How Demand Media Keeps its Books

Tweet

With Max Chafkin off to Wisconsin for the holidays, I'll fill in for him and cover the ongoing saga of the Demand Media IPO.

To briefly catch you up, the media start-up is hoping to raise $125 million through a public offering to support its strategy of expertly matching content to what people want and paying the producers of said content below-market wages. Many have looked to this as a model that could make media profitable again. Indeed, Wired wrote that it was 'profitable as hell.'

But, after it filed for its IPO in August, that claim came under a lot of scrutiny because its financials based on generally accepted accounting principles (GAAP) showed that – drum roll – it, in fact, was not profitable. Instead, those profitability claims were based on non-GAAP calculations that backed out little things like depreciation, amortization and other non-cash items.

Yesterday, Demand Media filed yet another amended S-1 with the Securities and Exchange Commission. Part of the hold up with the IPO, All Things D reports, is that government regulators would like to know a little bit more about how Demand Media accounts for its content costs.

From All Things D:

Currently, using a concept of 'long-lived' content, Demand has been amortizing those expenses over five years, since it says it continues to generate revenue on that material over that much time…That's different from many companies in the publishing business, which typically account for costs of creating content immediately as they are incurred or over a much shorter time period.

Demand justifies this treatment by saying its content has an evergreen nature and generates revenue over five years, so amortizing the related expenses over the same period should be kosher.

All of this, of course, is based on a 'sophisticated algorithmic platform–which other content creators do not have,' according to All Things D.

Sounds pretty mysterious to me. Now, what if that algorithm is a bit off? Demand says:

 'Changes from the five year useful life we currently use to amortize our capitalized content would have a significant impact on our financial statements. For example, if underlying assumptions were to change such that our estimate of the weighted average useful life of our media content was higher by one year from January 1, 2010, our net loss would decrease by approximately $1.6 million for the nine months ended September 30, 2010, and would increase by approximately $2.4 million should the weighted average useful life be reduced by one year.'

Creating an algorithm forecasting content consumption habits sounds like a daunting task (please tell me how we'll consume media in five years and I'll get my checkbook). But betting your financials on it sounds crazy to me. The above paragraph confirms the seriousness in a shift. Digging into the August S-1 filing, we find that the life expectancy for Demand content was 5.6 years at that time and then, in the latest filing, it was down to 5.4 years. That's a 3.5 percent change over a couple months in the wrong direction for Demand.

Yes, sounds like this saga is just getting going.

Matt Quinn contributes to the Wall Street Journal's corporate finance blog. He has also written extensively about banking and corporate finance for publications including Inc., American Banker, and Financial Week. He lives in Brooklyn, New York.