UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-K/A

 

Amendment No. 1

 

 

 

Commission file number: 001-34197

 

LOCAL.COM CORPORATION

(Exact name of registrant as specified in its charter)

 

 

(949) 784-0800
Registrant’s telephone number, including area code

 

Securities registered pursuant to Section 12(b) of the Act:

 

Securities registered pursuant to Section 12(g) of the Act:

None

(Title of class)

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.  Yes o     No þ

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File require to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit an post such files).  Yes o     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

The aggregate market value of voting and non-voting common equity held by non-affiliates of the issuer was approximately $112.7 million based on the last reported sale price of registrant’s common stock on June 30, 2010 as reported by Nasdaq Capital Market.

 

As of February 28, 2011, the number of shares of the registrant’s common stock outstanding: 21,222,390

 

Documents incorporated by reference: None.

 

This Amendment No. 1 to Form 10-K (“Amendment No. 1”) of Local.com Corporation (the “Company”) amends the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010, originally filed March 16, 2011 (the “Form 10-K”). It is being filed solely to include the information required in Part III (Items 10, 11, 12, 13 and 14) of Form 10-K that was previously omitted from the Form 10-K.

 

General Instruction G(3) to Form 10-K allows such omitted information to be filed as an amendment to the Form 10-K or incorporated by reference from the Company’s definitive proxy statement which involves the election of directors not later than 120 days after the end of the fiscal year covered by the Form 10-K. Because the Company’s definitive Proxy Statement for the 2011 Annual Meeting of Stockholders will not be filed with the Securities and Exchange Commission (“SEC”) within 120 days after the end of the fiscal year ended December 31, 2010, the information required by Part III of Form 10-K cannot be incorporated by reference and, therefore, must be included as part of the Form 10-K. Accordingly, the Company is filing this Amendment No. 1 to include such omitted information as part of the Form 10-K.

 

Except as modified herein, no other information in the Form 10-K is being modified or amended by Amendment No. 1, and unless indicated otherwise, Amendment No. 1 does not reflect events occurring after March 16, 2011, which is the filing date of the Form 10-K. Unless otherwise indicated, capitalized terms used herein but not defined shall have the meanings ascribed to them in the Form 10-K.

 

LOCAL.COM CORPORATION
TABLE OF CONTENTS

 

 

 

References herein to “we”, “us”, “our” or “the Company” refer to Local.com Corporation and its wholly-owned subsidiaries unless the context specifically states or implies otherwise.

 

Local.com Overview

 

We are an internet search advertising company that enables businesses and consumers to find each other and connect, locally. We operate online businesses that collectively reach over 20 million monthly unique visitors across over 100,000 websites, and we serve over 45,000 small business customers with a variety of web hosting and local online advertising products.

 

Our Owned & Operated business unit (“O&O”) manages our flagship property, Local.com, and a proprietary network of over 20,000 local websites, which reaches over 15 million monthly unique visitors. Our Network business unit (“Network”) operates (i) a leading private label local syndication network of over 1,000 U.S. regional media websites, (ii) 80,000 third-party local websites, and (iii) our own organic feed of local businesses plus third-party advertising feeds, both of which are focused primarily on local consumers to a distribution network of hundreds of websites. Our Sales & Ad Services business unit (“SAS”) provides over 45,000 direct monthly subscribers with web hosting or web listing products. We use patented and proprietary search technologies and systems, to provide consumers with relevant search results for local businesses, products and services. By providing our users and those of our network partners with robust, current, local information about businesses and other offerings in their local area, we have created an audience of users that our direct advertisers and advertising partners desire to reach. Sales of advertising on Local.com and our local syndication network accounted for 80% of our total revenues in 2010.

 

We launched Local.com in August of 2005, our local syndication network in July 2007, and we expanded our sales and advertiser services offerings to include a larger number of direct service subscribers throughout 2009 and 2010. In the third quarter of 2010, we also acquired all of the assets of Simply Static, LLC (doing business as Octane360), a Delaware limited liability company (“Octane360”). The Octane360 assets acquired include a technology platform, which can be used to offer targeting and registration of geo-category based local website domains; small business and geo-category website creation, hosting and management; an ad exchange to manage the selection and deployment of ad inventory across all Octane360-controlled domains and websites; and a content marketplace to allow for the management of geo-category content written for advertising customers or our directly owned portfolio properties. We have been regularly developing and deploying new features and functionality to each of these channels designed to enhance the experience of our users and increase the value of our audience to our advertisers. With a strategic focus on three key drivers for our business — traffic, technology and advertisers — we believe we can continue to grow through our own efforts and the acquisition of complementary businesses and technologies intended to accelerate our growth.

 

In January 2011, we announced the formation of our Social Buying business unit (“Social Buying”) following our acquisition of the iTwango deal-of-the-day technology platform.

 

O&O

 

Our O&O business unit represents our proprietary local search traffic. We serve consumers primarily via our flagship web property, Local.com, and via our proprietary network of over 20,000 local websites, most of which were developed using the Octane360 technology platform. Traffic reaches Local.com organically, which includes both direct-to-site and Search Engine Optimized (“SEO”) search traffic, as well as through our Search Engine Marketing (“SEM”) campaigns. Traffic generally reaches our proprietary network organically via SEO. We monetize our local search traffic by placing a variety of display, performance and subscription ad products alongside our search results. In November 2010, we relaunched Local.com to include additional content, including coupons, articles and information about local events. These improvements are intended to increase organic traffic to our website and further improve consumer satisfaction with our offerings.

Network

 

Our Network business unit represents third-party local search traffic. We serve over 1,000 partner websites, such as local newspaper, TV and radio station websites with a hosted geo-targeted small business directory product. This drives SEO traffic to the directories on our partners’ sites, which we monetize with ads. We also serve hundreds of other search engines with our organic and third-party ad feeds. These partners receive an XML feed which contains our advertiser listings as well as our organic search results in some instances, and they display those results in their websites’ own look and feel. We also, host and manage over 80,000 local websites owned by third-parties via our Octane360 platform. We optimize these websites by commissioning unique, targeted category/location-specific content from our “Octane Experts” content marketplace and distributing that content on our domain network. We monetize all our network partners’ local search traffic by placing a variety of performance and subscription ad products alongside the search results, and we share a portion of the ad revenues generated with those partners.

 

SAS

 

Our SAS business unit serves, as of December 31, 2010, over 45,000 direct small business customers with subscription advertising and web hosting products, as well as partners who supply us with additional advertiser listings. Our direct customers pay a fixed fee each month to receive either a higher listing on our Local.com search results’ pages (web listing) or a website (web hosting). Our partners provide us with various performance ad products including pay per click, pay per call and pay per lead, as well as display ad units that are paid per thousand impressions, which provide us with an effective way to monetize our search traffic. Yahoo!, Inc. and SuperMedia Inc. are our two largest advertiser partners. We recently introduced a new ad product, which is based on the Octane360 platform. We are focusing our future SAS efforts primarily on selling this new product via channel sales partners such as yellow page directory publishers, regional media publishers, search verticals and ad agencies. In the fourth quarter of 2010, we announced that we will suspend acquisitions of Local Exchange Carrier (“LEC”) billed subscriber bases in order to concentrate our resources around the Octane360 product suite. As a result, we anticipate revenue from our existing subscribers to decline as the number of subscribers declines, partially offset by the addition of Octane360 product suite customers. Any decline in subscriber revenue and related margin could materially adversely affect our business and financial results. In early February 2011, we announced that we have entered into a definitive agreement to acquire the assets of Rovion, Inc. (“Rovion”), which include a rich media advertising platform that enables the creation, tracking, and distribution of rich media ads. If this acquisition is successfully concluded, the assets will be utilized to enhance the advertising products offered across all business units to include rich media advertising.

 

Industry Overview

 

U.S. online advertising is an over $29 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 September 2010 study The Kelsey Group estimates that the local search market in the United States will grow to approximately $8.6 billion by 2014. 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 user. As a result, advertisers often pay a significant premium to place their ads in front of local searchers on websites like Local.com or our Network partner websites. Additionally, local small and medium-sized businesses 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 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 in 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.

 

The Local.com Solution

 

We believe our search results and local content, delivered on our own websites and our network partner websites, provide the following benefits to local advertisers and consumers:

 

 

Our Strategy

 

Our growth strategy is to expand our online reach via partnering, developing or acquiring websites that have search traffic, and monetize that traffic with a broader range of local ad products. We have adopted an integrated growth strategy that addresses the needs of each of our business units, O&O, Network, SAS, and Social Buying, individually, while allowing the growth in one of our business units to be leveraged by our other business units. We have also taken steps to diversify our revenue sources, while maintaining our focus on local offerings through the acquisition of Octane360 and more recently the iTwango deal-of-the-day technology platform acquisition that closed in January 2011. In early February 2011, we also announced that we have entered into a definitive agreement to acquire the assets of Rovion, which includes a self-service rich media advertising platform. Our development and acquisition efforts also represent a point of differentiation from an increasingly crowded field in online advertising. We believe that a diversity of offerings will differentiate us from certain of our competitors that may offer one or two

of our services, but not the full suite of our product offerings, which we believe appeals to our customers and partners alike.

 

O&O

 

Our O&O growth strategy is centered on increasing organic traffic to our websites, which includes type-in and SEO traffic. In November 2010, we relaunched our flagship, Local.com website, to include additional content, including coupons, articles and information about local events. We believe that adding more content and presenting that content in a useful way to our users will ultimately drive more type-in and SEO traffic over time, both of which are our high margin traffic sources. We plan to add more content to the website by launching verticals that appeal to our core demographic of soccer moms — for example, shopping, education and health & wellness. If we are able to increase the amount of type-in and SEO traffic that our Local.com website receives, we may be able to reduce our reliance on lower-margin traffic we acquire from other search engines.

 

We also expect to add new brands, products and services to our O&O business unit via acquisitions. We expect our acquisition focus to be primarily on websites which serve our target demographic and have material type-in traffic to their own websites, thereby adding to our O&O proprietary traffic base and to the overall value proposition we offer our SAS direct and indirect advertisers. Additionally, we anticipate that much of the content we develop or acquire for our own O&O properties may also be useful to enhance the product and content offerings we make to our network partners. Our Octane360 acquisition has provided us with some of these attributes including: the ability to quickly create websites focused on particular geographies and categories; and to populate those websites with targeted content that we believe will be useful to both our core demographic and our advertisers. Similarly, our acquisition of the iTwango technology platform allows us entry into the rapidly expanding market for deal-of-the-day offerings, which we intend to be a featured offering on our Local.com website.

 

Network

 

Our Network growth strategy includes adding new websites, expanding the content and products available to our network partners, growing the user base of our existing products through SEO efforts and content expansion, and improving our overall ad yield per visitor through continued page optimization of our SAS-managed advertising partners. We believe that expanded distribution increases our value in the local search ecosystem, thereby attracting new advertisers. This, in turn, allows us to compete for expanded distribution, creating what we feel is a virtuous cycle, with strategic defensibility originating from our significant base of traffic on our O&O properties. We further believe that over time, any local search network without an accompanying proprietary traffic source will find it increasingly difficult to compete.

 

As with O&O, we expect that we may acquire content channels and products that would be well suited to deployment throughout our Network. We expect that any acquisitions made primarily for our Network, will also be able to be leveraged by our O&O websites and could result in additional advertising and sponsorship opportunities becoming available through our SAS business unit. The assets acquired in the Octane360 and iTwango transactions, as well as the assets to be acquired in the impending acquisition of Rovion, each provide additional products, services and channels we can market to our network partners, building what we believe is a stronger and more defensible long term relationship with those partners.

 

SAS

 

Our SAS business unit is closely linked to the expansion of our O&O and Network business units and, as such, our strategy with respect to SAS is also connected. As our overall traffic increases, we believe we can attract more direct and indirect advertisers and, in turn, use our higher monetization to compete for more distribution. We expect to add incrementally to our direct customer base internal sales efforts. We also expect to be able to offer new and compelling products to our potential customers as we add new content and functionality to our O&O and Network business units. In the fourth quarter of 2010, we announced that we will suspend acquisitions of LEC-billed subscriber bases in order to concentrate our resources around the Octane360 product suite powered by our recently acquired Octane360 platform. As a result, we anticipate revenue from our existing subscribers to decline. Initially, the expected growth in revenue from Octane360 products is not expected to fully offset the decline in revenue from

existing subscribers. If the proposed acquisition of Rovion is ultimately completed, we expect that the availability of new rich-media offerings will provide additional products that are attractive to our direct advertisers, as well as those of some of our partners. These new Rovion offerings are initially also not expected to fully offset the decline in revenue from existing subscribers.

 

Technology, Research and Development

 

We make our services available to advertisers and consumers through a combination of our own proprietary technology and commercially available technology from industry leading providers.

 

We believe that it is important that our technologies be compatible with the systems used by our partners. In addition to our Octane360 hosting services, we rely upon third parties to provide hosting services, including hardware support and service and network coordination.

 

Our research and development efforts are focused on developing new services and enhancing our existing services to provide additional features and functionality that we believe will appeal to our advertisers and consumers. Our research and development efforts also include the development and implementation of business continuity and disaster recovery systems, improvement of data retention, backup and recovery processes. As of December 31, 2010, we had 32 employees in product and technical development.

 

Our research and development expenses were $5.1 million, $3.5 million and $3.1 million for the years ended December 31, 2010, 2009 and 2008, respectively.

 

Keyword DNA^tm/Web Indexing Technology

 

Our Keyword DNA and patented web indexing technologies are our proprietary methods for indexing large amounts of data, and are critical to Local.com. Our technology enables consumers to enter into a search engine the particular product or service they are seeking and a given geographic area. Our technology then attempts to locate the appropriate business listings, by searching as many different data sources as directed, to find the results. Unlike other search engine technologies, our web indexing technology is designed to return only the businesses that supply, or are likely to supply, the appropriate product or service in a given geographic area. Keyword DNA does not return results based upon information that may appear on a website. We believe that our methodology increases the relevancy of geographically targeted search results.

 

Competition

 

The online local paid-search market is intensely competitive. Our competitors include the major search engines, Google, Yahoo!, and Bing, as well as online directories and city guides, such as Yellowpages.com and Dex. We partner with many of our competitors. Non-paid search engines are beginning to offer paid-search services, and we believe that additional companies will enter into the local search advertising market. Also, as we enter new business lines, as we have with the creation of our new Social Buying business unit and the acquisition of the iTwango assets, we will have new competitors to consider in those business lines, including Groupon and Living Social, among many others. Although we currently pursue a strategy that allows us to partner with a broad range of websites and search engines, our current and future partners may view us as a threat to their own local search services. We believe that the principal competitive factors in our local paid-search market are network size, revenue sharing agreements, services, convenience, accessibility, customer service, quality of search tools, quality of editorial review and reliability and speed of fulfillment of search results and ad listings across the Internet infrastructure.

 

We also compete with other online advertising services as well as traditional offline media such as television, radio and print, for a share of businesses’ total advertising budgets. Nearly all of our competitors have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial, marketing and other resources than we do. Our competitors may secure more favorable revenue sharing agreements with network distributors, devote greater resources to marketing and promotional campaigns, adopt more aggressive growth strategies and devote substantially more resources to website and systems development than we do.

The search industry has experienced consolidation, including the acquisitions of companies offering local paid-search services. Industry consolidation may result in larger, more established and well-financed competitors with a greater focus on local search services. If this trend continues, we may not be able to compete in the local search market and our financial results may suffer.

 

Additionally, larger companies may implement technologies into their search engines or software that make it less likely that consumers will reach, or execute searches on, Local.com and less likely to access our partners’ sponsored listings. If we are unable to successfully compete against current and future competitors or if our current network partners choose to rely more heavily on their own distribution networks in the future, our operating results will be adversely affected.

 

Major Customers

 

We have two customers that each represents more than 10% of our total revenue. Our largest advertising partner, Yahoo! Inc., represented 43%, 45% and 54% of our total revenue for the years ended December 31, 2010, 2009 and 2008, respectively. Our local advertising partner, SuperMedia Inc., represented 24%, 23% and 18% of our total revenue for the years ended December 31, 2010, 2009 and 2008, respectively. Our relationship with Yahoo! Inc. and generally all of our partners are short term in nature. There can be no assurance that our agreements with Yahoo! Inc. and other partners will be renewed upon their expiration. If those agreements are renewed, there can be no assurance that it will be on terms as favorably as those we currently have with such partners. If those agreements are not renewed, there can be no assurance that we will be able to find alternative partners on terms as favorable as those we currently have, if at all. The loss of Yahoo! Inc. and/or SuperMedia, Inc. as a partner and a failure to find a comparable replacement would have a material adverse affect on our operating results. The Company’s agreement with SuperMedia Inc. ends June 30, 2013.

 

In the fourth quarter of 2010, in connection with Yahoo!’s integration of its advertising service with Microsoft’s Bing, we experienced a material reduction in the Revenue Per Click (“RPC”) that Yahoo! pays for clicks on their advertisements on our websites. The material reduction in RPC from Yahoo! had a material adverse effect on our revenue and earnings results for the fourth quarter of 2010. We have been actively working with Yahoo! to improve RPC and have also been pursuing a number of other strategies, including, but not limited to, optimization of our SEM campaigns as well as optimization and deployment of advertiser feeds from existing and new partners. We have begun to normalize our operations to this shift in RPC from Yahoo! and continue in our efforts to maximize our revenue and earnings opportunities with Yahoo!. These and other strategies are intended to preserve revenue and net income. However, we cannot give assurances that our efforts to improve monetization with Yahoo! or any of the alternative strategies will be successful. If we are unable to improve RPC in the near term, our business and financial results may be materially harmed and our revenue and net income going forward may be lower than experienced in the fourth quarter 2010.

 

Major Suppliers and Advertising Costs

 

We advertise on other search engine websites, primarily google.com, but also yahoo.com, bing.com, ask.com and others, by bidding on certain keywords we believe will drive consumers to our Local.com website. During the year ending December 31, 2010, approximately 68% of the traffic on our Local.com website and network partner websites was acquired through SEM campaigns on other search engine websites. During the year ended December 31, 2010, advertising costs to drive consumers to our Local.com website were $30.8 million of which $22.5 million was paid to Google, Inc. We are dependent on the advertising we do with other search engines, especially Google, to drive consumers to our Local.com website in order to generate revenue from searches and other actions they may undertake while at Local.com. If we were unable to advertise on these websites, or the cost to advertise on these websites increases, our financial results will suffer. While our strategy is to decrease our dependence on advertising with other search engines by growing our organic traffic through repeat usage, better content, and increased search engine optimization efforts, we cannot guarantee that these efforts will be successful or that we will not remain dependent on advertising with other search engines to secure the large majority of consumers who visit Local.com.

Intellectual Property

 

Our success and ability to compete are substantially dependent upon our internally developed technology and data resources. We seek to protect our intellectual property through existing laws and regulations, as well as through contractual restrictions. We rely on trademark, patent and copyright law, trade secret protection and confidentiality and license agreements with our employees, customers, partners and others to protect our intellectual property.

 

We own the registered trademarks for “Local.com,” “OCTANE360,” “Keyword DNA,” “Local Promote,” “Local Connect” and “Pay Per Connect,” among others, in the United States. We may claim trademark rights in, and apply for registrations in the United States for a number of other marks.

 

We have been issued seven patents by the United States Patent and Trademark Office:

 

 

We have patent applications pending related to a variety of business and transactional processes associated with paid-search and other cost-per-event advertising models in different environments. We may consolidate some of our current applications and expect to continue to expand our patent portfolio in the future. We cannot assure you, however, that any of these patent applications will be issued as patents, that any issued patents will provide us with adequate protection against competitors with similar technology, that any issued patents will afford us a competitive advantage, that any issued patents will not be challenged by third parties, that any issued patents will not be infringed upon or designed around by others, or that the patents of others will not have a material adverse effect on our ability to do business. Furthermore, our industry has been subject to frequent patent-related litigation by the companies and individuals that compete in it. The outcome of ongoing litigation or any future claims in our industry could adversely affect our business or financial prospects.

 

Government Regulation

 

Like many companies, we are subject to existing and potential government regulation. There are, however, comparatively few laws or regulations specifically applicable to Internet businesses. Accordingly, the application of existing laws to Internet businesses, including ours, is unclear in many instances. There remains significant legal uncertainty in a variety of areas, including, but not limited to: user privacy, the positioning of sponsored listings on search results pages, defamation, taxation, the provision of paid-search advertising to online gaming websites, the

legality of sweepstakes, promotions and gaming websites generally, and the regulation of content in various jurisdictions.

 

Compliance with federal laws relating to the Internet and Internet businesses may impose upon us significant costs and risks, or may subject us to liability if we do not successfully comply with their requirements, whether intentionally or unintentionally. Specific federal laws that impact our business include The Digital Millennium Copyright Act of 1998, The Communications Decency Act of 1996, The Children’s Online Privacy Protection Act of 1998 (including related Federal Trade Commission regulations), The Protect Our Children Act of 2008, and The Electronic Communications Privacy Act of 1986, among others. For example, the Digital Millennium Copyright Act, which is in part intended to reduce the liability of online service providers for listing or linking to third-party websites that include materials that infringe the rights of others, was adopted by Congress in 1998. If we violate the Digital Millennium Copyright Act we could be exposed to costly and time-consuming copyright litigation.

 

There are a growing number of legislative proposals before Congress and various state legislatures regarding privacy issues related to the Internet generally, and some of these proposals apply specifically to paid-search businesses. We are unable to determine if and when such legislation may be adopted. If certain proposals were to be adopted, our business could be harmed by increased expenses or lost revenue opportunities, and other unforeseen ways. We anticipate that new laws and regulations affecting us will be implemented in the future. Those new laws, in addition to new applications of existing laws, could expose us to substantial liabilities and compliance costs.

 

Employees

 

As of December 31, 2010 we had 116, all of which were full-time employees. 32 were engaged in research and development, 56 in sales and marketing and 28 in general and administration. None of our employees are represented by a labor union. We have not experienced any work stoppages, and we consider our relations with our employees to be good.

 

Seasonality

 

Our future results of operations may be subject to fluctuation as a result of seasonality. In particular, we expect our results of operations for the fourth quarter may demonstrate seasonal weakness because a larger portion of online consumer traffic and advertising is typically focused on holiday gift purchases and there is less advertising for locally-focused services during this quarter. Additionally, as other advertisers significantly increase their bid prices to acquire traffic for the holiday season, we generally keep our bid prices consistent throughout the year, resulting in less traffic to our websites from our SEM efforts. Online consumer traffic will also be lower due to increased holidays and vacation time during this quarter. We generally see an increase in revenue during the first quarter, when we expect to benefit from a higher volume of locally-focused traffic and a higher volume of online consumer traffic due to fewer holidays and vacation time; however, we expect first quarter 2011 revenue to decline from fourth quarter 2010 related to lower monetization of our traffic from a major customer.

 

Corporation Information

 

We were incorporated in Delaware in March 1999 as eWorld Commerce Corporation. In August 1999, we changed our name to eLiberation.com Corporation. In February 2003, we changed our name to Interchange Corporation. On November 2, 2006, we changed our name to Local.com Corporation. Our website is located at http://www.local.com. Our investor relations website is located at http://ir.local.com. We make available free of charge on our investor relations website under “SEC Filings” our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and any amendments to those reports as soon as reasonably practicable after we have electronically file or furnish such materials to the U.S. Securities and Exchange Commission (“SEC”). The SEC maintains a website that contains reports, proxy and information statements, and other information regarding our filings at http://www.sec.gov.

 

Investing in our common stock involves a high degree of risk. You should carefully consider the risks described below with all of the other information included in this Report before making an investment decision. If any of the possible adverse events described below actually occur, our business, results of operations or financial condition would likely suffer. In such an event, the market price of our common stock could decline and you could lose all or part of your investment. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial may also adversely affect our business, results of operations or financial condition.

 

Risks Relating to our Business

 

If we are not successful with our local search initiative, our future financial performance may be affected.

 

Since August 9, 2005, we have been operating Local.com, a consumer facing destination website specializing in local search and content. Since the third quarter of 2007, we have been operating our local syndication network which provides local search results and local content to our publisher partners. Since the third quarter of 2009, we have been operating a distribution network that provides organic and third party advertising feeds to hundreds of websites. We have and expect to continue to invest significant amounts of time and resources in our Local.com website, local syndication network, our distribution network and other similar initiatives, including our Octane360 platform launched in the third quarter of 2010. We cannot assure you that we will continue to sustain or grow our current revenue from these or other local search initiatives. We also cannot assure you that we will sustain or grow the number of consumers or advertisers that use or advertise on Local.com or other network offerings. If we are unable to sustain or grow the number of consumers using and/or advertisers advertising with Local.com, our local syndication and distribution networks, and our Octane360 platform, our financial performance may be adversely affected.

 

We have historically incurred losses and expect to incur losses in the future, which may impact our ability to implement our business strategy and adversely affect our financial condition.

 

We have a history of losses. We had a net loss of $6.3 million for the year ended December 31, 2009, and $8.6 million for the year ended December 31, 2008. We also had an accumulated deficit of $54.8 million at December 31, 2010, reduced from prior year due to net income for the current year of $4.2 million. We have significantly increased our operating expenses by expanding our operations, including through acquisitions, in order to grow our business and further develop and maintain our services. Such increases in operating expense levels may adversely affect our operating results if we are unable to immediately realize benefits from such expenditures. We cannot assure you that we will be profitable or generate sufficient profits from operations in the future. If our revenue does not grow, we may experience a loss in one or more future periods. We may not be able to reduce or maintain our expenses in response to any decrease in our revenue, which may impact our ability to implement our business strategy and adversely affect our financial condition.

 

Our advertising partners may unilaterally change how they value our inventory of available advertising placements, which could materially affect our advertising revenue. Recently, Microsoft’s Bing began charging advertisers less for our search traffic, which resulted in less RPC for our search results than Yahoo! had paid prior to the Yahoo!-Bing integration. If we are unable to improve RPC in the near term, these recent changes to the Yahoo! search and advertising platform could have a material and adverse effect on our financial results.

 

Our advertising partners, such as Yahoo!, may unilaterally change how they value our inventory of available advertising placements for any number of reasons, including changes in their services, changes in pricing, algorithms or advertising relationships. We have little control over such decisions. If our advertising partners pay us less for our advertising inventory, our advertising revenue would be materially adversely affected.

 

We are actively working with Yahoo! to improve RPC and are also pursuing a number of other strategies, including, but not limited to, optimization of our SEM campaigns as well as optimization and deployment of

advertiser feeds from existing and new partners. These and other strategies are intended to preserve revenue and net income. However, we cannot give assurances that our efforts to improve monetization with Yahoo! or any of the alternative strategies will be successful. If we are unable to improve RPC in the near term, our business and financial results may be materially harmed and our revenue and net income going forward may be lower than we reported for the fourth quarter 2010.

 

Until the drop in RPC, we had derived about half of our revenue from the display of advertising from Yahoo!. If we are unable to increase our RPC under the Yahoo!-Bing advertising platform, then our business revenues and financial condition will be materially adversely affected. In addition, any decreases in the breadth or depth of advertising available for display or any increase in our traffic acquisitions costs could materially adversely affect our ability to produce revenue and margin that is comparable to our historical results, in which case our business and financial results may be significantly harmed.

 

Recent changes to our Local.com website could have a material adverse effect on our financial results.

 

In the fourth quarter of 2010, we launched our redesigned Local.com website. The impact of the relaunch of our Local.com website will have on the ability of the Local.com website to generate revenue and margin comparable to the website’s historical performance is uncertain. Any deterioration in the number of visits, click-throughs, page views, searches and other important metrics or any increase in traffic acquisition costs compared to historical results could materially adversely affect our ability to produce revenue and margin that is comparable to our historical results, in which case our business and financial results may be significantly harmed.

 

If we fail to maintain the number of customers purchasing our monthly subscription products, our revenue and our business could be harmed. Our announced suspension of LEC-billed subscriber bases is expected to result in a decline in revenue and earnings.

 

Our monthly subscription customers do not have long-term obligations to purchase our products or services and many will cancel their subscriptions each month. As a result of this customer churn, we must continually add new monthly subscription customers to replace customers who cancelled and to grow our business beyond our current customer base.

 

In the fourth quarter of 2010, we announced that we suspended acquisitions of LEC-billed subscriber bases in order to concentrate our resources around the Octane360 product suite powered by our recently acquired Octane360 platform. As a result, we anticipate revenue from our existing subscribers to decline as the number of subscribers churns out. As we shift our efforts to focus on the sale of our Octane360 products, we initially do not anticipate that the revenues from those efforts will fully-offset the decline in revenue from existing subscribers as they churn out as anticipated. Any decline in subscriber revenue and related margin could materially adversely affect our business and financial results.

 

We have recently acquired assets and businesses and may face risks with integration and performance of these assets and businesses.

 

As part of our business strategy, in July 2010, we acquired the assets of Octane360, a technology startup providing domain-based local advertising solutions to small businesses, domain portfolio owners, agencies and channel partners. We are continuing to integrate the Octane360 business with our existing business, products and services. There can be no assurance that we will be able to successfully integrate the Octane360 business into our operations or that the sale of Octane360 products and services by us will be successful.

 

In January 2011, we acquired the assets of iTwango LLC., including a technology platform that enables group-buying of discounted daily deals by consumers from local businesses. We are in the process of developing the iTwango business and have formed a new Social Buying business unit for that purpose. Notwithstanding our efforts, there can be no assurance that we will be able to successfully launch the Social Buying business and integrate it into our operations. Additionally, the daily deals business is highly competitive and we face intense competition from larger, more established companies and we may not be able to compete effectively.

In February 2011, we announced that we had entered into an agreement to acquire the assets of Rovion, a rich media advertising company which sells, creates, delivers and tracks rich media advertising. The completion of the Rovion transaction is subject to the satisfaction of certain customary closing conditions, including the seller of the Rovion assets receiving necessary shareholder and debtholder approval. If the transaction is completed, we will begin the process of integrating the Rovion business with our existing business, products and services. There can be no assurance that we will be able to successfully integrate the Rovion business into our operations or that the sale of Rovion products and services by us will be successful.

 

We may enter into additional acquisitions, business combinations or strategic alliances in the future. Acquisitions may result in dilutive issuances of equity securities, use of our cash resources, incurrence of debt and amortization of expenses related to intangible assets acquired. In addition, the process of integrating an acquired company, business or technology, which require a substantial commitment of resources and management’s attention, may create unforeseen operating difficulties and expenditures. The acquisition of a company or business is accompanied by a number of risks, including, without limitation:

 

 

We may not be successful in addressing these risks or any other problems encountered in connection with the acquisitions of Octane360 or iTwango, or that we could encounter in future acquisitions, including Rovion, which would harm our business or cause us to fail to realize the anticipated benefits of our acquisitions.

 

Two of our advertising partners have provided a substantial portion of our revenue; the loss of either of these partners may have a material adverse effect on our operating results.

 

Our advertising partner, Yahoo! Inc., represented 43% of our total revenue for the year ended December 31, 2010, and our advertising partner, SuperMedia Inc., represented 24% of our total revenue for the year ended December 31, 2010. It is difficult to predict whether Yahoo! and SuperMedia will continue to represent such a significant portion of our revenue in the future. Additionally, our contracts with each of these advertising partners are generally short term in nature, with Yahoo!’s contract expiring in July 2011 and SuperMedia’s contract expiring in June 2013. Upon expiration of these agreements, there can be no assurance that they will be renewed, or, if these agreements are renewed, that we would receive the same or a higher revenue share as we do under the current agreement, or involve the same amount of use of our paid-search services as currently used, or contain the same

rights as they currently do, in which case our business and financial results may be harmed. Additionally, there can be no assurance that if we enter into an arrangement with alternative advertising partners the terms would be as favorable as those under the current Yahoo! and SuperMedia agreements. Even if we were to enter into an arrangement with an alternative advertising partners with terms as or more favorable than those under the current agreements with Yahoo! and SuperMedia, such arrangements might generate significantly lower search advertising revenues for us if the alternative advertising partners are not able to generate advertising revenues as successfully as Yahoo! and SuperMedia currently generate.

 

Two customers account for a significant portion of our accounts receivable, and the failure to collect from these customers would harm our financial condition and results of operations.

 

While most of our customers pay for our services in advance, some do not. Two of our customers that do not pay in advance, Yahoo! and SuperMedia, have and for the foreseeable future will likely continue to account for a significant portion of our accounts receivable. At December 31, 2010, Yahoo! and SuperMedia represented 55% of our total accounts receivable. Yahoo! and SuperMedia’s accounts have been, and will likely continue to be, unsecured and any failure to collect on those accounts would harm our financial condition and results of operations.

 

A significant portion of the traffic to our Local.com website is acquired from other search engines, mainly google.com, the loss of the ability to acquire traffic could have a material and adverse effect on our financial results.

 

We advertise on other search engine websites, primarily google.com, but also yahoo.com, MSN/bing.com and ask.com, by bidding on certain keywords we believe will drive traffic to our Local.com website. During the year ending December 31, 2010, approximately 68% of the traffic on our Local.com website and network partner websites was acquired through SEM campaigns on other search engine websites. During the year ended December 31, 2010, advertising costs to drive consumers to our Local.com website were $30.8 million of which $22.5 million was paid to Google, Inc. If we are unable to advertise on these websites, or the cost to advertise on these websites increases, our financial results will suffer.

 

Problems with our computer and communication systems may harm our business.

 

A key element of our strategy is to generate a high volume of traffic across our network infrastructure to and from our advertising partners and local syndication and distribution networks. Accordingly, the satisfactory performance, reliability and availability of our software systems, transaction-processing systems and network infrastructure are critical to our reputation and our ability to attract and retain advertising customers, as well as maintain adequate customer service levels. We may experience periodic systems interruptions. Any substantial increase in the volume of traffic on our software systems or network infrastructure will require us to expand and upgrade our technology, transaction-processing systems and network infrastructure. We cannot assure you that we will be able to accurately project the rate or timing of increases, if any, in the use of our network infrastructure or timely expand and upgrade our systems and infrastructure to accommodate such increases.

 

We face intense competition from larger, more established companies, as well as our own advertising partners, and we may not be able to compete effectively, which could reduce demand for our services.

 

The online paid-search market is intensely competitive. Our primary current competitors include Yahoo! Inc., Microsoft Corporation, Google Inc. and online directories, such as Yellowpages.com. Although we currently pursue a strategy that allows us to partner with a broad range of websites and search engines, our current and future partners may view us as a threat to their own internal paid-search services. Nearly all of our competitors have longer operating histories, larger customer bases, greater brand recognition and significantly greater financial, marketing and other resources than we do. Our competitors may secure more favorable revenue sharing agreements with network distributors, devote greater resources to marketing and promotional campaigns, adopt more aggressive growth strategies and devote substantially more resources to website and systems development than we do. In addition, the search industry has experienced consolidation, including the acquisitions of companies offering paid-search services. Industry consolidation has resulted in larger, more established and well-financed competitors with a

greater focus on paid-search services. If these industry trends continue, or if we are unable to compete in the paid-search market, our financial results may suffer.

 

We are dependent on third-party products, services and technologies; changes to existing products, services and technologies or the advent of new products, services and technologies could adversely affect our business.

 

Our business is dependent upon our ability to use and interact with many third-party products, services and technologies, such as browsers, data and search indices, and privacy software. Any changes made by third parties or consumers to the settings, features or functionality of these third-party products, services and technologies or the development of new products, services and technologies that interfere with or disrupt our products, services and technologies could adversely affect our business. For instance, if a major search index were to alter its algorithms in a manner that resulted in our content not being indexed as often or appearing as high in its search results, our consumers might not be able to reach and use our content, products and services and our business could be adversely affected. Similarly, if more consumers were to switch their browsers to higher security settings to restrict the acceptance of cookies from the websites they visit, our ability to effectively use cookies to track consumer behavior in our business could be impacted and our business could be adversely affected.

 

We rely on our advertising partners to provide us access to their advertisers, and if they do not, it could have an adverse impact on our business.

 

We rely on our advertising partners to provide us with advertiser listings so that we can distribute these listings to Local.com and our network partners in order to generate revenue when a consumer click-through or other paid event occurs on our advertising partners’ sponsored listings. For the year ended December 31, 2010, 72% of our revenue was derived from our advertising partners. Most of our agreements with our advertising partners are short-term, and, as a result, they may discontinue their relationship with us or negotiate new terms that are less favorable to us, at any time, with little or no notice. Our success depends, in part, on the maintenance and growth of our advertising partners. If we are unable to develop or maintain relationships with these partners, our operating results and financial condition could suffer.

 

We are dependent on network partners to provide us with local search traffic and access to local advertisers, and if they do not, our business could be harmed.

 

We have contracts with our network partners to provide us with either local search traffic or access to local advertisers. Our network partners are very important to our revenue and results of operations. Any adverse change in our relationships with key network partners could have a material adverse impact on our revenue and results of operations. In many cases, our agreements with these network partners are short-term and/or subject to many variables which enable us or our network partners to discontinue our relationship or negotiate new terms that are less favorable to us with little or no notice. If we are unable to maintain relationships with our current network partners or develop relationships with prospective network partners on terms that are acceptable to us, our operating results and financial condition could suffer. Any decline in the number and/or quality of our network partners could adversely affect the value of our services.

 

The effects of the recent global economic crisis may impact our business, operating results, or financial condition.

 

The recent global economic crisis has caused disruptions and extreme volatility in global financial markets, increased rates of default and bankruptcy, and has impacted levels of consumer spending. These macroeconomic developments could negatively affect our business, operating results, or financial condition in a number of ways. For example, current or potential customers, such as advertisers, may delay or decrease spending with us or may not pay us or may delay paying us for previously performed services. In addition, if consumer spending continues to decrease, this may result in fewer clicks on our advertisers’ ads displayed on our Local.com website or our network partner websites.

The current global financial crisis and uncertainty in global economic conditions may have significant negative effects on our access to credit and our ability to raise capital.

 

We have historically relied on private placements of our equity to fund our operations. On January 20, 2011, we completed a underwritten public offering of 4,600,000 shares of our common stock at $4.25 per share, resulting in net proceeds to us of $18.2 million. On June 28, 2010, we entered into a Loan and Security Agreement with Silicon Valley Bank, replacing our line of credit with Square 1 Bank that expired by its terms on June 25, 2010. The loan agreement provides us with a revolving credit facility of up to $30.0 million. The maturity date of the revolving credit facility is June 28, 2013. As of December 31, 2010, we had $7.0 million in borrowings outstanding under the revolving credit facility and total availability of $23 million. We must meet certain financial covenants during the term of the revolving credit facility, including maintaining a minimum adjusted quick ratio of 1.25 to 1, which is a ratio of our unrestricted cash and cash equivalents plus net billed accounts receivable and investments that mature in fewer than 12 months to our current liabilities minus deferred revenue, warrant liability and plus 25% of any outstanding credit extensions under the revolving credit facility. We are also required to maintain a leverage ratio of not greater than 2.5 at the end of each fiscal quarter through June 30, 2012, and 2.0 at the end of each fiscal quarter thereafter. In addition, our quarterly adjusted EBITDA must equal at least $1,000,000 (this minimum amount is for financial covenant purposes only, and does not represent projections or expectations of our future financial results). As of December 31, 2010, we were in compliance with all such financial covenants; however, we cannot assure you that we will remain in compliance with our financial covenants in the future. If we are unable to comply with our financial covenants, the lender may declare an event of default under the loan agreement, in which event all outstanding borrowings would become immediately due and payable. We cannot assure you that we would have sufficient cash on hand to repay such outstanding borrowings if an event of default were declared under the loan agreement. The recent global financial crisis which has included, among other things, significant reductions in available capital and liquidity from banks and other providers of credit, substantial reductions and/or fluctuations in equity and currency values worldwide, and concerns that the worldwide economy may enter into a prolonged recessionary period, may make it difficult for us to raise additional capital or obtain additional credit, when needed, on acceptable terms or at all. The failure to raise capital or obtain credit when needed, or on acceptable terms, could have a material adverse effect on our business, prospects, financial condition and results of operations.

 

Our executive officers and certain key personnel are critical to our success, and the loss of these officers and key personnel could harm our business.

 

Our performance is substantially dependent on the continued services and performance of our executive officers and other key personnel. While we have employment agreements with our five executive officers and certain key personnel, each of these may, however, be terminated with 30 days notice by either party. No key man life insurance has been purchased on any of our executive officers. Our performance also depends on our ability to retain and motivate our officers and key employees. The loss of the services of any of our officers or other key employees could have a material adverse effect on our business, prospects, financial condition and results of operations. Our future success also depends on our ability to identify, attract, hire, train, retain and motivate other highly skilled technical, managerial and marketing personnel. Competition for such personnel is intense, and we cannot assure you that we will be successful in attracting and retaining such personnel. The failure to attract and retain our officers or the necessary technical, managerial and marketing personnel could have a material adverse effect on our business, prospects, financial condition and results of operations.

 

The market for Internet and local search advertising services is in the early stages of development, and if the market for our services decreases it will have a material adverse effect on our business, prospects, financial condition and results of operations.

 

Internet marketing and advertising, in general, and paid-search, in particular, are in the early stages of development. Our future revenue and profits are substantially dependent upon the continued widespread acceptance, growth, and use of the Internet and other online services as effective advertising mediums. Many of the largest advertisers have generally relied upon more traditional forms of media advertising and have only limited experience advertising on the Internet. Local search, in particular, is still in an early stage of development and may not be accepted by consumers for many reasons including, among others, that consumers may conclude that local

search results are less relevant and reliable than non-paid-search results, and may view paid-search results less favorably than search results generated by non-paid-search engines. If consumers reject our paid-search services, or commercial use of the Internet generally, and the number of click-throughs on our sponsored listings decreases, the commercial utility of our search services could be adversely affected which could have a material adverse effect on our business, prospects, financial condition and results of operations.

 

We expect that our anticipated future growth, including through potential acquisitions, may strain our management, administrative, operational and financial infrastructure, which could adversely affect our business.

 

We anticipate that significant expansion of our present operations will be required to capitalize on potential growth in market opportunities. This expansion has placed, and is expected to continue to place, a significant strain on our management, operational and financial resources. We expect to add a significant number of additional key personnel in the future, including key managerial and technical employees who will have to be fully integrated into our operations. In order to manage our growth, we will be required to continue to implement and improve our operational and financial systems, to expand existing operations, to attract and retain superior management, and to train, manage and expand our employee base. We cannot assure you that we will be able to effectively manage the expansion of our operations, that our systems, procedures or controls will be adequate to support our operations or that our management will be able to successfully implement our business plan. If we are unable to manage growth effectively, our business, financial condition and results of operations could be materially adversely affected.

 

We may incur impairment losses related to goodwill and other intangible assets which could have a material and adverse effect on our financial results.

 

As a result of our acquisition of Inspire Infrastructure 2i AB, the purchase of Local.com domain name, the Atlocal asset purchase, the acquisition of PremierGuide, Inc., the acquisition of Simply Static, LLC (doing business as Octane360), the acquisition of the iTwango technology platform, and the purchase of subscribers from LiveDeal, Inc., LaRoss Partners, Inc., Turner Consulting Group, LLC, and Best Click Advertising.com, LLC, we have recorded substantial goodwill and intangible assets in our consolidated financial statements. We are required to perform impairment reviews of our goodwill and other intangible assets, which are determined to have an indefinite life and are not amortized. Such reviews are performed annually or earlier if indicators of potential impairment exist. We performed our annual impairment analysis as of December 31, 2010, and determined that no impairment existed. Future impairment reviews may result in charges against earnings to write-down the value of intangible assets.

 

If we are not successful in defending against the patent infringement lawsuit filed against us, our operations could be materially adversely affected.

 

On July 23, 2010, a lawsuit alleging patent infringement was filed in the United States District Court for the Eastern District of Texas against us and others in our sector, by GEOTAG, Inc., a Delaware corporation with its principal offices in Plano, Texas. The complaint alleges that we infringe U.S. Patent No. 5,930,474 (hereinafter, the “ ‘474 Patent”) as a result of the operation of our website at www.local.com. GEOTAG, Inc. purports to be the rightful assignee of all right, title and interest in and to the ‘474 Patent. The complaint seeks unspecified amounts of damages and costs incurred, including attorney fees, as well as a permanent injunction preventing us from continuing those activities that are alleged to infringe the ‘474 Patent. If it is determined that we have infringed the ‘474 Patent, we could be subject to damages and a permanent injunction that could have a material adverse effect on us and our operations. In addition, this litigation could have a material adverse effect on our financial condition and results of operations because of defense costs, diversion of management’s attention and resources and other factors.

 

We may be subject to intellectual property claims that create uncertainty about ownership of technology essential to our business and divert our managerial and other resources.

 

There has been a substantial amount of litigation in the technology industry regarding intellectual property rights. We cannot assure you that third parties will not, in the future, claim infringement by us with respect to our current or future services, trademarks or other proprietary rights. Our success depends, in part, on our ability to

protect our intellectual property and to operate without infringing on the intellectual property rights of others in the process. There can be no guarantee that any of our intellectual property will be adequately safeguarded, or that it will not be challenged by third parties. We may be subject to patent infringement claims or other intellectual property infringement claims that would be costly to defend and could limit our ability to use certain critical technologies.

 

We may also become subject to interference proceedings conducted in the patent and trademark offices of various countries to determine the priority of inventions. The defense and prosecution, if necessary, of intellectual property suits, interference proceedings and related legal and administrative proceedings is costly and may divert our technical and management personnel from their normal responsibilities. We may not prevail in any of these suits. An adverse determination of any litigation or defense proceedings could cause us to pay substantial damages, including treble damages if we willfully infringe, and, also, could put our patent applications at risk of not being issued.

 

Furthermore, because of the substantial amount of discovery required in connection with intellectual property litigation, there is a risk that some of our confidential information could be compromised by disclosure during this type of litigation. In addition, during the course of this kind of litigation, there could be public announcements of the results of hearings, motions or other interim proceedings or developments in the litigation. If investors perceive these results to be negative, it could have an adverse effect on the trading price of our common stock.

 

Any patent litigation could negatively impact our business by diverting resources and management attention away from other aspects of our business and adding uncertainty as to the ownership of technology and services that we view as proprietary and essential to our business. In addition, a successful claim of patent infringement against us and our failure or inability to obtain a license for the infringed or similar technology on reasonable terms, or at all, could have a material adverse effect on our business.

 

We may be subject to lawsuits for information displayed on our websites and the websites of our advertisers, which may affect our business.

 

Laws relating to the liability of providers of online services for activities of their advertisers and for the content of their advertisers’ listings are currently unsettled. It is unclear whether we could be subjected to claims for defamation, negligence, copyright or trademark infringement or claims based on other theories relating to the information we publish on our websites or the information that is published across our network of websites and partner websites. These types of claims have been brought, sometimes successfully, against online services as well as other print publications in the past. We may not successfully avoid civil or criminal liability for unlawful activities carried out by our advertisers. Our potential liability for unlawful activities of our advertisers or for the content of our advertisers’ listings could require us to implement measures to reduce our exposure to such liability, which may require us, among other things, to spend substantial resources or to discontinue certain service offerings. Our insurance may not adequately protect us against these types of claims and the defense of such claims may divert the attention of our management from our operations. If we are subjected to such lawsuits, it may adversely affect our business.

 

If we do not deliver traffic that converts into revenue for advertisers, then our advertisers and our advertising partners may pay us less for their listing or discontinue listings with us.

 

For our services to be successful, we need to deliver consumers to advertisers’ websites that convert into sales for the advertiser. If we do not meet advertisers’ expectations by delivering quality traffic, then our advertisers may pay us less for their monthly subscription listings and our advertising partners may pay us less per click or in both cases, cease doing business with us altogether, which may adversely affect our business and financial results. We compete with other web search services, online publishers and high-traffic websites, as well as traditional media such as television, radio and print, for a share of our advertisers’ total advertising expenditures. Many potential advertisers and advertising agencies have only limited experience advertising on the Internet and have not devoted a significant portion of their advertising expenditures to paid-search. Acceptance of our advertising offerings among our advertisers and advertising partners will depend, to a large extent, on its perceived effectiveness and the

continued growth of commercial usage of the Internet. If we experience downward pricing pressure for our services in the future, our financial results may suffer.

 

If we fail to detect click-through fraud, we could lose the confidence of our advertisers and advertising partners, thereby causing our business to suffer.

 

We are exposed to the risk of fraudulent or illegitimate clicks on our sponsored listings. If fraudulent clicks are not detected, the affected advertisers may experience a reduced return on their investment in our advertising programs because the fraudulent clicks will not lead to revenue for the advertisers. As a result, our advertisers and advertising partners may become dissatisfied with our advertising programs, which could lead to loss of advertisers, advertising partners and revenue.

 

If we do not continue to develop and offer compelling content, products and services, our ability to attract new consumers or maintain the engagement of our existing consumers could be adversely affected.

 

We believe we must offer compelling content, products and services in order to attract new consumers and maintain the engagement of our existing consumers. Our ability to acquire, develop and offer new content, products and services, as well as new features, functionality and enhanced performance for our existing content, services and products requires substantial costs and efforts. The consumer reception of any new offerings we may make is unknown and subject to consumer sentiment that is difficult to predict. If we are unable to provide content, products, and services that are sufficiently attractive and relevant to consumers (including subscribers to our monthly subscription listing products), we may not be able to attract new consumers or maintain or increase our existing consumers’ engagement with our Local.com site or our other offerings. Even if we are successful in the development and offering of compelling content, products, features, and services, we may not be able to attract new consumers or maintain or increase our existing consumers’ engagement.

 

If we cannot continue to develop and offer effective advertising products and services, our advertising revenues could be adversely affected.

 

We believe that growth in our advertising revenues depends on our ability to continue offering our advertisers and publishers with effective products and services. Developing new and improving upon our existing products and services may require significant effort and expense. If we are unable to develop and improve our advertising products and services, including those that more effectively or efficiently plan, price or target advertising, our advertising revenues could be adversely affected.

 

If our billing partners lose the ability to bill our monthly subscription customers through LECs on those monthly subscription customers’ telephone bills it would adversely impact our results of operations.

 

We currently maintain a billing relationship with certain third parties that bill some of our monthly subscription customers for us through each customer’s LEC. These third parties are approved to bill our products and services directly on most of our monthly subscription customers’ local telephone bills through their LEC, commonly referred to as their local telephone company. In fiscal 2010, approximately 87% of our monthly subscription customers were billed via LEC billing and revenue from LEC billing represented 15% of our total revenue in fiscal 2010. The existence of the LECs is the result of federal legislation. As such, Congress could pass future legislation that obviates the existence of or the need for the LECs. Additionally, regulatory agencies could limit or prevent the ability of our third-party partners to use the LECs to bill our monthly subscription customers. Similarly, the introduction of and advancement of new technologies, such as WiFi technology or other wireless-related technologies, could render unnecessary the existence of fixed telecommunication lines, which also could obviate the need for and access to the LECs. Finally, our third-party billing partners have historically been affected by the LECs’ internal policies. With respect to certain LECs, such policies are becoming more stringent. The inability on the part of our third-party billing partners to use the LECs to bill our advertisers through their monthly telephone bills could reduce the rate at which we are able to acquire new monthly subscription customers and increase the churn rate of our existing monthly subscription customers and would have a material adverse impact on our financial condition and results of operations.

Our revenue may decline over time due to the involvement of the alternative telephone suppliers in the local telephone markets.

 

Due to competition in the telephony industry, many business customers are finding alternative telephone suppliers, such as Competitive LECs, cable companies, VOIP offerings, and the like that offer less expensive alternatives to the LECs. When the LECs effectuate a price increase, many business customers look for an alternative telephone supplier. When our monthly subscription customers switch service providers from the LECs to an alternate telephone supplier, our third-party billing partners may be precluded from billing these monthly subscription customers on their monthly telephone bill and we must instead convert them to alternative billing methods such as credit card. This conversion process can be disruptive to our operations and result in lost revenue. We cannot provide any assurances that our efforts will be successful. The inability on the part of our third-party billing partners to use the LECs to bill our advertisers through their monthly telephone bills could reduce the rate at which we are able to acquire new monthly subscription customers and increase the churn rate of our existing monthly subscription customers and would have a material adverse impact on our financial condition and results of operations.

 

Our ability to efficiently bill our monthly subscription customers depends upon our third-party billing partners.

 

We currently depend upon our third-party billing partners to efficiently bill and collect monies through LEC billing. We currently have agreements with two third-party billing partners. Any disruption in these third parties’ ability to perform these functions could adversely affect our financial condition and results of operations.

 

If our monthly subscription customers file complaints against us or our partners, we could be forced to refund material amounts of monthly subscription revenues and our ability to operate our subscription service could be adversely impacted, which would adversely affect our results of operation.

 

We have internal and outsourced telesales initiatives that could result in complaints from our monthly subscription customers against us or our third-party partners who dispute that they have agreed to receive and be billed for our monthly subscription services. Monthly subscription customers may also direct their complaints to a state’s attorney general’s office, federal agencies such as the Federal Trade Commission, their LEC and other authorities. If a complaint is directed to an attorney general, a Federal agency, a LEC or other authorities, we may be forced to alter or curtail our sales and billing activity and to refund the monthly subscription fees that have already been collected for services rendered in unknown amounts. If this were to happen, our financial results could be materially impacted.

 

Failure to adequately protect our intellectual property and proprietary rights could harm our competitive position.

 

Our success is substantially dependent upon our proprietary technology, which relates to a variety of business and transactional processes associated with our paid-search advertising model, our Keyword DNA technology and our Local Connect search and advertising platform. We rely on a combination of patent, trademark, copyright and trade secret laws, as well as confidentiality agreements and technical measures, to protect our proprietary rights. We have been issued seven patents and although we have filed additional patent applications on certain parts of our technology, much of our proprietary information may not be patentable. We cannot assure you that we will develop proprietary technologies that are patentable or that any pending patent applications will be issued or that their scope is broad enough to provide us with meaningful protection. We own the trademarks for Local.com, OCTANE360, Pay Per Connect, Local Promote, Local Connect and Keyword DNA, among others, in the United States and may claim trademark rights in, and apply for trademark registrations in the United States for a number of other marks. We cannot assure you that we will be able to secure significant protection for these marks. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our services or to obtain and use information that we regard as proprietary. We cannot assure you that our means of protecting our proprietary rights will be adequate or that our competitors will not independently develop similar technology or duplicate our services or design around patents issued to us or our other intellectual property rights. If we are unable to adequately protect our intellectual property and proprietary rights, our business and our operations could be adversely affected.

We rely on third-party technology, server and hardware providers, and a failure of service by any of these providers could adversely affect our business and reputation.

 

We rely upon third-party data center providers to host our main servers and expect to continue to do so. In the event that these providers experience any interruption in operations or cease operations for any reason or if we are unable to agree on satisfactory terms for continued hosting relationships, we would be forced to enter into a relationship with other service providers or assume hosting responsibilities ourselves. If we are forced to switch hosting facilities, we may not be successful in finding an alternative service provider on acceptable terms or in hosting the computer servers ourselves. We may also be limited in our remedies against these providers in the event of a failure of service. In the past, we have experienced short-term outages in the service maintained by one of our current co-location providers. We also rely on third-party providers for components of our technology platform, such as hardware and software providers, credit card processors and domain name registrars. A failure or limitation of service or available capacity by any of these third-party providers could adversely affect our business and reputation.

 

If we fail to scale and adapt our existing technology architecture to manage the expansion of our offerings our business could be adversely affected.

 

We anticipate expanding our offerings to consumers, advertisers and publishers. Any such expansion will require substantial expenditures to scale or adapt our technology infrastructure. As usage increases and products and services expand, change or become more complex in the future, our complex technology architectures utilized for our consumer offerings and advertising services may not provide satisfactory support. As a result, we may make additional changes to our architectures and systems to deliver our consumer offerings and services to advertisers and publishers, including moving to completely new technology architectures and systems. Such changes may be challenging to implement and manage, may take time to test and deploy, may cause us to incur substantial costs and may cause us to suffer data loss or delays or interruptions in service. These delays or interruptions in service may cause consumers, advertisers and publishers to become dissatisfied with our offerings and could adversely affect our business.

 

Our business is subject to a number of natural and man-made risks, including natural disasters such as fires, floods, and earthquakes and problems such as computer viruses or terrorism.

 

Our systems and operations are vulnerable to damage or interruption from natural disaster and man-made problems, including fires, floods, earthquakes, power losses, telecommunications failures, terrorist attacks, acts of war, human errors, break-ins and similar events. As an example, if we were to experience a significant natural disaster, such as an earthquake, fire or flood, it likely would have a material adverse impact on our business, operating results and financial condition, and our insurance coverage will likely be insufficient to compensate us for all of the losses we incur. Additionally, our servers may be vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems, which could lead to interruptions, delays, loss of critical data or the unauthorized disclosure of confidential intellectual property or customer data. We may not have sufficient protection or recovery plans in certain circumstances, such as natural disasters affecting the Southern California area, and our business interruption insurance may be insufficient to compensate us for losses that may occur. As we rely heavily on our servers, computer and communications systems and the Internet to conduct our business and provide customer service, such disruptions could negatively impact our ability to run our business, which could have an adverse affect on our operating results and financial condition.

 

State and local governments may be able to levy additional taxes on Internet access and electronic commerce transactions, which could result in a decrease in the level of usage of our services.

 

Beginning in 1998, the federal government imposed a moratorium on state and local governments’ imposition of new taxes on Internet access and eCommerce transactions, which has now expired. State and local governments may be able to levy additional taxes on Internet access and eCommerce transactions unless the moratorium is reinstituted. Any increase in applicable taxes may make eCommerce transactions less attractive for businesses and consumers, which could result in a decrease in eCommerce activities and the level of usage of our services.

Federal, state or international laws or regulations applicable to our business could adversely affect our business.

 

We are subject to a variety of existing federal, state and international laws and regulations in the areas of advertising, content regulation, privacy, consumer protection, defamation, child protection, advertising to and collecting information from children, taxation and billing, among others. These laws can change, as can the interpretation and enforcement of these laws. Additionally, new laws and regulations may be enacted at any time. Compliance with laws is often costly and time consuming and may result in the diversion of a significant portion of management’s attention. Our failure to comply with applicable laws and regulations could subject us to significant liabilities which could adversely affect our business. Specific federal laws that impact our business include The Digital Millennium Copyright Act of 1998, The Communications Decency Act of 1996, The Children’s Online Privacy Protection Act of 1998 (including related Federal Trade Commission regulations), The Protect Our Children Act of 2008, and The Electronic Communications Privacy Act of 1986. Additionally, there are a number of state laws and pending legislation governing the breach of data security in which sensitive consumer information is released or accessed. If we fail to comply with applicable laws or regulations we could be subject to significant liability which could adversely affect our business.

 

Failure to comply with federal, state or international privacy laws or regulations, or the expansion of current or the enactment of new privacy laws or regulations, could adversely affect our business.

 

We are subject to a variety of federal, state and international laws and regulations that govern the collection, retention, use, sharing and security of consumer data. Existing privacy-related laws and regulations are evolving and subject to potentially differing interpretations. Additionally, it is possible that existing laws may be expanded upon or new laws passed that would require our compliance. Any failure to comply with the existing laws, regulations, industry self-regulatory principles or our own posted privacy policies and practices concerning the collection, use and disclosure of user data on our websites could result in claims, proceedings or actions against us by governmental entities or others, which could adversely affect our business. In addition, any failure or perceived failure by us to comply with industry standards or with our own privacy policies and procedures could result in a loss of consumers or advertisers and adversely affect our business.

 

Government and legal regulations with respect to the Internet may damage our business.

 

There are currently few significant laws or regulations directly applicable to access to or commerce on the Internet. It is possible, however, that a number of laws and regulations may be adopted with respect to the Internet, covering issues such as the positioning of sponsored listings on search results pages. For example, the Federal Trade Commission, or FTC, has in the past reviewed the way in which search engines disclose paid-search practices to Internet users. In 2002, the FTC issued guidance recommending that all search engine companies ensure that all paid-search results are clearly distinguished from non-paid results, that the use of paid- search is clearly and conspicuously explained and disclosed and that other disclosures are made to avoid misleading users about the possible effects of paid-search listings on search results. In February 2009, the FTC issued a staff report titled “Self-Regulatory Principles for Online Behavioral Advertising.” In December 2009, the FTC issued “Guides Concerning the Use of Endorsements and Testimonials in Advertising.”

 

The adoption of laws, regulations, guidelines and principles relating to online advertising, including behavioral advertising, placement of paid search advertisements or user privacy, defamation or taxation and the like may inhibit the growth in use of the Internet, which in turn, could decrease the demand for our services and increase our cost of doing business or otherwise have a material adverse effect on our business, prospects, financial condition and results of operations. Any new legislation or regulation, or the application of existing laws and regulations to the Internet or other online services, could have a material adverse effect on our business, prospects, financial condition and results of operations.

 

Any regulation of our use of cookies or similar technologies could adversely affect our business.

 

We use small text files placed in a consumer’s browser, commonly known as cookies, to facilitate authentication, preference management, research and measurement, personalization and advertisement and content

delivery. Several Federal, state and international governmental authorities are regularly evaluating the privacy implications inherent in the use of third-party web “cookies” for behavioral advertising and other purposes. Any regulation of these tracking technologies and other current online advertising practices could adversely affect our business.

 

Our ability to utilize our net operating loss carryforwards and certain other tax attributes may be limited.

 

Under Section 382 of the Internal Revenue Code, if a corporation undergoes an “ownership change” generally defined as a greater than 50% change (by value) in its equity ownership over a three-year period, the corporation’s ability to use its pre-change net operating loss carryforwards and other pre-change tax attributes against its post-change income may be limited. We performed a Section 382 study during the fourth quarter of 2010 and determined that it has more likely than not undergone five ownership changes as described in IRC Section 382. The latest ownership change occurred in December 2004. However, due to the relatively large annual limitations based on the value of the Company, the identified ownership changes had no material impact to the amount of net operation loss that can be carried forward to the future years. Any future ownership change may impact our ability to utilize the net operation loss carryforwards in the future year. At December 31, 2010, the Company had federal and state income tax net operating loss carryforwards of approximately $43.9 million and $41.3 million, respectively. The federal and state net operating loss carryforwards will expire through 2029 and 2021, respectively, unless previously utilized. On September 23, 2008, the State of California suspended the use of net operating loss carryforwards for 2008 and 2009 and on October 19, 2010, suspended the use of net operating loss carryforwards for 2010 and 2011. As a result of this suspension, we will not be able to make use of net operating loss carryforwards for state income tax purposes for the indefinite future. There can be no guarantee that we will ever be able to use these state net operating loss carryforwards in the future.

 

If we are not successful with developing our third-party sales channels, our future financial performance may be negatively affected.

 

Our future revenue growth is, in part, dependent upon the development of third-party sales channels to sell certain of our products, including certain of our SAS and Octane360 products. If we are unsuccessful in developing these third-party sales channels or if we are not able to secure these third-party sales channels on acceptable terms, our financial performance may be negatively affected. Additionally, if we or our established third-party sales channels are not able to sell our products at sufficient prices or in sufficient volumes, our financial performance may be negatively impacted. We cannot assure you that we will be successful in developing these third-party sales channels or that any third-party sales channels that are established will be successful in their efforts to sell our products.

 

Risks Relating to our Common Stock

 

The market price of our common stock has been and is likely to continue to be highly volatile, which could cause investment losses for our stockholders and result in stockholder litigation with substantial costs, economic loss and diversion of our resources.

 

The trading price of our common stock has been and is likely to continue to be highly volatile and could be subject to wide fluctuations as a result of various factors, many of which are beyond our control, including:

 

 

 

Due to the short-term nature of our advertising partner agreements and the emerging nature of the online advertising market, we may not be able to accurately predict our operating results on a quarterly basis, if at all, which may lead to volatility in the trading price of our common stock. In addition, the stock market in general, and the Nasdaq Capital Market and the market for online commerce companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of the listed companies. These broad market and industry factors may seriously harm the market price of our common stock, regardless of our operating performance. In the past, following periods of volatility in the market, securities class action litigation has often been instituted against these companies. Litigation against us, whether or not a judgment is entered against us, could result in substantial costs, and potentially, economic loss, and a diversion of our management’s attention and resources. As a result of these and other factors, you may not be able to resell your shares above the price you paid and may suffer a loss on your investment.

 

We have never paid dividends on our common stock.

 

Since our inception, we have not paid cash dividends on our common stock and we do not intend to pay cash dividends in the foreseeable future due to our limited funds for operations. Therefore, any return on your investment would likely come only from an increase in the market value of our common stock.

 

Certain warrants contain anti-dilution provisions that would be triggered upon an offering of our common stock and the exercise of options and warrants and other issuances of shares of common stock will likely have a dilutive effect on our stock price.

 

As of December 31, 2010, there were outstanding options to purchase an aggregate of 4,037,768 shares of our common stock at a weighted average exercise price of $5.02 per share, of which options to purchase approximately 1,964,612 shares were exercisable as of such date. As of December 31, 2010, there were outstanding warrants to purchase 1,334,022 shares of our common stock, at a weighted average exercise price of $7.88 per share.

 

On January 20, 2011, in connection with the completion of the public offering of 4,600,000 shares of our common stock and in accordance with the anti-dilution provisions contained in each of the warrants to purchase up to 537,373 shares of common stock at an exercise price of $7.89 per share that were issued in a private placement transaction on August 1, 2007 (the “Series A Warrants”) and the warrants to purchase up to 537,373 shares of common stock at an exercise price of $9.26 per share that were issued in the same private placement transaction on August 1, 2007 (the “Series B Warrants”), the exercise price of the Series A Warrants and the Series B Warrants was reduced to $7.02 per share and $8.09 per share, respectively, and we issued an additional 66,207 Series A Warrants at an exercise price of $7.02 per share, which are immediately exercisable (the “New Series A Warrants”), and an additional 77,707 Series B Warrants at an exercise price of $8.09 per share, which are immediately exercisable (the “New Series B Warrants”). The Series A Warrants and the Series B Warrants are exercisable until February 1, 2013

and February 3, 2014, respectively, and the New Series A Warrants and the New Series B Warrants are exercisable until February 1, 2013 and February 3, 2014, respectively.

 

The exercise of options and warrants, and the conversion of convertible securities, at prices below the market price of our common stock could adversely affect the price of shares of our common stock. In addition, the exercise of options and warrants will cause dilution to our existing shareholders. Additional dilution may result from the issuance of shares of our capital stock in connection with collaborations or commercial agreements or in connection with other financing efforts.

 

The issuance of additional shares of our common stock could be dilutive to stockholders if they do not invest in future offerings. Moreover, to the extent that we issue options or warrants to purchase, or securities convertible into or exchangeable for, shares of our common stock in the future and those options, warrants or other securities are exercised, converted or exchanged (or if we issue shares of restricted stock), stockholders may experience further dilution. Holders of shares of our common stock have no preemptive rights that entitle them to purchase their pro rata share of any offering of shares of any class or series.

 

Because almost all of our outstanding shares are freely tradable, sales of these shares could cause the market price of our common stock to drop significantly, even if our business is performing well.

 

As of January 31, 2011, we had outstanding 21,206,033 shares of common stock, of which our directors and executive officers owned 83,412 shares as of January 31, 2011 which are subject to the limitations of Rule 144 under the Securities Act. All of the 21,122,621 remaining outstanding shares are freely tradable.

 

In general, Rule 144 provides that any non-affiliate of ours, who has held restricted common stock for at least six months, is entitled to sell their restricted stock freely, provided that we stay current in our filings with the SEC. Because almost all of our outstanding shares are freely tradable and the shares held by our affiliates may be freely sold (subject to the Rule 144 limitations), sales of these shares could cause the market price of our common stock to drop significantly, even if our business is performing well.

 

Anti-takeover provisions may limit the ability of another party to acquire us, which could cause our stock price to decline.

 

Our amended and restated certificate of incorporation, our amended and restated bylaws and Delaware law contain provisions that could discourage, delay or prevent a third party from acquiring us, even if doing so may be beneficial to our stockholders. In addition, these provisions could limit the price investors would be willing to pay in the future for shares of our common stock. The following are examples of such provisions in our amended and restated certificate of incorporation and in our amended and restated bylaws:

 

 

 

We implemented a Stockholder Rights Plan, dated October 15, 2008, which may also have the effect of deterring or delaying attempts by our stockholders to affect changes in control. Each Right entitles the registered holder to purchase from our company one one-thousandth (1/1000) of a share of Series A Participating Preferred Stock, par value $0.00001, which we refer to as the preferred shares, of our company at a price of $10.00, which we refer to as the purchase price, subject to adjustment. The number of shares constituting the series of preferred shares is 30,000. The Rights are intended to protect our stockholders in the event of an unfair or coercive offer to acquire us and to provide the Board of Directors with adequate time to evaluate unsolicited offers. The Rights may have anti-takeover effects. The Rights will cause substantial dilution to a person or group that acquires 15% or more of the shares of our outstanding common stock without the approval of our Board of Directors. The Rights, however, should not affect any prospective offer or willingness to make an offer at a fair price as determined by our Board. The Rights should not interfere with any merger or other business combination approved by our Board of Directors. However, because the rights may substantially dilute the stock ownership of a person or group attempting to take us over without the approval of our Board of Directors, our rights plan could make it more difficult for a third party to acquire us (or a significant percentage of our outstanding capital stock) without first negotiating with our Board of Directors regarding that acquisition.

 

We are also subject to Section 203 of the Delaware General Corporation Law, which provides, subject to enumerated exceptions, that if a person acquires 15% or more of our voting stock, the person is an “interested stockholder” and may not engage in “business combinations” with us for a period of three years from the time the person acquired 15% or more of our voting stock.

 

 

Not applicable

 

 

Our executive and administrative offices are located at 7555 Irvine Center Drive, Irvine, CA, where we lease approximately 34,612 square feet of space in a two-story office building. Our current monthly rent is $32,881, subject to annual increases. Our lease for this space ends in July 2015. We also maintain offices for our Octane360 business at 1845 S. Elena Avenue, 4th Floor, Redondo Beach, CA 90277, where we lease approximately 2,000 square feet of space. Our current monthly rent for our Redondo Beach office is $4,738, subject to annual increases. Our lease for this space ends in January 2012.

 

 

From time to time we may be subject to a variety of legal proceedings and claims in the ordinary course of business, including claims of alleged infringement of intellectual property rights and claims arising in connection with our services. Other than the GEOTAG litigation discussed below, we are not currently a party to any material legal proceedings.

 

GEOTAG Litigation

 

On July 23, 2010, a lawsuit alleging patent infringement was filed in the United States District Court for the Eastern District of Texas against us and others in our sector, by GEOTAG, Inc., a Delaware corporation with its principal offices in Plano, Texas. The complaint alleges that we infringe U.S. Patent No. 5,930,474 (hereinafter, the “ ‘474 Patent”) as a result of the operation of our website at www.local.com. GEOTAG, Inc. purports to be the rightful assignee of all right, title and interest in and to the ‘474 Patent. The complaint seeks unspecified amounts of damages and costs incurred, including attorney fees, as well as a permanent injunction preventing us from continuing those activities that are alleged to infringe the ‘474 Patent. We are investigating the merits of the claims and intend to vigorously defend ourselves.

Leite Litigation

 

On March 9, 2011, a putative class action was filed in the Superior Court for the State of California, County of Orange, against us, DigitalPost Interactive, Inc. (“DGLP”) and the directors of DGLP, Michael Sawtell, Steven Dong, and Brian Goss by Chris Leite, an individual and purported shareholder of DGLP on behalf of himself and others alleged to be similarly situated. The complaint alleges that DGLP and its directors have breached their fiduciary duties to DGLP’s shareholders and that we aided and abetted such breach in connection with the proposed acquisition by us of the assets of Rovion, Inc., the wholly-owned subsidiary of DGLP, pursuant to that certain Asset Purchase Agreement by and between DGLP and the Company dated February 11, 2011 (the “Proposed Transaction”). The claim seeks an injunction preventing us from completing the Proposed Transaction. The claim also seeks to have certified as a class of plaintiffs certain holders of DGLP common stock that are unaffiliated with DGLP directors named in the action. The claim further seeks a court order requiring that all of the directors of DGLP exercise certain fiduciary duties that were alleged by the plaintiff not to have been previously undertaken by such defendants. The claim also seeks a court order requiring DGLP to obtain a fairness opinion with respect to the Proposed Transaction. Additionally, the claim seeks certain disclosures with respect to retention bonuses proposed to be received by certain of the employees, including the directors of DGLP, pursuant to the Proposed Transaction and certain modifications to the escrow provisions of the Asset Purchase Agreement. Finally, the claim seeks an award of fees, expenses and costs to the plaintiff and plaintiff’s counsel. We are investigating the merits of the claims and intend to vigorously defend ourselves.

 

 

 

Market information

 

Our common stock has traded on the Nasdaq Capital Market under the symbol “LOCM” since November 2, 2006, when we changed the ticker symbol of our common stock in connection with our company name change to Local.com Corporation. Prior to that, our common stock was traded under the symbol “INCX.” The following table sets forth the range of high and low per share sales prices as reported on the Nasdaq Capital Market for each period indicated. These prices reflect inter-dealer prices without retail markup, markdown or commissions and may not represent actual transactions.

 

Performance Graph

 

The graph below compares the cumulative 5-year total return of holders of Local.com Corporation’s common stock with the cumulative total returns of the NASDAQ Composite index and the RDG Internet Composite index. The graph tracks the performance of a $100 investment in our common stock and in each of the indexes (with the reinvestment of all dividends) from 12/31/2005 to 12/31/2010. The stock price performance included in this graph is not necessarily indicative of future stock price performance. This performance graph shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), or otherwise subject to the liabilities under that section and shall not be deemed to be incorporated by reference into any filing of Local.com Corporation under the Securities Act of 1933, as amended, or the Exchange Act.

 

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Local.com Corporation, the NASDAQ Composite Index
and the RDG Internet Composite Index

 

 

*$100 invested on 12/31/05 in stock or index, including reinvestment of dividends.

Fiscal year ending December 31.

 

 

Holders

 

On February 28, 2011, the closing price of our common stock, as reported by the Nasdaq Capital Market, was $3.97 per share and the number of stockholders of record of our common stock was 59.

 

Dividends

 

We have never declared or paid any cash dividends on our capital stock. We currently intend to retain any future earnings to finance the growth and development of our business and therefore do not anticipate paying any cash dividends in the foreseeable future. Any future determination to pay cash dividends will be at the discretion of our board of directors and will depend upon our financial condition, operating results, capital requirements, and such other factors as our board of directors deems relevant.

Equity Compensation Plans

 

The information required by this item regarding equity compensation plans is incorporated by reference to the information set forth in Item 12 of this Annual Report on Form 10-K. See Note 12 to the consolidated financial statements for a description of securities authorized for issuance under equity compensation plans.

 

Unregistered Securities

 

We did not make any unregistered sales of our equity securities during fourth quarter of the year ended December 31, 2010. All other issuances of unregistered securities during 2010 have been previously disclosed.

 

Repurchase of Securities

 

We did not repurchase any shares of our equity securities during the fourth quarter of the year ended December 31, 2010.

 

 

Consolidated Statement of Operations Data (in thousands, except per share amounts):

 

 

Consolidated Balance Sheet Data (in thousands):

 

 

 

 

 

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 an internet search advertising company that enables businesses and consumers to find each other and connect, locally. We operate online businesses that collectively reach over 20 million monthly unique visitors across over 100,000 websites, and we serve over 45,000 small business customers with a variety of web hosting and local online advertising products.

 

Our Owned & Operated business unit manages our flagship property, Local.com, and a proprietary network of over 20,000 local websites, which reaches over 15 million monthly unique visitors. Our Network business unit operates (i) a leading private label local syndication network of over 1,000 U.S. regional media websites, (ii) 80,000 third-party local websites, and (iii) our own organic feed of local businesses plus third-party advertising feeds, both of which are focused primarily on local consumers to a distribution network of hundreds of websites. Our Sales & Ad Services business unit provides over 45,000 direct monthly subscribers with web hosting or web listing products. We use patented and proprietary search technologies and systems, to provide consumers with relevant search results for local businesses, products and services. By providing our users and those of our network partners with robust, current, local information about businesses and other offerings in their local area, we have created an audience of users that our direct advertisers and advertising partners desire to reach. Sales of advertising on Local.com and our local syndication network accounted for 80% of our total revenues in 2010.

 

We launched Local.com in August of 2005, our local syndication network in July 2007, and we expanded our sales and advertiser services offerings to include a larger number of direct service subscribers throughout 2009 and 2010. In the third quarter of 2010 we also acquired all of the assets of Simply Static, LLC (doing business as Octane360), a Delaware limited liability company. The Octane360 assets acquired included a technology platform, which can be used to offer targeting and registration of geo-category based local website domains; small business and geo-category website creation, hosting and management; an ad exchange to manage the selection and deployment of ad inventory across all Octane360-controlled domains and websites; and a content marketplace

to allow for the management of geo-category content written for advertising customers or our directly owned portfolio properties. We have been regularly developing and deploying new features and functionality to each of these channels designed to enhance the experience of our users and increase the value of our audience to our advertisers. With a strategic focus on three key drivers for our business — traffic, technology and advertisers — we believe we can continue to grow through our own efforts and the acquisition of complementary businesses and technologies intended to accelerate our growth.

 

In January 2011, we announced the formation of our Social Buying business unit following our acquisition of the iTwango deal-of-the-day technology platform.

 

2010 Corporate Highlights

 

During the year we entered into asset purchase agreements with LaRoss Partners, LLC (“LaRoss”), Turner Consulting Group, LLC (“Turner”) and Best Click Advertising.com, LLC (“BestClick”) for the purchase of an aggregate of 49,516 web hosting subscribers for a total of $5,307,645 in cash. In some cases the third party from whom such subscribers were acquired continues to provide ongoing billing services and hosting of the websites. The purchase price will be amortized on an accelerated basis over four years based on how we expect the customer relationships to contribute to future cash flows, as further described elsewhere in this Management’s Discussion and Analysis. In the fourth quarter of 2010, we announced that we will suspend acquisitions of LEC-billed subscriber bases in order to concentrate our resources around our Octane360 product suite powered by our recently acquired Octane360 platform. As a result, we anticipate revenue from our existing subscribers to decline and the remaining subscriber base to be significantly reduced in the upcoming year. Initially, the expected growth in revenue from Octane360 products is not expected to fully offset the decline in revenue from existing subscribers.

 

On April 21, 2010, we entered into an amended lease agreement with The Irvine Company LLC, which amends our lease with The Irvine Company LLC dated March 18, 2005. Pursuant to the amended lease agreement, we lease approximately 34,612 square feet of space in Irvine, California. We took possession of the new premises in August 2010 and concurrently ceased the lease of our previous headquarters, also in Irvine, California. The amended lease agreement provides for a lease term of sixty (60) months from the commencement date with the option to extend for an additional sixty (60) month term at then-current market rates. The aggregate rent for the term of the lease, as amended, is approximately $2.2 million.

 

On June 28, 2010, we entered into a Loan and Security Agreement with Silicon Valley Bank, replacing our line of credit with Square 1 Bank that expired by its terms on June 25, 2010. The Loan and Security Agreement provides us with a revolving credit facility of up to $30.0 million, depending on certain financial ratios. The maturity date of the revolving credit facility is June 28, 2013.

 

On July 1, 2010, we acquired all of the assets of Octane360. The assets acquired include a technology platform, which can be used to offer targeting and registration of geo-category based local website domains; small business and geo-category website creation, hosting and management; an ad exchange to manage the selection and deployment of ad inventory across all Octane360-controlled domains and websites; and a content marketplace to allow for the management of geo-category content written for advertising customers or our directly owned portfolio properties. Under the terms of the Asset Purchase Agreement, dated July 1, 2010 between us and Octane360, we acquired the assets of Octane360 for $3.5 million in cash, 200,482 shares of our common stock and possible future contingent consideration based on the achievement of certain earnout milestones. On July 28, 2010, Octane360 achieved one of the milestones and received an additional $325,000 in cash and 48,077 shares of our common stock. On September 28, 2010, three additional earnout milestones were achieved resulting in an additional cash payment to Octane360 totaling $1,950,000. Octane360 may receive up to an additional $3.3 million in a combination of cash and stock based on Octane360 achieving certain milestones and its operating performance during the two year period ending June 30, 2012, as more particularly described in the Octane360 Asset Purchase Agreement.

 

At the end of the third quarter of 2010, we entered into an expanded local advertising distribution agreement with SuperMedia Inc., effective September 30, 2010. The expanded agreement is expected to increase the monetization of our search traffic by providing an increased number of advertiser listings from SuperMedia in response to search requests on our Local.com website, and on network partner websites.

In November 2010, we relaunched our flagship, Local.com website, to include additional content, including coupons, articles and information about local events.

 

Outlook for Our Business

 

Local search allows consumers to search for local businesses, products or services by including geographic area, zip code, city name, or other geographically targeted search parameters in their search requests.

 

According to a September 2010 study, The Kelsey Group estimates that the local search market in the United States will grow from $4.2 billion in 2010 to $8.6 billion by 2014. Local businesses, those that principally serve consumers within a fifty mile radius of their location, are increasingly shifting their newspaper and print yellow pages ad spend to online advertising, some of which is directed towards local search advertising.

 

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 O&O and Network business units are designed to serve this market of consumers and advertisers, 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.

 

Local search is relatively new, and as a result it is difficult to determine our current market share or predict our future market share. Our revenue, profitability and future growth depend not only on our ability to execute our business plan, but also, among other things, on acceptance of our services, the growth of the paid-search market, our ability to effectively compete with other providers of local search, and paid-search technologies and services.

 

We have also taken steps to diversify our revenue sources, while maintaining our focus on local offerings, including through the acquisition of Octane360 and more recently the iTwango deal-of-the-day technology platform acquisition that closed in January 2011. In early February 2011, we also announced that we have entered into a definitive agreement to acquire the assets of Rovion, which includes a self-service rich media advertising platform.

 

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 to bring users to our Local.com website, the deployment of new features and functionality across business units and the support of our acquired companies. We also intend to continue to increase our sales and marketing expenses to promote our Local.com website.

 

In the fourth quarter of 2010, in connection with Yahoo!’s integration of its advertising service with Microsoft’s Bing, we experienced a material reduction in the RPC that Yahoo! pays for clicks on their advertisements on our sites. The material reduction in RPC from Yahoo! had a material adverse effect on our revenue and earnings results for the fourth quarter of 2010. We have been actively working with Yahoo! to improve RPC and have also been pursuing a number of other strategies, including, but not limited to, optimization of our SEM campaigns as well as optimization and deployment of advertiser feeds from existing and new partners. We have begun to normalize our operations to this shift in RPC from Yahoo! and continue in our efforts to maximize our revenue and earnings opportunities with Yahoo!. These and other strategies are intended to preserve revenue and net income. However, this lower level of monetization from Yahoo! is expected to continue into 2011. We cannot give assurances that our efforts to improve monetization with Yahoo! or any of the alternative strategies will be successful.

 

Sources of Revenue

 

We generate revenue primarily on our Local.com website and Network from both direct and indirect advertiser relationships, via:

 

 

 

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 year ended December 31, 2010, approximately 68% of our overall traffic was purchased from other search engine websites. During the year ended December 31, 2010, advertising costs to drive consumers to our Local.com website were $30.8 million of which $22.5 million was attributable to Google, Inc. 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. 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.

Results of Operations

 

The following table sets forth our historical operating results as a percentage of revenue for the years ended December 31, 2010, 2009 and 2008:

 

 

Years ended December 31, 2010 and 2009

 

Revenue

 

 

 

 

Owned and operated revenue for the year ended December 31, 2010, increased 20.8% compared to the same period in 2009. O & O revenue is affected by fluctuations in traffic at our Local.com website as well as the effectiveness by which we are able to monetize such traffic. A measure of the monetization of the traffic on our flagship Local.com website is revenue per thousand visitors (RKV). RKV decreased to $237 for the year ended December 31, 2010, from $261 for the year ended December 31, 2009. The decrease in monetization was offset by an increase in traffic to the Local.com website in 2010. The increase in traffic at our website is the result of higher cost of revenues to attract users to our Local.com website as well as increased organic search traffic over the same period. On a year-to-date basis, the decrease in RKV was a result of decreased RPC from Yahoo!, Inc., our largest customer. The decrease in RPC was, in part, due to the Yahoo!/Bing alliance, which resulted in changes to the Yahoo! search and advertising platform. The decline in the revenue from Yahoo! occurred during the fourth quarter of 2010. This lower level of monetization from Yahoo! is expected to continue into 2011.

 

Network revenue for the year ended December 31, 2010, increased $13.1 million, or 108.5%, compared to the same period in 2009. The increase is primarily due to a $10.5 million increase in revenue related to our distribution network and the sale of Octane360 products, including domains and websites, of $3.7 million as part of a new

revenue component of Network revenue, partially offset by a $802,000 decrease in revenue related to our local syndication network for the year. During the third quarter of 2009 we launched our distribution network, which distributes our advertising and content feeds to third-party websites. The increase in distribution network revenues is mainly due to the expansion of the distribution network being effective for the entire 2010 year. The decrease in local syndication network revenues is due to lower monetization of traffic on our network of over a 1000 regional media websites. The decrease in RPC due to the Yahoo/Bing alliance resulted in a decrease in revenue for us and our network partners which could in turn result in the loss of network partners in the future.

 

Sales and advertiser services revenue for the year ended December 31, 2010, increased $7.1 million or 95.3% as we grew our base of small business subscribers from approximately 40,000 at the end of 2009 to over 45,000 at the end of 2010. The increase in small business subscribers was primarily the result of acquisitions of subscriber bases during 2010 coupled with our internal and outsourced sales efforts. During the year, we purchased approximately 50,000 website hosting subscribers from LaRoss, Turner and BestClick while we lost approximately 45,000 subscribers during the year due to expected attrition. In the fourth quarter of 2010, we announced that we will suspend acquisitions of LEC-billed subscriber bases in order to concentrate our resources around the Octane360 product suite powered by our recently acquired Octane360 platform. As a result, we anticipate revenue from our existing subscribers to decline and the remaining subscriber base to be significantly reduced in the upcoming year. Initially, the expected growth in revenue from Octane360 products is not expected to fully offset the decline in revenue from existing subscribers.

 

The growth in small business subscribers are 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):

 

 

 

 

Based on the above, total revenue for the year ended December 31, 2010, increased to $84.1 million from $56.2 million for the year ended December 31, 2009, an increase of $27.9 million, or 49.5%.

 

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

 

Operating expenses:

 

Operating expenses were as follows (dollars in thousands):

 

 

 

 

Cost of revenues

 

Cost of revenues expenses for the year ended December 31, 2010, increased by 37.0%, compared to the same period in 2009. The increase was primarily due to increased revenue share payments related to network partners and higher traffic acquisition costs associated with driving more consumers to our Local.com website. As a percent of revenue, cost of revenues declined to 55.3% for the year ended December 31, 2010, from 60.3% for the comparable prior year. The decline in cost of revenues as a percent of revenue was attributable to the high-margin revenue generated during the year ended December 31, 2010, from products related to the recently acquired Octane360 platform.

 

Sales and marketing

 

Sales and marketing expenses for the year ended December 31, 2010, increased by 20.0% compared to the same period in 2009. The increase was primarily due to higher personnel-related costs related to increased headcount and higher commissions on higher revenue as well as increased third-party sales expenses related to our outsourced sales efforts.

 

General and administrative

 

General and administrative expenses for the year ended December 31, 2010, increased by 17.3% compared to the same period in 2009. The increase is largely attributable to higher personnel-related costs, due to an increase in headcount, and increased office expenses.

 

Research and development

 

Research and development expenses for the year ended December 31, 2010, increased by 44.9% compared to the same period in 2009. The increase is mainly due to higher personnel-related costs and consulting fees as we invest in our systems and technology platforms. We capitalized an additional $3,085,000 of research and development expenses for website development and amortized $700,000 during the year ended December 31, 2010. We capitalized an additional $1,219,000 of research and development expenses for website development and amortized $355,000 of capitalized website development costs during the year ended December 31, 2009.

 

Amortization of intangibles

 

Amortization of intangibles expense was $5.7 million for the year ended December 31, 2010, compared to $2.5 million for the year ended December 31, 2009. Amortization increased in 2010 due to the subscriber acquisitions of customer-related intangible assets. The customer-related intangible assets of $5.3 million purchased in 2010 are amortized over the expected life of the assets based on the expected cash flow from the customers, resulting in accelerated amortization of the intangible assets over a period of approximately four years with the

weighted average percentage amortization for all small business subscriber relationships acquired to date being approximately 60% in year one, 21% in year two, 14% in year three and 5% in year four.

 

Interest and other income (expense), net

 

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

 

 

Interest and other income (expense) was ($275,000) and ($27,000) for the year ended December 31, 2010 and 2009, respectively. The increase is due to interest expense and amortization of fees related to our revolving credit facility. We had between $3.0 million and $7.0 million of borrowings outstanding on our revolving credit facility during the 2010 year, and no debt outstanding during 2009 other than the three days prior to year end. We expect interest and other income (expense) to continue at current levels.

 

Change in Fair Value of Warrant Liability

 

The change in fair value of the warrant liability was $0.9 million for the year ended December 31, 2010. In accordance with updated provisions of U.S. GAAP regarding accounting for derivatives, adopted effective January 1, 2009, certain warrants previously classified within equity were reclassified as liabilities. This change in fair value of warrant liability is a result of revaluing the warrant liability based on the Black-Scholes valuation model. This revaluation has no impact on our cash balances.

 

Provision for income taxes

 

Provision for income taxes was $102,000 for the year ended December 31, 2010, primarily relating to state income tax resulting from the California tax law change that suspended the use of corporate net operating loss carryforwards and an increase in the deferred tax liabilities on indefinite-lived assets, partially offset by California research and development credits and prior year actual to provision adjustments. Provision for income taxes was $158,000 for the year ended December 31, 2009, primarily relating to state income tax in California as state legislation postponed the use of corporate net operating loss carryfowards.

 

Years ended December 31, 2009 and 2008

 

Revenue

 

 

 

 

Owned and operated revenue for the year ended December 31, 2009, increased 20.0% compared to the same period in 2008. The increase in revenue was primarily due to increased traffic at our Local.com website. A measure of the monetization of the traffic on our flagship Local.com website is RKV. RKV increased to $261 for the year ended December 31, 2009, from $258 for the year ended December 31, 2008. The increase in traffic at our website was the result of higher marketing expense to attract users to our Local.com website as well as increased organic

search traffic over the same period. On a year-to-date basis, the increase in RKV was a result of additional ad units per page, optimization of search results to improve page yields, greater revenue share received from our advertising partners and improved SEM. The increases in owned and operated revenue were partially offset by a decline in our local international revenue for the year ended December 31, 2009, which decreased $654,000 compared to the same period in 2008. International revenue decreased as we shut down our UK website in April 2009.

 

Network revenue for the year ended December 31, 2009, increased $5.7 million, or 91.0%, compared to the same period in 2008. The increase was primarily due to a $2.6 million increase in revenue related to the distribution network and $3.1 million increase in revenue relating to the local syndication network. During the third quarter of 2009, we launched our distribution network, which distributes our advertising and content feeds to third-party websites. The increase in local syndication network revenues was due to the improved monetization of traffic on our network of approximately 750 regional media websites.

 

Sales and advertiser services revenue for the year ended December 31, 2009, increased $6.1 million or 464.8% as we grew our base of small business subscribers from approximately 5,000 at the end of 2008, to over 40,000 at the end of 2009. The increase in small business subscribers was the result of acquisitions of subscriber bases during 2009 coupled with our internal and outsourced sales efforts. During February 2009, we purchased 11,754 website hosting subscribers from LaRoss. During March 2009, we purchased 14,185 local business listing subscribers from LiveDeal, Inc. (“LiveDeal”) and its wholly owned subsidiary, Telco Billing, Inc. During December 2009, we purchased up to an additional 21,972 website hosting subscribers from LaRoss, an amount that was subsequently reduced to 18,817 after reduction for website hosting customers that failed to successfully transfer to us.

 

The growth in small business subscribers are 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):

 

 

 

 

Based on the above, total revenue for the year ended December 31, 2009, increased to $56.3 million from $38.3 million for the year ended December 31, 2008, an increase of $18.0 million, or 47.1%.

 

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

 

Operating expenses:

 

Operating expenses were as follows (dollars in thousands):

 

 

 

 

Cost of revenues

 

Cost of revenues for the year ended December 31, 2009, increased by $7.1 million, or 26.4%, compared to the same period in 2009. The increase was primarily due an increase in our revenue share payments to our private label network partners and expenses incurred to provide additional content to our Local.com website. We also increased our advertising costs associated with driving consumers to our Local.com website.

 

Cost of revenues as a total of revenues decreased from 70.2% to 60.3% for the years ended December 31, 2008 and 2009, respectively. The decrease in percentage was due to a greater return on our consumer-driving advertising costs and an increase in the amount organic traffic, which typically yields revenue without sales and marketing costs.

 

Sales and marketing

 

Sales and marketing expenses for the year ended December 31, 2009, increased by 9.9% compared to the same period in 2008. The increase was primarily due to higher personnel-related costs related to increased headcount and higher commissions on higher revenue as well as increased third-party sales expenses related to our outsourced sales efforts.

 

General and administrative

 

General and administrative expenses for the year ended December 31, 2009, increased by 39.2% compared to the same period in 2008. The increase was largely attributable to higher personnel-related costs. Included in the personnel-related cost was a non-recurring charge related to a change in officer recognized in the first quarter of 2009. The increases in general and administrative expenses were partially offset by a $138,000 gain on a contract settlement in the second quarter of 2009.

 

Research and development

 

Research and development expenses for the year ended December 31, 2009, increased by 15.4% compared to the same period in 2008. The increase was mainly due to higher personnel-related costs and consulting fees. We capitalized an additional $1,219,000 of research and development expenses for website development and amortized $355,000 during the year ended December 31, 2009. We capitalized an additional $234,000 of research and development expenses for website development and amortized $316,000 of capitalized website development costs during the year ended December 31, 2008.

 

Amortization and write-down of intangibles

 

Amortization of intangibles expense was $2.5 million for the year ended December 31, 2009, compared to $1.0 million for the year ended December 31, 2008. Amortization increased in 2009 due to the LaRoss and LiveDeal subscriber acquisitions of customer-related intangible assets. The customer-related intangible assets of $6.8 million

purchased in 2009 are amortized over the expected life of the assets based on the expected cash flow from the customers, resulting in accelerated amortization of the intangible assets over a period of approximately four years with the weighted average percentage amortization for all small business subscriber relationships acquired to date being approximately 60% in year one, 21% in year two, 14% in year three and 5% in year four.

 

Interest and other income (expense), net

 

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

 

 

Interest and other income (expense) was ($27,000) and $312,000 for the year ended December 31, 2009 and 2008, respectively. The decrease was due to a decrease in cash over the same period, a decline in interest rates and amortization of fees related to establishing our revolving credit facility. On December 29, 2009, we borrowed $3.0 million on our revolving credit facility at an interest rate equal to the greater of (i) 5.0% or (ii) the Prime Rate (as announced by Square 1 Bank) plus 1.75%. This amount was repaid in its entirety in June 2010.

 

Change in Fair Value of Warrant Liability

 

The change in fair value of the warrant liability was ($3.0) million for the year ended December 31, 2009. In accordance with updated provisions of U.S. GAAP regarding accounting for derivatives, adopted effective January 1, 2009, certain warrants previously classified within equity were reclassified as liabilities. This change in fair value of warrant liability was a result of revaluing the warrant liability based on the Black-Scholes valuation model. This revaluation had no impact on our cash balances for the period presented.

 

Provision for income taxes

 

Provision for income taxes was $158,000 for the year ended December 31, 2009, as we had taxable income and were required to record a provision primarily for state income tax in California as state legislation postponed the use of corporate net operating loss carryforwards. Provision for income taxes was $1,000 for the year ended December 31, 2008, and represented the minimum amounts required for state income taxes.

 

Liquidity and Capital Resources

 

Liquidity and capital resources highlights (in thousands):

 

 

Cash flow highlights (in thousands):

 

 

We have funded our business, to date, primarily from issuances of equity and debt securities; however, during the years ended December 31, 2010 and 2009, we generated positive cash flow from operations. Cash and cash equivalents were $13.1 million as of December 31, 2010 and $10.1 million as of December 31, 2009. We had

working capital of $8.2 million as of December 31, 2010 and $4.8 million as of December 31, 2009. Additionally, pursuant to the loan and security agreement with Silicon Valley Bank that we entered into on June 28, 2010, as further discussed below, we have secured a revolving credit facility of up to $30 million, based on certain formulas as set forth below. During 2010, we repaid $3 million to Square 1 Bank at the expiration of the credit facility and drew $7 million on the new credit facility with Silicon Valley Bank. The $7 million was used to fund various projects including the acquisition all of the assets of Octane360 and the purchase of small business subscribers during the year.

 

Net cash provided by operating activities was $8.3 million for the year ended December 31, 2010. Net income adjusted for non-cash charges (adding back depreciation and amortization, provision for doubtful accounts, changes in deferred income taxes, stock-based compensation expense and change in fair value of warrant liability) provided cash of $13.7 million. Changes in operating assets and liabilities used cash of $5.4 million. Net cash provided by operating activities was $3.4 million for the year ended December 31, 2009, primarily from the net income adjusted for non-cash items. The improvement in net cash provided by or used in operations from the prior year period is primarily due to improved bottom-line results driven by higher revenue and improved operating margins over the same period.

 

There are four primary drivers that affect cash provided by or used in operations: net income (loss); non-cash adjustments to net income (loss); changes in accounts receivable; and changes in accounts payable. For the year ended December 31, 2010, the terms of our accounts receivable and accounts payable remained unchanged, except for a significant customer change from prepaid status to “net 30 days” payment terms as of April 1, 2010. During the third quarter, we made an additional payment to our largest vendor to bring our outstanding accounts payable balances within the “net 30 days” payment terms.

 

The table below substantiates the change in net cash used in operating activities for the years ended December 31, 2010 and 2009 (in thousands):

 

 

 

 

Net cash used in investing activities was $16.9 million for the year ended December 31, 2010, and consisted of $6.3 million for capital expenditures, $4.9 million related to purchases of customer-related intangible assets from LaRoss, Turner and Best Click subscriber acquisitions, and $5.8 million related to the Octane360 acquisition. Net cash used in investing activities was $8.7 million for the year ended December 31, 2009, and consisted of capital expenditures of $1.9 million and purchases of customer-related intangible assets from LaRoss and LiveDeal subscriber acquisitions totaling $6.8 million.

 

Net cash provided by financing activities was $11.6 million for the year ended December 31, 2010, primarily from the $8.9 million proceeds from the exercise of warrants and stock options coupled with $4.0 million net proceeds from our credit facilities partially offset by the repurchase of $1.2 million of the company’s common stock. During the year ended December 31, 2009, net cash provided by financing activities was $3.2 million and consisted of $3.0 million proceeds from the revolving credit facility, $591,000 proceeds from the exercise of stock options, partially offset by $337,000 cash used for the repurchase of common stock.

 

Management believes, based upon projected operating needs, that our working capital is sufficient to fund our operations for at least the next 12 months.

Credit facility

 

On June 28, 2010, we entered into a Loan and Security Agreement (the “LSA”) with Silicon Valley Bank (“SVB”). The LSA provides us with a revolving credit facility of up to $30.0 million (the “Revolving Line”). The maturity date of the Revolving Line is June 28, 2013.

 

The LSA allows us to choose whether borrowings made from the Revolving Line bear interest either at the prime rate announced from time to time by SVB or the prime rate plus 0.5% or 1%, or at LIBOR plus 2%, 2.5% or 3%, depending in the case of both prime rate and LIBOR rate borrowings on whether our leverage ratio is less than one, at least one and not greater than two, or greater than two. The leverage ratio is our consolidated funded indebtedness to our consolidated EBITDA for the twelve months ending on the date of determination. For the majority of the year we elected the LIBOR rate as the interest rate for the facility.

 

Our ability to borrow under the Revolving Line is subject to various ongoing conditions precedent, described in further detail in the LSA. Some of these conditions are subject to SVB’s judgment in its sole discretion as to specified matters such as whether or not there has been any material impairment in our results of operation or financial condition. The LSA contains customary representations, warranties, and affirmative and negative covenants for facilities of this type, including certain restrictions on dispositions of our assets, changes in business, change in control, mergers and acquisitions, payment of dividends, and incurrence of certain indebtedness and encumbrances. The LSA also contains customary events of default, including payment defaults and a breach of representations and warranties and covenants. If an event of default occurs and is continuing, SVB has certain rights and remedies under the LSA, including declaring all outstanding borrowings immediately due and payable, ceasing to advance money or extend credit, and rights of set-off.

 

We must meet certain financial covenants during the term of the Revolving Line, including maintaining a minimum adjusted quick ratio of 1.25 to 1, which is a ratio of our unrestricted cash and cash equivalents plus net billed accounts receivable and investments that mature in fewer than 12 months to our current liabilities minus deferred revenue, warrant liability and plus 25% of any outstanding credit extensions under the Revolving Line. We are also required to maintain a Leverage Ratio of not greater than 2.5 at the end of each fiscal quarter through June 30, 2012, and 2.0 at the end of each fiscal quarter thereafter. In addition, our quarterly adjusted EBITDA must equal at least $1,000,000 (this minimum amount is for financial covenant purposes only, and does not represent projections of our future financial results). As of December 31, 2010, we were in compliance with all such financial covenants; however, we cannot assure you that we will remain in compliance with our financial covenants in the future. If we are unable to comply with our financial covenants, the lender may declare an event of default under the loan agreement, in which event all outstanding borrowings would become immediately due and payable and no further amounts would be available under the Revolving Line. The projected results of the Company for the first quarter of 2011 are such that the Company would not satisfy the quarterly EBITDA requirement of $1,000,000 under the Revolving Line. As such, we expect that we will not have any funds available under the Revolving Line at the end of the first quarter of 2011 and continuing until such time as the our quarterly results satisfy such covenant requirements.

 

We paid a facility fee of $75,000 to SVB on June 28, 2010, pursuant to the LSA. Additionally, there is an annual facility fee of 0.25% of the unused portion of the Revolving Line, calculated as specified in the LSA. In addition, we paid $225,000 in professional fees related to closing the LSA.

 

All amounts borrowed under the facility are secured by a general security interest on our assets, except for our intellectual property, which we have instead agreed to remain unencumbered during the term of the LSA.

 

As of December 31, 2010, we have $7 million borrowings outstanding under the Revolving Line and $23 million available under the line of credit

 

The Revolving Line replaced a $10 million credit facility with Square 1 Bank, entered into on June 26, 2009, pursuant to a Loan and Security Agreement (the “Agreement”). The Agreement expired by its terms on June 25, 2010, and we paid off the $3 million balance at that time.

 

The Company repaid the $7 million balance outstanding on the Revolving Line subsequent to year-end. The projected results of the Company for the first quarter of 2011 are such that the Company would not satisfy the

quarterly EBITDA requirement of $1,000,000 under the Revolving Line. As such, the Company expects that it will not have any funds available under the SVB Revolving Line at the end of the first quarter of 2011 and continuing until such time as the Company’s quarterly results satisfy such covenant requirements.

 

Shelf Registration Statement

 

At December 31, 2010, we had an effective shelf registration statement on file with the SEC pursuant to which the Company registered 8,000,000 shares of its common stock. The shelf registration statement was set to expire in January 2011, but was extended as a result of the filing by the Company on January 14, 2011, of a new shelf registration statement on Form S-3 to register 8,000,000 shares of its common stock in replacement of the expiring shelf registration statement. While we sold 4,600,000 shares of our common stock in the Offering which reduced the number of available shares under the new registration statement, we intend to increase the number of available shares so that we will have up to 8,000,000 shares available for future offerings under the replacement registration statement. We may periodically offer all or a portion of the remaining shares of common stock registered on the shelf registration statement at prices and on terms to be announced when and if the shares of common stock are so offered. The specifics of any future offerings, along with the use of proceeds of any common stock offered, will be described in detail in a prospectus supplement, or other offering materials, at the time of the offering. Our ability to sell our common stock, including on terms and at prices that are acceptable to the Company, is subject to market conditions and other factors, such as contractual commitments in our line of credit agreement with Silicon Valley Bank and certain of our previously issued warrants in certain instances.

 

Stock repurchase program

 

On August 4, 2010, our Board of Directors approved a stock repurchase program of up to $2.0 million of Local.com Corporation common stock. The share repurchase program is authorized for 12 months and authorizes us to repurchase shares from time to time through open market or privately negotiated transactions. From time to time, we may enter into a Rule 10b5-1 trading plan that will allow us to purchase our shares at times when we ordinarily would not be in the market because of self-imposed trading blackout periods. The number of shares to be purchased and the timing of the purchases will be based on market conditions, share price and other factors. The stock repurchase program does not require us to repurchase any specific dollar value or number of shares and may be modified, extended or terminated by the Board of Directors at any time. Any Rule 10b5-1 trading plan we enter into in connection with carrying out our stock repurchase program will not, however, be capable of modification or extension once established. During the year ended December 31, 2010, we repurchased 270,400 shares of common stock at an average price of $4.52 per share and an aggregate purchase price of approximately $1.2 million. The remaining authorization under the stock repurchase program is approximately $800,000.

 

On October 8, 2008, our Board of Directors approved a stock repurchase program of up to $2.0 million of Local.com Corporation common stock. The share repurchase program was authorized through April 2010 and authorized us to repurchase shares from time to time through open market or privately negotiated transactions. During the year ended December 31, 2009, we repurchased 131,239 shares of common stock at an average price of $2.56 per share. Total cash consideration for the repurchased stock was $337,000.

 

Purchase of customer related intangible assets

 

On February 18, 2009, we entered into an Asset Purchase and Fulfillment Agreement with LaRoss whereby we purchased 11,754 website hosting accounts for $1.2 million in cash from LaRoss. LaRoss will provide ongoing billing services, hosting of the websites and customer service operations (Fulfillment) for us in exchange for a percentage of future collected billing revenues. The term of the Fulfillment is for two years with automatic renewal in one year increments unless cancelled 60 days prior to expiration. The purchase price was allocated $1,098,000 to customer-related intangible assets amortized over four years based on how we expect the customer relationships to contribute to future cash flows and $77,000 to accounts receivable.

 

On March 9, 2009, we purchased 14,185 local business listing subscribers from LiveDeal and Telco Billing, Inc., a wholly owned subsidiary of LiveDeal for a cash payment of $3,092,000. The acquisition of this base of advertisers also increased our base of customers, diversified our revenue stream, and continues to provide a platform

for future revenue growth. The purchase price was allocated to customer-related intangibles assets and is being amortized over four years based on how we expect the customer relationships to contribute to future cash flows.

 

On December 30, 2009, we entered into an Asset Purchase Agreement with LaRoss whereby we purchased up to 21,972 website hosting accounts for up to $2.6 million in cash, which amount was subject to reduction in the event any of the subscribers were not successfully transferred to the Company. After giving effect to certain purchase price and subscriber adjustments, the final purchase price has been adjusted to $2.2 million and the number of website hosting accounts purchased has been finalized at 18,817. LaRoss will provide ongoing billing services and hosting of the websites. The purchase price was allocated to customer-related intangible assets amortized over four years based on how we expect the customer relationships to contribute to future cash flows.

 

On February 12, 2010, we entered into an Asset Purchase Agreement with LaRoss whereby we purchased approximately 10,186 website hosting accounts for up to $1,616,000 in cash, which amount will be reduced in the event any of the subscribers are not successfully transferred to us or the subscriber base fails to achieve a certain performance requirement. All performance criteria per the Asset Purchase Agreement were met, resulting in the maximum purchase price of $158.60 per account or an aggregate $1,616,000, based on 10,186 accounts. LaRoss will provide ongoing billing services and hosting of the websites. The purchase price will be amortized over four years based on how we expect the customer relationships to contribute to future cash flows.

 

On April 20, 2010, we entered into an Asset Purchase Agreement with Turner whereby we acquired up to 8,032 web hosting subscribers for a cash purchase price of up to $803,200. The purchase price was subject to adjustment in our favor if Turner actually transferred fewer than 8,032 web hosting subscribers. After giving effect to these purchase price and subscriber adjustments, the final purchase price was adjusted to $780,300 and the number of website hosting accounts purchased finalized at 7,803. The purchase price will be amortized over four years based on how we expect the customer relationships to contribute to future cash flows.

 

On May 28, 2010, we entered into an Asset Purchase Agreement with LaRoss whereby we acquired up to 26,000 web hosting subscribers for a cash purchase price of up to $2,210,000. The purchase price was subject to adjustment in our favor if LaRoss actually transferred fewer than 26,000 web hosting subscribers, or in the event some or all of the purchased subscribers are no longer billable once transferred under certain limited circumstances. After giving effect to these purchase price and subscriber adjustments, the final purchase price was adjusted to $1,890,825 and the number of website hosting accounts purchased finalized at 22,245. The purchase price will be amortized over four years based on how we expect the customer relationships to contribute to future cash flows.

 

On September 30, 2010, we entered into an Asset Purchase Agreement with BestClick whereby we acquired up to 10,000 web hosting subscribers for a cash purchase price of up to $1,100,000. The Purchase Price is subject to adjustment in our favor if BestClick actually transfers fewer than 10,000 web hosting subscribers, or in the event some or all of the Purchased Subscribers are no longer billable once transferred under certain limited circumstances, as more completely described in the Asset Purchase Agreement. After giving effect to these purchase price and subscriber adjustments the final purchase price was adjusted to $1,021,020 and the number of website hosting accounts finalized at 9,282. The purchase price will be amortized over four years based on how we expect the customer relationships to contribute to future cash flows.

 

Acquisitions

 

On July 1, 2010, we acquired all of the assets of Octane360. The assets acquired include a technology platform, which can be used to offer targeting and registration of geo-category based local website domains; small business and geo-category website creation, hosting and management; an ad exchange to manage the selection and deployment of ad inventory across all Octane360-controlled domains and websites; and a content marketplace to allow for the management of geo-category content written for advertising customers or our directly owned portfolio properties. Under the terms of the Asset Purchase Agreement, dated July 1, 2010, between us and Octane360, we acquired the assets of Octane360 for $3.5 million in cash, 200,482 shares of our common stock and possible future contingent consideration based on the achievement of certain earnout milestones. On July 28, 2010, Octane360 achieved one of the milestones and received an additional $325,000 in cash and 48,077 shares of our common stock. On September 28, 2010, three additional earnout milestones were achieved resulting in an additional cash payment of $1,950,000 to Octane360. Octane360 may receive up to an additional $3.3 million

in a combination of cash and stock based on Octane360 achieving certain milestones and its operating performance during the two year period ending June 30, 2012, as more particularly described in the Octane360 Asset Purchase Agreement.

 

Subsequent Events

 

In January 2011 the Company entered into an asset purchase agreement with iTwango for the purchase of a deal-of-the-day technology platform. The purchase price, including earnouts, totaled approximately $450,000 to be paid in a combination of cash and Company’s common stock.

 

On January 20, 2011, we completed a underwritten public offering of 4,600,000 shares of our common stock at $4.25 per share (the “Offering”), resulting in net proceeds to us of $18.2 million after deducting underwriting discounts and commissions and other related expenses.

 

On February 11, 2011, the Company entered into an asset purchase agreement (“Rovion Agreement”) with Digital Post Interactive, Inc., a Nevada corporation, and its wholly-owned subsidiary, Rovion, Inc., a Delaware corporation, pursuant to which the Company will acquire substantially all of the assets of Rovion. Under the terms of the Rovion Agreement, the transaction contemplated under such agreement will be completed upon the satisfaction of certain closing conditions, including the receipt by DGLP of the affirmative vote of at least a majority of the stockholders of DGLP in favor of the Rovion Agreement and the transactions contemplated thereby. DGLP intends to file a proxy soliciting the approval by holders of a majority of its outstanding common stocks of the Rovion Agreement and the transaction contemplated thereby. Assuming all closing conditions are met, at the closing of the transaction between the Company and DGLP, DGLP shall receive $1.5 million in cash of which $400,000 will be held in escrow. DGLP may receive up to an additional $7.0 million upon the Rovion Business (the “Business”) achieving certain milestones and certain operating performance thresholds during the three year period following the closing date, all as more particularly described in the Rovion Agreement. $1 million of the earnout will be paid in cash if the necessary milestones and operating performance thresholds are met in the first year and the other $6 million of the earnout may be paid in any combination of cash and Company common stock as the Company determines, provided the necessary milestones and operating performance thresholds associated with that portion of the earnout are achieved over the three year period following the closing. Allocation of the purchase price will be determined based on fair market valuation of the assets acquired. We assumed no significant liabilities in connection with the transaction, except for contractual commitments arising from certain contracts we assumed after the closing of the transaction and approximately $214,000 of accounts payable related to Rovion.

 

Critical Accounting Policies, Judgments and Estimates

 

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 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 from these estimates under different assumptions or conditions. Our significant accounting policies described in more detail in Note 1 to our consolidated financial statements included in this Report, involve judgments and estimates that are significant to the presentation of our 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 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, or the delivery of Octane360 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 our contractual agreement. Sponsored listings and banner advertisements are included as search results 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. We have analyzed our revenue recognition and determined that our web hosting revenue will be recognized net of direct costs. All other revenue is recognized on a gross basis.

 

During the year we entered into multiple-deliverable arrangements for the sale of domains and for providing services relating to such domains. We evaluated the agreements in accordance with the provision of the revenue recognition topic that addresses multiple-deliverable revenue arrangements as updated in October 2009. Although such updated provisions will only be effective for fiscal periods beginning on or after June 15, 2010, we opted to adopt such provisions early. 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 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.

 

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 December 31, 2010, two customers, Yahoo! and SuperMedia represented 55% of our total accounts receivable. These customers have historically paid within the payment period provided for under their contracts and management believes these customers will continue to do so.

 

Depreciation of Property and Equipment

 

Depreciation and amortization of property and equipment are calculated under the straight-line basis over the shorter of the estimated useful lives or the respective assets as follows:

 

 

Repairs and maintenance expenditures that do not significantly add to the value of the property, or prolong its life, are charged to expense, as incurred. Gains and losses on dispositions of property and equipment are included in the operating results of the related period.

Amortization of Intangible Assets

 

Intangible assets are amortized over their estimated useful lives, generally on a straight-line basis over two to five years. The small business subscriber relationships are amortized based on how we expect the customer relationships to contribute to future cash flows. As a result, amortization of the small business subscriber relationships intangible assets is accelerated over a period of approximately four years with the weighted average percentage amortization for all small business subscriber relationships acquired to date being approximately 60% in year one, 21% in year two, 14% in year three and 5% in year four.

 

Stock Based Compensation

 

Calculating stock-based compensation expense requires the input of highly subjective assumptions, including the expected term of the stock options, stock price volatility, and the pre-vesting forfeiture rate of stock awards. We estimate the expected life of options granted based on historical exercise patterns, which we believe are representative of future behavior. We estimate the volatility of our common stock on the date of grant based on the historical market activity of our stock. The assumptions used in calculating the fair value of stock-based awards represent our best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future. In addition, we are required to estimate the expected pre-vesting award forfeiture rate and only recognize expense for those shares expected to vest. We estimate the forfeiture rate based on historical experience of our stock-based awards that are granted and cancelled before vesting. If our actual forfeiture rate is materially different from the original estimate, the stock-based compensation expense could be significantly different from what we recorded in the current period. Changes in the estimated forfeiture rate can have a significant effect on reported stock-based compensation expense, as the effect of adjusting the forfeiture rate for all current and previously recognized expense for unvested awards is recognized in the period the forfeiture estimate is changed. If the actual forfeiture rate is higher than the estimated forfeiture rate, then an adjustment will be made to increase the estimated forfeiture rate, which will result in a decrease to the expense recognized in the financial statements. If the actual forfeiture rate is lower than the estimated forfeiture rate, then an adjustment will be made to lower the estimated forfeiture rate, which will result in an increase to the expense recognized in the financial statements. See Note 12 — Stock Plans for additional information.

 

Total stock-based compensation expense recognized for the years ended December 31, 2010, 2009 and 2008 is as follows (in thousands, except per share amounts):

 

 

Accounting for Income Taxes

 

We are required to recognize a provision for income taxes based upon the taxable income and temporary differences for each of the tax jurisdictions in which we operate. This process requires a calculation of taxes payable under currently enacted state and federal tax laws and an analysis of temporary differences between the book and tax bases of our assets and liabilities, including various accruals, allowances, depreciation and amortization. The tax effect of these temporary differences is reported as deferred tax assets and liabilities in our consolidated balance sheet. We also assess the likelihood that our net deferred tax assets will be realized from future taxable income. To

the extent we believe that it is more likely than not that all or some portion or the deferred tax asset will not be realized, we establish a valuation allowance. At December 31, 2010, we had a full valuation allowance on net operating losses based on our assessment that it is more likely than not that the deferred tax asset will not be realized. To the extent we establish a valuation allowance or change the allowance in a period, we reflect the change with a corresponding increase or decrease in our tax provision in our consolidated statement of income or against additional paid-in-capital in our consolidated balance sheet to the extent any tax benefits would have otherwise been allocated to equity. In making our judgment regarding the valuation allowance, we considered all evidence, both positive and negative and although we generated taxable income in the current year and expect to do so in future periods, we also considered our history of losses and placed more weight on the historical results in judging our ability to realize the deferred tax asset related to net operating losses.

 

We analyze and quantify the impact of uncertain tax positions in accordance with U.S. GAAP, pursuant to which we only recognize the tax benefit from an uncertain tax position if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50 percent likelihood of being realized upon ultimate settlement. Per U.S. GAAP companies should report a liability for tax benefits resulting from uncertain tax positions taken or expected to be taken in a tax return. U.S. GAAP further requires that a change in judgment related to the expected ultimate resolution of uncertain tax positions be recognized in earnings in the quarter of such change. In addition companies should recognize interest and penalties, if any, related to unrecognized tax benefits in income tax expense. We have not identified any uncertain tax positions that have not been adequately reserved for as of December 31, 2010.

 

Provision for income taxes was $102,000 for the year ended December 31, 2010, primarily relating to state income tax resulting from the California tax law change that suspended the use of corporate net operating loss carryforwards and increase in the deferred tax liabilities on indefinite-lived assets, partially offset by California research and development credits and prior year actual to provision adjustments.

 

Warrant Liability

 

As discussed in Note 1 — The Company and Summary of Significant Accounting Policies, effective January 1, 2009, we adopted the updated guidance of U.S. GAAP regarding accounting for derivatives, which requires that certain of our warrants be accounted for as derivative instruments and that we record the warrant liability at fair value and recognize the change in valuation in our statement of operations each reporting period. Determining the warrant liability to be recorded requires us to develop estimates to be used in calculating the fair value of the warrants. We calculate the fair values using the Black-Scholes valuation model.

 

The use of the Black-Scholes model requires us to make estimates of the following assumptions:

 

 

We are exposed to the risk of changes in the fair value of the derivative liability related to outstanding warrants. The fair value of these derivative liabilities is primarily determined by fluctuations in our stock price. As our stock price increases or decreases, the fair value of these derivative liabilities increases or decreases, resulting in a corresponding current period loss or gain to be recognized. Based on the number of outstanding warrants, market interest rates and historical volatility of our stock price as of December 31, 2010, a $1 decrease or increase in our stock price results in a non-cash derivative gain or loss of approximately $693,000 and $742,000, respectively.

 

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. We perform annual impairment reviews during the fourth fiscal quarter of each year or earlier if indicators of potential impairment exist.

For goodwill, we engage an independent appraiser to assist management in the determination of the fair value of our reporting unit and compare the resulting fair value to the carrying value of the reporting unit to determine if there is goodwill impairment. 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, 2010 and determined that the estimated fair value of the reporting unit substantially exceeded its carrying value and therefore no impairment existed. Future impairment reviews may result in charges against earnings to write-down the value of intangible assets.

 

Recent Accounting Pronouncements

 

See Note 1 — The Company and Summary of Significant Accounting Policies to the consolidated financial statements, regarding the impact of certain recent accounting pronouncements on our consolidated financial statements.

 

Contractual Obligations

 

The following table sets forth certain payments due under contractual obligations with minimum firm commitments as of December 31, 2010 (in thousands):

 

 

 

 

Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to our investors.

 

 

Market risk refers to the risk that a change in the level of one or more market factors such as interest rates, foreign currency exchange rates, or equity prices will result in losses for a certain financial instrument or group of instruments. We are exposed to the risk of increased interest rates on our current debt instruments and the risk of loss on credit extended to our customers. We have issued equity instruments, including warrants which contain certain derivatives which fluctuate, primarily as a result of changes in our stock price.

 

Interest Rate Risk

 

We are exposed to the risk of fluctuation in interest rates on our debt instruments. During 2010, we did not use interest rate swaps or other types of derivative financial instruments to hedge our interest rate risk. Our outstanding debt instruments with Silicon Valley Bank bear interest at prime rate or the prime rate plus 0.5% or 1%, or at LIBOR plus 2%, 2.5% or 3%, depending in the case of both prime rate and LIBOR rate borrowings on certain financial ratios as set out in the loan and security agreement. The use of the prime rate or LIBOR rate is at the discretion of the Company. The debt outstanding under these notes entering 2011 is $7.0 million. Therefore, a one-percentage point increase in interest rates would result in an increase in interest expense of approximately $70,000 per annum.

Derivative Liability Risk

 

We adopted the updated U.S. GAAP guidance regarding accounting for derivatives, which requires that certain of our warrants be accounted for as derivative instruments and that we record the warrant liability at fair value and recognize the change in valuation in our statement of operations each reporting period. We are therefore exposed to the risk of change in the fair value of derivative liability related to outstanding warrants. The fair value of these derivative liabilities is primarily determined by fluctuations in our stock price. As our stock price increases or decreases, the fair value of these derivative liabilities increase or decrease, resulting in a corresponding current period loss or gain to be recognized. Based on the number of outstanding warrants, market interest rates and historical volatility of our stock price as of December 31, 2010, a $1 decrease or increase in our stock price results in a non-cash derivative gain or loss of approximately $693,000 and $742,000, respectively. During 2010 and 2009, we experienced a $0.9 million non-cash gain and a $3.0 million non-cash loss, respectively, on the outstanding warrants.

 

 

Our consolidated financial statements, including the report of our independent registered public accounting firm, are included beginning at page F-1 immediately following the signature page of this Report.

 

 

None

 

 

Evaluation of Disclosure Controls and Procedures

 

Under the supervision and with the participation of management, including our Chief Executive Officer and our Chief Financial Officer, we have carried out an evaluation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2010, to ensure that information we are required to disclose in reports that are filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified by the SEC and is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

Management’s Report on Internal Control over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed by, or under the supervision of, our principal executive and principal financial officer and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2010. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based upon its assessment, management concluded that, as of December 31, 2010, our internal control over financial reporting was effective.

The effectiveness of our internal control over financial reporting as of December 31, 2010, has been audited by Haskell & White, LLP, an independent registered public accounting firm, as stated in their report on our internal control over financial reporting which is included herein.

 

Changes in Internal Control over Financial Reporting

 

We took certain actions throughout 2010 to remediate our material weakness identified in our 2009 evaluation of disclosure controls and procedures and our 2009 assessment of internal control over financial reporting. Specifically, during the year, we engaged and will continue to engage outside experts, as needed, to provide counsel and guidance in areas where we cannot economically maintain the required expertise internally (e.g., with the appropriate classifications and treatments of complex and non-routine transactions). Specifically, we have engaged a consulting firm to review our derivative valuation assumptions and calculations.

 

Other than the remediation of the material weakness related to reporting of complex and non-routine transactions, there were no changes in our internal control over financial reporting during the fiscal quarter ended December 31, 2010, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

None

 

 

Directors and Executive Officers

 

The following table sets forth, as of December 31, 2010, certain information concerning our executive officers and directors:

 

 

 

 

Heath B. Clarke has served as our Chairman of the Board since March 1999, as our President from March 1999 to December 2000 and as our Chief Executive Officer since January 2001. From 1998 to February 1999, Mr. Clarke was the Vice President of eCommerce for LanguageForce, Inc., a language translation software company. Prior to that time, he was a Marketing Manager for Starnet International (Canada), an Internet company. From 1995 to 1998 he held managerial positions with the Berg Group of Companies (Australia), and from 1988 to 1995 he was founder and Chief Executive Officer of Australian Fibre Packaging.

Stanley B. Crair has served as our Chief Operating Officer since July 2005 and as our President since April 2006. From 2003 to April 2005 Mr. Crair was the COO of ZeroDegrees, Inc., an internet company that provided online social networking services to business professionals, which he co-founded. As COO of ZeroDegrees, Mr. Crair was responsible for the day-to-day oversight of network operations, customer service, facilities, quality assurance, human resources, and overall company support. The company was purchased by IAC/InterActiveCorp in 2004 and Crair remained active in the company until April 2005. Mr. Crair received a Masters of Business Administration degree in Corporate Strategy and International Business from the University of California, Berkeley and a Bachelor of Science degree in Physics from the United States Naval Academy.

 

Kenneth S. Cragun has served as our Chief Financial Officer since December 2010, as our Secretary since October 2010, as our interim Chief Financial Officer from October 2010 to December 2010 and our Vice President of Finance from April 2009 to October 2010. From June 2006 to March 2009, Mr. Cragun was the Chief Financial Officer of Modtech Holdings, Inc., a supplier of modular buildings. From May 2005 to April 2006 Mr. Cragun served as Senior Vice President of Finance for MIVA, Inc. an online advertising and media company. Prior to that role, Mr. Cragun served at MIVA as Vice President of Finance from October 2004 to May 2005, and as Director of Finance from July 2003 to October 2004. Mr. Cragun received a Bachelors of Science degree in Accounting from Colorado State University-Pueblo. Mr. Cragun’s responsibilities prior to Local.com have included chief financial officer functions at a public company, including preparation of financials for SEC disclosures in accordance with GAAP, audit experience at a nationally recognized certified public accounting firm, and day-to-day management of the financial affairs of both public and private companies.

 

Michael O. Plonski has served as our Chief Technology Officer since July 2009. From July 2005 to June 2009, Mr. Plonski served as SVP/Chief Information Officer and Chief Operating Officer Digital of Martha Stewart Living Omnimedia, Inc., an integrated media and merchandising company providing consumers with inspiring lifestyle content and well-designed, high-quality products. Mr. Plonski received a Bachelor of Science degree in Mechanical Engineering from the University of Notre Dame. Mr. Plonski’s responsibilities prior to Local.com have included chief information officer and chief technology officer functions at a public company, including oversight of technology development, deployment, maintenance and enhancement, managing multiple technology initiatives, managing corporate infrastructure and integrating the technologies of acquired companies. In the role of chief operating officer digital, his responsibilities included product management, project management, editorial, design, user-experience, web site production and integration of partners and partner digital properties.

 

Scott Reinke has served as our General Counsel since April 2009. From October 2006 to April 2009, Mr. Reinke served as executive vice president and general counsel of Emerging Media Group, Inc., parent company of TRAFFIQ, Inc., a marketplace for advertising inventory and a self-service media management and planning platform. From March 2004 to October 2006, Mr. Reinke served as assistant general counsel and vice president — legal of MIVA, Inc., an online advertising and media company. Mr. Reinke received a Juris Doctorate from Georgetown University Law Center and a Bachelors of Arts degree in English and Political Science from Boston College. Mr. Reinke’s responsibilities prior to Local.com have included general counsel functions at a private technology company, day-to-day management of the legal affairs of both public and private companies, including securities law compliance, contract management, merger, acquisition and capital fundraising related matters and risk assessment.

 

Norman K. Farra Jr. has served as a director since August 2005. Mr. Farra is currently a Managing Director, Investment Banking for R.F. Lafferty & Co. Inc. since December 2009. From May 2008 to December 2009, he served as Director, Investment Banking for Cresta Capital Strategies, LLC. He was an independent financial consultant from September 2007 to May 2008, and served as Managing Director of Investment Banking for GunnAllen Financial Inc. from August 2006 to September 2007. From June 2001 to August 2006, he was Independent contractor acting as Managing Director of Investment Banking for GunnAllen Financial Inc. In the past five years, Mr. Farra has held no other public company directorships. The Board of Directors has concluded that the following experience, qualifications and skills qualify Mr. Farra to serve as a Director of the Company: Over 20 years experience in the finance, capital markets and financial services industry; significant experience in the investment banking and financial consulting industry; certification from the National Association of Corporate Directors; and a strong educational background, including a Bachelor of Science degree in Business Administration from Widener University.

Philip K. Fricke has served as a director since October 2003. Mr. Fricke is currently President of PKF Financial Consultants, Inc., a private company he founded in March 2001, which provides financial communications services and advisory services to public and private companies. In the past five years, Mr. Fricke has held one other public company directorship with MI Developments Inc. (from August 2003 to May 2009). The Board of Directors has concluded that the following experience, qualifications and skills qualify Mr. Fricke to serve as a Director of the Company: Over 25 years experience as a Wall Street financial analyst; significant experience gained as a director of another public company; and a strong educational background with a Bachelor of Arts degree and a Master of Arts degree in Psychology, as well as a Master of Business Administration degree in Finance and Economics received from Fairleigh Dickinson University.

 

Theodore E. Lavoie has served as a director since April 1999. Mr. Lavoie is currently an independent management consultant to the renewable fuel/waste-to-energy market since May 2009. From June 2007 to May 2009, he was Vice President of Strategic Development of Greenline Industries, a biodiesel production equipment manufacturer. From May 2006 to June 2007, he was Chief Executive Officer of Greenline Industries. From January 2005 to May 2006, Mr. Lavoie was an independent financial consultant. In the past five years, Mr. Lavoie has held no other public company directorships, though he has served on the board and executive committee of a private emerging market company and as a director of Financial Executives International, San Francisco (from 2004 to 2007). Mr. Lavoie also serves as an Advisory Board member of The Salvation Army, Golden State Division. The Board of Directors has concluded that the following experience, qualifications and skills qualify Mr. Lavoie to serve as a Director of the Company: Experience as a chief executive officer in an emerging market industry; experience as a chief financial officer; over 25 years senior execute experience in managing start-ups and high-growth companies; finance experience in the public and private capital markets, global risk and financial services; and strong educational background having earned his Masters of Business Administration degree and Bachelor of Science degree in Business Administration from Loyola Marymount University.

 

John E. Rehfeld has served as a director since August 2005 and our lead independent director, responsible for overseeing the independence of the board, since December 2005. Mr. Rehfeld is currently the adjunct professor of marketing and strategy for the Executive MBA Program at Pepperdine University (since 1998) and the University of San Diego (since 2010). Mr. Rehfeld is currently a Director of Lantronix, Inc. (since May 2010). Mr. Rehfeld was previously a Director of ADC Telecommunication, Inc. (from September 2004 to December 2010) and Primal Solutions, Inc. (from December 2008 to June 2009). Additionally, Mr. Rehfeld currently holds directorships with a number of private companies. The Board of Directors has concluded that the following experience, qualifications and skills qualify Mr. Rehfeld to serve as a Director of the Company: Over 30 years executive experience in high growth industries, including prior experience as a chief executive officer of a number of companies; prior and current experience serving as a director of a number of public and private companies; and a distinguished educational background, including a Masters of Business Administration degree from Harvard University and a Bachelor of Science degree in Chemical Engineering from the University of Minnesota, as well as his current positions as adjunct professor of marketing and strategy for the Executive MBA Programs at Pepperdine and the University of San Diego.

 

Involvement in Certain Legal Proceedings

 

On October 20, 2008, Modtech Holdings, Inc., a Delaware Corporation, filed a voluntary petition for reorganization under Chapter 11 of the US Bankruptcy Code. Mr. Cragun, our chief financial officer was chief financial officer of Modtech Holdings, Inc. at the time of filing.

 

Board of Directors

 

Our board of directors currently consists of the following five members: Heath B. Clarke (Chairman), Norman K. Farra Jr., Philip K. Fricke, Theodore E. Lavoie and John E. Rehfeld. There are no family relationships among any of our current directors and executive officers.

 

The number of authorized members of our board of directors is determined by resolution of our board of directors. In accordance with the terms of our amended and restated certificate of incorporation, our board of

directors is divided into three classes, with each class serving staggered three-year terms. The membership of each of the three classes is as follows:

 

 

Our amended and restated bylaws provide that the authorized number of directors may be changed only by resolution of our board of directors. Any additional directorships resulting from an increase in the number of directors will be distributed between the three classes so that, as nearly as possible, each class will consist of one-third of our directors. This classification of our board of directors may have the effect of delaying or preventing changes in control or management of our company.

 

Our board of directors has designated an audit committee and a nominating, compensation and governance committee, and may establish other committees as it deems necessary or appropriate.

 

Board Committees

 

Our Board has two active committees, an Audit Committee and a Nominating, Compensation and Corporate Governance Committee.

 

Audit Committee

 

The Audit Committee is currently comprised of Mr. Lavoie as Chairman and Messrs. Fricke and Farra, each of whom satisfies the Nasdaq and Securities and Exchange Commission (the “SEC”) rules for Audit Committee membership (including rules regarding independence). The Audit Committee held ten meetings during 2010. The Board has determined that Mr. Lavoie is an “audit committee financial expert” within the meaning of the rules and regulations of the SEC and satisfies the financial sophistication requirements of the Nasdaq listing standards.

 

The Audit Committee operates pursuant to its written charter, which is available on our corporate web site at http://ir.local.com, under the “Corporate Governance” tab, as well as our by-laws and applicable law. In accordance with its charter, the Audit Committee’s purpose is to assist the Board in fulfilling its oversight responsibilities to our stockholders with respect to the integrity of our financial statements and reports and financial reporting process. Specific responsibilities include:

 

 

 

The Audit Committee meets periodically with management to consider the adequacy of Local.com’s internal controls and the financial reporting process. It also discusses these matters with our independent registered public accounting firm and with appropriate company financial personnel. The Audit Committee reviews Local.com’s financial statements and discusses them with management and our independent registered public accounting firm before those financial statements are filed with the SEC.

 

The Audit Committee regularly meets privately with the independent registered public accounting firm. The Audit Committee has the sole authority and direct responsibility for the appointment, compensation, retention, termination, evaluation and oversight of the work of the independent registered public accounting firm engaged by Local.com to perform the audit of the Company’s financial statement or related work or other audit, review or attestation services for the Company. The Audit Committee periodically reviews the independent registered public accounting firm’s performance and independence from management. The independent registered public accounting firm has access to Company records and personnel and reports directly to the Audit Committee.

 

The Audit Committee is empowered to retain outside legal counsel and other experts at our expense where reasonably required to assist and advise the Audit Committee in carrying out its duties and responsibilities.

 

Nominating, Compensation and Corporate Governance Committee

 

The Nominating, Compensation and Corporate Governance Committee (the “NCCG Committee”) is currently comprised of Mr. Rehfeld as Chairman and Messrs. Lavoie and Fricke, each of whom satisfies the Nasdaq and SEC rules for membership to the NCCG Committee (including rules regarding independence). The NCCG Committee held nine meetings during 2010.

 

The NCCG Committee operates pursuant to its written charter, which is available on our corporate web site at http://ir.local.com, under the “Corporate Governance” tab, as well as our by-laws and applicable law. In accordance with its charter, the NCCG Committee’s purpose is to assist the Board in discharging the Board’s responsibilities regarding:

 

 

 

In addition to the powers and responsibilities expressly delegated to the NCCG Committee in its charter, the NCCG Committee may exercise other powers and carry out other responsibilities that may be delegated to it by the Board from time to time, consistent with the Company’s bylaws.

 

Code of Ethics, Governance Guidelines and Committee Charters

 

We have adopted a Code of Business Conduct and Ethics that applies to all Local.com employees. Our Code of Business Conduct and Ethics are posted on our website at http://ir.local.com. We will post any amendments to or waivers from the Code of Business Conduct and Ethics at that location.

 

We have also adopted a written committee charter for our Audit Committee and Nominating, Compensation and Governance Committee. Each of these documents are available on our website at http://ir.local.com.

 

Section 16(a) Beneficial Ownership Reporting Compliance

 

Section 16(a) of the Exchange Act of 1934, as amended, requires our directors and officers, and persons who own more than 10% of a registered class of our equity securities, to file with the SEC reports of ownership and changes in ownership of our equity securities. Copies of the reports filed with the SEC are required by SEC Regulation to be furnished to Local.com. Based solely on our review of the copies of such reports furnished to us and written representations from certain insiders that no other reports were required, the Company believes each reporting person has complied with the disclosure requirements with respect to transactions made during 2010.

 

 

Compensation Discussion and Analysis

 

Executive Summary

 

2010 was a year of continued growth for the Company. Our annual revenue increased to $84 million, a 49% increase over 2009 results. The Company also delivered positive net income for the first time in 2010.

 

The Company’s executive compensation programs, as developed by the Nominating, Compensation and Corporate Governance Committee of our Board of Directors (the “NCCG Committee”), have been designed to

incentivize and reward sustainable growth. We continued to deliver a majority of our executives’ compensation in a performance-based manner, primarily through the cash incentive bonus plan and grants of stock options. In 2010, the NCCG Committee also entered into amended employment agreements with its Named Executive Officers, specifically to remove change in control excise tax gross-up payments and “single trigger” change in control severance provisions. The NCCG Committee removed these provisions in light of the potentially high cost to our shareholders in a change in control transaction.

 

The NCCG Committee administers the Company’s executive compensation arrangements. In conference with the Board of Directors, the NCCG Committee determines the compensation of our Chief Executive Officer. As discussed in more detail below, in determining the compensation for our other Named Executive Officers (as defined below), the recommendations of our Chief Executive Officer, among other factors, are considered by the NCCG Committee. Nevertheless, the NCCG Committee is solely responsible for making the final decisions on compensation for our Named Executive Officers.

 

The general compensation arrangements of the Company are guided by the following principles and business objectives:

 

 

Our Company is guided by the above principles in its compensation philosophy for our executive officers, which has been designed to achieve the following two objectives:

 

 

The executives listed in the Summary Compensation Table in this amendment to our annual report on Form 10-K/A are referred to as the “Named Executive Officers.” Mr. Cragun became our Interim Chief Financial Officer on October 18, 2010, and our Chief Financial Officer on December 29, 2010, following the departure of Brenda Agius as our Chief Financial Officer on October 18, 2010.

 

Executive Compensation Program Objectives and Overview

 

Overview

 

Our Company is dependent upon the experience and talents of our executives to successfully manage our highly technical, complex and rapidly evolving business. Our Company is in a rapidly changing industry, one which regularly experiences paradigm shifting technological developments and shifting trends in the businesses and markets in which we compete. We rely on our executives to successfully address these developments and to improve our business and its performance in order to increase shareholder value. We face a highly competitive executive labor market and face competitors for our executives’ skills of similar size and scale to the Company, as well as larger competitors with greater resources than we have and smaller competitors that seek to hire our executives to facilitate and expedite their own businesses that compete with us directly or in the same industry.

Executive Compensation Programs

 

The current executive compensation program for the Company is comprised of three key components, which collectively are intended to conform to the Company’s compensation philosophy and to reward our executives based on individual and company performance. The Company uses (1) base salary, (2) quarterly or semi-annual incentive cash bonuses, and (3) long-term equity awards, in the form of stock options, as its primary compensation components. The NCCG Committee considers how each such component of executive compensation promotes retention and rewards performance by the individual and the Company generally when structuring its executive compensation arrangements.

 

The Company seeks to provide targeted compensation opportunities above the median of competitive market practice in order to attract, retain, and motivate our executives. However, the NGGC Committee may target an individual executive’s compensation higher or lower than the median based on the individual’s role, experience, and/or performance, among other factors. The NCCG Committee uses certain peer companies (as identified below) to inform it of competitive pay levels and generally intends that base salary levels be consistent with competitive market base salary levels. The NCCG Committee generally targets performance-based compensation, such as bonus and long-term incentive equity opportunities to make up a substantial portion of each executive’s total direct compensation opportunity, as achievement of those are tied to company and individual performance and provide long-term incentives to our executives. The NCCG Committee believes that the cash and long-term equity incentives provided to our executives have been designed to provide an effective and appropriate mix of incentives to ensure our executive performance is focused on building long-term stockholder value. In furtherance of this, the NCCG Committee has designed our compensation arrangements for our executive officers such that the performance based compensation opportunities represent a material portion of the total direct compensation opportunity.

 

The Company does not provide any pensions or other retirement benefits for our executives other than our 401(k) plan. Generally, except for payment of up to $1,500 a month in health insurance payments that would otherwise be paid by our executives, the Company also does not provide any perquisites. The Company provides our executive officers with certain severance protections as a further means of attracting and retaining our key executives and to preserve the stability of our executive team. These severance protections are described below under “Severance and Change in Control Severance Benefits” and “Potential Payments Upon Termination or Change in Control.”

 

Independent Consultant and Peer Group

 

The NCCG Committee has retained Frederic W. Cook & Co., Inc. (“Cook & Co.”) as its independent compensation consultants, to provide advice to the NCCG Committee with respect to the compensation programs of the Company. Cook & Co. advised the NCCG Committee with respect to trends in executive compensation, the selection of the Company’s peer companies, the determination of pay programs, an assessment of competitive pay levels, and the setting of compensation levels. Cook & Co. provided no other services to the Company in 2010 beyond the compensation consulting services provided to our Board of Directors and the NCCG Committee, as noted above.

 

The NCCG Committee considers peer company data obtained and evaluated by Cook & Co, as well as compensation data compiled by management, in establishing compensation levels. The NCCG Committee utilizes this information to when considering executive compensation arrangements, including the reasonableness of such arrangements from a competitive vantage point. For 2010, the NCCG Committee, in consultation with Cook & Co., considered compensation data for the following companies in 2010: InfoSpace, Openwave Systems, the Knot, Saba Software, Travelzoo, Web.com, marchex, eLoyalty, Double-Take, Innodata, Healthstream, TheStreet.com, Autobytel, Spark Networks, ADAM, Market Leader. This group of companies is referred to by us hereafter as our “peer group” or our “peer companies for 2010.

 

The peer group was selected based on objective criteria, taking into account company size and industry. The peers revenue and market capitalizations generally fell within a range of 0.3x to 3x ours, with our revenue and market capitalization in the middle range to avoid distortion from size. The peers are technology and/or media companies that have businesses that are generally similar to the Company’s business.

Current Executive Compensation Program Elements

 

Base Salaries

 

The Company provides the Named Executive Officers, along with other employees, with base salary to compensate them for their services throughout the year. The NCCG Committee performs an annual review of the base salaries of the Company’s Named Executive Officers. These base salary levels are intended to be generally consistent with competitive market base salary levels, but are not specifically targeted or “bench-marked” against any particular company or group of companies, including the Company peer group. The NCCG Committee sets base salaries so that a substantial portion of the executives’ total direct compensation remains contingent on performance-based bonuses and long-term incentive equity awards. The NCCG Committee considers and assesses, among other factors, the scope of an executive’s responsibility, prior experience, past performance, advancement potential, impact on results, salary relative to other executives in the Company and relevant competitive data in setting specific salary levels for each of our Named Executive Officers, as well as the Company’s other officers.

 

The annual base salary of each of our Named Executive Officers was increased effective July 1, 2010, following the NCCG Committee’s review of relevant market compensation data, general economic conditions, and the Company’s financial performance and position. Mr. Clarke’s salary was increased from $350,000 to $415,000, which was the median. Mr. Crair’s salary was increased to the median of $287,000 per year from $270,000 per year, effective July 1, 2010. Mr. Cragun’s salary was increased to $208,500 per year from $199,000 per year, effective July 1, 2010, during which time he was serving as our vice president of finance. Mr. Cragun’s salary was subsequently increased again to $220,000 per year on October 18, 2010, in connection with becoming our interim chief financial officer (the 25th percentile), and to $268,000 per year on January 1, 2011, in connection with becoming our permanent chief financial officer (the 60th percentile). Mr. Plonski’s salary was increased to $268,000 per year from $260,000 per year, effective July 1, 2010. Mr. Reinke’s salary was increased to $227,500 per year from $215,000 per year (the median), effective July 1, 2010. Our former chief financial officer, Ms. Agius, had her salary increased from $260,000 per year to $268,000 per year (the 60th percentile), effective July 1, 2010.

 

Cash Bonuses

 

For 2010, the Committee approved a cash bonus plan (“Bonus Plan”) under which our Named Executive Officers were eligible to earn cash bonuses based on achievement against pre-determined semi-annual performance goals. The cash bonus incentive opportunity is intended to motivate and reward executives by tying a significant portion of their total compensation to the achievement of pre-established performance metrics that are generally short-term. The Committee determined that use of independent semi-annual performance and payment periods for 2010 was appropriate in light of the Company’s strong growth and the difficulty in setting meaningful annual performance goals.

 

First-Half 2010 Bonus

 

For the First-Half 2010 Bonus period, each of our Named Executive Officers’ target bonuses were defined as a percentage of base salary as set forth in each officer’s employment agreement. Actual earned awards could range between 70% and 150% of target depending on performance. Performance is measured against Company-wide financial goals and individual performance goals. The weighting of the Company and individual goal components range from 50% to 80% and 20% to 50%, respectively. In determining the mix of Company and individual performance goals for each executive, the Committee considered each executive’s ability to affect Company-wide performance and the importance of individual contributions.

 

 

 

 

First-Half Bonus: Company Performance Component

 

The Company performance component of the First-Half period was based equally on Revenue and Adjusted Net Income¹. The Committee believes these metrics, and the related goals, are the key drivers of delivering value to our stockholders. The Revenue and Adjusted Net Income targets were set to the Company’s budget for the period. The Committee also set threshold and maximum performance goals, which corresponded to bonus payouts equal to 70% and 150% of target. For the First-Half period, the Company’s performance was above the target for both the Revenue and Adjusted Net Income goals. The resulting bonus payout for the Company performance component was 129% of target. The performance levels and actual performance for First-Half 2010 are shown in detail below:

 

 

 

 

 

¹ Adjusted Net Income (Loss) is defined by the Company as net income (loss) excluding: provision for income taxes; interest and other income (expense), net; depreciation; amortization; stock based compensation charges, warrant revaluation and non-recurring items. Adjusted Net Income (Loss), as defined above, is not a measurement under GAAP. Adjusted Net Income (Loss) is reconciled to net income (loss) and earnings (loss) per share, which we believe are the most comparable GAAP measures, in the company’s press release dated February 7, 2011, as furnished on the Company’s Form 8-K filed with the Securities and Exchange Commission on February 7, 2011. The Company believes that Adjusted Net Income (Loss) provides useful information to investors about the Company’s performance because it eliminates the effects of period-to-period changes in income from interest on the Company’s cash and marketable securities, expense from the Company’s financing transactions and the costs associated with income tax expense, capital investments, stock-based compensation expense, warrant revaluation charges, and non-recurring charges which are not directly attributable to the underlying performance of the Company’s business operations. Management used Adjusted Net Income (Loss) in evaluating the overall performance of the Company’s business operations, making it useful to the NCCG Committee in evaluating management’s performance. A limitation of non-GAAP Adjusted Net Income is that it excludes items that often have a material effect on the company’s net income and earnings per common share calculated in accordance with GAAP. Therefore, management compensates for this limitation by using Adjusted Net Income in conjunction with net income (loss) and net income (loss) per share measures. The non-GAAP measures should be viewed as a supplement to, and not as a substitute for, or superior to, GAAP net income or earnings per share.

 

First-Half Bonus: Individual Performance Component

 

The individual performance component of each Named Executive Officer’s bonus is determined by the Committee and actual bonuses can range between 0% and 150% of target. The Committee’s assessment is based on performance against pre-set strategic objectives and for Named Executive Officers, except the Chief Executive officer, the general recommendations and performance evaluations of the Chief Executive Officer. For the First-Half period, the Committee’s bonus decisions were based upon the following individual goals.

 

Heath B. Clarke — The Committee awarded Mr. Clarke a bonus equal to 110% of target for the individual performance component. In addition to delivering financial performance during the period, the Committee recognized Mr. Clarke’s achievement of the following key strategic objectives: achievement of subscriber targets, enhancement of traffic reporting systems, introduction and Board-approval of growth plans, completion of the Octane360 acquisition, achievement of traffic targets, enhancement of network business platform and achievement of financing objectives. The Committee determined that most of these objectives were achieved, certain of them, including the achievement of a $30 million line of credit, were overachieved, while others were underachieved, including goals with respect to enhancement of the network business platform.

 

Stanley B. Crair — Based in part on the CEO’s recommendation, the Committee approved Mr. Crair’s individual performance bonus component at 96% of target. Mr. Crair’s goals were tied to achievement of traffic targets, enhancement of traffic reporting systems, Local.com site enhancements, certain facilities based goals, growth of the Network business unit, and enhancement of the SAS operations plan. The Committee’s decision to award an amount below target was based on achievement of most goals satisfactorily, partially offset by achievement of a less than planned increase in organic traffic.

 

Kenneth S. Cragun — During the first half of the fiscal year, Mr. Cragun served as our Vice President of Finance and was not an executive officer of the Company. His bonus based on individual performance was approved by the CEO and was equal to 106% of target. Mr. Cragun’s goals were tied to annual audit related matters, SEC reporting matters, enhancement of business unit financial reporting, enhancements to the financial forecasting processes and executive financial reporting dashboard, developing a second half 2010 budget, and completion of the Octane360 acquisition. The decision to award Mr. Cragun an amount above target was based on the Committee’s determination that Mr. Cragun met or exceeded nearly all of these goals.

 

Michael O. Plonski — Based in part on the CEO’s recommendation, the Committee approved Mr. Plonski’s individual performance bonus component at 108% of target. Mr. Plonski’s goals were related to achievement of traffic targets, development and deployment of key product functionality, enhancing technology support plans, achievement of certain site performance metrics, and completion of the Octane360 acquisition. The decision to award Mr. Plonski an amount above target was based on the Committee’s determination that Mr. Plonski met many or his targets, exceeded others, including assistance with acquisition matters and certain technology development milestones, while underperforming others, including with respect to certain other technology development goals and achievement of certain traffic target goals.

 

Brenda Agius — Based in part on the CEO’s recommendation, the Committee approved Ms. Agius’s individual performance bonus component at 116% of target. Ms. Agius’s goals related to accounting, finance, and investor relations matters. The approved award was based on Ms. Agius’s key accomplishments related to exceeding the Board-approved budget, closing of the $30 million line of credit, and achievement of certain investor relations goals.

 

Scott Reinke — Based in part on the CEO’s recommendation, the Committee determined Mr. Reinke’s individual performance bonus component to be earned at 106% of target. Mr. Reinke’s goals were based on the legal matters of the Company related to risk management, litigation, contracts, and securities regulations.

Total First-Half bonuses for our Named Executive Officers are summarized in the following table.