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 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. This source of revenue has been decreasing since Salon's quarter ended December 31, 2004 when paid subscriptions peaked at approximately 89,100 and have since decreased to approximately 8,100 as of March 31, 2012. Salon expects this downward trend to continue, as it is placing greater emphasis on its advertising sales to generate revenue. In June 2012, Salon refocused its strategy on its core Salon.com website, and made the decision to restructure and eliminate certain non core initiatives. As a result, Salon laid-off Well staff associated with its online discussion forum, The Well and began to look for a buyer for the property and stopped accepting renewals and new subcriptions for its premium subscription business.

Revenue from membership to 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, for hosting links to a third party's personals/dating Websites, and operating its emerging e-commerce activities.

Operating Expenses

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.

Critical Accounting Policies

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 accounting for debt and equity are the most critical to Salon's financial statements. Future results may differ from current estimates if different assumptions or conditions were to prevail.

Stock Based Compensation

Salon recognizes the fair value of stock awards on a straight-line basis over the requisite service period of the award, which is the standard vesting term of four years.

Salon recognized stock-based compensation expense of $311,000 and $295,000 during the years ended March 31, 2012 and 2011, respectively. As of March 31, 2012, Salon had an aggregate of $145,000 of stock-based compensation remaining to be amortized to expense over the remaining requisite service period of the underlying awards. Salon currently expects this stock-based compensation balance to be amortized as follows: $103,000 during fiscal 2013; $27,000 during fiscal 2014; $10,000 during fiscal 2015 and $5,000 during fiscal 2016. The expected amortization reflects only outstanding stock option awards as of March 31, 2012. Salon expects to continue to issue stock-based awards to its employees in future periods.

The full impact of stock-based compensation in the future is dependent upon, among other things, the timing of when Salon hires additional employees, the effect of new long-term incentive strategies involving stock-based awards in order to continue to attract and retain employees, the total number of stock-based awards granted, the fair value of the stock awards at the time of grant and the tax benefit that Salon may or may not receive from stock-based expenses. Additionally, stock-based compensation requires the use of an option-pricing model to determine the fair value of stock option awards. This determination of fair value is affected by Salon's stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, Salon's expected stock price volatility over the term of the awards.

Liquidity

Salon has incurred significant net losses and negative cash flows from operations since its inception. As of March 31, 2012, Salon had an accumulated deficit of $112.5 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, from the issuance of convertible notes payable and other advances from related parties.

Burr Pilger Mayer, Inc., Salon's independent registered public accounting firm for the years ended March 31, 2012, March 31, 2011 and March 31, 2010 has 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.

Income Taxes

Salon has not recorded a provision for federal or state income taxes since inception due to recurring operating losses. At March 31, 2012, Salon had net operating loss carryforwards of $81.5 million for federal income tax purposes that begin to expire in March 2016, and $22.0 million for California income tax purposes. As Salon has been incurring tax losses, $2.1 million of California net operating loss carryforwards expired as of March 31, 2012, and if Salon were to incur a tax loss for the year ending March 31, 2013, an additional $1.8 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 $0.3 million during the year ended March 31, 2012 to $29.4 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.

Revenue Recognition

Salon recognizes revenues once persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collectability 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 79%, 78%, and 69% of Salon's revenues, respectively for the years ended March 31, 2012, 2011 and 2010. 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 and other promotional items including books and merchandise, free access to Table Talk, an online 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 online discussion forums. Revenue is recognized ratably over the subscription period. The Well's declining subscriber base, and aging technology led to a decision in June 2012 to restructure the service. As a result, The Well staff were laid off and current subscriptions will be honored but not renewed upon expiration. On May 29, 2012, Salon entered an Indication of Intent and Confidentiality Agreement with a company that has expressed interest in acquiring the Well. In addition, discussions with parties interested in potentially buying the domain name have been initiated.

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, 2010, Salon has fully utilized the advertising credits of Rainbow and NBC.

Reclassifications

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 of The Well in March 1999. This asset is tested for impairment at least annually and has not been found to be impaired.

Results of Operations

Fiscal Years Ended March 31, 2012 and 2011

Net Revenues

Salon's net revenue decreased 16% to $3.8 million in the year ended March 31, 2012 from $4.6 million in the year ended March 31, 2011.

Advertising revenues decreased 16% to $3.0 million for the year ended March 31, 2012 from $3.6 million for the year ended March 31, 2011, mainly due to stronger online presence from other competitive companies.

Salon Premium subscription revenues decreased by 25% to $0.4 million for the year ended March 31, 2012 from $0.5 million for the year ended March 31, 2011. The drop in Salon Premium revenues recognized for the year ended March 31, 2012 compared to the year ended March 31, 2011 is attributable to a substantial reduction in the number of new subscribers. Salon acquired approximately 5,900 paid one-year subscriptions for the year ended March 31, 2012 compared to approximately 7,700 for the year ended March 31, 2011. As a result, the number of paid subscribers decreased from approximately 10,900 at March 31, 2011 to approximately 8,100 at March 31, 2012. As a result of this trend, Salon has continued to emphasize increasing advertising income over promoting Premium subscriptions.

An important factor in increasing advertising revenues in future periods, including Salon's typically 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 Website visitors. 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 increasing the quantity of content, the average number of unique monthly Website grew by 18% for the full year, to approximately 6.4 million. Aiding the continued growth in unique visitors to Salon's Website is the migration of readers to the Internet from print newspapers.

All other sources of revenue were $0.5 million for each of the years ended March 31, 2012 and March 31, 2011. Approximately 76% of this revenue was derived from subscriptions to the Well, an online discussion forum.

Production and Content Expenses

Production and content expenses during the year ended March 31, 2012 were $3.5 million versus $3.2 million for the year ended March 31, 2011, an increase of $0.3 million. The 9% increase primarily reflects costs for launching the new Salon Studio platform which features original video, music and art contents.

Sales and Marketing Expenses

Sales and marketing expenses during the year ended March 31, 2012 remained flat from one year ago at approximately $1.5 million.

Information Technology Support Expenses

Information technology support expenses during the year ended March 31, 2012 were $1.0 million, an increase of $0.1 million. The 7% increase is primarily attributed to higher consulting fees, increased wages and recruiting fees and the additional costs of software.

General and Administrative Expenses

General and administrative expenses during the year ended March 31, 2012 were $1.6 million versus $1.3 million for the year ended March 31, 2011, an increase of $0.3 million. The 22% increase was primarily attributed to sales taxes and higher consulting and legal fees.

Interest Expense

Interest expense during the year ended March 31, 2012 remained flat from one year ago at approximately $0.3 million. The minimal increase was due to higher accrued interest costs for Salon's bank debt, convertible promissory notes and sales taxes.

Fiscal Years Ended March 31, 2011 and 2010

Net Revenues

Salon's net revenue increased 7% to $4.6 million in the year ended March 31, 2011 from $4.3 million in the year ended March 31, 2010.

Advertising revenues increased 21% to $3.6 million for the year ended March 31, 2011 from $3.0 million for the year ended March 31, 2010, due to greater traffic and an improved economy.

Salon Premium subscription revenues decreased by 33% to $0.5 million for the year ended March 31, 2011 from $0.7 million for the year ended March 31, 2010. The drop in Salon Premium revenues recognized for the year ended March 31, 2011 compared to the year ended March 31, 2010 is attributable to a substantial reduction in the number of new subscribers. Salon acquired approximately 7,700 paid one-year subscriptions for the year ended March 31, 2011 compared to approximately 12,000 for the year ended March 31, 2010. As a result, the number of paid subscribers decreased from approximately 15,800 at March 31, 2010 to approximately 10,900 at March 31, 2011. As a result of this trend, Salon has continued to emphasize increasing advertising income over promoting Premium subscriptions.

An important factor in increasing advertising revenues in future periods, including Salon's typically 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 Website visitors. 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 increasing the quantity of content, the average number of unique monthly Website grew by 12% for the full year, to approximately 5.4 million. Aiding the continued growth in unique visitors to Salon's Website is the migration of readers to the Internet from print newspapers.

All other sources of revenue were $0.5 million for the year ended March 31, 2011 and $0.6 million for the year ended March 31, 2010. Approximately 71% of this revenue was derived from subscriptions to the Well, an online discussion forum.

Production and Content Expenses

Production and content expenses during the year ended March 31, 2011 were $3.2 million versus $3.7 million for the year ended March 31, 2010, a decrease of $0.5 million. The 14% decrease primarily reflects a decrease in staff and related salary and benefit costs, as well as a reduction in freelance costs.

Sales and Marketing Expenses

Sales and marketing expenses during the year ended March 31, 2011 were $1.5 million versus $2.7 million for the year ended March 31, 2010, a decrease of $1.2 million. The 47% decrease primarily reflects the cessation of utilization of advertising credits in the prior year.

Information Technology Support Expenses

Information technology support expenses during the year ended March 31, 2011 remained flat from one year ago at approximately $0.9 million.

General and Administrative Expenses

General and administrative expenses during the year ended March 31, 2011 were $1.3 million versus $1.6 million for the year ended March 31, 2010, a decrease of $0.3 million. The 17% decrease was primarily attributed to lower stock-based compensation expenses, executive bonuses, consulting fees and bad debt expenses.

Interest Expense

Interest expense for the year ended March 31, 2011 increased slightly to approximately $0.3 million from $0.2 million one year ago, due to higher accrued interest costs for Salon's bank debt, convertible promissory notes and state taxes.

Liquidity and Capital Resources

Net cash used in operations was $3.2 million for the year ended March 31, 2012, $2.0 million for the year ended March 31, 2011 and $2.6 million for the year ended March 31, 2010. The principal use of cash during the years ended March 31, 2012, 2011 and 2010 was to meet the Company's operating deficits.

Net cash used in investing activities was immaterial for each of the years ended March 31, 2012, 2011 and 2010. The approximately $0.1 million net cash used during the year ended March 31, 2012 was to fund the acquisition of computers, video and office equipment for Salon Studio.

For each of the respective years ended March 31, 2012, 2011 and 2010, net cash provided from financing activities was $3.0 million, $2.2 million and $2.5 million, consisting primarily of long-term borrowings from related parties and convertible promissory notes.

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, 2012, Salon has one outstanding capital lease on computer equipment and does not anticipate entering into similar debt instruments during its year ending March 31, 2013. The following summarizes Salon's contractual obligations as of March 31, 2012, 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 5
                          Total        1 Year or less       1 - 3 Years        3 - 5 Years            Years
Operating leases       $     1,045     $           522     $         523     $              -     $           -
Short-term borrowing         1,000               1,000                 -                    -                 -
Short-term borrowing
interest                       182                 182                 -                    -                 -
Related party
advances                     8,105               8,105                 -                    -                 -
Convertible notes
principal                    3,106               3,106                 -                    -                 -
Convertible notes
interest                        92                  92                 -                    -                 -
Total                  $    13,530     $        13,007     $         523     $              -     $           -

Capital requirements

Salon has a history of significant losses and expects to incur a net loss from operations for its year ending March 31, 2013. 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, 2012, March 31, 2011 and March 31, 2010 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 related party advances to meet its cash requirements.

Based on current cash projections for next year, which contemplate a smaller operating loss, positive cash flow generation in the second half of the year, and takes into account $1.5 million in related party advances received subsequent to year end, Salon estimates it will require approximately $1.5 to $2.5 million in additional funding to meet its operating needs. During fiscal 2010, in the face of reduced revenues resulting from the recession's impact on advertising budgets, the Company implemented significant organizational changes that lowered its breakeven level. Additional cost savings achieved in fiscal years 2011 and 2012 have further reduced fixed costs. On May 31, 2012, after a thorough analysis of operations, a total of six staff from The Well, Salon Studio and Core were laid off. Total severance costs are estimated to be $0.2 million. However, if planned revenues are less than expected, then Salon will not meet its operating targets and the projected cash shortfall may be higher. Salon is in discussions with potential investors, including related parties, to obtain additional funding, and has engaged an investment banker to facilitate these efforts. There can be no assurance that the Company will be able to raise additional funds on commercially reasonable terms, if at all.

Off-Balance Sheet Arrangements

Salon has no off-balance sheet arrangements.

Recent Accounting Pronouncements

In September 2009, the Financial Accounting Standards Board (FASB) ratified Accounting Standards Update (ASU) 2009-13 (ASU 2009-13) (previously Emerging Issues Task Force (EITF) Issue No. 08-1, Revenue Arrangements with Multiple Deliverables (EITF 08-1)). ASU 2009-13 superseded EITF 00-21 and addresses criteria for separating the consideration in multiple-element arrangements. ASU 2009-13 requires companies to allocate the overall consideration to each deliverable by using a best estimate of the selling price of individual deliverables in the arrangement in the absence of vendor-specific objective evidence or other third-party evidence of the selling price. The Company adopted this guidance during fiscal year 2012, and it did not have a material impact on the Company's consolidated financial statements.

In September 2011, the FASB issued ASU No. 2011-08 Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment. ASU 2011-08 provides companies with guidance to assess qualitative factors to determine if it is more-likely-than-not that goodwill might be impaired and whether it is necessary to perform the two-step goodwill impairment test required under current accounting standards. These qualitative factors include macroeconomic conditions (such as limitations on accessing capital, developments in equity and credit markets, etc.), industry and market conditions (such as increased competitive environment, change in regulatory environment, change in market for a product, etc.), cost factors (such as increase in cost of labor and materials), overall financial performance, litigation, changes in key personnel, and sustained decrease in share price. For the year ended March 31, 2012, the Company adopted this guidance and did not identify any potential impairment to its goodwill.