Overview

Salon is an online news and social networking company and an Internet publishing pioneer. Salon's award-winning journalism combines original investigative stories and provocative personal essays along with quick-take commentary and staff-written Weblogs about politics, technology, culture and entertainment. Committed to interactivity, the Website also hosts two online communities, Table Talk and The Well, and is developing Open Salon, a social network for bloggers. In its editorial product Salon balances two crucial missions: (1) providing original and provocative content on topics that the mainstream media overlook, and (2) filtering through the media chatter and clutter to help readers find the stories that matter.

Sources of Revenue

The most significant portion of Salon's revenues is derived from advertising from the sale of promotional space on its Website. The sale of promotional space is generally less than ninety days in duration. Advertising units sold include "rich media" streaming advertisements, as well as traditional banner and pop-up advertisements.

Salon also derives a significant portion of its revenues from its Salon Premium subscription program. Prior to March 2007, subscriptions to Salon Premium were generally $35 for one year with no ads, and during March 2007, the rate was increased to $45. Salon Premium revenue is recognized ratably over the period that services are provided. This source of revenue has been decreasing since Salon's quarter ended December 31, 2004 when paid subscriptions peaked at approximately 89,100 and decreased to approximately 33,900 as of March 31, 2008. Salon expects this downward trend to continue, as it is placing greater emphasis on its advertising sales to generate revenue. Revenue from the on-line discussion forum The Well has been recognized ratably over the subscription period. Salon also generates nominal revenue from the licensing of content that previously appeared in Salon's Website and for hosting links to a third party's personals/dating Website.

Production and content expenses consist primarily of salaries and related expenses for Salon's editorial, artistic, and production staff, online communities' staff, payments to freelance writers and artists, bandwidth costs associated with serving pages and hosting our online communities on our Website, credit card transaction costs and ad serving costs.

Sales and marketing expenses consist primarily of salaries, commissions and related personnel costs, travel, and other costs associated with Salon's sales force, business development efforts and its subscription service. It also includes advertising, promotions and the amortization of prepaid advertising rights.

Information technology support expenses consist primarily of salaries and related personnel costs associated with the development, testing and enhancement of Salon's software to manage its Website, and to maintain and enhance the software utilized in managing Salon Premium, as well as supporting marketing and sales efforts.

General and administrative expenses consist primarily of salaries and related personnel costs, accounting and legal fees, and other fees associated with operating a publicly traded company. Certain shared overhead expenses are allocated to other departments.

On April 1, 2006 Salon adopted the provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, or SFAS 123R, which requires companies to expense their stock option awards. Salon adopted SFAS 123R using the modified prospective transition method and therefore did not restate results for prior periods. Salon's expenses include stock-based expenses related to stock option grants to employees, non-employee Directors and consultants.

Salon has incurred significant net losses and negative cash flows from operations since its inception. As of March 31, 2008, Salon had an accumulated deficit of $96.3 million. These losses have been funded primarily through the issuance of common stock from Salon's initial public offering in June 1999, issuances of preferred stock, bank debt and from the issuance of convertible notes payable.

Burr, Pilger & Mayer LLP, Salon's independent accountants for the years ended March 31, 2008, March 31, 2007 and March 31, 2006 have included a paragraph in their report indicating that substantial doubt exists as to Salon's ability to continue as a going concern because of Salon's recurring operating losses, negative cash flow and accumulated deficit.

Salon has not recorded a provision for federal or state income taxes since inception due to recurring operating losses. At March 31, 2008 Salon had net operating loss carryforwards of $69.1 million for federal income tax purposes that begin to expire in March 2016, and $32.8 million for California income tax purposes. As Salon has been incurring tax losses, $3.3 million of California net operation loss carryforwards expired as of March 31, 2008, and if Salon were to incur a tax loss for the year ending March 31, 2009, an additional $2.3 million operating loss carryforward will expire. Utilization of Salon's net operating loss carryforwards may be subject to a substantial annual limitation due to ownership change limitations provided by the Internal Revenue Code and similar California State provisions. Such an annual limitation could result in the expiration of the net operating loss carryforwards before utilization. A valuation allowance has been established and, accordingly, no benefit has been recognized for such operating losses and other deferred tax assets. The net valuation allowance increased $1.0 million during the year ended March 31, 2008 to $26.5 million. Salon believes that, based on a number of factors, the availability of objective evidence creates sufficient uncertainty regarding the realization of the deferred tax assets such that a full valuation allowance has been recorded. These factors include Salon's history of net losses since inception and expected near-term future losses.

The preparation of financial statements in conformity with generally accepted accounting principles requires Salon to utilize accounting policies and make estimates and assumptions that affect our reported amounts. Salon's significant accounting policies are described in Note 2 to the Consolidated Financial Statements. Salon believes accounting policies and estimates related to revenue recognition and prepaid advertising rights are the most critical to Salon's financial statements. Future results may differ from current estimates if different assumptions or conditions were to prevail.

Revenue Recognition

Salon recognizes revenues once persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collectibility is reasonably assured. Revenues are recognized ratably in the period over which Salon's obligations are fulfilled. Payments received before Salon's obligations are fulfilled are classified as "Deferred revenue" in Salon's consolidated balance sheet.

Advertising revenues, derived from the sale of promotional space on its Website, comprised 72%, 70% and 57% of Salon's revenues, respectively for the years ended March 31, 2008, 2007 and 2006. The duration of the advertisements are generally short term, usually less than ninety days. Revenues derived from such arrangements are recognized during the period the advertising space is provided. Salon's obligations typically include a guaranteed minimum number of impressions, a set number of Site Pass advertisements viewed, or a set number of days that a Site Pass advertisement will run. To the extent minimum guaranteed amounts are not achieved, Salon defers recognition of the corresponding revenue until the remaining guaranteed amounts are provided, if mutually agreeable to an advertiser. If these "make good" impressions are not agreeable to an advertiser, no further revenue is recognized.

Salon Premium, a pay-for-online content service, provides unrestricted access to Salon's content with no banners, pop-ups or site pass advertisements, and includes free magazine subscriptions, free access to Table Talk, an on-line forum, and the ability to easily download content in text or PDF format, a convenience that enables readers to view Salon's content when not connected to the Internet. The subscription duration for Salon Premium is generally one year. Non Salon Premium subscribers can gain access to Salon's content after viewing some form of advertisement.

Salon offers The Well as a monthly subscription service for access to on-line discussion forums. Revenue is recognized ratably over the subscription period.

Prepaid Advertising Rights

In January 2000, Salon sold 1,125,000 shares of common stock to Rainbow Media Holdings ("Rainbow") and received $11.8 million of advertising credits that were to be utilized by December 2009. As the per share price of Salon's common stock declined from the time the agreement was made and the date the agreement was finalized and signed, the advertising credits were valued for financial reporting purposes at $8.1 million. As of March 31, 2008, Salon has $3.1 million advertising credits resulting from the transaction, valued at $2.1 million for financial reporting purposes. Of the $3.1 million of advertising credits, approximately $1.8 million remain with Rainbow and approximately $1.3 million are with NBC. Salon believes that it should be able to utilize all the credits with Rainbow and NBC before they expire on December 31, 2009. Salon is currently exploring ways of fully utilizing the credits, including supporting the launch of Open Salon, before they expire. Salon expects to recover the full value of all the advertising credits through usage or settlement in cash, per the terms of the agreement, but there can be no absolute assurance as to any potential cash settlement or full utilization thereof.

Certain reclassifications, not affecting previously reported net income or loss, have been made to the previously issued consolidated financial statements to conform to the current period presentation.

Goodwill

Salon has $0.2 million of goodwill remaining from a purchase in March 1999. This asset is tested for impairment at least annually and has been found not to be impaired.

Results of Operations

Fiscal Years Ended March 31, 2008 and 2007

Net Revenues

Salon's net revenue decreased 3% to $7.5 million in the year ended March 31, 2008 from $7.7 million in the year ended March 31, 2007.

Advertising revenues remained flat from one year ago at $5.4 million for the year ended March 31, 2008, as sales trailed off in the fourth quarter, despite record audiences, due to sales force turnover.

Salon Premium subscription revenues decreased by 14% to $1.3 million for the year ended March 31, 2008 from $1.5 million for the year ended March 31, 2007. The drop in Salon Premium revenues recognized for the year ended March 31, 2008 compared to the year ended March 31, 2007 is attributable to a substantial reduction in the number of new subscribers. Salon acquired approximately 27,900 paid one-year subscriptions for the year ended March 31, 2008 compared to approximately 44,200 for the year ended March 31, 2007. As a result, the number of paid subscribers decreased from approximately 47,200 at March 31, 2007 to approximately 33,900 at March 31, 2008. As of June 1, 2008, Salon had approximately 32,000 paid subscribers.

An important factor in increasing advertising revenues in future periods, including Salon's peak third quarter ending December 31, is attracting more unique visitors to Salon's Website. Attracting more unique Website visitors is important to Salon as they generate page views, and each page view becomes a potential platform for serving advertisements. Ultimately, Salon charges advertisers based on a set number of impressions viewed by a Website visitor. Due to various factors, including concerted efforts to make Salon's content more accessible to readers by auto launching the site pass, a better optimized Website to facilitate appearance in search engine results, and marketing campaigns with select Websites, the average number of unique monthly Website visitors for the year ended March 31, 2008 increased 33% to 4.4 million from the year ended March 31, 2007, and attained a record high of 6.5 million in March 2008. Aiding the continued growth in unique visitors to Salon's Website is the migration of readers to the Internet from print newspapers.

Salon has evaluated the balance between its subscription and advertising businesses and has shifted emphasis toward advertising. Until recently, a Website visitor was given a choice of: (1) becoming a Salon Premium subscriber to avoid having to view advertisements on Salon's Website or (2) viewing an advertisement to gain access to all of Salon's content. This strategy was found to impede access to Salon's Website and its ability to generate advertising impressions. During the quarter ended December 31, 2006, Salon changed its Site Pass model to automatically serve advertisements, enabling a Website visitor to gain a more seamless access to Salon's content. This change has produced an increase in the number of ad impressions that Salon can serve and improved Salon's potential to generate an even greater amount of advertising revenues, offsetting a drop in Salon Premium subscriptions that traditionally were solicited from the Site Pass and the relatively small revenue they generate.

Production and Content

Production and content expenses during the year ended March 31, 2008 were $5.5 million versus $5.2 million for the year ended March 31, 2007, an increase of $0.3 million. The 6% increase primarily reflects an increase in staff and benefit costs.

Sales and Marketing Expenses

Sales and marketing expenses during the year ended March 31, 2008 were $2.8 million versus $2.0 million for the year ended March 31, 2007, an increase of $0.8 million. The 40% increase primarily reflects utilizing an additional $0.7 million advertising credits this year compared to last year.

Information Technology Support Expenses

Information technology support expenses during the year ended March 31, 2008 remained flat from one year ago at $0.8 million. The 29% increase in salary costs was offset by capitalized development costs for the Open Salon project.

General and Administrative Expenses

General and administrative expenses during the year ended March 31, 2008 were $1.8 million versus $1.3 million for the year ended March 31, 2007, an increase of $0.5 million. The 38% increase is primarily attributable to increased staff salaries, stock-based compensation expenses, professional fees, severance costs and directors fees.

Preferred Deemed Dividend

Salon sold 292 shares of Series D-5 preferred stock on November 19, 2007. All the shares sold are convertible to common stock at an effective price less than the fair market value of Salon's common stock on the commitment date of the respective transaction. Salon valued the beneficial conversion feature of these shares of preferred stock at $0.05 million. As the shares of preferred stock sold were immediately convertible, Salon recorded a total of $0.05 million non-cash preferred deemed dividend for the year ended March 31, 2008, representing the value of the beneficial conversion feature of the shares issued.

During the year ended March 31, 2007, Salon sold 208 shares of Series D-3 preferred stock and 42 shares of Series D-4 preferred stock on July 27, 2006, 333 shares of Series D-4 preferred on September 21, 2006, and 42 shares of Series D-4 preferred stock and 125 shares of Series D-5 preferred stock on December 18, 2006 that were convertible to common stock at an effective price less than the fair market value of Salon's common stock on the commitment date. Salon valued the beneficial conversion feature of the preferred stock sold at $0.3 million. As the shares of preferred stock were immediately convertible, for its year ended March 31, 2007, Salon recorded a $0.3 million non-cash preferred deemed dividend, representing the value of the beneficial conversion feature of the shares issued.

Net Revenues

Salon's net revenue increased 19% to $7.7 million in the year ended March 31, 2007 from $6.5 million in the year ended March 31, 2006.

Advertising revenues increased 47% to $5.4 million for the year ended March 31, 2007 from $3.7 million for the year ended March 31, 2006. The increase in advertising sales reflects an industry wide trend of corporations earmarking more funds for Internet advertising.

Salon Premium subscription revenues decreased by 24% to $1.5 million for the year ended March 31, 2007 from $2.0 million for the year ended March 31, 2006. The drop in Salon Premium revenues recognized for the year ended March 31, 2007 compared to the year ended March 31, 2006 is attributable to a substantial reduction in the number of new subscribers. Salon acquired approximately 44,200 paid one-year subscriptions for the year ended March 31, 2007 compared to approximately 58,700 for the year ended March 31, 2006. As a result, the number of paid subscribers decreased from approximately 65,500 at March 31, 2006 to approximately 47,200 at March 31, 2007. As of June 1, 2007, Salon had approximately 44,900 paid subscribers.

An important factor in increasing advertising revenues in future periods, including Salon's peak third quarter ending December 31, is attracting more unique visitors to Salon's Website. Attracting more unique Website visitors is important to Salon as they generate page views, and each page view becomes a potential platform for serving advertisements. Ultimately, Salon charges advertisers based on a set number of impressions viewed by a Website visitor. Due to various factors, including concerted efforts to make Salon's content more accessible to readers by auto launching the site pass, a better optimized Website to facilitate appearance in search engine results, and marketing campaigns with select Websites, the average number of unique monthly Website visitors for the year ended March 31, 2007 increased 43% to 3.3 million from the year ended March 31, 2006, and attained a record high of 4.4 million in March 2007. Aiding the continued growth in unique visitors to Salon's Website is the migration of readers to the Internet from print newspapers.

Salon has evaluated the balance between its subscription and advertising businesses and has shifted emphasis toward advertising. Until recently, a Website visitor was given a choice of: (1) becoming a Salon Premium subscriber to avoid having to view advertisements on Salon's Website or (2) viewing an advertisement to gain access to all of Salon's content. This strategy was found to impede access to Salon's Website and its ability to generate advertising impressions. During the quarter ended December 31, 2006, Salon changed its Site Pass model to automatically serve advertisements, enabling a Website visitor to gain a more seamless access to Salon's content. This change has produced an increase in the number of ad impressions that Salon can serve and improved Salon's potential to generate an even greater amount of advertising revenues, offsetting a drop in Salon Premium subscriptions that traditionally were solicited from the Site Pass and the relatively small revenue they generate.

All other sources of revenue were $0.8 million each for the years ended March 31, 2007 and March 31, 2006. Approximately half of this revenue was derived from the Well, an online discussion forum.

Production and content expenses during the year ended March 31, 2007 were $5.2 million versus $4.5 million for the year ended March 31, 2006, an increase of $0.7 million. The 16% increase primarily reflects an increase in staff and benefit costs.

Sales and Marketing Expenses

Sales and marketing expenses during the year ended March 31, 2007 were $2.0 million versus $1.5 million for the year ended March 31, 2006, an increase of $0.5 million. The 31% increase primarily reflects utilizing an additional $0.2 million advertising credits this year compared to last year and a $0.2 million increase in commission expenses.

Information Technology Support Expenses

Information technology support expenses during the year ended March 31, 2007 were $0.8 million versus $0.7 million for the year ended March 31, 2006, an increase of $0.1 million. The 22% increase primarily reflects the temporary retention of contractors to augment Salon's salaried staff.

General and Administrative Expenses

General and administrative expenses during the year ended March 31, 2007 were $1.3 million versus $1.0 million for the year ended March 31, 2006, an increase of $0.3 million. The 33% increase is primarily attributable to hiring a Publisher in June 2006 with no comparable position in the prior year period and a raise awarded an officer in October 2005.

Preferred Deemed Dividend

Salon sold 208 shares of Series D-3 preferred stock and 42 shares of Series D-4 preferred stock on July 27, 2006, 333 shares of Series D-4 preferred on September 21, 2006, and 42 shares of Series D-4 preferred stock and 125 shares of Series D-5 preferred stock on December 18, 2006. All the shares sold are convertible to common stock at an effective price less than the fair market value of Salon's common stock on the commitment date of the respective transaction. Salon valued the beneficial conversion feature of these shares of preferred stock at $0.3 million. As the shares of preferred stock sold were immediately convertible, Salon recorded a total of $0.3 million non-cash preferred deemed dividend for the year ended March 31, 2007, representing the value of the beneficial conversion feature of the shares issued.

During the year ended March 31, 2006, Salon sold 209 shares of Series D-3 preferred stock that were convertible to common stock at an effective price less than the fair market value of Salon's common stock on the commitment date. Salon valued the beneficial conversion feature of the preferred stock sold at $0.2 million. As the shares of preferred stock were immediately convertible, for its year ended March 31, 2006, Salon recorded a $0.2 million non-cash preferred deemed dividend, representing the value of the beneficial conversion feature of the shares issued.

Liquidity and Capital Resources

Net cash used in operations was $1.5 million for the year ended March 31, 2008, $1.2 million for the year ended March 31, 2007, and $0.6 million for the year ended March 31, 2006. The principal use of cash during the year ended March 31, 2008 was to meet its operating deficit. The principal use of cash during the year ended March 31, 2007 was to fund the $1.6 million net loss and reflects accounts receivable increasing by $0.5 million, less $0.8 million of non-cash charges. The principal use of cash during the year ended March 31, 2006 was to fund the $1.1 million net loss, less $0.5 million of non-cash charges, and a $0.2 million decrease in deferred revenue, all offset by a reduction of $0.2 million of accounts receivable, prepaid expenses and other current assets and other assets.

For the year ended March 31, 2008, net cash provided from financing activities was $1.9 million, which included $1.0 million in short term borrowings, $0.5 million in long term borrowing and $0.4 million from the issuance of 292 shares of preferred stock. For the year ended March 31, 2007, net cash provided from financing activities was $1.7 million, which included $0.8 million from the exercise of warrants and $0.9 million from the issuance of 750 shares of preferred stock. For the year ended March 31, 2006, net cash provided from financing activities was $0.4 million from the issuance of Series D preferred stock, and the exercise of common stock options and warrants.

Salon, as permitted under Delaware law and in accordance with its Bylaws, indemnifies its officers and directors for certain events or occurrences, subject to certain limits, while the officer is or was serving at Salon's request in such capacity. The term of the indemnification period is for the officer's, or director's lifetime. The maximum amount of potential future indemnification is unlimited; however, Salon does have a Director and Officer Insurance Policy that limits Salon's exposure and enables Salon to recover a portion of any future amounts paid. As a result of the insurance policy coverage, Salon believes the fair value of these indemnification agreements is minimal.

As of March 31, 2008, Salon has two outstanding capital leases on computer equipment and does not anticipate entering into similar debt instruments during its year ending March 31, 2009. The following summarizes Salon's contractual obligations as of March 31, 2008, and the effect these contractual obligations are expected to have on Salon's liquidity and cash flows in future periods (in thousands):

                                                         Payments Due By Period
                                                                                            More than 3
                                   Total           1 Year or Less        1 - 3 Years           Years
Operating leases               $         340      $            329     $            11     $            -
Capital leases                            81                    25                  56                  -
Capital lease interest                    19                    11                   8                  -
Total                          $         440      $            365     $            75     $            -

Capital requirements

Salon has a history of significant losses and expects to incur a net loss from operations for its year ending March 31, 2009. Because of past losses, an anticipated loss next year and a history of negative cash flows from operations, Salon's independent registered public accounting firm for the years ended March 31, 2008, March 31, 2007 and March 31, 2006 have included a paragraph in its reports indicating substantial doubt as to Salon's ability to continue as a going concern. During the last three years, Salon has relied on cash from bank debt, the issuance of convertible notes and preferred stock and from the exercise of warrants to meet its cash requirements.