10-K 1 lfgr-20171231x10k.htm 10-K lfgr_Current Folio_10K

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


FORM 10-K

 


 (Mark One)

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

For the fiscal year ended December 31, 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 Number)

 

 

 

1655 26th Street

Santa Monica, CA

 

90404

(Address of principal executive offices)

 

(Zip Code)

 

(310) 656-6253

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

 

 

 

 

Title of each class

 

Name of each exchange on which registered

Common Stock, $0.0001 par value

 

The New York Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act:   None.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐    No ☒ 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ☐    No ☒ 

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☒ 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or emerging growth company. See definitions of “large accelerated filer,” “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 June 30, 2017, the aggregate market value of the registrant’s common stock, $0.0001 par value, held by non-affiliates of the registrant was approximately $95.2 million (based upon the closing sale price of the common stock on that date on the New York Stock Exchange).

As of February 22, 2018, there were 24,461,965 shares of the common stock, $0.0001 par value, outstanding.

Documents Incorporated by Reference
Part III of this Annual Report on Form 10-K incorporates by reference portions of the registrant’s Proxy Statement for its 2018 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission within 120 days after the end of the fiscal year to which this report relates.



 

LEAF GROUP LTD.

INDEX TO FORM 10-K

 

 

 

 

 

 

 

    

    

    

Page

PART I. 

 

 

 

 

 

 

 

Item 1 

    

Business

 

1

Item 1A 

 

Risk Factors

 

7

Item 1B 

 

Unresolved Staff Comments

 

26

Item 2 

 

Properties

 

26

Item 3 

 

Legal Proceedings

 

26

Item 4 

 

Mine Safety Disclosures

 

27

 

 

 

 

 

PART II. 

 

 

 

 

 

 

 

Item 5 

 

Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

28

Item 6 

 

Selected Financial Data

 

30

Item 7 

 

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

 

33

Item 7A 

 

Quantitative and Qualitative Disclosures About Market Risk

 

54

Item 8 

 

Financial Statements and Supplementary Data

 

55

Item 9 

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

55

Item 9A 

 

Controls and Procedures

 

55

Item 9B 

 

Other Information

 

56

 

 

 

 

 

PART III. 

 

 

 

 

 

 

 

Item 10 

 

Directors, Executive Officers and Corporate Governance

 

56

Item 11 

 

Executive Compensation

 

57

Item 12 

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

57

Item 13 

 

Certain Relationships and Related Transactions, and Director Independence

 

57

Item 14 

 

Principal Accounting Fees and Services

 

57

 

 

 

 

 

PART IV. 

 

 

 

 

 

 

 

Item 15 

 

Exhibits, Financial Statement Schedules

 

58

Item 16 

 

Form 10-K Summary

 

58

 

 

 

 

 

SIGNATURES 

 

61

 

 

 



 

 

SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical facts contained in this Annual Report on Form 10-K, including statements regarding our future results of operations and financial position, business strategy and plans and our objectives for future operations, are forward-looking statements. The words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect,” “predict,” “plan” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements are so identified. You should not rely upon forward-looking statements as guarantees of future performance. We have based these forward-looking statements largely on our current estimates of our financial results and our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in Item 1A. under the heading entitled “Risk Factors.” Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this Annual Report on Form 10-K may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements. We undertake no obligation to revise or update any forward-looking statements for any reason after the date of this Annual Report on Form 10-K, except as required by law.

You should read this Annual Report on Form 10-K and the documents that we reference in this Annual Report on Form 10-K and have filed with the Securities and Exchange Commission (the “SEC”) with the understanding that our actual future results, levels of activity, performance and events and circumstances may be materially different from what we currently expect.

 

 



 

PART I

 

Item 1. Business

As used herein, “Leaf Group,” the “Company,” “our,” “we,” “us” and similar terms include Leaf Group Ltd. and its subsidiaries, unless the context indicates otherwise.

“Leaf Group” and other trademarks of ours appearing in this report, such as “Society6”, “Deny Designs”, “eHow”, “Hunker” and “The Other Art Fair”, are our property. This report contains additional trade names and trademarks of other companies. We do not intend our use or display of other companies’ trade names or trademarks to imply an endorsement or sponsorship of us or our business by such companies, or any relationship with any of these companies.

Overview

Leaf Group is a diversified consumer internet company. We build enduring, creator-driven brands that reach passionate audiences in large and growing lifestyle categories, including art and design, fitness and wellness, home and décor, do-it-yourself projects and crafts, amongst others.

Our business is comprised of two reporting segments: Marketplaces and Media. Financial information by segment is set forth in Note 15 of our Notes to Consolidated Financial Statements included in Part IV, Item 15, “Exhibits, Financial Statement Schedules” of this Annual Report on Form 10-K.

Marketplaces

Leaf Group’s Marketplaces segment includes art and design marketplaces that serve a global community of approximately 380,000 independent artists. Our marketplaces empower artists to reach a global audience of art lovers and design conscious buyers and earn a living or supplement their income while pursuing their passion, while we handle various marketing, promotion, and logistics, such as coordination of made-to-order production, global shipping and payment processing. Through our portfolio of marketplace brands, we create compelling and differentiated experiences that serve the needs of an attractive demographic of art enthusiasts and design conscious consumers throughout their key life stages. Our marketplace brands are distinguished by the diversity and quality of available products, high caliber of artists and superior customer service that we provide to both artists and buyers.

Our portfolio of marketplace brands includes:

 

Made-to-order marketplaces.  We operate artist-driven, made-to-order digital commerce 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 distinct made-to-order marketplaces target diverse demographics across multiple channels and operate as an integrated business, which allows for strategic and advantageous partnerships with our third party vendors and suppliers.

 

·

Society6.  Society6 is a digital commerce brand which aims to empower style and creative independence, targeting young adults who are culturally sophisticated and self-expressive. Society6 provides artists with an online commerce platform to feature and sell their original art and designs on consumer products in the home décor, accessories, and apparel categories. Artists post their designs, set the price for art prints and select other products within the Society6 product portfolio on which their art and designs can be sold. After a product is purchased, third party vendors produce, package and ship the product directly to the buyer. As of December 31, 2017, there were approximately 270,000 active artists on Society6, an increase of more than 17% from the prior year. There are now more than 4.7 million unique designs and approximately 40 consumer products available across the Society6 product portfolio. During 2017, Society6 facilitated sales from customers located in over 180 countries.

 

·

Deny Designs.  Deny Designs, acquired in May 2017, is an artist-driven, home décor brand aimed toward sophisticated and contemporary customers who desire to express themselves through individualized home


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statement pieces. Deny Designs offers a collection of designs from their gallery of curated artists. These designs are printed on an assortment of premium home décor products, including select proprietary furniture products manufactured in-house at Deny Designs’ facility in Denver, CO. In addition to its online direct-to-consumer channels, Deny Designs also sells products through wholesale channels to trade and hospitality clients, as well as retail distribution partners. As of December 31, 2017, there were approximately 170 active artists on Deny Designs and more than 12,000 unique designs available.

 

Fine art marketplace.  We also operate a fine art marketplace, Saatchi Art, which allows consumers to discover a large selection of original artwork and designs.

 

·

Saatchi ArtSaatchi Art, which includes SaatchiArt.com and its complementary art fair event brand, The Other Art Fair (collectively, “Saatchi Art”), is a leading fine art marketplace where approximately 110,000 artists exhibit and sell their original artwork directly to consumers through a curated online gallery or in-person at art fairs currently 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 and has sold works to buyers located in over 100 countries. There are currently more than 870,000 original, unique works available on the Saatchi Art platform. In addition, artists can choose to sell open edition or exclusive limited edition art prints derived from the artwork they post on Saatchi Art. Saatchi Art also offers an art advisory service which provides individual collectors and trade professionals with access to an art curator who will help select artwork tailored to the customer’s needs, space and style. In 2017, Saatchi Art’s The Other Art Fair hosted seven art fairs, showcasing approximately 110 artists and their work at each fair. We intend to expand our reach and launch additional art fairs in two new cities during 2018.  

Media

Leaf Group’s Media segment consists of a diverse portfolio of media properties that educate and inform consumers on a broad range of topics. Our media properties enable a large community of subject matter experts to share their knowledge and passion with consumers across the internet. We generate the majority of our media revenue from the sale of advertising.  

Brands.  Our portfolio of owned and operated media properties includes Livestrong.com, Hunker, eHow and Cuteness.com, as well as approximately 20 other media properties that are focused on specific topics or interests. Collectively, our owned and operated media properties reached over 50 million average monthly unique visitors in the United States in the fourth quarter of 2017 according to comScore.

·

Livestrong.com, our largest media brand, is an online destination for healthy living with an extensive library of health, fitness, lifestyle and nutrition articles and videos. Livestrong.com also offers mobile applications that monitor users’ health, fitness and life achievements.

·

Hunker is an online destination for home and space inspiration, with original home tours, practical do-it-yourself solutions and design advice for real people.

·

Cuteness.com is an online community serving pet owners and animal lovers through useful pet information and pet training tips, as well as fun animal related articles and videos. 

·

eHow is a leading online how-to resource providing inspiration and solutions for do-it-yourself projects and crafts to make them attainable and fun for everyone.

 

Content Creation. We create high-quality, informative and entertaining digital content in a wide variety of formats including videos, articles and slideshows. We use a combination of internal editorial staff, freelance contributors and social influencers to produce this content. Our platform uses advanced algorithms to identify the questions or topics that are on consumers’ minds. Our platform also manages the development, refinement and eventually the publishing of this content to the web, email and social channels. Our mission is to connect the knowledge and the passion of an expert with interested and curious consumers.

 


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Traffic Sources.  Consumers can find our content through a variety of modern digital distribution channels including search, social networks, email campaigns and direct navigation. Once a consumer discovers us, we make it easier for them to follow us on social networks, share our content with friends and sign-up for our newsletters. We have a large and growing following across social networks including Facebook, Pinterest and Instagram.

Mobile Applications.  Our media portfolio also includes mobile applications. MyPlate, our most successful app, is integrated into our Livestrong.com brand. As of December 2017, MyPlate was used by over 410,000 consumers to track their calories and improve their diet. MyPlate is monetized via ads, sponsorships and a premium subscription offering that unlocks advanced features.

Monetization.   Each of our owned and operated properties is designed to optimize revenues from a diverse set of buyers. We carefully maximize yield across the monetization ad stack between direct brand, programmatic and third parties, each representing a different value bracket. We engage directly with brands on unique content and sponsorship opportunities to connect with our diverse consumers. We also leverage programmatic tools and proprietary data to connect advertisers with valuable audiences across our media properties.

Partner Sites.  Some of our websites were developed in coordination with other media companies and publishers. In these cases, we create, maintain and host content that exists on the partner’s sub-domain and is seamlessly integrated into our partner’s website. Revenues from this content are shared with the partner. We currently have 25 such hosted properties in our portfolio of media properties

Technology

Our technologies include software applications built to run on independent clusters of standard and commercially available servers located at co-location facilities in North America. We make substantial use of off-the-shelf available open-source technologies such as Linux, PHP, MySQL, Redis, mongoDB, Memcache, Elasticsearch and Couchbase. These systems are connected to the internet via load balancers, firewalls, and routers installed in multiple redundant pairs. We also utilize third party services to geographically deliver data using major content delivery network (“CDN”) providers, such as Akamai. Virtualization is heavily deployed throughout our technology architecture, which affords scaling numerous properties in an efficient and cost effective manner. Enterprise class storage systems provide redundancy in order to maintain continued and seamless system availability in the event of most component failures.

Our business intelligence platform and financial systems are hosted in a Tier IV data center alongside most of our public facing Media websites and applications. Some of our Marketplaces websites are hosted with a third party cloud hosting provider. Each of our significant websites is designed to be fault-tolerant, with collections of application servers, typically configured in a load balanced state, in order to provide additional resiliency. Our environment is equipped with a full-scale monitoring solution, which includes an outsourced network operations center that is continuously staffed.

International Operations

We provide our products and services to consumers around the world. Our marketplaces are available to artists and buyers globally and while it is still a small part of our outsourced production process, we work with international vendors in the Asia-Pacific and European regions to more efficiently ship products to customers and we will continue to look for opportunities to work with additional international vendors. In addition, Saatchi Art’s The Other Art Fair currently hosts art fairs in the United Kingdom, Australia and the United States.

Information regarding financial data by geographic areas is set forth in Note 15 of our Notes to Consolidated Financial Statements included in Part IV, Item 15, “Exhibits, Financial Statement Schedules” of this Annual Report on Form 10-K, and additional information regarding certain risks associated with our international operations is provided under the heading “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K.

 


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Customers

The products and artwork sold through our Marketplaces segment are primarily sold directly to consumers. We also distribute products through third party retailers and sell products and artwork to trade professionals and commercial customers.

Our Media customers currently include advertisers and advertising providers that purchase advertising space on our owned and operated media properties, as well as third party brands, publishers and advertisers for whom we create and, in some cases, host content. Our advertising strategy is currently focused on both direct sales channels with brands and advertising agencies, particularly with respect to native and sponsored ad campaigns, and programmatic offerings that utilize various advertising network exchanges to manage our ad stack. A significant portion of the advertising revenue generated by our Media business is derived from our agreements with Google. See “Item 1A.  Risk Factors—We depend upon certain arrangements with Google for a significant portion of our revenue. A termination of, or a loss of revenue generated from, our agreements with Google would have a material adverse effect on our business, financial condition and results of operations.”

 

Competition

We operate in highly competitive and developing industries that are characterized by rapid technological change, various business models and frequent disruption of incumbents by innovative entrants.

Marketplaces.  Our art and design marketplaces compete with a wide variety of online and brick-and-mortar companies selling comparable products. Our made-to-order marketplaces, Society6 and Deny Designs, primarily compete with companies that also utilize a made-to-order business model whereby consumer products featuring artist designs are produced by third party fulfillment partners and shipped directly to customers, such as RedBubble and Threadless, as well as companies that offer broader home décor and apparel products for creative, design conscious consumers, such as Etsy, Wayfair, Urban Outfitters, and West Elm. Our fine art marketplace, Saatchi Art, competes with traditional offline art galleries, art consultants, and online platforms selling original artwork such as Artfinder, Artspace, Rise Art, eBay and Amazon Art, as well as various art fairs that feature reasonably priced artwork from emerging artists such as The Affordable Art Fair. Our marketplaces must successfully attract, retain and engage both buyers and sellers to use our platforms and attend our fairs. We believe that the principal competitive factors for such marketplaces include the quality, price and uniqueness of the products, artwork or services being offered; the selection of goods and artists featured; the ability to source numerous products efficiently and cost-effectively with respect to our made-to-order products; customer service; the convenience and ease of the shopping experience we provide; and our reputation and brand strength. We expect competition to continue to intensify as online and offline businesses increasingly compete with each other and the barriers to enter online channels are reduced.

Media.  We face intense competition for the properties within our Media segment from a wide range of competitors. These markets are rapidly evolving, highly fragmented and competition could increase in the future as more companies enter the space. We compete for advertisers on the basis of a number of factors, including return on marketing expenditures, price of our offerings, and the ability to deliver large audiences or precise types of segmented audiences. Our principal competitors in this space currently include various online media companies ranging from large internet media companies to specialized and enthusiast properties that focus on particular areas of consumer interest, as well as social media outlets such as Facebook, Instagram, Snapchat and Pinterest, where brands and advertisers are focusing a significant portion of their online advertising spend in order to connect with their customers. Some of our competitors have larger audiences and more financial resources than we have and many of our competitors are making significant investments in order to compete with various aspects of our business.  

Many of our current Marketplaces and Media competitors have, and potential competitors may have, substantially greater financial, marketing and other resources than we have; greater technical capabilities; greater brand recognition; longer operating histories; differentiated products and services; and larger customer bases. These resources may help some of our competitors and potential competitors respond more quickly as the industry and technology evolves, focus more on product innovation, adopt more aggressive pricing policies and devote substantially more resources to website and system development than we do. Additional information regarding competition is included under the heading “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K.


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Intellectual Property

Our intellectual property consists of trademarks, service marks, patents, copyrights and trade secrets, and is, in the aggregate, important to our business. To protect our proprietary rights, we rely on a combination of intellectual property rights in the United States and other jurisdictions, including trademarks, patents, copyrights, and trade secret laws, together with contractual provisions and technical measures that we have implemented. We rely more heavily on trade secret protection than patent protection. To protect our trade secrets, we maintain strict control access to our proprietary systems and technology, including our platforms, infrastructure and production environments. We also enter into confidentiality and invention assignment agreements with our employees and consultants, as well as confidentiality and non-disclosure agreements with third parties that provide products and services to us. We also license certain trademarks, tradenames and/or copyrights through long-term license arrangements.

We have trademarks registered in the United States and in various countries (some of which are registered in multiple classes) for some of our core properties, including “Society6”, “Hunker”, “Cuteness” and “eHow”, and we have additional trademark applications pending in the United States and other jurisdictions. We also have patents granted by the United States Patent and Trademark Office and other jurisdictions with respect to certain methods, processes and technologies related to our Media segment that expire between 2027 and 2034, and we have patent applications pending in the United States and other jurisdictions specific to our Media segment. We believe that the duration of our patents is adequate for the current needs of our business. We generally do not register the copyrights associated with our Media content with the United States Copyright Office due to the relatively high costs we would incur to register all of our copyrights.

In addition to the intellectual property we own, we also have perpetual licenses to use the “Saatchi” name in connection with our Saatchi Art marketplace and the “Livestrong.com” name in connection with our Livestrong.com media property, in each case, as permitted by the terms of intellectual property or licensing agreements with the third parties who retain the perpetual ownership rights to such names. Additional information regarding certain risks related to our intellectual property is included under the heading “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K.

Regulation

We are subject to numerous laws and regulations in the United States and abroad, including laws and regulations relating to freedom of expression; information security; data privacy and data collection; pricing and fees; employment related matters; online content and the distribution of content; intellectual property rights, including secondary liability for infringement by others; product liability claims; taxation, including sales and value-added taxes (“VAT”); online advertising and marketing, including email marketing, unsolicited commercial email, native advertising and sponsored content; and the use of social media influencers.

In the United States, Congress has adopted legislation that regulates certain aspects of the internet, including the Communications Decency Act, the Digital Millennium Copyright Act, the Lanham Act, the Anticybersquatting Consumer Protection Act, the CAN-SPAM Act, the Children’s Online Privacy Protection Act (“COPPA”) and the Federal Trade Commission Act. Advertising and promotional information presented to visitors on our online properties, our related social media channels and through our other marketing activities are subject to federal and state consumer protection laws and regulations that govern unfair and deceptive practices. Because we operate large consumer-facing media properties and marketplace platforms, we are also subject to state, federal and foreign laws and regulations governing privacy of users’ search and purchasing habits and other information, including requirements related to the collection and protection of consumers’ non-public personal information, user preferences and similar personal data. We believe that we will also be subject to the General Data Protection Regulation (“GDPR”), which was enacted in the European Union in May 2016, becomes effective in May 2018 and relates to data protection and privacy.

We must also comply with certain foreign and U.S. laws and regulations that apply to our international operations, including restrictions imposed by the Foreign Corrupt Practices Act (“FCPA”) and the economic and trade sanctions administered by the Office of Foreign Assets Control (“OFAC”) and the U.S. Commerce Department based on U.S. foreign policy and national security goals against targeted foreign states, organizations and individuals. Additionally,


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some of the products and services we provide to customers globally may require approval under applicable U.S. export and customs laws.

Federal, state, local and foreign governments are also considering other legislative and regulatory proposals that would regulate the internet in more and different ways than exist today, including with respect to taxes. New laws and regulations, or new interpretations of existing laws and regulations, may significantly impact our business. The costs of compliance with the various laws and regulations applicable to us are high and may increase in the future and any failure to comply with applicable laws and regulations may subject us to additional liabilities and penalties. See “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K for additional information.

Employees

As of December 31, 2017, we had 286 employees. None of our employees is represented by a labor union or is subject to a collective bargaining agreement. We believe that relations with our employees are good.

Seasonality

Our Marketplaces service offering is affected by traditional retail seasonality and there is generally increased sales activity on our marketplaces platforms during the third and fourth quarter back-to-school and holiday seasons. Both our Marketplaces and Media service offerings are also affected by seasonal fluctuations in internet usage, which generally slows in the first quarter of the calendar year as well as during the summer months. These seasonal trends have caused, and will likely continue to cause, fluctuations in our quarterly results.

Available Information

We file reports with the SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any other filings required by the SEC. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports are made available free of charge in the investor relations section of our corporate website (http://ir.leafgroup.com) as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. The public may also read and copy any materials we file with the SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site (http://www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.

We webcast our earnings calls and certain events we participate in or host with members of the investment community on the investor relations section of our corporate website. Additionally, we provide notifications of news or announcements regarding our financial performance, including SEC filings, investor events, and press and earnings releases, on the investor relations section of our corporate website. Investors and others can receive notifications of press releases and SEC filings by signing up for email alerts. Investors and others should note that we also use social media to communicate with the public about our company, our services and other issues. It is possible that the information we post on social media could be deemed to be material information. Therefore, we encourage investors, the media, and others interested in our company to review the information we post on the social media channels listed on the investor relations section of our corporate website. Further corporate governance information, including our corporate governance guidelines, board committee charters and code of business conduct and ethics, is also available on the investor relations section of our corporate website under the heading “Corporate Governance.”

Any references to our corporate website address in this Annual Report on Form 10-K are intended to be inactive textual references only. None of the information contained on our website is part of this Annual Report on Form 10-K or incorporated by reference into this report or any other report or document we file with the SEC.

 


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Item 1A.Risk Factors

In addition to the other information set forth in this Annual Report on Form 10-K, you should consider carefully the risks and uncertainties described below, which could materially adversely affect our business, financial condition and results of operations.

Risks Relating to our Business

If we are unable to successfully drive traffic to our marketplaces and media properties and expand the customer base for our marketplaces, our business, financial condition and results of operations would be adversely affected.

In order for our businesses to grow, we must attract new visitors and customers to our marketplaces and media properties and retain our existing visitors and customers. One of the key factors to growing our marketplace platforms is expanding our new and repeat customer base. Our ability to attract new customers, some of whom may already purchase similar products from our competitors, depends in part on our ability to successfully drive traffic to our marketplaces using social media platforms, e-mail marketing campaigns and promotions, paid referrals and search. We may incur significant expenses related to customer acquisition and promotional activities, and the net sales from new customers may not ultimately exceed the cost of acquiring these customers. Additionally, we believe that many of the new customers for our marketplaces originate from word-of-mouth and other non-paid referrals from existing customers. If we fail to deliver a differentiated consumer experience or if customers do not perceive the products or designs sold through our marketplaces to be of high value and quality, we may have difficulty retaining our existing customers and attracting new customers through referrals and other channels.

Our success in attracting traffic to our media properties and converting these visitors into repeat users depends, in part, upon our ability to identify, create and distribute high-quality and reliable content through engaging products and our ability to meet rapidly changing consumer demand. We may not be able to identify and create the desired content and produce an engaging user experience in a cost-effective or timely manner, if at all. As discussed further below, we depend on search engines to direct a significant amount of traffic to our media properties and we utilize search engine optimization efforts to help generate search referral traffic to our media properties. If we are unable to successfully modify our search engine optimization practices in response to changes regularly implemented by search engine algorithms and in search query trends, or if we are unable to generate increased or diversified traffic from other sources such as social media, e-mail, direct navigation and online marketing activities, we could experience substantial declines in traffic to our media properties and to our partners’ media properties, which would adversely impact our business, financial condition and results of operations.

If internet search engines continue to modify their methodologies, traffic to our online properties, and particularly to our media properties, could decline significantly.

We depend on various internet search engines, such as Google, Bing and Yahoo!, to direct a significant amount of traffic to our properties, including media properties that we host for our partners. Our media properties are particularly dependent on search referral traffic. For the year ended December 31, 2017, based on our internal data, a majority of the traffic directed to our media properties came directly from internet search engines and more than half of the traffic from search engines came from Google. Changes in the methodologies or algorithms used by search engines to display results could cause our properties to receive less favorable placements in the search results. In addition, search engine providers typically display, together with organic search results, content and advertising links that may divert traffic from the pages referenced in the organic search results, including paid search results and content and links selected by the search engine provider or other online marketing firms. Accordingly, even if we rank highly in organic search results, traffic to our properties may still decline as a result of paid search results and other content included on the search results page generated by a search query. Internet search engines could also decide that content on our media properties, or the size, placement and type of ad units displayed on webpages hosting our content, is unacceptable or violates their policies, which continue to evolve over time. Internet search engines could also view product or layout changes made to our properties unfavorably, leading to lower search result rankings and a decrease in search referral traffic.

Google, Bing and Yahoo! regularly deploy changes to their search engine algorithms. Since our inception, we have experienced fluctuations in the total number of search referrals to our properties. The changes to search engine


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algorithms by Google, Bing and Yahoo! have resulted in the past, and may result in the future, in substantial declines in traffic directed to our media properties, which contributed to significant and sustained revenue declines from our media segment in prior periods. Any future or ongoing changes made by search engines that negatively impact the volume of search referral traffic to any of our media or marketplace properties could materially and adversely affect our business, financial condition and results of operations.

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

We currently generate the majority of our Media revenue from advertisements displayed on our media properties, and we expect to continue to derive a significant amount of our Media revenue from advertising. For the years ended December 31, 2017, 2016 and 2015, we generated 32%, 37% and 53%, respectively, of our total revenue from advertising. We have historically experienced declines in blended ad unit rates for both desktop and mobile since 2014, resulting in lower advertising revenue, and any further reductions in ad unit rates would negatively impact our financial results. In addition, an increasing percentage of our content is now consumed on social media platforms, which does not monetize as well as the same content consumed on directly on our websites. Software developers have also increased the availability of ad blocking software, primarily on desktop devices. Increased adoption of ad blocking software by users could reduce our advertising revenue and negatively impact our financial results.

We also believe that advertising spend on the internet, as in traditional media, fluctuates significantly as a result of a variety of factors, many of which are outside of our control. These factors include variations in expenditures by advertisers due to budgetary constraints; the evolving online media landscape where advertisers are more selective as to where they allocate capital for branded campaigns vs. programmatic spend; the cyclical and discretionary nature of advertising spending, including the perceived impact of campaign strategies; general economic conditions, as well as economic conditions specific to the internet and media industry; and the occurrence of extraordinary events, such as natural disasters, terrorist attacks or political instability. Brands and advertisers are also increasingly focusing a significant portion of their online advertising budgets on social media platforms such as Facebook, Snapchat, Instagram and Pinterest. If this trend continues and we are unable to offer competitive or similarly valued advertising opportunities across our media properties, our revenue from advertising could be adversely impacted. An inability to maintain or increase our advertising revenue would have a material adverse effect on our business, financial condition and results of operations.

Additionally, our advertising strategy is currently focused on both direct sales channels with brands and advertising agencies, including native and sponsored ad campaigns, as well as programmatic offerings that utilize various advertising network exchanges, including exchanges operated by Google and Index Exchange. Operating on a programmatic basis requires us to actively manage the sale of our ad inventory on these exchanges, and many advertisers and agencies are now focusing more of their budgetary advertising spend through these exchanges. An inability to successfully manage our ad stack, including the programmatic process and our direct sales team, could have a material adverse effect on our business, financial condition and results of operations.

One component of our platform that we use to generate advertiser interest is our system of monetization tools, which is designed to match content with advertisements in a manner that optimizes revenue yield and end-user experience. Advertising providers and advertisers will stop placing advertisements on our media properties if their investments do not generate sales leads, branding opportunities and customer awareness, or if we do not deliver their advertisements in an appropriate and effective manner. The failure of our yield-optimized monetization technology to effectively match advertisements with our content in a manner that results in increased revenue for advertisers would have an adverse impact on our ability to maintain or increase our revenue from advertising. If any of our advertisers or advertising providers, and in particular Google, decides not to continue advertising on, or providing advertisements to, our media properties, or modifies its advertising policies in a manner that could negatively impact yield, we could experience a rapid decline in our revenue over a relatively short period of time.


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We depend upon certain arrangements with Google for a significant portion of our advertising revenue. A termination of, or a loss of revenue generated from, our arrangements with Google would have a material adverse effect on our business, financial condition and results of operations.

We have an extensive relationship with Google and a significant portion of our total revenue is generated by advertising provided by and through Google products and services. For the years ended December 31, 2017, 2016 and 2015, we derived approximately 24%, 27% and 36%, respectively, of our total revenue from our various arrangements with Google. Google provides both cost-per-click advertisements and cost-per-impression advertisements to our media properties and we receive a portion of the revenue generated by such advertisements. We also utilize Google’s DoubleClick Ad Exchange, a sell-side auction marketplace, to sell display advertising space on our media properties to third party advertisers. In addition, we use Google’s DoubleClick ad serving technology to deliver advertisements to our media properties. Our various services agreements with Google, which govern our advertising, technology and search relationships with Google, are set to expire between 2018 and 2020. Google has the right to terminate its agreements with us prior to their expiration upon the occurrence of certain events, including if Google reasonably believes that our use of its products and services violates the rights of third parties, and other breaches of contractual provisions, a number of which are broadly defined. In addition, Google is permitted to discontinue the provision of certain services to us under our primary services agreements at specified times, in its sole discretion. If Google terminates our arrangements with it or ceases to provide certain key advertising products or services to us, or if we are unable to enter into new agreements with Google or its competitors that provide similar products or services on terms and conditions favorable to us prior to the expiration of the current agreements, we may not be able to enter into new agreements with alternative third party advertisement providers or for alternative ad serving platforms on acceptable terms or on a timely basis or both.

Furthermore, our advertising and technology agreements with Google may not continue to generate the same level of revenue that we have received from such arrangements during past periods for a variety of reasons, including a reduction in the amounts Google is able to charge advertisers and the acceptance and effectiveness of Google’s ad serving and sales technology. Our ability to generate advertising revenue from Google also depends, in part, on Google’s assessment of the quality and performance characteristics of internet traffic resulting from advertisements placed on our media properties. In addition, Google may at any time change the nature of, or suspend, the services that it provides to advertisers and the catalog of advertisers from which advertisements are sourced, or modify its policies with respect to how advertisements may be displayed on a webpage. These types of changes or suspensions would adversely impact our ability to generate revenue from our various agreements with Google. Any termination of or change in the services that Google provides to us, or a loss of revenue generated by our various agreements with Google, would have a material adverse effect on our business, financial condition and results of operations.

Mobile devices are increasingly being used to access the internet and, in addition, our content is increasingly being consumed on social media platforms. Advertising yields on mobile web and social media platforms are typically lower than direct desktop yields, and this shift could negatively impact our business, financial condition and results of operation.

The number of people who access the internet through mobile devices such as smartphones and tablets, rather than through desktop or laptop computers, has increased substantially. Additionally, individuals are increasingly consuming publisher content through social media platforms. If we cannot effectively distribute our media content, products and services on these devices or through these platforms, we could experience a decline in visits and traffic and a corresponding decline in revenue. It is also more difficult to display advertisements on mobile devices without disrupting the consumer experience. We have made, and may make further, changes to the layouts and formats of our mobile optimized sites in order to improve the user experience or comply with the requirements of our advertising partners, which could negatively impact our monetization efforts on mobile devices. In addition, advertising yields on mobile web and social media platforms are currently lower than direct desktop yields. The significant increase in consumption of our media content on mobile devices and through social media platforms has, in part, contributed to a reduction in our Media revenue per one thousand visits, or RPVs. As a result of these factors, the increasing use of mobile devices and social media platforms to access our content could negatively impact our business, financial condition and results of operations.


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Certain changes to the business model for our Media segment and related expenditures could negatively impact our operating margins in the near-term and may not lead to our anticipated increased revenue in the long-term.

As part of the transformation of our Media business, we have taken various actions and incurred significant expenses to improve the user experience and engagement on certain of our media properties by redesigning the websites; removing duplicative or low-quality content; improving and/or rewriting existing content; reducing the ad unit density; changing the format of ad units; improving the mobile experience and adding products and user engagement tools. Such actions do not directly generate related revenue and certain changes will likely negatively impact our revenue and operating margins in the near-term. In particular, since 2013, we removed a significant amount of content from eHow and Livestrong.com, some of which was migrated to new content specific websites, and reduced the number of ad units on each page, which collectively resulted in a large decrease in revenue and may continue to negatively impact revenue and operating margins due to the reduction in content and ad units generating advertising revenue on these sites. We may also incur additional expenses in order to further improve the content, product and user experience associated with our media properties.

In addition, in the second half of 2016, we began launching several category-specific media properties leveraging topics and content from eHow because we feel that more narrowly focused media properties with a distinct editorial voice now resonate better with audiences and advertisers. These category-specific media properties currently include: Hunker, a design and home décor focused website for millennials and first time homeowners; Cuteness.com, a community for pet owners and animal lovers; Techwalla.com, a site that provides expansive reviews and information on tech products for your home and family; LEAF.tv, a site with rich content in living, eating, and fashion; and Sapling.com, a millennial source for information on personal finance. We have historically received lower advertising rates on the new properties as compared to eHow, particularly when the new properties were first launched, and the content that is moved may not ultimately generate the same or increased traffic on the new category-specific properties. These recent changes and any additional changes may not result in increased visits to, or increased revenue generated by, our media properties in the aggregate in the near-term or long-term.

If we are unable to attract new customers to our marketplaces and successfully grow our marketplaces business, our business, financial condition and results of operations could be adversely affected.

We operate leading art and design marketplaces, as well as a leading art fair for discovering emerging artists. If we are unable to attract new customers to our marketplaces and successfully grow these platforms, our business and results of operation would be adversely affected.

The success of our marketplaces is dependent upon a number of factors, including:

·

demand for these types of products and market acceptance of our products and services;

·

our ability to attract and retain new customers;

·

increased brand awareness and the reputation of our marketplaces;

·

our ability to increase conversion rates and average order values;

·

our ability to maintain the artist communities on Society6, Deny Designs and Saatchi Art so that artists continue to contribute and maintain their original artwork and designs on these marketplaces;

·

our ability to cost-effectively introduce and market new products on Society6 and Deny Designs on a timely basis to address changing consumption trends and consumer preferences and to differentiate us from our competitors;

·

our ability to identify and attract local artists who will drive attendance and art sales, as well as local art directors and personnel to efficiently operate at fairs hosted by Saatchi Art’s The Other Art Fair in multiple cities around the world;


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·

the success and competitiveness of new entrants into this highly competitive industry;

·

competitive pricing pressures, including potential discounts offered to attract customers and reduced or free shipping;

·

maintaining significant strategic relationships with our made-to-order suppliers and ensuring the costs and quality of their products and the timeliness of our production cycle for our art and design marketplaces;

·

disruptions in the supply-chain, production and fulfillment operations associated with the made-to-order products sold through our art and design marketplaces;

·

our ability to source reliable local vendors as we look to expand internationally;

·

shipping disruptions or delays with, or return rates for, the products sold through our online marketplaces;

·

the overall growth rate of e-commerce and marketplaces and changes in consumer spending on discretionary purchases; and

·

legal claims, including copyright and trademark infringement claims, right of publicity claims and product liability claims, which may expose us to greater litigation costs in the future as compared to historical levels.

If we are unable to successfully grow our marketplaces, including as a result of lower customer growth or retention than expected, or if the revenue generated from marketing initiatives related to our marketplaces is less than the costs of such initiatives, our business, financial condition and results of operations could be materially and adversely affected.

If the mobile solutions available to buyers and sellers using our online marketplaces are not effective, the growth prospects for our marketplaces could decline and our marketplaces revenue and business could be adversely affected.

Consumers are increasingly conducting online shopping on mobile devices, including smartphones and tablets, rather than on desktop/laptop computers. Although we continually strive to improve the mobile experience for users of Society6 and Saatchi Art accessing our marketplaces through mobile devices, the smaller screen size and reduced functionality associated with some mobile device interfaces may make the use of our marketplace platforms more difficult or less appealing to our members. Historically, visits to our marketplaces on mobile devices have not converted into purchases as often as visits made through desktop/laptop computers and the average order value for mobile transactions has been lower than desktop transactions. Society6, Deny Designs and Saatchi Art sellers are also increasingly using mobile devices to operate and monitor their accounts on our platforms and if we are not able to deliver a rewarding experience to sellers using mobile devices, our Marketplaces segment may suffer. If our members encounter difficulty accessing or using our marketplace platforms on their mobile devices, or if our members choose not to use our marketplace platforms on their mobile devices, the growth prospects for our marketplaces could decline. Additionally, if conversion rates and average order values for mobile transactions on our marketplaces do not increase, our marketplaces revenue and results of operation for our Marketplaces segment may be adversely affected.

We face significant competition, which we expect will continue to intensify, and we may not be able to maintain or improve our competitive position or market share.

We operate in highly competitive and still developing markets. The industries in which we compete are characterized by rapid technological change, various business models and frequent disruption of incumbents by innovative entrants. There can be no assurance that we will be able to compete successfully against current or future competitors and a failure to increase, or the loss of, market share, would likely seriously harm our business, financial condition and results of operations.


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Marketplaces

Our art and design marketplaces compete with a wide variety of online and brick-and-mortar companies selling comparable products. Society6 and Deny Designs primarily competes with companies that also utilize a made-to-order business model whereby consumer products featuring artist designs are produced by third party fulfillment partners and shipped directly to customers, such as RedBubble and Threadless, as well as companies that offer broader home décor and apparel products for creative, design conscious consumers, such as Etsy, Wayfair, Urban Outfitters, and West Elm. Saatchi Art competes with traditional offline art galleries, art consultants and other online properties selling original artwork, such as Artfinder, Artspace, Rise Art, eBay and Amazon Art, as well as various art fairs that feature reasonably priced artwork from emerging artists such as The Affordable Art Fair. We expect competition to continue to intensify as online and offline businesses increasingly converge or compete with each other, and because the barriers to entry into online channels can be low.

Our marketplace platforms must successfully attract, retain and engage both buyers and sellers to use our platforms. We believe that the principal competitive factors for our marketplaces include the quality, price and uniqueness of the products, artwork or services being offered; the selection of goods and artists featured; the ability to source our product assortment efficiently and cost-effectively with respect to our made-to-order products; customer service; the convenience and ease of the shopping experience we provide; and our reputation and brand strength.

Many of the current competitors to our Marketplaces segment have, and potential competitors may have, longer operating histories, larger customer bases, greater technical capabilities, greater brand recognition, differentiated products and services, and substantially greater financial, marketing and other resources than we have. These resources may help some of our competitors and potential competitors react more quickly as the industry evolves, focus more on product innovation, and devote substantially more resources to website and system development than we do. Some of the competitors to our online marketplaces may offer or continue to offer faster and/or free shipping, more favorable return policies or other transaction-related services which improve the overall customer experience, but which could be impractical or inefficient for us to implement. Some of our competitors may be able to use the advantages of brick-and-mortar stores or other sorts of physical presence to build their customer bases and drive sales. Our competitors may engage in more extensive research and development efforts, undertake more far-reaching marketing campaigns and adopt more aggressive pricing policies, which may allow them to build larger customer bases or generate net sales from their customer bases more effectively than we do.

Media

We face intense competition for the properties within our Media segment from a wide range of competitors. We compete for advertisers on the basis of a number of factors including return on marketing expenditures, price of our offerings and the ability to deliver large or precise types of segmented audiences. Our current principal competitors include:

·

Online Media Properties. We compete with numerous digital media companies, some of which have much larger audiences and financial resources than we have, for online marketing budgets. We also compete with companies and individuals that provide specialized consumer information online, including through enthusiast websites, message boards and blogs. These competitors compete with us across several areas of consumer interest including do-it-yourself, fitness and health, home décor, fashion and beauty, crafts, personal finance, technology and pets.

·

Social Media Outlets. We compete with social media outlets such as Facebook, Snapchat, Instagram and Pinterest, where brands and advertisers are focusing a significant portion of their online advertising spend in order to connect with their customers.

Our Media segment may face increased future competition if any of our competitors devote increased resources to more directly address the online market for the professional creation and distribution of content. Many of our current and potential competitors enjoy substantial competitive advantages, such as greater brand recognition, longer operating histories, substantially greater financial, marketing and other resources, greater technical capabilities, access to larger customer bases and, in some cases, the ability to combine their online marketing products with traditional offline media


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such as newspapers or magazines. These companies may use these advantages to offer products and services similar to ours at a lower price, develop different products to compete with our current offerings and respond more quickly and effectively than we can to new or changing opportunities, technologies, standards or customer requirements. For example, if Google chose to compete more directly with us as a publisher of similar content, we may face the prospect of the loss of business or other adverse financial consequences due to Google’s significantly greater customer base, financial resources, distribution channels and patent portfolio.

We rely on freelance artists and designers to generate the artwork and designs sold through our art and design marketplaces. We may not be able to attract or retain enough artists or designers to generate artwork and designs on a scale or of a quality sufficient to grow our business.

Our art and design marketplaces rely on artists and designers to join our communities and contribute original artwork and designs that they seek to sell or monetize through the sale of art prints and other made-to-order consumer products in the home décor, accessories, and apparel categories. We rely on freelance artists and designers to upload their unique art or designs to Society6 and Deny Designs or sell their original artwork on Saatchi Art, or at fairs hosted by Saatchi Art’s The Other Art Fair. We may not be able to attract or retain enough artists to generate artwork and designs on a scale or of a quality sufficient to grow our business. Furthermore, our competitors may attempt to attract members of our artist communities by offering compensation and revenue-sharing arrangements that we are unable to match. If we are unable to continue attracting artists and designers to our marketplaces, our revenues from sales of artwork and made-to-order products will decrease, which would have a negative impact on our business, financial condition and results of operations. 

Poor perception of our brands or business could harm our reputation and adversely affect our business, financial condition and results of operations.

Our Media segment is dependent on attracting a large number of visitors to our media properties and providing leads and clicks to our advertisers, which depends in part on our reputation within the industry and with our users. Historical perception that the quality of our content may not be the same or better than that of other published internet content, even if baseless, may damage our reputation and impact our ability to effectively solicit prospective advertisers. In addition, Livestrong.com is a licensed trademark from the Livestrong Foundation and there has been negative publicity surrounding Mr. Armstrong in the past. Any damage to the reputation of our brands could harm our ability to attract and retain advertisers, visitors, partners, customers and artists, which would materially adversely affect our business, financial condition and results of operations.

Risks Relating to our Company

We have a history of operating losses and may not be able to operate profitably or generate positive cash flow.

We were founded in 2006 and, except for the year ended December 31, 2012, when we generated net income, we have had a net loss in every year since inception, including generating a net loss of $31.1 million for the fiscal year ended December 31, 2017. As of December 31, 2017 we had an accumulated deficit of approximately $428.8 million and we may continue to incur net operating losses in the future. Moreover, our cash flows from operating activities do not currently cover all of our operating expenses, and we may not generate sufficient cash to cover operating expenses for the foreseeable future. Our ability to generate net income in the future will depend in large part on our ability to generate and sustain substantially increased revenue levels, while continuing to control our expenses. We may incur significant operating losses in the future for a number of reasons, including those discussed in other risk factors and factors that we cannot foresee, and we may be unable to generate net income or sufficient positive cash flows.

We may not be able to obtain capital when desired on favorable terms, if at all, or without substantial dilution to our stockholders, which may impact our ability to execute on our current or future business strategies.

We anticipate that our current cash, cash equivalents and cash provided by operating activities will be sufficient to fund our operations for the next 12 months. It is possible, however, that we may not generate sufficient cash from operations or otherwise have the capital resources to meet our future capital needs, including to invest in areas for growth or to acquire complementary businesses, and we do not currently have a line of credit in place if we need to


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borrow funds. If we do not generate sufficient cash from operations or otherwise have sufficient capital resources available, we may need to enter into a new financing arrangement or dispose of certain assets to execute on our current or future business strategies, including developing new or investing in existing lines of business, maintaining our operating infrastructure, acquiring complementary businesses, hiring additional personnel or otherwise responding to competitive pressures. We cannot assure you that financing arrangements will be available to us on favorable terms, or at all. Furthermore, if we raise additional funds through the issuance of convertible debt or equity securities, including as a result of our recent follow-on offering of common stock, the percentage ownership of our existing stockholders could be significantly diluted, and these newly issued securities may have rights, preferences or privileges senior to those of existing stockholders. Any debt financing that we may secure in the future could include restrictive covenants relating to our capital raising activities, buying or selling assets and other financial and operational matters, which may make it more difficult for us to obtain additional capital, manage our business and pursue business opportunities. If adequate funds are not available or are not available on acceptable terms, if and when needed, our ability to fund our operations, meet obligations in the normal course of business, take advantage of strategic opportunities, or otherwise respond to competitive pressures would be significantly limited.

The intangible assets and goodwill on our balance sheet may be subject to impairment. If our intangible assets or goodwill become impaired we may be required to record a significant non-cash charge to earnings which would have a material adverse effect on our results of operations.

We carry a substantial amount of intangible assets on our balance sheet, primarily from the creation of our long-lived media content and from certain past acquisitions. We also carry goodwill on our balance sheet from certain acquisitions we have made. We assess potential impairments to our intangible assets and goodwill when there is evidence that events or changes in circumstances indicate that the carrying value of such intangible assets or goodwill may not be recoverable. In the third quarter of 2014, we recorded a $232.3 million pre-tax impairment charge after we determined that the implied fair value of goodwill in our Media reporting unit was substantially lower than its carrying value. We most recently performed our annual impairment analysis in the fourth quarter of the year ended December 31, 2017, and based on the results, there were no goodwill impairment charges for the year ended December 31, 2017. Future significant and sustained declines in our stock price and market capitalization relative to our book value or our inability to generate sufficient revenue or cash flows from our long-lived media content or the businesses that we have acquired may result in us having to take additional impairment charges against certain of our intangible assets or goodwill. If we are required to record additional impairment charges in future periods, it could have a material adverse effect on our results of operations and financial condition, particularly in the period such charge is taken.

Our operating results may fluctuate on a quarterly and annual basis due to a number of factors, which may make it difficult to predict our future performance.

Our revenue and operating results could fluctuate significantly from quarter-to-quarter and year-to-year due to a variety of factors, many of which are outside of our control. Therefore, comparing our operating results on a period-to-period basis may not be meaningful. In addition to other risk factors discussed in this section, factors that may contribute to the variability of our quarterly and annual results include:

·

lower than anticipated levels of traffic to our media properties and corresponding advertising rates achieved through our ad stack;

·

seasonality of the revenue associated with our marketplaces, including increased sales activity during the back-to-school and holiday seasons;

·

spikes in sales of our made-to-order products due to major social or political events resulting in a short-term demand for products with related content;

·

competitive pricing pressures, including shipping costs, potential discounts offered and promotional activity associated with driving new and repeat customers to and impacting products sold through our marketplaces;


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·

disruptions in the supply-chain, production and fulfillment operations associated with the products sold through our marketplaces;

·

the amount and timing of operating costs and capital expenditures related to the maintenance and expansion of our services, operations and infrastructure, especially one-time costs related to the development or acquisition of new products and services;

·

increased costs associated with the acquisition or production of new content for our media properties, including video and other visual formats;

·

changes in internet advertising purchasing patterns by advertisers and changes in how we sell advertisements;

·

timing of and revenue recognition for certain transactions;

·

changes in generally accepted accounting principles;

·

our focus on long-term goals over short-term results; and

·

weakness or uncertainty in general economic or industry conditions.

It is possible that our operating results may fluctuate from period to period and our operating results may be below the expectations of public market analysts and investors in one or more future quarters due to any of the factors listed above or for other reasons, any of which could have a material adverse impact on the price of shares of our common stock.

We have made and may make additional acquisitions that involve significant execution, integration and operational risks and we may not realize the anticipated benefits of any such acquisitions.

We evaluate acquisition and expansion opportunities on an ongoing basis and may pursue select acquisitions from time to time. We may continue to make acquisitions of complementary businesses, websites, solutions, technologies or talent in the future to increase the scope of our business. The identification of suitable acquisition candidates can be difficult, time-consuming and costly. Potential acquisitions require significant attention from our management and could result in a diversion of resources from our existing businesses, which in turn could have an adverse effect on our business and results of operations. In addition, the expected benefits of acquisitions may not materialize as planned, including achieving certain financial and revenue objectives. Certain acquired businesses or the transactions entered into as part of business combinations may also carry contingent liabilities that could materially impact our future results of operations and financial condition. Furthermore, we may not be able to successfully complete identified acquisitions. If we are unable to identify suitable future acquisition opportunities, reach agreement with such parties or obtain the financing necessary to make such acquisitions, we could lose market share to competitors who are able to make such acquisitions. This loss of market share could negatively impact our business, revenue and future growth.

Even if we successfully complete an acquisition, we may not be able to successfully assimilate and integrate the acquired business, websites, assets, technologies, solutions, personnel or operations, particularly if key personnel of an acquired company decide not to work for us, and we therefore may not achieve the anticipated benefits of such acquisition. In addition, financing an acquisition may require us to (i) use substantial portions of our available cash on hand, (ii) incur additional indebtedness, which would increase our costs and could impose operational limitations, and/or (iii) issue equity securities, which would dilute our stockholders’ ownership and could adversely affect the price of our common stock. We may also unknowingly inherit liabilities that arise after the acquisition and are not adequately covered by indemnities, and certain stockholders of an acquired company may dissent from or object to an acquisition or otherwise seek to assert claims related to the transaction.


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We depend on key personnel to operate our business, and if we are unable to retain our current personnel or hire additional personnel, our ability to develop and successfully market our business could be harmed.

We believe that our future success is highly dependent on the contributions of our executive officers, as well as our ability to attract and retain highly skilled personnel, including engineers, developers and sales and marketing personnel. Qualified individuals that are critical to the success of our current and future businesses, including engineers, developers and sales and marketing personnel, are in high demand, and we may incur significant costs to attract and retain them. All of our officers and other employees are at-will employees, which means they can terminate their employment relationship with us at any time, and their knowledge of our business and industry may be difficult to replace. Volatility or under-performance in our stock price may also affect our ability to attract new employees and retain our existing key employees. Our executive officers and employees may be more inclined to leave us if the perceived value of equity awards, including restricted stock units and stock options, decline. If we lose the services of key personnel or do not hire or retain other qualified personnel for key positions, our business and results of operation could be adversely affected. In addition, we do not maintain “key person” life insurance policies for any of our executive officers.

Our business is subject to online security risks, including cyberattacks and other security breaches, and any actual or perceived security breach could have a material adverse effect on our business, financial condition and results of operations.

Some of our systems, products and services involve the storage and transmission of information regarding our users, customers, and advertising and publishing partners, and our information technology and infrastructure may be vulnerable to cyberattacks, malware or security incidents that result in third parties gaining access to such proprietary information. An increasing number of websites have disclosed online security breaches in recent years, some of which have involved sophisticated and highly targeted attacks on portions of their websites or infrastructure. Our security measures may be breached and unauthorized parties may attempt to gain access to our systems and information through various means, including hacking into our systems or facilities, fraud, employee error, malfeasance, or inserting malicious code or malware into our code base. For example, in 2014, we determined that an unauthorized individual may have gained access to the user names, email addresses and passwords of certain eHowNow customers, which was a test feature of eHow that is no longer available. Additionally, outside parties may attempt to fraudulently induce employees, users, or customers to disclose sensitive information or take other actions by using fraudulent “spoof” and “phishing” emails. Outside parties may also subject us to distributed denial of services attacks or introduce viruses or other malware through “trojan horse” programs to our users’ computers in order to gain access to our systems and the data stored therein. Because the techniques used to obtain unauthorized access, disable or degrade service, or sabotage systems change frequently, often are not recognized until launched against a target and may be difficult to detect for a long time, we may be unable to anticipate these techniques or to implement adequate preventive measures. Any security breach or unauthorized access could result in a misappropriation of our proprietary information or the proprietary information of our users, customers or partners, which could result in significant legal and financial exposure, an interruption in our operations and damage to our reputation. If an actual or perceived breach of our security occurs, or if our consumer facing sites become the subject of external attacks that affect or disrupt service or availability, the market perception of the effectiveness of our security measures could be harmed and we could lose users, customers, advertisers or partners, all of which could have a material adverse effect on our business, financial condition and results of operations. Any security breach at a company providing services to us or our users, including third party payment processors, could have similar effects and we may not be fully indemnified for the costs we may incur as a result of any such breach. In addition, we may need to expend significant resources to protect against security breaches or to address problems caused by a breach, and the coverage limits on our insurance policies may not be adequate to reimburse us for any losses caused by security breaches.

We are subject to risks and compliance rules and regulations related to the third party credit card payment processing solutions integrated within our websites or otherwise used by our businesses.

Many of our customers pay amounts owed to us using a credit card or debit card. For credit and debit card payments, we pay payment processing fees in addition to interchange and other fees, which may increase over time and raise our operating expenses and adversely affect our net income. We are also subject to payment card association operating rules, certification requirements and rules governing electronic funds transfers, which could change or be


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reinterpreted to make it difficult or impossible for us to comply. We believe that we and our payment processing service providers are compliant in all material respects with the Payment Card Industry Data Security Standard, which incorporates Visa’s Cardholder Information Security Program and MasterCard’s Site Data Protection standard. However, there is no guarantee that such compliance will be maintained or that compliance will prevent illegal or improper use of our systems that are integrated with our payment processing providers. If any of our third party payment processors fails to be in compliance with applicable credit card rules and regulations, we may be required to migrate to an alternate payment processor which could result in transaction downtime during the migration and/or a loss of customers and have a material adverse effect on our business, financial condition and results of operations.

If we do not adequately protect our intellectual property rights, our competitive position and business may suffer.

Our intellectual property, consisting of trademarks, service marks, patents, copyrights and trade secrets, is, in the aggregate, important to our business. We rely on a combination of trademark, patent, copyright and trade secret laws in the United States and other jurisdictions, together with contractual provisions and technical measures that we have implemented, to protect our proprietary rights. We rely more heavily on trade secret protection than patent protection. To protect our trade secrets, we control strict access to our proprietary systems and technology, including our platforms and technical infrastructure, and we enter into confidentiality and invention assignment agreements with our employees and consultants, as well as confidentiality and non-disclosure agreements with third parties that provide products and services to us. We face risks related to our intellectual property, including that:

·

because of the relatively high cost we would experience in registering all of our copyrights with the United States Copyright Office, we generally do not register the copyrights associated with our media content;

·

our ability to assert our intellectual property rights against potential competitors or to settle current or future disputes may be limited by our agreements with third parties;

·

our intellectual property rights may not be enforced in jurisdictions where legal protections are weak;

·

any of the trademarks, patents, copyrights, trade secrets or other intellectual property rights that we presently employ in our business, including our perpetual licenses for the “Livestrong” and “Saatchi” names, could lapse or be invalidated, circumvented, challenged or abandoned;

·

competitors may design around our protected systems and technology; or

·

we may lose the ability to assert our intellectual property rights against others.

Effective protection of our trademarks, service marks, copyrights, patents and trade secrets may not be available in all countries where we currently operate or in which we may operate in the future. Policing unauthorized use of our proprietary rights can be difficult and costly. In addition, it may be necessary to enforce or protect our intellectual property rights through litigation or to defend litigation brought against us, which could result in substantial costs, diversion of resources and management attention and could adversely affect our business, even if we are successful on the merits.

Some of our software and systems contain open source software, which may pose risks to our proprietary software and solutions.

We use open source software in our software and systems and will continue to use open source software in the future. The licenses applicable to open source software typically require that the source code subject to the license be made available to the public and that any modifications or derivative works to open source software continue to be licensed under open source licenses. In addition to risks related to license requirements, use of certain open source software can lead to greater risks than use of third party commercial software, as open source licensors generally do not provide warranties, indemnities or other contractual protections with respect to the software (for example, non-infringement or functionality). Our use of open source software may also present additional security risks because the source code for open source software is publicly available, which may make it easier for hackers and other third parties


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to determine how to breach our sites and systems that rely on open source software. Any of these risks could be difficult to eliminate or manage, and, if not addressed, could have a material adverse effect on our business, financial condition and results of operation.

The interruption or failure of our information technology and communications systems, or those of third parties that we rely upon, could adversely affect our business, financial condition and results of operations.

The availability of our media properties and marketplaces depends on the continuing operation of our information technology and communications systems. Any damage to or failure of our systems, or those of third parties that we rely upon (e.g., co-location providers for data servers, storage devices, and network access), could result in interruptions in our service, which could reduce our revenue and profits, and damage our brand. Additionally, if our internal processes do not adequately safeguard against inadvertent coding errors, our online properties may experience disruptions in service and availability. We have previously experienced certain server outages and computer distributed denial of service attacks, and any future server outages at our data center facilities or distributed denial of service attacks may cause all or portions of our online media properties or marketplaces to become unavailable to users. Our systems are also vulnerable to damage or interruption from natural disasters, terrorist attacks, power loss, telecommunications failures, computer viruses or other attempts to harm our systems. Our data centers may also be subject to break-ins, sabotage and intentional acts of vandalism, and to potential disruptions if the operators of these facilities have financial difficulties. Some of our systems are not fully redundant, and our recently implemented disaster recovery planning may not account for all eventualities. The occurrence of a natural disaster, a decision to close a facility we are using without adequate notice for financial reasons or other unanticipated problems at our data centers could result in lengthy interruptions in our service. Delays or interruptions in our service may cause our users, advertisers, partners, customers and/or artists to become dissatisfied with our offerings and could adversely affect our business.

Furthermore, third party service providers may experience an interruption in operations or cease operations for any reason. If we are unable to agree on satisfactory terms for continued data center hosting relationships, we would be forced to enter into a relationship with other service providers or assume hosting responsibilities ourselves. If we are forced to switch hosting facilities, we may not be successful in finding an alternative service provider on acceptable terms or in hosting the computer servers ourselves. We may also be limited in our remedies against these providers in the event of a failure of service. We also rely on third parties to provide certain components of our technology platform, such as hardware and software providers, and to serve as operators for our content delivery networks, or CDNs. A failure or limitation of service or available capacity by any of these third party providers could adversely affect our business, financial condition and results of operations.

We rely on technology infrastructure and a failure to update or maintain this technology infrastructure, or difficulty scaling and adapting our existing technology and network infrastructure to accommodate increased traffic, could adversely affect our business.

Significant portions of our content, products and services are dependent on technology infrastructure that was developed over multiple years. To be successful, our network infrastructure has to perform well and be reliable. The greater the user traffic and the greater the complexity of our products and services, the more computing power we will need. In the future, we may spend substantial amounts to purchase or lease data centers and equipment, upgrade our technology and network infrastructure to handle increased traffic on our online properties and roll out new products and services. Updating and replacing our technology infrastructure could be challenging to implement and manage, take time to test and deploy, cause us to incur substantial costs, cause us to suffer data loss, delays or interruptions in service or result in inefficiencies or operational failures. If we do not successfully update our technology and network infrastructure as needed, or if we experience inefficiencies and operational failures during such updates, the quality of our products and services and our users’ experience could decline. This could damage our reputation and lead us to lose current and potential users, advertisers, partners, customers and artists. Failure to update our technology infrastructure as new technologies become available may also put us in a weaker position relative to a number of our key competitors. Competitors with newer technology infrastructure may have greater flexibility and be in a position to respond more quickly than us to new opportunities, which may impact our competitive position in certain markets and adversely affect our business. The costs associated with any adjustments to our technology and network infrastructure could also harm our operating results. Cost increases, loss of traffic or failure to accommodate new technologies could harm our business, revenue and financial condition.


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Regulations concerning privacy and protection of data could subject us to claims or otherwise harm our business and changes in these regulations could diminish the value of our services and cause us to lose visitors and revenue.

 

We receive, process and store large amounts of personally identifiable data, or personal data, from users of our online properties, including our marketplaces, freelance professionals who provide services to us and artists who post artwork or designs on our marketplaces. When a user visits one of our websites or certain pages of our content channel customers’ websites, we use technologies, including “cookies,” to collect information related to the user, such as the user’s Internet Protocol, or IP, address, demographic information, and history of the user’s interactions with content or advertisements previously delivered by us. The information that we collect about our users helps us deliver content and advertising targeted to these users.

 

We post privacy policies on all of our owned and operated websites.  These privacy policies set forth our policies and practices related to the collection, use, sharing, disclosure and protection of personal data. The storing, sharing, use, disclosure and protection of personal information and user data are subject to federal and state privacy laws as well as the privacy and data protection requirements of foreign countries that govern the collection, use, retention, sharing and security of personal data  and other information that we receive from and about our users.

 

The European Community, in particular pursuant to Directive 95/46/EC, or the Directive, has required European Union member states to implement data protection laws to meet the strict privacy requirements of the Directive.  Among other requirements under the Directive, the Directive regulates transfers of personally identifiable data that is subject to the Directive, or Directive Personal Data, to third countries, such as the United States, that have not been found to provide adequate protection to such Directive Personal Data.  We have in the past relied upon adherence to the U.S. Department of Commerce’s Safe Harbor Privacy Principles and compliance with the U.S.-EU and U.S.-Swiss Safe Harbor Frameworks as agreed to and set forth by the U.S. Department of Commerce, and the European Union and Switzerland, which established a means for legitimizing the transfer of Directive Personal Data by data controllers in the European Economic Area, or the EEA, to the United States. As a result of the October 6, 2015 European Union Court of Justice opinion in Case C-362/14 (Schrems v. Data Protection Commissioner) regarding the adequacy of the U.S.-EU Safe Harbor Framework, the U.S.-EU Safe Harbor Framework is no longer deemed to be a valid method of compliance with requirements set forth in the Directive (and member states’ implementations thereof) regarding the transfer of Directive Personal Data outside of the EEA.

Recently, negotiators from the European Union and United States reached an agreement on a successor to the U.S.-EU Safe Harbor frameworks, referred to as the EU-U.S. Privacy Shield, and negotiators from Switzerland and the United States reached agreement on the Swiss-U.S. Privacy Shield. We recently registered for the EU-U.S. Privacy Shield and we intend to register for the Swiss-U.S. Privacy Shield shorty after it becomes open for registration. However, the future of these programs as means of legitimizing cross-border data transfers remains uncertain since the EU-U.S. Privacy Shield has already been subject to legal challenges that are not yet resolved and we cannot rule out the possibility that the Swiss-U.S. Privacy Shield will also be subject to a legal challenge. If either the EU-U.S. Privacy Shield or the Swiss-U.S. Privacy Shield is invalidated, we would have to implement an alternative mechanism for legitimizing our cross-border transfers of Directive Personal Data.

 

We may also experience hesitancy, reluctance, or refusal by European or multi-national customers to continue to use our services due to the potential risk exposure to such customers as a result of the current data protection obligations imposed on them by certain data protection authorities. Such customers may also view any alternative approaches to compliance as being too costly, burdensome, legally uncertain or otherwise objectionable and therefore decide not to do business with us.  We may find it necessary to establish systems to maintain personal data originating from the European Union in the EEA, which may involve substantial expense and may cause us to need to divert resources from other aspects of our business, all of which may adversely affect our business.

 

The Directive will be replaced in time with the European General Data Protection Regulation, which may impose additional obligations and risk upon our business and which may substantially increase the penalties to which we could be subject in the event of any non-compliance. We may incur substantial expense in complying with the new obligations to be imposed by the European General Data Protection Regulation and we may be required to make significant changes in our business operations, all of which may adversely affect our revenues and our business overall.

 


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Existing privacy-related laws and regulations in the United States and in foreign countries are evolving and subject to potentially differing interpretations. In addition, new laws may be enacted, new industry self-regulation may be promulgated, or existing laws may be amended or re-interpreted, in a manner that limits our ability to analyze user data. If requirements regarding the manner in which certain personal information and other user data are processed and stored change significantly, our business may be adversely affected, impacting our financial condition and results of operations. In addition, we may be exposed to potential liabilities as a result of differing views on the level of privacy required for consumer and other user data we collect. Any failure, or perceived failure, by us or various third party vendors and service providers to comply with applicable privacy policies or with industry standards or laws or regulations could result in a loss of consumer confidence in us, or result in actions against us by governmental entities or others, all of which could potentially cause us to lose consumers and revenue.

 

We may also need to expend significant resources to protect against security breaches, including encrypting personal information, or remedy breaches after they occur, including notifying each person whose personal data may have been compromised and offering to provide credit monitoring services. In the event of any data breach, we may be subject to regulatory investigations, fines and lawsuits.  We may also lose actual and potential business in the event of any data security breach.

Third parties may sue us for intellectual property infringement or misappropriation or make similar claims which, if successful, could require us to pay significant damages, incur expenses or curtail our offerings.

We cannot be certain that our internally developed or acquired systems and technologies, as well as the content or designs available on our marketplace and media properties do not, and will not, infringe the intellectual property rights of others. In addition, we license content, software and other intellectual property rights from third parties and may be subject to claims of infringement or misappropriation if such parties do not possess the necessary intellectual property rights to the products or services they license to us. We have in the past and may in the future be subject to legal proceedings and claims that we have infringed the patent or other intellectual property rights of a third party. These claims sometimes involve patent holding companies or other patent owners who have no relevant product revenue and against whom our own patents may provide little or no deterrence. In addition, third parties may in the future assert intellectual property infringement claims against our customers for whom we have produced content, which we have agreed in certain circumstances to indemnify and defend against such claims. Any intellectual property-related infringement or misappropriation claims, whether or not meritorious, could result in costly litigation and could divert management resources and attention. If we are found liable for infringement or misappropriation, we may be required to enter into licensing agreements, if available on acceptable terms or at all, pay substantial damages or limit or curtail our systems and technologies. Also, any successful lawsuit against us could subject us to the invalidation of our proprietary rights. Moreover, we may need to redesign some of our systems and technologies to avoid future infringement liability. Any of the foregoing could prevent us from competing effectively and increase our costs.

Additionally, our marketplaces allow individuals to sell their artwork or their original designs printed on art prints and other consumer products in the home décor, accessories, and apparel categories. On occasion, the designs or products posted to our online marketplaces, including Society6, Deny Designs or Saatchi Art, may infringe certain copyrights or trademarks or misappropriate the right of publicity of well-known figures. As a result, we may be the subject of letters, lawsuits and takedown notices from rights holders, and the Digital Millennium Copyright Act may not provide safe-harbors for all types of infringing content hosted on these properties. Addressing these types of claims could require us to expend significant time and resources, which could have an adverse impact on our business and results of operations.

We also have perpetual licenses to use the “Saatchi” name in connection with our Saatchi Art marketplace and the “Livestrong.com” name in connection with our Livestrong.com media property, in each case, as permitted by the terms of intellectual property or licensing agreements with third parties who retain the ownership rights to such names. These intellectual property or licensing agreements may be terminated by such third parties if we do not comply with certain requirements contained in the relevant agreements.  If either of these licensing arrangements was terminated, we would experience business disruption and would have to incur significant resources to rebrand the relevant business, which could have an adverse impact on our business, financial condition and results of operations.


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As a creator and a distributor of Internet content, we face potential liability and expenses for legal claims based on the nature and subject matter of the content that we create or distribute, or that are accessible via our media properties. If we are required to pay damages or expenses in connection with these legal claims, our business, financial condition and results of operations may be harmed.

As a creator and distributor of original content and third party provided content, we face potential liability in the United States and abroad based on a variety of theories, including copyright or trademark infringement, defamation, right of publicity, negligence, unlawful practice of a licensed profession and other legal theories based on the nature, creation or distribution of this information, and under various laws, including the Lanham Act and the Copyright Act. We may also be exposed to similar liability in connection with content that we do not create but that is posted to the media properties we own or host for our partners by users and other third parties through forums, comments, personas and other social media features. In addition, it is possible that visitors to the media properties that we own or host for our partners could bring claims against us for losses incurred in reliance upon information provided on such media properties. These claims, regardless of their merit, could divert management time and attention away from our business and result in significant costs to investigate and defend. If we become subject to these or similar types of claims and are not successful in our defense, we may be forced to pay damages, some of which may be substantial. If the content we distribute through our owned and operated media properties or the media properties we host for our partners violates the intellectual property rights of others or gives rise to other legal claims against us, we could be subject to substantial liability, which could have a negative impact on our business, financial condition and results of operations.

Certain U.S. and foreign laws and regulations could subject us to claims or otherwise harm our business.

We are subject to a variety of laws and regulations in the United States and abroad that may subject us to claims or other remedies. Our failure to comply with applicable laws and regulations may subject us to additional liabilities, which could adversely affect our business, financial condition and results of operations. Laws and regulations that are particularly relevant to our business address freedom of expression; information security; privacy and data collection; pricing and fees; employment related matters; online content and the distribution of content, including liability for user reliance on such content; intellectual property rights, including secondary liability for infringement by others; product liability claims; taxation, including VAT and sales tax; online advertising and marketing, including email marketing, unsolicited commercial email, native advertising and sponsored content. See “ — Regulations concerning privacy and protection of data could subject us to claims or otherwise harm our business and changes in these regulations could diminish the value of our services and cause us to lose visitors and revenue.”  

In the United States, Congress has adopted legislation that regulates certain aspects of the Internet, including the Communications Decency Act, the Digital Millennium Copyright Act, the Lanham Act, the CAN-SPAM Act, the Anticybersquatting Consumer Protection Act, the Children’s Online Privacy Protection Act and the Federal Trade Commission Act. Advertising and promotional information presented to visitors on our online properties, our related social media channels and through our other marketing activities are subject to federal and state consumer protection laws and regulations that govern unfair and deceptive practices. Many applicable laws were adopted prior to the advent of the Internet and do not contemplate or address the unique issues of the Internet. Moreover, the applicability and scope of the laws that do address the internet remain uncertain. For example, the laws relating to the liability of providers of online services are evolving. Claims have been either threatened or filed against us under both U.S. and foreign laws for defamation, copyright infringement, patent infringement, privacy violations, cybersquatting, trademark infringement and discrimination. In the future, claims may also be brought against us based on tort law liability and other theories based on our content, products and services or content generated by our users.

We must also comply with certain foreign and U.S. laws and regulations that apply to our international operations. Our business operations in countries outside the United States are subject to a number of U.S. federal laws and regulations, including restrictions imposed by the FCPA and economic and trade sanctions administered by OFAC and the U.S. Commerce Department based on U.S. foreign policy and national security goals against targeted foreign states, organizations and individuals. The FCPA is intended to prohibit bribery of foreign officials or parties and requires public companies in the United States to keep books and records that accurately and fairly reflect those companies’ transactions. OFAC regulations prohibit U.S.-based entities from entering into or facilitating transactions with, for the benefit of, or involving the property of, persons, governments or countries designated by the U.S. government under one or more sanctions regimes, which could include transactions that provide a benefit that is received in an OFAC


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designated country. Additionally, some of the products and services we provide to customers globally may require approval under applicable U.S. export and customs law.

VAT, sales and use, and similar tax laws and rates vary greatly by jurisdiction. We do not collect such taxes in every jurisdiction in which we have sales based on our belief that such taxes are not applicable. Certain jurisdictions in which we do not collect VAT, sales and use, or similar taxes on our sales may assert that such taxes are applicable, which could result in tax assessments, penalties and interest for prior periods for which it was not collected or accrued, and a requirement to collect such taxes in the future. Such tax assessments, penalties and interest, or future requirements, including implementing products and technologies to calculate, collect and remit such taxes, may materially and adversely affect our business, financial condition and operating results.

The costs of compliance with these regulations may increase in the future as a result of changes in the regulations or the interpretation of them. Further, if we fail to comply with applicable laws and regulations, we could be exposed to claims for damages, financial penalties, reputational harm, incarceration of our employees or restrictions on our operations, which could increase our costs of operations, reduce our profits or cause us to forgo opportunities that would otherwise support our growth.

Changes in state, federal or international taxation laws and regulations may adversely affect our business.

Due to the global nature of the internet, it is possible that, although our services and the internet transmissions related to them typically originate in Nevada and California, governments of other states or foreign countries might attempt to regulate our transmissions or levy sales, income or other taxes relating to our activities. Tax authorities at the international, federal, state and local levels are also currently reviewing the appropriate treatment of companies engaged in internet commerce. New or revised international, federal, state or local tax regulations may subject us or our customers to additional sales, income, VAT and other taxes. We cannot predict the effect of current attempts to impose sales, income, VAT or other taxes on commerce over the internet. New or revised taxes and, in particular, additional sales taxes or VAT, would likely increase the cost of doing business online and decrease the attractiveness of advertising and selling goods and services over the internet. New taxes could also create significant increases in internal costs necessary to capture data and collect and remit taxes. Any of these events could have an adverse effect on our business and results of operations.

We may not succeed in expanding our businesses internationally, which may limit our future growth. Additionally, operating internationally exposes us to certain additional risks and operating costs, including the impact of foreign currency fluctuations.

One potential area of growth for our business is international expansion. The artwork and designs sold through our marketplaces are created by a global community of artists and designers and sold to customers around the world. We also own and operate certain foreign language websites. We cannot be certain that we will be successful in marketing our products and services internationally or that our products and services will gain market acceptance in new geographic markets. If we are unable to expand and market our products and services internationally, it could have a negative effect on our future growth prospects.

There are also risks inherent in conducting business in international markets, including the need to localize our products and services to foreign customers’ preferences and customs, difficulties in managing operations due to language barriers, distance, staffing and cultural differences, application of foreign laws and regulations to us, tariffs and other trade barriers, fluctuations in currency exchange rates, establishing management and financial systems and infrastructures, reduced protection for intellectual property rights in some countries, changes in foreign political and economic conditions, and potentially adverse tax consequences. In addition, although we currently present and settle all sales through our online marketplaces in U.S dollars, if foreign currencies decline relative to the U.S. dollar, this may have the impact of making the pricing for the products available on our marketplaces appear higher in the markets with the currency declines. For example, in June 2016, a referendum was passed in the United Kingdom to leave the European Union, commonly referred to as “Brexit”. Following Brexit, the value of the British pound declined, which we believe negatively impacted conversion rates in the United Kingdom due to the impact on product pricing. Operating internationally, where we have limited experience, exposes us to additional risks and operating costs that may outweigh the financial and other benefits of operating in such markets.


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A reclassification by tax authorities of any freelance professionals we currently or have previously contracted with from independent contractors to employees could require us to pay retroactive taxes and penalties and significantly increase our cost of operations.

We previously contracted with freelance professionals to create the substantial majority of the content for our media properties and we continue to contract with freelance professionals for various purposes, including to develop, create and edit content, and otherwise contribute to the content creation process, for our media properties and the media properties we host for our partners. Because we consider the freelance professionals who we contract with or have contracted with to be independent contractors, as opposed to employees, we do not withhold federal or state income or other employment related taxes, make federal or state unemployment tax or Federal Insurance Contributions Act payments, or provide workers’ compensation insurance with respect to such freelance professionals. Our contracts with freelance professionals that are classified as independent contractors obligate the freelance professionals to pay these taxes. The classification of freelance professionals as independent contractors depends on the specific facts and circumstances of each relationship. In the event of a determination by federal or state taxing authorities that any freelance professionals we engage or have engaged as independent contractors are employees, we may be adversely affected and subject to retroactive taxes and penalties. In addition, if the freelance professionals we categorize as independent contractors were deemed to be employees, our costs associated with content creation could increase significantly, we could potentially incur fines, penalties or other damages, and our financial results would be adversely affected.

Risks Relating to Owning Our Common Stock

The trading price of our common stock is likely to be volatile and an active, liquid and orderly market for our common stock may not be sustained.

The trading price of our common stock has been, and is likely to be, highly volatile and could be subject to wide fluctuations in response to various factors, some of which are beyond our control. For example, from the date of our initial public offering in January 2011 through February 22, 2018, our closing stock price, as adjusted for the Distribution and the 1-for-5 reverse stock split, has ranged from $4.05 to $48.75. In addition, we were recently selected to be part of a two-year Tick Size Pilot Program approved by the SEC and implemented by the national securities exchanges and FINRA. The Tick Size Pilot Program commenced in October 2016 and, pursuant to such program, our common stock is now quoted and traded in $0.05 minimum increments. As a result, we have experienced lower average daily trading volume since the launch of the program and could continue to experience such lower trading volume, which could also lead to greater volatility in the trading price of our common stock or a less liquid market for our stock to trade. In addition, an active trading market for our common stock may not be sustained, which could depress the market price of our common stock.

In addition to the factors discussed in this “Risk Factors” section and elsewhere in this report, factors that may cause the trading price of our common stock to be volatile include:

·

our operating performance and the operating performance of similar companies;

·

the overall performance of the equity markets;

·

the number of shares of our common stock publicly owned and available for trading;

·

any major change in our board of directors or management;

·

publication of research reports about us (including, but not limited to, the performance of our business or certain key operating metrics) or our industries or changes in recommendations or withdrawal of research coverage by securities analysts; and

·

general political and economic conditions, including any negative economic effects or instability resulting from the transition to a new presidential administration in the United States, including changes in the political environment and international relations as well as resulting regulatory or tax policy changes.  


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In addition, the stock market in general, and the market for internet-related companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Securities class action litigation has often been instituted against companies following periods of volatility in the overall market and in the market price of a company’s securities. This litigation, if instituted against us, could result in very substantial costs, divert our management’s attention and resources and harm our business, financial condition and results of operation.

The large number of shares of our common stock eligible for public sale could depress the market price of our common stock.

The market price of our common stock could decline as a result of sales of a large number of shares of our common stock in the market, and the perception that these sales could occur may also depress the market price of our common stock. In particular, certain of our existing stockholders are venture funds or investment funds and they may make distributions to their limited and general partners, who then would be free to sell shares of our common stock in the public market. These distributions and/or sales by venture funds or investment funds could cause the trading price of our common stock to decline. As of February 22, 2018, we had 24,461,965 shares of common stock outstanding (excluding shares held in treasury). As of February 22, 2018, we also had over ten million shares of common stock reserved for future issuance under our equity compensation plans, of which approximately four million shares are registered under our registration statement on Form S-8 on file with the SEC. Subject to the satisfaction of applicable exercise periods, vesting requirements and, in certain cases, performance conditions, the shares of registered common stock issued upon exercise of outstanding options, vesting of future awards or pursuant to purchases under our employee stock purchase plan (the “ESPP”) will be available for immediate resale in the open market. We also have previously, and may from time to time in the future, issue shares of our common stock as consideration for acquisitions and investments. If any such acquisition or investment is significant, the number of shares that we may issue may in turn be significant. In addition, certain stockholders, including investors in our preferred stock that converted into common stock in connection with our initial public offering, are eligible to resell shares of common stock under Rule 144 and Rule 701 without registering such shares with the SEC. Sales of our common stock may make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate. These sales could also cause our stock price to fall and make it more difficult for shareholders to sell shares of our common stock.

Our stock repurchase program may be suspended or terminated at any time, which may result in a decrease in the trading price of our common stock.

Our board of directors previously approved a stock repurchase program under which we are authorized to repurchase up to $50.0 million of our common stock, of which approximately $14.3 million remained available as of December 31, 2017. Such stock repurchases may be limited, suspended, or terminated at any time without prior notice. There can be no assurance that we will repurchase additional shares of our common stock under our stock repurchase program or that any future repurchases will have a positive impact on the trading price of our common stock or earnings per share. Important factors that could cause us to limit, suspend or terminate our stock repurchase program include, among others, unfavorable market conditions, the trading price of our common stock, the nature of other investment or strategic opportunities presented to us from time to time, the rate of dilution of our equity compensation programs, the availability of adequate funds, and our ability to make appropriate, timely, and beneficial decisions as to when, how, and whether to purchase shares under the stock repurchase program. If we limit, suspend or terminate our stock repurchase program, our stock price may be negatively affected.

As a public company, we are subject to compliance initiatives that require substantial time from our management and result in significantly increased costs.

The Sarbanes-Oxley Act of 2002, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, and other rules implemented by the SEC and the NYSE, impose various requirements on public companies, including requirements related to certain corporate governance practices. Compliance with these rules and regulations has resulted in significantly increased costs for us as a public company than we incurred as a private company, including substantially higher costs to obtain comparable levels of director and officer liability insurance. Proposed corporate governance laws and regulations under consideration may further increase our compliance costs. If compliance with these various legal and regulatory requirements diverts our management’s attention from other business concerns, it could have a material adverse effect on our business, financial condition and results of operations. Additionally, these


24


 

laws and regulations may make it more difficult for us to attract and retain qualified individuals to serve on our board of directors, on committees of our board of directors, or as executive officers.

We are required to make an assessment of the effectiveness of our internal controls over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002. We are also required to obtain an opinion on the effectiveness of our internal controls over financial reporting from our independent registered public accounting firm. Section 404 requires us to perform system and process evaluation and testing of our internal controls over financial reporting to allow management and our independent registered public accounting firm to report on the effectiveness of our internal controls over financial reporting for each fiscal year. Our testing, or the subsequent testing by our independent registered public accounting firm, may reveal deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses. If we are unable to comply with the requirements of Section 404, management may not be able to assess whether our internal controls over financial reporting are effective, which may subject us to adverse regulatory consequences and could result in a negative reaction in the financial markets due to a loss of confidence in the reliability of our financial statements. In addition, if we fail to maintain effective controls and procedures, we may be unable to provide the required financial information in a timely and reliable manner or otherwise comply with the standards applicable to us as a public company. Any failure by us to provide the required financial information in a timely and reliable manner could materially and adversely impact our financial condition and the trading price of our securities. In addition, we may incur additional expenses and commitment of management’s time in connection with further assessments of our compliance with the requirements of Section 404, which could materially increase our operating expenses and adversely impact our results of operations.

If securities or industry analysts publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.

The trading market for our common stock will depend in part on the research and reports that securities or industry analysts publish about us or our business. If one or more of the analysts who cover us downgrade our stock or publish inaccurate or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts ceases to cover us or fails to publish reports on us regularly, demand for our stock could decrease, which might cause our stock price and trading volume to decline.

We do not anticipate paying cash dividends and, accordingly, stockholders must rely on stock appreciation for any return on their investment.

We have never declared or paid cash dividends on our common stock and we do not anticipate paying cash dividends in the future. As a result, only appreciation of the price of our common stock, which may never occur, will provide a return to stockholders. Investors seeking cash dividends should not invest in our common stock.

Certain provisions in our charter documents and Delaware law could discourage takeover attempts and lead to management entrenchment.

Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that could have the effect of delaying or preventing changes in control or changes in our management without the consent of our board of directors, including, among other things:

·

a classified board of directors with three-year staggered terms, which may delay the ability of stockholders to change the membership of a majority of our board of directors;

·

no cumulative voting in the election of directors, which limits the ability of minority stockholders to elect director candidates;

·

the ability of our board of directors to determine to issue shares of preferred stock and to determine the price and other terms of those shares, including preferences and voting rights, without stockholder approval, which could be used to significantly dilute the ownership of a hostile acquiror;


25


 

·

the exclusive right of our board of directors to elect a director to fill a vacancy created by the expansion of our board of directors or the resignation, death or removal of a director, which prevents stockholders from being able to fill vacancies on our board of directors;

·

a prohibition on stockholder action by written consent, which forces stockholder action to be taken at an annual or special meeting of our stockholders;

·

the requirement that a special meeting of stockholders may be called only by the chairman of our board of directors, the Chief Executive Officer, the president (in absence of a Chief Executive Officer) or our board of directors, which may delay the ability of our stockholders to force consideration of a proposal or to take action, including the removal of directors;

·

the requirement for the affirmative vote of holders of at least 66 2/3% of the voting power of all of the then outstanding shares of the voting stock, voting together as a single class, to amend the provisions of our amended and restated certificate of incorporation relating to the issuance of preferred stock and management of our business or our amended and restated bylaws, which may inhibit the ability of an acquiror from amending our certificate of incorporation or bylaws to facilitate a hostile acquisition;

·

the ability of our board of directors, by majority vote, to amend the bylaws, which may allow our board of directors to take additional actions to prevent a hostile acquisition and inhibit the ability of an acquiror from amending the bylaws to facilitate a hostile acquisition; and

·

advance notice procedures that stockholders must comply with in order to nominate candidates to our board of directors or to propose matters to be acted upon at a stockholders’ meeting, which may discourage or deter a potential acquiror from conducting a solicitation of proxies to elect the acquiror’s own slate of directors or otherwise attempting to obtain control of us.

We are also subject to certain anti-takeover provisions under Delaware law. Under Delaware law, a corporation may not, in general, engage in a business combination with any holder of 15% or more of its capital stock unless the holder has held the stock for three years or, among other things, our board of directors has approved the transaction.

Item 1B.Unresolved Staff Comments

None.

Item 2.Properties

We do not own any real estate. We currently occupy approximately 52,000 square feet of office space in a Santa Monica, California facility that serves as our corporate headquarters. 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. We also occupy approximately 25,500 square feet of office and manufacturing space in Denver, Colorado in connection with the operations of Deny Designs. The lease for our Colorado facility expires in October 2021. In addition, we occupy a small office in London, United Kingdom in connection with the operations of The Other Art Fair, and we have arrangements for shared office space to supplement the needs of our business in locations outside of our corporate headquarters. Our primary data center is located in Las Vegas, Nevada. We believe that our current data centers and office facilities will be adequate for the foreseeable future.

Item 3.Legal Proceedings

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  


26


 

threatened legal proceedings to which we are a party, either individually or in the aggregate, will have a material adverse effect on our future financial results. However, the outcome of such legal matters is subject to significant uncertainties.

Item 4.Mine Safety Disclosures

Not applicable.


27


 

PART II

Item 5.        Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

Our common stock is listed and traded on the NYSE under the symbol “LFGR”. Prior to November 9, 2016, our common stock was listed and traded on the NYSE under the symbol “DMD”. The following table sets forth, for the periods indicated and on a per-share basis, the high and low daily closing sales prices of our common stock as reported by the NYSE.

 

 

 

 

 

 

 

 

 

    

High

    

Low

 

Fiscal Year end December 31, 2017

 

 

 

 

 

 

 

First Quarter

 

$

8.35

 

$

6.30

 

Second Quarter

 

$

8.70

 

$

7.05

 

Third Quarter

 

$

7.75

 

$

6.45

 

Fourth Quarter

 

$

10.10

 

$

7.00

 

 

 

 

 

 

 

 

 

 

 

 

    

High

    

Low

 

Fiscal Year end December 31, 2016

 

 

 

 

 

 

 

First Quarter

 

$

5.50

 

$

4.41

 

Second Quarter

 

$

6.26

 

$

5.07

 

Third Quarter

 

$

5.91

 

$

5.25

 

Fourth Quarter

 

$

7.00

 

$

5.45

 

Holders of Record

As of February 22, 2018, our common stock was held by 36 stockholders of record. A substantially greater number of holders of our common stock are “street name” holders, or beneficial holders, whose shares are held of record by banks, brokers and other financial institutions.

Dividend Policy

We have never declared or paid cash dividends on our common stock. We currently do not anticipate paying any cash dividends in the foreseeable future. Instead, we anticipate that all of our earnings will be used to provide working capital, to support our operations and to finance the growth and development of our business. Any future determination to declare cash dividends will be made at the discretion of our board of directors and will depend on our financial condition, results of operations, capital requirements, any applicable debt covenant requirements, general business conditions and other factors that our board of directors may deem relevant.

Performance Graph

The following performance graph shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), or incorporated by reference into any filing of Leaf Group under the Securities Act of 1933, as amended (the “Securities Act”), except as shall be expressly set forth by specific reference in such filing.

The graph compares the cumulative total return of our common stock for the five-year period starting on December 31, 2012, and ending on December 31, 2017, with that of the S&P 500 Index and RDG Internet Composite Index over the same period. The graph assumes that the value of the investment was $100 on December 31, 2012, and


28


 

that all dividends and other distributions were reinvested. Such returns are based on historical results and are not intended to suggest future performance.

Picture 7

Unregistered Sales of Equity Securities and Use of Proceeds

We did not issue or sell any equity securities that were not registered under the Securities Act during the three months ended December 31, 2017.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

As disclosed in our current report on Form 8-K filed on August 22, 2011, our board of directors approved a stock repurchase program authorizing us to repurchase up to $25.0 million of our outstanding common stock, effective as of August 19, 2011. Our board of directors subsequently approved a $25.0 million increase to this stock repurchase program, for an aggregate authorized repurchase amount of $50.0 million, as disclosed in a current report on Form 8-K filed on February 16, 2012. In total, as of December 31, 2017, we had spent approximately $35.7 million of the authorized $50.0 million to repurchase shares of our common stock under the stock repurchase program. The stock repurchase program does not require us to purchase a specific number of shares, and the timing and actual number of shares repurchased will depend on various factors including price, corporate and regulatory requirements, any applicable debt covenant requirements, alternative investment opportunities and other market conditions. Stock repurchases may be effected through negotiated transactions or open market purchases, including pursuant to a trading plan implemented pursuant to Rule 10b5-1 of the Exchange Act. The stock repurchase program does not have an expiration date but may be suspended, modified or discontinued at any time without prior notice. We did not repurchase any of our common stock during the three months ended December 31, 2017.

 


29


 

 

Item 6. Selected Financial Data

The consolidated statement of operations data for the years ended December 31, 2017, 2016 and 2015, as well as the consolidated balance sheet data as of December 31, 2017 and 2016, are derived from our audited consolidated financial statements that are included elsewhere in this Annual Report on Form 10-K. The consolidated statement of operations data for the years ended December 31, 2014 and 2013, as well as the consolidated balance sheet data as of December 31, 2015, 2014 and 2013, are derived from audited consolidated financial statements not included in this Annual Report on Form 10-K. The historical results presented below are not necessarily indicative of financial results to be achieved in future periods.

The following selected consolidated financial data should be read in conjunction with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year ended December 31,

 

 

    

2017(1)

    

2016(1)

    

2015(1)

    

2014(1)

    

2013(1)

 

 

 

(In thousands, except per share data)

 

Consolidated Statement of Operations:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total revenue

 

$

128,990

 

$

113,452

 

$

125,969

 

$

172,429

 

$

209,411

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Product costs (exclusive of amortization of intangible assets)

 

 

56,292

 

 

42,081

 

 

33,769

 

 

26,058

 

 

9,882

 

Service costs (exclusive of amortization of intangible assets)

 

 

21,810

 

 

25,434

 

 

37,481

 

 

43,553

 

 

51,274

 

Sales and marketing

 

 

28,297

 

 

26,654

 

 

21,041

 

 

20,624

 

 

36,275

 

Product development

 

 

18,613

 

 

19,964

 

 

26,315

 

 

37,674

 

 

32,185

 

General and administrative

 

 

29,591

 

 

30,704

 

 

35,428

 

 

41,086

 

 

53,014

 

Goodwill impairment charge(2)

 

 

 —

 

 

 —

 

 

 —

 

 

232,270

 

 

 —

 

Amortization of intangible assets

 

 

5,728

 

 

10,900

 

 

18,706

 

 

38,316

 

 

36,519

 

Total operating expenses

 

 

160,331

 

 

155,737

 

 

172,740

 

 

439,581

 

 

219,149

 

Loss from operations

 

 

(31,341)

 

 

(42,285)

 

 

(46,771)

 

 

(267,152)

 

 

(9,738)

 

Interest income

 

 

195

 

 

96

 

 

361

 

 

328

 

 

 5

 

Interest expense

 

 

(5)

 

 

(4)

 

 

(143)

 

 

(4,692)

 

 

(1,642)

 

Other (expense) income, net

 

 

(19)

 

 

40,172

 

 

3,107

 

 

654

 

 

13

 

Loss from continuing operations before income taxes

 

 

(31,170)

 

 

(2,021)

 

 

(43,446)

 

 

(270,862)

 

 

(11,362)

 

Income tax benefit (expense)(2)

 

 

37

 

 

10

 

 

(55)

 

 

14,713

 

 

(2,856)

 

Net loss from continuing operations

 

 

(31,133)

 

 

(2,011)

 

 

(43,501)

 

 

(256,149)

 

 

(14,218)

 

Net loss from discontinued operations(3)

 

 

 —

 

 

 —

 

 

 —

 

 

(11,208)

 

 

(5,956)

 

Net loss

 

 

(31,133)

 

 

(2,011)

 

 

(43,501)

 

 

(267,357)

 

 

(20,174)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per share - basic and diluted

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss from continuing operations

 

$

(1.52)

 

$

(0.10)

 

$

(2.18)

 

$

(13.66)

 

$

(0.80)

 

Net loss from discontinued operations

 

 

 —

 

 

 —

 

 

 —

 

 

(0.60)

 

 

(0.34)

 

Net loss per share - basic and diluted

 

$

(1.52)

 

$

(0.10)

 

$

(2.18)

 

$

(14.26)

 

$

(1.14)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares - basic and diluted (4)(5)

 

 

20,501

 

 

20,152

 

 

19,938

 

 

18,745

 

 

17,707

 


(1)

We completed one business acquisition during each of the years ended December 31, 2017, 2016 and 2014 and two business acquisitions during the year ended December 31, 2013. Excluding the dispositions of non-core media properties, we completed one business disposition during each of the years ended December 31, 2016 and 2015 and two business dispositions during the year ended December 31, 2014.

(2)

During the year ended December 31, 2014, we recorded a pre-tax impairment charge of $232.3 million on the carrying value of our goodwill based on the results of an interim assessment of impairment of the goodwill in our media reporting unit. This resulted in a reduction of tax amortization of goodwill from the impairment of goodwill and the corresponding valuation allowance.

(3)

Discontinued operations for the periods presented relate to the reclassification of the Rightside operations to discontinued operations during 2014.


30


 

(4)

In June 2014, our stockholders approved a 1-for-5 reverse stock split of our outstanding common stock, which was effected in August 2014. Accordingly, all share and per share amounts for all periods presented prior to the 1-for-5 reverse stock split have been adjusted retrospectively, where applicable, to reflect this reverse stock split.

(5)

Basic net income (loss) per share is computed by dividing the net income (loss) attributable to common stockholders by the weighted average number of common shares outstanding during the period. For the periods where we presented losses, all potentially dilutive common shares comprised of stock options, restricted stock units and warrants are antidilutive. Restricted stock units are considered outstanding common shares and included in the computation of basic earnings per share as of the date that all necessary conditions of vesting are satisfied. Restricted stock units are excluded from the diluted earnings per share calculation when their impact is antidilutive. Prior to satisfaction of all conditions of vesting, unvested restricted stock units are considered contingently issuable shares and are excluded from weighted average common shares outstanding.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31,

 

 

    

2017

    

2016

    

2015

    

2014

    

2013

 

 

 

(In thousands)

 

Consolidated Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents and marketable securities

 

$

31,344

 

$

50,864

 

$

38,570

 

$

47,820

 

$

153,511

 

Working capital

 

$

21,522

 

$

46,204

 

$

33,953

 

$

37,215

 

$

91,048

 

Total assets

 

$

83,242

 

$

101,252

 

$

101,459

 

$

149,555

 

$

777,088

 

Long-term debt

 

$

 —

 

$

 —

 

$

 —

 

$

 —

 

$

96,250

 

Capital lease obligations, long-term

 

$

35

 

$

103

 

$

 —

 

$

 —

 

$

61

 

Total stockholders' equity

 

$

58,520

 

$

79,750

 

$

79,120

 

$

114,842

 

$

496,005

 

Non-GAAP Financial Measures

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

Adjusted EBITDA is one of the primary measures used by our management and board of directors to understand and evaluate our financial performance and operating trends, including period-to-period comparisons, because it excludes certain expenses and gains that management believes are not indicative of our core operating results. Management believes that the exclusion of these expenses and gains provides a useful measure for period-to-period comparisons of our underlying core revenue and operating costs that is focused more closely on the current costs necessary to operate our businesses and reflects our ongoing business in a manner that allows for meaningful analysis of trends. In addition, management believes that excluding certain non-cash charges can be useful because the amounts of such expenses is the result of long-term investment decisions made in previous periods rather than day-to-day operating decisions. Adjusted EBITDA is also one of the primary measures management uses to prepare and update our short and long term financial and operational plans and to evaluate investment decisions. We also frequently use Adjusted EBITDA in our discussions with investors, commercial bankers, equity research analysts and other users of our financial statements. 

Accordingly, we believe that Adjusted EBITDA provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management and in comparing operating results across periods and to those of our peer companies. However, the use of Adjusted EBITDA has certain limitations because it does not reflect all items of income and expense that affect our operations. We compensate for these limitations by reconciling Adjusted EBITDA to net income (loss), the most comparable GAAP financial measure. Further, Adjusted EBITDA does not have a standardized meaning, and therefore other companies, including peer companies, may use the same or similarly named measures but exclude different items or use different computations, so comparability may be limited. Adjusted EBITDA should be considered in addition to, and not as a substitute for, measures prepared in accordance with GAAP. We encourage investors and others to review our financial information in its entirety and not rely on a single financial measure.


31


 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year ended December 31,

 

 

    

2017

    

2016

    

2015

    

2014

    

2013

 

Net loss

 

$

(31,133)

 

$

(2,011)

 

$

(43,501)

 

$

(267,357)

 

$

(20,174)

 

Less: Net loss from discontinued operations, net of taxes

 

 

 —

 

 

 —

 

 

 —

 

 

(11,208)

 

 

(5,956)

 

Net loss from continuing operations

 

 

(31,133)

 

 

(2,011)

 

 

(43,501)

 

 

(256,149)

 

 

(14,218)

 

Add (deduct):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income tax (benefit) expense

 

 

(37)

 

 

(10)

 

 

55

 

 

(14,713)

 

 

2,856

 

Interest (income) expense, net

 

 

(190)

 

 

(92)

 

 

(218)

 

 

4,364

 

 

1,637

 

Other expense (income), net(1)

 

 

19

 

 

(40,172)

 

 

(3,107)

 

 

(654)

 

 

(13)

 

Depreciation and amortization(2)

 

 

11,803

 

 

18,090

 

 

29,884

 

 

50,567

 

 

50,976

 

Stock-based compensation(3)

 

 

8,565

 

 

7,779

 

 

7,562

 

 

18,866

 

 

22,603

 

Goodwill impairment charge

 

 

 —

 

 

 —

 

 

 —

 

 

232,270

 

 

 —

 

Acquisition, disposition and realignment costs(4)

 

 

299

 

 

1,396

 

 

2,488

 

 

2,905

 

 

529

 

Adjusted EBITDA

 

$

(10,674)

 

$

(15,020)

 

$

(6,837)

 

$

37,456

 

$

64,370

 


(1)

Primarily consists of income from the disposition of certain businesses, including Cracked for the year ended December 31, 2016, and other online properties.

(2)

Represents depreciation expense of our long-lived tangible assets and amortization expense of our finite-lived intangible assets, including amortization expense related to our investment in media content assets, included in our GAAP results of operations. Amortization expense for the years ended December 31, 2017, 2016, 2015, 2014, and 2013 includes $0.7 million, $1.9 million, $3.4 million, $7.7 million and $3.1 million, respectively, of accelerated non-cash amortization expense associated with the removal of certain media content intangible assets from service during those years.

(3)

Represents the fair value of stock-based awards and certain warrants to purchase our stock included in our GAAP results of operations.

(4)

Acquisition, disposition and realignment costs include such items, when applicable, as (a) legal, accounting and other professional service fees directly attributable to acquisition, disposition or corporate realignment activities, (b) employee severance and other payments attributable to acquisition, disposition or corporate realignment activities, and (c) expenditures related to the separation of Leaf Group into two distinct publicly traded companies. Management does not consider these costs to be indicative of our core operating results.

 

 


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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with Part II, Item 6, “Selected Financial Data” and our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. In addition to historical data, this discussion contains forward-looking statements about our business, operations and financial performance based on current expectations that involve risks, uncertainties and assumptions. Our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including but not limited to those discussed in “Special Note Regarding Forward-Looking Statements” and Item I, Part 1A, “Risk Factors” included elsewhere in this Annual Report on Form 10-K.

Overview

Leaf Group is a diversified consumer internet company. We build enduring, creator-driven brands that reach passionate audiences in large and growing lifestyle categories, including art and design, fitness and wellness, home and décor, do-it-yourself projects and crafts, 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 in the home décor, accessories, and apparel categories. Our fine art marketplace, Saatchi Art, inclusive of SaatchiArt.com and its complementary art fair event brand, The Other Art Fair (collectively, “Saatchi Art”), is a leading fine art marketplace where over 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. 

Our Marketplaces segment primarily generates revenue from the sale of products and services through our art and design marketplaces. On Society6 and Deny Designs, revenue is generated from the sale of made-to-order products. Saatchi Art primarily generates revenue through commissions on the final sale price of original works of art and from various sources relating to the hosting of art fairs, including commissions from the sale of original art, fees paid by artists for stands and sponsorship opportunities.

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 fitness, health and wellness destination; Hunker, a home and space inspiration destination; Cuteness.com, an online community for pet owners and animal lovers; eHow, a do-it-yourself reference destination; and over 40 other media properties focused on specific categories or interests that we either own and operate or host and operate for our partners. In 2016, we launched several category-specific properties leveraging topics and content from eHow because we feel that more narrowly focused media properties now resonate better with audiences. As a result of migrating categories of content onto new media properties, eHow.com has narrowed its focus on informative and entertaining projects for do-it-yourself enthusiasts.

We believe that there are opportunities to increase the number of visits to our media properties from direct visits, social media platforms and search engine referrals by building high-quality products that provide a better user experience and lead to increased engagement across distribution channels. For example, Livestrong.com has seen sustained growth in traffic over the last two years. We have also seen increases in traffic when we moved certain category-specific content from eHow.com and other content from our content library to new vertically focused media


33


 

properties, including Hunker.com, Cuteness.com, Techwalla.com, LEAF.tv and Sapling.com. In order to improve the quality of our products, we continually redesign and update our websites; refine our content library; rationalize ad unit density; and develop a greater variety of content formats, particularly video content and formats better suited for mobile devices and consumption on other platforms. We are also working with a curated network of contributors and influencers to create more authoritative and engaging content and we are focused on building strong followings on various social media platforms such as Facebook and Pinterest, where we also publish our content. Although these changes result in initial increased operating expenses and lower revenue, we believe that by providing consumers with an improved user and content experience, we will be able to continue to increase the number of visits and revenue in a sustained fashion over the long-term. We also believe that there are opportunities to increase our advertising revenue by continuing to optimize our ad product stack, increasing branded ad sales through direct sellers and offering more innovative products such as native advertisements and sponsored content in order to increase the overall ad unit rates we receive from our advertising partners. 

Historically, the majority of our advertising revenue has been generated by our relationship with Google. While Google continues to be our primary advertising vendor for advertising monetization, we have been significantly diversifying our monetization partners and expect to continue to do so in the future. Google also serves as one of our primary technology platform partners in connection with our programmatic advertising sales offering. Any change in the type of services that Google provides to us, or to the terms of our agreements with Google, could adversely impact our results of operations.  

Sale of Cracked Business

In April 2016, we completed the sale of substantially all of the assets relating to our Cracked business, including the Cracked.com humor website, to Scripps Media, Inc., a subsidiary of The E.W. Scripps Company, for a cash purchase price of $39.0 million. A portion of the purchase price equal to $3.9 million was placed into escrow at closing to secure certain of our post-closing indemnification obligations. In July 2017, the full escrow amount of $3.9 million was released and paid to us following the expiration of the indemnification period. Revenue for the Cracked business for the years ended December 31, 2016 (through the sale date of April 12, 2016) and 2015 was $1.8 million and $10.9 million, respectively. The Cracked business had a pre-tax loss of $1.9 million for the year ended December 31, 2016 (through the sale date of April 12, 2016) and pre-tax income of $3.1 million for the year ended December 31, 2015, excluding allocations for corporate costs and including stock-based compensation expense resulting from the sale.

Content Studio Realignment

In June 2016, we took certain actions to streamline our content publishing studio business and better integrate the business into our broader Media segment. As part of this realignment, we reduced the staffing within this business by 35 full-time employees and integrated the remaining employees into our other Media businesses.   

Revenue

For the years ended December 31, 2017, 2016 and 2015, we reported revenue of $129.0 million, $113.5 million and $126.0 million, respectively. For the years ended December 31, 2017, 2016 and 2015, our Marketplaces revenue accounted for 65%, 58% and 41% of our total revenue, respectively, and our Media revenue accounted for 35%, 42% and 59% of our total revenue, respectively.

The revenue generated by our Marketplaces segment has higher costs associated with it as compared to our Media segment due to variable product costs, including outsourced product manufacturing costs, artist payments, marketing costs, and shipping and handling costs. During the year ended December 31, 2017, a higher percentage of our total revenue was generated by our Marketplaces segment as compared to the prior year. If our revenue sources continue to shift from our Media segment to our Marketplaces segment, our total costs relative to our revenue will be negatively impacted.


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Follow-on Public Offering of Common Stock

 

On February 12, 2018, we completed an underwritten registered public offering of 3,373,332 shares of our common stock, including full exercise of the underwriter’s option to purchase additional shares of common stock, at a public offering price of $7.50 per share. We received aggregate net proceeds from the offering of approximately $23.3 million, after deducting the underwriting discounts and commissions and estimated offering expenses payable by Leaf Group. We intend to use the net proceeds from the offering for working capital and general corporate purposes. We may also use a portion of the net proceeds to acquire or invest in complementary businesses, products and technologies, although we have no specific agreements, commitments or understandings to do so at this time. 

Key Business Metrics

We regularly review a number of business metrics, including the following key metrics, to evaluate our business, measure the performance of our business model, identify trends impacting our business, determine resource allocations, formulate financial projections and make strategic business decisions. Measures which we believe are the primary indicators of our performance are described below. We believe that the number of transactions, average revenue per transaction, number of visits and revenue per visit are currently the key metrics for understanding our results of operations. We believe that video views and social media followers are currently key metrics because we believe that these are key areas of growth in digital media, and that we can expand our audience and grow traffic by increasing our followers on social media platforms and creating highly sharable content such as videos.  

Marketplaces Metrics

·

Number of transactions: We define transactions as the total number of transactions successfully completed by a customer during the applicable period, excluding certain transactions generated by Saatchi Art’s The Other Art Fair that primarily relate to the hosting of the art fairs, such as sales of leased space to artists, sponsorships and tickets.

·

Average revenue per transaction: We calculate average revenue per transaction by dividing total revenue, excluding certain revenue generated by Saatchi Art that primarily relate to the hosting of the art fairs, such as fees paid by artists for leased space, fees paid for sponsorship opportunities and fair ticket sales, by the number of transactions initiated in that period.

Media Metrics

·

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

·

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

·

Video Views: We define video views as the total number of views of all of our media videos on Facebook and YouTube, or on Leaf Group sites or third party sites via YouTube or any other embedded video player, during the applicable period. We include in this metric (i) views of videos published by any of our media properties, including Livestrong.com, eHow, category-specific sites and international sites; and (ii) videos viewed on multiple YouTube channels affiliated with our properties.

Social Media Metrics

·

Social Media Followers: We define social media followers as the sum of all Facebook, Pinterest, Instagram and Twitter followers, as well as all YouTube subscribers, across our Marketplaces or Media properties, as applicable, as of the last day of the relevant period. Social Media Followers includes subscribers for multiple YouTube channels affiliated with our properties. Individuals are counted more than once if they follow


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multiple properties or the same property on multiple platforms, or if they subscribe to multiple YouTube channels.

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

% Change

 

% Change

 

 

 

2017

 

2016

 

2015

 

 

2017

 

2016

 

Marketplaces Metrics(1)(2)(3):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Number of Transactions

 

 

1,448,211

 

 

1,185,272

 

 

925,111

 

 

22

%

 

28

%  

 

Average Revenue per Transaction

 

$

56.98

 

$

55.38

 

$

56.38

 

 

 3

%

 

(2)

%  

 

Media Metrics(3)(4):

    

 

 

    

 

 

    

 

 

 

 

 

 

 

 

    

 

Visits (in thousands)

 

 

2,794,244

 

 

2,729,990

 

 

3,374,385

 

 

 2

%

 

(19)

%

 

Revenue per Visit

 

$

16.06

 

$

17.33

 

$

21.87

 

 

(7)

%

 

(21)

%

 

Video Views (in thousands)

 

 

820,568

 

 

638,277

 

 

N/A(5)

 

 

29

%

 

N/A

(5)

 

Social Metrics (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Social Media Followers - Marketplaces(2)

 

 

2,757

 

 

2,074

 

 

N/A(6)

 

 

33

%

 

N/A

(6)

 

Social Media Followers - Media

 

 

15,036

 

 

12,339

 

 

N/A(6)

 

 

22

%

 

N/A

(6)

 


(1)

Marketplaces Metrics excludes certain revenue or transactions generated by Saatchi Art’s The Other Art Fair that primarily relate to the hosting of the art fairs, such as sales of leased space to artists, sponsorships and tickets.

(2)

Marketplaces Metrics and Social Media Followers for prior period metrics have been revised to conform to current period presentation to include Saatchi Art’s The Other Art Fair acquired in July 2016.

(3)

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

(4)

Media Metrics include visits and revenue generated by Cracked.com and other non-core media properties prior to their respective disposition dates and are not adjusted to be shown on a pro forma basis.

(5)

Video Views for the year ended December 31, 2015 are not available because we did not start formally tracking this metric for all media properties until the third quarter of 2015.

(6)

We did not track Social Media Followers across all platforms prior to the third quarter of 2016. As of December 31, 2015, our Marketplaces properties had 0.8 million total Social Media Followers on Facebook and YouTube, respectively, and our Media properties had 10.3 million total Social Media Followers on Facebook and YouTube, respectively.

Basis of Presentation

Revenue

Our revenue is primarily derived from products and services sold through our art and design marketplaces and from sales of advertising.  

Product Revenue

We recognize product revenue from sales of products when the title and risk of loss transfers to the customer, net of sales allowances and estimated returns based on historical experience. Payments received in advance of shipment are included in deferred revenue in the accompanying consolidated balance sheets. Product revenue is recorded at the gross amount due to the following factors: we are the primary obligor in a transaction, we have inventory and credit risk, and we have latitude in establishing prices and selecting suppliers. We record revenue net of any incentive offers periodically provided to customers to encourage purchases, including percentage discounts off current purchases, free shipping and other offers. Value-added taxes (“VAT”), sales tax and other taxes are not included in product revenue because we are a pass-through conduit for collecting and remitting any such taxes.  

During the first quarter of 2017, we revised the terms of sales for Society6 to reflect to the transfer of title and risk of loss upon shipment and began recognizing revenue upon the shipment of fulfilled orders. The impact as a result of this change was an increase in product revenue of approximately $1.1 million for the year ended December 31, 2017. Such amounts would have been otherwise recorded as deferred revenue at the end of the period.


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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 the fair. We recognize service revenue arising from the sale of original art net of amounts paid to the artist because we are not the primary obligor in the transaction, we do not have inventory risk, and we do not establish the prices for the art sold. Revenue is recognized after the original art has been delivered and the return period has expired. Payments received in advance of delivery and completion of the return period are included in deferred revenue in the accompanying consolidated balance sheets. We periodically provide incentive offers to Saatchi Art customers to encourage purchases, including percentage discounts off current purchases, free shipping and other offers. VAT, sales tax and other taxes are not included in Marketplaces service revenue because we are a pass-through conduit for collecting and remitting any such taxes. 

Media

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 performance-based cost-per-click advertising, in which an advertiser pays only when a visitor clicks on an advertisement; display advertisements, where revenue is dependent upon the number of advertising impressions delivered; native advertisements, which are advertisements created to match the form and function of the platform on which they appear; sponsored content; or advertising links. At times, we enter into revenue-sharing arrangements with our partners, and if we are considered the primary obligor, we report the underlying revenue on a gross basis in our consolidated statements of operations and record the revenue-sharing payments to our partners in service costs.

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

Product Costs

Product costs consist of product manufacturing costs, including both in-house and contract manufacturing costs, artist payments, personnel costs and credit card and other transaction processing fees. In the near term, we expect our product costs to remain relatively flat as a percentage of product revenue.  

Service Costs

Service costs consist of payments relating to our internet connection and co-location charges and other platform operating expenses, including depreciation of the systems and hardware used to build and operate our content creation and distribution platform; expenses related to creating, rewriting, or auditing certain content units; and personnel costs related to in-house editorial, customer service and information technology. Service costs also include payments to our partners pursuant to revenue-sharing arrangements where we are the primary obligor. In addition, service costs include expenses related to art fairs hosted by Saatchi Art’s The Other Art Fair, such as venue-related costs and fair personnel costs. In the near term, we expect service costs to remain relatively flat as a percentage of service revenue.


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Shipping and Handling

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

Sales and Marketing

Sales and marketing expenses consist primarily of sales and marketing personnel costs, sales support, public relations, advertising, marketing and general promotional expenditures. Fluctuations in our sales and marketing expenses are generally the result of our efforts to drive growth in our product and service offerings. We currently anticipate that our sales and marketing expenses will remain relatively flat as a percentage of total revenue.

Product Development

Product development expenses consist primarily of expenses incurred in our software engineering, product development and web design activities and related personnel costs. Fluctuations in our product development expenses are generally the result of hiring personnel to support and develop our platforms, including the costs to improve our owned and operated media properties and related mobile applications, as well as the costs to develop future product and service offerings. We currently anticipate that our product development expenses will remain relatively flat in the near term as a percentage of total revenue.

General and Administrative

General and administrative expenses consist primarily of personnel costs from our corporate executive, legal, finance, human resources and information technology organizations and facilities-related expenditures, as well as third party professional fees and insurance. Professional fees are largely comprised of outside legal, audit and information technology consulting. We currently anticipate that general and administrative expenses will remain relatively flat in the near term as a percentage of revenue.

Amortization of Intangible Assets

We capitalize certain costs (i) allocated to the purchase price of certain identifiable intangible assets acquired in connection with business combinations and (ii) incurred to develop media content that is determined to have a probable economic benefit. We amortize these costs on a straight-line basis over the related expected useful lives of these assets. We determine the appropriate useful life of intangible assets by performing an analysis of expected cash flows based on our historical experience of intangible assets of similar quality and value. In the event of content remediation or removal in future periods, additional accelerated amortization expense may be incurred in the periods such actions occur. We expect amortization expense related to business combinations to increase in the near term due to recent acquisitions. We expect total amortization expense to decrease in the near term due to assets completing their useful lives. Amortization as a percentage of revenue will depend upon a variety of factors, such as the amounts and mix of our investments in content and identifiable intangible assets acquired in business combinations.

Goodwill

We test goodwill for impairment as of October 1st of each year unless there are interim indicators that suggest that it is more likely than not that goodwill may be impaired. Goodwill is tested at the reporting unit level and as of December 31, 2017, we have two reporting units: marketplaces and media.  As of December 31, 2017, our goodwill balance related entirely to our marketplaces reporting unit. We did not record any goodwill impairment charges for the year ended December 31, 2017. We may be required to record impairment charges on our remaining goodwill in future periods.

Stock-based Compensation

Included in operating expenses are expenses associated with stock-based compensation, which are allocated and included in service costs, sales and marketing, product development and general and administrative expenses. Stock-


38


 

based compensation expense is largely comprised of costs associated with stock options and restricted stock units granted to employees, directors and non-employees, and expenses relating to our Employee Stock Purchase Plan. We record the fair value of these equity-based awards and expenses at their cost ratably over related vesting periods.  

Interest Income (Expense), Net

Interest income consists primarily of interest earned on cash balances and money market deposits, which are included in cash and cash equivalents.  

Other Income (Expense), Net

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

Provision for Income Taxes

Since our inception, we have been subject to income taxes principally in the United States, and certain other countries where we have or had a legal presence, including the United Kingdom, Australia, Canada and Argentina. We may in the future become subject to taxation in additional countries based on the foreign statutory rates in those countries and our effective tax rate could fluctuate accordingly.

Income taxes are computed using the asset and liability method, under which deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.

We currently believe that based on the available information, it is more likely than not that our deferred tax assets will not be realized, and accordingly we have taken a full valuation allowance against all of our United States federal and state and certain foreign deferred tax assets. Federal and state laws impose substantial restrictions on the utilization of net operating loss and tax credit carryforwards in the event of an “ownership change,” as defined in Section 382 of the Code. Currently, we do not expect the utilization of our net operating loss and tax credit carryforwards in the near term to be materially affected as no significant limitations are expected to be placed on these carryforwards as a result of our previous ownership changes. However, if all or a portion of our net operating loss carryforwards are subject to limitation because we experience an ownership change, our future cash flows could be adversely impacted due to increased tax liability.


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Results of Operations

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year ended December 31, 

 

 

    

2017

    

2016

    

2015

 

Revenue:

 

 

 

 

 

 

 

 

 

 

Product revenue

 

$

75,784

 

$

60,563

 

$

48,715

 

Service revenue

 

 

53,206

 

 

52,889

 

 

77,254

 

Total revenue

 

 

128,990

 

 

113,452

 

 

125,969

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

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

 

 

56,292

 

 

42,081

 

 

33,769

 

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

 

 

21,810

 

 

25,434

 

 

37,481

 

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

 

 

28,297

 

 

26,654

 

 

21,041

 

Product development(1)(2)(3)

 

 

18,613

 

 

19,964

 

 

26,315

 

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

 

 

29,591

 

 

30,704

 

 

35,428

 

Amortization of intangible assets

 

 

5,728

 

 

10,900

 

 

18,706

 

Total operating expenses

 

 

160,331

 

 

155,737

 

 

172,740

 

Loss from operations

 

 

(31,341)

 

 

(42,285)

 

 

(46,771)

 

Interest income

 

 

195

 

 

96

 

 

361

 

Interest expense

 

 

(5)

 

 

(4)

 

 

(143)

 

Other (expense) income, net

 

 

(19)

 

 

40,172

 

 

3,107

 

Loss before income taxes

 

 

(31,170)

 

 

(2,021)

 

 

(43,446)

 

Income tax benefit (expense)

 

 

37

 

 

10

 

 

(55)

 

Net loss

 

$

(31,133)

 

$

(2,011)

 

$

(43,501)

 

 

 

 

 

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