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LOCM > SEC Filings for LOCM > Form 10-Q on 9-Nov-2012All Recent SEC Filings

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Form 10-Q for LOCAL CORP


9-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q or certain information included or incorporated by reference in this report, contains or may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical fact, are statements that could be deemed "forward-looking statements" within the meaning of the federal securities laws. These statements relate to our future operations, prospects, potential products, services, developments and business strategies. These statements can, in some cases, be identified by the use of terms such as "may," "will," "should," "could," "would," "expect," "plan," "anticipate," "believe," "estimate," "predict," "project," and "potential" or the negative of such terms or other comparable terminology. In addition, important factors to consider in evaluating such forward-looking statements include changes or developments in social, economic, market, legal or regulatory circumstances, changes in our business or growth strategy or an inability to execute our strategy due to changes in our industry or the economy generally, the emergence of new or growing competitors, the actions or omissions of third parties, including customers, competitors and governmental authorities, and various other factors, including those described or referred to in Item 1A of Part II of this Quarterly Report. Should any one or more of these risks or uncertainties materialize, or the underlying estimates or assumptions prove incorrect, our actual results could differ materially from those expressed in the forward-looking statements and there can be no assurance that the forward-looking statements contained in this report will in fact occur.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the attached condensed consolidated financial statements and related notes thereto, and with the audited consolidated financial statements and related notes thereto as of December 31, 2011, and for the year ended December 31, 2011, included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 15, 2012.

Overview

We are a local media company that specializes in connecting local businesses with online consumers. We reach consumers on our proprietary sites, as well as third-party sites (collectively, "Consumer Properties"), which includes our Owned & Operated web sites such as Local.com and Krillion.com (collectively, "O&O"), as well as our network of over 1,000 third-party U.S. regional media websites (collectively, "Network"). We provide a variety of digital media services to small and medium sized businesses ("SMBs") to enable these customers to reach consumers both on our Consumer Properties as well as on the major search engines (collectively, "Business Solutions") and we also enable third parties to distribute their advertiser listings on our Consumer Properties, for which we generate ad revenues. We generate revenue from performance ad units such as daily deals, pay-per-click, pay-per-call and lead generation, subscription ad units, and CPM ad units, among others.

Our Consumer Properties serve over 30 million consumers each month. We use patented and proprietary search technologies and systems to provide users of our O&O websites and our Network with relevant search results for local businesses, products and services, incorporating daily deals, event information, ratings and reviews, driving directions and more. By distributing this information across our Consumer Properties we are able to reach users that our direct advertisers and advertising partners desire to reach.

Our Business Solutions offer a variety of digital media products. The products are sold primarily via telesales. Our sales efforts focus principally around our Launch by Local product suite, which offers a variety of digital media features including web hosting, search engine optimization services, display ads, mobile ads, and social media presence management. Approximately 900 direct SMB customers are enrolled in our new Launch by Local product. An average Launch by Local subscription generates approximately the same monthly revenue as six legacy customers. Our Business Solutions technologies also power a variety of platform products targeted towards larger businesses such as regional media publishers and ad agencies. Over 6,000 of our direct SMB customers use a legacy web hosting and/or listing solution that will be phased out by the end of 2012.


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We regularly develop and deploy new products and product features based on our powerful technology platform, for which we have 9 issued patents and 11 pending. We have a long-term focus on building three key drivers for our business - traffic, technology and advertisers. Our traffic is at record levels, our technology platform has been dramatically expanded, and we are generating record revenues from our own direct Launch by Local customers. We also recently launched our Local.com mobile device application with the intent to capitalize on an ever expanding mobile device market.

Recent Developments

On March 28, 2012, we entered into the First Amendment to the Loan and Security Agreement with Square One Bank, which amends the Loan and Security Agreement by and between us and Square One Bank dated August 3, 2011 ("Loan Agreement"). The First Amendment to the Loan Agreement modifies the borrowing base eligibility criteria under the Loan Agreement, provides a five (5) day cure period for any liquidity ratio violations before any such violation would be deemed an event of default under the Loan Agreement, and establishes certain Adjusted EBITDA financial covenant, as defined, levels for fiscal 2012 pursuant to the Loan Agreement. On April 11, 2012, we entered into the Second Amendment to Loan Agreement with Square One Bank, which amends the Loan Agreement by and among the Company and Square One Bank dated August 3, 2011. The Second Amendment of the Loan Agreement modifies the maximum allowable borrowings under the non-formula line by increasing the maximum to $5.0 million from $3.0 million under certain circumstances. Additionally, it redefines the liquidity ratio to provide that non-formula borrowings only require a 1.0:1.0 ratio, rather than the 1.25:1.0 ratio. On August 17, 2012, we entered into the Third Amendment of the Loan Agreement to lower the maintenance limits for its depository and operating accounts to 90% and to amend the definition of Adjusted EBITDA to exclude any non-cash expenses, as well as to provide a waiver of a technical violation of the Adjusted EBITDA covenant described in Section 6.7(a) of the Agreement that occurred prior to the definition amendment noted above.

During the second quarter 2012, we decided to sell all assets relating to the Rovion business. The Rovion business, which is considered a usage model, did not align with our intent to become both a local media publisher and local advertising sales and marketing organization. On October 19, 2012, we sold all assets relating to the Rovion business. We licensed the Rovion technology as part of the asset purchase agreement and will continue to use the technology in its Launch by Local product offering.

At June 30, 2012, we performed an impairment valuation of goodwill as it relates to the Spreebird business unit. The evaluation was triggered by the continued decline in the market capitalization of comparable public companies and lower than expected financial performance of the Spreebird business unit during the second quarter of 2012. The evaluation resulted in an estimated impairment charge of $5.5 million to goodwill. The goodwill impairment valuation was finalized in the third quarter and no additional impairment charges were recorded. During the second quarter of 2012, we also recorded an impairment charge relating to intangible assets and capitalized software of the Spreebird business unit for $799,000 and $152,000, respectively.

On September 14, 2012, we changed our name from Local.com Corporation to Local Corporation. We amended our Amended and Restated Certificate of Incorporation in connection with a merger of our wholly-owned subsidiary with and into us in accordance with Section 253 of the Delaware General Corporation Law.

During the third quarter 2012, revenue from our LEC-billed subscriber bases decreased significantly due to a decision by certain LEC's to no longer provide billing services for our products and services. The majority of the LEC billing ceased at the end of August 2012 and we expect the remainder of the LEC billing to cease at the end of November 2012. In connection therewith, we accelerated the amortization of our subscriber base to align with the expected related future cash flows.

On November 1, 2012, we entered into a new Yahoo! Publisher Network Agreement with Yahoo! Inc., which provides for the distribution of Yahoo! Inc.'s paid search results by us for which we are compensation a certain percentage of the adjusted gross revenue (as defined in the agreement) derived by Yahoo! from such paid search results. The agreement with Yahoo ends on October 31, 2017, unless earlier terminated by the parties.

Outlook for Our Business

According to BIA/Kelsey, the U.S. online advertising market is an over $47 billion a year industry. "Local search," that is, searches for products, services and businesses within a geographic region is an increasingly significant segment of the online advertising industry. Local search allows consumers to search for local businesses' products or services by including geographic area, zip code, city and other geographically targeted search parameters in their search requests. According to a May 2011 study, BIA/Kelsey estimates that the local search market in the United States will grow from $5.1 billion in 2010, to $8.2 billion by 2015. Consumers who conduct local searches on the Internet ("local searchers") tend to convert into buying customers at a higher rate than other types of Internet users. As a result, advertisers often pay a significant premium to place their ads in front of local searchers on websites like those powered by our Consumer Properties business, including Local.com or our network partners' websites. Additionally, local SMBs that would not normally compete at the national level for advertising opportunities are increasingly engaging in and competing for local advertising opportunities, including local search, to promote their products and services.


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Local online search is still relatively new, and as a result, it is difficult to determine our current market share, or predict our future market share. However, we have a number of competitors that have announced an intention to increase their focus on local search with regard to U.S. online advertising, including some of the leading online advertising companies in the world, including Google, Yahoo!, and Microsoft, among many others, with greater experience and resources than we have.

The U.S. online advertising industry, including the local search segment, is regularly impacted and changed by new and emerging technologies, including, for instance, ad targeting and mobile technologies, as well as the increased fragmentation of the online advertising industry in general, from different technology platforms, to different advertising formats, targeting methodologies and the like. Those companies within our industry that are able to quickly adapt to new technologies, as well as offer innovations of their own, have a better chance of succeeding than those that do not.

We believe that local search will be an increasingly significant segment of the online advertising industry. Although search advertising has been used primarily by businesses that serve the national market, local businesses are increasingly using online advertising to attract local customers. Our Consumer Properties and Business Solutions are all designed to serve this market of consumers, advertisers and publishers, which we believe will provide an opportunity for growth from increased local search volumes by consumers, as well as increased competition by advertisers to display their ad listings in front of those consumers.

Our revenue, profitability and future growth depend not only on our ability to execute our business plan, but also, the growth of the paid-search market and our ability to effectively compete with other providers of local, and paid-search technologies and services among other things.

As we continue to diversify our technologies and traffic sources, we remain focused on local media offerings that will improve the experience for our end users, enable our SMBs to better reach their potential customers, and allow our regional media network partners to enhance their service offerings and lower their costs. While we are still very focused on the local search industry, we believe there are additional opportunities in local media that we and our customers can benefit from, while diversifying our revenue sources. We intend to continue making significant investments in initiatives to diversify our revenue sources and promote our future growth.

As we continue to invest in our core offerings, while pursuing the acquisitions noted above, we have increased our operating expenses, mainly related to traffic acquisition costs, the deployment of new features and functionality across our business and the support of our acquired companies. We cannot give assurances that our efforts to improve our results of operations through this strategy will be successful.

Sources of Revenue

We generate revenue primarily on our Consumer Properties from both direct and indirect advertiser relationships, via:

click-throughs on sponsored listings;

calls to cost-per-call advertiser listings;

lead generation;

banner ads;

subscription advertiser listings;

domain sales and services;

web hosting services; and

daily deal offerings.

Operating Expenses

Cost of Revenues

Cost of revenues consists of traffic acquisition costs, revenue sharing payments that we make to our network partners, and other cost of revenues. Traffic acquisition costs consist primarily of campaign costs associated with driving consumers to our Local.com website, including personnel costs associated with managing traffic acquisition programs. Other cost of revenues consists of Internet connectivity costs, data center costs, amortization of certain software license fees and maintenance, depreciation of computer equipment used in providing our paid-search services, and payment processing fees (credit cards and fees for LEC billings). We advertise on large search engine websites such as Google, Yahoo!, MSN/Bing and Ask.com, as well as other search engine websites, by bidding on certain keywords we believe will drive traffic to our Local.com website. During the three and nine months ended September 30, 2012, approximately 61% and 62%, of our overall traffic was purchased from other search engine websites. During the three and nine months ended September 30, 2012, advertising


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costs to drive consumers to our Local.com website were $15.2 million and $46.4 million respectively. Of the total advertising cost for the three and nine months ended September 30, 2012, $10.3 million and $32.1 million were attributable to Google, Inc. and $4.3 million and $12.7 million were attributable to Yahoo!, respectively. During the three and nine months ended September 30, 2011, approximately 68% and 66% respectively, of our overall traffic was purchased from other search engine websites. During the three and nine months ended September 30, 2011, advertising costs to drive consumers to our Local.com website were $9.4 million and $25.0 million respectively. Of the total advertising cost for the three and nine months ended September 30, 2011, $6.6 million and $18.4 million were attributable to Google, Inc. and $1.3 million and $4.1 million were attributable to Yahoo!, respectively.

Sales and Marketing

Sales and marketing expenses consist of sales commissions and salaries for our internal and outsourced sales force, customer service staff and marketing personnel, advertising and promotional expenses. We record advertising costs and sales commission in the period in which the expense is incurred. We expect our sales and marketing expenses will increase in absolute dollars as we continue to experience growth.

General and Administrative

General and administrative expenses consist of salaries and other costs associated with employment of our executive, finance, human resources and information technology staff, legal, tax and accounting, and professional service fees.

Research and Development

Research and development expenses consist of salaries and other costs of employment of our development staff, outside contractor costs and amortization of capitalized website development costs.

Critical Accounting Policies

The preparation of our consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and equity and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenue and expenses during the reported period. We review our estimates on an ongoing basis. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the result of which forms the basis for making judgments about the carrying values of assets and liabilities and the reported amounts of revenue and expenses. Actual results may differ materially from these estimates under different assumptions or conditions. Our significant accounting policies described in more detail in Note 1 to our condensed consolidated financial statements included in this Report on Form 10-Q, involve judgments and estimates that are significant to the presentation of our condensed consolidated financial statements.

Revenue Recognition

We recognize revenue when all of the following conditions are satisfied:
(1) there is persuasive evidence of an arrangement; (2) the service or product has been provided to the customer; (3) the amount of fees to be paid by the customer is fixed or determinable; and (4) the collection of our fees is probable.

We generate revenue when it is realizable and earned, as evidenced by click-throughs occurring on advertisers' sponsored listings, the display of a banner advertisement, the fulfillment of subscription listing obligations, the sale of deal of the day vouchers, or the delivery of Exact Match products to our customers. We enter into contracts to distribute sponsored listings and banner advertisements with our direct and indirect advertisers. Most of these contracts are short-term, do not contain multiple elements and can be cancelled at anytime. Our indirect advertisers provide us with sponsored listings with bid prices (for example, what their advertisers are willing to pay for each click-through on those listings). We recognize our portion of the bid price based upon the execution of our contractual obligations. Sponsored listings and banner advertisements are included within pages that display search results, among others, in response to keyword searches performed by consumers on our Local.com website and network partner websites. Revenue is recognized when earned based on click-through and impression activity to the extent that collection is reasonably assured from credit worthy advertisers. Management has analyzed our revenue recognition and determined that our web hosting revenue is recognized net of direct costs.

During the year ended December 31, 2010, we entered into multiple-deliverable arrangements for the sale of domains and for providing services relating to such domains. Management evaluated the agreements in accordance with the provision of the revenue recognition topic that addresses multiple-deliverable revenue arrangements. The multiple-deliverable arrangements entered into consisted of various units of accounting such as the sale of domains, website development fees, content delivery and hosting fees. Such elements were considered separate units of accounting due to each element having value to the


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customer on a stand-alone basis. The selling price for each of the units of accounting was determined using a combination of vendor-specific objective evidence and management estimates. Revenue relating to domains was recognized with the transfer of title of such domains. Revenue for website development, content delivery and hosting fees are recognized as such services are performed or delivered. The agreements did not include any cancellation, termination or refund provisions that we consider probable. Subsequent to December 31, 2010, we did not enter into any significant multiple deliverable arrangements.

We launched our Spreebird daily deals business in May 2011. Revenue relating to the Spreebird daily deals business is recorded exclusive of the portion of gross billings paid as merchant revenue share, since we generally act as the agent, rather than the principal, when connecting merchants with online customers. Spreebird deal vouchers are sold primarily through email marketing and our www.spreebird.com website. Revenue for our Spreebird business is recognized when earned. Revenue is considered to be earned once all revenue recognition criteria have been satisfied.

We evaluate whether it is appropriate to record the gross amount of sales and related costs or the net amount earned as revenue. Generally, when we are primarily obligated in a transaction, are subject to inventory risk, have latitude in establishing prices and selecting suppliers, or have several but not all of these indicators, revenue is recorded at the gross sales price. We generally record the net amounts as revenue earned if we are not primarily obligated and do not have latitude in establishing prices. Such amounts earned are determined using a fixed percentage, a fixed-payment schedule, or a combination of the two. All revenue, other than Spreebird daily deals revenue and web hosting revenue, is recognized on a gross basis.

Allowance for Doubtful Accounts

Our management estimates the losses that may result from that portion of our accounts receivable that may not be collectible as a result of the inability of our customers to make required payments. Management specifically analyzes accounts receivable and historical bad debt, customer concentration, customer credit-worthiness, current economic trends and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. If we believe that our customers' financial condition has deteriorated such that it impairs their ability to make payments to us, additional allowances may be required. We review past due accounts on a monthly basis and record an allowance for doubtful accounts generally equal to any accounts receivable that are over 90 days past due and for which collectability is not reasonably assured.

As of September 30, 2012 and December 31, 2011, two customers, Yahoo! and Google represented 56% and 47% of our total accounts receivable, respectively. These customers have historically paid within the payment period provided for under their contracts and management believes these customers will continue to do so.

Goodwill and Other Intangible Assets

Goodwill representing the excess of the purchase price over the fair value of the net tangible and intangible assets arising from acquisitions and purchased domain names are recorded at cost. Intangible assets, such as goodwill and domain names, which are determined to have an indefinite life, are not amortized. The first step in determining if there is any goodwill impairment is a comparison of the estimated fair value of an internal reporting unit with its carrying amount, including goodwill. If the estimated fair value of the reporting unit exceeds its carrying value, goodwill of the reporting unit is not considered impaired and the second step is unnecessary. If the carrying value of the reporting unit exceeds its estimated fair value, the second step is performed to measure the amount of impairment by comparing the carrying amount of the goodwill to a determination of the implied value of the goodwill. If the carrying amount of goodwill is greater than the implied value, an impairment charge is recognized for the difference. We engage an independent appraiser to assist management in the valuation. We perform annual impairment reviews during the fourth fiscal quarter of each year or earlier if indicators of potential impairment exist. For other intangible assets with indefinite lives, we compare the fair value of related assets to the carrying value to determine if there is impairment. For other intangible assets with definite lives, we compare future undiscounted cash flow forecasts prepared by management to the carrying value of the related intangible asset group to determine if there is impairment. We performed our annual impairment analysis as of December 31, 2011, and determined that the estimated fair value of the reporting units exceeded its carrying value and therefore no impairment existed. The Spreebird business unit was identified as a separate reporting unit for evaluation of goodwill impairment. Due to lower than expected financial performance by the Spreebird business unit and a significant decrease in the market capitalization of comparable public companies during the second quarter of fiscal 2012, we determined that there were potential indicators of impairment at June 30, 2012. Goodwill was tested for impairment by estimating the fair value of the reporting unit using a consideration of market multiples (Level 3 Fair Value Measurement) and was written down to its estimated implied fair value, which was approximately $6.7 million as of June 30, 2012, resulting in an estimated impairment charge of approximately $5.5 million, which is included in Impairment of goodwill and intangible assets in the accompanying condensed consolidated statements of operations. We finalized the goodwill impairment review of the


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Spreebird business unit and the related impairment charge recorded in the second quarter 2012 during the third quarter 2012. The finalization of the Spreebird goodwill impairment review did not result in any adjustments to the initial impairment charge recorded in the second quarter 2012. The Company noted no potential indicators of impairment related to the Spreebird goodwill as of September 30, 2012.

Stock Based Compensation

Total stock-based compensation expense related to continuing operations
recognized for the three and nine months ended September 30, 2012 and 2011, is
as follows (in thousands, except per share amount):



                                          Three Months Ended September 30,                 Nine Months Ended September 30,
                                           2012                     2011                    2012                      2011
Cost of revenues                      $            22          $            12        $             61          $            165
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