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Table Of Contents

 

UNITED STATES

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 


FORM 10-Q


(Mark One)

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 

 

For the quarterly period ended June 30, 2014

 

OR

 

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 

 

For the transition period from              to            

 

Commission file number 001-34749

 


REACHLOCAL, INC.

(Exact name of registrant as specified in its charter)


Delaware 

20-0498783 

(State or other jurisdiction of incorporation

or organization) 

(I.R.S. Employer Identification No.) 

 

21700 Oxnard Street, Suite 1600

Woodland Hills, California 

91367 

(Address of principal executive offices) 

(Zip Code) 

 

Registrant’s telephone number, including area code: (818) 274-0260


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      No  

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes      No  

 

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

 

Large accelerated filer ☐

Accelerated filer ☒

   
Non-accelerated filer ☐  (Do not check if a smaller reporting company) Smaller reporting company ☐

 

 
PAGE 1

Table Of Contents
 

 

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

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Title of Class 

  

Number of Shares Outstanding on August 1, 2014 

Common Stock, $0.00001 par value

  

29,143,870

 

 
PAGE 2

Table Of Contents
 

 

INDEX

 

  

  

 

  

Page 

Part I.

Financial Information

4

 

Item 1.

Consolidated Financial Statements (unaudited)

4

  

  

Consolidated Balance Sheets as of June 30, 2014 and December 31, 2013

4

  

  

Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2014 and 2013

5

  

  

Consolidated Statements of Comprehensive Loss for the Three and Six Months Ended June 30, 2014 and 2013

6

  

  

Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2014 and 2013

7

  

  

Notes to the Consolidated Financial Statements

8

  

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

19

  

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

32

  

Item 4.

Controls and Procedures

33

  

  

  

Part II.

Other Information

34

  

Item 1.

Legal Proceedings

34

  

Item 1A.

Risk Factors

34

  

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

34

  

Item 6.

Exhibits

34

  

  

Signatures

35

 

 
PAGE 3

Table Of Contents
 

 

PART I

 

FINANCIAL INFORMATION

 

Item 1.         FINANCIAL STATEMENTS

REACHLOCAL, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

(Unaudited) 

 

   

June 30,

2014

   

December 31,

2013

 

Assets

               

Current Assets:

               

Cash and cash equivalents

  $ 64,274     $ 77,514  

Short-term investments

    259       260  

Accounts receivable, net of allowance for doubtful accounts of $3,812 and $2,212 at June 30, 2014 and December 31, 2013, respectively

    7,856       9,699  

Prepaid expenses and other current assets

    10,713       8,746  

Deferred tax assets

    2,151       1,250  

Assets of discontinued operations

    65       3,415  

Total current assets

    85,318       100,884  
                 

Property and equipment, net

    14,075       12,903  

Capitalized software development costs, net

    19,960       17,300  

Restricted deposits

    3,866       3,654  

Deferred tax assets

    2,351       1,883  

Intangible assets, net

    2,033       1,270  

Other assets

    13,021       6,032  

Goodwill

    44,560       42,083  

Total assets

  $ 185,184     $ 186,009  
                 

Liabilities and Stockholders’ Equity

               

Current Liabilities:

               

Accounts payable

  $ 33,485     $ 36,970  

Accrued compensation and benefits

    17,121       17,280  

Deferred revenue

    31,469       33,013  

Accrued restructuring

    2,993        

Other current liabilities

    17,322       15,089  

Liabilities of discontinued operations

    849       1,324  

Total current liabilities

    103,239       103,676  
                 

Deferred rent and other liabilities

    4,852       3,965  

Total liabilities

    108,091       107,641  
                 

Commitments and contingencies (Note 7)

               
                 

Stockholders’ Equity:

               

Common stock, $0.00001 par value—140,000 shares authorized; 29,152 and 28,259 shares issued and outstanding at June 30, 2014 and December 31, 2013, respectively

           

Receivable from stockholder

    (79

)

    (73

)

Additional paid-in capital

    126,098       111,934  

Accumulated deficit

    (45,827

)

    (29,559

)

Accumulated other comprehensive loss

    (3,099

)

    (3,934

)

Total stockholders’ equity

    77,093       78,368  

Total liabilities and stockholders’ equity

  $ 185,184     $ 186,009  

 

See notes to consolidated financial statements.

 

 
PAGE 4

Table Of Contents
 

 

REACHLOCAL, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)

 

   

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
   

2014

   

2013

   

2014

   

2013

 

Revenue

  $ 123,553     $ 126,757     $ 248,289     $ 248,364  

Cost of revenue

    63,461       63,599       126,859       124,705  

Operating expenses:

                               

Selling and marketing

    48,146       45,096       94,907       88,730  

Product and technology

    6,816       5,259       13,775       11,146  

General and administrative

    14,530       9,924       28,694       19,123  

Restructuring charges

    2,226             4,049        

Total operating expenses

    71,718       60,279       141,425       118,999  

Operating income (loss)

    (11,626

)

    2,879       (19,995

)

    4,660  

Other income, net

    195       114       383       341  

Income (loss) from continuing operations before income taxes

    (11,431

)

    2,993       (19,612

)

    5,001  

Income tax provision (benefit)

    (1,105

)

    1,672       (2,973

)

    3,328  

Income (loss) from continuing operations

    (10,326

)

    1,321       (16,639

)

    1,673  

Gain (loss) from discontinued operations (including gain on disposal of $1,201 for the six months ended June 30, 2014)

    49       (2,346

)

    593       (3,960

)

Income tax provision (benefit)

    18       (884

)

    222       (1,511

)

Net loss

  $ (10,295

)

  $ (141

)

  $ (16,268

)

  $ (776 )
                                 

Net income (loss) per share:

                               
                                 

Basic:

                               

Income (loss) from continuing operations

  $ (0.36

)

  $ 0.05     $ (0.59

)

  $ 0.06  

Income (loss) from discontinued operations, net of income taxes

          (0.06

)

    0.01       (0.09

)

Net loss per share

  $ (0.36

)

  $ (0.01

)

  $ (0.58

)

  $ (0.03

)

                                 

Diluted:

                               

Income (loss) from continuing operations

  $ (0.36

)

  $ 0.04     $ (0.59

)

  $ 0.06  

Income (loss) from discontinued operations, net of income taxes

          (0.04

)

    0.01       (0.09

)

Net loss per share

  $ (0.36

)

  $     $ (0.58

)

  $ (0.03

)

                                 

Weighted average common shares used in the computation of income (loss) per share:

                               

Basic

    28,469       27,910       28,279       28,011  

Diluted

    28,469       29,656       28,279       29,591  

 

 See notes to consolidated financial statements.

 

 
PAGE 5

Table Of Contents
 

 

REACHLOCAL, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS 

(in thousands)

(Unaudited)

  

   

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
   

2014

   

2013

   

2014

   

2013

 

Net loss

  $ (10,295

)

  $ (141

)

  $ (16,268

)

  $ (776

)

Other comprehensive loss:

                               

Foreign currency translation adjustments

    550       (1,878

)

    835       (1,866

)

Comprehensive loss

  $ (9,745

)

  $ (2,019

)

  $ (15,433

)

  $ (2,642

)

 

See notes to consolidated financial statements.

   

 
PAGE 6

Table Of Contents
 

 

REACHLOCAL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS 

(in thousands)

(Unaudited) 

 

   

Six Months Ended

June 30,

 
   

2014

   

2013

 

Cash flows from operating activities:

               

Income (loss) from continuing operations

  $ (16,639

)

  $ 1,673  

Adjustments to reconcile income (loss) from continuing operations, net of income taxes, to net cash provided by (used in) operating activities:

               

Depreciation and amortization

    8,240       7,666  

Stock-based compensation

    8,047       5,061  

Restructuring charges

    4,049        

Excess tax shortfalls (benefits) from stock-based awards

    568       (1,090

)

Provision for doubtful accounts

    1,602       296  

Deferred taxes, net

    (1,372

)

     

Changes in operating assets and liabilities:

               

Accounts receivable

    (73

)

    (3,030

)

Prepaid expenses and other current assets

    (1,890

)

    (1,667

)

Other assets

    (397

)

    (721

)

Accounts payable

    (4,204

)

    3,809  

Accrued compensation and benefits

    (524

)

    (772

)

Deferred revenue

    (2,129

)

    921  

Accrued restructuring

    (867

)

     

Deferred rent and other liabilities

    1,371       1,382  

Net cash provided by (used in) operating activities, continuing operations

    (4,218

)

    13,528  

Net cash used in operating activities, discontinued operations

    (1,262

)

    (1,960

)

Net cash provided by (used in) operating activities

    (5,480

)

    11,568  
                 

Cash flows from investing activities:

               

Additions to property, equipment and software

    (10,942

)

    (9,585

)

Acquisitions, net of acquired cash

    (1,760

)

    (363

)

Investment in partnership

    (2,000

)

    (2,500

)

Maturities of certificates of deposits and short-term investments

    (73

)

    2,578  

Purchases of certificates of deposits and short-term investments

          (2,522

)

Net cash used in investing activities, continuing operations

    (14,775

)

    (12,392

)

Net cash used in investing activities, discontinued operations

          (1,598

)

Net cash used in investing activities

    (14,775

)

    (13,990

)

                 

Cash flows from financing activities:

               

Proceeds from exercise of stock options

    6,438       4,370  

Excess tax benefits (shortfalls) from stock-based awards

    (568

)

    1,090  

Common stock repurchases

    (21

)

    (12,990

)

Net cash provided by (used in) financing activities

    5,849       (7,530

)

                 

Effect of exchange rate changes on cash and cash equivalents

    1,166       (3,193

)

Net change in cash and cash equivalents

    (13,240

)

    (13,145

)

Cash and cash equivalents—beginning of period

    77,514       92,320  

Cash and cash equivalents—end of period

  $ 64,274     $ 79,175  
                 

Supplemental disclosure of non-cash investing and financing activities:

               

Capitalized software development costs resulting from stock-based compensation

  $ 219     $ 191  

Deferred payment obligation decrease

  $ (290

)

  $ (122

)

Unpaid purchases of property and equipment

  $ 317     $ 382  

Investment related to the ClubLocal disposition

  $ 4,500     $  

 

See notes to consolidated financial statements.

 

 
PAGE 7

Table Of Contents
 

 

REACHLOCAL, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS  

(UNAUDITED)

 

1. Organization and Description of Business

 

ReachLocal, Inc. (the “Company”) was incorporated in the state of Delaware in August 2003. The Company’s operations are located in the United States, Canada, Australia, New Zealand, Japan, the United Kingdom, Germany, the Netherlands, Austria, Belgium, Brazil, Mexico, and India. The Company’s mission is to help small and medium-sized businesses (“SMBs”) acquire, transact with, and retain customers online. The Company offers a comprehensive suite of online marketing solutions, including a marketing system that combines an optimized website and automated lead management (ReachEdge™), search engine marketing (ReachSearch™), display advertising (ReachDisplay™), display retargeting (ReachRetargeting™), search engine optimization (ReachSEO™), Web presence (ReachCast™), online marketing analytics (TotalTrack®), an assisted chat service (TotalLiveChat™), and other products, each targeted to the SMB market. The Company delivers its suite of services to SMBs through a combination of its proprietary technology platform, its sales force of outside and inside salespeople, and select third-party agencies and resellers. 

 

2. Summary of Significant Accounting Policies

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of ReachLocal, Inc. and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

 

Basis of Presentation

 

The accompanying consolidated financial statements are unaudited. These unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and applicable rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been or omitted pursuant to such rules and regulations. Accordingly, these interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013. The Consolidated Balance Sheet as of December 31, 2013 included herein was derived from the audited consolidated financial statements as of that date, but does not include all disclosures included in those audited consolidated financial statements.

 

The unaudited interim consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and include all adjustments (consisting only of normal recurring adjustments) necessary for the fair presentation of the Company’s statement of financial position at June 30, 2014, the Company’s results of operations for the three and six months ended June 30, 2014 and 2013 and the Company’s cash flows for the six months ended June 30, 2014 and 2013. The results for the three and six months ended June 30, 2014 are not necessarily indicative of the results to be expected for the year ending December 31, 2014. All references to the three and six months ended June 30, 2014 and 2013 in the notes to the consolidated financial statements are unaudited.

  

Reclassifications and Adjustments

 

Certain prior period amounts have been reclassified to conform to the current period presentation. 

 

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results may differ from those estimates.  

 

 
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Table Of Contents
 

 

Restricted Cash

 

Restricted cash represents certificates of deposit held at financial institutions, which are pledged as collateral for letters of credit related to lease commitments or as collateral for the Company’s merchant accounts. The restrictions will lapse when the letters of credit related to lease commitments expire at the end of the respective lease terms in 2021. The restrictions on the certificates of deposits related to the merchant accounts will lapse upon termination of the merchant accounts. Restricted certificates of deposit are classified as non-current assets.

 

Commissions

 

Generally, the Company expenses commissions (which include variable sales compensation) as earned. Commencing in 2014, the Company began paying commissions to certain sales people for the acquisition of new clients. The client contracts are not cancelable without a penalty, and the Company defers those commissions and amortizes them over the term of the initial customer campaign. The amortization of deferred commissions is included in selling and marketing expense in the accompanying consolidated statements of operations. Unamortized commission expense of $0.4 million at June 30, 2014, is included in prepaid expenses and other current assets in the accompanying consolidated balance sheet.

 

Recent Accounting Pronouncements

 

In June 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-12, Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. The amendments in this update require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in Accounting Standards Codification (“ASC”) 718, Compensation – Stock Compensation, as it relates to awards with performance conditions that affect vesting to account for such awards. The amendments in this update will be effective for the Company as of January 1, 2016. Earlier adoption is permitted. Entities may apply the amendments in this update either: (a) prospectively to all awards granted or modified after the effective date; or (b) retrospectively to all awards with performance targets that are outstanding as of the beginning of the earliest annual period presented in the financial statements and to all new or modified awards thereafter. If retrospective transition is adopted, the cumulative effect of applying this update as of the beginning of the earliest annual period presented in the financial statements should be recognized as an adjustment to the opening retained earnings balance at that date. In addition, if retrospective transition is adopted, an entity may use hindsight in measuring and recognizing the compensation cost. The Company is currently assessing the impact of this update, and believes that its adoption on January 1, 2016 will not have a material impact on its consolidated financial statements.

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers. The guidance in this update supersedes the revenue recognition requirements in ASC 605, Revenue Recognition, and most industry-specific guidance throughout the Codification. This update supersedes some cost guidance included in ASC 605-35, Revenue Recognition - Construction-Type and Production-Type Contracts. In addition, the existing requirements for the recognition of a gain or loss on the transfer of nonfinancial assets that are not in a contract with a customer (for example, assets within the scope of ASC 360, Property, Plant, and Equipment, and intangible assets, within the scope of ASC 350, Intangibles - Goodwill and Other) are amended to be consistent with the guidance on recognition and measurement in this update. The standard will be effective for the Company as of January 1, 2017. Earlier adoption is not permitted for public entities. An entity can apply the revenue standard retrospectively to each prior reporting period presented (full retrospective method) or retrospectively with the cumulative effect of initially applying the standard recognized at the date of initial application in retained earnings (simplified transition method). The Company is currently assessing the impact of this update on its consolidated financial statements.

 

In April 2014, the FASB issued ASU No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. The amendments in this update change the criteria for determining which disposals can be presented as discontinued operations and modify related disclosure requirements. The guidance applies prospectively to new disposals and new classifications of disposal groups as held for sale after the effective date, and is effective for the Company as of January 1, 2015. However, all entities may early adopt the guidance for new disposals (or new classifications as held for sale) that have not been reported in financial statements previously issued or available for issuance. The Company will apply this guidance to any new disposals or new classification as held for sale after the effective date.

 

 
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3. Fair Value of Financial Instruments

 

The Company applies the fair value hierarchy for its financial instruments. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value maximize the use of observable inputs and minimize the use of unobservable inputs. The fair value hierarchy is based on three levels of inputs, of which the first two are considered observable and the last is considered unobservable, that are used to measure fair value:

 

 

Level 1—Quoted prices in active markets for identical assets or liabilities.

   

 

Level 2—Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

   

 

Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

   

The following table summarizes the basis used to measure certain of the Company’s financial assets and liabilities that are carried at fair value (in thousands):

 

         

Basis of Fair Value Measurement

 
   

Balance at

June 30,

2014

   

Quoted Prices in Active Markets for Identical

Items

(Level 1)

   

Significant

Other

Observable Inputs (Level 2)

   

Significant Unobservable

Inputs

(Level 3)

 

Assets:

                               

Short-term investments

  $ 259     $ 259     $     $  

Restricted deposits

  $ 3,866     $     $ 3,866     $  
                                 

Liabilities:

                               

Contingent acquisition consideration

  $ 808     $     $     $ 808  

 

           

Basis of Fair Value Measurement

 
   

Balance at

December 31,

2013

   

Quoted Prices in Active Markets for Identical

Items

(Level 1)

   

Significant

Other

Observable Inputs (Level 2)

   

Significant Unobservable

Inputs

(Level 3)

 

Assets:

                               

Short-term investments

  $ 260     $ 260     $     $  

Restricted deposits

  $ 3,654     $     $ 3,654     $  

  

 The Company’s restricted deposits are valued using pricing sources and models utilizing market observable inputs, as provided to the Company by its broker.

 

 
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Table Of Contents
 

 

The Company also has an investment in a privately held partnership that is one of its service providers. The Company’s ownership is less than 20% and the Company does not have significant influence over the entity. In addition, the Company has an equity interest of 19.9% in an entity that was formally its ClubLocal business and the Company does not have significant influence over the entity. These investments are accounted for under the cost method and are periodically assessed for other-than-temporary impairment. If the Company determines that an other-than-temporary impairment has occurred, it will write-down the investments to their fair value. The fair value of a cost method investment is not evaluated if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value of the investment. However, if such significant adverse events were identified, the Company would estimate the fair value of its cost method investment considering available information at the time of the event, such as current cash position, earnings and cash flow forecasts, recent operational performance and any other readily available data. During the six months ended June 30, 2014, the Company invested $2.0 million for an additional 3.2% equity interest in the service provider, resulting in a total ownership of 7.2%. The carrying amounts of the Company’s cost method investments were each $4.5 million at June 30, 2014, and are included in “Other assets” in the accompanying Consolidated Balance Sheet.

  

4. Acquisitions

 

SureFire Acquisition

 

On March 21, 2014, the Company acquired certain assets and hired certain employees of SureFire Search Limited (“SureFire”) as part of the Company’s international expansion plan. Prior to the acquisition, SureFire was the Company’s exclusive reseller in New Zealand since 2010.

 

At closing, the Company paid NZ$1.7 million ($1.5 million) in cash of the estimated NZ$3.1 million ($2.7 million) purchase price. The remaining balance of the estimated purchase price is deferred subject to meeting revenue targets and an indemnity holdback, which will be payable, if at all, after the 12-month anniversary of the closing date, and the 12- and 18-month anniversaries of the closing date, respectively. The maximum amount of contingent consideration payable is NZ$2.0 million ($1.7 million) and the contingent consideration was recorded as an accrued expense. The fair value of the earn-out consideration was determined by applying the income approach. This approach is based on significant inputs that are not observable in the market, which ASC 820-10-35 refers to as Level 3 inputs. Key assumptions include probability-adjusted assumptions for sales performance of approximately NZ$10 million ($9.0 million) and a discount rate of 25% based on an estimated payment date of April 2015. The fair value of the contingent consideration at the date of acquisition was NZ$0.9 million ($0.8 million). There were no material changes to the fair value of contingent consideration or assumptions used since the date of acquisition. The liability for the indemnity holdback was recorded based on the assumption that there will be no claims made against the holdback and that 65% of the indemnity holdback will be paid April 2015 and the remaining 35% will be paid October 2015. The fair value of the indemnity holdback at the date of acquisition was NZ$0.4 million ($0.4 million).

 

           The acquisition was accounted for using the acquisition method of accounting. The Company completed a preliminary purchase price allocation in the first quarter of 2014 and expects to finalize the allocation in the third quarter of 2014 with respect to the timing of certain valuation adjustments. The Company recorded acquired assets and liabilities assumed at their respective fair values. The following table summarizes the preliminary fair value of acquired assets and liabilities assumed (in thousands):

 

Assets acquired:

       

Goodwill

  $ 2,445  

Intangible assets

    1,306  

Accounts receivable

    330  

Property and equipment

    10  

Total assets acquired

    4,091  

Liabilities assumed:

       

Deferred tax liabilities

    366  

Deferred revenue

    158  

Accrued compensation and benefits

    123  

Other

    766  

Total fair value of net assets acquired

  $ 2,678  

 

Intangible assets acquired from SureFire included customer relationships of $1.3 million which are amortized over three years, their estimated useful life, using the straight line method. The fair value of the intangible assets was determined by applying the income approach and based on Level 3 inputs. Key assumptions include estimated future revenues from acquired customers and a discount rate of 25%. The goodwill arising from the acquisition consists largely of the synergies expected from combining the operations of SureFire. The Company expects to increase its presence in the Asia Pacific region as a result of this acquisition. The acquired goodwill is not expected to be deductible for tax purposes.

 

 
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Acquisition costs in connection with the SureFire acquisition were immaterial for the six months ended June 30, 2014. The revenues and results of operations of the acquired businesses for the periods post-acquisition were included in the consolidated statements of operations and were immaterial for the periods ended June 30, 2014. The pro forma results are not shown as the impact is not material.

 

RealPractice Acquisition

 

On January 6, 2014, the Company made the final deferred payment in connection with its 2012 RealPractice acquisition in the amount of $0.3 million.

 

Intangible Assets

 

At June 30, 2014, intangible assets from acquisitions included developed technology of $0.8 million (net of accumulated amortization of $1.7 million) and customer relationships of $1.2 million (net of accumulated amortization of $0.1 million), each amortized over three years. At December 31, 2013, intangible assets from acquisitions included developed technology of $1.3 million (net of accumulated amortization of $1.8 million) amortized over three years. Based on the current amount of intangibles subject to amortization, the estimated amortization expense over the remaining lives is as follows (in thousands):

 

Years Ending December 31,

       

2014

  $ 640  

2015

    858  

2016

    441  

2017

    94  

Total

  $ 2,033  

 

For the three months ended June 30, 2014 and 2013, amortization expense related to acquired intangibles was $0.3 million. For the six months ended June 30, 2014 and 2013, amortization expense related to acquired intangibles was $0.6 million and $0.7 million, respectively.

 

Goodwill

 

The changes in the carrying amount of goodwill for the six months ended June 30, 2014 were as follows (in thousands):

 

   

North America

   

Asia-Pacific

   

Total

 

Balance at December 31, 2013

  $ 9,695     $ 32,388     $ 42,083  

Goodwill acquired

          2,445       2,445  

Foreign currency translation

          32       32  

Balance at June 30, 2014

  $ 9,695     $ 34,865     $ 44,560  

 

The North American region consists of the Company’s operations in the United States and Canada. The increase in goodwill for the Asia-Pacific region, which includes the Company’s operations in Australia, New Zealand and Japan, was related to the SureFire acquisition.

 

 
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5. Software Development Costs

 

Capitalized software development costs consisted of the following (in thousands):

 

   

June 30,

2014

   

December 31,

2013

 

Capitalized software development costs

  $ 49,924     $ 42,538  

Accumulated amortization

    (29,964 )     (25,238

)

Capitalized software development costs, net

  $ 19,960     $ 17,300  

 

For the three months ended June 30, 2014 and 2013, the Company recorded amortization expense of $2.2 million and $2.0 million respectively. For the six months ended June 30, 2014 and 2013, amortization expense related to software development costs was $4.7 million and $4.1 million, respectively. At June 30, 2014 and December 31, 2013, $4.2 million and $2.8 million, respectively, of capitalized software development costs were related to projects still in process.

  

6. Variable Interest Entities

 

On July 6, 2012, the Company completed a transaction with OxataSMB, in which the Company entered into a franchise agreement with OxataSMB permitting OxataSMB to operate and resell the Company’s services under the ReachLocal brand in Slovakia, Czech Republic, Hungary, Poland and Russia. Pursuant to the franchise agreement, OxataSMB receives access to the RL platform, training, marketing and branding materials, media purchasing, campaign management and provisioning, sourcing of telephony, and technical support. The Company does not anticipate OxataSMB will pursue activities other than as a franchisee. In addition, the Company entered into a market development loan agreement with OxataSMB pursuant to which the Company agreed to provide financing to OxataSMB of up to €2.9 million ($3.7 million), of which €1.45 million ($1.9 million) was advanced in 2012. In August 2013, the Company advanced an additional €0.92 million ($1.2 million) to OxataSMB. Prior to advancement of the loan in 2012, OxataSMB had €1.45 million ($2.0 million) of contributed capital.

 

OxataSMB is considered a variable interest entity (VIE) with respect to the Company because, depending on its performance, OxataSMB may not have sufficient equity to finance its activities without additional financial support. Based on the Company’s initial assessment in 2012, the Company was not the primary beneficiary of OxataSMB because it did not have: (1) the power to direct the activities that most significantly impact OxataSMB’s economic performance or (2) the obligation to absorb losses of OxataSMB or the right to receive benefits from OxataSMB that could potentially be significant. Therefore, the Company did not consolidate the results of OxataSMB, and transactions with OxataSMB results were accounted for similarly to the Company’s resellers.  In December 2013, the Company reserved all amounts due from OxataSMB. The Company continues to supply OxataSMB on a cash-in-advance basis under the amended terms of the franchise agreement. At June 30, 2014, the Company concluded no events or changes in circumstances have occurred that would change the Company’s assessment of OxataSMB’s VIE status and that the Company was not a primary beneficiary of OxataSMB.

 

 7. Commitments and Contingencies  

 

Litigation

 

On May 2, 2014, a lawsuit, purporting to be a class action, was filed by one of the Company’s former clients in the United States District Court in Los Angeles. The complaint alleges breach of contract, breach of the implied covenant of good faith and fair dealing, and violation of California’s unfair competition law. The complaint seeks monetary damages, restitution and attorneys’ fees. While the case is at an early stage, the Company believes that the case is substantively and procedurally without merit.

 

The Company is subject to various other legal proceedings and claims arising in the ordinary course of business. Although occasional adverse decisions or settlements may occur, management believes that the final disposition of existing matters will not have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

  

 
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8. Stockholders’ Equity

 

Common Stock Repurchases

 

The Company’s Board of Directors has authorized the repurchase of up to $47.0 million of the Company’s outstanding common stock. At June 30, 2014, the Company had executed repurchases of 3.4 million shares of its common stock under the program for an aggregate of $36.3 million. There were no repurchases during the six months ended June 30, 2014. Purchases may be made from time-to-time in open market or privately negotiated transactions as determined by the Company’s management. The amount and timing of the share repurchase will depend on business and market conditions, stock price, trading restrictions, acquisition activity, and other factors. The share repurchase program does not obligate the Company to acquire any particular amount of common stock, and the repurchase program may be suspended or discontinued at any time at the Company’s discretion.

 

9. Stock-Based Compensation

 

Stock Options

 

Stock-based compensation cost is measured at the grant date, based on the fair value of the award, and recognized on a straight-line basis over the requisite service period, which is generally the vesting period.

  

The following table summarizes stock option activity (in thousands, except years and per share amounts): 

 

   

Number of

Shares

   

Weighted

Average

Exercise

Price per

Share

   

Weighted

Average

Remaining Contractual

Life

(in years)

   

Aggregate

Intrinsic

Value

 

Outstanding at December 31, 2013

    6,733     $ 11.44                  

Granted

    2,379     $ 9.60                  

Exercised

    (718 )   $ 8.96                  

Forfeited

    (1,354 )   $ 11.92                  

Outstanding at June 30, 2014

    7,040     $ 10.98       5.1       555  
                                 

Vested and exercisable at June 30, 2014

    3,798     $ 11.54       3.9       384  
                                 

Unvested at June 30, 2014, net of estimated forfeitures

    2,880     $ 10.35       6.5       149  

 

      The following table presents the weighted-average assumptions used to estimate the fair values of the stock options granted during the three months ended March 31, 2014 and 2013.

 

   

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
   

2014

   

2013

   

2014

   

2013

 

Expected dividend yield

    0

%

    0

%

    0

%

    0

%

Risk-free interest rate

    1.71

%

    0.80

%

    1.63

%

    0.85

%

Expected life (in years)

    5.32       5.07       5.09       4.82  

Expected volatility

    54

%

    60

%

    54

%

    60

%

 

The per-share weighted-average grant date fair value of options granted during the six months ended June 30, 2014 was $4.46. The aggregate intrinsic value of stock options exercised during the six months ended June 30, 2014 was $2.7 million.

  

 
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Restricted Stock and Restricted Stock Units

 

The following table summarizes restricted stock and restricted stock unit awards (in thousands, except per share amounts):

 

   

Number of

shares

   

Weighted

Average Grant

Date Fair Value

 

Unvested at December 31, 2013

    1,157     $ 9.44  

Granted

    209     $ 7.82  

Forfeited

    (153 )   $ 12.67  

Vested

    (168 )   $ 12.34  

Unvested at June 30, 2014

    1,045     $ 9.15  

 

Stock-Based Compensation Expense

 

The Company records stock-based compensation expense, net of amounts capitalized associated with software development costs. The following table summarizes stock-based compensation (in thousands):

 

   

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
   

2014

   

2013

   

2014

   

2013

 

Stock-based compensation

  $ 3,597     $ 2,541     $ 8,266     $ 5,252  

Less: Capitalized stock-based compensation

    121       132       219       191  

Stock-based compensation expense, net

  $ 3,476     $ 2,409     $ 8,047     $ 5,061  

  

Stock-based compensation, net of capitalization, is included in the accompanying Consolidated Statements of Operations within the following captions (in thousands):

 

   

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
   

2014

   

2013

   

2014

   

2013

 

Stock-based compensation expense, net

                               

Cost of revenue

  $ 255     $ 153     $ 530     $ 271  

Selling and marketing

    859       709       1,736       1,494  

Product and technology

    222       38       608       262  

General and administrative

    2,140       1,509       5,173       3,034  
    $ 3,476     $ 2,409     $ 8,047     $ 5,061  

  

 Stock-based compensation for the six months ended June 30, 2014 includes $1.9 million of expense related to the extension of time to exercise from seven years to ten years for certain options granted during 2008 and 2009, with a strike price of $10.91. Grants to 73 participants were modified. At June 30, 2014, there was $21.2 million of unrecognized stock-based compensation related to restricted stock, restricted stock units and outstanding stock options, net of estimated forfeitures. This amount is expected to be recognized over a weighted average period of 1.5 years. Future stock-based compensation expense for these awards may differ in the event actual forfeitures deviate from management’s estimates.

 

10. Restructuring Charges

 

The Company records costs associated with exit activities related to restructuring plans in accordance with the ASC Topic 420, “Exit or Disposal Obligations.”  Liabilities for costs associated with an exit or disposal activity are recognized in the period in which the liability is incurred. Restructuring accruals are subject to future refinement as additional information becomes available.

 

As a result of declining performance in the Company’s North America market (which consists of the United States and Canada), during the first quarter of 2014, the Company implemented a preliminary restructuring plan to streamline operations and increase profitability. The restructuring plan primarily involves a reduction of the Company’s North American workforce as well as the closure of certain global facilities. The Company expects to have continued activity under this plan throughout 2014.

 

 
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A summary of the accrued restructuring liability related to this plan, which is recorded in “Accrued restructuring” on the consolidated balance sheet is as follows (in thousands):

 

   

Workforce Reduction Costs

   

Facility Closures
and Equipment
Write-downs

   

Total

 

Balance at December 31, 2013

  $     $     $  

Amounts accrued

    547       2,972       3,519  

Amounts paid

    (547 )     (255 )     (802 )

Accretion

          6       6  

Non-cash items

          (195 )     (195 )

Balance at June 30, 2014

  $     $ 2,528     $ 2,528  

 

The workforce reductions were fully paid by June 30, 2014, and the Company expects the facility closures and equipment write-downs to be paid through the third quarter of 2024.

 

During the second quarter of 2014, as a result of continued declines in Company performance, the Company began implementing a business restructuring plan to streamline operations and increase profitability. The initial actions under this restructuring plan involved the elimination of certain senior management positions. The Company expects to have continued activity under this plan throughout 2014.

 

A summary of the accrued restructuring liability related to this plan, which is recorded in “Accrued restructuring” on the consolidated balance sheet is as follows (in thousands):

 

   

Workforce Reduction Costs

 

Balance at December 31, 2013

  $  

Amounts accrued

    530  

Amounts paid

    (65 )

Balance at June 30, 2014

  $ 465  

 

Severance and other costs related to the workforce reductions that have occurred to date are expected to be paid in the third quarter of 2014.

 

 11. Income Taxes

 

The Company provides for income taxes in interim periods based on the estimated effective income tax rate for the complete fiscal year. The income tax provision is computed on the year to date pretax income of the consolidated entities located within each taxing jurisdiction based on current tax law. Deferred tax assets and liabilities are determined based on the future tax consequences associated with temporary differences between income and expenses reported for financial accounting and tax reporting purposes. A valuation allowance for deferred tax assets is recorded to the extent the Company determines that it is more likely than not that the deferred tax assets will not be realized.

 

Realization of deferred tax assets is principally dependent upon the achievement of future taxable income, the estimation of which requires significant management judgment. The Company’s judgment regarding future profitability may change due to many factors, including future market conditions and the Company’s ability to successfully execute its business plans and/or tax planning strategies. These changes, if any, may require material adjustments to these deferred tax asset balances. On a quarterly basis, the Company reassesses the need for these valuation allowances based on operating results and its assessment of the likelihood of future taxable income and developments in the relevant tax jurisdictions. The Company continues to maintain a valuation allowance against its net deferred tax assets in various foreign jurisdictions in 2014, where the Company believes it is more likely than not that deferred tax assets will not be realized.

  

 
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The Company strives to resolve open matters with each tax authority at the examination level and could reach agreement with a tax authority at any time. While the Company has accrued for amounts it believes are the expected outcomes, the final outcome with a tax authority may result in a tax liability that is more or less than that reflected in the financial statements. In addition, the Company may later decide to challenge any assessments, if made, and may exercise its right to appeal. The liability is reviewed quarterly and adjusted as events occur that affect potential liabilities for additional taxes, such as lapsing of applicable statutes of limitations, proposed assessments by tax authorities, negotiations between tax authorities, identification of new issues, and issuance of new legislation, regulations or case law. Management believes that adequate amounts of tax and related interest, if any, have been provided for any adjustments that may result from these examinations of uncertain tax positions. Interest and penalties are included in income tax expense.

 

The Company and its subsidiaries file income tax returns in the U.S. federal, various state and foreign jurisdictions. The Company has used net operating losses in recent periods, which extended the statutes of limitations with respect to a number of the Company’s tax years. Currently a majority of the Company’s tax years remain subject to audit, however, certain jurisdiction’s statutes of limitations will begin to expire in 2016.  

 

12. Net Income (Loss) Per Share

 

Basic net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of common and potential dilutive shares outstanding during the period, to the extent such shares are dilutive. Potential dilutive shares are composed of incremental common shares issuable upon the exercise of stock options, warrants and unvested restricted shares using the treasury stock method. The Company was in a loss from continuing operations position for the three and six month periods ended June 30, 2014 and 2013, and therefore the number of diluted shares was equal to the number of basic shares for this period.

  

The following potentially dilutive securities have been excluded from the calculation of diluted net income (loss) per common share as they would be anti-dilutive for the periods below (in thousands):

 

   

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
   

2014

   

2013

   

2014

   

2013

 

Deferred stock consideration and unvested restricted stock

    775       357       653       292  

Stock options and warrant

    7,163       3,797       6,258       3,721  
      7,938       4,154       6,911       4,013  

 

Basic income (loss) from continuing operations per share is computed by dividing income from continuing operations for the period by the weighted average number of common shares outstanding during the period. Diluted income from continuing operations per share is computed by dividing income from continuing operations for the period by the weighted average number of common and potentially dilutive shares outstanding during the period, to the extent such shares are dilutive. 

 

 
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The following table sets forth the computation of basic and diluted income from continuing operations per share (in thousands, except per share amounts):

 

   

Three Months Ended
June 30,

   

Six Months Ended
June 30,

 
   

2014

   

2013

   

2014

   

2013

 

Numerator:

                               

Income (loss) from continuing operations

  $ (10,326

)

  $ 1,321     $ (16,639

)

  $ 1,673  

Denominator:

                               

Weighted average common shares used in computation of income (loss) per share from continuing operations, basic

    28,469       27,910       28,279       28,011  

Deferred stock consideration and unvested restricted stock

          340             275  

Stock options and warrant

          1,406             1,305  

Weighted average common shares used in computation of income (loss) per share from continuing operations, diluted

  $ 28,469     $ 29,656     $ 28,279     $ 29,591  
                                 

Income (loss) per share from continuing operations, basic

  $ (0.36

)

  $ 0.05     $ (0.59

)

  $ 0.06  
                                 

Income (loss) per share from continuing operations, diluted

  $ (0.36

)

  $ 0.04     $ (0.59

)

  $ 0.06  

 

 13. Segment Information

 

The Company operates in one operating segment. The Company’s chief operating decision maker manages the Company’s operations on a consolidated basis for purposes of evaluating financial performance and allocating resources. 

 

14. Discontinued Operations

 

ClubLocal

 

In the fourth quarter of 2013, the Company’s Board of Directors approved a plan to dispose of the Company’s ClubLocal business, and on February 18, 2014, the Company closed a transaction in which it transferred its ClubLocal business to a new entity in exchange for a minority equity interest. The Company has an equity interest in the new entity of 19.9%, with a recorded fair value of $4.5 million. As a result of the disposition, the Company recorded a gain on disposal of $0.8 million, net of income tax of $0.4 million. This business has been accounted for as discontinued operations for all periods presented. Long-lived assets of ClubLocal that were disposed of include property, plant, and equipment of $0.2 million. In addition, the Company granted a license to the new entity for the use of certain technology. The book value of ClubLocal’s capitalized software development costs was approximately $3.1 million, which reduced the gain on disposal.

 

 
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 Item 2.       MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS   

 

Cautionary Notice Regarding Forward-Looking Statements

 

In this document, ReachLocal, Inc. and its subsidiaries are referred to as “we,” “our,” “us,” the “Company” or “ReachLocal.”

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our 2013 Annual Report on Form 10-K.

 

This quarterly report on Form 10-Q contains “forward-looking statements” that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements are often identified by the use of words such as, but not limited to, “anticipate,” “believe,” “can,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “will,” “plan,” “project,” “seek,” “should,” “target,” “will,” “would,” and similar expressions or variations intended to identify forward-looking statements. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Risk Factors” included in our 2013 Annual Report on Form 10-K. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

 

Overview

 

ReachLocal’s mission is to help local small- to medium-sized businesses (SMBs) around the world acquire, transact with, and retain customers online. We began in 2004 with the goal of helping SMBs move their advertising spend from traditional media and yellow pages to online search. While we have sold to a variety of SMBs and will continue to do so, our present focus is on what we refer to as Premium SMBs. A Premium SMB generally has 10 to 30 employees, $1 to $10 million in annual revenue and spends approximately $40,000 annually on marketing. Premium SMBs have become increasingly sophisticated in their understanding of online marketing. However, we believe that Premium SMBs have not changed their desire for a single, unified solution to their marketing needs. Our goal is to be the “one-stop shop” for SMBs’ online marketing needs.

 

With the rollout of ReachSearch in 2005, we pioneered the provisioning of search engine marketing services (SEM) on a mass scale for SMBs through the use of our technology platform. ReachSearch combines search engine marketing optimized across multiple publishers, call tracking and call recording services, and industry leading campaign performance transparency. This product enabled us to become one of the largest adTech companies focusing on the SMB marketplace. ReachSearch remains the leading SEM offering for SMBs in the market and was recently recognized by Google in the United States with its 2013 “Best Quality Accounts” award. However, ReachSearch only solves part of the marketing challenges of our SMB clients. We have therefore added additional elements to our platform including our display product, ReachDisplay, our behavioral targeting product, ReachRetargeting, and other products that are primarily focused on leveraging third-party media to drive leads to our clients. 

 

 
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We also recognize that even successfully driving leads to our clients does not represent a complete solution to our SMBs’ online marketing needs. This led to our next major product rollout—ReachEdge. The launch of ReachEdge in 2013 was our first step to move beyond being a media-driven lead generation business to offer integrated solutions that address the majority of the online marketing needs of our clients. ReachEdge is a marketing automation platform that includes a responsive website solution designed to enhance lead tracking and conversion, and includes tools for capturing web traffic information and converting leads into new customers for our clients. ReachEdge represents a significant step to allow us to leverage our collection of critical lead generation and conversion data in order to enhance the performance of our online marketing services for the benefit of our clients. Each ReachEdge site also includes a mobile optimized version of the site reflecting that leads for local businesses are increasingly coming from mobile devices. We believe that ReachEdge can both significantly enhance a client’s ability to convert leads into customers and, over time, could substantially increase our share of our clients’ marketing expenditures. ReachEdge further enhances the ability of our clients to convert leads that we are generating for them through ReachSearch and our other products, while at the same time providing even further transparency into the efficacy of our advertising products. This automated platform will form the basis for a multiproduct engagement with our clients. We have begun and will continue to introduce ReachEdge in certain of our international markets in 2014.

 

We plan over time to add further dynamic optimization functionality to ReachEdge, as well as features that create a more seamless relationship between our clients and their customers, such as real-time appointment booking. Many SMBs already spend marketing dollars in these categories, and we hope to shift some of that spending to our integrated solutions. We recently introduced ReachSEO, our search engine optimization product, in the US. ReachSEO drives organic search traffic to ReachEdge client websites with a range of features, including site optimization, custom content, and distribution of site listings across hundreds of directories.

 

While our strategy is to expand our solution offerings, ReachSearch will, for the foreseeable future, continue to represent the significant majority of our revenue. However, we believe that the expansion of our product suite moves us closer to our goal of becoming the one-stop shop for our clients and will provide our clients with significantly greater value as our products are used together.

 

We have also focused on international expansion. Our first expansion was in Australia in 2006. We have subsequently entered Europe (the United Kingdom, Germany, the Netherlands, Austria and Belgium), Japan and Brazil. In 2014, we opened our first office in Mexico and entered New Zealand by purchasing the ReachLocal-related business of our exclusive reseller in the territory. However, for the remainder of 2014 we intend to focus on optimizing our operations in our existing international markets.

 

During 2013 we made significant changes to our Direct Local sales model. We substantially expanded our inside sales force (a dedicated telemarketing sale force). Our inside sales force was designed to expand our geographic reach while reducing selling costs. Over time we plan to expand our inside sales forces as we continue to seek to deepen our presence in our international markets while driving down our customer acquisition costs.

 

We also commenced a significant realignment of our sales force in North America (which consists of the United States and Canada), which will continue through 2014. Historically, we sold our products directly, through our “feet-on-the-street” sales force of internet marketing consultants, or IMCs. Previously, IMCs both generated new business and remained the primary contact for their clients. This sales structure worked well for a company that was primarily selling one product and we believe that our substantial corps of experienced IMCs has historically provided us with a significant competitive advantage. As we move more deeply into integrated solutions, however, we believe we require more specialization within our sales structure and beginning in late 2013, we have shifted our North American sales organization to a hunter/farmer model. Our Sales Executives (SEs), our hunters, are product experts who are solely focused on new client generation, and they are compensated for generating new clients. Our Account Executives (AEs), our farmers, are solely focused on client retention and account growth, and they are compensated for retaining and upselling existing clients. However, this transition has affected our results adversely through June 30, 2014 and will likely continue to adversely affect our results in the near term. This transition has also occurred in some of our international markets. We continue to iterate and refine this new go-to-market model with the intention of improving sales force performance and economics.

 

We believe that the transformation of our product suite to focus on integrated solutions and our changes in our go-to-market strategy will position us for future profitable growth by better meeting our clients’ needs, increasing operational efficiencies, reducing the costs of client acquisition and increasing the value to us of our client relationships.

 

In addition to our Direct Local channel, we also employ a separate sales channel targeting national brands, franchises and strategic accounts with operations in multiple local markets and select third-party agencies and resellers. We refer to this as our NBAR channel. In addition, we sell and provide access to our technology platform to select third-party agencies and resellers in customer segments where they have sales forces with established relationships with their SMB client bases. We currently have over 600 agencies and resellers actively selling on our technology platform. In 2012, we entered into our first franchise relationship, in which a third party was given the exclusive right to exploit and resell certain ReachLocal products in selected Eastern European markets under the ReachLocal name.

 

 
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Operating Metrics

 

We track the number of Active Clients and Active Product Units to evaluate the growth, scale and diversification of our business. We also use these metrics to determine the needs and capacity of our sales forces, our support organization, and other personnel and resources.

 

Active Clients is a number we calculate to approximate the number of clients directly served through our Direct Local channel as well as clients served through our National Brands, Agencies and Resellers channel. We calculate Active Clients by adjusting the number of Active Product Units to combine clients with more than one Active Product Unit as a single Active Client. Clients with more than one location are generally reflected as multiple Active Clients. Because this number includes clients served through the National Brands, Agencies and Resellers channel, Active Clients includes entities with which we do not have a direct client relationship. Numbers are rounded to the nearest hundred.

 

Active Product Units is a number we calculate to approximate the number of individual products, licenses, or services we are providing to Active Clients. For example, if we were performing both ReachSearch and ReachDisplay campaigns for a client who also licenses ReachEdge, we consider that three Active Product Units. Similarly, if a client purchases ReachSearch campaigns for two different products or purposes, we consider that two Active Product Units. Numbers are rounded to the nearest hundred.

 

At June 30, 2014, we had approximately 23,200 Active Clients and 34,600 Active Product Units, as compared to approximately 23,700 Active Clients and 35,100 Active Product Units at June 30, 2013. Active Clients and Active Product Units decreased over the three months ended June 30, 2014, primarily due to a decrease in the number of North American Direct Local clients. Active Clients and Active Product Units both decreased by 4% compared to the period ended March 31, 2014.

 

 Basis of Presentation

 

Discontinued Operations

 

As a result of the winding down of the operations of Bizzy and the contribution of our ClubLocal business to a new entity in exchange for a minority equity interest, we have reclassified and presented all related historical financial information with respect to Bizzy and ClubLocal as “discontinued operations” in the Consolidated Balance Sheets, Consolidated Statements of Operations and Consolidated Statements of Cash Flows. In addition, we have excluded all ClubLocal and Bizzy related activities from the following discussions, unless specifically referenced.

  

Sources of Revenue

 

We derive our revenue principally from the provision and sale of online marketing services to our clients. Revenue includes (i) the sale of our ReachSearch, ReachDisplay, ReachRetargeting and other products based on a package pricing model in which our clients commit to a fixed fee that includes the media, optimization, reporting and tracking technologies of our technology platform, and the personnel dedicated to support and manage their campaigns; (ii) the license (or sale) of our ReachEdge, ReachSEO, TotalLiveChat, ReachCast, TotalTrack, and other products and services; and (iii) set-up, management and service fees associated with these products and other services. We distribute our products and services directly through our outside and inside sales force that is focused on serving SMBs in their local markets through a consultative process, which we refer to as our Direct Local channel, as well as a separate sales force targeting our National Brands, Agencies and Resellers channel. The sales cycle for sales to SMBs ranges from one day to over a month. Sales to our National Brands, Agencies and Resellers clients generally require several months. 

 

We typically enter into multi-month agreements for the delivery of our products. Under our agreements, our Direct Local clients typically pay, in advance, a fixed fee on a monthly basis, which includes all charges for the included technology and media services, management, third-party content and other costs and fees. We record these prepayments as deferred revenue and only record revenue for income statement purposes as we purchase media and perform other services on behalf of clients. Certain Direct Local clients are extended credit privileges, with payment generally due in 30 days. There were $4.1 million and $4.2 million of accounts receivable related to our Direct Local channel at June 30, 2014 and December 31, 2013, respectively.

 

 
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Our National Brands, Agencies and Resellers clients enter into agreements of various lengths or that are indefinite. Our National Brands, Agencies and Resellers clients either pay in advance or are extended credit privileges with payment generally due in 30 to 60 days. There were $5.4 million and $4.6 million of accounts receivable related to our National Brands, Agencies and Resellers at June 30, 2014 and December 31, 2013, respectively.

  

Cost of Revenue

 

Cost of revenue consists primarily of the costs of online media acquired from third-party publishers. Media cost is classified as cost of revenue in the period in which the corresponding revenue is recognized. From time to time, publishers offer us rebates based upon various factors and operating rules, including the amount of media purchased. We record these rebates in the period in which they are earned as a reduction to cost of revenue and the corresponding payable to the applicable publisher, or as an other receivable, as appropriate. Cost of revenue also includes the third-party telephone and information services costs, other third-party service provider costs, data center and third-party hosting costs, credit card processing fees, and other direct costs.

 

In addition, cost of revenue includes costs to manage and operate our various solutions and technology infrastructure, other than costs associated with our sales force, which are reflected as selling and marketing expenses. Cost of revenue includes salaries, benefits, bonuses and stock-based compensation for the related staff, and allocated overhead such as depreciation expense, rent and utilities. Cost of revenue also includes the amortization and impairment charges on certain acquired intangible assets.

 

Operating Expenses

 

Selling and Marketing. Selling and marketing expenses consist primarily of personnel and related expenses for our selling and marketing staff, including salaries and wages, commissions and other variable compensation, benefits, bonuses and stock-based compensation; travel and business costs; training, recruitment, marketing and promotional events; advertising; other brand building and product marketing expenses; and occupancy, technology and other direct overhead costs. A portion of the compensation for employees in the sales organization is based on commissions (which include variable sales compensation). In addition, the cost of agency commissions is included in selling and marketing expenses. Generally, commissions are expensed as earned. However, commencing in 2014, we began paying commissions to certain sales people for the acquisition of new clients. We defer those commissions and amortize them over the term of the initial customer campaign.

 

Product and Technology. Product and technology expenses consist primarily of personnel and related expenses for our product development and engineering professionals, including salaries, benefits, bonuses and stock-based compensation, and the cost of third-party contractors and certain third-party service providers and other expenses, including occupancy, technology and other direct overhead costs. Technology operations costs, including related personnel and third-party costs, are included in product and technology expenses. We capitalize a portion of costs for software development and, accordingly, include amortization of those costs as product and technology expenses as our technology platform addresses all aspects of our activities, including supporting the selling and consultation process, online publisher integration, efficiencies and optimization, providing insight to our clients into the results and effects of their online advertising campaigns and supporting all of the financial and other back-office functions of our business.

 

Product and technology expenses also include the amortization of the technology obtained in acquisitions and expenses of the deferred payment obligations related to acquisitions attributable to product and technology personnel. Product and technology costs do not include the costs to deliver our solutions to clients which are included in cost of revenue.

 

General and Administrative. General and administrative expenses consist primarily of personnel and related expenses for board, executive, legal, finance, human resources and corporate communications, including wages, benefits, bonuses and stock-based compensation, professional fees, insurance premiums and other expenses, including occupancy, technology and other direct overhead, public company costs and other corporate expenses.

 

Restructuring Charges. Restructuring charges consist of costs associated with the realignment and reorganization of our operations. Restructuring charges include employee termination costs, facility closure and relocation costs, and contract termination costs. The timing of associated cash payments is dependent upon the type of exit cost and can extend over a 12-month period. We record restructuring charges liabilities in accrued liabilities or other liabilities in the consolidated balance sheet. See further discussion in Note 10 of the Notes to the Consolidated Financial Statements.

 

 
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Critical Accounting Policies and Estimates

 

The preparation of our consolidated financial statements in conformity with U.S. generally accepted accounting principles, or GAAP, requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses. We continually evaluate our estimates, judgments and assumptions based on available information and experience. Because the use of estimates is inherent in the financial reporting process, actual results could differ from those estimates.

 

There have been no material changes to our critical accounting policies. For further information on our critical and significant accounting policies, see our 2013 Annual Report on Form 10-K.

 

Restricted Cash

 

Restricted cash represents certificates of deposit held at financial institutions, which are pledged as collateral for letters of credit related to lease commitments or as collateral for our merchant accounts. The restrictions will lapse when the letters of credit related to lease commitments expire at the end of the respective lease terms in 2021. The restrictions on the certificates of deposits related to the merchant accounts will lapse upon termination of the merchant accounts. Restricted certificates of deposit are classified as non-current assets.

 

Commissions

 

Generally, we expense commissions (which include variable sales compensation) as earned. Commencing in 2014, we began paying commissions to certain sales people for the acquisition of new clients. The client contracts are not cancelable without a penalty, and we defer those commissions and amortize them over the term of the initial customer campaign. The amortization of deferred commissions is included in selling and marketing expense in the accompanying consolidated statements of operations. Unamortized commission expense is included in prepaid expenses and other current assets in the accompanying consolidated balance sheets.

 

Restructuring Charges

 

We record costs associated with exit activities related to restructuring plans in accordance with the ASC Topic 420, “Exit or Disposal Obligations.”  Liabilities for costs associated with an exit or disposal activity are recognized in the period in which the liability is incurred, except for liabilities for certain one-time employee termination benefits that are incurred over time. In the unusual circumstance in which fair value cannot be reasonably estimated, the liability is recognized initially in the period in which fair value can be reasonably estimated.  See further discussion in Note 10 of the Notes to the Consolidated Financial Statements.

 

 
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Results of Operations

 

Comparison of the Three and Six Months Ended June 30, 2014 and 2013

 

   

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
   

2014

   

2013

   

2014

   

2013

 

(in thousands)

                               

Revenue

  $ 123,553     $ 126,757     $ 248,289     $ 248,364  

Cost of revenue (1)

    63,461       63,599       126,859       124,705  

Operating expenses:

                               

Selling and marketing (1)

    48,146       45,096       94,907       88,730  

Product and technology (1)

    6,816       5,259       13,775       11,146  

General and administrative (1)

    14,530       9,924       28,694       19,123  

Restructuring charges

    2,226             4,049        

Total operating expenses

    71,718       60,279       141,425       118,999  

Operating income (loss)

    (11,626 )     2,879       (19,995 )     4,660  

Other income, net

    195       114       383       341  

Income (loss) from continuing operations before income taxes

    (11,431 )     2,993       (19,612 )     5,001  

Income tax provision (benefit)

    (1,105 )     1,672       (2,973 )     3,328  

Income (loss) from continuing operations

    (10,326 )     1,321       (16,639 )     1,673  

Gain (loss) from discontinued operations (including gain on disposal of $1,201 for the six months ended June 30, 2014)

    49       (2,346

)

    593       (3,960

)

Income tax provision (benefit)

    18       (884

)

    222       (1,511

)

Net loss

  $ (10,295 )   $ (141

)

  $ (16,268 )   $ (776

)

 


(1) Stock-based compensation, net of capitalization, and depreciation and amortization, included in the above line items (in thousands):

 

   

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
   

2014

   

2013

   

2014

   

2013

 

Stock-based compensation:

                               

Cost of revenue

  $ 255     $ 153     $ 530     $ 271  

Selling and marketing

    859       709       1,736       1,494  

Product and technology

    222       38       608       262  

General and administrative

    2,140       1,509       5,173       3,034  
    $ 3,476     $ 2,409     $ 8,047     $ 5,061  
                                 

Depreciation and amortization:

                               

Cost of revenue

  $ 169     $ 187     $ 346     $ 398  

Selling and marketing

    674       678       1,309       1,649  

Product and technology

    2,650       2,576       5,608       5,189  

General and administrative

    525       322       977       430  
    $ 4,018     $ 3,763     $ 8,240     $ 7,666  

       

 
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Revenue

 

   

Three Months Ended June 30,

           

Six Months Ended June 30,

         
   

2014

   

2013

   

2014-2013 % Change

   

2014

   

2013

   

2014-2013 % Change

 

(in thousands)

                                               

Direct Local

  $ 97,162     $ 101,056       (3.9

)%

  $ 195,729     $ 198,449       (1.4

)%

National Brands, Agencies and Resellers

    26,391       25,701       2.7

%

    52,560       49,915       5.3

%

Total revenue

  $ 123,553     $ 126,757       (2.5

)%

  $ 248,289     $ 248,364      

%

 

   

Three Months Ended June 30,

           

Six Months Ended June 30,

         
   

2014

   

2013

   

2014-2013 % Change

   

2014

   

2013

   

2014-2013 % Change

 

(in thousands)

                                               

North America (1)

  $ 76,968     $ 86,009       (10.5

)%

  $ 154,056     $ 168,929       (8.8

)%

International (1)

    46,585       40,748       14.3

%

    94,233       79,435       18.6

%

Total revenue

  $ 123,553     $ 126,757       (2.5

)%

  $ 248,289     $ 248,364      

%

 

At period end:

                       

Active Clients (2)

    23,200       23,700       (2.1

)%

Active Product Units (3)

    34,600       35,100       (1.4

)%

___________________

(1)

North America includes the United States and Canada. International includes all other countries.

 

(2)

Active Clients is a number we calculate to approximate the number of clients directly served through our Direct Local channel as well as clients served through our National Brands, Agencies and Resellers channel. We calculate Active Clients by adjusting the number of Active Product Units to combine clients with more than one Active Product Unit as a single Active Client. Clients with more than one location are generally reflected as multiple Active Clients. Because this number includes clients served through the National Brands, Agencies and Resellers channel, Active Clients includes entities with which we do not have a direct client relationship. Numbers are rounded to the nearest hundred.

 

(3)

Active Product Units is a number we calculate to approximate the number of individual products, licenses, or services we are managing under contract for Active Clients. For example, if we were performing both ReachSearch and ReachDisplay campaigns for a client who also licenses ReachEdge, we consider that three Active Product Units. Similarly, if a client purchases ReachSearch campaigns for two different products or purposes, we consider that two Active Product Units. Numbers are rounded to the nearest hundred.

 

The decreases in Direct Local revenue of $3.9 million and $2.7 million for the three and six months ended June 30, 2014, respectively, compared to the same periods in 2013 were due to a decline in North American revenue as a result of decreased new customer acquisitions due to lower sales productivity and lower customer retention, which we believe are both primarily attributable to our realignment of the North American Direct Local sales force. The decline in revenue was partially offset by an increase in the number of international Direct Local clients, including clients acquired as part of the SureFire acquisition in March 2014 that were previously reported as part of our National Brands, Agencies and Resellers channel. Revenue from SureFire clients included in Direct Local revenue that was not previously reported as part of our Direct Local channel was $2.0 million and $2.2 million for the three and six months ended June 30, 2014, respectively. Excluding the impact of the SureFire acquisition, Direct Local revenue decreased 6% and 2% during the three and six months ended June 30, 2014, respectively, as compared to the same periods in 2013.

 

During the three and six months ended June 30, 2014, North American Direct Local revenue decreased 15.6% and 13.2%, respectively, as compared to the prior year period, which we principally attribute to the realignment of our North American Direct Local sales force in late 2013 and its impact on sales force productivity and client experience. North American Direct Local revenue during the three months ended June 30, 2014 decreased 2.3% from the three months ended March 31, 2014. Growth in our Direct Local channel in North America will depend on our ability to improve our go-to-market strategies and the introduction of new products. We believe the sales force realignment has adversely affected our results through June 30, 2014 and will likely continue to affect our results adversely in the near term. Growth in our Direct Local channel generally will also depend on our success in our international markets and our ability to successfully launch new products internationally.

  

 
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The increases in National Brands, Agencies and Resellers revenue of $0.7 million and $2.6 million for the three and six months ended June 30, 2014, compared to the same periods in 2013, were due to growth in the number of international Agencies and Resellers, partially offset by a decrease in the number of international National Brands clients. Due to the SureFire acquisition, SureFire-related revenue that had been reported as part of our National Brands, Agencies and Resellers channel prior to the acquisition is reported as part of our Direct Local channel post-acquisition. There was no revenue from SureFire included in National Brands, Agencies and Resellers for the three months ended June 30, 2014 as compared to $1.3 million in the prior-year period. Revenue from SureFire included in National Brands, Agencies and Resellers for the six months ended June 30, 2014 was $1.3 million as compared to $2.3 million in the prior-year period. Excluding the impact of the SureFire acquisition, revenue from National Brands, Agencies and Resellers increased 8% and 7% during the three and six months ended June 30, 2014 as compared to the same periods in 2013.

 

  The impact of foreign currency translation during the three and six months ended June 30, 2014 was not significant.

 

Cost of Revenue

 

   

Three Months Ended June 30,

           

Six Months Ended June 30,

         
   

2014

   

2013

   

2014-2013 % Change

   

2014

   

2013

   

2014-2013 % Change

 

(in thousands)

                                               

Cost of revenue

  $ 63,461     $ 63,599       (0.2

)%

  $ 126,859     $ 124,705       1.7

%

As a percentage of revenue:

    51.4

%

    50.2

%

            51.1

%

    50.2

%

       

 

The increases in our cost of revenue as a percentage of revenue for the three and six months ended June 30, 2014, compared to the same periods in 2013, were primarily due to an increase in service and support costs and the change in our geographic, product and service mix, partially offset by improved media buying efficiencies. Publisher rebates as a percentage of revenue was flat at 4.0% of revenue during the three months and six ended June 30, 2014, compared to 4.1% and 4.0% during the same periods in 2013.

 

Our cost of revenue as a percentage of revenue will be affected in the future by the mix and relative amount of media we purchase to fulfill service requirements, the availability and amount of publisher rebates, the cost of third-party service providers that we use as part of our solutions, the mix of products and solutions we offer, our geographic mix, our media buying efficiency, and the costs of support and delivery.

 

On June 27, 2014, we entered into a new global agreement with Google Inc. and certain of its affiliates (collectively, “Google”) that replaces our expiring Google agreement. The new Google agreement provides rebates based on overall global growth of our spending with Google, as opposed to the commitments to enter new markets and market-specific growth targets. Given our recent operating performance, we expect rebates from Google under the new Google agreement to decline during the second half of 2014. However, the new Google agreement provides the opportunity for us to earn rebates in amounts similar to our previous Google agreement if our operating performance improves.

 

Operating Expenses

 

Over the past several years, we have significantly increased the scope of our operations. In growing our business, particularly in international markets, and in developing new products and solutions, we are incurring expenses to support our long-term growth plans, acknowledging that these investments may put pressure on near-term operating results and increase our operating expenses as a percentage of revenue.

 

 
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Selling and Marketing 

  

   

Three Months Ended June 30,

    2014-2013    

Six Months Ended June 30,

    2014-2013  
   

2014

   

2013

   

% Change

   

2014

   

2013

   

% Change

 

(in thousands)

                                               

Salaries, benefits and other costs

  $ 37,494     $ 32,078       16.9

%

  $ 73,515     $ 63,031       16.6

%

Commission expense

    10,652       13,018       (18.2

)%

    21,392       25,699       (16.8

)%

Total selling and marketing

  $ 48,146     $ 45,096       6.8

%

  $ 94,907     $ 88,730       7.0

%

                                                 

As a percentage of revenue: