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DMD > SEC Filings for DMD > Form 10-Q on 9-Aug-2013All Recent SEC Filings

Show all filings for DEMAND MEDIA INC.

Form 10-Q for DEMAND MEDIA INC.


9-Aug-2013

Quarterly Report


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

Forward Looking Statements

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our 2012 Annual Report on Form 10-K.

This Quarterly Report on Form 10-Q contains forward-looking statements. All statements other than statements of historical facts contained in this Quarterly Report on Form 10-Q, including statements regarding our future results of operations and financial position, business strategy and plans and our objectives for future operations, are forward-looking statements. The words "believe," "may," "will," "estimate," "continue," "anticipate," "intend," "expect" and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our estimates of our financial results and our current expectations and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy, short term and long-term business operations and objectives, and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including


those described in the section entitled "Risk Factors" in Part II Item 1A of this Quarterly Report on Form 10-Q. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this Quarterly Report on Form 10-Q may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.

You should not rely upon forward-looking statements as predictions of future events. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee that the future results, levels of activity, performance or events and circumstances reflected in the forward-looking statements will be achieved or occur. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. We undertake no obligation to update publicly any forward-looking statements for any reason after the date of this Quarterly Report on Form 10-Q to conform these statements to actual results or to changes in our expectations.

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

As used herein, "Demand Media," "the Company," "our," "we," or "us" and similar terms include Demand Media, Inc. and its subsidiaries, unless the context indicates otherwise.

"Demand Media" and other trademarks of ours appearing in this report are our property. This report contains additional trade names and trademarks of other companies. We do not intend our use or display of other companies' trade names or trademarks to imply an endorsement or sponsorship of us by such companies, or any relationship with any of these companies.

Overview

We are a diversified Internet media and domain services company. We have developed a leading Internet-based model for the professional creation and distribution of high-quality, commercially valuable, long-lived content at scale and we operate the world's largest wholesale registrar and the world's second largest registrar overall. Our business is comprised of two service offerings:
Content & Media and Registrar. Our Content & Media offering is engaged in is engaged in creating long-lived media content, primarily consisting of text articles and videos, and delivering it along with social media and monetization tools to the Company's owned and operated websites, network of customer websites and to related mobile applications. As a complement to our content offerings we have recently begun to integrate products, e-learning and other on-demand services for purchase, on an a la carte or subscription basis. To accelerate our commerce initiatives, in March 2013 we acquired Creativebug, an online destination for arts and crafts instructional content and in June 2013 we acquired Society6, LLC ("Society6"), a digital artist marketplace and e-commerce platform that enables a large community of talented artists to seamlessly sell their original designs on art prints and other products. Our Content & Media service offering also includes a portfolio of websites primarily containing advertising listings, which we refer to as undeveloped websites. Our Registrar service is the world's largest wholesale registrar of Internet domain names and the world's second largest registrar overall, based on the number of names under management, and provides domain name registration and related value-added services. We are also a leading participant in The Internet Corporation for Assigned Names and Numbers ("ICANN") significant expansion of the number of generic Top Level Domain ("gTLDs"), which is expected to result in the delegation on new gTLDs commencing in 2013 ("New gTLD Program").

Our principal operations and decision-making functions are located in the United States. We report our financial results as one operating segment, with two distinct service offerings. Our operating results are regularly reviewed by our chief operating decision maker on a consolidated basis, principally to make decisions about how we allocate our resources and to measure our consolidated operating performance. Together, our service offerings provide us with proprietary data that facilitate the creation of commercially valuable, long-lived content, which we combine with broad distribution and targeted monetization capabilities. We currently generate the vast majority of our Content & Media revenue through the sale of advertising, and to a lesser extent through subscriptions to our social media applications and through licensing and sales of products, e-learning and other on-demand services. Substantially all of our Registrar revenue is derived from domain name registration and related value-added service subscriptions. Our chief operating decision maker regularly reviews revenue for each of our Content & Media and Registrar service offerings in order to gain more depth and understanding of the key business metrics driving our business. Accordingly, we report Content & Media and Registrar revenue separately.


In February 2013, we announced that our board of directors authorized a plan to explore separating the Company into two independent, publicly traded companies:
a pure-play Internet-based content and media company and a pure-play domain services company (hereinafter referred to as the "Proposed Business Separation"). We anticipate that the Proposed Business Separation will be structured as a tax-free pro rata distribution to stockholders of new publicly traded shares in the new domain services company. Consummation of the Proposed Business Separation is subject to final approval by our board of directors. Consummation of the Proposed Business Separation also is subject to satisfaction of several conditions, including confirmation of the transaction's tax-free treatment, receipt of listing approval, and the filing and effectiveness of a registration statement on Form 10 with the SEC. We have not yet finalized all of the details of the Proposed Business Separation and there is no assurance that the Proposed Business Separation as described herein will occur.

For the six months ended June 30, 2013 and 2012, we reported revenue of $201.7 million and $179.3 million, respectively. For the six months ended June 30, 2013 and 2012, our Content & Media offering accounted for 64% and 63% of our total revenue, respectively, and our Registrar service accounted for 36% and 37% of our total revenue, respectively.

Key Business Metrics

We regularly review a number of business metrics, including the following key metrics, to evaluate our business, measure the performance of our business model, identify trends impacting our business, determine resource allocations, formulate financial projections and make strategic business decisions. Measures which we believe are the primary indicators of our performance are as follows:

Content & Media Metrics

• page views: We define page views as the total number of web pages viewed across (1) our owned and operated websites and/or (2) our network of customer websites, to the extent that the viewed web pages of our customers host the Company's monetization, social media and/or content services. Page views are primarily tracked through internal systems, such as our Omniture web analytics tool, contain estimates for our customer websites using our social media tools and may use data compiled from certain customer websites. We periodically review and refine our methodology for monitoring, gathering, and counting page views in an ongoing effort to improve the accuracy of our measure.

•RPM: We define RPM as Content & Media revenue per one thousand page views.

Registrar Metrics

•domain: We define a domain as an individual domain name registered by a third-party customer on our platform for which we have begun to recognize revenue. This metric does not include any of the company's owned and operated websites.

• average revenue per domain: We calculate average revenue per domain by dividing Registrar revenues for a period by the average number of domains registered in that period. The average number of domains is the simple average of the number of domains at the beginning and end of the period. Average revenue per domain for partial year periods is annualized.


The following table sets forth additional performance highlights of key business metrics for the periods presented:

Three months ended June 30, Six months ended June 30,
2013 2012 % Change 2013 2012 % Change
Content & Media Metrics (1)
Owned & operated
Page views (in millions) 4,441 3,333 33 % 8,221 6,475 27 % RPM $ 11.64 $ 13.50 (14 )% $ 12.34 $ 13.03 (5 )% Network of customer websites
Page views (in millions) 6,557 4,770 37 % 11,424 9,494 20 % RPM $ 1.95 $ 3.08 (37 )% $ 2.48 $ 3.09 (20 )% RPM ex-TAC (1) $ 1.33 $ 2.16 (38 )% $ 1.65 $ 2.27 (27 )% Registrar Metrics (2)
End of period # of domains
(in millions) 14.2 13.5 4 % 14.2 13.5 4 % Average revenue per domain $ 10.39 $ 9.96 4 % $ 10.34 $ 10.01 3 %



(1) Traffic acquisition costs (TAC) represents revenue-sharing payments made to our network customers from advertising revenue generated from such customers' websites.

(2) For a discussion of these period-to-period changes in the number of page views, RPM, end of period domains and average revenue per domain and how they impacted our financial results, see "Results of Operations" below.

Opportunities, Challenges and Risks

To date, we have derived the majority of our revenue through the sale of advertising in connection with our Content & Media service offering and through domain name registration subscriptions in our Registrar service offering. Our advertising revenue is primarily generated by advertising networks, which include both performance based Internet advertising, such as cost-per-click where an advertiser pays only when a user clicks on its advertisement, and display Internet advertising where an advertiser pays when the advertising is displayed. Historically and for the six months ended June 30, 2013, the majority of our advertising revenue was generated by our relationship with Google. We deliver online advertisements provided by Google on our owned and operated websites as well as on certain of our customer websites where we share a portion of the advertising revenue. For the six months ended June 30, 2013, approximately 38% of our total consolidated revenue was derived from our advertising arrangements with Google. Google maintains the direct relationships with the advertisers and provides us with cost-per-click and display advertising services.

Content & Media revenue is principally dependent upon page views and RPMs. Our recent growth in page views has been primarily due to an increase in the number of visitors resulting from traffic growth from mobile devices, which tend to have higher engagement. We believe that there are opportunities to grow our page views by improving the user experience on our websites, creating and publishing more content in a greater variety of formats, particularly formats better suited for mobile devices, on our owned and operated websites, as well as expanding our network of customer websites where we can distribute content produced through our platform. Our RPMs are subject to changes in the online advertising marketplace, which could include lower rates received for mobile and other ad units. Currently, our Content & Media revenue is primarily advertising-based. However, we believe there is an opportunity to diversify our Content & Media revenue streams through commerce initiatives by offering products, e-learning and other on-demand services for purchase on subscription and a la carte. For example, to accelerate our commerce initiatives, in March 2013, we acquired Creativebug, an online destination for arts and crafts instructional content and in June 2013, we acquired Society6, a digital artist marketplace and e-commerce platform that enables a large community of talented artists to seamlessly sell their original designs on art prints and other products.

Google, the largest provider of search engine referrals to the majority of our websites, regularly deploys changes to its search engine algorithms. Since 2011, we have experienced fluctuations in the total number of Google search referrals to its owned and operated websites, including eHow and Livestrong.com, and its network of customer websites. During 2013, we have experienced several negative changes in Google referrals that, in the aggregate, are larger in magnitude than those that we have previously experienced. These changes have resulted in substantial declines to traffic to our owned and operated websites. Other search engines may deploy similar changes. These changes, as well as any potential future changes, may result in material fluctuations in our financial performance.


The changes in Google search referrals have had a limited negative impact, if any, on traffic referrals to our network of customer websites. If our network of customer websites were to experience significant negative changes in Google search referrals, our relationships with the publishers within our network of customer websites may be adversely affected. In addition, any negative changes in search referrals to our network of customer websites could cause us to re-evaluate and potentially reduce our level of investment in content produced for those websites. Our network of customer websites is our primary distribution outlet for content that we are currently producing through our platform, and we anticipate increased production and distribution of content to our network of customer websites due to attractive expected returns.

We regularly evaluate and strive to continuously improve our websites, content library and content creation and distribution platform in an effort to improve user experience and engagement. Such improvements include redesigning our websites, refining our content library through select removals and additions, establishing more stringent criteria for the admission of content creators, adding processes to ensure that each additional unit of content published is unique in relation to existing content units, creating new content formats designed to further diversify our content offering, and integrating commerce products and services with our content experience. During 2011 and 2012, and in response to changes in search engine algorithms in 2011, we performed an evaluation of its existing content library to identify potential improvements in its content creation and distribution platform. As a result of this evaluation, we elected to remove certain content assets from service, resulting in $5.9 million of accelerated amortization expense in the fourth quarter of 2011 and $2.1 million of accelerated amortization expense during the six months ended June 30, 2012.
There can be no assurance that these or any future changes that may be implemented by we, by search engines to their algorithms and search methodologies, or by consumers in their web usage habits will not adversely impact the carrying value, estimated useful life or intended use of our long-lived assets. We will continue to monitor these changes as well as any future changes and emerging trends in search engine algorithms and methodologies, including the resulting impact that these changes may have on future operating results, the economic performance of our long-lived assets and in its assessment as to whether significant changes in circumstances might provide an indication of potential impairment of the carrying value of its long-lived assets, including its media content and goodwill arising from acquisitions. We have experienced a decline in its stock price over the course of 2013. However, its market capitalization remains in excess of the carrying value of its net assets as of June 30, 2013. Based on a review of events and changes in circumstances at the reporting unit level through June 30, 2013, we have not identified any indications that the carrying value of our goodwill is impaired or should be subject to interim impairment testing. We will continue to perform our annual goodwill impairment test in the fourth quarter of the year ending December 31, 2013, or more frequently if impairment indicators are present, consistent with our existing accounting policy.

The growth in our Registrar revenue is dependent upon our ability to attract and retain customers to our Registrar platform through competitive pricing on domain registrations and value added services. Beginning in the first quarter of 2010 and extending through the third quarter of 2011, we added several customers with large volumes of domains to our Registrar platform. This resulted in fluctuations in our average revenue per domain over these periods, from which we only recognized revenue on a portion of these domain names while deferring revenue recognition on the remainder. As the mix of large, higher volume customers increases, we also expect that the associated service costs as a percentage of revenue will increase when compared to our historical results.

A framework for the significant expansion of the number of gTLDs has been approved by ICANN, which is expected to result in the delegation of new gTLDs commencing in 2013. We believe that such expansion, once completed, could result in an increase in the number of domains registered on our platform commencing in the latter half of 2013. In addition, we believe that the New gTLD Program could also provide us with new revenue opportunities commencing in the latter half of 2013, which include operating the back-end infrastructure for new gTLD registries and/or owning one or more gTLDs in our own right.

During 2012, we paid $18.2 million for certain gTLD applications under the New gTLD Program. Payments for gTLD applications represent amounts paid directly to ICANN and or third parties in the pursuit of our ownership of certain gTLD operator rights. While there can be no assurance that we will be awarded any gTLDs, our capitalized payments made for gTLD applications that are determined to embody a probable economic benefit, which are included in other long-term assets at December 31, 2012 and June 30, 2013. During the remainder of 2013 and as part of the New gTLD Program, we may receive partial cash refunds for certain gTLD applications, and to the extent we elect to sell or dispose of certain gTLD applications throughout the process, it may also incur gains or losses on amounts invested. Gains on the sale of our interest in gTLDs will be recognized when realized, while losses will be recognized when deemed probable. Upon the delegation of operator rights for each gTLD by ICANN, which we expect to commence in 2013, gTLD application fees will be reclassified as finite lived intangible assets and amortized on a straight-line basis over their estimated useful life. Other costs incurred by us as part of its gTLD initiative and not directly attributable to the acquisition of gTLD operator rights are expensed as incurred.


We expect to incur between $8 million and $10 million of formation expenses related to the New gTLD Program in 2013, and the total amount of our investment at the completion of the New gTLD Program could be substantially higher or lower than the amounts invested to date. Revenue is not expected to commence until the latter half of 2013 at the earliest.

Our service costs, the largest component of our operating expenses, can vary from period to period, particularly as a percentage of revenue, based upon the mix of the underlying Content & Media and Registrar services revenues we generate. In the near term, we expect that the period-over-period growth in our Content & Media revenue will be similar to the growth in our Registrar revenue, and we expect that our service costs will increase in 2013 compared to 2012 in line with revenue growth and also due to the impact of our acquisitions of Name.com, Creativebug and Society6. We believe that these factors, together with costs associated with our preparation for new gTLDs becoming available for registration later in 2013, will constrain our operating margin growth in the short-term as we increase our investment in new business initiatives to support future growth.

Our content studio identifies and creates online text articles and videos through a community of freelance creative professionals and is core to our business strategy and long-term growth initiatives. Historically, we have made substantial investments in our platform to support our expanding community of freelance creative professionals and the growth of our content production and distribution and expect to continue to make such investments. As we develop new content formats, we may not be able to attract and retain qualified creative professionals to produce such new content at scale, which may adversely impact our ability to execute against emerging business opportunities or retain existing content creators.

For the six months ended June 30, 2013, more than 90% of our revenue has been derived from websites and customers located in the United States. While our content is primarily targeted towards English-speaking users in the United States today, we believe that there is an opportunity in the longer term for us to create content targeted to users outside of the United States and thereby increase our revenue generated from countries outside of the United States. We plan to further expand our operations internationally to address this opportunity by launching new websites and expanding our existing web properties eHow en Español and eHow Brasil. As we expand our business internationally, we may incur additional expenses associated with this growth initiative.

Basis of Presentation

Revenue

Our revenue is derived from our Content & Media and Registrar service offerings.

Content & Media Revenue

We currently generate a vast majority of of our Content & Media revenue through the sale of advertising, and to a lesser extent through subscriptions to our social media applications and select content and service offerings. Articles and videos, each of which we refer to as a content unit, generate revenue both directly and indirectly. Direct revenue is that directly attributable to a content unit, such as advertisements, including sponsored advertising links, display advertisements and in-text advertisements, on the same webpage on which the content is displayed. Indirect revenue is also derived primarily by our content library, but is not directly attributable to a specific content unit. Indirect revenue includes advertising revenue generated on our owned and operated websites' home pages (e.g., home page of eHow), on topic category webpages (e.g., home and garden category page), on user generated article pages that feature content that was not acquired through our proprietary content acquisition process, and subscription revenue. Our revenue generating advertising arrangements, for both our owned and operated websites and our network of customer websites, include cost-per-click performance-based advertising, display advertisements where revenue is dependent upon the number of page views, and lead generating advertisements where revenue is dependent upon users registering for, or purchasing or demonstrating interest in, advertisers' products and services. We generate revenue from advertisements displayed alongside our content offered to consumers across a broad range of topics and categories on our owned and operated websites and on certain customer websites. Our advertising revenue also includes revenue derived from cost-per-click advertising links we place on undeveloped websites owned both by us, which we acquire and sell on a regular basis, and certain of our customers. To a lesser extent, we also generate revenue from our subscription-based offerings, which include our social media applications deployed on our network of customer websites and subscriptions to premium content or services offered on certain of our owned and operated websites. Other revenue is generated through the sale or license of media content or the sale of undeveloped websites. Revenue from the sale or perpetual license of content and undeveloped websites are recognized when the content and the sale of undeveloped websites have been delivered and the contractual performance obligations have been fulfilled. Revenue from the license of content is recognized over the period of the license as content are delivered or when other related performance criteria are fulfilled.


Where we enter into revenue sharing arrangements with our customers, such as those relating to our IndieClick network and our undeveloped customer websites, and when we are considered the primary obligor, we report the underlying revenue on a gross basis in our consolidated statements of operations, and record these revenue-sharing payments to our customers as traffic acquisition costs, or TAC, . . .

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