based cost-per-click advertising, in which an advertiser pays only when a visitor clicks on an advertisement; sponsored content; or advertising links. Performance obligations pursuant to our advertising revenue arrangements typically include a minimum number of impressions or the satisfaction of other performance criteria. Revenue from performance-based arrangements is recognized as the related performance criteria are met. We assess whether performance criteria have been met based on a reconciliation of the performance criteria. The reconciliation of the performance criteria generally includes a comparison of third party performance data to the contractual performance obligation and to internal or partner performance data in circumstances where that data is available. 

Where we enter into revenue-sharing arrangements with our partners, such as those relating to our advertiser network, we report revenue on a gross or net basis depending on whether we are considered the principal in the transaction. In addition, we consider which party controls the service, including which party is primarily responsible for fulfilling the promise to provide the service. We also consider which party has the latitude to establish the sales prices to advertisers. When we are considered the principal, we report the underlying revenue on a gross basis in our consolidated statements of operations, and record these revenue-sharing payments to our partners in service costs.

 

Content Sales and Licensing Revenue. We generate revenue from the sale or license of media content, including the creation and distribution of content for third party brands and publishers through our content studio. Revenue from the sale or perpetual license of media content is recognized when the control of content is transferred or when the right to use is transferred 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 the right to access 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 principal, we recognize revenue on a net basis.

 

Disaggregation of Revenue

 

The following table presents our revenues disaggregated by revenue source (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended June 30, 

 

Six months ended June 30, 

 

 

2018

    

2017

    

2018

    

2017

Product

 

 

 

 

 

 

 

 

 

 

 

 

Marketplaces

 

$

17,192

 

$

15,349

 

$

35,644

 

$

29,933

Service

 

 

 

 

 

 

 

 

 

 

 

 

Marketplaces

 

 

2,463

 

 

2,342

 

 

4,978

 

 

3,635

Media

 

 

14,666

 

 

10,874

 

 

27,446

 

 

22,235

Total revenue

 

$

34,321

 

$

28,565

 

$

68,068

 

$

55,803

 


9

 


 

Deferred Revenue

Deferred revenue consists of amounts received from or invoiced to customers in advance of our performance obligations being satisfied, including amounts which are refundable. Deferred revenue includes payments received from sales of our products on Society6 and Deny Designs prior to the transfer of control of such products to the customers; payments made for original art sold via Saatchi Art that are collected prior to the completion of the return period upon which our service is considered completed; and amounts billed to media customers prior to delivery of content; and sales of subscriptions for premium content or services not yet delivered. During the six months ended June 30, 2018, we recognized $1.9 million of revenues that were included in the deferred revenue balance as of December 31, 2017.

Our payment terms vary by the type and location of our customer and the products or services offered. The term between invoicing and when payment is due is not significant. For certain products or services, we require payment before the products or services are delivered to the customer. 

 

Practical Expedients and Exemptions

 

We generally expense sales commissions when incurred because the amortization period would have been one year or less. These costs are recorded within sales and marketing expenses. We do not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed. We do not capitalize costs incurred to fulfill a contract when the contract term is one year or less.

4. Property and Equipment

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

 

 

 

 

 

 

 

 

    

June 30, 

    

December 31, 

 

 

2018

 

2017

Computers and other related equipment

 

$

9,772

 

$

9,106

Purchased and internally developed software

 

 

27,641

 

 

26,319

Furniture and fixtures

 

 

1,466

 

 

1,503

Leasehold improvements

 

 

6,795

 

 

6,784

Machinery and related equipment

 

 

626

 

 

581

 

 

 

46,300

 

 

44,293

Less accumulated depreciation

 

 

(33,849)

 

 

(32,628)

Property and equipment, net

 

$

12,451

 

$

11,665

 

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 and six months ended June 30, 2018 and 2017, is shown by classification below (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended June 30, 

 

Six months ended June 30, 

 

    

2018

    

2017

    

2018

    

2017

Product costs

 

$

213

 

$

19

 

$

395

 

$

19

Service costs

 

 

737

 

 

702

 

 

1,391

 

 

1,445

Sales and marketing

 

 

 8

 

 

 9

 

 

16

 

 

18

Product development

 

 

18

 

 

23

 

 

38

 

 

46

General and administrative

 

 

514

 

 

650

 

 

1,079

 

 

1,305

Total depreciation

 

$

1,490

 

$

1,403

 

$

2,919

 

$

2,833

 


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5. Goodwill and Intangible Assets

 

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

 

 

 

 

 

Balance at December 31, 2017

    

$

17,152

Acquisition - preliminary allocation

 

 

9,895

Foreign currency impact

 

 

(19)

Balance at June 30, 2018

 

$

27,028

As of June 30, 2018, we have two reporting units, marketplaces and media. Goodwill related to our marketplaces reporting unit was $17.1 million as of June 30, 2018. In June 2018, we preliminarily recorded $9.9 million in goodwill in connection with the acquisition of Well+Good. The goodwill will be included in our media reporting unit. Refer to Note 11 for additional information.

Intangible assets consisted of the following (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2018

 

 

Gross carrying

 

Accumulated

 

Net carrying

 

 

amount

 

amortization

 

amount

Customer relationships

 

$

2,853

 

$

(1,768)

 

$

1,085

Artist relationships

 

 

12,230

 

 

(10,835)

 

 

1,395

Media content

 

 

91,472

 

 

(90,848)

 

 

624

Technology

 

 

6,204

 

 

(5,335)

 

 

869

Non-compete agreements

 

 

25

 

 

(24)

 

 

 1

Trade names

 

 

9,877

 

 

(5,381)

 

 

4,496

 

 

$

122,661

 

$

(114,191)

 

$

8,470

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2017

 

 

Gross carrying

 

Accumulated

 

Net carrying

 

 

amount

 

amortization

 

amount

Customer relationships

 

$

2,853

 

$

(1,628)

 

$

1,225

Artist relationships

 

 

12,235

 

 

(10,659)

 

 

1,576

Media content

 

 

91,445

 

 

(90,187)

 

 

1,258

Technology

 

 

6,204

 

 

(4,751)

 

 

1,453

Non-compete agreements

 

 

25

 

 

(20)

 

 

 5

Trade names

 

 

9,889

 

 

(4,975)

 

 

4,914

 

 

$

122,651

 

$

(112,220)

 

$

10,431

 

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

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended June 30, 

 

Six months ended June 30, 

 

    

2018

    

2017

    

2018

    

2017

Service costs

 

$

300

 

$

755

 

$

669

 

$

2,058

Sales and marketing

 

 

159

 

 

196

 

 

319

 

 

339

Product development

 

 

293

 

 

268

 

 

585

 

 

515

General and administrative

 

 

204

 

 

177

 

 

409

 

 

321

Total amortization

 

$

956

 

$

1,396

 

$

1,982

 

$

3,233

Service costs include accelerated amortization charges of less than $0.1 million and $0.1 million for the three months ended June 30, 2018 and 2017, respectively, and less than $0.1 million and $0.6 million for the six months ended June 30, 2018 and 2017, respectively, as a result of removing certain assets from service.


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6. Accrued Expenses and Other Liabilities

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

 

 

 

 

 

 

 

 

 

 

June 30, 

 

December 31, 

 

    

2018

 

2017

Accrued payroll and related items

 

$

3,655

 

$

4,252

Artist payables

 

 

3,748

 

 

4,999

Accrued product costs

 

 

1,072

 

 

1,914

Accrued marketing

 

 

1,499

 

 

1,301

Contingent liabilities

 

 

1,038

 

 

1,176

Other

 

 

4,663

 

 

3,540

Accrued expenses and other current liabilities

 

$

15,675

 

$

17,182

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

 

 

 

 

 

 

 

 

 

June 30, 

 

December 31, 

 

    

2018

 

2017

Accrued rent

 

$

1,383

 

$

1,443

Contingent liabilities

 

 

936

 

 

1,944

Other

 

 

34

 

 

69

Other liabilities

 

$

2,353

 

$

3,456

As part of the acquisition of Deny Designs in May 2017, contingent consideration of up to $3.6 million is payable to the seller annually in three equal installments on the first through third anniversary of the closing date. The contingent consideration was 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 are adjusted at each subsequent period based on probability of achievement until settlement of such liability. Adjustments to the liability are recorded to income or expense in our condensed consolidated statement of operations. The fair value adjustment to the liability for the three and six months ended June 30, 2018 was not material. In May 2018, the first installment of the contingent consideration, net of post-closing working capital adjustments to the purchase price, was paid to the seller in the amount of $1.1 million. The estimated amount payable upon the second year anniversary is included in accrued expenses and other current liabilities, and estimated amounts payable upon the third anniversary is included in other liabilities in our condensed consolidated balance sheets.

 

 

7. Commitments and Contingencies

Leases

We conduct our operations utilizing leased office facilities in various locations under operating leases and, as of June 30, 2018, these leases have non-cancelable periods ending between June 2018 and July 2024. The lease for our Santa Monica facility expires in July 2024, subject to a one-time early termination right allowing us to terminate the lease effective as of August 2019.

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.


12

 


 

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 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 for each of the three and six month periods ended June 30, 2018 and 2017 was less than $0.1 million.

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 a portion of the deferred tax assets. However, the reversal of deferred tax liabilities associated with tax deductible goodwill can be a source of taxable income to support the realization of a deductible temporary difference that is scheduled to reverse into net operating losses with an unlimited carryforward period. 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 records the income tax benefits and deficiencies related to share-based payments as income tax expense or benefit in the consolidated income statements and the tax effects of exercised or vested awards as discrete items in the reporting period in which they occur. Income tax benefits and deficiencies are recognized as income tax expense or benefit in the income statement and the tax effects of exercised or vested awards are treated as discrete items in the reporting period in which they occur.

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 six months ended June 30, 2018 or 2017, 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.


13

 


 

On December 22, 2017, the Tax Cuts and Jobs Act (the “2017 Act”) was enacted into law. The 2017 Act will have pervasive financial reporting implications for all companies with U.S. operations. Changes include, but are not limited to, a federal corporate tax rate decrease from 35% to 21%, effective for tax years beginning after December 31, 2017, the transition of U.S. international taxation from a worldwide tax system to a territorial system, additional limitations on executive compensation and a one-time transition tax on the mandatory deemed repatriation of cumulative foreign earnings. 

 

On December 22, 2017, Staff Accounting Bulletin No. 118, or SAB 118, was issued to address the application of GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the 2017 Act. During the measurement period, impacts of the law are expected to be recorded at the time a reasonable estimate for all or a portion of the effects can be made, and provisional amounts can be recognized and adjusted as information becomes available, prepared, or analyzed. Any subsequent adjustment to these amounts will be recorded to current tax expense in 2018 when the analysis is complete.

 

The enactment of the 2017 Act requires the remeasurement of deferred taxes at the new corporation tax rate of 21%, for which we have recorded a provisional amount that reduces the net deferred tax assets, before valuation allowance, by $38.4 million. Due to a full valuation allowance, the change in deferred taxes was fully offset by the change in valuation allowance. We do not expect the amount related to the one-time transition tax on the mandatory deemed repatriation of foreign earnings to be material based on cumulative foreign deficits from our foreign subsidiaries. We expect to finalize our analysis by the end of 2018.  

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 June 30, 

 

Six months ended June 30, 

 

    

2018

    

2017

    

2018

    

2017

Service costs

 

$

177

 

$

143

 

$

326

 

$

298

Sales and marketing

 

 

258

 

 

176

 

 

468

 

 

377

Product development

 

 

651