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LOCM > SEC Filings for LOCM > Form 10-Q on 9-Aug-2013All Recent SEC Filings

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Form 10-Q for LOCAL CORP


9-Aug-2013

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, 2012, and for the year ended December 31, 2012, included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 2, 2013.

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 third-party U.S. regional media websites (collectively, "Network"). We also continue to provide digital media services to our existing small and medium sized businesses ("SMBs") acquired through our legacy direct sales business and continue to seek channel sales opportunities for these products ("Business Solutions"). We also enable third parties to distribute their advertiser listings on our Consumer Properties, from which we generates ad revenue. We generate revenue principally from display advertising and performance ad units such as pay-per-click, pay-per-call, daily deals, lead generation and subscription ad units.

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

In January 2013, we shifted our Business Solutions strategy to focus exclusively on channel sales opportunities. We continue to develop theses channel sales relationships through which we intend to be able to offer our Launch by Local products. Also included in our Business Solutions business unit are activities related to our Spreebird daily deals business. We recognize revenue from our daily deals business net of the merchant's portion of gross billings.

Recent Developments

During the second quarter 2013, we decided to sell the assets relating to the Spreebird business and cease all operations of the Spreebird business. This resulted in an impairment charge of $3.1 million in the second quarter 2013, with the remaining assets being classified as held for sale assets as of June 30, 2013. With the decision to sell the Spreebird assets and cease all operations relating to the Spreebird business we now operate in a single reportable segment.

On April 10, 2013, we entered into a Convertible Note and Warrant Purchase Agreement ("Agreement") with two investors. Pursuant to this Agreement, the investors purchased an aggregate of $5.0 million of 7% subordinated convertible notes ("Notes") and warrants to purchase 746,268 shares of our common stock (the "Warrants"). The obligation under the Notes and Warrants are secured by all of our assets. The Notes mature on April 10, 2015. The Warrants expire on April 10, 2018. The Notes are convertible into our common stock and the Warrants are exercisable at $2.01 a share. In connection with the issuance of the Notes, we paid $356,000 in cash for placement agent fees of which $127,500 was paid to one of our directors. The Company also incurred legal and other consulting fees totaling $244,000 related to the issuance of the Notes. Fees related to the Notes are recorded in prepaid expenses at March 31, 2013 and will be amortized into interest expense over the life of the Notes.


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Outlook for Our Business

According to BIA/Kelsey, the U.S. online advertising market is an approximately $42 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 - such as entering "florists in Irvine, CA." According to a September 2012 study, BIA/Kelsey estimates that the local search market in the United States will grow from $6.1 billion in 2011, to $13.4 billion by 2016. 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.

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. For example, Facebook recently announced a Graph Search tool which allows users to access the interests and opinions of friends regarding local places, movies and interests and which may emerge as a significant competitor to our current offerings.

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 who 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 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, 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, 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;

small business advertising services; and

domain sales and services.


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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 Local Exchange Carrier ("LEC") billings ended in December 2012). We advertise on large search engine websites such as Google, Yahoo and Microsoft, 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 six months ended June 30, 2013, approximately 54%, of our overall traffic were purchased from other search engine websites. During the three and six months ended June 30, 2013, advertising costs to drive consumers to our Local.com website were $8.7 million and $18.9 million respectively. Of the total advertising cost for the three and six months ended June 30, 2013, $6.3 million and $13.7 million were attributable to Google and $1.6 million and $3.6 million were attributable to Yahoo, respectively. During the three and six months ended June 30, 2012, approximately 62%, of our overall traffic were purchased from other search engine websites. During the three and six months ended June 30, 2012, advertising costs to drive consumers to our Local.com website were $16.7 million and $31.2 million respectively. Of the total advertising cost for the three and six months ended June 30, 2012, $11.9 million and $21.9 million were attributable to Google and $4.3 million and $8.4 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.

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 our SMB products to our customers or those of our channel partners. 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 Consumer Properties. Revenue is recognized when earned based on click-through


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and impression activity to the extent that collection is reasonably assured from credit worthy advertisers. Revenue recognized is net of estimated adjustments for traffic screening. Management has analyzed our revenue recognition and determined that our web hosting revenue is recognized net of direct costs.

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 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, including long-term 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 June 30, 2013 and December 31, 2012, two customers, Yahoo and Google represented 71% and 61% 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 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. Our indefinite lived intangible assets consist of domain names for which the fair value is determined by using a third party valuation site which calculates the value of domain names using internal algorithms. 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.

With our decision to sell the assets of the Spreebird business unit, the carrying value of the goodwill associated with the Spreebird business was determined to be fully impaired. As a result, we recorded an impairment charge of approximately $3.0 million as of June 30, 2013, which included goodwill of $2.6 million.


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Stock Based Compensation

Total stock-based compensation expense recognized for the three and six months
ended June 30, 2013 and 2012, is as follows (in thousands, except per share
amount):



                                           Three Months Ended June 30,              Six Months Ended June 30,
                                           2013                  2012                2013                2012

Cost of revenues                       $          31         $          18       $         59        $         39
Sales and marketing                              116                   212                250                 451
General and administrative                       306                   332                596                 668
Research and development                          73                    48                156                 100


Total stock-based compensation
expense                                $         526         $         610       $      1,061        $      1,258


Basic and diluted net stock-based
compensation expense per share         $        0.02         $        0.03       $       0.05        $       0.06

Results of Operations

The following table sets forth our historical operating results as a percentage
of revenue for the three and six months ended June 30, 2013 and 2012:



                                        Three Months Ended June 30,                  Six Months Ended June 30,
                                        2013                    2012                2013                  2012
Revenue                                    100.0 %                 100.0 %             100.0 %               100.0 %


Operating expenses:
Cost of revenues                            72.6                    74.7                72.6                  72.9
Sales and marketing                          8.9                    15.8                11.8                  16.2
General and administrative                  12.6                    10.5                13.1                  10.2
Research and development                     6.6                     4.7                 7.3                   4.8
Amortization of intangibles                  1.0                     2.5                 1.0                   2.9


Total operating expenses                   101.7                   108.2               105.9                 107.0


Operating loss                              (1.7 )                  (8.2 )              (5.9 )                (7.0 )

Interest and other income
(expense), net                              (1.9 )                  (0.4 )              (2.9 )                (0.4 )
Change in fair value of warrant
liability                                    2.8                     0.6                 1.5                   0.2


Loss from continuing operations
before income taxes                         (0.7 )                  (8.0 )              (7.3 )                (7.1 )

Provision for income taxes                   0.7                     0.2                 0.5                   0.2


Net loss from continuing
operations                                  (1.4 )                  (8.2 )              (7.8 )                (7.3 )

Loss from discontinued
operations (net of taxes)                  (14.4 )                 (26.9 )              (7.9 )               (17.3 )

Net loss                                   (15.8 )%                (35.0 )%            (15.7 )%              (24.6 )%

Three and six months ended June 30, 2013 and 2012

Revenue (dollars in thousands):

                                        Three Months Ended June 30,                Percent                 Six Months Ended June 30,                 Percent
                                 2013         (*)          2012         (*)         change         2013         (*)          2012         (*)         change
Owned and operated             $ 10,917        48.2 %    $ 20,478        76.7 %       -46.7 %    $ 23,904        54.2 %    $ 38,451        75.3 %       -37.8 %
Network                          11,590        51.2 %       4,114        15.4 %       181.7 %      19,873        45.0 %       8,328        16.3 %       138.6 %
Business solutions                  149         0.7 %       2,093         7.8 %       -92.9 %         343         0.8 %       4,255         8.3 %       -91.9 %

Total revenue                  $ 22,656       100.0 %    $ 26,685       100.0 %       -15.1 %    $ 44,120       100.0 %    $ 51,034       100.0 %       -13.5 %

(*) - Percent of total revenue

O&O revenue for the three and six months ended June 30, 2013, decreased 46.7% and 37.8%, respectively, compared to the same periods in 2012. The decrease in revenue for the three and six months ended June 30, 2013, compared to the same periods in 2012 is due to a decrease in monetization as our revenue per thousand visitors ("RKV") decreased from $299 and $292 for the three and six months ended June 30, 2012, to $201 and $210 for the three and six months ended June 30, 2013, coupled with a decrease in traffic. The decrease in RKV is largely due to periodical changes to traffic provider policies and guidelines. These changes impacted both our advertising campaigns to purchase traffic and the monetization of our search results pages. During October 2012, our largest traffic provider made certain changes to their policies and guidelines. These changes had a negative impact on our first and second quarter of fiscal 2013 O&O revenue and results of operations. We also expect changes from this advertising partner beginning in July 2013 related to bidding for mobile and desktop advertising campaigns, which may have a negative impact on our traffic and monetization of such traffic. We continue to work closely with this traffic provider to refine our traffic acquisition approach and user experience on our search results pages.


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Network revenue for the three and six months ended June 30, 2013, increased 181.7% and 138.6%, respectively, compared to the same periods in 2012. The increase is primarily due to an increase in the number of network partner websites. The increase is partially offset by a decrease in organic traffic to existing partner websites due to a change in the way third party search engines index our network partner websites. A portion of the Network revenue is based on other websites for which we provide our organic and third-party ad feeds. We have experienced volatility in this portion of our Network revenue related to changes in the partners' traffic levels, traffic quality and market conditions for paid search. This portion of our Network revenue remains volatile. If we experience a reduction in the number of Network partner websites receiving our organic and third-party ad feeds, or if the overall traffic levels derived from our Network partner websites is reduced, or if the quality of traffic derived from those Network partner websites is diminished, we expect that our Network revenue would decrease materially.

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