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LOCM > SEC Filings for LOCM > Form 10-K on 28-Mar-2014All Recent SEC Filings

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Form 10-K for LOCAL CORP


28-Mar-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of financial condition and results of operations should be read in conjunction with our financial statements and related notes included elsewhere in this Report. In addition to current and historical information, this Annual Report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. 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," "intend," "expect," "plan," "anticipate," "believe," "estimate," "predict," "project," "potential," or "continue," the negative of such terms, or other comparable terminology. These statements involve certain known and unknown risks and uncertainties that could cause our actual results to differ materially from those expressed or implied in our forward-looking statements. Such risks and uncertainties include, among others, those listed in Part 1, Item 1A. "Risk Factors" of this Annual Report on Form 10-K. We do not intend, and undertake no obligation, to update any of our forward-looking statements after the date of this Annual Report on Form 10-K to reflect actual results or future events or circumstances.

Overview

We are a leading technology and advertising company that provides our search results to consumers who are searching online for local businesses, products and services. Our search results consist primarily of local business listings and product listings that we aggregate, index, normalize and syndicate using our sophisticated technology platforms. We provide our search results through our flagship Local.com website, our Krillion.com website and platform and through other proprietary websites ("Owned and Operated" or "O&O") and to a network of over 1,600 other websites that rely on our search syndication services to provide local search results to their own users ("Network"). We also 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 aggregate and distribute product search results to third party partners through our proprietary Krillion® local shopping platform. We generate revenue from a variety of ad units we place alongside our search results, which include pay-per-click, pay-per-call, and display (banner) ad units, including video.

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.

2013 Corporate Highlights

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 are being amortized into interest expense over the life of the Notes.

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. The sale of the Spreebird business closed on July 26, 2013, for a minimum consideration of $210,000.

On November 11, 2013, we entered into a Settlement and Patent License Agreement ("Settlement Agreement") with GeoTag, Inc., pursuant to which we paid GeoTag, Inc. a license fee of $550,000 in return for a license to the '474 Patent, and all patent applications related thereto, and all reissue patents, continuations and continuations-in-part through the expiration of the last surviving patent related to the '474 Patent. In connection with the Settlement Agreement, Geotag dismissed its claims against us. We denied liability in the litigation and entered into the Settlement Agreement to put an end to litigation costs associated with the suit. We accrued for the total settlement amount of $550,000 as of September 30, 2013, which was paid in the fourth quarter of 2013.


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Outlook for Our Business

According to BIA/Kelsey, U.S. local online advertising revenue will reach approximately $137.5 billion in 2014. "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." In addition, BIA/Kelsey estimates that the local search market in the U.S. will grow from $6.3 billion in 2013, to $8.6 billion by 2017.

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.

Local online search and more specifically local mobile search is still growing at a fast pace, 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 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 and more specifically local mobile 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 product offerings 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 and local mobile 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 technology and advertising offerings that will improve the experience for our end users, and allow our network and other third party 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 technology and advertising 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 new initiatives. We cannot give assurances that our efforts to improve our results of operations through this strategy will be successful.

The consumer shift to mobile devices presents a tremendous opportunity for us. Today, consumers are using their mobile devices more than ever before to search for local products and services.

We believe that Krillion can become the engine which powers third party apps and sites that seek to provide on-the-go mobile consumers with the local product information they want, when they need it, along their path to purchase. We believe that our role in this emerging marketplace may enable us to be at the forefront of the ongoing transformation of consumer shopping behavior with what we believe could be a potentially disruptive solution. If this happens, we believe we will be in a better position to control our financial future by having direct relationships with retailers and brands and as a result we expect to be able to reduce our reliance on third party advertisers.


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In addition, we believe that any wide adoption of the Krillion platform would result in access to an immense amount of data about retailers, manufacturers, and consumers alike. We believe this could further evolve Krillion's platform into a location-based data play, complete with highly valuable consumer behavior trends, price history by category and other valuable information. We believe we are in the early stages of this evolution in consumer search and we believe we are well positioned to take advantage of it.

Sources of Revenue

We generate revenue primarily on our Local.com website and Network 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; and

• web hosting services.

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 O&O websites, 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, and Microsoft/Bing, as well as other search engine websites, by bidding on certain keywords we believe will drive traffic to its O&O websites. During the year ended December 31, 2013, approximately 57% of our overall traffic was purchased from other search engine websites. During the year ended December 31, 2013, advertising costs to drive consumers to our Local.com website were $35.9 million of which $27.4 million and $6.1 million was attributable to Google and Yahoo, respectively. During the year ended December 31, 2012, approximately 60% of our overall traffic was purchased from other search engine websites. During the year ended December 31, 2012, advertising costs to drive consumers to our Local.com website were $57.3 million of which $39.7 million and $15.4 million was attributable to Google and Yahoo, respectively. If we are unable to advertise on these websites, or the cost to advertise on these websites increases, our financial results will likely suffer materially.

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.


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Results of Operations

The following table sets forth our historical operating results as a percentage of revenue for the years ended December 31, 2013 and 2012:

                                                              Year ended December 31,
                                                             2013                  2012
Revenue                                                         100.0 %             100.0 %

Operating expenses:.
Cost of revenues                                                 72.6                74.4
Sales and marketing                                              10.6                15.8
General and administrative                                       14.4                12.3
Research and development                                          6.9                 5.3
Amortization of intangibles                                       1.0                 3.8

Total operating expenses                                        105.6               111.6

Operating income (loss)                                          (5.6 )             (11.6 )
Interest and other income (expense), net                         (2.5 )              (0.4 )
Change in fair value of conversion option warrant
liability                                                         1.2                 0.2

Income (loss) from continuing operations before
income taxes                                                     (6.9 )             (11.8 )
Provision for income taxes                                       (0.1 )              (0.1 )

Net income (loss) from continuing operations                     (7.0 )             (11.9 )
Income (loss) from discontinued operations (net of
taxes)                                                           (4.0 )             (13.3 )

Net income (loss)                                               (11.0 )%            (25.3 )%

Years ended December 31, 2013 and 2012

Revenue



                                        Year ended December 31,                         Percent
                           2013             (*)             2012             (*)         change
                      (in thousands)                   (in thousands)
 Owned and operated   $        43,312        45.9 %    $        69,241        72.1 %       -37.4 %
 Network                       50,517        53.5 %             20,926        21.8 %       141.4 %
 Business solutions               567         0.6 %              5,808         6.1 %       -90.2 %

 Total revenue        $        94,396       100.0 %    $        95,975       100.0 %        -1.6 %

(*) - Percent of total revenue.

Owned and Operated revenue for the year ended December 31, 2013, decreased 37.4% compared to the same period in 2012. The decrease in revenue for the year ended December 31, 2013, compared to the same period in 2012 is due to a decrease in monetization as our revenue per thousand visitors ("RKV") decreased from $270 for 2012 to $194 for 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 fiscal 2013 O&O revenue and results of operations. This advertising partner also made some changes beginning in July 2013 related to bidding for mobile and desktop advertising campaigns, which further had 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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RKV
Year ended December 31, 2012:
First quarter $ 285
Second quarter $ 299
Third quarter $ 276
Fourth quarter $ 230
Full year $ 270
Year ended December 31, 2013:
First quarter $ 215
Second quarter $ 199
Third quarter $ 180
Fourth quarter $ 178
Full year $ 194

Network revenue for the year ended December 31, 2013, increased 141.4% compared to the same period in 2012. The increase is primarily due to an increase in the number of network partner websites as well as an increase in revenue from certain network partners. The increase is partially offset by a decrease in organic traffic to existing partner websites due to algorithmic changes made by a large search engine affecting the way in which the search engine indexes 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. As a result of our heightened emphasis on providing high quality traffic to our advertising partners, we discontinued relationships with a number of our network partners in the later part of fiscal 2013, while increasing the volume of business with our remaining network partners.

Business Solutions revenue for the year ended December 31, 2013, decreased 90.2% compared to the same periods in 2012. The decrease in revenue is due to a decrease in revenue from our LEC-billed subscriber bases and a decrease in revenue from our Launch by Local product suite. The decrease in revenue from our LEC-billed subscriber bases is due to a decision by certain LEC's to no longer provide billing services for our products and services during 2012. In January 2013, we made a decision to eliminate our direct sales efforts of our SMB product suite to small and medium size businesses ("SMBs").

The growth in small business subscribers in prior years was a result of acquisitions of subscriber bases and internal and outsourced sales efforts. The following table provides the revenue relating to the acquisition of subscriber bases and revenue relating to internal and outsourced sales efforts (dollars in thousands):

                                                           Year Ended December 31,                Percent
                                                  2013        (*)         2012         (*)         change
Revenue from internal and outsourced sales        $ 567       100.0 %    $ 3,088        53.2 %       -81.6 %
Revenue from acquired bases                          -          0.0 %      2,720        46.8 %      -100.0 %

Total business solutions revenue                  $ 567       100.0 %    $ 5,808       100.0 %       -90.2 %

(*) - Percent of total revenue.

Based on the above, total revenue for the year ended December 31, 2013, decreased to $94.4 million from $96.0 million for the year ended December 31, 2012, a decrease of $1.6 million, or 1.6%.

The following table identifies our major partners that represented greater than 10% of our total revenue in the periods presented:


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                                   Percentage of Total Revenue
                                     Years Ended December 31,
                   Customer         2013                  2012
                   Yahoo! Inc.           46 %                  21 %
                   Google Inc.           26 %                  44 %

Operating expenses:

Operating expenses were as follows (dollars in thousands):

                                            Year ended December 31,                  Percent
                                  2013         (*)          2012          (*)         Change
  Cost of revenues              $ 68,541        72.6 %    $  71,434        74.4 %        (4.0 )%
  Sales and marketing             10,029        10.6 %       15,189        15.8 %       (34.0 )%
  General and administrative      13,633        14.4 %       11,765        12.3 %        15.9 %
  Research and development         6,554         6.9 %        5,092         5.3 %        28.7 %
  Amortization of intangibles        912         1.0 %        3,611         3.8 %       (74.8 )%

  Total operating expenses      $ 99,669       105.6 %    $ 107,091       111.6 %        (6.9 )%

(*) - Percent of total revenue.

Cost of revenues

Cost of revenues for the year ended December 31, 2013, decreased by 4% compared to the same period in 2012. The decrease of cost of revenues in 2013 was due to a decrease in traffic acquisition costs associated with driving consumers to our Local.com website. The decrease is partially offset by an increase in revenue share related to network revenue. Included in cost of revenues during the third quarter of fiscal 2013 was a benefit from our assertion of certain contractual rights as it relates to our partner agreements.

Sales and marketing

Sales and marketing expenses for the year ended December 31, 2013, decreased 34% compared to the same period in 2012. The decrease is mainly due to a decrease in personnel-related cost as part of our continued cost savings efforts. The reduction in personnel related costs was partially offset by severance costs. In January 2013, we made a decision to eliminate our direct sales efforts of our SMB product suite to small and medium size businesses. We are still providing our SMB solution through our channel partners.

General and administrative

General and administrative expenses for the year ended December 31, 2013, increased by 15.9% compared to the same period in 2012. The increase was due to an increase in consulting and legal expense related to our efforts to secure financing as well as legal costs relating to litigation and the payment of a legal settlement of $550,000 during fiscal 2013. We also recorded additional bad debt expense of approximately $2.3 million, of which $350,000 related to a second tier advertising partner and $1.7 million to the long-term receivable, all of which has been included in general and administrative expense for fiscal 2013. The long term receivable relates to our remaining LEC receivables that we determined should be fully reserved during the fourth quarter of fiscal 2013. Due to the significant amount of time the LEC receivables have been outstanding together with the liquidity of the third parties involved in the payment of the LEC receivables, we have determined that collectability is no longer reasonably assured. The increase was partially offset by a decrease in compensation expense for the year as part of our continued cost savings efforts.

Research and development

Research and development expenses for the year ended December 31, 2013, increased by 28.7% compared to the same period in 2012. The increase is due to lower capitalization of personnel related costs as well as an increase in personnel related costs in fiscal 2013 as we continue to invest in new initiatives, including mobile and local shopping.


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Amortization of intangibles

Amortization of intangibles expense was $912,000 for the year ended December 31, 2013, compared to $3.6 million for the year ended December 31, 2012. The decrease in amortization expense was primarily due to the accelerated amortization of subscriber related intangible assets in 2012 with all subscriber related intangible assets fully amortized as of the end of fiscal 2012.

Interest and other income (expense), net

Interest and other income (expense), net consisted of the following (in thousands):

                                                    Year ended December 31,
                                                      2013               2012
       Interest income                            $          12         $   33
       Interest expense                                  (2,333 )         (458 )

       Interest and other income (expense), net   $      (2,321 )       $ (425 )

Interest and other income (expense) was ($2.3) million and ($425,000) for the . . .

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