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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the quarterly period ended June 30, 2014

OR

 

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

For the transition period from                      to                     

Commission File Number: 333-189129-16

 

 

Ancestry.com LLC

(Exact name of registrant as specified in its charter)

 

 

 

Delaware		37-1708583
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)
360 West 4800 North Provo, Utah		84604
(Address of principal executive offices)		(Zip Code)

(801) 705-7000

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.    Yes  ¨    No  x*

* The registrant is a voluntary filer of reports required to be filed by certain companies under Sections 13 or 15(d) of the Securities Exchange Act of 1934 and has filed all reports that would have been required during the preceding 12 months had it been subject to such filing requirements.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer		¨		Accelerated filer		¨
Non-accelerated filer		x  (Do not check if a smaller reporting company)		Smaller reporting company		¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)    Yes  ¨    No  x

As of August 4, 2014, 100% of the registrant’s common interests outstanding (all of which are privately owned and are not traded on any public market) were owned by a sole member.

 

 

 

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Ancestry.com LLC

Table of Contents

 

		Page
Part I. Financial Information
Item 1. Financial Statements			3
Condensed Consolidated Balance Sheets as of June 30, 2014 (unaudited) and December 31, 2013			3
Condensed Consolidated Statements of Comprehensive Loss for the Three and Six Months Ended June  30, 2014 and 2013 (unaudited)			4
Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2014 and 2013 (unaudited)			5
Notes to Condensed Consolidated Financial Statements (unaudited)			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			19
Item 3. Quantitative and Qualitative Disclosures About Market Risk			33
Item 4. Controls and Procedures			33
Part II. Other Information
Item 1. Legal Proceedings			34
Item 1A. Risk Factors			34
Item 6. Exhibits			53
Signatures			54
Exhibit Index			55
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT

 

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

ANCESTRY.COM LLC

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

 

		June 30, 2014				December 31, 2013
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	91,465			$	86,554
Restricted cash			51,786				60,740
Accounts receivable, net of allowances of $591 and $605 at June 30, 2014 and December 31, 2013, respectively			10,345				11,382
Income tax receivable			3,505				3,285
Current deferred income taxes			9,523				20,350
Prepaid expenses and other current assets			14,559				11,530
Total current assets			181,183				193,841
Property and equipment, net			40,293				37,613
Content databases, net			277,994				272,758
Intangible assets, net			342,683				416,735
Goodwill			948,283				948,283
Other assets			32,194				35,512
Total assets		$	1,822,630			$	1,904,742
LIABILITIES AND MEMBER’S INTERESTS
Current liabilities:
Accounts payable		$	11,389			$	12,575
Accrued expenses			48,100				51,923
Acquisition-related liabilities			51,686				60,640
Deferred revenues			144,455				137,864
Current portion of long-term debt			36,832				36,760
Total current liabilities			292,462				299,762
Long-term debt, net			852,478				869,620
Deferred income taxes			147,484				185,553
Other long-term liabilities			13,625				9,110
Total liabilities			1,306,049				1,364,045
Commitments and contingencies
Member’s interests:
Member’s interests			678,942				693,072
Accumulated deficit			(162,361	)			(152,375	)
Total member’s interests			516,581				540,697
Total liabilities and member’s interests		$	1,822,630			$	1,904,742

See accompanying notes to condensed consolidated financial statements (unaudited)

 

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ANCESTRY.COM LLC

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2014				2013				2014				2013
		(unaudited)
Revenues:
Subscription revenues		$	137,961			$	122,708			$	275,155			$	236,482
Product and other revenues			18,091				9,240				34,543				18,988
Total revenues			156,052				131,948				309,698				255,470
Costs of revenues:
Cost of subscription revenues			23,895				20,786				47,263				41,519
Cost of product and other revenues			10,615				6,812				21,928				13,553
Total cost of revenues			34,510				27,598				69,191				55,072
Gross profit			121,542				104,350				240,507				200,398
Operating expenses:
Technology and development			24,236				21,418				48,801				41,935
Marketing and advertising			40,986				34,364				86,191				71,322
General and administrative			15,341				13,456				29,555				25,275
Amortization of acquired intangible assets			37,001				46,296				74,052				92,682
Total operating expenses			117,564				115,534				238,599				231,214
Income (loss) from operations			3,978				(11,184	)			1,908				(30,816	)
Interest expense, net			(17,759	)			(29,492	)			(35,150	)			(51,500	)
Other income (expense), net			306				(161	)			325				(712	)
Loss before income taxes			(13,475	)			(40,837	)			(32,917	)			(83,028	)
Income tax benefit			5,866				19,557				22,931				40,321
Net loss		$	(7,609	)		$	(21,280	)		$	(9,986	)		$	(42,707	)
Comprehensive loss		$	(7,609	)		$	(21,280	)		$	(9,986	)		$	(42,707	)

See accompanying notes to condensed consolidated financial statements (unaudited)

 

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ANCESTRY.COM LLC

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

		Six Months Ended June 30,
		2014				2013
		(unaudited)
Operating activities:
Net loss		$	(9,986	)		$	(42,707	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation			10,298				7,828
Amortization of content databases			14,286				13,073
Amortization of acquired intangible assets			74,052				92,682
Amortization of debt-related costs			4,886				13,237
Deferred income taxes			(27,242	)			(35,183	)
Stock-based compensation expense			3,824				3,186
Excess tax benefits from stock-based compensation			(954	)			—
Non-cash adjustment to deferred revenues			—				17,250
Changes in operating assets and liabilities:
Accounts receivable			1,037				289
Other assets			(2,961	)			1,010
Income taxes, net			5,123				13,609
Accounts payable and other liabilities			(4,111	)			(26,202	)
Deferred revenues			6,591				5,213
Net cash provided by operating activities			74,843				63,285
Investing activities:
Capitalization of content databases			(19,519	)			(8,672	)
Purchases of property and equipment			(12,978	)			(13,190	)
Net cash used in investing activities			(32,497	)			(21,862	)
Financing activities:
Proceeds from exercise of stock options			—				457
Taxes paid related to net share settlement of stock-based awards			—				(417	)
Member’s capital contributions			26				2,521
Principal payments on debt			(18,785	)			(39,175	)
Excess tax benefits from stock-based compensation			954				—
Return-of-capital distribution			(18,430	)			—
Payment of contingent consideration			(1,200	)			—
Payment of deferred financing costs			—				(7,815	)
Net cash used in financing activities			(37,435	)			(44,429	)
Net increase (decrease) in cash and cash equivalents			4,911				(3,006	)
Cash and cash equivalents at beginning of period			86,554				35,651
Cash and cash equivalents at end of period		$	91,465			$	32,645
Supplemental disclosures of cash flow information:
Cash paid for interest		$	30,346			$	37,305
Cash received for income taxes			886				18,731

See accompanying notes to condensed consolidated financial statements (unaudited)

 

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ANCESTRY.COM LLC

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.

Ancestry.com LLC (the “Parent”) is a wholly-owned subsidiary of Ancestry.com Holdings LLC (“Holdings LLC”), which is controlled by Permira funds and co-investors (the “Sponsors”). Holdings LLC is a holding company with no material operations and limited assets other than its ownership of the membership interests of Ancestry.com LLC. Holdings LLC is not individually responsible for any liabilities of the Company solely for reason of being a member or participating in management of the Company.

Ancestry.com LLC is a holding company and all operations are conducted by its wholly-owned subsidiaries. Ancestry.com LLC and its subsidiaries are collectively referred to as “Ancestry.com” or the “Company.” Ancestry.com is an online family history resource that derives revenue primarily on a subscription basis from providing customers access to a proprietary technology platform and an extensive collection of billions of historical records that have been digitized, indexed and made available online.

Basis of Presentation

The condensed consolidated financial statements include the accounts of Ancestry.com LLC and its consolidated subsidiaries and have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). All significant intercompany accounts and transactions have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to the current year presentation of the financial statements. These reclassifications did not have a significant impact on the condensed consolidated financial statements.

Unaudited Interim Financial Statements

The accompanying condensed consolidated balance sheets and the condensed consolidated statements of comprehensive loss and cash flows are unaudited. These unaudited interim condensed consolidated financial statements have been prepared in accordance with GAAP on the same basis as the audited consolidated financial statements and, in the opinion of management, reflect all adjustments (all of which are considered of a normal recurring nature) considered necessary to present fairly the Company’s financial position, results of operations and cash flows.

The majority of the Company’s revenues are subscription revenues, which are recognized ratably over the subscription periods; the costs to acquire subscribers are generally incurred before the Company recognizes the associated subscription revenues. Results of operations may vary between periods due to the timing of when revenues and expenses are recognized. As such, the results of operations for the three and six months ended June 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014.

These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes for the year ended December 31, 2013 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission.

Use of Estimates

The preparation of interim condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported and disclosed in the financial statements and accompanying notes. Actual results could differ materially from these estimates.

The Company regularly evaluates its estimates to determine their appropriateness, including testing goodwill for impairment, recoverability of long-lived assets, income taxes, determination of the fair value of stock options included in stock-based compensation expense and the estimated useful lives of the Company’s intangible assets, including content databases. The Company bases its estimates on historical experience and on various assumptions that are believed to be reasonable, the results of which form the basis for the amounts recorded within the condensed consolidated financial statements.

There have been no changes to the Company’s significant accounting policies as described in the Company’s Annual Report on Form 10-K for the three and six months ended June 30, 2014.

 

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Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606), that will supersede nearly all existing revenue recognition guidance under US GAAP. The core principle of the guidance is that an entity should recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. Further, the guidance requires improved disclosures to help users of financial statements better understand the nature, amount, timing and uncertainty of revenue that is recognized. This guidance is effective for public companies for interim and annual periods beginning on or after December 15, 2016. For non-public companies, this guidance is effective for annual periods beginning after December 15, 2017 and interim periods within annual periods beginning after December 15, 2018. Early adoption is not permitted under US GAAP. As an “emerging growth company” under the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), the Company has elected to delay adoption of new or revised accounting standards applicable to public companies until such pronouncements are made applicable to private companies. Once effective, entities can choose to apply the standard using either a full retrospective approach or a modified retrospective approach. The Company has not yet selected a transition method and is currently assessing the potential impact that this standard will have on its consolidated financial statements.

2. CASH AND CASH EQUIVALENTS

Cash and cash equivalents consisted of the following (in thousands):

 

		June 30, 2014				December 31, 2013
Cash		$	30,268			$	47,271
Cash equivalents:
Money market funds			61,197				39,283
Total cash and cash equivalents		$	91,465			$	86,554

3. FAIR VALUE MEASUREMENTS

Fair value is based on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In order to increase consistency and comparability in fair value measurements, accounting guidance establishes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three broad levels. These levels, in order of highest priority to lowest priority, are described below:

Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities.

Level 2: Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.

Level 3: Unobservable inputs are used when little or no market data is available.

Cash equivalents are classified as Level 1 due to readily available market prices in an active market. There were no movements between fair value measurement levels of the Company’s cash equivalents during the six months ended June 30, 2014.

The following table summarizes the financial instruments of the Company at fair value based on the valuation approach applied at June 30, 2014 (in thousands):

 

						Fair Value Measurement at Reporting Date Using
		Carrying Value at June 30, 2014				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets:
Cash equivalents:
Money market funds		$	61,197			$	61,197			$	—			$	—
Total assets		$	61,197			$	61,197			$	—			$	—

 

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The following table summarizes the financial instruments of the Company at fair value based on the valuation approach applied at December 31, 2013 (in thousands):

 

						Fair Value Measurement at Reporting Date Using
		Carrying Value at December 31, 2013				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets:
Cash equivalents:
Money market funds		$	39,283			$	39,283			$	—			$	—
Total assets		$	39,283			$	39,283			$	—			$	—

The carrying amounts as of June 30, 2014 and December 31, 2013 for accounts receivable and accounts payable approximated their fair values due to the immediate or short-term maturities of these financial instruments. As of June 30, 2014, the fair value of debt was $958.1 million. As of December 31, 2013, the fair value of debt was $974.7 million. The fair value of debt was considered a Level 2 measurement as the value was determined using observable market inputs, such as current interest rates, credit quality and prices observable from less active markets.

As of June 30, 2014 and December 31, 2013, the Company had restricted cash of $45.3 million related to shares of the Company’s predecessor, Ancestry.com Inc. (the “Predecessor” or “Issuer”) for which appraisal rights were duly exercised under Delaware law. Shares of the Predecessor’s common stock for which appraisal rights were duly exercised were canceled and converted into the right to receive the fair value of such share in accordance with Delaware law in conjunction with the Parent’s acquisition of the Predecessor on December 28, 2012 for approximately $1.5 billion or $32.00 per share of common stock (the “Merger”). Following the Merger, the holders of such dissenting shares ceased to have any rights with respect to such shares, except for their rights to seek an appraisal under Delaware law. The Company remains liable for payments for the dissenting shares. The related liability is recorded in acquisition-related liabilities on the condensed consolidated balance sheets as of June 30, 2014 and December 31, 2013. If the fair value of these shares is determined to be greater than the $32.00 per share merger price, the Company would incur additional expense. The fair value of the liability was considered a Level 2 measurement as the value was determined based on observable prices from inputs not quoted on active markets. See Note 7 for further information regarding the litigation.

4. DEBT

Credit Facility

In December 2012, the Issuer entered into a credit facility, which as amended on May 15, 2013 and December 30, 2013 (the “Second Amended Credit Facility”) consists of a $457.1 million amended Term B-1 Loan (the “Amended Term B-1 Loan”) maturing in December 2018, a $165.0 million amended Term B-2 Loan (the “Amended Term B-2 Loan”) maturing in May 2018 and a $50.0 million revolving facility (the “Revolving Facility”) expiring in December 2017. As of June 30, 2014, no funds had been drawn against the Revolving Facility. Borrowings under the Revolving Facility may be used for the purpose of general working capital, capital expenditures and other capital needs. The Second Amended Credit Facility allows the Issuer to borrow additional amounts up to $150.0 million provided the pro forma total net secured leverage ratio as defined in the agreement for the Second Amended Credit Facility does not exceed 4.00 to 1.00 and subject to market availability. Additional amounts can be borrowed subject to covenants in the Second Amended Credit Facility.

Amounts borrowed under the Amended Term B-1 Loan are required to be paid in equal quarterly installments totaling 1% of the amended principal amount of the Amended Term B-1 Loan annually, with the balance payable upon maturity. Amounts borrowed under the Amended Term B-2 Loan are payable in equal quarterly installments of $8.25 million, with the balance payable upon maturity. Additionally, subject to certain conditions, mandatory prepayments are required to be made annually beginning in 2015 upon delivery of the 2014 audited financial statements. Mandatory prepayments are required up to 50% of excess cash flow, based on the Company’s net secured leverage ratio and net cash proceeds of certain other transactions as calculated at the end of each fiscal year.

The Amended Term B-1 Loan, Amended Term B-2 Loan and Revolving Facility bear interest on the outstanding unpaid principal amount at a rate equal to an applicable margin plus, at the Company’s option, either: (a) a base rate determined by reference to the highest of (i) the Barclays Bank PLC prime rate at such time, (ii) 0.50% in excess of the overnight federal funds rate at such time and (iii) the LIBOR rate that is in effect for a LIBOR loan with an interest period of one month plus 1.00%, provided that the base rate for the Amended Term B-1 Loan and Amended Term B-2 Loan is not less than 2.00%; or (b) a LIBOR rate, provided that the LIBOR rate for the Amended Term B-1 Loan and the Amended Term B-2 Loan is not less than 1.00%. The applicable margin shall mean either: (a) in

 

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the case of a base rate Amended Term B-1 Loan, 2.50%, and in the case of a base rate Amended Term B-2 Loan, 2.00%, or (b) in the case of a LIBOR Amended Term B-1 Loan, 3.50%, and in the case of a LIBOR Amended Term B-2 Loan, 3.00%. As of June 30, 2014, the interest rates on the Amended Term B-1 Loan and Amended Term B-2 Loan were equal to a LIBOR floor of 1.00% plus applicable margins of 3.50% and 3.00%, respectively. The applicable margin for the Revolving Facility is subject to step-ups and step-downs based on the Company’s leverage ratio. The Issuer is also required to pay a commitment fee of 0.50% per annum on the unutilized commitments under the Revolving Facility, which fee decreases to 0.375% if the total net secured leverage ratio is less than or equal to 2.75 to 1.00. The effective interest rates of both the Amended Term B-1 Loan and Amended Term B-2 Loan are approximately 5.9%.

The credit agreement governing the Second Amended Credit Facility permits restricted payments, including dividends, out of “available amounts” (as defined in the agreement for the Second Amended Credit Facility). The available amount formulation includes a starter amount of $25.0 million and will include available amounts beginning with respect to the year ended December 31, 2014. Available amounts are adjusted annually upon the delivery of the Company’s audited financial statements. Available amounts are adjusted based on the calculation of 50% of the Company’s annual retained excess cash flow. Separately, the credit agreement has a general basket for restricted payments of $40.0 million. As of June 30, 2014 and December 31, 2013, the Company was in compliance with all covenants of the Second Amended Credit Facility.

The Second Amended Credit Facility also requires the Issuer to maintain an interest rate protection agreement for a period of not less than three years from the closing date such that not less than 50% of the outstanding debt of the Issuer and its restricted subsidiaries at the closing date is (i) subject to an interest rate protection agreement or (ii) fixed-rate borrowings. Accordingly, the Issuer has interest rate cap agreements with a $190.0 million total notional amount that cap the three-month LIBOR rate at 1.50% expiring March 31, 2016. This agreement, in conjunction with the fixed interest rate borrowings discussed below, met the stipulations prescribed by the Second Amended Credit Facility agreement. The Issuer, at its discretion, has also entered into an interest rate cap agreement with a $200.0 million total notional amount effective on March 31, 2016 that caps the three-month LIBOR rate at 2.00% expiring December 30, 2016. Changes in the fair value of the interest rate cap are recorded in the condensed consolidated statements of comprehensive loss during the period of the change. The fair value as of June 30, 2014 and December 31, 2013 and the change in fair value of the interest rate caps for the three and six months ended June 30, 2014 and June 30, 2013 were immaterial.

Senior Notes

The Issuer has outstanding $300.0 million of fixed-rate 11.0% notes (the “Notes”) due in December 2020. Interest on the Notes is payable semi-annually in arrears on June 15 and December 15 of each year. The Issuer may redeem all or any portion of the Notes at any time prior to December 15, 2016 at a price equal to 100% of the aggregate principal plus the applicable premium, as defined in the indenture, and accrued interest. The Issuer may redeem any portion or all of the Notes after December 15, 2016 at redemption prices as set forth in the indenture, plus accrued and unpaid interest. In addition, the Issuer may redeem up to 35% of the aggregate principal of the Notes with an amount equal to the proceeds of certain equity offerings any time prior to December 2015 at 111% plus accrued interest. Upon a change of control, the Issuer is required to make an offer to redeem all of the Notes from the holders at 101% of the principal amount thereof plus accrued interest. The Notes are guaranteed by Ancestry.com LLC and certain of its subsidiaries. The effective interest rate of the Notes is approximately 12.0%.

The indenture governing the Notes generally permits the payment of restricted payments, including dividends, out of a cumulative basket, which grows quarterly based on 50% of the Company’s cumulative consolidated net income, as defined in the indenture governing the Notes, since October 1, 2012. In addition, as a condition to making such payments, the Company must be in compliance with a pro-forma fixed charge coverage ratio greater than or equal to 2.0 to 1.0. Separately, the indenture has a general basket for such payments of the greater of $50.0 million or 2.5% of total assets.

Outstanding long-term debt consists of the following (in thousands):

 

		June 30, 2014												December 31, 2013
		Outstanding Principal				Unamortized Discount				Net Carrying Amount				Outstanding Principal				Unamortized Discount				Net Carrying Amount
Amended Term B-1 loan		$	454,819				(11,190	)			443,629			$	457,104			$	(12,285	)		$	444,819
Amended Term B-2 loan			148,500				(2,819	)			145,681				165,000				(3,439	)			161,561
Senior unsecured notes			300,000				—				300,000				300,000				—				300,000
Total debt			903,319				(14,009	)			889,310				922,104				(15,724	)			906,380
Less: Current portion			(37,571	)			739				(36,832	)			(37,571	)			811				(36,760	)
Long-term debt		$	865,748				(13,270	)			852,478			$	884,533			$	(14,913	)		$	869,620

 

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The following is a schedule by year of future principal payments as of June 30, 2014 (in thousands):

 

Years Ending December 31,		Amended Term B-1 Loan				Amended Term B-2 Loan				Senior Unsecured Notes				Total
2014		$	2,286			$	16,500			$	—			$	18,786
2015			4,571				33,000				—				37,571
2016			4,571				33,000				—				37,571
2017			4,571				33,000				—				37,571
2018			438,820				33,000				—				471,820
Thereafter			—				—				300,000				300,000
Total future principal payments		$	454,819			$	148,500			$	300,000			$	903,319

Ancestry.com Holdings LLC Senior Unsecured PIK Notes

On September 17, 2013, Holdings LLC, closed a private offering of $300.0 million aggregate principal amount of senior unsecured payment-in-kind toggle notes due October 15, 2018. On February 3, 2014, Holdings LLC closed an additional private follow-on offering of $100.0 million aggregate principal amount of senior unsecured payment-in-kind toggle notes, which have identical terms (other than issue date and issue price) and constitute part of the same series as the notes under the indenture dated as of September 17, 2013 (collectively, the “PIK Notes”). The follow-on offering was issued at 103%, resulting in an original issue premium of $3.0 million. Holdings LLC subsequently distributed the proceeds of the follow-on offering, net of related fees and expenses, to its indirect parent entity to fund a return-of-capital distribution to its indirect parent entity’s shareholders and stock-based award holders.

Interest on the PIK Notes is payable semi-annually in arrears on April 15 and October 15 each year through maturity. The first and last interest payments on the PIK Notes are required to be entirely payable in cash. All other interest payments are required to be paid in cash, subject to cash availability and restricted payment capacity. If interest payments are not required to be paid in cash, Holdings LLC will be entitled to pay all or a portion of the interest payment by increasing the principal amount of the notes or issuing new notes in an amount equal to the interest payment for the applicable interest period (“PIK Interest”). Cash interest on the PIK Notes will accrue at the rate of 9.625% per annum; PIK Interest will accrue at the rate of 10.375% per annum.

The PIK Notes are senior unsecured obligations of Holdings LLC and are structurally subordinated to all the Company’s existing and future indebtedness. Additionally, the Company did not guarantee the PIK Notes, nor were any of its assets pledged as collateral for the PIK Notes. As the Company is not an obligor or a guarantor on the PIK Notes, the debt is recorded only in the financial statements of Holdings LLC and is not reflected in the condensed consolidated financial statements of Ancestry.com LLC. While not required, in April 2014, the Company declared and paid its parent, Holdings LLC, a return-of-capital distribution of $18.4 million to pay accumulated interest on the PIK Notes. The Company intends to make future distributions to Holdings LLC in order to fund cash interest payments on the PIK Notes, provided that such distributions are permitted under the covenants of the Second Amended Credit Facility and the Notes.

5. STOCK-BASED AWARDS

The Company’s indirect parent adopted the 2013 Equity Incentive Plan, which provides for employees, directors and consultants of the Company to be granted options and restricted stock units (“RSUs”), which represent the option to purchase or rights to own “Investor Interests” in an indirect parent entity of the Company, respectively. Additionally, the Company’s indirect parent adopted the Predecessor’s 2009 Stock Incentive Plan, the Generations Holding, Inc. Stock Purchase and Option Plan and the 2004 Stock Option Plan (the “Predecessor Plans”). The Company’s indirect parent does not anticipate issuing additional awards under the Predecessor Plans. All awards granted and outstanding pursuant to these plans have a term not greater than ten years from the original date of grant.

In February 2014, the Company’s indirect parent entity paid a return-of-capital distribution to its shareholders and stock-based award holders. Under the terms of the 2013 Equity Incentive Plan and the Predecessor Plans, an equitable adjustment was required to be made to all stock-based awards outstanding upon a return-of-capital distribution such that no dilution or enlargement of benefits occurred. The stock-based awards outstanding as of the date of the distribution were modified as follows:

 

•

Options outstanding were modified such that the exercise price of each option was reduced by the same percentage as the return-of-capital distribution percentage. Holders of in-the-money options also received a cash distribution or a further reduction in the exercise price of the options dependent upon the terms of the individual award and the equity plan under which the award was originally granted.

 

•

The holders of RSUs outstanding either received an immediate cash distribution or will receive a cash distribution upon the vesting of the awards dependent upon the terms of the individual award and the equity plan under which the award was originally granted.

 

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In accordance with ASC 718 – Stock Compensation, the changes to the awards were accounted for as a modification. As such, the fair value of each award immediately before and after the modification was compared and no incremental stock-based compensation cost was recognized.

The disclosures below have been updated to retroactively reflect the effects of the return-of-capital distribution for the weighted-average exercise price of the options and weighted-average grant date fair value of the RSUs.

Stock Options

Stock options granted are in an indirect parent entity of the Company. Each option in the indirect parent entity entitles the grantee to an investor interest in that entity upon exercise. The activity for stock options in an indirect parent entity of the Company for the six months ended June 30, 2014 was as follows:

 

		Number of Units (In thousands)				Weighted Average Exercise Price
Outstanding at December 31, 2013			393			$	63.74
Granted			112				77.68
Exercised			(49	)			29.23
Canceled			(6	)			70.07
Outstanding at June 30, 2014			450				70.85
Exercisable at June 30, 2014			70				68.53
Vested and expected to vest at June 30, 2014			412				70.60

The Company estimates the fair value of each stock option on the date of grant using the Black-Scholes option-pricing model. The Black-Scholes option-pricing model requires several estimates, including an estimate of the fair value of the underlying investor interest. The fair value of the underlying investor interest was based on the fair value on the grant date. The expected term of the options was based on the remaining contractual term of the options and the expected exercise behavior of employees including a historical analysis of exercise behavior of the Predecessor’s employees. The Company calculated its expected volatility based on the volatilities of a peer group of publicly traded companies. The risk-free interest rate of the option is based on the U.S. Treasury rate for the expected term of the option. The following weighted-average assumptions were used in the calculations for the six months ended June 30, 2014 and 2013:

 

		Six months ended June 30,
		2014				2013
Expected volatility			46.0	%			44.6	%
Expected term (in years)			4.5				5.0
Weighted-average risk-free interest rate			1.5	%			0.8	%
Weighted-average fair value of the underlying investor interest		$	77.68			$	154.99
Expected dividends			—				—

Restricted Stock Units

Each RSU entitles the grantee to an investor interest in an indirect parent entity of the Company or at the discretion of the indirect parent entity, cash equal to the fair market value of the award at the settlement date. RSU activity for the six months ended June 30, 2014 was as follows:

 

		Number of Units (in thousands)				Weighted Average Grant Date Fair Value
Outstanding at December 31, 2013			76			$	69.12
Granted			1				77.48
Vested			(29	)			68.93
Forfeited			(1	)			71.86
Outstanding at June 30, 2014			47				69.36

 

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Summary of Stock-Based Compensation Expense

Stock-based compensation was included in the following captions within the condensed consolidated statements of comprehensive loss (in thousands):

 

		Three Months Ended June 30,								Six months ended June 30,
		2014				2013				2014				2013
Cost of revenues		$	34			$	54			$	61			$	54
Technology and development			836				1,277				1,633				1,491
Marketing and advertising			236				372				466				372
General and administrative			912				1,037				1,664				1,269
Total stock-based compensation expense		$	2,018			$	2,740			$	3,824			$	3,186

Unrecognized stock-based compensation for stock options and RSUs at June 30, 2014 was as follows (in thousands, except years):

 

		Unrecognized Stock-Based Compensation				Weighted Average Remaining Period of Recognition
Stock options		$	15,750				3.8
RSUs			6,409				1.9
Total unrecognized stock-based compensation at June 30, 2014		$	22,159

6. INCOME TAXES

For the three and six months ended June 30, 2014, the Company recorded income tax benefits of $5.9 million and $22.9 million, respectively, compared to income tax benefits of $19.6 million and $40.3 million for the three and six months ended June 30, 2013, respectively. For the three months ended June 30, 2014, the Company’s effective income tax rate was 43.5%, a decrease of 4.4 percentage points compared to the three months ended June 30, 2013. The decrease in the effective income tax rate resulted primarily from unfavorable discrete items related to intercompany transactions for the three months ended June 30, 2014. For the six months ended June 30, 2014, the Company’s effective income tax rate was 69.7%, an increase of 21.1 percentage points compared to the six months ended June 30, 2013. The increase in the effective income tax rate resulted primarily from an increased foreign tax rate benefit for the six months ended June 30, 2014, offset by decreased federal research and development tax credits due to the expiration of the tax credit on December 31, 2013, in accordance with the provisions of the American Taxpayer Relief Act of 2012.

The Company is subject to income taxes in U.S. and foreign jurisdictions and to examination by tax authorities. Significant judgment is required in evaluating the Company’s uncertain tax positions and determining its provision for income taxes. The Company’s total gross unrecognized tax benefits at June 30, 2014 and December 31, 2013 were $13.3 million and $8.7 million, respectively. The $4.6 million increase in the gross unrecognized tax benefits at June 30, 2014 compared to December 31, 2013 resulted primarily from positions taken on the Company’s income tax returns related to intercompany transactions and various tax credits. The gross uncertain tax positions, if recognized, would largely result in a reduction of tax expense.

7. COMMITMENTS AND CONTINGENCIES

Appraisal Litigation (In re: Appraisal of Ancestry.com Inc.)

Following the consummation of the Merger, three former shareholders, who, combined, owned approximately 1.4 million shares of the Predecessor’s common stock, instituted two separate appraisal proceedings in the Court of Chancery of the State of Delaware pursuant to Del. C. § 262: Merion Capital, L.P. v. Ancestry.com, Inc. (C.A. No. 8173) and Merlin Partners LP et al. v. Ancestry.com Inc. (C.A. No. 8175). The two appraisal petitions allege that the $32 per share price paid to the Predecessor’s shareholders in the Merger did not represent the fair value of the Company on the date the Merger was consummated. On June 24, 2013, the Court consolidated the two pending appraisal proceedings as In re: Appraisal of Ancestry.com Inc.

On May 9, 2014, Ancestry moved for summary judgment as to Merion Capital, LP, arguing that Merion had failed to establish an entitlement to appraisal of its shares. Merion filed a brief in opposition to the motion on June 11, 2014. The Company filed a reply brief on July 11, 2014.

Additionally, trial before the Court of Chancery took place from June 17 to June 19, 2014. Post-trial briefing is expected to be completed on September 3, 2014.

 

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In view of the inherent difficulty of predicting the outcome of such litigation, particularly where the claimants seek very large or indeterminate damages or where the matter presents novel legal theories or involve a large number of parties, the Company generally cannot predict or reasonably estimate what the eventual outcome of the pending matter described above will be, what the timing of the ultimate resolution of this matter will be, or what any loss or range of loss related to the pending matter may be. With respect to the outstanding legal matter described in the prior paragraph, the Company believes that it has substantial defenses to the claims asserted by the claimants in the litigation. Based on the Company’s current knowledge, it does not believe that a loss, if any, arising from the pending matter described in the prior paragraph should have a material adverse effect on its consolidated financial position.

General

The Company has and may become party to various other legal proceedings and other claims that arise in the ordinary course of business or otherwise in the future. Such matters are subject to many uncertainties, and outcomes are not predictable with assurance. While the Company cannot assure the ultimate outcome of any legal proceeding or contingency in which it is or may become involved, the Company does not believe that any pending legal claim or proceeding arising in the ordinary course will be resolved in a manner that would have a material adverse effect on its business. Although the Company considers the likelihood of such an outcome to be remote, if one or more of these legal matters resulted in an adverse money judgment against the Company, such a judgment could have a material adverse effect on its operating results and financial conditions and may result in the Company being required to pay significant monetary damages.

8. GUARANTOR CONDENSED CONSOLIDATING FINANCIAL STATEMENTS

The Notes are fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by Ancestry.com LLC and by certain of its direct and indirect restricted subsidiaries (“Guarantor Subsidiaries”) in accordance with the indenture. All other subsidiaries that do not guarantee the Notes are “Non-Guarantors.” Each subsidiary is 100% owned directly or indirectly by the Parent, and there are no significant restrictions on the ability of the Parent or any of the Guarantor Subsidiaries to obtain funds from its subsidiaries by dividend or loan. The Parent conducts substantially all of its business through its subsidiaries. In servicing payments on the Notes and other indebtedness, the Issuer will rely on cash flows from these subsidiaries. See Note 4 for further information regarding the Notes.

The Guarantor Subsidiaries are exempt from reporting under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”), pursuant to Rule 12h-5 under the Exchange Act. As such, the Company is presenting the following condensed consolidating balance sheets, statements of comprehensive loss and statements of cash flows as set forth below of the Parent, Issuer, Guarantor Subsidiaries and the Non-Guarantor subsidiaries.

Basis of Presentation

The same accounting policies as described in the condensed consolidated financial statements are used by each entity in the condensed consolidating financial statements, except for the use of the equity method of accounting to reflect ownership interests in subsidiaries, which are eliminated upon consolidation. Consolidating entries and eliminations in the following condensed consolidating financial statements represent adjustments to (a) eliminate intercompany transactions between or among the Parent, the Issuer, the Guarantor Subsidiaries and the Non-Guarantors, (b) eliminate the investments in subsidiaries and (c) record consolidating entries.

All direct and indirect domestic subsidiaries are included in Ancestry U.S. Holdings Inc.’s consolidated U.S. tax return. In the condensed consolidating financial statements, income tax benefit (expense) has been allocated based on each such domestic subsidiary’s relative pretax income (loss) to the consolidated pretax income (loss).

Management believes that the allocations and adjustments noted above are reasonable. However, such allocations and adjustments may not be indicative of the actual amounts that would have been incurred had the Parent, Guarantor Subsidiaries and Non-Guarantors operated independently.

Certain prior period amounts have been reclassified to conform to the current year presentation of the financial statements. These reclassifications did not have a significant impact on the condensed consolidating financial statements.

 

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ANCESTRY.COM LLC

CONDENSED CONSOLIDATING BALANCE SHEETS

(in thousands)

June 30, 2014

 

		Parent				Issuer				Guarantor Subsidiaries				Non- Guarantor Subsidiaries				Elimination				Total
ASSETS
Current assets:
Cash and cash equivalents		$	173			$	77			$	85,133			$	6,082			$	—			$	91,465
Restricted cash			—				45,280				6,506				—				—				51,786
Accounts receivable, net of allowances			—				—				7,820				2,525				—				10,345
Income tax receivable			—				—				3,505				—				—				3,505
Current deferred income taxes			—				—				9,523				—				—				9,523
Prepaid expenses and other current assets			—				855				13,408				296				—				14,559
Intercompany receivables			86				—				2,380				2,176				(4,642	)			—
Total current assets			259				46,212				128,275				11,079				(4,642	)			181,183
Property and equipment, net			—				—				39,893				400				—				40,293
Content databases, net			—				—				277,126				868				—				277,994
Intangible assets, net			—				—				342,683				—				—				342,683
Goodwill			—				—				947,482				801				—				948,283
Investment in subsidiary			516,379				1,351,255				489,505				—				(2,357,139	)			—
Other assets			—				28,586				3,392				216				—				32,194
Total assets		$	516,638			$	1,426,053			$	2,228,356			$	13,364			$	(2,361,781	)		$	1,822,630
LIABILITIES AND MEMBER’S INTERESTS
Current liabilities:
Accounts payable		$	—			$	30			$	11,207			$	152			$	—			$	11,389
Accrued expenses			—				1,623				41,764				4,713				—				48,100
Acquisition-related liabilities			—				45,280				6,406				—				—				51,686
Deferred revenues			—				—				144,299				156				—				144,455
Current portion of long-term debt			—				36,832				—				—				—				36,832
Intercompany payables			57				—				2,187				2,398				(4,642	)			—
Total current liabilities			57				83,765				205,863				7,419				(4,642	)			292,462
Long-term debt, net			—				852,478				—				—				—				852,478
Deferred income taxes			—				—				147,512				(28	)			—				147,484
Other long-term liabilities			—				—				13,625				—				—				13,625
Total liabilities			57				936,243				367,000				7,391				(4,642	)			1,306,049
Total member’s interests			516,581				489,810				1,861,356				5,973				(2,357,139	)			516,581
Total liabilities and member’s interests		$	516,638			$	1,426,053			$	2,228,356			$	13,364			$	(2,361,781	)		$	1,822,630

 

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ANCESTRY.COM LLC

CONDENSED CONSOLIDATING BALANCE SHEETS (continued)

(in thousands)

December 31, 2013

 

		Parent				Issuer				Guarantor Subsidiaries				Non- Guarantor Subsidiaries				Elimination				Total
ASSETS
Current assets:
Cash and cash equivalents		$	338			$	562			$	60,362			$	25,292			$	—			$	86,554
Restricted cash			—				45,280				15,460				—				—				60,740
Accounts receivable, net of allowances			—				—				7,872				3,510				—				11,382
Income tax receivable			—				—				3,285				—				—				3,285
Current deferred income taxes			—				—				20,350				—				—				20,350
Prepaid expenses and other current assets			—				911				10,267				352				—				11,530
Intercompany receivables			168				—				6,793				2,160				(9,121	)			—
Total current assets			506				46,753				124,389				31,314				(9,121	)			193,841
Property and equipment, net			—				—				37,155				458				—				37,613
Content databases, net			—				—				271,839				919				—				272,758
Intangible assets, net			—				—				416,735				—				—				416,735
Goodwill			—				—				947,482				801				—				948,283
Investment in subsidiary			540,191				1,400,522				524,792				—				(2,465,505	)			—
Other assets			—				31,757				3,546				209				—				35,512
Total assets		$	540,697			$	1,479,032			$	2,325,938			$	33,701			$	(2,474,626	)		$	1,904,742
LIABILITIES AND MEMBER’S INTERESTS
Current liabilities:
Accounts payable		$	—			$	106			$	11,854			$	615			$	—			$	12,575
Accrued expenses			—				1,735				44,887				5,301				—				51,923
Acquisition-related liabilities			—				45,280				15,360				—				—				60,640
Deferred revenues			—				—				137,597				267				—				137,864
Current portion of long-term debt			—				36,760				—				—				—				36,760
Intercompany payables			—				—				2,249				6,872				(9,121	)			—
Total current liabilities			—				83,881				211,947				13,055				(9,121	)			299,762
Long-term debt, net			—				869,620				—				—				—				869,620
Deferred income taxes			—				—				185,574				(21	)			—				185,553
Other long-term liabilities			—				—				9,110				—				—				9,110
Total liabilities			—				953,501				406,631				13,034				(9,121	)			1,364,045
Total member’s interests			540,697				525,531				1,919,307				20,667				(2,465,505	)			540,697
Total liabilities and member’s interests		$	540,697			$	1,479,032			$	2,325,938			$	33,701			$	(2,474,626	)		$	1,904,742

 

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ANCESTRY.COM LLC

CONDENSED CONSOLIDATING STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

Three Months Ended June 30, 2014

 

		Parent				Issuer				Guarantor Subsidiaries				Non-Guarantor Subsidiaries				Elimination				Total
Total revenues		$	—			$	—			$	155,599			$	4,750			$	(4,297	)		$	156,052
Total cost of revenues			—				—				37,971				836				(4,297	)			34,510
Gross profit			—				—				117,628				3,914				—				121,542
Operating expenses:
Technology and development			—				—				23,671				565				—				24,236
Marketing and advertising			—				—				38,366				2,620				—				40,986
General and administrative			—				57				14,614				670				—				15,341
Amortization of acquired intangible assets			—				—				37,001				—				—				37,001
Total operating expenses			—				57				113,652				3,855				—				117,564
Income (loss) from operations			—				(57	)			3,976				59				—				3,978
Interest income (expense), net			—				(17,733	)			(28	)			2				—				(17,759	)
Other income, net			—				—				126				180				—				306
Income (loss) before income taxes			—				(17,790	)			4,074				241				—				(13,475	)
Income tax benefit (expense)			—				6,493				(583	)			(44	)			—				5,866
Income (loss) before loss from subsidiaries			—				(11,297	)			3,491				197				—				(7,609	)
Loss from subsidiaries			(7,609	)			(12,100	)			(23,200	)			—				42,909				—
Net income (loss)		$	(7,609	)		$	(23,397	)		$	(19,709	)		$	197			$	42,909			$	(7,609	)
Comprehensive income (loss)		$	(7,609	)		$	(23,397	)		$	(19,709	)		$	197			$	42,909			$	(7,609	)

Three Months Ended June 30, 2013

 

		Parent				Issuer				Guarantor Subsidiaries				Non-Guarantor Subsidiaries				Elimination				Total
Total revenues		$	—			$	—			$	131,415			$	5,833			$	(5,300	)		$	131,948
Total cost of revenues			55				—				31,884				959				(5,300	)			27,598
Gross profit			(55	)			—				99,531				4,874				—				104,350
Operating expenses:
Technology and development			1,276				—				19,716				426				—				21,418
Marketing and advertising			372				—				30,471				3,521				—				34,364
General and administrative			1,036				82				11,612				726				—				13,456
Amortization of acquired intangible assets			—				—				46,296				—				—				46,296
Total operating expenses			2,684				82				108,095				4,673				—				115,534
Income (loss) from operations			(2,739	)			(82	)			(8,564	)			201				—				(11,184	)
Interest income (expense), net			—				(29,500	)			(199	)			207				—				(29,492	)
Other expense, net			—				—				(8	)			(153	)			—				(161	)
Income (loss) before income taxes			(2,739	)			(29,582	)			(8,771	)			255				—				(40,837	)
Income tax benefit (expense)			1,000				10,797				7,788				(28	)			—				19,557
Income (loss) before loss from subsidiaries			(1,739	)			(18,785	)			(983	)			227				—				(21,280	)
Loss from subsidiaries			(19,541	)			(15,356	)			(33,914	)			—				68,811				—
Net income (loss)		$	(21,280	)		$	(34,141	)		$	(34,897	)		$	227			$	68,811			$	(21,280	)
Comprehensive income (loss)		$	(21,280	)		$	(34,141	)		$	(34,897	)		$	227			$	68,811			$	(21,280	)

 

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ANCESTRY.COM LLC

CONDENSED CONSOLIDATING STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

Six Months Ended June 30, 2014

 

		Parent				Issuer				Guarantor Subsidiaries				Non-Guarantor Subsidiaries				Elimination				Total
Total revenues		$	—			$	—			$	308,706			$	10,441			$	(9,449	)		$	309,698
Total cost of revenues			—				—				76,839				1,801				(9,449	)			69,191
Gross profit			—				—				231,867				8,640				—				240,507
Operating expenses:
Technology and development			—				—				47,951				850				—				48,801
Marketing and advertising			—				—				80,296				5,895				—				86,191
General and administrative			—				97				28,117				1,341				—				29,555
Amortization of acquired intangible assets			—				—				74,052				—				—				74,052
Total operating expenses			—				97				230,416				8,086				—				238,599
Income (loss) from operations			—				(97	)			1,451				554				—				1,908
Interest income (expense), net			—				(35,071	)			(82	)			3				—				(35,150	)
Other income (expense), net			—				(8	)			147				186				—				325
Income (loss) before income taxes			—				(35,176	)			1,516				743				—				(32,917	)
Income tax benefit (expense)			—				12,839				10,209				(117	)			—				22,931
Income (loss) before loss from subsidiaries			—				(22,337	)			11,725				626				—				(9,986	)
Loss from subsidiaries			(9,986	)			(17,994	)			(39,705	)			—				67,685				—
Net income (loss)		$	(9,986	)		$	(40,331	)		$	(27,980	)		$	626			$	67,685			$	(9,986	)
Comprehensive income (loss)		$	(9,986	)		$	(40,331	)		$	(27,980	)		$	626			$	67,685			$	(9,986	)

Six Months Ended June 30, 2013

 

		Parent				Issuer				Guarantor Subsidiaries				Non-Guarantor Subsidiaries				Elimination				Total
Total revenues		$	—			$	—			$	254,258			$	11,692			$	(10,480	)		$	255,470
Total cost of revenues			55				—				63,508				1,989				(10,480	)			55,072
Gross profit			(55	)			—				190,750				9,703				—				200,398
Operating expenses:
Technology and development			1,490				—				39,683				762				—				41,935
Marketing and advertising			372				—				64,161				6,789				—				71,322
General and administrative			1,268				283				22,247				1,477				—				25,275
Amortization of acquired intangible assets			—				—				92,682				—				—				92,682
Total operating expenses			3,130				283				218,773				9,028				—				231,214
Income (loss) from operations			(3,185	)			(283	)			(28,023	)			675				—				(30,816	)
Interest income (expense), net			—				(51,525	)			(187	)			212				—				(51,500	)
Other expense, net			—				—				(310	)			(402	)			—				(712	)
Income (loss) before income taxes			(3,185	)			(51,808	)			(28,520	)			485				—				(83,028	)
Income tax benefit (expense)			1,163				18,909				20,269				(20	)			—				40,321
Income (loss) before loss from subsidiaries			(2,022	)			(32,899	)			(8,251	)			465				—				(42,707	)
Loss from subsidiaries			(40,685	)			(34,490	)			(67,286	)			(331	)			142,792				—
Net income (loss)		$	(42,707	)		$	(67,389	)		$	(75,537	)		$	134			$	142,792			$	(42,707	)
Comprehensive income (loss)		$	(42,707	)		$	(67,389	)		$	(75,537	)		$	134			$	142,792			$	(42,707	)

 

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ANCESTRY.COM LLC

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

(in thousands)

Six Months Ended June 30, 2014

 

		Parent				Issuer				Guarantor Subsidiaries				Non-Guarantor Subsidiaries				Elimination				Total
Net cash provided by (used in) operating activities		$	18,239			$	48,699			$	111,345			$	(3,854	)		$	(99,586	)		$	74,843
Investing activities:
Capitalization of content databases			—				—				(19,519	)			—				—				(19,519	)
Purchases of property and equipment			—				—				(12,946	)			(32	)			—				(12,978	)
Investment in subsidiaries			—				(12,839	)			—				—				12,839				—
Return of capital from subsidiaries			—				—				17,560				—				(17,560	)			—
Net cash used in investing activities			—				(12,839	)			(14,905	)			(32	)			(4,721	)			(32,497	)
Financing activities:
Member’s capital contributions			26				—				—				—				—				26
Principal payments on debt			—				(18,785	)			—				—				—				(18,785	)
Excess tax benefits from stock-based compensation			—				—				954				—				—				954
Return-of-capital distribution			(18,430	)			—				—				—				—				(18,430	)
Payment of contingent consideration			—				—				(1,200	)			—				—				(1,200	)
Capital contribution from parent			—				—				12,839				—				(12,839	)			—
Return of capital to parent			—				(17,560	)			—				—				17,560				—
Intercompany dividends paid			—				—				(84,262	)			(15,324	)			99,586				—
Net cash used in financing activities			(18,404	)			(36,345	)			(71,669	)			(15,324	)			104,307				(37,435	)
Net increase (decrease) in cash and cash equivalents			(165	)			(485	)			24,771				(19,210	)			—				4,911
Cash and cash equivalents at beginning of period			338				562				60,362				25,292				—				86,554
Cash and cash equivalents at end of period		$	173			$	77			$	85,133			$	6,082			$	—			$	91,465

Six Months Ended June 30, 2013

 

		Parent				Issuer				Guarantor Subsidiaries				Non-Guarantor Subsidiaries				Elimination				Total
Net cash provided by (used in) operating activities		$	1,001			$	(8,240	)		$	83,815			$	(5,635	)		$	(7,656	)		$	63,285
Investing activities:
Capitalization of content databases			—				—				(8,596	)			(76	)			—				(8,672	)
Purchases of property and equipment			—				—				(13,173	)			(17	)			—				(13,190	)
Collection of intercompany loans receivable			—				—				—				8,300				(8,300	)			—
Investment in subsidiary			(3,522	)			(25,210	)			—				—				28,732				—
Return of capital from subsidiary			—				84,141				3,432				—				(87,573	)			—
Net cash provided by (used in) investing activities			(3,522	)			58,931				(18,337	)			8,207				(67,141	)			(21,862	)
Financing activities:
Proceeds from exercise of stock options			—				—				457				—				—				457
Taxes paid related to net share settlement of stock-based awards			—				—				(417	)			—				—				(417	)
Principal payments on debt			—				(39,175	)			—				—				—				(39,175	)
Member’s capital contributions			2,521				—				—				—				—				2,521
Payment of deferred financing costs			—				(7,815	)			—				—				—				(7,815	)
Repayment of intercompany loans payable			—				—				(8,300	)			—				8,300				—
Capital contribution from parent			—				—				28,732				—				(28,732	)			—
Return of capital to parent			—				—				(84,141	)			(3,432	)			87,573				—
Intercompany dividends paid			—				(3,828	)			(3,828	)			—				7,656				—
Net cash provided by (used in) financing activities			2,521				(50,818	)			(67,497	)			(3,432	)			74,797				(44,429	)
Net decrease in cash and cash equivalents			—				(127	)			(2,019	)			(860	)			—				(3,006	)
Cash and cash equivalents at beginning of period			—				470				28,925				6,256				—				35,651
Cash and cash equivalents at end of period		$	—			$	343			$	26,906			$	5,396			$	—			$	32,645

 

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ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

This Quarterly Report on Form 10-Q (the “Quarterly Report”) contains forward-looking statements relating to future events and future performance. All statements other than those that are purely historical may be forward-looking statements. We may, in some cases, use words such as “project,” “believe,” “anticipate,” “plan,” “expect,” “estimate,” “intend,” “should,” “would,” “could,” “potentially,” “will” or “may,” or other words that convey uncertainty of future events or outcomes to identify these forward-looking statements. Forward-looking statements in this Quarterly Report include statements about:

 

•

our future financial performance, including our revenues, cost of revenues and operating expenses, and our ability to sustain profitability and achieve long-term growth;

 

•

our rate of revenue and expense growth;

 

•

our ability to attract and retain subscribers;

 

•

our high degree of leverage and our ability to service our debt;

 

•

our ability or our parent’s ability to take on additional debt;

 

•

our intention to pay distributions to our parent to fund future cash interest payments on the PIK Notes;

 

•

risks related to the “Notes” and to high yield debt securities generally;

 

•

the potential impact of debt covenant restrictions on our flexibility in operating our business;

 

•

the pool of our potential subscribers;

 

•

our investments in content, technology and products, including our AncestryDNA service, and the success of our promotional programs and new products;

 

•

our competitive position;

 

•

our ability to generate additional revenues on a cost-effective basis;

 

•

our ability to acquire content and make it available online;

 

•

our ability to enhance the subscribers’ experience with added tools and features and to provide value;

 

•

our continued investment in our international operations;

 

•

our ability to adequately manage costs and control margins and trends;

 

•

our liquidity and working capital requirements and the availability of cash and credit;

 

•

our ability to protect users’ data and privacy concerns and to comply with privacy and security standards and laws, including data related to our Ancestry DNA service;

 

•

our ability to manage growth, including adding employees and facilities;

 

•

our success with respect to any recent or future acquisitions, and our ability to integrate acquired businesses;

 

•

changes in our effective tax rate;

 

•

the impact of external market forces, including changes in the macroeconomic environment, interest rates and foreign currency exchange rates;

 

•

the impact of claims or litigation; and

 

•

the impact of current and potential legislation and regulatory changes on privacy, subscription renewal, DNA or other aspects of our business.

 

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Although we believe that the assumptions underlying the forward-looking statements are reasonable, we cannot guarantee future results, level of activity, performance or achievements. There are a number of important factors that could cause actual results to differ materially from the results anticipated by these forward-looking statements. These important factors include those that we discuss in this Quarterly Report under the captions “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Risk Factors” and elsewhere, including information contained in our Annual Report on Form 10-K. You should read these factors and the other cautionary statements made in this Quarterly Report as being applicable to all related forward-looking statements wherever they appear in this Quarterly Report.

If one or more of these factors materialize, or if any underlying assumptions prove incorrect, our actual results, performance or achievements may vary materially from any future results, performance or achievements expressed or implied by these forward-looking statements. All subsequent written or spoken forward-looking statements attributable to our company or persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. The forward-looking statements included in this Quarterly Report are made only as of the date of this Quarterly Report, and we undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

Overview

Ancestry.com LLC (the “Parent”) is a holding company and all operations are conducted by its wholly-owned subsidiaries. Ancestry.com LLC and its subsidiaries are collectively referred to as “Ancestry.com,” “we” or “us.” Ancestry.com is the world’s largest online family history resource, with approximately 2.1 million paying subscribers around the world to Ancestry.com branded websites as of June 30, 2014. Total subscribers across all websites, including Ancestry.com branded websites, Archives.com, Fold3.com and Newspapers.com, were approximately 2.7 million as of June 30, 2014.

We offer access on a subscription basis to an extensive collection of billions of historical records that we have digitized, indexed and made available online over the past 18 years. Our subscribers use our proprietary web-based services and content collection to research their family histories, build their family trees, collaborate with other subscribers, upload their own records and publish and share their stories. These subscribers are our primary source of revenues. We believe we provide ongoing value to our subscribers by regularly adding new historical content and enhancing our web-based services and platforms with new tools, features and services that enable greater collaboration among our users through the growth of our global community. Our goal is to remain the leading online resource for family history and to grow our worldwide subscriber base by offering a superior value proposition to anyone interested in learning more about their family history.

The following discussion and analysis is based on and should be read in conjunction with the condensed consolidated financial statements included elsewhere in this Quarterly Report, as well as the consolidated financial statements and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations and other information in our Annual Report on Form 10-K.

Key Business Metrics

Our management regularly reviews a number of financial and operating metrics, including the following key operating metrics to evaluate our business, determine the allocation of resources, make decisions regarding corporate strategies and evaluate forward-looking projections. The following key operating metrics reflect data with respect to our Ancestry.com websites and exclude our other subscription-based websites, such as Archives.com, Fold3.com, and Newspapers.com.

 

•

Total subscribers. A subscriber is an individual who pays for renewable access or redeems a gift subscription to one of our Ancestry.com branded websites. Total subscribers is defined as the number of subscribers at the end of the period.

 

•

Net subscriber additions. Net subscriber additions is the total number of new customers who purchase a subscription or redeem a gift subscription to our Ancestry.com branded websites less the total number of subscribers who choose not to renew a completed subscription in the period.

 

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Our key business metrics are presented for the three months ended June 30, 2014, March 31, 2014 and June 30, 2013 (in thousands):

 

		Three Months Ended
		June 30,         2014					March 31,         2014					June 30,         2013
Total subscribers at end of quarter				2,109					2,161					2,112
Net subscriber additions				(52	)				21					16

The following table presents the percentage of total subscribers by subscription duration type at June 30, 2014, March 31, 2014 and June 30, 2013:

 

		June 30,         2014					March 31,         2014					June 30,         2013
Annual				40.9	%				40.9	%				43.8	%
Semi-annual				22.4					22.4					26.6
Quarterly				2.4					2.5					3.1
Monthly				34.3					34.2					26.5
Total				100.0	%				100.0	%				100.0	%

Components of Condensed Consolidated Statements of Comprehensive Loss

Revenues

Subscription revenues. We derive subscription revenues primarily from providing access to our Ancestry.com websites, and we recognize the subscription revenues, net of estimated cancellations, ratably over the subscription period. We offer a 14-day free trial, after which, unless cancelled, we charge the full period subscription amount. No revenue is recognized or allocated to the 14-day free trial period. Amounts received from subscribers for which the performance obligations have not been fulfilled are recorded in deferred revenue. We have established a revenue reserve based on historical subscription cancellations. Actual customer subscription cancellations are charged against the allowance or deferred revenues to the extent that revenue has not yet been recognized.

Subscription revenues from our Ancestry.com branded websites accounted for approximately 92% of the total subscription revenues for the three and six months ended June 30, 2014. Total subscription revenues also include subscriptions to our other websites, such as Archives.com, Fold3.com and Newspapers.com. We attribute subscription revenues by country based on the billing address of the subscriber, regardless of the website to which the person subscribes. The following table presents subscription revenue by geographic region (in thousands):

 

		Three Months Ended June 30,								Six months ended June 30,
		2014				2013				2014				2013
United States		$	105,383			$	93,209			$	209,973			$	179,605
United Kingdom			16,178				13,855				32,117				26,768
All other countries			16,400				15,644				33,065				30,109
Total subscription revenues		$	137,961			$	122,708			$	275,155			$	236,482

Subscription revenues for the three and six months ended June 30, 2013 were lower than they otherwise would have been due to the write-down of deferred revenues to fair value as a result of the application of purchase accounting. Deferred revenues were written down to fair value in conjunction with the Parent’s acquisition of our predecessor, Ancestry.com Inc. (the “Predecessor” or “Issuer”) on December 28, 2012 (the “Merger) and all activity related to the Merger (collectively the “Transaction”). As a result, subscription revenues recognized for the three and six months ended June 30, 2014 are not directly comparable to subscription revenues recognized for the three and six months ended June 30, 2013.

Product and other revenues. Product and other revenues include sales of our AncestryDNA services, Family Tree Maker desktop software, ProGenealogists’ genealogical research services, shipping revenue, physical delivery of copies of historical vital records (birth, marriage and death certificates) and other products and services. Revenues related to these products or services are recognized upon shipment of the product or completion of the services, as applicable.

 

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Expenses

Personnel-related costs for each category of cost of revenues and operating expenses include salaries, employee benefit costs, employer payroll taxes, bonuses, and stock-based compensation expense.

Cost of Revenues

Cost of subscription revenues. Cost of subscription revenues consist of amortization of content databases, web server operating costs, personnel-related costs of web support and customer service employees, credit card processing fees, outside service costs for customer services, royalty costs on certain content licensed from others and iOS transaction fees. Web server operating costs include depreciation, software licensing on web servers and related equipment and web hosting costs.

Cost of product and other revenues. Cost of product and other revenues consist of AncestryDNA service costs, personnel-related costs of customer service and other product fulfillment employees, direct costs of products sold, shipping costs and credit card processing fees.

Operating Expenses

Technology and development. Technology and development expenses consist primarily of personnel-related costs and outside service costs. Technology and development personnel-related costs include the personnel costs of developing new products and tools and maintaining and testing our websites. Our development personnel are primarily based in the United States and are focused on creating accessibility to content and tools for individuals to do family history research. Outside service costs are primarily incurred for third-party product development and quality assurance services.

Marketing and advertising. Marketing and advertising expenses consist primarily of external marketing expenses, such as television, search and display advertising, and personnel-related costs. Marketing and advertising costs are principally incurred in the United States, the United Kingdom, Australia and Canada. The marketing and advertising costs to acquire subscribers are generally incurred before we recognize the associated subscription revenues, which are recognized ratably over the subscription periods. As a result, marketing and advertising expenses as a percentage of total revenues may vary between periods due to the timing of when revenues and expenses are recognized.

General and administrative. General and administrative expenses consist principally of personnel-related and outside service expenses related to our executive, finance, legal, human resources and other administrative functions.

Amortization of acquired intangible assets. Amortization of acquired intangible assets is the amortization expense associated with subscriber relationships and contracts, technologies, trademarks and tradenames and other acquired intangible assets.

Interest Expense, Net, Other Income (Expense), Net and Income Tax Benefit

Interest expense, net. Interest expense, net includes interest expense associated with our debt, amortization of deferred financing and original issue discount costs associated with the issuance of our debt, including accelerated amortization of costs as a result of any debt repricings, and interest income earned on cash and cash equivalents. Our interest expense varies based on the level of debt outstanding and changes in interest rates.

Other income (expense), net. Other income (expense), net primarily includes foreign currency transaction and remeasurement gains and losses, which vary based on changes in foreign currency exchange rates.

Income tax benefit. Income tax benefit consists of federal and state income taxes in the United States and income taxes in certain foreign jurisdictions.

 

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Results of Operations

The following table sets forth our statements of operations, as included in the condensed consolidated statements of comprehensive loss, as a percentage of total revenues for the three and six months ended June 30, 2014 and 2013. The information contained in the table below should be read in conjunction with our condensed consolidated financial statements and the related notes.

 

		Three Months Ended June 30,								Six months ended June 30,
		2014				2013				2014				2013
Revenues:
Subscription revenues			88.4	%			93.0	%			88.8	%			92.6	%
Product and other revenues			11.6				7.0				11.2				7.4
Total revenues			100.0				100.0				100.0				100.0
Costs of revenues:
Cost of subscription revenues			15.3				15.7				15.3				16.3
Cost of product and other revenues			6.8				5.2				7.0				5.3
Total cost of revenues			22.1				20.9				22.3				21.6
Gross profit			77.9				79.1				77.7				78.4
Operating expenses:
Technology and development			15.5				16.2				15.9				16.4
Marketing and advertising			26.3				26.0				27.8				27.9
General and administrative			9.9				10.2				9.5				9.9
Amortization of acquired intangible assets			23.7				35.1				23.9				36.3
Total operating expenses			75.4				87.5				77.1				90.5
Income (loss) from operations			2.5				(8.4	)			0.6				(12.1	)
Interest expense, net			(11.4	)			(22.4	)			(11.3	)			(20.2	)
Other income (expense), net			0.2				(0.1	)			0.1				(0.3	)
Loss before income taxes			(8.7	)			(30.9	)			(10.6	)			(32.6	)
Income tax benefit			3.8				14.8				7.4				15.8
Net loss			(4.9	)%			(16.1	)%			(3.2	)%			(16.8	)%

Revenues, Costs of Revenues and Gross Profit

 

		Three Months Ended June 30,												Six months ended June 30,
		2014				2013				% Change				2014				2013				% Change
		(in thousands)												(in thousands)
Revenues:
Subscription revenues		$	137,961			$	122,708				12.4	%		$	275,155			$	236,482				16.4	%
Product and other revenues			18,091				9,240				95.8				34,543				18,988				81.9
Total revenues			156,052				131,948				18.3				309,698				255,470				21.2
Costs of revenues:
Cost of subscription revenues			23,895				20,786				15.0				47,263				41,519				13.8
Cost of product and other revenues			10,615				6,812				55.8				21,928				13,553				61.8
Total cost of revenues			34,510				27,598				25.0				69,191				55,072				25.6
Gross profit		$	121,542			$	104,350				16.5	%		$	240,507			$	200,398				20.0	%
Gross profit percentage			77.9	%			79.1	%							77.7	%			78.4	%

Subscription revenues

For the three months ended June 30, 2014, our subscription revenues increased $15.3 million compared to the three months ended June 30, 2013. Excluding the $5.8 million non-cash adjustment to write down deferred revenue to fair value as a result of the application of purchase accounting for the Transaction in the prior year, subscription revenues for the three months ended June 30, 2014 would have increased by $9.5 million compared to the three months ended June 30, 2013. This increase was primarily the result of guiding our new subscribers into monthly subscription durations, which have a higher average monthly revenue per subscriber than longer term subscription durations. Additionally, the average number of total subscribers to Ancestry.com websites was higher during the three months ended June 30, 2014 compared to the three months ended June 30, 2013. While the average number of total subscribers to Ancestry.com websites was higher during the three months ended June 30, 2014, the number of total subscribers at June 30, 2014 decreased compared to June 30, 2013 primarily due to continued softness in gross subscriber additions. Subscription revenues were also

 

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higher due to a $2.1 million increase in revenues from our other subscription-based websites, Newspapers.com, Archives.com and Fold3.com, for the three months ended June 30, 2014 compared to the three months June 30, 2013. For the three months ended June 30, 2014, changes in average foreign currency exchange rates had an insignificant impact on subscription revenues compared to the three months ended June 30, 2013.

For the six months ended June 30, 2014, our subscription revenues increased $38.7 million compared to the six months ended June 30, 2013. Excluding the $17.2 million non-cash adjustment to write down deferred revenue to fair value as a result of the application of purchase accounting for the Transaction in the prior year, subscription revenues for the six months ended June 30, 2014 would have increased by $21.5 million compared to the six months ended June 30, 2013. This increase was primarily due to an increase in revenues from Ancestry.com websites, which was driven by the same factors that influenced the three-month results. Subscription revenues were also higher due to a $5.3 million increase in revenues from our other subscription-based websites, Archives.com, Newspapers.com and Fold3.com, for the six months ended June 30, 2014 compared to the six months ended June 30, 2013. For the six months ended June 30, 2014, changes in average foreign currency exchange rates had a slight negative impact on subscription revenues compared to the six months ended June 30, 2013.

Product and other revenues

For the three months ended June 30, 2014, our product and other revenues increased $8.9 million compared to the three months ended June 30, 2013. The increase was primarily due to higher sales volume for AncestryDNA as a result of increased marketing.

For the six months ended June 30, 2014, our product and other revenues increased $15.6 million compared to the six months ended June 30, 2013. The increase was driven by the same factors that influenced the three-month results.

Cost of subscription revenues

For the three months ended June 30, 2014, our cost of subscription revenues increased $3.1 million compared to the three months ended June 30, 2013. The increase was primarily due to a $2.0 million increase in web hosting costs, which increased primarily due to additional depreciation expense for new web operations equipment. Additionally, content database amortization increased for the three months ended June 30, 2014 compared to the three months ended June 30, 2013 due to an incremental investment in content databases.

For the six months ended June 30, 2014, our cost of subscription revenues increased $5.7 million compared to the six months ended June 30, 2013. The increase was primarily due to a $3.4 million increase in web hosting costs, which increased primarily due to additional depreciation expense for new web operations equipment. Additionally, content database amortization increased $1.2 million for the six months ended June 30, 2014 compared to the six months ended June 30, 2013 due to an incremental investment in content databases.

Cost of product and other revenues

For the three months ended June 30, 2014, our cost of product and other revenues increased $3.8 million compared to the three months ended June 30, 2013. The increase was primarily due to an increase in costs associated with AncestryDNA due to increased sales volume, partially offset by a reduction in per-unit processing costs.

For the six months ended June 30, 2014, our cost of product and other revenues increased $8.4 million compared to the six months ended June 30, 2013. The increase was driven by the same factors that influenced the three-month results.

Operating Expenses

 

		Three Months Ended												Six months ended
		June 30,												June 30,
		2014				2013				% Change				2014				2013				% Change
		(in thousands)												(in thousands)
Operating expenses:
Technology and development		$	24,236			$	21,418				13.2	%		$	48,801			$	41,935				16.4	%
Marketing and advertising			40,986				34,364				19.3				86,191				71,322				20.8
General and administrative			15,341				13,456				14.0				29,555				25,275				16.9
Amortization of acquired intangible assets			37,001				46,296				(20.1	)			74,052				92,682				(20.1	)
Total operating expenses		$	117,564			$	115,534				1.8	%		$	238,599			$	231,214				3.2	%

 

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Technology and development

For the three months ended June 30, 2014, our technology and development expenses increased $2.8 million compared to the three months ended June 30, 2013. The increase is primarily due to an increase in personnel-related expenses as a result of an increase in the average number of technology and development personnel during the three months ended June 30, 2014 compared to the three months ended June 30, 2013.

For the six months ended June 30, 2014, our technology and development expenses increased $6.9 million compared to the six months ended June 30, 2013. The increase was driven by the same factors that influenced the three-month results.

Marketing and advertising

For the three months ended June 30, 2014, our marketing and advertising expenses increased $6.6 million compared to the three months ended June 30, 2013. The increase was primarily due to a $6.1 million increase in external marketing expenses due to additional marketing campaigns, including marketing campaigns for AncestryDNA, and an increase in media rates.

For the six months ended June 30, 2014, our marketing and advertising expenses increased $14.9 million compared to the six months ended June 30, 2013. The increase was primarily due to a $13.5 million increase in external marketing expenses due to additional marketing campaigns, including marketing campaigns for AncestryDNA, and an increase in media rates.

General and administrative

For the three months ended June 30, 2014, our general and administrative expenses increased $1.9 million compared to the three months ended June 30, 2013. This increase was primarily due to a $1.8 million increase in professional service fees primarily related to the appraisal litigation.

For the six months ended June 30, 2014, our general and administrative expenses increased $4.3 million compared to the six months ended June 30, 2013. This increase was primarily due to a $2.4 million increase in personnel-related expenses largely as a result of an increase in the average number of general and administrative personnel and a $2.0 million increase in professional service fees primarily related to the appraisal litigation.

Amortization of acquired intangible assets

For the three months ended June 30, 2014, our amortization of acquired intangible assets decreased $9.3 million compared to the three months ended June 30, 2013. These decreases were primarily due to certain intangible assets being amortized on an accelerated basis over the estimated useful lives of the assets.

For the six months ended June 30, 2014, our amortization of acquired intangible assets decreased $18.6 million compared to the six months ended June 30, 2013. The decrease was driven by the same factors that influenced the three-month results.

Interest Expense, Net, Other Income (Expense), Net and Income Tax Benefit

 

		Three Months Ended												Six months ended
		June 30,												June 30,
		2014				2013				% Change				2014				2013				% Change
		(in thousands)												(in thousands)
Interest expense, net		$	(17,759	)		$	(29,492	)			(39.8	)%		$	(35,150	)		$	(51,500	)			(31.7	)%
Other income (expense), net			306				(161	)			(290.1	)			325				(712	)			(145.6	)
Income tax benefit			5,866				19,557				(70.0	)			22,931				40,321				(43.1	)
Other data:
Effective tax rate			43.5	%			47.9	%							69.7	%			48.6	%

Interest expense, net

For the three months ended June 30, 2014, interest expense, net decreased $11.7 million compared to the three months ended June 30, 2013. For the three months ended June 30, 2013, interest expense included approximately $9.2 million primarily due to the acceleration of original issue discount and deferred financing costs resulting from the repricing of the original term loan in May 2013. In addition, due to the repricing of the term loans in May 2013 and again in December 2013, the effective interest rate on our term loans was lower for the three months ended June 30, 2014 compared to the three months ended June 30, 2013. For the three months ended June 30, 2014, the effective interest rate of both the Amended Term B-1 Loan and Amended Term B-2 Loan was approximately 5.9%. For the three months ended June 30, 2013, the effective interest rate of the outstanding term loans was approximately 7.9%. Also, the average term loan balance outstanding for the three months ended June 30, 2014 was lower than the average term loan balance outstanding for the three months ended June 30, 2013.

 

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For the six months ended June 30, 2014, interest expense, net decreased $16.4 million compared to the six months ended June 30, 2013. The decrease was driven by the same factors that influenced the three-month results.

Other income (expense), net

For the three months ended June 30, 2014, other income (expense), net changed primarily due to changes in foreign currency exchange rates compared to the three months ended June 30, 2013.

For the six months ended June 30, 2014, other income (expense), net changed primarily due to changes in foreign currency exchange rates compared to the six months ended June 30, 2013.

Income tax benefit

For the three months ended June 30, 2014, we recorded an income tax benefit of $5.9 million, resulting in an effective income tax rate of 43.5%, compared to an income tax benefit of $19.6 million, resulting in an effective income tax rate of 47.9%, for the three months ended June 30, 2013. The decrease of 4.4 percentage points in the effective income tax rate resulted primarily from unfavorable discrete items related to intercompany transactions for the three months ended June 30, 2014.

For the six months ended June 30, 2014, we recorded an income tax benefit of $22.9 million, resulting in an effective income tax rate of 69.7%, compared to an income tax benefit of $40.3 million, resulting in an effective income tax rate of 48.6%, for the six months ended June 30, 2013. The increase of 21.1 percentage points in the effective income tax rate resulted primarily from an increased foreign tax rate benefit for the six months ended June 30, 2014, offset by decreased federal research and development tax credits due to the expiration of the tax credit on December 31, 2013, in accordance with the provisions of the American Taxpayer Relief Act of 2012.

Other Financial Data

In addition to our results discussed above determined under accounting principles generally accepted in the United States (“GAAP”), we believe non-GAAP revenues, adjusted EBITDA and free cash flow are useful to investors as supplemental measures to evaluate the overall operating performance of our business. For the three and six months ended June 30, 2014 and 2013, our non-GAAP revenues, adjusted EBITDA and free cash flow were as follows:

 

		Three Months Ended												Six months ended
		June 30,												June 30,
		2014				2013				% Change				2014				2013				% Change
		(in thousands)												(in thousands)
Non-GAAP Revenues(1)		$	156,052			$	137,698				13.3	%		$	309,698			$	272,719				13.6	%
Adjusted EBITDA(2)			55,396				54,223				2.2				104,368				103,202				1.1
Free cash flow(3)			10,245				12,076				(15.2	)			42,411				62,766				(32.4	)

 

(1)

Non-GAAP revenues. We define non-GAAP revenues as the revenues that would have been recognized, except for the write-down of deferred revenue to fair value as a result of the application of purchase accounting for the Transaction. Non-GAAP revenues is calculated as total revenues plus the effects of non-cash adjustments to revenue from purchase accounting.

(2)

Adjusted EBITDA. We define adjusted EBITDA as net income (loss) plus non-cash adjustments to revenue from purchase accounting, interest expense, net; other (income) expense, net; income tax expense (benefit); and non-cash charges including depreciation, amortization, and stock-based compensation expense.

(3)

Free cash flow. We define free cash flow as net income (loss) plus non-cash adjustments to revenue from purchase accounting, interest expense, net; other (income) expense, net; income tax expense (benefit); and non-cash charges including depreciation, amortization, and stock-based compensation expense; minus capitalization of content databases, purchases of property and equipment and cash received (paid) for income taxes and interest.

We believe non-GAAP revenues, adjusted EBITDA and free cash flow are useful to investors as supplemental measures to evaluate the overall operating performance of the Company. Non-GAAP revenues, adjusted EBITDA and free cash flow are financial data that are not calculated in accordance with GAAP. The tables below provide a reconciliation of these non-GAAP financial measures to total revenues or net income (loss), the most directly comparable financial measure calculated and presented in accordance with GAAP. We prepare non-GAAP revenues, adjusted EBITDA and free cash flow to eliminate the impact of items that we do not consider indicative of our core operating performance. We encourage you to evaluate these adjustments and the reasons we consider them appropriate, as well as the material limitations of non-GAAP measures.

 

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Our management uses non-GAAP revenues, adjusted EBITDA and free cash flow as measures of operating performance, for planning purposes, including the preparation of our annual operating budget, to allocate resources to enhance the financial performance of our business, to evaluate the effectiveness of our business strategies and in communications with our Operating Committee concerning our financial performance. Adjusted EBITDA together with non-GAAP revenues has also been used as a financial performance objective in determining the bonus pool under our recent performance incentive programs. Management believes that the use of non-GAAP revenues, adjusted EBITDA and free cash flow provides consistency and comparability with our past financial performance, facilitates period-to-period comparisons of operations and also facilitates comparisons with other peer companies, many of which use similar non-GAAP financial measures to supplement their GAAP results. Management believes that it is useful to exclude non-cash charges such as purchase accounting adjustments, depreciation, amortization and stock-based compensation from non-GAAP revenues, adjusted EBITDA and free cash flow because (i) the amount of such non-cash expenses in any specific period may not directly correlate to the underlying performance of our business operations and (ii) such expenses can vary significantly between periods as a result of new acquisitions, full amortization of previously acquired tangible and intangible assets or the timing of stock-based awards, as the case may be.

Although non-GAAP revenues, adjusted EBITDA and free cash flow are frequently used by investors and securities analysts in their evaluations of companies, non-GAAP revenues, adjusted EBITDA and free cash flow each have limitations as an analytical tool, and you should not consider them in isolation or as a substitute for analysis of our results of operations as reported under GAAP.

Some of these limitations are:

 

•

non-GAAP revenues does not include the impact of purchase accounting adjustments, which are intended to reflect the fair value of the recognized deferred revenue at the date of the Transaction;

 

•

adjusted EBITDA and free cash flow do not reflect our future requirements for contractual commitments, and adjusted EBITDA does not reflect our cash expenditures or future requirements for capital expenditures;

 

•

adjusted EBITDA and free cash flow do not reflect changes in, or cash requirements for, our working capital;

 

•

adjusted EBITDA does not reflect interest income or interest expense;

 

•

adjusted EBITDA does not reflect cash requirements for income taxes;

 

•

adjusted EBITDA and free cash flow do not reflect the non-cash component of employee compensation;

 

•

although depreciation and amortization are non-cash charges, the assets being depreciated or amortized will often have to be replaced in the future, and adjusted EBITDA does not reflect any cash requirements for these replacements; and

 

•

other companies in our industry may calculate adjusted EBITDA or free cash flow or similarly titled measures differently than we do, limiting their usefulness as comparative measures.

The following table presents a reconciliation of non-GAAP revenues to total revenues, the most comparable GAAP measure, for each of the periods identified.

 

		Three Months Ended								Six months ended
		June 30,								June 30,
		2014				2013				2014				2013
Reconciliation of non-GAAP revenues to total revenues		(in thousands)								(in thousands)
Total revenues		$	156,052			$	131,948			$	309,698			$	255,470
Non-cash revenue adjustment(1)			—				5,750				—				17,249
Non-GAAP revenues		$	156,052			$	137,698			$	309,698			$	272,719

 

(1)	Represents non-cash adjustments to revenue or the revenues that would have been recognized, except for the write-down of deferred revenue to fair value as a result of the application of purchase accounting for the Transaction.

 

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The following table presents a reconciliation of our adjusted EBITDA and free cash flow to net loss, the most comparable GAAP measure, for the periods presented.

 

		Three Months Ended								Six months ended
		June 30,								June 30,
		2014				2013				2014				2013
		(in thousands)								(in thousands)
Reconciliation of adjusted EBITDA and free cash flow to net loss(1):
Net loss		$	(7,609	)		$	(21,280	)		$	(9,986	)		$	(42,707	)
Non-cash revenue adjustment(2)			—				5,750				—				17,249
Interest expense, net			17,759				29,492				35,150				51,500
Other (income) expense, net			(306	)			161				(325	)			712
Income tax benefit			(5,866	)			(19,557	)			(22,931	)			(40,321	)
Depreciation			5,199				4,055				10,298				7,828
Amortization			44,201				52,862				88,338				105,755
Stock-based compensation expense			2,018				2,740				3,824				3,186
Adjusted EBITDA		$	55,396			$	54,223			$	104,368			$	103,202
Capitalization of content databases			(11,533	)			(3,919	)			(19,519	)			(8,672	)
Purchases of property and equipment			(8,483	)			(9,667	)			(12,978	)			(13,190	)
Cash paid for interest			(23,424	)			(25,524	)			(30,346	)			(37,305	)
Cash received (paid) for income taxes			(1,711	)			(3,037	)			886				18,731
Free cash flow(3)		$	10,245			$	12,076			$	42,411			$	62,766

 

(1)

Net loss and therefore adjusted EBITDA and free cash flow for the three and six months ended June 30, 2014 include $2.6 million and $3.5 million, respectively, of professional service fees related to litigation and costs associated with the return of capital transaction declared in February 2014 by our Parent. For the three and six months ended June 30, 2013, net loss, adjusted EBITDA and free cash flow include $1.0 million and $2.2 million, respectively, of professional services related to litigation, costs associated with reorganizing our corporate structure and registering the Notes with the SEC.

(2)	Represents non-cash adjustments to revenue or the revenues that would have been recognized, except for the write-down of deferred revenue to fair value as a result of the application of purchase accounting for the Transaction.

(3)	Free cash flow does not include an $18.4 million return-of-capital distribution paid to our parent company, Ancestry.com Holdings LLC, to pay accumulated interest on its PIK Notes.

Liquidity and Capital Resources

Credit Facility

In December 2012, the Issuer entered into a credit facility, which as amended on May 15, 2013 and December 30, 2013 (the “Second Amended Credit Facility”) consists of a $457.1 million amended Term B-1 Loan (the “Amended Term B-1 Loan”) maturing in December 2018, a $165.0 million amended Term B-2 Loan (the “Amended Term B-2 Loan”) maturing in May 2018 and a $50.0 million revolving facility (the “Revolving Facility”) expiring in December 2017. As of June 30, 2014, no funds had been drawn against the Revolving Facility. Borrowings under the Revolving Facility may be used for the purpose of general working capital, capital expenditures and other capital needs. The Second Amended Credit Facility allows the Issuer to borrow additional amounts up to $150.0 million provided the pro forma total net secured leverage ratio as defined in the agreement for the Second Amended Credit Facility does not exceed 4.00 to 1.00 and subject to market availability. Additional amounts can be borrowed subject to covenants in the Second Amended Credit Facility.

Amounts borrowed under the Amended Term B-1 Loan are required to be paid in equal quarterly installments totaling 1% of the amended principal amount of the Amended Term B-1 Loan annually, with the balance payable upon maturity. Amounts borrowed under the Amended Term B-2 Loan are payable in equal quarterly installments of $8.25 million, with the balance payable upon maturity. Additionally, subject to certain conditions, mandatory prepayments are required to be made annually beginning in 2015 upon delivery of the 2014 audited financial statements. Mandatory prepayments are required up to 50% of excess cash flow, based on our net secured leverage ratio and net cash proceeds of certain other transactions as calculated at the end of each fiscal year.

The Amended Term B-1 Loan, Amended Term B-2 Loan and Revolving Facility bear interest on the outstanding unpaid principal amount at a rate equal to an applicable margin plus, at our option, either: (a) a base rate determined by reference to the highest of (i) the Barclays Bank PLC prime rate at such time, (ii) 0.50% in excess of the overnight federal funds rate at such time and (iii) the LIBOR rate that is in effect for a LIBOR loan with an interest period of one month plus 1.00%, provided that the base rate for the Amended Term B-1 Loan and Amended Term B-2 Loan is not less than 2.00%; or (b) a LIBOR rate, provided that the LIBOR rate for the Amended Term B-1 Loan and the Amended Term B-2 Loan is not less than 1.00%. The applicable margin shall mean either: (a) in the case of a base rate Amended Term B-1 Loan, 2.50%, and in the case of a base rate Amended Term B-2 Loan, 2.00%, or (b) in the case of a LIBOR Amended Term B-1 Loan, 3.50%, and in the case of a LIBOR Amended Term B-2 Loan, 3.00%. As of June 30, 2014, the interest rates on the Amended Term B-1 Loan and Amended Term B-2 Loan were equal to a LIBOR floor of 1.00% plus applicable margins of 3.50%

 

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and 3.00%, respectively. The applicable margin for the Revolving Facility is subject to step-ups and step-downs based on our leverage ratio. The Issuer is also required to pay a commitment fee of 0.50% per annum on the unutilized commitments under the Revolving Facility, which fee decreases to 0.375% if the total net secured leverage ratio is less than or equal to 2.75 to 1.00. The effective interest rates of both the Amended Term B-1 Loan and Amended Term B-2 Loan are approximately 5.9%.

The credit agreement governing the Second Amended Credit Facility permits restricted payments, including dividends, out of “available amounts” (as defined in the agreement for the Second Amended Credit Facility). The available amount formulation includes a starter amount of $25.0 million and will include available amounts beginning with respect to the year ended December 31, 2014. Available amounts are adjusted annually upon the delivery of our audited financial statements based on the calculation of 50% of our annual retained excess cash flow. Separately, the credit agreement has a general basket for restricted payments of $40.0 million.

The Issuer’s obligations under the Second Amended Credit Facility are guaranteed by Parent and all existing and future, wholly owned material restricted subsidiaries of Parent, except (i) any subsidiaries constituting controlled foreign corporations (“CFCs”) or any direct subsidiaries thereof, (ii) any wholly owned domestic restricted subsidiaries substantially all of the assets of which constitute the equity of CFCs, (iii) any wholly owned foreign subsidiaries to the extent a guaranty by such subsidiary is not permitted or materially restricted under the law of the jurisdiction of such foreign subsidiary and (iv) wholly owned subsidiaries that contributed less than 5.0% of Consolidated EBITDA (as defined in the Second Amended Credit Facility) (10.0% of revenues in respect of any foreign subsidiary of Parent) and, in the case of domestic subsidiaries, less than 5.0% of total assets, provided that if at any time the aggregate amount of Consolidated EBITDA or total assets attributable to such domestic subsidiaries exceeds 7.5% of Consolidated EBITDA or total assets or the aggregate amount of revenue attributable to such foreign subsidiaries exceeds 10% of revenues, Parent must designate sufficient subsidiaries as guarantors to eliminate such excess. All obligations under the Second Amended Credit Facility and the related guarantees are secured by a perfected first priority lien or security interest in substantially all of the Issuer’s and the guarantors’ tangible and intangible assets.

The Second Amended Credit Facility contains customary affirmative and negative covenants, including limitations on indebtedness; limitations on liens; limitations on certain fundamental changes (including, without limitation, mergers, consolidations, liquidations and dissolutions); limitations on dispositions; limitations on dividends, other payments in respect of capital stock and other restricted payments; limitations on investments, loans, advances and acquisitions; limitations on guarantees and other contingent obligations; limitations on payments, repayments and modifications of subordinated indebtedness and certain other indebtedness; limitations on transactions with affiliates; limitations on sale and leaseback transactions; limitations on changes in fiscal periods; limitations on agreements restricting liens and/or dividends; and limitations on changes in lines of business. In addition, the Second Amended Credit Facility contains a maximum total net secured leverage ratio, which will be tested quarterly if outstanding loans and letters of credit under the Revolving Credit Facility exceed $15.0 million or upon the drawdown of loans and/or issuance letters of credit if such drawdown and/or issuance exceeds $15.0 million after giving effect thereto. Events of default under the Second Amended Credit Facility include, among others, nonpayment of principal when due; nonpayment of interest, fees or other amounts; cross-defaults; covenant defaults; material inaccuracy of representations and warranties; bankruptcy events with respect to us, or any of our material restricted subsidiaries; material unsatisfied or unstayed judgments; certain ERISA events; a change of control; or actual or asserted invalidity of any material guarantee or security document. As of June 30, 2014 and December 31, 2013, the Company was in compliance with all covenants of the Second Amended Credit Facility.

The Second Amended Credit Facility also requires the Issuer to maintain an interest rate protection agreement for a period of not less than three years from the closing date such that not less than 50% of the outstanding debt of the Issuer and its restricted subsidiaries at the closing date is (i) subject to an interest rate protection agreement or (ii) fixed-rate borrowings. Accordingly, the Issuer has interest rate cap agreements with a $190.0 million total notional amount that cap the three-month LIBOR rate at 1.50% expiring March 31, 2016. This agreement, in conjunction with the fixed interest rate borrowings discussed below, met the stipulations prescribed by the Second Amended Credit Facility agreement. See Note 4 in the condensed consolidated financial statements as of June 30, 2014 for further description of the terms of our Second Amended Credit Facility. The Issuer, at its discretion, has also entered into an interest rate cap agreement with a $200.0 million total notional amount effective on March 31, 2016 that caps the three-month LIBOR rate at 2.00% expiring December 30, 2016.

Senior Notes

The Issuer has outstanding $300.0 million of fixed-rate 11.0% notes (the “Notes”) due in December 2020. Interest on the Notes is payable semi-annually in arrears on June 15 and December 15 of each year. The Issuer may redeem all or any portion of the Notes at any time prior to December 15, 2016 at a price equal to 100% of the aggregate principal plus the applicable premium, as defined in the indenture, and accrued interest. The Issuer may redeem any portion or all of the Notes after December 15, 2016 at redemption prices as set forth in the indenture, plus accrued and unpaid interest. In addition, the Issuer may redeem up to 35% of the aggregate principal of the Notes with an amount equal to the proceeds of certain equity offerings any time prior to December 2015 at 111% plus accrued interest. Upon a change of control, the Issuer is required to make an offer to redeem all of the Notes from the holders at 101% of the principal amount thereof plus accrued interest.

 

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The Notes are unconditionally guaranteed, jointly and severally, on a senior unsecured basis by Ancestry.com LLC and each of its direct and indirect restricted subsidiaries that guarantee indebtedness under the Second Amended Credit Facility. Not all of Ancestry.com LLC’s subsidiaries guarantee the Notes, and restricted subsidiaries guarantee the notes only to the extent provided for in the indenture. In the event of a bankruptcy, liquidation or reorganization of any of the non-guarantor subsidiaries, the non-guarantor subsidiaries will pay the holders of their debt and their trade creditors before they will be able to distribute any of their assets to the Issuer.

The Notes contain customary covenants, including limitations on indebtedness; limitations on liens; limitations on certain fundamental changes (including, without limitation, mergers, consolidations, liquidations and dissolutions); limitations on dispositions; limitations on dividends, other payments in respect of capital stock and other restricted payments; limitations on investments, loans, advances and acquisitions; limitations on guarantees and other contingent obligations; limitations on payments, repayments and modifications of subordinated indebtedness and certain other indebtedness; limitations on transactions with affiliates; limitations on sale and leaseback transactions; and limitations on agreements restricting liens and/or dividends. Events of default under the Notes include, among others, nonpayment of interest, principal, fees or other amounts; cross-defaults; covenant defaults; material inaccuracy of representations and warranties; bankruptcy events with respect to us, or any of our material restricted subsidiaries; material unsatisfied or unstayed final judgments; a change of control; or actual or asserted invalidity of any material guarantee or security document.

The indenture governing the Notes generally permits the payment of restricted payment, including dividends, out of a cumulative basket, which grows quarterly based on 50% of our cumulative Consolidated Net Income, as defined in the indenture governing the Notes, since October 1, 2012. In addition, as a condition to making such payments, we must be in compliance with a pro-forma fixed charge coverage ratio greater than or equal to 2.0 to 1.0. Separately, the indenture has a general basket for such payments of the greater of $50.0 million or 2.5% of total assets.

Ancestry.com Holdings LLC Senior Unsecured PIK Notes

On September 17, 2013, our parent, Ancestry.com Holdings LLC (“Holdings LLC”), closed a private offering of $300.0 million aggregate principal amount of senior unsecured payment-in-kind toggle notes due October 15, 2018. On February 3, 2014, Holdings LLC closed an additional private follow-on offering of $100.0 million aggregate principal amount of senior unsecured payment-in-kind toggle notes, which have identical terms (other than issue date and issue price) and constitute part of the same series as the notes under the indenture dated as of September 17, 2013 (collectively, the “PIK Notes”). The follow-on offering was issued at 103%, resulting in an original issue premium of $3.0 million. Holdings LLC subsequently distributed the proceeds of the follow-on offering, net of related fees and expenses, to its indirect parent entity to fund a return-of-capital distribution to its indirect parent entity’s shareholders and stock-based award holders. Holdings LLC is a holding company with no material operations and limited assets other than its ownership of the membership interests of Ancestry.com LLC.

Interest on the PIK Notes is payable semi-annually in arrears on April 15 and October 15 each year through maturity. The first and last interest payments on the PIK Notes are required to be entirely payable in cash. All other interest payments are required to be paid in cash, subject to cash availability and restricted payment capacity. If interest payments are not required to be paid in cash, Holdings LLC will be entitled to pay all or a portion of the interest payment by increasing the principal amount of the notes or issuing new notes in an amount equal to the interest payment for the applicable interest period (“PIK Interest”). Cash interest on the PIK Notes will accrue at the rate of 9.625% per annum; PIK Interest will accrue at the rate of 10.375% per annum.

The PIK Notes are senior unsecured obligations of Holdings LLC and are structurally subordinated to all our existing and future indebtedness. Additionally, we did not guarantee the PIK Notes, nor were any of its assets pledged as collateral for the PIK Notes. As we are not an obligor or a guarantor on the PIK Notes, the debt is recorded only in the financial statements of Holdings LLC and is not reflected in the condensed consolidated financial statements of Ancestry.com LLC. While not required, in April 2014, the Company declared and paid its parent, Holdings LLC, a return-of-capital distribution of $18.4 million to pay accumulated interest on the PIK Notes. The Company intends to make future distributions to Holdings LLC in order to fund cash interest payments on the PIK Notes, provided that such distributions are permitted under the covenants of the Second Amended Credit Facility and the Notes. If interest on the PIK Notes is paid in cash, annual interest payments will total approximately $38.5 million.

Liquidity

Our primary sources of liquidity are our cash and cash equivalents, our cash flows from operations and amounts available under our Revolving Facility. At June 30, 2014, we had $91.5 million in cash and cash equivalents and $50.0 million of availability on our Revolving Facility.

Operating costs include costs such as marketing and advertising, personnel-related expenses, capital expenditures related to content databases and equipment, investments in new service offerings and technologies and web hosting costs, and business acquisitions. Expenditures have increased as operations and the number of personnel has grown, and we anticipate that our expenditures will continue to increase in the future. Our future cash expenditures may vary significantly from those now planned and will depend on many factors including:

 

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•

amounts we must pay to service our debt;

 

•

distributions we intend to make to our parent to fund cash interest payments on the PIK Notes;

 

•

the levels of advertising and promotion required to acquire and retain subscribers;

 

•

the development of new services and enhancement of functionality in our technology and tools;

 

•

market acceptance of our services;

 

•

the launch of additional services and expansion into new markets;

 

•

the level of new content acquisition required to retain and acquire subscribers ;

 

•

the building of infrastructure necessary to support our growth;

 

•

the expansion of our development, marketing and administrative organizations;

 

•

our relationships with subscribers and vendors;

 

•

our engaging in additional business acquisitions; and

 

•

amounts we must spend to integrate and operate acquired businesses.

We expect cash and cash equivalents on hand, cash flow from operations and amounts available under our Revolving Facility will provide adequate funds for our currently anticipated operating and recurring cash needs (e.g., debt service, working capital and capital expenditures) for at least the next twelve months; however, our substantial level of debt and debt service obligations as well as our intention to make further distributions to our parent to fund cash interest payments due on the PIK Notes could have important consequences including:

 

•

making it more difficult for us to satisfy our obligations with respect to our debt, which could result in an event of default under the indenture governing the Notes and the agreements governing our other debt, including the Second Amended Credit Facility;

 

•

limiting our ability to obtain additional financing on satisfactory terms to fund our working capital requirements, capital expenditures, acquisitions, investments, debt service requirements and other general corporate requirements;

 

•

increasing our vulnerability to general economic downturns and industry conditions, which could place us at a disadvantage compared to our competitors that are less leveraged and can therefore take advantage of opportunities that our leverage prevents us from pursuing;

 

•

allowing increases in floating interest rates to negatively impact our cash flows;

 

•

having our financing documents place restrictions on the manner in which we conduct our business, including restrictions on our ability to pay dividends, make investments, incur additional debt and sell assets; and

 

•

reducing the amount of our cash flows available to fund working capital requirements, capital expenditures, acquisitions, investments, other debt obligations and other general corporate requirements, because we will be required to use a substantial portion of our cash flows to service debt obligations.

In the future, any credit ratings agency may lower a given credit rating, if that rating agency judges that our business, the economic environment, or other future circumstances so warrant. A ratings downgrade could impair our ability to access the capital markets and increase the cost of obtaining capital.

We may also seek, depending on market conditions, to refinance certain categories of our debt. We may also, from time to time, seek to repurchase the Notes in the open market or otherwise. We and/or our parent entities (the “Ancestry Group”) may also seek to incur additional debt for which we would need to fund the interest and principal payments, which may impact our ability to satisfy our cash requirements. Any such transaction would be subject to market conditions, compliance with the Second Amended Credit Facility agreement and the indenture governing the Notes and various other factors.

 

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Cash Flow Analysis

Summary cash flow information for cash and cash equivalents for the six months ended June 30, 2014 and 2013 is set forth below. We consider cash and cash equivalents in evaluating our overall cash position.

 

		Six months ended June 30,
		2014				2013				% Change
		(in thousands)
Net cash and cash equivalents provided by (used in):
Operating activities		$	74,843			$	63,285				18.3	%
Investing activities			(32,497	)			(21,862	)			48.6
Financing activities			(37,435	)			(44,429	)			(15.7	)
Net increase (decrease) in cash and cash equivalents		$	4,911			$	(3,006	)			(263.4	)

Net cash provided by operating activities

For the six months ended June 30, 2014, net cash provided by operating activities totaled $74.8 million, an increase of $11.6 million compared to the six months ended June 30, 2013. Net cash provided by operating activities consisted of a net loss of $10.0 million, adjustments for non-cash items of $79.2 million and changes in operating assets and liabilities of $5.7 million. For the six months ended June 30, 2014, this represented a $32.7 million decrease in net loss, a $32.9 million decrease in non-cash adjustments and a $11.8 million increase in the changes in operating assets and liabilities over the six months ended June 30, 2013. The decrease in adjustments for non-cash items primarily consisted of a $17.3 million decrease for non-cash fair value adjustments to deferred revenue as a result of the application of purchase accounting for the Transaction in the prior year and an $18.6 million decrease in amortization of intangible assets due to certain intangible assets being amortized on an accelerated basis. Additionally, amortization of debt-related costs decreased $8.4 million primarily due to the acceleration of original issue discount and deferred financing costs resulting from the repricing of the original term loan in May 2013. These decreases were partially offset by increases in other non-cash items such as deferred income taxes, depreciation, amortization of content databases and stock-based compensation expense. The increase in the changes in operating assets and liabilities was primarily due to a $20.2 million increase in cash due to the timing of cash receipts and payments offset in part by a decrease of net cash received from tax refunds of $8.5 million.

Net cash used in investing activities

For the six months ended June 30, 2014, net cash used in investing activities totaled $32.5 million, an increase of $10.6 million compared to the six months ended June 30, 2013. The change was primarily due to a $10.8 million increased investment in content databases, partially offset by a decrease in purchases of property and equipment.

Net cash used in financing activities

For the six months ended June 30, 2014, net cash used in financing activities totaled $37.4 million, a decrease of $7.0 million compared to the six months ended June 30, 2013. The change was due in part to a decrease in principal payments on our debt of $20.4 million due to changes in our debt terms as a result of the repricing of the Term Loans in May and December 2013. In addition, in May 2013, we paid $7.8 million in deferred financing costs as part of the repricing. These changes were offset in part by a return-of-capital distribution of $18.4 million paid in April 2014 to our parent, Holdings LLC, to pay accumulated interest on its PIK Notes. Additionally, contributions from members decreased $2.5 million, and we made a $1.2 million contingent consideration payment in March 2014 related to a prior acquisition.

Contractual Obligations

There have been no significant changes to our contractual obligations table since December 31, 2013.

Off-Balance Sheet Arrangements

We do not engage in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, as part of our ongoing business. Accordingly, our operating results, financial condition and cash flows are not subject to off-balance sheet risks.

Recently Issued Accounting Standards

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606), that will supersede nearly all existing revenue recognition guidance under US GAAP. The core principle of the guidance is that an entity should recognize revenue when it transfers promised goods or services to

 

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customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. Further, the guidance requires improved disclosures to help users of financial statements better understand the nature, amount, timing and uncertainty of revenue that is recognized. This guidance is effective for public companies for interim and annual periods beginning on or after December 15, 2016. For non-public companies, this guidance is effective for annual periods beginning after December 15, 2017 and interim periods within annual periods beginning after December 15, 2018. Early adoption is not permitted under US GAAP. As an “emerging growth company” under the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), we have elected to delay adoption of new or revised accounting standards applicable to public companies until such pronouncements are made applicable to private companies. Once effective, entities can choose to apply the standard using either a full retrospective approach or a modified retrospective approach. We have not yet selected a transition method and are currently assessing the potential impact that this standard will have on our consolidated financial statements.

Critical Accounting Policies and Estimates

Our condensed consolidated financial statements are prepared in conformity with GAAP. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs, expenses and related disclosures. These estimates and assumptions are often based on historical experience and judgments that we believe to be reasonable under the circumstances at the time made. However, all such estimates and assumptions are inherently uncertain and unpredictable and actual results may differ. It is possible that other professionals, applying their own judgment to the same facts and circumstances, could develop and support alternative estimates and assumptions that could result in material changes to our operating results and financial condition. We evaluate our estimates and assumptions on an ongoing basis.

We consider the assumptions and estimates associated with the testing of goodwill for impairment, recoverability of long-lived assets, income taxes, determination of the fair value of stock options included in stock-based compensation expenses and the estimated useful lives of our intangible assets, including content databases, to be our critical accounting estimates. For further information on our significant accounting policies, see Note 1 to our 2013 consolidated financial statements included in our Annual Report on Form 10-K. There have been no changes to our significant accounting policies since December 31, 2013.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

We are exposed to market risks in the ordinary course of our business, which currently are comprised primarily of interest rate risks and foreign currency exchange risks. For financial market risks related to interest rates and foreign currency exchange, refer to the “Quantitative and Qualitative Disclosures about Market Risk” contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K. Our exposure to market risk has not changed significantly since December 31, 2013.

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this Quarterly Report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this Quarterly Report our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and include controls and procedures designed to ensure that the information required to be disclosed by us in such reports is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.

Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures will prevent or detect all error and all fraud. While our disclosure controls and procedures are designed to provide reasonable assurance of their effectiveness, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.

(b) Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the quarter ended June 30, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II

 

Item 1.

Legal Proceedings

Appraisal Litigation (In re: Appraisal of Ancestry.com Inc.)

Following the consummation of the Merger, three former shareholders, who, combined, owned approximately 1.4 million shares of our Predecessor’s common stock, instituted two separate appraisal proceedings in the Court of Chancery of the State of Delaware pursuant to Del. C. § 262: Merion Capital, L.P. v. Ancestry.com, Inc. (C.A. No. 8173) and Merlin Partners LP et al. v. Ancestry.com Inc. (C.A. No. 8175). The two appraisal petitions allege that the $32 per share price paid to our Predecessor’s shareholders in the Merger did not represent the fair value of the Company on the date the Merger was consummated. On June 24, 2013, the Court consolidated the two pending appraisal proceedings as In re: Appraisal of Ancestry.com Inc.

On May 9, 2014, Ancestry moved for summary judgment as to Merion Capital, LP, arguing that Merion had failed to establish an entitlement to appraisal of its shares. Merion filed a brief in opposition to the motion on June 11, 2014. The Company filed a reply brief on July 11, 2014.

Additionally, trial before the Court of Chancery took place from June 17 to June 19, 2014. Post-trial briefing is expected to be completed on September 3, 2014.

In view of the inherent difficulty of predicting the outcome of such litigation, particularly where the claimants seek very large or indeterminate damages or where the matter presents novel legal theories or involves a large number of parties, we generally cannot predict or reasonably estimate what the eventual outcome of the pending matter described above will be, what the timing of the ultimate resolution of this matter will be, or what any loss or range of loss related to the pending matter may be. With respect to the outstanding legal matter described in the prior paragraph, we believe that we have substantial defenses to the claims asserted by the claimants in the litigation. Based on our current knowledge, we do not believe that a loss, if any, arising from the pending matter described in the prior paragraph should have a material adverse effect on our consolidated financial position.

General

We have and may become party to various other legal proceedings and other claims that arise in the ordinary course of business or otherwise in the future. Such matters are subject to many uncertainties and outcomes are not predictable with assurance. While we cannot assure the ultimate outcome of any legal proceeding or contingency in which we are or may become involved, we do not believe that any pending legal claim or proceeding arising in the ordinary course will be resolved in a manner that would have a material adverse effect on our business. Although we consider the likelihood of such an outcome to be remote, if one or more of these legal matters resulted in an adverse money judgment against the Company, such a judgment could have a material adverse effect on our operating results and financial conditions and may result in us being required to pay significant monetary damages. See the risk factors “Expenses or liabilities resulting from litigation could adversely affect our results of operations and financial condition” and “Intellectual property claims against us could be costly and result in the loss of significant rights related to, among other things, our websites, content indexes, and marketing and advertising activities,” under the heading “Risk Factors.”

 

Item 1A.

Risk Factors

A wide range of factors could materially affect our performance. The following factors and other information included in this Quarterly Report should be carefully considered. Although the risk factors described below are the ones management deems significant, additional risks and uncertainties not presently known to us or that we presently deem less significant may also impair our business operations. If any of the following events actually occur, our business, financial condition and results of operations could be adversely affected.

Risks Related to Our Business

If our efforts to retain and attract subscribers are not successful, our number of subscribers could fail to grow or decline and our revenues may be materially affected.

We generate substantially all of our revenues from subscriptions to our services. We must continue to retain existing and attract new subscribers both to grow our business and to replace subscribers who choose to cancel their subscriptions. We seek to do this in part by investing in our product platform and new services and technologies, such as mobile, AncestryDNA and Archives.com. If consumers do not perceive our services to be reliable, valuable and of high quality, if we fail to regularly introduce new and improved services and more content, or if we introduce new services that are not favorably received by the market, we may not be able to retain existing or attract new subscribers and our revenues could be materially adversely affected. Subscribers choose to cancel their subscriptions for many personal reasons, including a desire to reduce discretionary spending, a perception that they do not have sufficient time to use the service or otherwise do not use the service sufficiently or customer service issues are not satisfactorily resolved.

 

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The relative service levels, pricing and related features of competitors to our products and services are some additional factors that may adversely impact our ability to retain existing subscribers and attract new subscribers. Some of our current competitors provide genealogical records free of charge. Some governments or private organizations may make historical records available online at no cost to consumers, and some commercial entities could choose to make such records available on an advertising-supported basis rather than a subscription basis. In addition to competition from outside services, certain of our products, such as Archives.com, may compete with our Ancestry.com websites for subscribers. If consumers are able to satisfy their family history research needs at no or lower cost, they may not perceive value in our higher priced products and services. Further, subscriber growth, or our number of subscribers, may decrease as a result of a decline in interest in family history research.

Any of these factors could cause our subscriber growth rate, or our number of subscribers, to fall, which could materially adversely impact our business, financial condition and results of operations. For example, the number of total subscribers decreased during the three months ended June 30, 2014 compared to the three months ended March 31, 2014 due to softness in gross subscriber additions. We cannot assure you that subscriber growth and our number of subscribers will not continue to decline in future periods. If we are unable to effectively retain existing subscribers and attract new subscribers or our number of subscribers further declines, our business, financial condition and results of operations could be materially adversely affected.

Our business may not grow, which could negatively affect our financial condition and results of operations.

While we have experienced periods of rapid growth in the past, we are currently experiencing softness in gross subscriber additions and do not expect rapid growth rates in future periods. Since we do not expect rapid growth rates in future periods, you should not rely on the revenue growth of any prior year or other period as an indication of our future performance. Additionally, we expect to continue to devote substantial resources and funds to improving our technologies and product offerings, including new product offerings, and to continue acquiring new and relevant content and also to expanding awareness of our brand and category through marketing, which may reduce our margins in the near term. If our revenue growth rate were to decline or become negative, it could materially adversely affect our financial condition and results of operations.

Our business strategy and projections rely on a number of assumptions, some or all of which may be incorrect. For example, it is difficult to predict the ultimate size of the industry and the acceptance by the market of our products and services. Also, we believe that consumers will be willing to pay for subscriptions to our online family history resources, notwithstanding the fact that some of our current and future competitors may provide such resources free of charge. We cannot accurately predict whether our products and services will achieve significant acceptance by potential users in significantly larger numbers than at present. You should therefore not rely on our historic growth rates as an indication of future growth.

A change in our mix of subscription durations or recurring rate of conversion could have a significant impact on our revenues and total subscribers.

We continually evaluate and test the types of subscriptions that we offer. Based on the results of any product or price testing conducted, we may change the price and types of subscriptions we offer and market. While the majority of our subscribers have a subscription duration of six months or greater, our new subscribers are primarily choosing a shorter subscription duration due to changes in our pricing strategy. As a result, we are experiencing higher cancellation volumes, which may result in decreased immediate and long-term revenues and total subscribers. In the future, we may continue to perform product and price tests involving our users, the results of which could affect our number or mix of subscribers and may have a material adverse impact on our results of operations, and key operating metrics.

In addition, recently proposed and new requirements regarding affirmative agreement by our subscribers to recurring subscription fees, whether imposed by regulators or third-party businesses, could impose significant obstacles to subscriptions, which could materially adversely affect our financial condition and results of operation.

Acquisitions, if any, may not be completed within the expected timeframe or at all, and businesses or technologies we acquire could prove difficult to integrate, disrupt our ongoing business or have a material adverse effect on our results of operations.

As part of our business strategy, we have engaged and may continue to engage in acquisitions of businesses or technologies from time to time to augment our organic or internal growth. While we have engaged in acquisitions in the past, our experience with integrating and managing acquired businesses or assets is still limited. Acquisitions involve challenges and risks in negotiation, execution, valuation and integration. Moreover, we may not be able to find suitable acquisition opportunities on terms that are acceptable to us or if we do, we may be delayed or unsuccessful in completing the transaction. We could assume the economic risks of such failed or unsuccessful acquisitions. Even if successfully negotiated, closed and integrated, certain acquisitions may not advance our business strategy, may fall short of expected return-on-investment targets or may fail. Any recent or future acquisition could involve numerous risks, including:

 

•

potential disruption of our ongoing business and distraction of management;

 

•

difficulty integrating the operations and products of the acquired business;

 

•

inability to effectively operate the new business;

 

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•

exposure to unknown liabilities, including litigation, against the companies we acquire;

 

•

use of cash or borrowings under our Revolving Facility or otherwise to fund the acquisition or for unanticipated expenses;

 

•

additional outside service costs, including legal, accounting and consulting fees;

 

•

additional costs due to differences in culture, geographical locations and duplication of key talent;

 

•

difficulty integrating the financial reports of the acquired business in our Consolidated Financial Statements and implementing our internal controls in the acquired business;

 

•

potential impairment of goodwill and acquired intangible assets;

 

•

potential loss of key employees or customers of the acquired company; and

 

•

potential weakening of our core business due to competition for subscribers and revenues from acquired businesses.

We may not be successful in addressing these risks or any other problems encountered in connection with any attempted acquisitions.

Our operating results fluctuate from period to period and may not immediately reflect downturns or upturns in subscriptions, which could make our operating results difficult to predict and affect future operating results.

Our quarterly and annual operating results are tied to certain financial and operational metrics that have fluctuated in the past and may fluctuate significantly in the future. As a result, you should not rely upon our past operating results as indicators of future performance. Our operating results depend on numerous factors, many of which are outside of our control. For the reasons set forth in this Risk Factors section or other reasons, the results of any prior quarterly or annual periods should not be relied upon as indicators of our future performance, and our revenues and operating results in the future may differ materially from the expectations of management or investors.

We recognize revenues from subscribers ratably over the term of their subscriptions. Since the majority of our subscription durations have historically been greater than six months, a large portion of our revenues for each quarter has reflected deferred revenues from subscriptions entered into during previous quarters. Consequently, a decline in new or renewed subscriptions in any one quarter will not necessarily be fully reflected in revenues in that quarter but will negatively affect our revenues in future quarters. Accordingly, the effect of significant downturns or upturns in subscriptions or market acceptance of our service, or changes in subscriber cancellation rates, may not fully impact our results of operations until future periods.

In addition, the largely long-term commitments of our subscribers historically have enhanced our near-term visibility on our revenues, which we believe has enabled us to more effectively manage the growth of our business and provide working capital benefits. If the change in the mix of subscriptions from longer to shorter durations continues, it may cause a reduction in this near-term visibility, which could make it more difficult to manage our business and effectively budget future working capital requirements.

We continuously attempt to generate revenues through marketing, advertising and product integration. If our marketing, television, integration and advertising efforts fail to generate additional revenues on a cost-effective basis, or if we are unable to manage our marketing and advertising expenses, it could materially harm our results of operations and growth.

Our future growth and profitability, as well as the maintenance and enhancement of our brands, will depend in large part on the effectiveness and efficiency of our marketing and advertising expenditures. We use a diverse mix of marketing and advertising programs to promote our products and services, and we periodically adjust our mix of these programs. Significant increases in the pricing of one or more of our marketing and advertising channels could increase our marketing and advertising expense or cause us to choose less effective marketing and advertising channels. We have experienced price increases in some of our marketing and advertising channels, including television. Television advertising comprises a large percentage of our marketing and advertising expense, which may have significantly higher costs than other channels and which could materially adversely affect our profitability. Further, we may over time become disproportionately reliant on one channel or partner, which could increase our operating expenses. Because we recognize revenues ratably over the subscription period, we have incurred and may in the future incur marketing and advertising expenses significantly in advance of the time we anticipate recognizing revenues associated with such expenses, and our marketing and advertising expenditures may not continue to result in increased revenues. If we are unable to maintain our marketing and advertising channels on cost-effective terms or replace existing marketing and advertising channels with similarly effective channels, our marketing and advertising expenses could increase substantially, our subscriber levels could be affected adversely, and our business, financial condition and results of operations may suffer. In addition, we may be required to incur significantly higher marketing and advertising expenses than we currently anticipate if excessive numbers of subscribers cancel our services or for other reasons. Our expanded marketing efforts may increase our subscriber acquisition cost, as additional expenses may not result in sufficient customer growth to offset cost, which would have an adverse effect on our business, financial condition and results of operations.

We have purchased and intend to continue to purchase product integration in and television advertising associated with television shows relevant to family history research, which have aired in the United States and other countries in past years. Television shows that focus on family history

 

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research have caused increased interest in our core business. If we do not receive benefits from family history research related television shows or if such shows do not continue to be well received or are canceled, the visibility of our core business and our brand may be reduced and our results of operations, financial condition and key metrics, such as net subscriber additions, may be materially adversely affected.

We face competition from a number of different sources, and our failure to compete effectively could materially impact our revenues, results of operations and financial condition.

We face competition in our business from a variety of organizations, some of which provide genealogical records free of charge. Many external factors, including the cost of marketing, content acquisition and technology and our current and future competitors’ pricing and marketing strategies can significantly affect our competitive strategies, including pricing. If we fail to meet our subscribers’ expectations, we could fail to retain existing or attract new subscribers, either of which could harm our business and results of operations.

Ancestry.com and our other websites face competition from:

 

•

FamilySearch, and its website FamilySearch.org, a genealogy organization that is part of The Church of Jesus Christ of Latter-day Saints. FamilySearch has an extensive collection of paper and microfilm records. FamilySearch has digitized a large quantity of these records and has published them online at FamilySearch.org, where it makes them available to the public for free and through thousands of family history centers located throughout the world. FamilySearch is a well-funded organization and is undertaking a large-scale digitization project to make its collection available online. While we have engaged, and continue to engage, in certain collaborative efforts with FamilySearch to digitize and make historical records available online, FamilySearch has partnered and may in the future partner with other commercial entities to broaden the distribution of its records.

 

•

Commercial entities, including online genealogical research services, library content distributors, search engines and portals, retailers of books and software related to genealogical research and family tree creation and family history oriented social networking websites.

 

•

Non-profit entities and organizations, genealogical societies, governments and agencies that may make vital statistics or other records available to the public for free or that partner with commercial entities to make their records widely available.

We expect our competition to grow both through industry consolidation and the emergence of new participants in our existing markets. We will also face competitors in new markets that we enter. For example, we face competition from other companies, such as 23andme, in providing family history DNA services. Our future competitors may include other Internet-based businesses, governments, religious organizations, not-for-profit entities and other entities. The market for Internet-based services evolves at a very rapid pace, and our competitors may offer products and services that are superior to any of our products and services. In addition, Internet business models are constantly changing. The online family history market could move to an advertising-supported model to the detriment of our subscription-based model. Our competitors may have greater resources, more well-established brand recognition or more sophisticated technologies, such as search algorithms, than we do. Our competitors may more easily obtain relevant records in domestic and international markets or offer new categories of content, products or services before we do, or at lower prices, which may give them a competitive advantage in attracting subscribers. In addition to competition from outside sources, certain of our products, such as Archives.com, may compete with our Ancestry.com websites for subscribers.

To compete effectively, we may need to expend significant resources on content acquisition, technology or marketing and advertising, which could reduce our margins and have a material adverse effect on our business, financial condition and results of operations. If we do not compete effectively, our ability to retain and expand our subscriber base, and our revenues, results of operations and financial condition, could be materially adversely affected. See Item 1, “Business – Competition.” in our Annual Report on Form 10-K.

Because we generate substantially all of our revenues from online family history resources, particularly in the United States and United Kingdom, a decline in demand for our services or for online family history resources in general, and particularly in the United States and United Kingdom, could cause our revenues to materially decline.

We generate substantially all of our revenues from our online family history services, and we expect that we will continue to depend upon our online family history services for substantially all of our revenues in the foreseeable future. Because we depend on our online family history services, factors such as changes in consumer preferences for these products may have a disproportionately greater impact on us than if we offered multiple services. The market for online family history resources, and for consumer services in general, is subject to rapidly changing consumer demand and trends in preferences. If consumer interest in our online family history services declines, or if consumer interest in family history in general declines, we would likely experience a significant loss of revenues and net income. Some of the potential factors that could affect interest in and demand for online family history services include:

 

•

individuals’ interest in, and their willingness to spend time and money, conducting family history research;

 

•

availability of discretionary funds;

 

•

awareness of our brand and the family history category;

 

•

the appeal, reliability and performance of our services;

 

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•

the price, performance and availability of competing family history products and services;

 

•

public concern regarding privacy and data security;

 

•

our ability to maintain high levels of customer satisfaction; and

 

•

the rate of growth in online commerce generally.

In addition, substantially all of our revenues are from subscribers in the United States and the United Kingdom, and, to a lesser extent, Australia and Canada. Consequently, a decrease of interest in and demand for online family history services or increased competition in these countries could have a disproportionately greater impact on us than if our geographical mix of revenues were less concentrated.

Challenges in acquiring historical content and making it available online could materially adversely affect our ability to retain and expand our subscriber base, and therefore could materially affect our business, financial condition and results of operations.

In order to retain and expand our subscriber base, both domestically and internationally, we must continue to expend significant resources to acquire significant amounts of additional historical content, digitize it and make it available to our subscribers online. We face legal, logistical, cultural and commercial challenges in acquiring new content. Relevant governmental records may be widely dispersed and held at a national, state or local level. Religious and private records are even more widely dispersed.

These problems often pose particular challenges in acquiring content internationally. Desirable content may not be available to us on favorable terms, or at all, due to competition for a particular collection, privacy concerns relative to information contained in a given collection or our lack of negotiating leverage with a certain content provider. For example, some of our most popular databases include “vital records” content—namely, historical birth, marriage and death records—made available by certain governmental agencies. To help prevent identity theft, or other malicious activities, governments may attempt to restrict the release of or increase the difficulty of accessing all or substantial portions of their vital records content, and particularly birth records, to third parties. If these efforts are successful, it may limit, increase the cost of or altogether prevent us from acquiring these types of vital record content or continuing to make them available online. In some cases, we have had to lobby for legislation to be changed or otherwise work to surmount administrative or other bureaucratic hurdles to enable government or other bodies to grant us access to records.

While we own or license most of the images in our database, we generally do not own the underlying historical documents. If owners of content have sold or licensed the rights to digitize that content, even on a non-exclusive basis, they may elect not to sell or license it for digitization purposes to any other person. Therefore, if one of our competitors acquires rights to digitize a set of content, even on a non-exclusive basis, we may be unable to acquire rights to digitize that content. Conversely, the owners of historical records may allow more than one party to digitize those records and our competitors may digitize and make available the same content that we offer. In some cases, acquisition of content involves competitive bidding, and we may choose not to bid or may not successfully bid to acquire content rights. In addition, a number of governmental bodies and other organizations are interested in making historical content available for free and owners of historical records may license or sell their records to such governmental bodies and organizations in addition to or instead of licensing or selling their content to us. Our inability to offer certain vital records or other valuable content as part of our family history research databases or the widespread availability of such content elsewhere at lower cost or for free could result in our subscription services becoming less valuable to consumers, which could have a material adverse impact on our number of subscribers, and therefore on our business, financial condition and results of operations.

We depend in part upon third-party licenses for some of our historical content, and a loss of these licenses, or disputes regarding royalties under these licenses, could adversely affect our ability to retain and expand our subscriber base, and therefore could materially affect our revenues, financial condition and results of operations.

We acquire a portion of our content pursuant to ongoing license agreements. Some of these agreements have finite terms, and we may not be able to renew the agreements on terms that are advantageous to us or at all. For example, we license a significant amount of our United Kingdom content from The National Archives of the United Kingdom under several license agreements that generally have ten-year terms, with varying automatic extension periods. The agreements are generally terminable by either party for breach by the other party and by The National Archives of the United Kingdom upon our insolvency or bankruptcy. Some of these agreements also contain change in control provisions that may permit The National Archives of the United Kingdom to terminate these licenses.

If a current or future license for a significant content collection were to be terminated, we may not be able to obtain a new license on terms advantageous to us or at all, and we could be required to remove the relevant content from our websites, either immediately or after some period of time. If a content provider were to license or sell us content in violation of that content provider’s agreements with other parties or if we misused any of the licensed content, we could be required to remove that content from our websites and potentially face liability. If we were required to remove a material amount of content from our websites, as a result of the termination of one or more licenses or otherwise, it could adversely affect our business and results of operations. Some of these license agreements restrict the manner in which we use the applicable content, which could limit our ability to leverage that content for new uses as we expand our business.

 

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Digitizing and indexing new content can take a significant amount of time and expense, and can expose us to risks associated with the loss or damage of historical documents. Our inability to maintain or acquire content or make new content available online in a timely and cost-effective manner, or liability for loss of historical documents, could have a material adverse effect on our business, financial condition and results of operations.

Digitizing and indexing new historical content can take a significant amount of time and expense, and we generally incur the expenses related to such content significantly in advance of the time we can make it available to our subscribers. We have made significant investments to acquire, digitize and index content, including content acquired through business acquisitions, and we expect to continue to spend significant resources on content. Increases in the cost or time required to digitize and index new content could harm our financial results. Currently, two transcription vendors perform a substantial portion of our data transcription as measured by cost. We do not have long-term contracts with any of our transcription vendors. If we were to replace one of these transcription vendors for any reason, we would be required to provide extensive training to the new vendor, which could delay our ability to make our new content available to our subscribers, and our relationships with the new transcription vendors may be on financial or other terms less favorable to us than our existing arrangements. Our inability to maintain or acquire content or to make new content available online in a timely and cost-effective manner would have a material adverse effect on our business, financial condition and results of operations.

While we are digitizing content, we may be in possession of valuable and irreplaceable original historical documents. While we maintain insurance with respect to such documents, any loss or damage to such documents, while in our possession, could cause us significant expense and could have a material adverse effect on our reputation and the potential willingness of content owners to license or lend their content to us.

Our failure to attract, integrate and retain highly qualified key personnel, including our CEO, could harm our business.

To execute our growth plan, we must attract and retain highly-qualified personnel. Competition for these employees is intense, and we may not be successful in attracting and retaining qualified personnel. We have from time to time in the past experienced, and we expect to continue to experience in the future, difficulty in hiring and retaining highly skilled employees with appropriate qualifications. Many of the companies with which we compete for experienced personnel have greater resources than we have. In addition, in making employment decisions, particularly in the Internet and high-technology industries, job candidates often consider the value of the stock-based awards they may receive in connection with their employment and may be concerned about the value and liquidity of the stock-based awards we offer. If we fail to attract new personnel, or fail to retain and motivate our current personnel, our business and future growth prospects could be materially adversely affected.

We depend on the continued service and performance of our key personnel, including Timothy Sullivan, our President and Chief Executive Officer. We do not maintain key man insurance on any of our officers or key employees. We also do not have long-term employment agreements with our officers or key employees. In addition, much of our key technology and systems are custom-made for our business by our personnel. The loss of key personnel, including key members of our management team, as well as certain of our key marketing, product development or technology personnel could disrupt our operations and have an adverse effect on our ability to operate our business.

We currently outsource some of our customer service, DNA testing services and product development activities to third parties, which exposes us to significant risks if these parties fail to perform under our agreements with them.

Because we currently outsource some of our customer service, DNA testing services and product development activities to third parties, we have less control over the work produced by these providers than over our own employees. If customer service or DNA testing personnel fail to perform in accordance with the terms of our agreements, we may fail to meet customer expectations. If third-party developers fail to adequately protect or transfer our intellectual property rights in our products, our intellectual property portfolio could be damaged. These outcomes could result in negative publicity, damage our reputation and brands and have a material adverse effect on our business and results of operations.

Our growth has strained our personnel, technology and infrastructure resources, and if we are unable to implement appropriate controls and procedures to manage our growth, and hire and integrate appropriate personnel, we may not be able to successfully implement our business plan.

Our growth in operations has placed a strain on our management, administrative, technological, operational and financial infrastructure. Anticipated future growth, including growth related to the broadening of our product and service offerings and growth related to the acquisition of businesses, will continue to place similar strains on our personnel, technology and infrastructure. Our full-time employee headcount, excluding customer service and digital processing service employees, increased approximately 10% from January 1, 2013 to December 31, 2013, and we have continued to hire additional personnel in 2014. Particularly when adding staff quickly, we may not make optimal hiring decisions or may not integrate personnel effectively. Increased activity on our websites, particularly sudden increases, could strain our capacity and result in website performance issues or cause us to hit limitations in our present infrastructure or other technology. Our success will depend in part upon the management ability of our officers with respect to growth opportunities. To manage the expected growth of our operations, we will need to continue to improve our operational, financial, technological and management controls and our reporting systems and procedures. Additional personnel and capital investments will increase our cost base, which, if we fall short of anticipated revenue growth, will make it more difficult to decrease expenses in the short term. If we fail to successfully manage our growth, it could materially adversely affect our business, financial condition and results of operations.

 

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Any continued service outages or a significant disruption in service on our websites or in our computer systems, which are currently hosted primarily by a single third party, could damage our reputation and result in a loss of subscribers, which would harm our business and operating results.

Our brand, reputation and ability to attract, retain and serve our subscribers depend upon the reliable performance of our websites, network infrastructure, content delivery processes and payment systems. We have experienced interruptions in these systems in the past, including server failures and electronic attacks that temporarily slowed down our websites’ performance and users’ access to content, or made our websites inaccessible, and we may experience interruptions in the future. For example, we have experienced “distributed-denial-of-service” and other attacks in the past that have caused our systems to respond slowly or be inaccessible. Our efforts to fix these disruptions may redirect resources from product development or other business initiatives and may not result in lasting benefits. Interruptions in these systems, whether due to system failures, computer viruses or physical or electronic break-ins, could affect the security or availability of our websites and prevent our subscribers from accessing our data and using our products and services. Problems with the reliability or security of our systems may harm our reputation and cause subscribers to cancel, and the cost of remedying these problems could negatively affect our business, financial condition and results of operations.

Substantially all of our communications, network and computer hardware used to operate our websites are co-located in a facility in Salt Lake City, Utah. We do not own or control the operation of this facility. We have established a disaster recovery facility located at a third-party facility in Denver, Colorado. Our disaster recovery facility is not fully redundant to our facility in Utah. Our systems and operations are vulnerable to damage or interruption from fire, flood, power loss, telecommunications failure, terrorist attacks, acts of war, electronic and physical break-ins, computer viruses, earthquakes and similar events. The occurrence of any of the foregoing events at one or both facilities could result in reduced functionality or interruption of our websites, damage to our systems and hardware or could cause them to fail completely, and our insurance may not cover such events or may be insufficient to compensate us for losses that may occur. A network or communications failure or interruption of our system could also result in our customers losing access to or experiencing reduced functionality of our websites.

In addition, we may utilize third-party Internet-based or “cloud” computing services in connection with our business operations, which are vulnerable to the same disruptions as our systems and facilities. Disruptions of the cloud computing services we use may result in customers losing access or in reduced functionality of our websites. Problems faced by our third-party web hosting provider, with telecommunications network providers or with the systems by which these providers allocate capacity among their customers, including us, could adversely affect the experience of our subscribers. Our third-party web hosting provider could decide to close its facilities without adequate notice. In addition, any financial difficulties, such as bankruptcy reorganization, faced by our third-party web hosting provider or any other service providers may have negative effects on our business, the nature and extent of which are difficult to predict. Additionally, if our third-party web hosting provider is unable to keep up with our growing needs for capacity, this could have a material adverse effect on our business. Any errors, defects, disruptions or other performance problems with our services could harm our reputation and have a material adverse effect on our business, financial condition and results of operations.

We face many risks associated with our plans to continue to expand our international offerings and marketing and advertising efforts, which could have a material adverse effect on our business, financial condition and results of operations.

As of June 30, 2014, approximately 30% of subscribers to our Ancestry.com branded websites were from locations outside the United States. We are subject to many of the risks of doing business internationally, including the following:

 

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exposure to foreign currency exchange rate fluctuations;

 

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compliance with foreign laws and the interpretation of those laws, including tax and employment laws, and anti-bribery laws;

 

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compliance with changing and conflicting legal and regulatory regimes;

 

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compliance with U.S. laws affecting operations outside of the United States, including the Foreign Corrupt Practices Act;

 

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compliance with varying and conflicting intellectual property laws;

 

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difficulties in staffing and managing international operations;

 

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prevention of business or user fraud; and

 

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effective implementation and maintenance of internal controls and processes across diverse operations and a dispersed employee base.

We anticipate that our continuing international expansion will entail increased marketing and advertising of our products, services and brands, and the development of localized websites throughout our geographical markets. We may not succeed in these efforts or achieve our subscriber acquisition or other goals. For some international markets, customer preferences and buying behaviors may be different than those in our current markets, and we may use business models that are different from our traditional subscription models. Our revenues from new foreign markets may not exceed the costs of acquiring, establishing, marketing and maintaining international offerings, and therefore may not be profitable on a sustained basis, if at all. The risks of international expansion include:

 

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difficulties in developing and marketing our offerings and brands as a result of distance, language and cultural differences;

 

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more stringent consumer and data protection laws;

 

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inability to effectively deal with local socio-economic and political conditions;

 

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technical difficulties and costs associated with the localization of our service offerings;

 

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strong local competitors; and

 

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lack of experience in certain geographical markets.

One or more of these factors could have a material adverse effect on our business, financial condition and results of operations.

If we are unable to improve market recognition of and loyalty to our brands, or if our reputation were to be harmed, we could lose subscribers or fail to increase the number of subscribers, which could have a material adverse effect on our revenues, results of operations and financial condition.

We believe that maintaining and enhancing our Ancestry.com brand and other brands is critical to our success. We believe that the importance of brand recognition and loyalty will only increase in light of increasing competition in our markets. We plan to continue to promote our brands, both domestically and internationally, but there is no guarantee that our selected strategies will increase the favorable recognition of our brands. Some of our existing and potential competitors, including search engines, media companies and government and religious institutions have well-established brands with greater brand recognition than we have.

Additionally, from time to time, our subscribers express dissatisfaction with our service, including, among other things, dissatisfaction with our auto-renewal and other billing policies, our handling of personal data and the way our services operate. To the extent that dissatisfaction with our service is widespread or not adequately addressed, our brand may be adversely impacted. If our efforts to promote and maintain our brand are not successful, our operating results and our ability to attract and retain subscribers may be adversely affected. In addition, even if our brand recognition and loyalty increase, this may not result in increased use of our products and services or higher revenues. Many individuals are passionate about family history research and participate in blogs and social media on this topic both on our websites and elsewhere. If actions we take or changes we make to our products, services or performance upset these individuals, their blogging and contributions to social media could negatively affect our brand and reputation, which could have a material adverse effect on our revenues, results of operations and financial condition.

If we are unable to continually enhance our products and services and adapt them to technological changes and subscriber needs, we may not remain competitive and our business may fail to grow or decline; our mobile apps and the mobile web are becoming increasingly important ways to engage with our customers and we have not yet been able to meaningfully monetize any such engagement.

Our business is rapidly changing. To remain competitive, we must continue to provide relevant content and enhance and improve the functionality and features of our products and services. If we fail to do so, or if competitors introduce new solutions embodying new technologies, our existing products and services may become obsolete. Our future success will depend, among other things, on our ability to:

 

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anticipate demand for new products and services;

 

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enhance our existing solutions, cross-platform compatibility, systems capacity and processing speed; and

 

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respond to technological advances on a cost-effective and timely basis.

Developing the technologies in our products entails significant technical and business risks. We may use new technologies ineffectively, or we may fail to adapt our products and services to the demands of our subscribers. If we face material delays in introducing new or enhanced solutions, our subscribers may forego the use of our solutions in favor of those of our competitors.

Our mobile app and the mobile web are becoming increasingly important ways for users to engage with our service. If our mobile app or mobile web experience is slow, subject to intermittent failures, difficult to use or does not contain the same functionality of our desktop experience, it may not meet the user’s expectations and as a result could damage our reputation, prevent us from retaining existing or acquiring new subscribers and may have a material adverse effect on our business and results of operations. Despite our efforts to date, we have not been able to meaningfully monetize mobile users of our services. As more and more users seek to use our services through our mobile app and the mobile web, it will become increasingly important that we are able to meaningfully monetize our mobile users and failure to do so could have a material adverse effect on our business and results of operation.

 

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Most mobile apps are downloaded from various service providers that do not currently charge us fees or commissions for distribution of our mobile apps. If one or more of these service providers were to begin to impose fees or commissions upon us in connection with their distribution of our mobile apps, or prohibit us from distributing our mobile apps on their platforms, we may be unable to attract on a cost-effective basis a similar number of new registered users that we can convert to subscribers, which could materially affect our financial condition and results of operations.

Undetected product or service errors or defects could result in the loss of revenues, delayed market acceptance of our products or services or claims against us.

We offer a variety of Internet-based services and software products, which are complex and frequently upgraded. Our Internet-based services and software products may contain undetected errors, defects, failures or viruses, especially when first introduced or when new versions or enhancements are released. Despite product testing, our products, or third-party products that we incorporate into our products, may contain undetected errors, defects or viruses that could, among other things:

 

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require us to make extensive changes to our subscription services or software products, which would increase our expenses;

 

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expose us to claims for damages;

 

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require us to incur additional technical support costs;

 

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cause a negative registered user reaction that could reduce future sales;

 

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generate negative publicity regarding us and our subscription services and software products; or

 

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result in subscribers delaying their subscription or software purchase or electing not to renew their subscriptions.

Any of these occurrences could have a material adverse effect upon our business, financial condition and results of operations.

We use a single-source supplier for our DNA testing needs, which could materially harm our business by adversely affecting the availability, quality and cost of our DNA testing services.

We currently obtain DNA testing analysis and the technology used in our DNA testing kits from a single-source supplier. If our DNA analysis is delayed or curtailed by such source, we may not be able to meet our customers’ expectations with respect to timing, quality and price. Even if we were able to locate alternative laboratories, qualification of an alternative laboratory, obtaining the appropriate technology and establishment of reliable DNA analysis could result in delays and a possible loss of sales, which could materially harm our operating results. We may also be unable to locate an alternative laboratory that can provide the necessary services and technology at comparable prices, which could result in an increase in the cost of our DNA testing services.

Reliance on a single-source laboratory subjects us to a risk of delays, as well as a risk of increased cost and/or reduced quality of our DNA testing services. In addition, faulty analyses from our DNA testing provider could harm our reputation and may adversely affect our future DNA revenues and the success of our DNA testing services.

Privacy concerns could require us to incur significant expense and modify our operations in a manner that could result in restrictions and prohibitions on our use of certain information, and therefore harm our business.

As part of our business, we make biographical and historical data available through our websites, we use registered users’ personal data for internal purposes and we host websites and message boards, among other things, that contain content supplied by third parties. In addition, in connection with our AncestryDNA testing services, we obtain biological DNA samples used for genetic testing. For privacy or security reasons, privacy groups, governmental agencies and individuals may seek to restrict or prevent our use or publication of certain biological or historical information pertaining to individuals, particularly living persons. Because most of our genetic testing of DNA samples is outsourced to third-party service providers, we have less control over privacy and security measures. If our third-party DNA testing providers fail to comply with privacy and security standards, as required pursuant to the terms of our agreements with such providers, this could have a material adverse effect on our business, financial condition and results of operations. We will also face additional privacy issues as we expand into other international markets, as many nations have privacy protections more stringent than those in the United States. We have incurred, and will continue to incur, expenses to comply with privacy and security standards and protocols imposed by law, regulation, industry standards or contractual obligations. Increased domestic or international regulation of data utilization and distribution practices, including self-regulation, could require us to modify our operations and incur significant expense, which could have a material adverse effect on our business, financial condition and results of operations.

Our possession and use of personal information present risks and expenses that could harm our business. Unauthorized disclosure or use of such data, whether through breach of our network security or otherwise, could expose us to significant liability and damage our reputation.

Maintaining the security of our information technology and network systems infrastructure is of critical importance because we handle confidential subscriber, registered user, employee and other sensitive data, such as names, addresses, credit card numbers and other personal information. In addition, our online systems include the content that our registered users upload onto our websites, such as family records and photos. This content is often personally meaningful, and our registered users may rely on our online system to store digital copies of such content. If we were to lose such content, if our users’ private content were to become publicly available or if third parties were able to gain unauthorized access to such content, we may face liability and harm to our brand and reputation.

 

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Almost all of our subscribers use credit and debit cards to purchase our products and services. If we or our processing vendors were to have problems with our billing software, it could have an adverse effect on our subscriber satisfaction and could cause one or more of the major credit card companies to disallow our continued use of their payment services. In addition, if our billing software fails to work properly and, as a result, we do not charge our subscribers’ credit cards on a timely basis or at all, our business, financial condition, cash flows and results of operations could be materially affected.

We and our vendors use commercially available encryption technology to transmit personal information when taking orders. We use security and business controls to limit access and use of personal information, including registered users’ uploaded content. However, third parties may be able to circumvent these security and business measures, including by developing and deploying viruses, worms and other malicious software programs that are designed to attack or attempt to infiltrate our systems and networks. In addition, employee error, malfeasance or other errors in the storage, use or transmission of personal information could result in a breach of registered user or employee privacy.

There can be no assurances that we will be able to continue to operate our facilities and customer service and sales operations in accordance with industry practices, such as Payment Card Industry Data Security Standards. Even if we remain compliant with those standards, we may not be able to prevent security breaches involving customer data. If we experience a security breach or other lapse in the handling of confidential information, the incident could give rise to risks including data loss, litigation and liability, and could harm our reputation or disrupt our operations, any of which could materially adversely affect our business. In addition, various states and countries have differing laws regarding protection of customer privacy and confidential information, including notification requirements in the event of certain breaches or losses of information. Efforts to comply with these laws and regulations increase our costs of doing business, and failure to achieve compliance could result in substantial liability to our business and harm our reputation. In the event of a security breach or loss of confidential information, we could be subject to fines, penalties, damages and other remedies under applicable laws, any of which could have a material adverse impact on our reputation, business, operating results and financial condition.

If third parties improperly obtain and use the personal information of our registered users or employees, we may be required to expend significant resources in efforts to address these problems. A major breach of our network security and systems could have serious negative consequences for our businesses, including possible fines, penalties and damages, reduced demand for our products and services, an unwillingness of subscribers to provide us with their credit card or payment information, an unwillingness of registered users to upload family records or photos onto our websites, harm to our reputation and brand and loss of our ability to accept and process subscriber credit card orders. Similarly, if a well-publicized breach of data security at any other major consumer website were to occur, there could be a general public loss of confidence in the use of the Internet for commercial transactions. Any of these events could have material adverse effects on our business, financial condition and results of operations. In addition, we may have inadequate insurance coverage to compensate for any related losses.

Any claims related to activities of registered users and the content they upload could result in expenses that could harm our results of operations and financial condition.

Our registered users often upload their own content onto our websites. The terms of use of such content are set forth in the terms and conditions of our websites and a submission agreement to which registered users must agree when they upload their content. Disputes or negative publicity about the use of such content could make users more reluctant to upload personal content or harm our reputation. We do not review or monitor content uploaded by our registered users, and could face claims arising from or liability for making any such content available on our websites. In addition, our collaboration tools and other features of our site allow subscribers to contact each other. While subscribers can choose to remain anonymous in such communications, subscribers may choose to engage with one another without anonymity. If any such contact were to lead to fraud or other harm, we may face claims against us and negative publicity. Litigation to defend these claims or efforts to counter any negative publicity could be costly and any other liabilities we incur in connection with any such claims may have a material adverse effect on our business, financial condition and results of operations.

Increases in credit card processing fees would increase our operating expenses and materially adversely affect our results of operations, and the termination of our relationship with any major credit card company could have a severe, negative impact on our ability to collect revenues from subscribers.

The majority of our subscribers pay for our products and services using credit cards. From time to time, the major credit card companies or the issuing banks may increase the fees that they charge for each transaction using their cards. An increase in those fees would require us to increase the prices we charge for our products and services or negatively impact our profitability, either of which could materially affect our business, financial condition and results of operations.

In addition, our credit card fees may be increased by credit card companies if our chargeback rate or the refund rate exceeds certain thresholds. If we are unable to maintain our chargeback rate at acceptable levels, our credit card fees for chargeback transactions, or for all credit card transactions, may be increased, and, if the problem significantly worsens, credit card companies may further increase our fees or terminate their relationships with us. Any increases in our credit card fees could adversely affect our results of operations, particularly if we elect not to raise our subscription rates to offset the increase. The termination of our ability to process payments on any major credit or debit card would significantly impair our ability to collect revenues from subscribers.

 

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If government regulation of the Internet or other areas of our business changes or if consumer attitudes toward use of the Internet change, we may need to change the way we conduct our business in a manner that is less profitable or incur greater operating expenses, which could harm our results of operations.

The adoption, modification or interpretation of laws or regulations relating to the Internet or other areas of our business could adversely affect the manner in which we conduct our business or the overall popularity or growth in use of the Internet. Such laws and regulations may cover automatic subscription renewal, credit card processing procedures, sales and other procedures, tariffs, user privacy, data protection, pricing, content, copyrights, distribution, electronic contracts, consumer protection, net neutrality, broadband residential Internet access and the characteristics and quality of services. In foreign countries, such as countries in Europe and Asia, such laws may be more restrictive than in the United States. It is not clear how existing laws governing issues such as property ownership, sales and other taxes, libel and personal privacy apply to the Internet. If we are required to comply with new regulations or legislation or new interpretations of existing regulations or legislation, this compliance could cause us to incur additional expenses, make it more difficult to renew subscriptions automatically, make it more difficult to attract new subscribers or otherwise alter our business model. Any of these outcomes could have a material adverse effect on our business, financial condition or results of operations.

Our revenues may be materially adversely affected if we are required to charge sales taxes in additional jurisdictions and/or other taxes for our products and services.

We collect or have imposed upon us sales or other taxes related to the products and services we sell in certain states and other jurisdictions. Additional states or one or more countries or other jurisdictions may seek to impose sales or other tax collection obligations on us in the future or states or jurisdictions in which we already collect tax may increase the amount of taxes we are required to collect. A successful assertion by any country, state or other jurisdiction in which we do business that we should be collecting sales or other taxes on the sale of our products and services could, among other things, result in substantial tax liabilities for past sales, create significant administrative burdens for us, discourage registered users from purchasing from us or otherwise substantially harm our business and results of operations. Further, if additional sales or other taxes were imposed in jurisdictions where we do business, we may be unable to fully pass these costs on to our subscribers, which may also harm our business and results of operations.

Our Revolving Facility may not be sufficient for our needs, and we may require additional capital for business opportunities, acquisitions or unforeseen circumstances. If such sources are not available to us, or are not available on acceptable terms, we may not be able to expand and our business and/or our operating results and financial condition may be materially harmed.

We intend to continue to make investments to support our business growth and may require additional funds to respond to business opportunities, including developing new features and products or enhancing our existing solutions, improving our operating infrastructure or acquiring complementary businesses and technologies. Our Revolving Facility, which provides for $50.0 million of borrowings, may not be sufficient for our needs. Accordingly, we or parent entities in the Ancestry Group may engage in debt financing to secure additional funds; however, we may not be able to obtain additional financing on terms favorable to us, if at all. For example, our Second Amended Credit Facility, and the indentures governing the Notes and the PIK Notes contain restrictive covenants relating to our capital-raising activities by us and Holdings LLC and other financial and operational matters, and any debt financing obtained by us or our parent entities in the Ancestry Group in the future could involve further restrictive covenants, which may make it more difficult for us to obtain additional capital and to pursue business opportunities. If we are unable to obtain adequate financing or financing on terms satisfactory to us when we require it, our ability to grow our business and to respond to business challenges could be significantly impaired, and our business may be materially harmed.

We face risks associated with currency exchange rate fluctuations, which could adversely affect our revenues and operating results.

For the six months ended June 30, 2014, approximately 20% of our total revenues were received and approximately 7% of our total expenses were paid, in currencies other than the United States dollar, such as the British pound sterling, the Euro, the Australian dollar and the Canadian dollar. As a result, we are at risk for exchange rate fluctuations between such foreign currencies and the United States dollar, which could affect our revenues and results of operations. If the U.S. dollar strengthens against foreign currencies, the translation of these foreign currency denominated transactions will result in decreased revenues, operating expenses and net income. We may not be able to offset adverse foreign currency impact with increased subscription pricing or volume. We attempt to limit our exposure by paying our operating expenses incurred in foreign jurisdictions with revenues received in the applicable currency, but if we do not have enough local currency to pay all our expenses in that currency, we are exposed to currency exchange rate risk with respect to those expenses. Even if we were to implement hedging strategies to mitigate foreign currency risk, these strategies might not eliminate our exposure to foreign exchange rate fluctuations and would involve costs and risks of their own, such as ongoing management time and expertise, external costs to implement the strategies and potential accounting implications.

Our business may be significantly impacted by a change in the economy, including any resulting effect on consumer spending.

Our business may be affected by changes in the economy generally, including any resulting effect on consumer spending specifically. Our products and services are discretionary purchases, and consumers may reduce their discretionary spending on our products and services during an economic downturn. Although we did not experience a material increase in subscription cancellations or a material reduction in subscription renewals during the recent economic downturn, we may yet be impacted if employment and personal income do not continue to improve or if global economic conditions deteriorate. Conversely, consumers may spend more time using the

 

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Internet during an economic downturn and may have less time for our products and services in a period of economic growth. In addition, we have already seen a rise in media prices, including television advertising, and prices may further increase if the economy continues to recover or grows, which could significantly increase our marketing and advertising expenses. As a result, our business, financial condition and results of operations may be significantly impacted by changes in the global economy generally.

We have made significant estimates in calculating our income tax provision and other tax assets and liabilities. If these estimates are incorrect, our operating results and financial condition may be materially affected.

We are subject to regular review and audit by both domestic and foreign tax authorities. Any adverse outcome of such a review or audit could have a negative effect on our operating results and financial condition. In addition, the determination of our provision for income taxes and other tax assets and liabilities requires significant judgment, and there are many transactions and calculations where the ultimate tax determination is uncertain at the present time. Although we believe our estimates are reasonable, the ultimate tax outcome may differ from the amounts recorded in our financial statements and may have a material effect on our operating results and financial condition.

We earn a significant amount of our operating income from outside the United States, and there have been proposals to change U.S. tax laws that would significantly impact how we are taxed on foreign earnings. Although we cannot predict whether or in what form any proposed legislation may pass, if enacted it could have a material adverse impact on our future tax expense and cash flow.

Expenses or liabilities resulting from litigation could materially adversely affect our results of operations and financial condition.

We have and may become party to various legal proceedings and other claims that arise in the ordinary course of business or otherwise in the future. Such matters are subject to many uncertainties and outcomes are not predictable with assurance. In addition, any such claims or litigation may be time-consuming and costly, divert management resources, require us to change our products and services, require us to accept returns of software products or have other adverse effects on our business. While we cannot assure the ultimate outcome of any legal proceeding or contingency in which we are or may become involved, we do not believe that any pending legal claim or proceeding arising in the ordinary course will be resolved in a manner that would have a material adverse effect on our business. However, if one or more of these legal matters resulted in an adverse monetary judgment against us, such a judgment could have a material adverse effect on our results of operations and financial condition. See also the risk factor “Intellectual property claims against us could be costly and result in the loss of significant rights related to, among other things, our websites, content indexes, and marketing and advertising activities” below. Please refer to Item 1 of Part II for more information about the Company’s current legal proceedings.

As an “emerging growth company” under the JOBS Act, we are permitted to, and intend to, rely on exemptions from certain disclosure requirements.

As an “emerging growth company” under the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), we are permitted to, and intend to, rely on exemptions from certain disclosure requirements. We are an emerging growth company until the earliest of: (i) the last day of the fiscal year during which we had total annual gross revenues of $1 billion or more, (ii) the last day of the fiscal year following the fifth anniversary of the date of the first sale of our common stock pursuant to an effective registration statement, (iii) the date on which we have, during the previous 3-year period, issued more than $1 billion in non-convertible debt or (iv) the date on which we are deemed a “large accelerated issuer” as defined under the federal securities laws. For so long as we remain an emerging growth company, we will not be required to:

 

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have an auditor report on our internal control over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act of 2002, as amended; and

 

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comply with any requirement that may be adopted by the Public Company Accounting Oversight Board (“PCAOB”) regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and the financial statements (auditor discussion and analysis); and

 

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submit certain executive compensation matters to shareholders advisory votes pursuant to the “say on frequency” and “say on pay” provisions (requiring a non-binding shareholder vote to approve compensation of certain executive officers) and the “say on golden parachute” provisions (requiring a non-binding shareholder vote to approve golden parachute arrangements for certain executive officers in connection with mergers and certain other business combinations) of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010; and

 

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include detailed compensation discussion and analysis in our filings under the Exchange Act, and instead may provide a reduced level of disclosure concerning executive compensation.

Although we intend to rely on the exemptions provided in the JOBS Act, the exact implications of the JOBS Act for us are still subject to interpretations and guidance by the SEC and other regulatory agencies. In addition, as our business grows, we may no longer satisfy the conditions of an emerging growth company. We are currently evaluating and monitoring developments with respect to these new rules, and we cannot assure you that we will be able to take advantage of all of the benefits from the JOBS Act.

 

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In addition, as an “emerging growth company,” we have elected under the JOBS Act to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. Therefore, our financial statements may not be comparable to those of companies that comply with standards that are otherwise applicable to public companies.

Risks Related to Our Indebtedness

We have a substantial amount of debt, which exposes us to various risks.

We have substantial debt, totaling approximately $903.3 million as of June 30, 2014, and as a result, we have significant debt service obligations. We also have the ability to borrow up to $50.0 million under the Revolving Facility. Our substantial level of debt and debt service obligations as well as our intention to pay distributions to our parent to fund cash interest payments due on the PIK Notes could have important consequences including:

 

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making it more difficult for us to satisfy our obligations with respect to our debt, which could result in an event of default under the indenture governing the Notes and the agreements governing our other debt, including the Second Amended Credit Facility;

 

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limiting our ability to obtain additional financing on satisfactory terms to fund our working capital requirements, capital expenditures, acquisitions, investments, debt service requirements and other general corporate requirements;

 

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increasing our vulnerability to general economic downturns and industry conditions, which could place us at a disadvantage compared to our competitors that are less leveraged and can therefore take advantage of opportunities that our leverage prevents us from pursuing;

 

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potentially allowing increases in floating interest rates to negatively impact our cash flows;

 

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having our financing documents place restrictions on the manner in which we conduct our business, including restrictions on our ability to pay dividends, make investments, incur additional debt and sell assets; and

 

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reducing the amount of our cash flows available to fund working capital requirements, capital expenditures, acquisitions, investments, other debt obligations and other general corporate requirements, because we will be required to use a substantial portion of our cash flows to service debt obligations.

The occurrence of any one of these events could have a material adverse effect on our business, financial condition, results of operations, prospects and ability to satisfy our obligations under our debt.

Our direct parent, Ancestry.com Holdings LLC, has issued $400.0 million in senior unsecured PIK Notes. In addition to servicing our debt, we intend to pay distributions to Ancestry.com Holdings LLC to fund cash interest payments of the PIK Notes, which may exacerbate the risks associated with our debt under the Second Amended Credit Facility and the Notes.

Our parent company, Ancestry.com Holdings LLC, has issued a total of $400.0 million of 9.625%/10.375% senior unsecured PIK Notes, which mature on October 15, 2018. Holdings LLC is a holding company with no material operations and limited assets other than its ownership of the membership interests of Ancestry.com LLC. While covenants in our Second Amended Credit Facility and the indenture governing the Notes limit the amount of cash that we are able to distribute to our parent companies, to the extent cash is available, we intend to pay distributions to Holdings LLC to fund cash interest payments of the PIK Notes. Paying cash distributions to our parent will reduce the amount of cash available to pay our debt obligations. Paying cash distributions to our parent could also compound the consequences and risks of our debt and could have a material adverse effect on our business, financial condition, results of operations, prospects and ability to satisfy our obligations under the Second Amended Credit Facility and the Notes.

Despite current debt levels, we and/or other members of the Ancestry Group may still be able to incur substantially more debt. This could further exacerbate the risks associated with our substantial leverage.

We and/or other members of the Ancestry Group may be able to, and may, incur substantial additional debt, including secured debt, in the future. Although our Second Amended Credit Facility and the indentures governing the Notes and the PIK Notes contain restrictions on the incurrence of additional debt and the ability to make payments to related entities to fund their debt obligations, these restrictions are subject to a number of significant qualifications and exceptions, and any debt we incur in compliance with these restrictions could be substantial. If we incur additional debt on top of our current debt levels, this would exacerbate the risks related to our substantial debt levels. Furthermore, as we increase our debt level and/or incur indebtedness that is contractually or structurally subordinated to our other indebtedness, we may be required to pay higher interest rates on additional debt, which would increase our cost of capital and could have a material adverse effect on our financial condition and results of operation.

Our debt agreements include covenants that restrict our ability to operate our business, and this may impede our ability to respond to changes in our business or to take certain important actions.

Our Second Amended Credit Facility and the indenture governing the Notes each contain, and the terms of any of our future debt would likely contain, a number of restrictive covenants that impose significant operating and financial restrictions, including restrictions on our ability to engage in acts that may be in our best long-term interests. For example, the credit agreement governing our Second Amended Credit Facility and the indentures governing the Notes and PIK Notes restrict our and our subsidiaries’ ability to:

 

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incur additional debt;

 

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pay dividends on our capital stock and make other restricted payments;

 

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make investments and acquisitions;

 

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engage in transactions with our affiliates;

 

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sell assets;

 

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make acquisitions or merge; and

 

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create liens.

In addition, our Second Amended Credit Facility requires us to comply with a total net secured leverage covenant tested both quarterly and upon drawdown when the outstanding loans and letters of credit under our Revolving Facility exceed $15.0 million. These restrictions could limit our ability to obtain future financings, make needed capital expenditures, respond to and withstand future downturns in our business or the economy in general or otherwise conduct corporate activities that may be necessary or desirable. We may also be prevented from taking advantage of business opportunities that arise because of limitations imposed on us by these restrictive covenants. In addition, it may be costly or time-consuming for us to obtain any necessary waiver or amendment of these covenants, or we may not be able to obtain a waiver or amendment on any terms.

A breach of any of these covenants could result in a default under our Second Amended Credit Facility or the Notes, as the case may be, that would allow lenders or noteholders to declare our outstanding debt immediately due and payable. If we are unable to pay those amounts because we do not have sufficient cash on hand or are unable to obtain alternative financing on acceptable terms, the lenders or noteholders could initiate a bankruptcy proceeding or, in the case of our Second Amended Credit Facility, proceed against any assets that serve as collateral to secure such debt.

We will require a significant amount of cash to service our debt, and our ability to generate cash depends on many factors beyond our control.

Our ability to satisfy our debt obligations will primarily depend upon our future operating performance and decisions we make with regards to operating our business. As a result, prevailing economic conditions and financial, business and other factors, many of which are beyond our control, will affect our ability to make these payments to satisfy our debt obligations.

If we do not generate cash flow from operations sufficient to pay our debt service obligations, we may have to undertake alternative financing plans, such as refinancing or restructuring our debt, selling assets, reducing or delaying capital investments or seeking to raise additional capital. Our ability to restructure or refinance our debt will depend on the condition of the capital markets and our financial condition at that time. Any refinancing of our debt could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. The terms of existing or future debt instruments may restrict us from adopting some of these alternatives, which in turn could exacerbate the effects of any failure to generate sufficient cash flow to satisfy our debt service obligations. In addition, any failure to make payments of interest and principal on our outstanding debt on a timely basis would likely result in a reduction of our credit rating, which could harm our ability to incur additional debt on acceptable terms and may materially adversely affect the price of the Notes. Furthermore, there currently is not a well-established secondary market for our assets. The lack of a secondary market may make the sale of our assets challenging, and the sale of assets should not be viewed as a significant source of funding.

Our inability to generate sufficient cash flow to satisfy our debt service obligations or to refinance our obligations on commercially reasonable terms or at all, would have a material adverse effect on our business, financial condition and results of operations and may restrict our current and future operations, particularly our ability to respond to business changes or to take certain actions, as well as on our ability to satisfy our obligations.

Variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly.

Certain of our borrowings, primarily borrowings under our Second Amended Credit Facility, will be at variable rates of interest and expose us to interest rate risk. As such, our cash flows are sensitive to movements in interest rates. There are many economic factors outside our control that have in the past, and may in the future, impact rates of interest, including publicly announced indices that underlie the interest obligations related to a certain portion of our debt. The condition of the financial markets and prevailing interest rates have fluctuated in the past and are likely to fluctuate in the future. Factors that impact interest rates include domestic or international governmental monetary policies, inflation, recession, changes in unemployment, the money supply, international disorder and instability in domestic and foreign financial markets. If interest rates increase, our debt service obligations on the variable rate indebtedness would increase even though the amount borrowed remained the same, and our cash flows would decrease. Such increases in interest rates could have a material adverse effect on our financial condition and results of operations.

 

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The Notes are not secured by our assets, which means the lenders under any of our secured debt, including our Second Amended Credit Facility, will have priority over holders of the Notes to the extent of the value of the assets securing that debt.

The Notes and the related guarantees are unsecured. This means they are effectively subordinated in right of payment to all of our and the guarantors’ secured debt, including our Second Amended Credit Facility, to the extent of the value of the assets securing that debt. Loans under our Second Amended Credit Facility are secured by substantially all of our and the guarantors’ assets (subject to certain exceptions). As of June 30, 2014, we had approximately $454.8 million and $148.5 million outstanding under the Amended Term B-1 Loan and Amended Term B-2 Loan, respectively; and $50.0 million of availability under the Revolving Facility. Furthermore, the indenture governing the Notes allows us to incur additional secured debt. See Note 4 in our Condensed Consolidated Financial Statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Credit Facility” for a further description of the terms of the Second Amended Credit Facility.

If we become insolvent or are liquidated, or if payment under our Second Amended Credit Facility or any other secured debt is accelerated, the lenders under our Second Amended Credit Facility and holders of other secured debt will be entitled to exercise the remedies available to secured lenders under applicable law (in addition to any remedies that may be available under documents pertaining to our Second Amended Credit Facility or other senior debt). For example, the secured lenders could foreclose upon and sell assets in which they have been granted a security interest to the exclusion of the holders of the Notes, even if an event of default exists under the indenture governing the Notes at that time. Any funds generated by the sale of those assets would be used first to pay amounts owing under secured debt, and any remaining funds, whether from those assets or any unsecured assets, may be insufficient to pay obligations owing under the Notes.

The Notes are structurally subordinated to the debt and other liabilities of our non-guarantor subsidiaries, including certain of our foreign subsidiaries.

Certain of our existing or future foreign subsidiaries do not guarantee the Notes, and only the Company and all of the Company’s direct and indirect existing and future restricted subsidiaries (except excluded subsidiaries) that guarantee any indebtedness of Ancestry.com Inc. or any guarantor, or incur indebtedness under a credit facility, in each case, subject to certain exceptions, guarantee the Notes. This means the Notes are structurally subordinated to the debt and other liabilities of these non-guarantor subsidiaries. As of June 30, 2014, our non-guarantor subsidiaries had no debt outstanding (excluding intercompany debt). Our non-guarantor subsidiaries may, in the future, incur substantial additional liabilities, including debt. Furthermore, we may, under certain circumstances described in the indenture governing the Notes, designate subsidiaries to be unrestricted subsidiaries, and any subsidiary that is designated as unrestricted will not guarantee the Notes. In the event of our non-guarantor subsidiaries’ bankruptcy, insolvency, liquidation, dissolution, reorganization or similar proceeding, the assets of those non-guarantor subsidiaries will not be available to pay obligations on the Notes until after all of the liabilities (including trade payables) of those non-guarantor subsidiaries have been paid in full.

We may not have the ability to raise the funds necessary to finance the change of control offer required by the indenture governing the Notes.

Upon the occurrence of certain change of control events, we will be required to offer to repurchase all of the Notes. A change of control would also give the holders of the Notes the right to require us to repurchase those Notes. Our Second Amended Credit Facility provides that certain change of control events (including a change of control as defined in the indenture governing the Notes) constitute a default. Any future credit agreement or other debt agreement would likely contain similar provisions. If we experience a change of control that triggers a default under our Second Amended Credit Facility, we could seek a waiver of that default or seek to refinance those facilities. In the event we do not obtain a waiver or complete a refinancing, the default could result in amounts outstanding under those facilities being declared immediately due and payable. In the event we experience a change of control that requires us to repurchase the Notes, we may not have sufficient financial resources to satisfy all of our obligations under our Second Amended Credit Facility and the Notes. A failure to make a required change of control offer or to pay a change of control purchase price when due would result in a default under the indenture governing the Notes.

In addition, the change of control and other covenants in the indenture governing the notes do not cover all corporate reorganizations, mergers or similar transactions and may not provide holders with protection in a transaction, including one that would substantially increase our leverage.

The ability of holders of the Notes to require us to repurchase the Notes as a result of a disposition of “substantially all” of our assets or a change in the composition of our Operating Committee is uncertain.

The definition of change of control in the indenture governing the Notes includes the sale, assignment, lease, conveyance or other disposition of “substantially all” of our and our subsidiaries’ assets, taken as a whole. Although there is a limited body of case law interpreting the phrase “substantially all,” there is no precise established definition of the phrase. Accordingly, the ability of a holder of the Notes to require us to repurchase such Notes as a result of a sale, assignment, lease, conveyance or other disposition of less than all of our and our subsidiaries’ assets, taken as a whole, to another person or group is uncertain. In addition, a recent Delaware Chancery Court decision raised questions about the enforceability of provisions that are similar to those in the indenture governing the Notes, related to the triggering of a change of control as a result of a change in the composition of a board of directors or similar governing body. Accordingly, the ability of a holder of Notes to require us to repurchase Notes as a result of a change in the composition of the members of our Operating Committee is uncertain.

 

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Federal and state statutes allow courts, under specific circumstances, to void guarantees of the Notes. In such event, holders of Notes would be structurally subordinated to creditors of the issuer of the voided guarantee.

Federal and state statutes allow courts, under specific circumstances, to void guarantees, subordinate claims under the guarantees to the guarantor’s other debt or take other action detrimental to holders of the guarantees of the Notes. Under the federal bankruptcy law and comparable provisions of state fraudulent transfer laws, the guarantees made by the guarantors could be voided or subordinated to other debt if, among other things:

 

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any guarantor issued the guarantee to delay, hinder or defraud present or future creditors; or

 

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any guarantor received less than reasonably equivalent value or fair consideration for issuing such guarantee and, at the time it issued its guarantee, any guarantor:

 

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was insolvent or rendered insolvent by reason of such incurrence;

 

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was engaged in a business or transaction for which such guarantor’s remaining unencumbered assets constituted unreasonably small capital;

 

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intended to incur, or believed that it would incur, debts beyond its ability to pay such debts as they mature; or

 

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was a defendant in an action for money damages, or had a judgment for money damages docketed against it if, in either case, after final judgment, the judgment is unsatisfied.

Among other things, a legal challenge of a guarantee on fraudulent conveyance grounds may focus on the benefits, if any, realized by the guarantor as a result of our issuance of the Notes. The measures of insolvency for purposes of these fraudulent transfer laws will vary depending upon the law applied in any proceeding to determine whether a fraudulent transfer has occurred. Generally, however, a guarantor would be considered insolvent if, at the time it incurred the debt,

 

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the sum of its debts is greater than the fair value of all of its assets;

 

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the present fair saleable value of its assets was less than the amount that would be required in order to pay its probable liability on its existing debts and liabilities, including contingent liabilities, as they become absolute and mature; or

 

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it could not pay or is generally not paying its debts as they become due.

There is no way to predict with certainty what standards a court would apply to determine whether a guarantor was solvent at the relevant time. It is possible that a court could view the issuance of guarantees as a fraudulent conveyance. To the extent that a guarantee were to be voided as a fraudulent conveyance or were to be held unenforceable for any other reason, holders of the Notes would cease to have any claim in respect of the guarantor and would be creditors solely of ours and of the guarantors whose guarantees had not been avoided or held unenforceable. In this event, the claims of the holders of the Notes against the issuer of an invalid guarantee would be subject to the prior payment in full of all other liabilities of the guarantor thereunder. After providing for all prior claims, there may not be sufficient assets to satisfy the claims of the holders of the Notes relating to the voided guarantees. Although each guarantee entered into by a guarantor will contain a provision intended to limit that guarantor’s liability to the maximum amount that it could incur without causing the incurrence of obligations under its guarantee to be a fraudulent transfer, this provision may not be effective to protect those guarantees from being voided under fraudulent transfer law, or may reduce that guarantor’s obligation to an amount that effectively makes its guarantee worthless. In a Florida bankruptcy case, this kind of provision was found to be unenforceable and, as a result, the subsidiary guarantees in that case were found to be fraudulent conveyances. We do not know if that case will be followed if there is litigation on this point under the indenture for the Notes. However, if it is followed, the risk that the guarantees will be found to be fraudulent conveyances will be significantly increased.

We are owned and controlled by funds advised by Permira, and the funds’ interests as equity holders may conflict with the interests of note holders.

We are indirectly controlled by funds advised by Permira, who have the ability to control our policies and operations. The interests of the funds may not in all cases be aligned with the interests of note holders. For example, if we encounter financial difficulties or are unable to pay our debts as they mature, the interests of our equity holders might conflict with the interests of note holders. In addition, our equity holders may have an interest in pursuing acquisitions, divestitures, financings or other transactions that, in their judgment, could enhance their equity investments, even when those transactions involve risks to holders of the Notes. Furthermore, funds advised by Permira may in the future own businesses that directly or indirectly compete with us. Funds advised by Permira also may pursue acquisition opportunities that may be complementary to our business, and as a result, those acquisition opportunities may not be available to us.

A lowering or withdrawal of the ratings assigned to our debt securities by rating agencies may impair our ability to obtain future borrowings at similar costs and reduce our access to capital.

The Notes currently have a non-investment grade rating. In the future, any ratings agency may lower a given rating, if that rating agency judges that our business, the economic environment or other future circumstances so warrant, and a ratings downgrade would likely materially adversely affect the price of the Notes. A ratings agency may also decide to withdraw its rating of the Notes entirely, which would impede their liquidity and materially adversely affect their price.

 

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During any period in which the Notes are rated investment grade, certain covenants contained in the indenture will not be applicable; however, there is no assurance that the Notes will be rated investment grade.

The indenture governing the Notes provides that certain covenants will not apply to us during any period in which the Notes are rated investment grade from each of Standard & Poor’s and Moody’s and no default has otherwise occurred and is continuing under the indenture. The covenants that would be suspended include, among others, limitations on our restricted subsidiaries’ ability to pay dividends, incur indebtedness, sell certain assets and enter into certain other transactions. Any actions that we take while these covenants are not in force will be permitted even if the Notes are subsequently downgraded below investment grade and such covenants are subsequently reinstated. Investors should be aware that the notes may never become rated investment grade and we do not expect the notes to become investment grade. If they do become rated investment grade, the notes may not maintain those ratings.

The Notes are only guaranteed by entities that also guarantee our Second Amended Credit Facility. Therefore, certain current and future subsidiaries of the Company that are considered controlled foreign corporations and certain other subsidiaries that are not required to guarantee the Second Amended Credit Facility will not provide guarantees of the Second Amended Credit Facility and will not guarantee the Notes.

Certain current and future U.S. and non-U.S. indirect subsidiaries of the Company are considered to be controlled foreign corporations. These subsidiaries will not provide guarantees of the Second Amended Credit Facility and, therefore, will not provide guarantees of the Notes. Furthermore, certain other subsidiaries of the Company will not be required to provide guarantees of the Second Amended Credit Facility and, unless they guarantee other indebtedness of ours or the guarantors, will not guarantee the Notes.

A substantial portion of our assets are owned, and a substantial portion of our revenue is generated, by guarantors organized outside the United States. Foreign laws applicable to such guarantors might not be as favorable to note holders as analogous United States federal and state laws.

A substantial portion of our assets are owned by non-U.S. guarantors. As a result of their jurisdiction of organization, laws other than United States federal and state law may apply to such entities in connection with, among other things, their liquidation or dissolution and the validity and enforceability of their guarantees of the Notes. We can give no assurance of which jurisdiction’s insolvency law will be applied in the event of the bankruptcy or insolvency of a foreign guarantor of the Notes. The procedural and substantive provisions of foreign insolvency laws are different from and, in certain jurisdictions, may be less favorable to holders of the Notes than comparable provisions of U.S. insolvency law. Further, pursuant to foreign insolvency law, a foreign guarantor’s liability under its guarantee may rank junior to certain debts entitled to priority under applicable law, which would not be entitled to a similar priority under U.S. insolvency law. Such debts could include, among others, amounts owed to foreign governments, amounts owed to employees such as wages, salary and holiday remuneration, amounts owed in respect of pension scheme contributions, social security contributions or contracts of insurance, and payments pursuant to applicable workmen’s compensation laws. As a result, there can be no assurance that, in the event of a liquidation or insolvency of a foreign guarantor of the Notes, note holders will be able to realize upon the guarantee of such foreign guarantor to the same extent as if such foreign guarantor was organized under the laws of a U.S. jurisdiction. The laws of such foreign jurisdictions might also be applied to hold the guarantee of a foreign guarantor void and unenforceable in connection with a liquidation or otherwise. Such foreign laws may also be used to hold a payment made under a guarantee to be void and refundable. Accordingly, the guarantee of a foreign guarantor could be held void and unenforceable under applicable foreign law in a situation in which, if foreign law did not apply, the same guarantee would be enforceable under applicable U.S. federal and state law. The guarantees of the foreign guarantors may also be held void under certain foreign laws if it is determined that the company issuing the guarantee does not receive sufficient commercial benefit for doing so. If there is insufficient commercial benefit, the beneficiary of the guarantee may not be able to rely on the authority of the directors of that company to grant the guarantee, and accordingly a court may set aside the guarantee at the request of, among others, the company’s shareholders or a liquidator. Although we believe that the guarantee of each foreign guarantor is enforceable and that each guarantor has received sufficient commercial benefit from issuing its guarantee, we cannot assure you that a foreign court would agree with our conclusion and not hold such guarantee to be void under applicable foreign law.

The Issuer is a holding company, and its ability to make any required payment on the Notes is dependent on the operations of, and the distribution of funds from, its and Parent’s subsidiaries.

The Issuer’s and Parent’s subsidiaries conduct substantially all of our operations and own all of our operating assets. Therefore, the Issuer depends on dividends and other distributions from its and Parent’s subsidiaries to generate the funds necessary to meet its obligations, including its required obligations under the Notes. Moreover, each of our subsidiaries is a legally distinct entity and, other than those of our subsidiaries that are guarantors of the Notes, have no obligation to pay amounts due pursuant to the Notes or to make any of their funds or other assets available for these payments. Although the indenture governing the Notes limits the ability of the restricted subsidiaries to enter into consensual restrictions on their ability to pay dividends and make other payments, these limitations have a number of significant qualifications and exceptions, including provisions contained in the indenture governing the Notes and the Second Amended Credit Facility that restrict the ability of the restricted subsidiaries to make dividends and distributions or otherwise transfer any of their assets to the Issuer.

 

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The Notes may trade at a discount from par.

The Notes may trade at a discount from their initial offering price due to a number of potential factors, including not only our financial condition, performance and prospects, but also many that are not directly related to us, such as a lack of liquidity in trading of the Notes, prevailing interest rates, the market for similar securities, general economic conditions and prospects for companies in our industry generally. In addition, the liquidity of the trading market in the Notes and the market prices quoted for the Notes may be materially adversely affected by changes in the overall market for high-yield securities.

Risks Related to Intellectual Property

If our intellectual property and technologies are not adequately protected to prevent use or appropriation by our competitors, the value of our brand and other intangible assets may be diminished, and our business may be materially affected.

Our future success and competitive position depend in part on our ability to protect our proprietary technologies and intellectual property. We rely and expect to continue to rely on a combination of confidentiality and license agreements with our employees, consultants and third parties with whom we have relationships, as well as on the protections afforded by trademark, copyright, patent and trade secret law, to protect our proprietary technologies and intellectual property. Because certain of our trademarks contain words or terms that have a common usage, we may have difficulty registering them in certain jurisdictions. Although we possess intellectual property rights in some aspects of our digital content, search technology, software products and digitization and indexing processes, our digital content is not protected by any registered copyrights or other registered intellectual property or statutory rights. Rather, our digital content is protected by user agreements that limit access to and use of our data, as well as by certain proprietary and non-proprietary technology and software. However, compliance with the use restrictions is difficult to monitor, and any technology or software that we deploy to protect our digital content may prove to be inadequate for such purpose. In addition, our proprietary rights in our digital content databases may be more difficult to enforce than other forms of intellectual property rights.

There can be no assurance that the steps we take will be adequate to protect our technologies and intellectual property, that our patent and trademark applications will lead to issued patents and registered trademarks in all instances, that others will not develop or patent similar or superior technologies, products or services, or that our patents, trademarks and other intellectual property will not be challenged, invalidated or circumvented by others. Furthermore, the intellectual property laws of other countries at which our websites are or may in the future be directed, may not protect our products and intellectual property rights to the same extent as the laws of the United States. The legal standards relating to the validity, enforceability and scope of protection of intellectual property rights in Internet-related industries are uncertain and still evolving, both in the United States and in other countries. In addition, third parties may knowingly or unknowingly infringe our patents, trademarks and other intellectual property rights, and litigation may be necessary to protect and enforce our intellectual property rights. Any such litigation could be very costly and could divert management attention and resources. If the protection of our technologies and intellectual property is inadequate to prevent use or appropriation by third parties, the value of our brand and other intangible assets may be diminished and competitors may be able to more effectively mimic our subscription services and methods of operations. Any of these events would have a material adverse effect on our business, financial condition and results of operations.

We also expect that the more successful we are, the more likely it will become that competitors will try to develop products that are similar to ours, which may infringe on our proprietary rights. It may also be more likely that competitors will claim that our products and services infringe on their proprietary rights. If we are unable to protect our proprietary rights or if third parties independently develop or gain access to our or similar technologies, our business, revenues, reputation and competitive position could be harmed.

Confidentiality agreements with employees and others may not adequately prevent disclosure of trade secrets and other proprietary information. Failure to protect our proprietary information could make it easier for third parties to compete with our products and harm our business.

A substantial amount of our tools and technologies are protected by trade secret laws. In order to protect our proprietary technologies and processes, we rely in part on security measures, as well as confidentiality agreements with our employees, licensees, independent contractors and other advisors. These measures and agreements may not effectively prevent disclosure of confidential information, including trade secrets, and may not provide an adequate remedy in the event of unauthorized disclosure of confidential information. We could lose future trade secret protection if any unauthorized disclosure of such information occurs. In addition, others may independently discover our trade secrets and proprietary information, and in such cases, we could not assert any trade secret rights against such parties. Laws regarding trade secret rights in certain markets in which we operate may afford little or no protection to our trade secrets. The loss of trade secret protection could make it easier for third parties to compete with our products by copying functionality. In addition, any changes in or unexpected interpretations of the trade secret and other intellectual property laws in any country in which we operate may compromise our ability to enforce our trade secret and intellectual property rights. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could materially affect our business, revenues, reputation and competitive position.

 

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Intellectual property claims against us could be costly and result in the loss of significant rights related to, among other things, our websites, content indexes, and marketing and advertising activities.

Trademark, copyright, patent and other intellectual property rights are important to us and other companies. Our intellectual property rights extend to our technologies, business processes and the content on our websites. We use intellectual property licensed from third parties in merchandising our products and marketing and advertising our services. From time to time, third parties may allege that we have violated their intellectual property rights. If there is a valid claim against us for infringement, misappropriation, misuse or other violation of third-party intellectual property rights, and we are unable to obtain sufficient rights or develop non-infringing intellectual property or otherwise alter our business practices on a timely basis, our business and competitive position may be adversely affected. Many companies are devoting significant resources to obtaining patents that could affect many aspects of our business. There are numerous patents that broadly claim means and methods of conducting business on the Internet. We have not exhaustively searched patents relevant to our technologies and business. If we are forced to defend ourselves against intellectual property infringement claims, whether they are with or without merit or are determined in our favor, we may face costly litigation, diversion of technical and management personnel, limitations on our ability to use our current websites or inability to market or provide our products or services. As a result of any such dispute, we may have to develop non-infringing technology, pay damages, enter into royalty or licensing agreements, cease providing certain products or services, adjust our merchandizing or marketing and advertising activities or take other actions to resolve the claims. These actions, if required, may be costly or unavailable on terms acceptable to us. In addition, many of our co-branding, distribution and other partnering agreements require us to indemnify our partners for third-party intellectual property infringement claims, which could increase the cost to us of an adverse ruling in such an action.

In addition, as a publisher of online content, we face potential liability for negligence, copyright, patent or trademark infringement or other claims based on the nature and content of data and materials that we publish or distribute. These claims could arise with respect to both institutional and user-generated content. Litigation to defend these claims could be costly and any other liabilities we incur in connection with the claims may have a material adverse effect on our business, financial condition and results of operations.

If we are unable to protect our domain names, our reputation and brand could be affected adversely, which may negatively impact our ability to compete.

We have registered domain names for website destinations that we use in our business, such as Ancestry.com, Ancestry.co.uk, Archives.com and Fold3.com. However, if we are unable to maintain our rights in these domain names, our competitors could capitalize on our brand recognition by using these domain names for their own benefit. In addition, our competitors could capitalize on our brand recognition by using domain names similar to ours. Domain names similar to ours have been registered in the United States and elsewhere, and in many countries the top-level domain names “ancestry,” “archives” or “genealogy” are owned by other parties. Although we own the “ancestry.co.uk” domain name in the United Kingdom, we might not be able to, or may choose not to, acquire or maintain other country-specific versions of the “ancestry,” “archives” and “genealogy” domain names. Further, the relationship between regulations governing domain names and laws protecting trademarks and similar proprietary rights varies from jurisdiction to jurisdiction and is unclear in some jurisdictions. We may be unable to prevent third parties from acquiring and using domain names that infringe on, are similar to, or otherwise decrease the value of, our brand or our trademarks or service marks. Protecting and enforcing our rights in our domain names and determining the rights of others may require litigation, which could result in substantial costs and divert management attention. We may not prevail if any such litigation is initiated.

 

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Item 6. Exhibits

 

Exhibit Number		Exhibit Description
10.1†		Third Amended and Restated Ancelux Topco S.C.A. Equity Incentive Plan (filed as Exhibit 10.1 to the Quarterly Report on Form 10-Q filed on May 7, 2014).
31.1		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 *		Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS **		XBRL Instance Document
101.SCH **		XBRL Taxonomy Extension Schema Document
101.CAL **		XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF **		XBRL Taxonomy Extension Definition Linkbase Document
101.LAB **		XBRL Taxonomy Extension Label Linkbase Document
101.PRE **		XBRL Taxonomy Extension Presentation Linkbase Document

 

*	These certifications are not deemed filed with the Securities and Exchange Commission and are not to be incorporated by reference in any filing we make under the Securities Act of 1933 or the Securities Exchange Act of 1934, irrespective of any general incorporation language in any filings.

**

In accordance with Rule 406T of Regulation S-T, these XBRL (eXtensible Business Reporting Language) documents are furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability under these sections.

†	Indicates a management contract or compensatory plan.

 

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Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

				Ancestry.com LLC
Dated: August 4, 2014				By:		/s/ Timothy Sullivan
						Timothy Sullivan
						President and Chief Executive Officer
Dated: August 4, 2014				By:		/s/ Howard Hochhauser
						Howard Hochhauser
						Chief Financial Officer

 

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EXHIBIT INDEX

 

Exhibit Number		Exhibit Description
10.1†		Third Amended and Restated Ancelux Topco S.C.A. Equity Incentive Plan (filed as Exhibit 10.1 to the Quarterly Report on Form 10-Q filed on May 7, 2014).
31.1		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 *		Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS **		XBRL Instance Document
101.SCH **		XBRL Taxonomy Extension Schema Document
101.CAL **		XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF **		XBRL Taxonomy Extension Definition Linkbase Document
101.LAB **		XBRL Taxonomy Extension Label Linkbase Document
101.PRE **		XBRL Taxonomy Extension Presentation Linkbase Document

 

*	These certifications are not deemed filed with the Securities and Exchange Commission and are not to be incorporated by reference in any filing we make under the Securities Act of 1933 or the Securities Exchange Act of 1934, irrespective of any general incorporation language in any filings.

**

In accordance with Rule 406T of Regulation S-T, these XBRL (eXtensible Business Reporting Language) documents are furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability under these sections.

†	Indicates a management contract or compensatory plan.

 

55