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MOVE INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following "Management's Discussion and Analysis of Financial Condition and Results of Operations" is intended to assist the reader in understanding the Company's business and is provided as a supplement to, and should be read in conjunction with, the Company's unaudited Condensed Consolidated Financial Statements and accompanying notes. The Company's results of operations discussed below are presented in conformity with U.S. GAAP. OUR BUSINESS With realtor.com® as our flagship web site and brand, Move, Inc. ("Move", the "Company", "we", "our" or "us") is a leading real estate information marketplace connecting consumers with the information and the expertise they need to make informed home buying, selling, financing and renting decisions. Move's purpose is to help people love where they live. To that end we strive to create the leading marketplace for real estate information and services by connecting people at every stage of the real estate cycle with the content, tools and professional expertise they need to find a perfect home. Through the collection of assets we have developed over 20 years in this business, Move is positioned to address the needs and wants of both consumers and real estate professionals ("customers") throughout the process of home ownership. Although the real estate marketplace has been unquestionably changed by the Internet, and likely will continue to evolve through the growth of mobile devices and social networking, our business continues to be about empowering consumers with timely and reliable information and connecting them to the real estate professionals who have the expertise to help them better understand and succeed in that marketplace. We provide consumers with a powerful combination of breadth, depth and accuracy of information about homes for sale, new construction, homes for rent, multi-family rental properties, senior living communities, home financing, home improvement and moving resources. Through realtor.com®, consumers have access to over 100 million properties across the United States ("U.S.") as well as properties for sale from another 38 countries worldwide. Our for-sale listing content, comprising nearly 4 million properties as of September 30, 2014, and accessible in 11 different languages, represents the most comprehensive, accurate and up-to-date collection of its kind, online or offline. Through realtor.com® and our mobile applications, we display more than 98% of all for-sale properties listed in the U.S. We source this content directly from more than 800 Multiple Listing Services ("MLSs") across the country with whom we have relationships, which represents nearly all MLSs, with approximately 90% of the active listings updated every 15 minutes and the remaining listings updated daily. Realtor.com®'s substantial content advantage has earned us trust with both consumers and real estate professionals. We attract a highly engaged consumer audience and have developed an exceptionally large number of relationships with real estate professionals across the country. Over 28 million users, viewing an average of over 470 million pages and spending an average of over 600 million minutes on the realtor.com® web site and mobile applications each month over the last twelve-month period, have exposure to over 400,000 real estate professionals on realtor.com® and our mobile applications. We delivered approximately 13% more connections between consumers and our customers during the twelve months ended September 30, 2014, as compared to the twelve-month period ended September 30, 2013. This illustrates the success of our continued commitment to not only deliver valuable information to consumers, but more importantly, to connect them with real estate professionals who can provide the local expertise consumers want when making home-related decisions. 20 -------------------------------------------------------------------------------- Table of Contents In addition to providing an industry-leading content mix, Move facilitates connections and transactions between consumers and real estate professionals. Although attracting and engaging a large consumer audience is an important part of our business, to succeed we must also focus on winning the hearts and minds of real estate professionals, who are both customers of our business and suppliers of much of our property content. We believe this starts with our commitment to respecting the listing and content rights of the real estate agents, brokers, MLSs and others who work hard to help generate these important data resources. Through our realtor.com® and ListHubTM businesses, we aggregate, syndicate and display real estate listings across the web and on mobile applications. Part of the reason we have become the leading source for real estate listing content is that we work closely with, and respect the rights of, real estate professionals while still maintaining a balance that allows consumers to obtain the information and expertise they expect and need. At the same time, we are committed to delivering valuable connections, advertising systems and productivity and lead management tools to real estate professionals, with the goal of helping to make them more successful. By combining realtor.com® advertising systems with the productivity and lead management tools offered through our Top Producer® and TigerLead® software-as-a-service ("SaaS") customer relationship management ("CRM") products, we are able to help grow and enrich connections between our customers and consumers, and to help our customers better manage those connections in an effort to facilitate transactions and grow their businesses. Our dual focus on both the consumer and the real estate professional has helped us create and maintain realtor.com® as a distinct advantage in the online real estate space. For over 20 years, we have provided consumers with access to a highly accurate and comprehensive set of real estate listing data and, as a result, have built relationships within the real estate industry that are both broad and deep. We expect this industry to continue to progress as new technologies are embraced and as consumers' needs and wants evolve. We also expect that real estate professionals, to stay relevant, will likewise need to evolve along with technology, consumers and the market. We aim to keep realtor.com® positioned to lead this transformation with consumers and real estate professionals at the forefront, and expect to leverage our collection of advertising systems, productivity tools and other assets to do so. PROPOSED ACQUISITION BY NEWS CORPORATION On September 30, 2014, the Company entered into an agreement and plan of merger ("Merger Agreement") with News Corporation ("Parent") and Magpie Merger Sub, Inc., an indirect wholly owned subsidiary of Parent ("Merger Sub"), pursuant to which, and on the terms and subject to the conditions thereof, among other things, Merger Sub will commence a tender offer ("Offer") on or before October 15, 2014 to acquire all of the outstanding shares of common stock of the Company at a purchase price of $21.00 per share in cash, without interest (the "Offer Price"). The Merger Agreement is not subject to a financing condition. The obligation of Merger Sub to purchase the shares of common stock of the Company validly tendered and not withdrawn pursuant to the Offer is subject to the satisfaction or waiver of a number of conditions set forth in the Merger Agreement, including (i) that there shall have been validly tendered and not validly withdrawn a number of shares of common stock of the Company that, when added to the shares of common stock of the Company then owned by Parent and its subsidiaries, equals at least one share more than one half of the total number of shares of common stock of the Company then issued and outstanding, (ii) the expiration or termination of the applicable waiting period (and any extensions thereof) under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (without the imposition of any condition or requiring a remedy that the parties are not required to accept pursuant to the Merger Agreement), (iii) the absence of certain disputes relating to the Operating Agreement between Realtors® Information Network, Inc., a subsidiary of the National Association of REALTORS® ("NAR"), and RealSelect, Inc., a subsidiary of the Company, as amended; and (iv) other customary conditions. Concurrently with the execution of the Merger Agreement, NAR provided the Company with its consent to the transaction. The NAR consent terminates if Move terminates the Merger Agreement due to a superior proposal or if both the Company and Parent announce that the Merger Agreement has been terminated. A copy of the NAR consent is attached hereto as Exhibit 99.1 and is incorporated by reference herein. The Merger Agreement contains certain termination rights in favor of each the Company and Parent including, under certain circumstances, the requirement for the Company to pay to Parent a termination fee of $32,500,000. The Company has also agreed (i) to cease any existing, and not to solicit or initiate any additional, discussions with third parties regarding other proposals to acquire the Company and (ii) to certain restrictions on its ability to respond to such proposals, subject to fulfillment of certain fiduciary requirements of the board of directors of the Company. 21 -------------------------------------------------------------------------------- Table of Contents Following the completion of the Offer and subject to the satisfaction or waiver of certain conditions set forth in the Merger Agreement, Merger Sub will merge with and into the Company, with the Company surviving as an indirect wholly owned subsidiary of Parent, pursuant to the procedure provided for under Section 251(h) of the Delaware General Corporation Law without any stockholder approvals (the "Merger"). At the effective time of the Merger (the "Effective Time"), by virtue of the Merger and without any action on the part of the holders of any shares of common stock of the Company, each outstanding share of common stock of the Company, other than any shares owned by Parent, Merger Sub or any wholly owned subsidiary of Parent or held in the treasury of the Company, or any stockholders who are entitled to and who properly exercise appraisal rights under Delaware law, will be cancelled and converted into the right to receive an amount in cash equal to the Offer Price. Pursuant to the Merger Agreement, among other obligations of the Company, (a) (w) the Company shall perform all of its pre-closing obligations under the certain 2.75% Convertible Senior Notes due 2018 (the "2018 Notes"), and shall give notice of the transactions contemplated under the Merger Agreement in accordance with the requirements therein, (x) on or prior to September 30, 2014, the Company shall provide the notice required by indenture agreement related to the 2018 Notes, (y) the Company shall elect cash settlement as the sole settlement method for any conversion of 2018 Notes, in each case prior to the applicable deadline therefor, (z) comply with the payment and other pre-closing obligations related to any conversion of 2018 Notes pursuant to the indenture agreement related to the 2018 Notes in order to validly effectuate the cash settlement thereof; (b) during the period between the completion of the Offer and the consummation of the Merger, the Company shall (w) elect to redeem the series A preferred stock of the Company as of such time, (x) provide written notice thereof to NAR, (y) redeem the series A preferred stock of the Company, and (z) pay, or make available for payment, to NAR the redemption price therefor; and (c) in the event that any holder of a Company stock option exercises such option between the completion of the Offer and the consummation of the Merger, the Company shall take all actions necessary to cash settle such Company option in an amount of cash equal to (x) the excess, if any, of the fair market value of a share (as determined in accordance with the applicable Company stock plan) on the date of exercise over the exercise price per share of such Company option, multiplied by (y) the number of shares covered by such Company stock option, with payment subject to applicable tax withholding and paid without interest. In addition, pursuant to the Merger Agreement: (i) at the Effective Time, each outstanding Company stock option (whether vested or unvested), will be assumed by Parent in accordance with the Merger Agreement (each, an "Adjusted Option"), and each Adjusted Option shall continue to have and be subject to the same terms and conditions as were applicable to the corresponding Company stock option immediately prior to the Effective Time, except that (x) each Adjusted Option will be exercisable for that number of shares of Parent common stock (rounded down to the nearest whole share) equal to the product of (A) the number of shares of Company common stock subject to the Company stock option immediately prior to the Effective Time and (B) the Equity Award Exchange Ratio provided under the Merger Agreement (the "Equity Award Exchange Ratio") and (y) the per share exercise price for the shares of Parent common stock issuable upon exercise of each such Adjusted Option will be equal to the quotient of (A) the per share exercise price of the Company stock option and (B) the Equity Award Exchange Ratio, rounded up to the nearest whole cent; (ii) at the Effective Time, each outstanding Company restricted stock unit (whether vested or unvested) will be assumed by Parent in accordance with the Merger Agreement (each, an "Adjusted RSU"), and each Adjusted RSU shall continue to have, and be subject to, the same terms and conditions as were applicable to the corresponding Company restricted stock unit immediately prior to the Effective Time, except that each Adjusted RSU will be converted into the right to receive a number of whole shares of Parent common stock (rounded to the nearest whole share) equal to the number of shares of Company common stock to which the Company restricted stock unit related immediately prior to the Effective Time, multiplied by the Equity Award Exchange Ratio; (iii) at the Effective Time, each Company restricted stock award that is not held by a non-employee director of the Company and that is outstanding as of immediately prior to the Effective Time, shall be assumed by Parent in accordance with the Merger Agreement (each, an "Adjusted RSA"), and each Adjusted RSA will continue to have, and be subject to, the same terms and conditions as were applicable to the corresponding Company restricted stock award immediately prior to the Effective Time, except that each Adjusted RSA will be converted into the right to retain a number of whole shares of Parent common stock (rounded to the nearest whole share) equal to the number of shares of Company common stock to which the Company restricted stock award related immediately prior to the Effective Time, multiplied by the Equity Award Exchange Ratio; and (iv) at the Effective Time, each Company restricted stock award that is outstanding as of immediately prior to the Effective Time and held by a non-employee director of the Company immediately prior to the Effective Time will vest and be cancelled and converted into the right to receive the Offer Price (the "Merger Consideration"), less any applicable taxes. Notwithstanding the treatment of Company stock options described above, Parent will have the right to decide, not later than 12 business days before the scheduled closing of the Merger, that each Company stock option that is outstanding and unexercised as of immediately prior to the Effective Time and held by any person whose employment or service terminated prior to the Effective Time will not be assumed, and will instead be cancelled and converted into the right to receive a cash payment equal to the product of (x) the excess, if any, of the Merger Consideration over the exercise price per share of such non-assumed Company stock option, multiplied by (y) the number of shares covered by such non-assumed Company stock option, less applicable tax withholding and without interest. To the extent that the exercise price per share of any such non-assumed Company stock option is equal to or greater than the Merger Consideration, each such non-assumed Company stock option will be cancelled and the holder thereof will not receive any payment therefor. 22 -------------------------------------------------------------------------------- Table of Contents The Merger Agreement contains customary representations, warranties and covenants, including covenants obligating the Company to continue to conduct its business in the ordinary course and to cooperate in seeking regulatory approvals. The board of directors of the Company has unanimously (i) determined that the Merger Agreement and the transactions contemplated thereby are advisable and fair to, and in the best interests of, the Company's stockholders, (ii) approved and declared advisable the Merger Agreement and the transactions contemplated thereby and (iii) resolved to recommend acceptance of the Offer by the Company's stockholders. The board of directors of Parent has also unanimously approved the transaction. The Company expects to complete the Merger by the end of calendar year 2014, subject to the satisfaction of the closing conditions. The foregoing description of the Merger Agreement is not complete and is qualified in its entirety by reference to the Merger Agreement, which is attached to this Quarterly Report on Form 10-Q as Exhibit 2.1 and incorporated herein by reference. The Merger Agreement and the foregoing description of the agreement have been included to provide investors and stockholders with information regarding the terms of the agreement. They are not intended to provide any other factual information about the Company. The representations, warranties and covenants contained in the Merger Agreement were made only as of specified dates for the purposes of such agreement, were solely for the benefit of the parties to such agreement and may be subject to qualifications and limitations agreed upon by such parties. In particular, in reviewing the representations, warranties and covenants contained in the Merger Agreement and discussed in the foregoing description, it is important to bear in mind that such representations, warranties and covenants were negotiated with the principal purpose of allocating risk between the parties, rather than establishing matters as facts. Such representations, warranties and covenants may also be subject to a contractual standard of materiality different from those generally applicable to stockholders and reports and documents filed with the U.S. Securities and Exchange Commission (the "SEC"), and are also qualified in important part by a confidential disclosure letter delivered by the Company to Parent in connection with the Merger Agreement. Investors and stockholders are not third-party beneficiaries under the Merger Agreement. Accordingly, investors and stockholders should not rely on such representations, warranties and covenants as characterizations of the actual state of facts or circumstances described therein. Information concerning the subject matter of such representations, warranties and covenants may change after the date of the Merger Agreement, which subsequent information may or may not be fully reflected in the parties' public disclosures. Parent and Merger Sub commenced the Offer on October 15, 2014. Parent and Move each filed a Premerger Notification and Report Form under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the "HSR Act"), with the Federal Trade Commission ("FTC") and the Antitrust Division of the Department of Justice (the "Antitrust Division") in connection with the purchase of shares in the Offer on October 15, 2014. The required waiting period with respect to the Offer expired at 11:59 p.m., New York City time, on October 30, 2014, without any action having been taken by the FTC or the Antitrust Division. Accordingly, the condition to the Offer relating to the expiration or termination of the waiting period under the HSR Act has been satisfied. Additional information regarding the Merger, the Offer, and related matters, may be found in the Solicitation/Recommendation Statement on 14D-9, as amended, and the Tender Offer Statement on Schedule TO, as amended, as filed by the Company and Parent, respectively, with the SEC. PRODUCTS AND SERVICES Our products and services are broadly defined into two groups: (i) Consumer Advertising and (ii) Software and Services. Consumer Advertising Our Consumer Advertising products are focused on providing real estate consumers with the information, tools and professional expertise they need to make informed home buying, selling, financing and renting decisions through our operation of realtor.com® and other consumer-facing web sites. realtor.com® Realtor.com® is the official web site of the NAR, the largest trade association in the U.S., which represents residential and commercial real estate professionals, including brokers, agents, property managers, appraisers, counselors and others engaged in all aspects of the real estate industry. The NAR had over one million members as of September 30, 2014. Under our exclusive and perpetual agreement with the NAR, we operate realtor.com®, and, as such, we present basic MLS property listings to consumers on our web site and our mobile applications at no charge to real estate professionals, in addition to presenting other property information. Through our realtor.com® web site, mobile applications and business operations, we offer a number of services to real estate franchises, brokers and agents, as well as non-real estate related advertisers, in an effort to connect those advertisers with our consumer audience. We categorize the products and services available through realtor.com® as listing advertisements and non-listing advertisements. 23 -------------------------------------------------------------------------------- Table of Contents Listing Advertisements-Showcase Listing Enhancements, Co-Broke and Featured HomesTM Our listing advertisements product line, which includes Showcase Listing Enhancements, Co-Broke and Featured HomesTM, allows real estate agents, brokers and franchises to enhance, prioritize and connect with consumers searching for for-sale property listings within the realtor.com® web site and mobile applications. Enhancements may include more prominent featuring and prioritization on the search results page, additional photos, virtual tours and video, personalization and branding for the listing agent or broker, and an ability to connect with consumers through web site transfers and phone or email communication. Listing advertisements are typically sold on a subscription basis and are priced based on the size and engagement of our consumer audience in the applicable geographic market and/or an agent or broker's historical listing count for the past twelve months. Non-Listing Advertisements-Display Advertising, Featured CommunityTM and Featured Competitive Market Analysis ("Featured CMATM") Our non-listing advertisements product line allows real estate agents, brokers and franchises, as well as non-real estate related advertisers (such as personal banking and mortgage companies, insurance providers, home improvement retailers, moving service providers and other consumer product and service companies) to connect with our highly engaged and valuable consumer audience in the real estate search process. We offer these advertisers a variety of products and services including sponsorships, graphical display advertisements, text links, directories, Featured CommunityTM and Featured CMATM. Pricing models include cost-per-thousand impressions ("CPM"), cost-per-click ("CPC"), cost-per-unique user and subscription-based sponsorships of specific content areas or specific targeted geographies. Rentals, Senior Housing, Moving.comTM and Doorsteps® We separately operate several other web sites providing single family and multi-family rental listings, senior housing and moving-related content and services to our consumer audience. Through our Rentals and Senior Housing businesses, we aggregate and display rental listings nationwide. We offer a variety of listing-related advertisements that allow rental property owners and managers to promote their listings and connect with consumers through our web sites. Pricing models include monthly subscriptions, CPC and cost-per-acquisition ("CPA"). Through our Moving.comTM business, we provide consumers with quotes from moving companies and truck rental companies. The majority of revenue from Moving.comTM is derived from cost-per-lead pricing models. In addition, through Doorsteps®, we offer homebuyers content, tools and advice along every step of the home buying process and help professionals connect, engage and collaborate with homebuyers during every step of the transaction. Our Consumer Advertising products represented 78% of our overall revenues for the three months ended September 30, 2014 and 2013, and 77% and 78% of our overall revenues for the nine months ended September 30, 2014 and 2013, respectively. Software and Services Our Software and Services products are designed to deliver valuable connections to real estate professionals by providing them with advertising systems, productivity and lead management tools, and reporting with the goal of helping to make them more successful. SaaS CRM Products By offering both realtor.com® advertising systems and productivity and lead management tools through our Top Producer® and TigerLead® SaaS CRM products, we are able to help grow and enrich connections between our customers and consumers, and help our customers better manage those connections in an effort to facilitate transactions and grow their businesses. Top Producer® and TigerLead® are our SaaS products providing productivity and lead management tools tailored to real estate agents on a subscription basis. These products complement realtor.com® and our mission of connecting consumers and real estate professionals to facilitate transactions by empowering real estate professionals' ability to connect with, cultivate and ultimately convert their relationships with homebuyers and sellers into transactions. Our Top Producer® product offerings include a web- and mobile-based CRM solution, our Market Snapshot® product and a series of template web site products. The TigerLead® SaaS CRM product provides real estate agents and brokers with a sophisticated internet data exchange web site platform to capture and manage leads that are delivered with unique insights such as how many times a user has returned to the site to search particular listings and price ranges. The Top Producer® product line also now includes expanded features offered through technology purchased as part of the FiveStreet, Inc. ("FiveStreet") acquisition in the fourth quarter of 2013. FiveStreet's software consolidates leads from more than 100 lead providers including realtor.com® and other major real estate sites, and automates the process of rapidly responding to, assigning and distributing leads. It provides agents with a single unified dashboard, ensuring leads are not lost or overlooked, and provides web and mobile tools for rapid response. TigerLead® Search Engine Marketing In addition, through our TigerLead® product suite, we are able to provide expertise in real estate search engine marketing through sophisticated key word buying and a platform and model that grades each lead source and lead in order to deliver high quality intelligent leads to the agent or broker. Pricing is based upon a percentage of marketing spend each month. 24 -------------------------------------------------------------------------------- Table of Contents ListHubTM-Listing Syndication and Reporting ListHubTM syndicates for-sale listing information from MLSs and other reliable data sources, such as real estate brokerages, and distributes that content to an array of online web sites. Our ListHubTM product line allows participating web sites to display real property listings, and provides agents, brokers, franchises and MLSs the ability to obtain advanced performance reporting about their listings on the participating web sites. Listing syndication pricing for participating web sites includes fixed- or variable-pricing models based on listing counts. Advanced reporting products are sold on a monthly subscription basis. Our Software and Services products represented 22% of our overall revenues for the three months ended September 30, 2014 and 2013, and 23% and 22% of our overall revenues for the nine months ended September 30, 2014 and 2013, respectively. MARKET AND ECONOMIC CONDITIONS In recent years, our business has been, and may continue to be, influenced by a number of macroeconomic, industry-wide and product-specific trends and conditions. For a number of years prior to 2006, the U.S. residential real estate market experienced a period of hyper-sales rates and home price appreciation, fueled by the availability of low interest rates and flexible mortgage options for many consumers. During the latter half of 2006 and through 2008, lending standards were tightened, equity markets declined substantially, liquidity in general was impacted, unemployment rates rose and consumer spending declined. The combination of these factors materially impacted the U.S. housing market in the form of fewer home sales, lower home prices and accelerating delinquencies and foreclosures, all of which created a cycle that further exacerbated the housing market downturn. The effects of this downturn on the housing market have persisted for several years but key market indicators suggest that large parts of the housing market may have bottomed out and have entered a recovery mode. The median age of inventory declined slightly and average listing counts remained relatively flat in the third quarter of 2014 compared to the same period in the prior year, both indicators suggesting that supply remains relatively tight. During the third quarter of 2014, the U.S. saw an increase in the national median list price of more than 7% compared to the same period in the prior year, further indication of improving conditions and a continuation of a broad housing recovery. Mortgage rates have risen from the levels seen in early 2013; however, they remain historically low despite these increases. Banks continue to have tighter credit standards for mortgage loans, which have made home purchases more difficult in recent years. Unemployment rates continue to decline. Accordingly, while there are a number of indicators of an improving housing market, homes sales remain sluggish, and we believe that market conditions could continue to adversely impact spending by real estate professionals in the near term. CRITICAL ACCOUNTING POLICIES Our discussion and analysis of our financial condition and results of operations is based upon our unaudited Condensed Consolidated Financial Statements, which have been prepared in accordance with U.S. GAAP. The preparation of these unaudited Condensed Consolidated Financial Statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, uncollectible receivables, valuation of investments, intangible and other long-lived assets, stock-based compensation and contingencies. Our estimates are based upon historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. There were no significant changes to our critical accounting policies during the nine months ended September 30, 2014, as compared to those policies disclosed in the Annual Report. LEGAL CONTINGENCIES We are currently involved in certain legal proceedings, as discussed within the section "Legal Proceedings" in Note 21, "Commitments and Contingencies," within our Consolidated Financial Statements contained in Item 8 in the Annual Report, and in Note 14, "Commitments and Contingencies," to our unaudited Condensed Consolidated Financial Statements contained in Part I, Item 1 of this Quarterly Report on Form 10-Q. Because of the uncertainties related to both the amount and range of potential liability in connection with legal proceedings, we are unable to make a reasonable estimate of the liability that could result from unfavorable outcomes in our remaining pending litigation. As additional information becomes available, we will assess the potential liability related to our pending litigation and determine whether reasonable estimates of the liability can be made. Unfavorable outcomes, or significant estimates of our potential liability, could materially impact our results of operations and financial position. 25 -------------------------------------------------------------------------------- Table of Contents BASIS OF PRESENTATION Revenue We derive our revenue primarily from two product groups: (i) Consumer Advertising and (ii) Software and Services. We derive all of our revenue from our operations in North America. As described below, significant management judgments and estimates must be made and used in connection with the revenue recognized in any accounting period. Consumer Advertising. Revenue from our Consumer Advertising products is generated from the sale of online advertising for display on our consumer-facing web sites. Listing advertisements are typically sold on a fixed-fee subscription basis. Fixed-fee subscription revenue is recognized ratably over the period in which the services are provided. Pricing models for non-listing advertisements are impression-based and include CPM, CPC, CPA, cost-per-lead, cost-per-unique user and subscription-based sponsorships of specific content areas or specific targeted geographies. The impression-based agreements range from spot purchases to 12-month contracts. The impression-based revenue is recognized based upon actual impressions delivered and viewed by a user in a period. We measure performance related to advertising obligations on a monthly basis prior to the recording of revenue. Software and Services. Revenue from our Software and Services products is generated from the sale of our SaaS CRM products, search engine marketing and listing syndication and reporting. We license our SaaS CRM products on a monthly subscription basis. Our hosting arrangements require customers to pay a fixed fee and receive service over a period of time, generally one year. Listing syndication pricing includes fixed- or variable-pricing models based on listing counts. Advanced reporting products are sold on a monthly subscription basis. Revenue for these products is recognized ratably over the service period. Pricing for our search engine marketing services is based upon the amount of marketing spend each month and is recognized as revenue at the time services are delivered. Costs and Operating Expenses Cost of Revenue. Cost of revenue consists of expenses related to operating and hosting our web sites and mobile applications and technical support of our SaaS products, including associated headcount expenses, such as salaries, benefits, bonuses, and stock-based compensation expense, as well as licenses and depreciation associated with computer equipment and software. Cost of revenue also includes lead acquisition expenses directly related to fulfilling our marketing services products, credit card processing fees, licensing costs related to our commercial business relationships, including amounts paid to the NAR, hosting costs, ad serving costs paid to third parties and licensed content. Sales and Marketing. Sales and marketing expenses consist of headcount expenses, including salaries, commissions, benefits, bonuses and stock-based compensation expense for sales, customer service, marketing, and public relations employees. Sales and marketing expenses also include advertising costs, licensing costs associated with marketing data, trade show costs, other sales expenses related to promotional and marketing activities, and traffic acquisition costs. Product and Web Site Development. Product and web site development expenses consist of headcount expenses, including salaries, benefits, bonuses and stock-based compensation expense and third-party contractor fees primarily associated with the design, development and testing of our products, web site and mobile applications. Product and web site development also includes amortization expense related to capitalized product and development activities. General and Administrative. General and administrative expenses consist of headcount expenses, including salaries, benefits, bonuses and stock-based compensation expense for executive, finance, accounting, business analytics, back office systems, legal, human resources, recruiting, data warehouse and administrative support personnel. General and administrative expenses also include outside legal, accounting, and other third-party professional service fees, bad debt and other overhead. Amortization of Intangible Assets. Amortization of intangible assets consists of the amortization of definite-lived intangible assets recorded in connection with acquisitions. 26 -------------------------------------------------------------------------------- Table of Contents Interest Income Interest income represents income earned on our cash, cash equivalents, investments and certain amounts due from customers. Interest Expense Interest expense consists of interest on our senior convertible notes, notes payable and capital lease obligations. See Note 6, "Convertible Senior Notes" to our consolidated financial statements in Part I, Item 1, "Condensed Consolidated Financial Statements" of this Quarterly Report on Form 10-Q. Earnings of Unconsolidated Joint Venture Earnings of unconsolidated joint venture consist of our proportionate share of the earnings from our unconsolidated joint venture based on the monthly financial statements of the joint venture, which is recorded one month in arrears. Other Income (Expense) Other income (expense) represents net income and expenses that are not related to our core business operations. Other income (expense) consists of gains or losses on the sale of certain investments, foreign currency gains or losses and gains or losses on the disposition of fixed assets. Income Taxes We are subject to income taxes in the U.S. and Canada. However, due to the NOLs and Canadian tax credits generated for tax purposes, we do not record a current U.S. federal or Canadian tax provision. However, we are subject to income taxes in various state jurisdictions and have recorded a current state tax provision. We have recorded a deferred tax provision due to certain indefinite-lived intangible assets being amortized for tax purposes but not for book purposes. In addition, a deferred tax provision is recorded when there is a change in the valuation allowance resulting from a deferred tax liability established as part of a business combination. At December 31, 2013, we had gross NOLs for federal and state income tax purposes of $910.6 million and $223.1 million, respectively. We have provided a full valuation allowance against our net deferred tax assets because, based on the weight of available evidence, it is more likely than not (a likelihood of more than 50%) that some or all of the deferred tax asset will not be realized. Therefore, other than the tax provision items described above, no tax liability or expense has been recorded in the financial statements. 27 -------------------------------------------------------------------------------- Table of Contents RESULTS OF OPERATIONS Three Months Ended September 30, 2014 and 2013 The following tables present our results of operations for the three months ended September 30, 2014 and 2013, and as a percentage of total revenue: Three Months Ended September 30, 2014 2013 (In thousands) Consolidated Statement of Operations Data: Revenue Consumer advertising $ 49,662 $ 45,630 Software and services 14,222 13,195 Total revenue 63,884 58,825 Costs and operating expenses: Cost of revenue(1) 13,811 11,750 Sales and marketing(1) 29,839 22,971 Product and web site development 10,223 9,894 General and administrative 16,938 12,209 Amortization of intangible assets 1,274 1,110 Total costs and operating expenses 72,085 57,934 (Loss) income from operations (8,201 ) 891 Interest expense, net (1,663 ) (917 ) Earnings of unconsolidated joint venture 988 585 Other expense, net (15 ) (46 ) (Loss) income before income taxes (8,891 ) 513 Income tax (benefit) expense (261 ) 375 Net (loss) income $ (8,630 ) $ 138 -------------------------------------------------------------------------------- (1) Effective October 1, 2013, the Company elected to change the presentation of certain lead acquisition costs and to reclassify these costs from "Cost of revenue" to "Sales and marketing" within its Consolidated Statements of Operations in order to be more consistent with certain of its peers and to combine all traffic acquisition costs that are not considered directly related to the fulfillment of products into "Sales and marketing." This had the effect of decreasing "Cost of revenue" and increasing "Sales and marketing" expense by $2.0 million, or 3% of revenue, for the three months ended September 30, 2013. 28 -------------------------------------------------------------------------------- Table of Contents Three Months Ended September 30, 2014 2013 As a Percentage of Revenue: Revenue Consumer advertising 78 % 78 % Software and services 22 22 Total revenue 100 100 Costs and operating expenses: Cost of revenue 22 20 Sales and marketing 47 39 Product and web site development 16 17 General and administrative 26 21 Amortization of intangible assets 2 2 Total costs and operating expenses 113 99 (Loss) income from operations (13 ) 1 Interest expense, net (2 ) (2 ) Earnings of unconsolidated joint venture 2 1 Other expense, net - - (Loss) income before income taxes (13 ) - Income tax (benefit) expense - - Net (loss) income (13 )% - % Revenue Revenue increased $5.1 million, or 9%, to $63.9 million for the three months ended September 30, 2014, compared to $58.8 million for the three months ended September 30, 2013. Revenue attributable to our Consumer Advertising products increased $4.0 million, or 9%, to $49.7 million for the three months ended September 30, 2014, compared to $45.6 million for the three months ended September 30, 2013. The increase in revenue was primarily due to increases in our Co-BrokeTM and Media advertisement products in our realtor.com® business. These increases were partially offset by revenue decreases from our Showcase and Featured products (i.e. Featured HomesTM, Featured CommunityTM, and Featured CMATM). In addition, there were revenue decreases in the Moving.comTM and rentals businesses. Revenue for our Software and Services products increased $1.0 million, or 8%, to $14.2 million for the three months ended September 30, 2014, compared to $13.2 million for the three months ended September 30, 2013. The increase in revenue was from all three of our SaaS product offerings: TigerLead®, ListHubTM and Top Producer®. Costs and Operating Expenses Cost of Revenue. Cost of revenue increased $2.1 million, or 18%, to $13.8 million for the three months ended September 30, 2014, compared to $11.8 million for the three months ended September 30, 2013. The increase was primarily due to a $0.5 million increase in lead acquisition costs related to the growth in our TigerLead® business. In addition, there was a $0.6 million increase in content acquisition costs, a $0.4 million increase in consulting costs, a $0.4 million increase in personnel-related costs, and a $0.2 million increase in depreciation expense. Sales and Marketing. Sales and marketing expenses increased $6.9 million, or 30%, to $29.8 million for the three months ended September 30, 2014, compared to $23.0 million for the three months ended September 30, 2013, primarily due to the increased investment in our marketing department and the national media campaign around our realtor.com® brand. This increase was mainly due to an increase in brand and consumer marketing expenses of $4.6 million, increased personnel-related costs of $2.5 million, of which $0.4 million was associated with the acceleration of vesting for outstanding equity awards due to the departure of an executive employee, and other cost increases of $0.3 million, partially offset by a decrease in traffic acquisition costs of $0.5 million due to the termination of the MSN agreement. We expect to continue to incur higher marketing costs through the remainder of 2014 as compared to 2013 as we continue to invest in our marketing campaigns to attract consumers to the realtor.com® brand. 29 -------------------------------------------------------------------------------- Table of Contents Product and Web Site Development. Product and web site development expenses increased $0.3 million, or 3%, to $10.2 million for the three months ended September 30, 2014, compared to $9.9 million for the three months ended September 30, 2013. This increase was mainly due to increased consulting and personnel-related costs of $0.8 million, increased amortization costs of $0.7 million associated with capitalized development costs and other cost increases of $0.2 million. These increases were partially offset by additional capitalized development costs of $1.4 million during the quarter ended September 30, 2014, related to building and deploying new functionality on our websites and in several product offerings, including our mobile platforms. General and Administrative. General and administrative expenses increased $4.7 million, or 39%, to $16.9 million for the three months ended September 30, 2014, compared to $12.2 million for the three months ended September 30, 2013. The increase was primarily due to non-recurring investment banking and legal costs of $4.3 million related to the proposed acquisition by News Corporation, an increase in personnel-related costs of $0.2 million and an increase in consulting costs of $0.3 million. Amortization of Intangible Assets. Amortization of intangible assets increased $0.2 million to $1.3 million for the three months ended September 30, 2014, compared to $1.1 million for the three months ended September 30, 2013. This increase was due to the amortization of intangible assets that were newly acquired in the second and fourth quarters of 2013. Stock-based Compensation and Charges. The following chart summarizes the stock-based compensation and charges that have been included in the following captions for each of the periods presented (in thousands): Three Months Ended September 30, 2014 2013 Cost of revenue $ 114 $ 74 Sales and marketing 1,223 648 Product and web site development 862 723 General and administrative 1,251 1,297 Total stock-based compensation and charges $ 3,450 $ 2,742 Stock-based compensation and charges increased $0.7 million for the three months ended September 30, 2014, compared to the three months ended September 30, 2013. The increase was primarily attributable to $0.4 million associated with the acceleration of vesting for outstanding equity awards due to the departure of an executive employee, as well as new grants of equity awards to key employees, partially offset by decreases in stock-based compensation related to grants of restricted stock units to senior members of previously acquired businesses pursuant to employment agreements that were fully vested as of September 30, 2013. Interest Expense, Net Interest expense, net increased to $1.7 million for the three months ended September 30, 2014, compared to $0.9 million for the three months ended September 30, 2013, primarily due to the issuance of the Notes in August 2013. Earnings of Unconsolidated Joint Venture Earnings of unconsolidated joint venture, which represent our proportionate share of the earnings from our unconsolidated joint venture, increased $0.4 million to $1.0 million for the three months ended September 30, 2014, compared to $0.6 million for the three months ended September 30, 2013. The increase was primarily due to increased revenue growth partially offset by incremental operating costs. Other Expense, Net Other expense, net remained relatively constant for the three months ended September 30, 2014 and 2013. Income Taxes As a result of our historical net operating losses, we have generally not recorded a provision for income taxes. However, we recorded a deferred tax liability related to certain indefinite-lived intangible assets as the amortization is recognized for tax purposes but not for book purposes. For the three months ended September 30, 2014 and 2013, income tax included state income taxes and a deferred tax provision related to amortization of certain indefinite-lived intangible assets. 30 -------------------------------------------------------------------------------- Table of Contents Nine Months Ended September 30, 2014 and 2013 The following tables present our results of operations for the nine months ended September 30, 2014 and 2013, and as a percentage of total revenue: Nine Months Ended September 30, 2014 2013 (In thousands) Consolidated Statement of Operations Data: Revenue Consumer advertising $ 141,842 $ 132,348 Software and services 41,374 38,205 Total revenue 183,216 170,553 Costs and operating expenses: Cost of revenue(1) 38,655 34,403 Sales and marketing(1) 85,279 67,619 Product and web site development 31,692 29,323 General and administrative 41,237 35,732 Amortization of intangible assets 3,770 3,172 Total costs and operating expenses 200,633 170,249 (Loss) income from operations (17,417 ) 304 Interest expense, net (4,877 ) (944 ) Earnings of unconsolidated joint venture 2,708 1,650 Other expense, net (72 ) (81 ) (Loss) income before income taxes (19,658 ) 929 Income tax expense 447 425 Net (loss) income $ (20,105 ) $ 504 -------------------------------------------------------------------------------- (1) Effective October 1, 2013, the Company elected to change the presentation of certain lead acquisition costs and to reclassify these costs from "Cost of revenue" to "Sales and marketing" within its Consolidated Statements of Operations in order to be more consistent with certain of its peers and to combine all traffic acquisition costs that are not considered directly related to the fulfillment of products into "Sales and marketing." This had the effect of decreasing "Cost of revenue" and increasing "Sales and marketing" expense by $5.9 million, or 3% of revenue, for the nine months ended September 30, 2013. 31 -------------------------------------------------------------------------------- Table of Contents Nine Months Ended September 30, 2014 2013 As a Percentage of Revenue: Revenue Consumer advertising 77 % 78 % Software and services 23 22 Total revenue 100 100 Costs and operating expenses: Cost of revenue 21 20 Sales and marketing 47 40 Product and web site development 17 17 General and administrative 22 21 Amortization of intangible assets 2 2 Total costs and operating expenses 109 100 (Loss) income from operations (9 ) - Interest expense, net (3 ) (1 ) Earnings of unconsolidated joint venture 1 1 Other expense, net - - (Loss) income before income taxes (11 ) - Income tax expense - - Net (loss) income (11 )% - % Revenue Revenue increased $12.7 million, or 7%, to $183.2 million for the nine months ended September 30, 2014, compared to $170.6 million for the nine months ended September 30, 2013. Revenue attributable to our Consumer Advertising products increased $9.5 million, or 7%, to $141.8 million for the nine months ended September 30, 2014, compared to $132.3 million for the nine months ended September 30, 2013. The increase in revenue was primarily due to increases in our Co-BrokeTM and Media advertisement products in our realtor.com® business. These increases were partially offset by revenue decreases from our Showcase and Featured products (i.e. Featured HomesTM, Featured CommunityTM, and Featured CMATM). In addition, there were revenue decreases in the Moving.comTM and rentals businesses. Revenue for our Software and Services products increased $3.2 million, or 8%, to $41.4 million for the nine months ended September 30, 2014, compared to $38.2 million for the nine months ended September 30, 2013. The increase in revenue was from all three of our SaaS product offerings: TigerLead®, ListHubTM and Top Producer®. Costs and Operating Expenses Cost of Revenue. Cost of revenue increased $4.3 million, or 12%, to $38.7 million for the nine months ended September 30, 2014, compared to $34.4 million for the nine months ended September 30, 2013. The increase was primarily due to a $1.3 million increase in lead acquisition costs related to the growth in our TigerLead® business. In addition, there was a $1.1 million increase in content acquisition costs, a $0.7 million increase in personnel-related costs, a $0.7 million increase in consulting costs, and a $0.6 million increase in depreciation expense. Sales and Marketing. Sales and marketing expenses increased $17.7 million, or 26%, to $85.3 million for the nine months ended September 30, 2014, compared to $67.6 million for the nine months ended September 30, 2013, primarily due to the increased investment in our marketing department and the national media campaign around our realtor.com® brand. This increase was mainly due to an increase in brand and consumer marketing expenses of $12.9 million, increased personnel-related costs of $4.1 million, of which $0.4 million was associated with the acceleration of vesting for outstanding equity awards due to the departure of an executive employee and which also includes increased sales commissions of $1.2 million associated with the increase in revenue, and an increase in traffic acquisition costs of $0.5 million. We expect to continue to incur higher marketing costs through the remainder of 2014 as compared to 2013 as we continue to invest in our marketing campaigns to attract consumers to the realtor.com® brand. 32 -------------------------------------------------------------------------------- Table of Contents Product and Web Site Development. Product and web site development expenses increased $2.4 million, or 8%, to $31.7 million for the nine months ended September 30, 2014, compared to $29.3 million for the nine months ended September 30, 2013. This increase was mainly due to increased stock-based compensation costs of $1.6 million, of which $0.9 million was associated with the acceleration of vesting for outstanding equity awards due to the departure of an executive employee. In addition, there was a $1.8 million increase in amortization costs associated with capitalized development costs, a $1.0 million increase in consulting and personnel-related costs, and $0.5 million in other cost increases. These increases were partially offset by additional capitalized development costs of $2.5 million during the nine months ended September 30, 2014, related to building and deploying new functionality on our websites and in several product offerings, including our mobile platforms. General and Administrative. General and administrative expenses increased $5.5 million, or 15%, to $41.2 million for the nine months ended September 30, 2014, compared to $35.7 million for the nine months ended September 30, 2013. The increase was primarily due to non-recurring costs of $4.3 million related to the proposed acquisition by News Corporation, an increase in personnel-related costs of $0.8 million, an increase in consulting costs of $0.5 million and other cost increases of $0.4 million. These increases were partially offset by a $0.5 million decrease in legal costs primarily due to the recovery of legal costs previously incurred as a result of a favorable arbitration ruling. Amortization of Intangible Assets. Amortization of intangible assets increased $0.6 million to $3.8 million for the nine months ended September 30, 2014, compared to $3.2 million for the nine months ended September 30, 2013. This increase was due to the amortization of intangible assets that were newly acquired in the second and fourth quarters of 2013. Stock-based Compensation and Charges. The following chart summarizes the stock-based compensation and charges that have been included in the following captions for each of the periods presented (in thousands): Nine Months Ended September 30, 2014 2013 Cost of revenue $ 337 $ 261 Sales and marketing 2,599 1,746 Product and web site development 3,677 2,050 General and administrative 3,545 4,184 Total stock-based compensation and charges $ 10,158 $ 8,241 Stock-based compensation and charges increased $1.9 million for the nine months ended September 30, 2014, compared to the nine months ended September 30, 2013. The increase was primarily attributable to $1.3 million associated with the acceleration of vesting for outstanding equity awards due to the departure of two executive employees, as well as grants of stock options and restricted stock units to key employees, partially offset by decreases in stock-based compensation related to grants of restricted stock units to senior members of previously acquired businesses pursuant to employment agreements that were fully vested as of September 30, 2013. Interest Expense, Net Interest expense, net increased to $4.9 million for the nine months ended September 30, 2014, compared to $0.9 million for the nine months ended September 30, 2013, primarily due to the issuance of the Notes in August 2013. Earnings of Unconsolidated Joint Venture Earnings of unconsolidated joint venture, which represent our proportionate share of the earnings from our unconsolidated joint venture, increased $1.1 million to $2.7 million for the nine months ended September 30, 2014, compared to $1.7 million for the nine months ended September 30, 2013. The increase was primarily due to increased revenue growth partially offset by incremental operating costs. Other Expense, Net Other expense, net remained relatively constant for the nine months ended September 30, 2014 and 2013. Income Taxes As a result of our historical net operating losses, we have generally not recorded a provision for income taxes. However, we recorded a deferred tax liability related to certain indefinite-lived intangible assets as the amortization is recognized for tax purposes but not for book purposes. For the nine months ended September 30, 2014 and 2013, income tax expense included state income taxes and a deferred tax provision related to amortization of certain indefinite-lived intangible assets. 33 -------------------------------------------------------------------------------- Table of Contents LIQUIDITY AND CAPITAL RESOURCES Net cash provided by operating activities of $11.4 million for the nine months ended September 30, 2014, was attributable to a net loss of $20.0 million plus non-cash expenses including depreciation, amortization of intangible assets, amortization of debt discount and issuance costs, provision for doubtful accounts, stock-based compensation and charges, earnings of unconsolidated joint venture and other non-cash items aggregating to $24.5 million, a $0.8 million cash distribution representing a return on our investment in an unconsolidated joint venture, and a $6.0 million change in operating assets and liabilities. Net cash provided by operating activities of $20.8 million for the nine months ended September 30, 2013, was attributable to net income of $0.5 million, plus non-cash expenses including depreciation, amortization of intangible assets, amortization of debt discount and issuance costs, provision for doubtful accounts, stock-based compensation and charges, earnings of unconsolidated joint venture and other non-cash items aggregating to $18.4 million, a $1.3 million change in operating assets and liabilities, and a $0.6 million cash distribution representing a return on our investment in an unconsolidated joint venture. Net cash used in investing activities of $20.1 million for the nine months ended September 30, 2014, was attributable to capital expenditures of $15.1 million and purchases of intangible assets of $5.0 million. Net cash used in investing activities of $10.6 million for the nine months ended September 30, 2013, was primarily attributable to capital expenditures of $8.9 million, and acquisitions, net of cash acquired, of $2.3 million, partially offset by a cash distribution representing a return of our investment in an unconsolidated joint venture of $0.6 million. Net cash provided by financing activities of $5.2 million for the nine months ended September 30, 2014, was attributable to proceeds from the exercise of stock options of $7.5 million, partially offset by tax withholdings related to net share settlements of equity awards of $2.2 million. Net cash provided by financing activities of $76.4 million for the nine months ended September 30, 2013, was primarily attributable to net proceeds of $96.6 million from the issuance of the Notes and proceeds from the exercise of stock options of $8.2 million, partially offset by repurchases of our common stock of $26.0 million and tax withholdings related to net share settlements of equity awards of $2.4 million. We have generated positive operating cash flows in each of the last three fiscal years. Our material financial commitments consist of those under our operating lease agreements, our operating agreement with the NAR and various web services and content agreements. In March 2013, our Board of Directors authorized a stock repurchase program (the "Program"). The Program authorizes, in one or more transactions taking place during a two-year period commencing May 2, 2013, the repurchase of our outstanding common stock utilizing surplus cash in an amount of up to $20 million. Under the Program, we are authorized to repurchase shares of our common stock in the open market or in privately negotiated transactions. The timing and amount of any repurchase transaction under the Program are dependent upon market conditions, corporate considerations, and regulatory requirements. Shares repurchased under the Program will be retired to constitute authorized but unissued shares of our common stock. As of September 30, 2014, we have repurchased 84,054 shares of our outstanding common stock in the open market for $1.0 million since the inception of the Program. There were no shares repurchased during the nine months ended September 30, 2014. In August 2013, we issued the Notes with a principal amount of $100.0 million. Interest is payable in cash in arrears at a fixed rate of 2.75% on March 1 and September 1 of each year, beginning on March 1, 2014. The Notes mature on September 1, 2018 unless repurchased or converted in accordance with their terms prior to such date. We cannot redeem the Notes prior to maturity. Additionally, in connection with the issuance of the Notes, we purchased 1,798,561 shares of our outstanding common stock in privately negotiated transactions for an aggregate purchase price of $25.0 million. We believe that our existing cash and any cash generated from operations will be sufficient to fund our working capital requirements, capital expenditures and other obligations for the foreseeable future. 34 -------------------------------------------------------------------------------- Table of Contents |