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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended September 30, 2014

OR

 

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

For the transition period from                      to                     

Commission File Number: 001-34197

 

 

LOCAL CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   33-0849123

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

7555 Irvine Center Drive

Irvine, CA 92618

(Address of principal executive offices, including zip code)

(949) 784-0800

(Registrant’s telephone number, including area code)

 

 

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  ¨

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  þ    No  ¨

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):

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   þ

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

As of October 31, 2014, there were 23,230,116 shares of the registrant’s common stock, $0.00001 par value, outstanding.

 

 

 


Table of Contents

LOCAL CORPORATION

Table of Contents

 

         Page

PART I.

 

FINANCIAL INFORMATION

  

Item 1.

 

Financial Statements (Unaudited)

  
 

Condensed Consolidated Balance Sheets As of September 30, 2014 and December 31, 2013

   3
 

Condensed Consolidated Statements of Operations For the three and nine months ended September 30, 2014 and 2013

   4
 

Condensed Consolidated Statements of Cash Flows For the nine months ended September 30, 2014 and 2013

   5
 

Notes to Condensed Consolidated Financial Statements

   6

Item 2.

 

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

   17

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

   26

Item 4.

 

Controls and Procedures

   26

PART II.

 

OTHER INFORMATION

  

Item 1.

 

Legal Proceedings

   26

Item 1A.

 

Risk Factors

   27

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

   28

Item 3.

 

Defaults Upon Senior Securities

   28

Item 4.

 

Mine Safety Disclosures

   28

Item 5.

 

Other Information

   28

Item 6.

 

Exhibits

   29
 

Signatures

   31
 

Index to Exhibits

   32

 

2


Table of Contents

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements.

LOCAL CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(in thousands, except par value)

 

     September 30,     December 31,  
     2014     2013  
ASSETS     

Current assets:

    

Cash

   $ 4,311      $ 5,069   

Accounts receivable, net of allowances of $312 and $533, respectively

     8,079        17,298   

Escrow receivable

     —          390   

Prepaid expenses and other current assets

     445        957   
  

 

 

   

 

 

 

Total current assets

     12,835        23,714   

Property and equipment, net

     6,048        6,073   

Goodwill

     19,281        19,281   

Intangible assets, net

     1,870        2,439   

Long-term receivable, net of allowances of $3,431 and $3,431, respectively

     —          —     

Deposits

     72        72   
  

 

 

   

 

 

 

Total assets

   $ 40,106      $ 51,579   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current liabilities:

    

Accounts payable

   $ 11,290      $ 12,786   

Accrued compensation

     973        1,462   

Deferred rent

     171        323   

Warrant liability

     622        537   

Other accrued liabilities

     1,835        2,403   

Revolving line of credit

     4,320        7,342   

Current portion of term loan

     —          1,500   

Senior secured convertible notes, net of debt discount of $702

     4,876        —     

Deferred revenue

     164        202   
  

 

 

   

 

 

 

Total current liabilities

     24,251        26,555   
  

 

 

   

 

 

 

Long-term portion of term loan

     —          375   

Senior secured convertible notes, net of debt discount of $1,533

     —          4,017   

Deferred income taxes

     444        347   
  

 

 

   

 

 

 

Total liabilities

     24,695        31,294   
  

 

 

   

 

 

 

Commitments, contingencies and subsequent events

    

Stockholders’ equity (deficit):

    

Convertible preferred stock, $0.00001 par value; 10,000 shares authorized; none issued and outstanding for all periods presented

     —          —     

Common stock, $0.00001 par value; 65,000 shares authorized; 23,230 and 23,038 issued and outstanding, respectively

     —          —     

Additional paid-in capital

     124,841        124,249   

Accumulated deficit

     (109,430     (103,964
  

 

 

   

 

 

 

Stockholders’ equity

     15,411        20,285   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 40,106      $ 51,579   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

3


Table of Contents

LOCAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(Unaudited)

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2014     2013     2014     2013  

Revenue

   $ 18,141      $ 23,472      $ 66,835      $ 67,591   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating Expenses:

        

Cost of revenues

     14,628        16,208        51,545        48,253   

Sales and marketing

     1,622        2,230        6,138        7,419   

General and administrative

     2,074        3,894        8,630        9,685   

Research and development

     1,452        1,664        4,263        4,900   

Amortization of intangibles

     119        225        569        687   

Income from settlement and patent licensing

     (700     —          (700     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     19,195        24,221        70,445        70,944   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating loss

     (1,054     (749     (3,610     (3,353

Interest and other income (expense), net

     (539     (537     (1,646     (1,799

Change in fair value of conversion option and warrant liability

     285        (413     (113     229   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from continuing operations before income taxes

     (1,308     (1,699     (5,369     (4,923

(Benefit from) provision for income taxes

     —          (109     97        121   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss from continuing operations

     (1,308     (1,590     (5,466     (5,044

Loss from discontinued operations (net of taxes)

     —          (154     —          (3,639
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss

   $ (1,308   $ (1,744   $ (5,466   $ (8,683
  

 

 

   

 

 

   

 

 

   

 

 

 

Per share data:

        

Basic and diluted net loss per share from continuing operations

   $ (0.06   $ (0.07   $ (0.24   $ (0.22
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted net loss per share from discontinued operations

   $ —        $ (0.01   $ —        $ (0.16
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted net loss per share

   $ (0.06   $ (0.08   $ (0.24   $ (0.38
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic and diluted weighted average shares outstanding

     23,230        22,962        23,228        22,802   

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

4


Table of Contents

LOCAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

 

     Nine Months Ended September 30,  
     2014     2013  

Cash flows from operating activities:

    

Net loss

   $ (5,466   $ (8,683

Adjustments to reconcile net loss to cash provided by operating activities:

    

Depreciation and amortization

     3,497        3,732   

Provision for doubtful accounts

     650        809   

Stock-based compensation expense

     634        1,431   

Non-cash interest expense

     831        409   

Loss on exchange of warrants

     —          723   

Change in fair value of conversion option and warrant liability

     113        (229

Impairment of goodwill and intangible assets

     —          3,051   

Deferred income taxes

     97        —     

Changes in operating assets and liabilities:

    

Accounts receivable

     8,569        (4,866

Long term receivable

     —          (137

Note receivable

     —          152   

Prepaid expenses and other

     512        (411

Accounts payable and accrued liabilities

     (2,705     4,386   

Deferred revenue

     (38     (41
  

 

 

   

 

 

 

Net cash provided by operating activities

     6,694        326   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Capital expenditures

     (2,903     (2,379

Decrease in restricted cash

     —          42   

Proceeds from escrow payout

     390        —     
  

 

 

   

 

 

 

Net cash used in investing activities

     (2,513     (2,337
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Proceeds from issuance of senior secured convertible notes and warrants

     —          5,000   

Proceeds from the exercise of options

     9        22   

Payments on revolving credit facility, net

     (3,022     (583

Payments on the term loan

     (1,875     (750

Payment of financing related costs

     (51     (527
  

 

 

   

 

 

 

Net cash (used in) provided by financing activities

     (4,939     3,162   
  

 

 

   

 

 

 

Net (decrease) increase in cash

     (758     1,151   

Cash, beginning of the period

     5,069        3,696   
  

 

 

   

 

 

 

Cash, end of the period

   $     4,311      $ 4,847   
  

 

 

   

 

 

 

Supplemental cash flow information:

    

Interest paid

   $ 595      $ 426   
  

 

 

   

 

 

 

Income taxes paid

   $ —        $ 7   
  

 

 

   

 

 

 

Non-cash financing activities:

    

Derivative liabilities recorded in connection with the issuance of senior secured convertible notes

   $ —        $     2,182   
  

 

 

   

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

5


Table of Contents

LOCAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. The Company and Summary of Significant Accounting Policies

Nature of operations

Local Corporation (the “Company”) is a leading local advertising technology company that provides its search results to consumers who are searching online for local businesses, products and services. The Company’s search results consist primarily of local business listings and product listings that it aggregates, indexes, normalizes and syndicates using its sophisticated technology platforms. The Company provides its search results through its flagship Local.com website, its Krillion.com website and platform and through other proprietary websites (“Owned and Operated” or “O&O”) and to a network of websites that rely on its search syndication services to provide local search results to their own users (“Network”). The Company also aggregates and distributes product search results to third party partners through its proprietary Krillion® local shopping platform. The Company generates revenue from a variety of ad units it places alongside its search results, which include pay-per-click, pay-per-call, and display (banner) ad units, including video.

The Company uses patented and proprietary technologies and systems to provide users of its O&O websites and Network with relevant search results for local businesses, products and services, event information, ratings and reviews, driving directions and more into its search results. By distributing this information across its O&O websites and Network, the Company is able to reach users that its direct advertisers and advertising partners desire to reach.

Principles of consolidation and basis of presentation

The Company’s condensed consolidated financial statements include the accounts of Local Corporation and its wholly-owned subsidiaries: Krillion, Inc. and Screamin Media Group, Inc. (“SMG”). All intercompany balances and transactions were eliminated. The Company has evaluated all subsequent events through the date the condensed consolidated financial statements were issued.

Certain comparative prior period amounts in the condensed consolidated financial statements and accompanying notes have been reclassified to conform to the current period presentation.

The unaudited interim condensed consolidated financial statements as of September 30, 2014, and for the three and nine months ended September 30, 2014 and 2013, included herein, have been prepared by the Company, without audit, pursuant to rules and regulations of the Securities and Exchange Commission, and, in the opinion of management, reflect all adjustments (consisting of only normal recurring adjustments), which are necessary for a fair presentation.

The consolidated results of operations for the three and nine months ended September 30, 2014, are not necessarily indicative of the results for the full year. The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2013, included in the Company’s Form 10-K filed with the Securities and Exchange Commission on March 28, 2014.

Future Operations, Liquidity and Capital Resources

The Company has experienced substantial net losses from operations for the nine months ended September 30, 2014 and 2013, totaling $5.5 million and $8.7 million, respectively. As of September 30, 2014, the Company had a working capital deficit of $10.8 million, which included $4.3 million relating to the line of credit with Square 1 Bank and $4.8 million relating to the senior secured convertible notes.

Although the Company has been able to generate positive cash flow from operations of $6.7 million during the nine months ended September 30, 2014, the decrease in the Company’s revenue during the third quarter of fiscal 2014 resulted in a decrease in the Company’s borrowing base on the Square 1 Bank line of credit. As a result, the Company was required to make payments on the line of credit with Square 1 Bank of approximately $4.5 million during the third quarter of fiscal 2014.

The Company expects to increase revenue in the fourth quarter of fiscal 2014 and into 2015, from its O&O and Network businesses which will result in a corresponding increase in the Company’s borrowing base. The Company also continues to focus on generating new revenue streams through various initiatives. However, if our revenue does not grow, we may continue to experience losses 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. The Company continues to evaluate its operating plan and manage its costs in line with estimated revenues and have recently undertaken cost reductions to better manage its costs in light of recent revenue trends.

 

6


Table of Contents

Discontinued Operations

As a result of the Company’s decision to sell all of the assets and liabilities relating to its Spreebird business, the Company has reclassified and presented all related historical financial information as it relates to this business as “discontinued operations” in the accompanying condensed consolidated statements of operations. In addition, all related activities have been excluded from footnote disclosures unless specifically referenced. These reclassifications have no effect on previously reported net income (loss).

Use of estimates

The preparation of consolidated financial statements in conformity with United States generally accepted accounting principles (“U.S. GAAP”) 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 period. On an ongoing basis, the Company evaluates its estimates, including those related to accounts receivable (including long-term receivable) and sales allowances, fair values of financial instruments, intangible assets and goodwill, useful lives of intangible assets and property and equipment, fair values of stock-based awards, warrant and conversion option liabilities, income taxes, and contingent liabilities, among others. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results could materially differ from those estimates.

Fair Value of Financial Instruments

The Company’s financial instruments consist principally of accounts receivable, revolving line of credit, accounts payable, the conversion option liability, warrant liability, term loan, and senior secured convertible notes. The carrying amounts of the revolving line of credit and term loan approximate their fair values because the interest rate on these instruments fluctuates with market interest rates. The senior secured convertible notes have a fixed interest rate considered to be at market rates and therefore the carrying value also approximates its fair value. The Company believes that the recorded values of all of its other financial instruments approximate their current fair values because of their nature and respective relatively short maturity dates or durations.

The fair values of the conversion option and warrant liability are determined using the Black-Scholes valuation model, a “Level 3” fair value measurement, based on the quoted price of common stock, volatility based on the historical market activity of the Company’s stock, the expected life based on the remaining contractual term of the conversion option and warrants and the risk free interest rate based on the implied yield available on U.S. Treasury Securities with a maturity equivalent to the warrants’ and conversion options’ contractual life.

Intangible Assets

Intangible assets, excluding domain names, are amortized over their estimated useful lives, generally on a straight-line basis over two to four years.

Impairment of Long-lived Assets

The Company accounts for the impairment and disposition of intangible assets with finite lives and property and equipment in accordance with U.S. GAAP guidance on accounting for the impairment or disposal of long-lived assets. In accordance with the guidance, such assets to be held for use are reviewed for events, or changes in circumstances, which indicate that their carrying value may not be recoverable.

Revenue Recognition

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

The Company generates revenue when it is realizable and earned, as evidenced by click-throughs occurring on advertisers’ sponsored listings, the display of a banner advertisement and the fulfillment of subscription listing obligations. The Company enters into contracts to distribute sponsored listings and banner advertisements with direct and indirect advertisers. Most of these contracts are short-term, do not contain multiple elements and can be cancelled at any time. The Company’s 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). The Company recognizes its portion of the bid price based upon the contractual agreement.

 

7


Table of Contents

Sponsored listings and banner advertisements are included within pages that display search results, among others, in response to keyword searches performed by consumers on its O&O websites and Network. Revenue is recognized when earned based on click-through and impression activity to the extent that collection is reasonably assured from credit worthy advertisers. Revenue recognized is net of estimated adjustments for traffic screening. Management has analyzed revenue recognition and determined that web hosting revenue is recognized net of direct costs.

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

Cost of Revenues

Cost of revenues consists of traffic acquisition costs, revenue sharing payments that the Company makes to its network partners, and other cost of revenues. Traffic acquisition costs consist primarily of campaign costs associated with driving consumers to its O&O websites, including personnel costs associated with managing traffic acquisition programs. Other cost of revenues consists of Internet connectivity costs, data center costs, amortization of certain software license fees and maintenance, depreciation of computer equipment used in providing our paid-search services, and payment processing fees. The Company advertises on large search engine websites such as Google, Inc. (“Google), Yahoo!, Inc. (“Yahoo”), and Microsoft Inc./Bing (“Microsoft”), as well as other search engine websites, by bidding on certain keywords we believe will drive traffic to its O&O websites. During the three and nine months ended September 30, 2014, approximately 82% and 78%, respectively of our overall traffic was purchased from other search engine websites. During the three and nine months ended September 30, 2014, advertising costs to drive consumers to our Local.com website were $9.2 million and $28.5 million respectively. Of the total advertising costs for the three and nine months ended September 30, 2014, $7.1 million and $22.1 million were attributable to Google and $1.2 million and $3.7 million were attributable to Yahoo, respectively. During the three and nine months ended September 30, 2013, approximately 56%, of our overall traffic was purchased from other search engine websites. During the three and nine months ended September 30, 2013, advertising costs to drive consumers to our Local.com website were $7.4 million and $26.3 million respectively. Of the total advertising costs for the three and nine months ended September 30, 2013, $5.7 million and $19.4 million were attributable to Google and $1.3 million and $5.0 million were attributable to Yahoo, respectively.

Income from Settlement and Patent Licensing

The Company recognizes the proceeds from settlement and patent licensing agreement based on the terms involved. If the arrangement has multiple elements, the payment will be separated and allocated to each deliverable using relative fair values. Income statement recognition and classification will be determined based upon the nature of each element, including the period to which the payment relates. The proceeds from settlement and patent licensing agreement received during the quarter related to prior infringement and use of our patent. The Company does not have sufficient historical evidence to segregate the proceeds from litigation settlement and patent licensing agreement between a gain on litigation settlement and patent license revenues; therefore the total proceeds from the settlement and patent licensing agreement received during the current quarter have been reported as “income from settlement and patent licensing” within operating costs and expenses.

Updated accounting guidance not yet adopted

In May 2014, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) which provides guidance for accounting for revenue from contracts with customers. The core principle of this ASU is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity would be required to apply the following five steps: 1) identify the contract(s) with a customer; 2) identify the performance obligations in the contract; 3) determine the transaction price; 4) allocate the transaction price to the performance obligations in the contract and 5) recognize revenue when (or as) the entity satisfies a performance obligation. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016. Early adoption is not permitted. Entities will have the option to apply the final standard retrospectively or use a modified retrospective method, recognizing the cumulative effect of the ASU in retained earnings at the date of initial application. An entity will not restate prior periods if it uses the modified retrospective method, but will be required to disclose the amount by which each financial statement line item is affected in the current reporting period by the application of the ASU as compared to the guidance in effect prior to the change, as well as reasons for significant changes. We will adopt the updated standard in the first quarter of 2017. We are currently evaluating the impact that implementing this ASU will have on its financial statements and disclosures, as well as whether it will use the retrospective or modified retrospective method of adoption.

In August 2014, the FASB issued ASU No. 2014-15, (“ASU 2014-15”), “Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern”. ASU 2014-15 requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued and provides guidance on determining when and how to disclose going concern uncertainties in the financial statements. Certain disclosures will be required if conditions give rise to substantial doubt about an entity’s ability to continue as a going concern. ASU 2014-15 applies to all entities and is effective for annual and interim reporting periods ending after December 15, 2016, with early adoption permitted. Management is currently evaluating the impact of the adoption of the updated standard on the financial statements and disclosures.

 

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Table of Contents

2. Intangible assets

Intangible assets, net, consisted of the following (in thousands):

 

     September 30, 2014    December 31, 2013
     Gross
Carrying
Amount
     Accumulated
Amortization/

Impairment
    Net
Carrying
Amount
     Weighted
Average
Useful Life
   Gross
Carrying
Amount
     Accumulated
Amortization/

Impairment
    Net
Carrying
Amount
     Weighted
Average
Useful Life
                         (years)                        (years)

Developed technology

   $ 5,623       $ (5,384   $ 239       4    $ 5,623       $ (4,855   $ 768       4

Non-compete agreements

     —           —          —         2      83         (83     —         2

Customer-related

     1,240         (1,239     1       4      1,240         (1,237     3       4

Patents

     431         (431     —         3      431         (431     —         3

Domain names—indefinite life

     1,601         —          1,601            1,601         —          1,601      

Trademarks and Trade Name

     700         (671     29       4      700         (633     67       4
  

 

 

    

 

 

   

 

 

       

 

 

    

 

 

   

 

 

    
   $ 9,595       $ (7,725   $ 1,870          $ 9,678       $ (7,239   $ 2,439      
  

 

 

    

 

 

   

 

 

       

 

 

    

 

 

   

 

 

    

Amortization of intangibles expense was $119,000 and $569,000 for the three and nine months ended September 30, 2014, respectively, compared to $225,000 and $687,000 for the same periods in 2013.

3. Goodwill and Other Intangible Assets

Goodwill representing the excess of the purchase price over the fair value of the net tangible and intangible assets arising from acquisitions and purchased domain names are recorded at cost. Intangible assets, such as goodwill and domain names, which are determined to have an indefinite life, are not amortized. The Company reviews goodwill for impairment utilizing either a qualitative assessment or a two-step process. If the Company decides that it is appropriate to perform a qualitative assessment and concludes that the fair value of a reporting unit more likely than not exceeds its carrying value, no further evaluation is necessary. When the Company performs the two-step process, the first step requires a comparison of the estimated fair value of the reporting unit with its carrying amount, including goodwill. If the estimated fair value of the reporting unit exceeds its carrying value, goodwill of the reporting unit is not considered impaired and the second step is unnecessary. If the carrying value of the reporting unit exceeds its estimated fair value, the second step is performed to measure the amount of impairment by comparing the carrying amount of the goodwill to a determination of the implied value of the goodwill. If the carrying amount of goodwill is greater than the implied value, an impairment charge is recognized for the difference.

The Company performs annual impairment reviews during the fourth fiscal quarter of each year or earlier if indicators of potential impairment exist. For other intangible assets with indefinite lives, the Company either performs a qualitative assessment or compares the fair value of related assets to the carrying value to determine if there is impairment. The Company’s indefinite lived intangible assets consist of domain names for which the fair value is determined by using a third party valuation site which calculates the value of domain names using internal algorithms. For other intangible assets with definite lives, the Company compares future undiscounted cash flow forecasts prepared by management to the carrying value of the related intangible asset group to determine if there is an impairment. The Company did not identify any indicators of potential impairment during the third quarter of fiscal 2014 and therefore no impairment review was performed.

4. Website development costs and computer software developed for internal use

U.S. GAAP requires that development costs incurred in the preliminary project and post-implementation stages of an internal use software project be expensed as incurred and that certain costs incurred in the application development stage of a project be capitalized. U.S. GAAP further requires that costs incurred in the preliminary project and operating stage of website development be expensed as incurred and that certain costs incurred in the development stage of website development be capitalized and amortized over its useful life. Capitalized website costs are included in property and equipment, net.

The following table sets forth the additional capitalized website development costs and the amortization of capitalized website development costs for the period indicated (in thousands):

 

     Three Months Ended September 30,      Nine Months Ended September 30,  
     2014      2013      2014      2013  

Additional capitalized website development costs

   $ 405       $ 531       $ 1,455       $ 1,595   

Amortization of capitalized website development costs

   $ 788       $ 648       $ 2,009       $ 1,893   

 

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5. Net income (loss) per share

Basic net income (loss) per share is calculated using the weighted average shares of common stock outstanding during the periods. Diluted net income (loss) per share is calculated using the weighted average number of common and potentially dilutive common shares outstanding during the period, using the treasury stock method for options and warrants.

The following table sets forth the computation of basic and diluted net income (loss) per share for the periods indicated (in thousands, except per share amounts):

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2014     2013     2014     2013  

Numerator:

        

Net loss from continuing operations

   $ (1,308   $ (1,590   $ (5,466   $ (5,044
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss from discontinued operations

   $ —        $ (154   $ —        $ (3,639
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator:

        

Denominator for historical basic calculation weighted average shares

     23,230        22,962        23,228        22,802   

Dilutive common stock equivalents:*

        

Options

     —          —          —          —     

Warrants

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator for historical diluted calculation weighted average shares

     23,230        22,962        23,228        22,802   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss from continuing operations per share:

        

Historical basic and diluted net loss from continuing operations per share

   $ (0.06   $ (0.07   $ (0.24   $ (0.22
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss from discontinued operations per share:

        

Historical basic and diluted net loss from discontinued operations per share

   $ —        $ (0.01   $ —        $ (0.16
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss per share:

        

Historical basic and diluted net loss per share

   $ (0.06   $ (0.08   $ (0.24   $ (0.38
  

 

 

   

 

 

   

 

 

   

 

 

 

 

* For the three and nine months ended September 30, 2014, potentially dilutive securities, which consist of options to purchase 4,394,535 shares of common stock at prices ranging from $1.41 to $16.59 per share, warrants to purchase 766,268 shares of common stock at prices ranging from $2.01 to $2.87 per share, secured convertible notes that could convert into 2,487,562 shares of common stock were not included in the computation of diluted net income (loss) per share because such inclusion would be antidilutive.

 

* For the three and nine months ended September 30, 2013, potentially dilutive securities, which consist of options to purchase 3,539,450 shares of common stock at prices ranging from $1.41 to $16.59 per share, warrants to purchase 766,268 shares of common stock at prices ranging from $2.01 to $2.87 per share, secured convertible notes that could convert into 2,487,562 shares of common stock were not included in the computation of diluted net income (loss) per share because such inclusion would be antidilutive.

6. Property and equipment

Property and equipment, net, consisted of the following (in thousands):

 

     September 30,
2014
    December 31,
2013
 

Furniture and fixtures

     993        981   

Office equipment

     549        529   

Computer equipment

     4,750        3,772   

Computer software

     16,160        14,277   

Leasehold improvements

     916        905   
  

 

 

   

 

 

 
     23,368        20,464   

Less accumulated depreciation and amortization

     (17,320     (14,391
  

 

 

   

 

 

 

Property and equipment, net

   $ 6,048      $ 6,073   
  

 

 

   

 

 

 

Depreciation expense for the three and nine months ended September 30, 2014 was $1.1 million and $2.9 million, respectively. Depreciation expense for the three and nine months ended September 30, 2013 was $938,000 and $2.8 million, respectively.

 

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7. Interest and other income (expense), net

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

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2014     2013     2014     2013  

Interest income

   $ —        $ 3      $ —        $ 10   

Interest expense

     (539     (540     (1,646     (1,086

Loss on exchange of warrants

     —          —          —          (723
  

 

 

   

 

 

   

 

 

   

 

 

 

Interest and other income (expense), net

   $ (539   $ (537   $ (1,646   $ (1,799
  

 

 

   

 

 

   

 

 

   

 

 

 

8. Credit facilities

On August 3, 2011, the Company entered into a Loan and Security Agreement (“Loan Agreement”) with Square 1 Bank, as amended. The Loan Agreement provides the Company with a revolving credit facility of up to $12.0 million (the “Facility”). The Loan Agreement maturity date is April 2, 2015. Subject to the terms of the Loan Agreement, the borrowing base used to determine loan availability under the Facility is based on a formula equal to 80% of eligible accounts receivable, with account eligibility measured in accordance with standard determinations as more particularly defined in the Loan Agreement (the “Formula Revolving Line”). Prior to March 28, 2013, the Company was allowed to borrow $3.0 million, irrespective of the formula noted above and had borrowed $3.0 million from the Facility (the “Non-Formula Advance”). On April 10, 2013, the date of the Seventh Amendment, Square 1 Bank added as security under the Loan Agreement all of the Company’s intellectual property and to undertake certain reporting obligations to Square 1 Bank with respect to such intellectual property. All amounts borrowed under the Facility are secured by a general security interest on the assets. On March 27, 2014, we entered into the Eighth Amendment to the Loan Agreement. In accordance with the Eighth Amendment, we paid in full our term loan with Square 1 Bank using credit available under our Formula Revolving Line. As of March 27, 2014, no amounts are outstanding and no further credit extensions are available under the Non-Formula Advance.

Except as otherwise set forth in the Loan Agreement, borrowings made pursuant to the Formula Revolving Line will bear interest at a rate equal to the greater of (i) 5.0% or (ii) the Prime Rate (as announced by Square 1 Bank) plus 1.75%. Additionally, there is an annual fee of $25,000 and an unused line fee equal to 0.25% of the unused line if less than 40% of the Facility is in use. In connection with the Eighth Amendment to the Loan Agreement, we paid an additional $5,000 fee.

The Loan Agreement contains customary representations, warranties, and affirmative and negative covenants for facilities of this type, including certain restrictions on dispositions of assets, changes in business, change in control, mergers and acquisitions, payment of dividends, and incurrence of certain indebtedness and encumbrances. The Loan Agreement 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, Square 1 Bank has certain rights and remedies under the Loan Agreement, including declaring all outstanding borrowings immediately due and payable, ceasing to advance money or extend credit, and rights of set-off.

The Company must meet certain financial covenants during the term of the Facility, which included certain Adjusted EBITDA covenants, as defined, as more particularly described in the Agreement and amendments to the Agreement (such Adjusted EBITDA amounts are for financial covenant purposes only, and do not represent projections of the Company’s financial results). As of September 30, 2014, the Company was in compliance with all of its financial covenants. The Eighth Amendment to the Loan Agreement removed the financial covenant that required the Company to maintain a minimum liquidity ratio.

At September 30, 2014, the Company had a total of $4.3 million outstanding under the Facility with no amount available to draw upon.

9. Senior secured convertible notes

On April 10, 2013, the Company entered into a Convertible Note and Warrant Purchase Agreement (“Agreement”) with two investors. Pursuant to this agreement, the investors purchased an aggregate of $5.0 million of 7% subordinated convertible notes (“Notes”) and warrants to purchase shares of the Company’s common stock. Interest is payable quarterly in cash or registered shares of the Company’s common stock at the Company’s option. Stock payments will be at a 7% discount to the lower of the closing price on the trading day immediately preceding or the average of the daily Volume Weighted Average Price (“VWAP”) for the 20 trading days preceding the payment date. The Notes are secured by the Company’s assets and are due on April 10, 2015. Each Note holder has the right, at any time, to convert their Note into shares of the Company’s common stock at an initial conversion ratio of one share of common stock for each $2.01 of principal amount of their note. The Company has the option to force conversion of all or part of the Notes provided the Company’s common stock price exceeds 200% of the conversion price for 90 consecutive trading days.

 

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The Company determined that the conversion option should be bifurcated and accounted for as a derivative liability. Using the Black-Scholes valuation model the Company determined the fair value of the conversion option liability to be $1.4 million at the date of the Agreement. The Company also issued warrants to purchase an aggregate of 746,268 shares of common stock at an exercise price of $2.01 per share that expire five years from the date of issuance. The fair value of these warrants, using the Black-Scholes valuation model at the date of grant, was $768,000. The fair value of the conversion option and warrant liability was recorded as convertible debt discount and is amortizing into interest expense over the life of the notes using the effective interest rate method. The conversion option liability and warrant liability are recorded at fair value each reporting period with changes in the fair value recorded in the condensed consolidated statements of operations. The fair value of the conversion option liability was $578,000 and $550,000 as of September 30, 2014 and December 31, 2013, respectively, and included in the senior secured convertible notes in the accompanying condensed consolidated balance sheets. The fair value of the warrant liability was $622,000 and $537,000 at September 30, 2014 and December 31, 2013, respectively.

The Notes are subordinate to the Square 1 Bank revolving line of credit.

In connection with the issuance of the Notes, the Company paid $356,000 in cash for placement agent fees of which $127,500 was paid to a director of the Company. The Company also incurred legal and other consulting fees totaling $244,000 related to the issuance of the Notes. Fees related to the issuance of the Notes are recorded in prepaid expenses and are amortized into interest expense over the life of the Notes, using the effective interest method.

As of September 30, 2014, the Notes were reclassified from non-current to current liabilities.

10. Operating information

The Company manages its business functionally and has historically had two reportable operating segments: Paid Search and Daily Deals. Paid Search consists of the Company’s online businesses that collectively reach customers with a variety of local online advertising products and web hosting. The Company’s Daily Deals segment consisted of the Company’s business that reached its customers with discounted offers for goods and services provided by merchants. During the second quarter of fiscal 2013, the Company decided to sell the assets relating to the Daily Deals segment. The Spreebird Business, which comprised the entire Daily Deals segment, was deemed to be discontinued operations; and therefore, the Company has one reporting segment going forward.

U.S. GAAP regarding disclosures about segments of an enterprise requires that public business enterprises report entity-wide disclosures. The following table presents summary operating geographic and product information as required by the entity-wide disclosure requirements (in thousands):

 

     Three Months Ended September 30,      Nine Months Ended September 30,  
     2014      2013      2014      2013  

Revenue by geographic region:

           

United States

   $ 18,141       $ 23,472       $ 66,835       $ 67,591   
  

 

 

    

 

 

    

 

 

    

 

 

 

Revenue by product:

           

Pay-Per-Click (PPC)

     14,385         20,692         53,590         57,948   

Subscription Advertising Products

     42         154         189         705   

Domain Sales and Services

     41         62         117         211   

Display and Banner Advertising Services

     3,589         2,469         12,603         8,531   

Other

     84         95         336         196   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total revenue

   $ 18,141       $ 23,472       $ 66,835       $ 67,591   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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11. Stock-based compensation

Stock option activity under the equity incentive plans during the nine months ended September 30, 2014, was as follows:

 

     Shares     Weighted
Average
Exercise Price
     Aggregate
Intrinsic Value
(in thousands)
 

Outstanding at December 31, 2013

     3,375,473      $ 4.17      

Granted

     1,603,905        1.70      

Exercised

     (2,909     1.50      

Cancelled

     (581,934     3.05      
  

 

 

      

Outstanding at September 30, 2014

     4,394,535      $ 3.42       $ 516   
  

 

 

   

 

 

    

 

 

 

Exercisable at September 30, 2014

     3,082,718      $ 4.11       $ 198   
  

 

 

   

 

 

    

 

 

 

The weighted-average fair value at grant date for the options granted during the nine months ended September 30, 2014 and 2013, was $0.82 and $1.06 per option, respectively.

The aggregate intrinsic value of all options exercised during the nine months ended September 30, 2014 and 2013, was $1,332 and $3,000, respectively.

The following table summarizes information regarding options outstanding and exercisable at September 30, 2014:

 

Range of Exercise Prices

   Options Outstanding                
   Shares      Weighted
Average
Remaining
Contractual
Life
     Weighted
Average
Exercise
Price
     Options Exercisable  
            Shares      Weighted
Average
Exercise
Price
 
              
              
              

$0.00 - $2.00

     1,700,951         6.1 years       $ 1.70         509,598       $ 1.61   

$2.01 - $3.00

     793,302         4.0 years         2.37         673,255         2.37   

$3.01 - $4.00

     530,305         3.0 years         3.49         529,888         3.49   

$4.01 - $5.00

     594,213         2.9 years         4.69         594,213         4.69   

$5.01 - $6.00

     159,757         3.5 years         5.59         159,757         5.59   

$6.01 - $7.00

     410,331         4.0 years         6.19         410,331         6.19   

$7.01 - $8.00

     70,000         1.5 years         7.18         70,000         7.18   

$8.01 - $9.00

     55,000         0.7 years         8.98         55,000         8.98   

$9.01 - $10.00

     15,000         0.7 years         9.90         15,000         9.90   

$10.01 - $16.59

     65,676         0.3 years         15.76         65,676         15.76   
  

 

 

          

 

 

    
     4,394,535         4.4 years       $ 3.42         3,082,718       $ 4.11   
  

 

 

          

 

 

    

The fair values of these options were estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions:

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2014     2013     2014     2013  

Risk-free interest rate

     1.12     1.01     1.02     0.66

Expected lives (in years)

     3.5 years        4.5 years        3.5 years        4.5 years   

Expected dividend yield

     None        None        None        None   

Expected volatility

     67.80     77.35     67.80     77.35

Restricted stock unit activity under the 2011 Omnibus Plan for the nine months ended September 30, 2014, is as follows:

 

     Shares     Weighted Average
Grant Date Fair
Value
 
    
    

Unvested at December 31, 2013

     247,855      $ 2.14   

Granted

     —          —     

Vested

     (214,704     2.12   

Cancelled

     (10,194     2.29   
  

 

 

   

Unvested at September 30, 2014

     22,957      $ 2.29   
  

 

 

   

 

 

 

 

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Total stock-based compensation expense recognized for the three and nine months ended September 30, 2014 and 2013, was as follows (in thousands, except per share amount):

 

     Three Months Ended September 30,      Nine Months Ended September 30,  
     2014      2013      2014      2013  

Cost of revenues

   $ 10       $ 26       $ 33       $ 85   

Sales and marketing

     22         83         75         333   

General and administrative

     169         192         475         787   

Research and development

     17         51         51         207   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total stock-based compensation expense

   $ 218       $ 352       $ 634       $ 1,412   
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic and diluted net stock-based compensation expense per share*

   $ 0.01       $ 0.02       $ 0.03       $ 0.06   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

* Non-GAAP disclosure.

12. Warrants

On February 7, 2013, the Company repriced warrants to purchase 615,080 shares of the Company’s common stock with an exercise price of $8.09 per share to an exercise price of $2.10 per share. The warrants were issued in connection with a private placement transaction consummated on August 1, 2007, including warrants to purchase 537,373 shares of the Company’s common stock issued on August 1, 2007 (the “Series B Warrants”) and warrants to purchase 77,707 shares of the Company’s common stock issued on January 20, 2011, as a result of the anti-dilution provisions contained in each of the Series B Warrants (the “New Series B Warrants” and together with the Series B Warrants, the “Warrants”).

On February 28, 2013, the Company entered into separate Exchange Agreements with each of the holders (collectively the “Investors”) of all of these outstanding Warrants.

In the Exchange Agreements, the Investors agreed to surrender for cancellation all of their Warrants in exchange for an aggregate of 430,561 shares of the Company’s common stock. As a result of the exchange, the Company recorded a loss on warrant exchange of $723,000 during the nine months ended September 30, 2013. The loss on warrant exchange has been included in interest income and other income (expense), net in the accompanying condensed consolidated statements of operations.

See note 9-Senior secured convertible notes footnote, relating to warrants issued in the second quarter fiscal 2013 as part of the issuance of the senior secured convertible notes.

Warrant activity for the nine months ended September 30, 2014, was as follows:

 

     Shares      Weighted
Average
Exercise Price
 

Outstanding at December 31, 2013

     766,268       $ 2.03   

Issued

     —           —     

Exercised

     —           —     

Expired

     —           —     

Exchanged

     —           —     
  

 

 

    

 

 

 

Outstanding at September 30, 2014

     766,268       $ 2.03   
  

 

 

    

 

 

 

Exercisable at September 30, 2014

     766,268       $ 2.03   
  

 

 

    

 

 

 

 

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The following table summarizes information regarding warrants outstanding and exercisable at September 30, 2014:

 

     Warrants Outstanding and Exercisable  

Range of Exercise Price

   Shares      Weighted
Average
Remaining
Contractual
Life
     Weighted
Average
Exercise Price
 

$ 2.01

     746,268         3.5 years       $ 2.01   

$ 2.87

     20,000         0.1 years         2.87   
  

 

 

       
     766,268         3.4 years       $ 2.03   
  

 

 

       

13. Discontinued Operations

As a result of the decision by the Company to sell all of the assets related to the Spreebird business, the results of operations relating to this business have been reclassified to discontinued operations in the consolidated statements of operations for all periods presented.

Revenue and pretax income (loss) related to discontinued operations are as follows: (in thousands):

 

     Spreebird  
     Three Months Ended September 30,     Nine Months Ended September 30,  
     2014      2013     2014      2013  

Revenue

   $ —         $ 34      $ —         $ 551   
  

 

 

    

 

 

   

 

 

    

 

 

 

Pretax income (loss)

   $ —         $ (122   $ —         $ (3,639

Provision (benefit) for income taxes

     —           32        —           —     
  

 

 

    

 

 

   

 

 

    

 

 

 

Loss from discontinued operations (net of taxes)

   $ —         $ (154   $ —         $ (3,639
  

 

 

    

 

 

   

 

 

    

 

 

 

14. Fair Value Measurement of Financial Assets and Liabilities

The following table summarizes our financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2014 (in thousands):

 

Description

   As of
September 30,
2014
     Significant
Unobservable
Inputs (Level 3)
 

Liabilities:

     

Convertible option liability

   $ 578       $ 578   
  

 

 

    

 

 

 

Warrant liability

   $ 622       $ 622   
  

 

 

    

 

 

 

The following table summarizes our financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2013 (in thousands):

 

Description

   As of
December 31,
2013
     Significant
Unobservable

Inputs (Level 3)
 

Liabilities:

     

Convertible option liability

   $ 550       $ 550   
  

 

 

    

 

 

 

Warrant liability

   $ 537       $ 537   
  

 

 

    

 

 

 

As of September 30, 2014, our conversion option and warrant liabilities were based on measurement at fair value without observable market values that required a high level of judgment to determine fair value (Level 3) using pricing models that take into account the contract terms as well as multiple inputs where applicable, such as our stock price, risk-free interest rates and expected volatility.

 

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The fair value of the financial liabilities was estimated at September 30, 2014, using a Black-Scholes option pricing model with the following assumptions:

 

     Warrant     Conversion
option
 

Risk-free interest rate

     1.07     0.03

Expected lives (in years)

     3.5 years        0.5 years   

Expected dividend yield

     None        None   

Expected volatility

     57.12     42.10

The following table presents a reconciliation for warrant and conversion option liabilities measured and recorded at fair value on a recurring basis, using significant unobservable inputs (Level 3) (in thousands):

 

     2014     2013  
     Warrant     Conversion
option
    Warrant     Conversion
option
 

Balance at January 1

   $ 537      $ 550      $ 5      $ —     

Change in fair value

     173        161        (5     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at March 31

     710        711        —          —     

Issuance of warrants and Notes

     —          —          768        1,414   

Change in fair value

     33        31        (195     (443
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at June 30

     743        742        573        971   

Change in fair value

     (121     (164     193        221   
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30

   $ 622      $ 578      $ 766      $ 1,192   
  

 

 

   

 

 

   

 

 

   

 

 

 

During the three and nine months ended September 30, 2014, the Company recorded a change in the fair value of the warrant liability of ($121,000) and $85,000, respectively, and a change in the fair value of the conversion option liability of ($164,000) and $28,000, respectively.

During the three and nine months ended September 30, 2013, the Company recorded a change in the fair value of the warrant liability of $193,000 and ($7,000), respectively, and a change in the fair value of the conversion option liability of $221,000 and ($222,000), respectively.

15. Subsequent Events

Subsequent to the third quarter of fiscal 2014 the Company reduced its headcount from 84 employees as of September 30, 2014 to 67 employees. We expect the reduction in headcount will result in annual cost savings to the Company of approximately $2.6 million.

 

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

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

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the attached condensed consolidated financial statements and related notes thereto, and with the audited consolidated financial statements and related notes thereto as of December 31, 2013, and for the year ended December 31, 2012, included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 28, 2014.

Overview

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

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

Recent Developments

On September 3, 2014, we reached a settlement agreement in the patent infringement action against Fry’s Electronics, Inc. As part of the settlement agreement, we received a one-time patent license fee payment related to prior infringement of our patent.

Outlook for Our Business

According to BIA/Kelsey, U.S. local online advertising revenue will reach approximately $137.5 billion in 2014. “Local search,” that is, searches for products, services and businesses within a geographic region is an increasingly significant segment of the online advertising industry. Local search allows consumers to search for local businesses’ products or services by including geographic area, zip code, city and other geographically targeted search parameters in their search requests – such as entering “florists in Irvine, CA.” In addition, BIA/Kelsey estimates that the local search market in the U.S. will grow from $6.3 billion in 2013, to $8.6 billion by 2017.

Consumers who conduct local searches on the Internet (“local searchers”) tend to convert into buying customers at a higher rate than other types of Internet users. As a result, advertisers often pay a significant premium to place their ads in front of local searchers on websites like those powered by our O&O and Network business, including Local.com or our network partners’ websites.

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

 

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

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

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

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

As we continue to invest in our core offerings, we are also investing in new initiatives. We cannot give assurances that our efforts to improve our results of operations through this strategy will be successful. We believe that these investments are important to our long term success, but intend to manage these investments to be proportioned to the results from our core offerings. Accordingly, we recently reduced our investments in new initiatives in light of reduced revenues from our core offerings in the third quarter.

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

We believe that Local can become the technology engine which powers third party apps and sites that seek to provide on-the-go mobile consumers with the local business, product, and service information they want, when they need it, along their path from discovery to decision. If this happens, we believe we will be in a better position to control our financial future by having direct relationships with retailers and brands and as a result we expect to be able to reduce our reliance on third party advertisers.

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

Sources of Revenue

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

 

    click-throughs on sponsored listings;

 

    calls to cost-per-call advertiser listings;

 

    lead generation;

 

    banner ads;

 

    subscription advertiser listings;

 

    domain sales and services; and

 

    web hosting services.

 

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Operating Expenses

Cost of Revenues

Cost of revenues consists of traffic acquisition costs, revenue sharing payments that we make to our network partners, and other cost of revenues. Traffic acquisition costs consist primarily of campaign costs associated with driving consumers to our Local.com website, including personnel costs associated with managing traffic acquisition programs. Other cost of revenues consists of Internet connectivity costs, data center costs, amortization of certain software license fees and maintenance, depreciation of computer equipment used in providing our paid-search services, and payment processing fees. We advertise on large search engine websites such as Google, Yahoo and Microsoft, as well as other search engine websites, by bidding on certain keywords we believe will drive traffic to our Local.com website. During the three and nine months ended September 30, 2014, approximately 82% and 78% respectively, of our overall traffic was purchased from other search engine websites. During the three and nine months ended September 30, 2014, advertising costs to drive consumers to our Local.com website were $9.2 million and $28.5 million respectively. Of the total advertising costs for the three and nine months ended September 30, 2014, $7.1 million and $22.1 million were attributable to Google and $1.2 million and $3.7 million were attributable to Yahoo, respectively. During the three and nine months ended September 30, 2013, approximately 56%, of our overall traffic was purchased from other search engine websites. During the three and nine months ended September 30, 2013, advertising costs to drive consumers to our Local.com website were $7.4 million and $26.3 million respectively. Of the total advertising costs for the three and nine months ended September 30, 2013, $5.7 million and $19.4 million were attributable to Google and $1.3 million and $5.0 million were attributable to Yahoo, respectively.

Sales and Marketing

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

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.

Income from Settlement and Patent Licensing

We recognize the proceeds from settlement and patent licensing agreement based on the terms involved. If the arrangement has multiple elements, the payment will be separated and allocated to each deliverable using relative fair values. Income statement recognition and classification will be determined based upon the nature of each element, including the period to which the payment relates. The proceeds from settlement and patent licensing agreement received during the quarter related to prior infringement and use of our patent. We do not have sufficient historical evidence to segregate the proceeds from litigation settlement and patent licensing agreement between a gain on litigation settlement and patent license revenues; therefore the total proceeds from the settlement and patent licensing agreement received during the current quarter have been reported as “income from settlement and patent licensing” within operating costs and expenses.

Critical Accounting Policies

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

Updated accounting guidance not yet adopted

In May 2014, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (ASU) which provides guidance for accounting for revenue from contracts with customers. The core principle of this ASU is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity would be required to apply the following five steps: 1) identify the contract(s) with a customer; 2) identify the performance obligations in the contract; 3) determine the transaction price; 4) allocate the transaction price to the performance obligations in the contract and 5) recognize revenue when (or as) the entity satisfies a performance obligation. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016. Early adoption is not permitted. Entities will have the option to apply the final standard retrospectively or use a modified

 

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retrospective method, recognizing the cumulative effect of the ASU in retained earnings at the date of initial application. An entity will not restate prior periods if it uses the modified retrospective method, but will be required to disclose the amount by which each financial statement line item is affected in the current reporting period by the application of the ASU as compared to the guidance in effect prior to the change, as well as reasons for significant changes. We will adopt the updated standard in the first quarter of 2017. We are currently evaluating the impact that implementing this ASU will have on its financial statements and disclosures, as well as whether it will use the retrospective or modified retrospective method of adoption.

In August 2014, the FASB issued ASU No. 2014-15, (“ASU 2014-15”), “Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern”. ASU 2014-15 requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued and provides guidance on determining when and how to disclose going concern uncertainties in the financial statements. Certain disclosures will be required if conditions give rise to substantial doubt about an entity’s ability to continue as a going concern. ASU 2014-15 applies to all entities and is effective for annual and interim reporting periods ending after December 15, 2016, with early adoption permitted. Management is currently evaluating the impact of the adoption of the updated standard on the financial statements and disclosures.

Revenue Recognition

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

We generate revenue when it is realizable and earned, as evidenced by click-throughs occurring on advertisers’ sponsored listings, the display of a banner advertisement and the fulfillment of subscription listing obligations. We enter into contracts to distribute sponsored listings and banner advertisements with direct and indirect advertisers. Most of these contracts are short-term, do not contain multiple elements and can be cancelled at any time. Our indirect advertisers provide us with sponsored listings with bid prices (for example, what their advertisers are willing to pay for each click-through on those listings). We recognize our portion of the bid price based upon the contractual agreement. Sponsored listings and banner advertisements are included within pages that display search results, among others, in response to keyword searches performed by consumers on its O&O websites and Network. Revenue is recognized when earned based on click-through and impression activity to the extent that collection is reasonably assured from credit worthy advertisers. Revenue recognized is net of estimated adjustments for traffic screening. Management has analyzed revenue recognition and determined that web hosting revenue is recognized net of direct costs.

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

Allowance for Doubtful Accounts

Our management estimates the losses that may result from that portion of our accounts receivable 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.

During the fourth quarter 2013, we fully reserved our long-term receivable resulting in an additional charge to the condensed consolidated statement of operations of $1.7 million. The long-term receivable relates to legacy subscribers that were billed via their phone bills from local exchange carriers.

As of September 30, 2014, two customers, Yahoo and Google, represented 48% 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.

 

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Goodwill and Other Intangible Assets

Goodwill representing the excess of the purchase price over the fair value of the net tangible and intangible assets arising from acquisitions and purchased domain names are recorded at cost. Intangible assets, such as goodwill and domain names, which are determined to have an indefinite life, are not amortized. The first step in determining if there is any goodwill impairment is a comparison of the estimated fair value of the reporting unit with its carrying amount, including goodwill. If the estimated fair value of the reporting unit exceeds its carrying value, goodwill of the reporting unit is not considered impaired and the second step is unnecessary. If the carrying value of the reporting unit exceeds its estimated fair value, the second step is performed to measure the amount of impairment by comparing the carrying amount of the goodwill to a determination of the implied value of the goodwill. If the carrying amount of goodwill is greater than the implied value, an impairment charge is recognized for the difference.

We perform annual impairment reviews during the fourth fiscal quarter of each year or earlier if indicators of potential impairment exist. For other intangible assets with indefinite lives, we compare the fair value of related assets to the carrying value to determine if there is impairment. Our indefinite lived intangible assets consist of domain names for which the fair value is determined by using a third party valuation site which calculates the value of domain names using internal algorithms. For other intangible assets with definite lives, we compare future undiscounted cash flow forecasts prepared by management to the carrying value of the related intangible asset group to determine if there is an impairment. We did not identify any indicators of potential impairment during the three and nine months ended September 30, 2014, and therefore no impairment review was performed.

Stock Based Compensation

Total stock-based compensation expense recognized for the three and nine months ended September 30, 2014 and 2013, is as follows (in thousands, except per share amount):

 

     Three Months Ended September 30,      Nine Months Ended September 30,  
     2014      2013      2014      2013  

Cost of revenues

   $ 10       $ 26       $ 33       $ 85   

Sales and marketing

     22         83         75         333   

General and administrative

     169         192         475         787   

Research and development

     17         51         51         207   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total stock-based compensation expense

   $ 218       $ 352       $ 634       $ 1,412   
  

 

 

    

 

 

    

 

 

    

 

 

 

Basic and diluted net stock-based compensation expense per share*

   $ 0.01       $ 0.02       $ 0.03       $ 0.06   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

* Non-GAAP disclosure.

Results of Operations

The following table sets forth our historical operating results as a percentage of revenue for the three and nine months ended September 30, 2014 and 2013:

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2014     2013     2014     2013  

Revenue

     100.0     100.0     100.0     100.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

        

Cost of revenues

     80.6        69.1        77.1        71.4   

Sales and marketing

     8.9        9.5        9.2        11.0   

General and administrative

     11.4        16.6        12.9        14.3   

Research and development

     8.0        7.1        6.4        7.2   

Amortization of intangibles

     0.7        1.0        0.9        1.0   

Income from settlement and patent licensing

     (3.9     —          (1.0     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     105.8        103.2        105.4        105.0   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating loss

     (5.8     (3.2     (5.4     (5.0

Interest and other income (expense), net

     (3.0     (2.3     (2.5     (2.7

Change in fair value of warrant liability

     1.6        (1.8     (0.2     0.3   
  

 

 

   

 

 

   

 

 

   

 

 

 

Loss from continuing operations before income taxes

     (7.2     (7.2     (8.0     (7.3

Provision for income taxes

     —          (0.5     0.1        0.2   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net loss from continuing operations

     (7.2     (6.8     (8.2     (7.5

Loss from discontinued operations (net of taxes)

     —          (0.7     —          (5.4

Net loss

     (7.2 )%      (7.4 )%      (8.2 )%      (12.8 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Three and nine months ended September 30, 2014 and 2013

Revenue (dollars in thousands):

 

     Three Months Ended September 30,     Percent     Nine Months Ended September 30,     Percent  
     2014      (*)     2013      (*)     change     2014      (*)     2013      (*)     change  

Owned and operated

   $ 11,673         64.3   $ 8,932         38.1     30.7   $ 35,692         53.4   $ 33,178         49.1     7.6

Network

     6,468         35.7     14,540         61.9     -55.5     31,143         46.6     34,413         50.9     -9.5
  

 

 

    

 

 

   

 

 

    

 

 

     

 

 

    

 

 

   

 

 

    

 

 

   

Total revenue

   $ 18,141         100.0   $ 23,472         100.0     -22.7   $ 66,835         100.0   $ 67,591         100.0     -1.1
  

 

 

    

 

 

   

 

 

    

 

 

     

 

 

    

 

 

   

 

 

    

 

 

   

 

(*) - Percent of total revenue

O&O Revenue

 

     2014      2013      Percentage change  
     Three months
ended
September 30,
     Nine months
ended
September 30,
     Three months
ended
September 30,
     Nine months
ended
September 30,
     Three months
ended
September 30,
    Nine months
ended
September 30,
 

Revenue per thousand visitors (“RKV”)

   $ 201       $ 198       $ 180       $ 199         11.6     -0.7

O&O Monthly Unique Visitors (in millions)

     55.8         173.5         46.3         155.1         20.5     11.9

O&O revenue for the three and nine months ended September 30, 2014, increased 30.7% and 7.6%, respectively, compared to the same periods in 2013. The increase in revenue for the three months ended September 30, 2014, compared to the same period in 2013 is due to an increase in monetization as our RKV increased from $180 for the three months ended September 30, 2013, to $201 for the three months ended September 30, 2014. The increase in revenue was also due to an increase in traffic to our owned and operated sites. Revenue for the nine months ended September 30, 2014, increased compared to the same period in 2013, due to increased traffic to our owned and operated sites. There was no change in monetization for the nine months ended September 30, 2014 compared to the same period in 2013, as our RKV was consistent period over period.

Network revenue

Network revenue for the three months and nine months ended September 30, 2014 decreased 55.5% and 9.5%, respectively, compared to the same periods in 2013. The decrease in network revenue for the three and nine months ended September 30, 2014, compared to the same periods in 2013, is mainly due to a reduction in the amount of traffic we accepted from our network partners as we continue to apply increasingly more stringent traffic filters to ensure our advertising partners continue to receive traffic that converts for our advertisers, which resulted in a reduction in network revenue in 2014. There was also a decrease in organic traffic to existing partner websites due to algorithmic changes made by a large search engine in 2013, affecting the way in which the search engine indexes our network partner websites, which resulted in a further decrease of our network revenue in 2014.

As previously noted, a large portion of Network revenue is based on traffic from other websites to which we provide our organic and third-party ad feeds. We continue to experience fluctuations in this portion of our Network revenue related to changes in the partners’ traffic levels, traffic quality and market conditions for paid search. We expect that this portion of our Network revenue will continue to be subject to significant fluctuations. If we experience a reduction in the number of Network partner websites receiving our organic and third-party ad feeds, or if the overall traffic levels derived from our Network partner websites is reduced, or if the quality of traffic derived from those Network partner websites is diminished, we expect that our Network revenue would decrease materially. During the three months ended September 30, 2014, we substantially reduced the total number of Network partners to which we provide organic and third-party ad feeds in order to focus on the implementation of increased monitoring and filtering tools to prevent questionable or fraudulent traffic. This has materially impacted the level of Network revenue we were able to achieve. This trend has continued into the fourth quarter of 2014. We have recently launched new tools that we believe could reverse this trend, but the launch is too recent to be certain as to its long term revenue impact, if any.

Based on the above, total revenue for the three and nine months ended September 30, 2014, decreased 19.7% and 0.1%, respectively, compared to the same periods in 2013.

 

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

 

     Percentage of Total Revenue     Percentage of Total Revenue  
     Three Months Ended September 30,     Nine Months Ended September 30,  

Customer

   2014     2013     2014     2013  

Google, Inc.

     40.7     20.1     31.1     25.0

Yahoo! Inc.

     32.9     56.7     43.3     46.2

Operating expenses:

Operating expenses were as follows (dollars in thousands):

 

    Three Months Ended September 30,           Nine Months Ended September 30,        
    2014     Percent of
Total
Revenue
    2013     Percent of
Total
Revenue
    Percent
Change
    2014     Percent of
Total
Revenue
    2013     Percent of
Total
Revenue
    Percent
Change
 

Cost of revenues

  $ 14,628        80.6   $ 16,208        69.1     (9.7 )%    $ 51,545        77.1   $ 48,253        71.4     6.8

Sales and marketing

    1,622        8.9     2,230        9.5     (27.3 )%      6,138        9.2     7,419        11.0     (17.3 )% 

General and administrative

    2,074        11.4     3,894        16.6     (46.7 )%      8,630        12.9     9,685        14.3     (10.9 )% 

Research and development

    1,452        8.0     1,664        7.1     (12.7 )%      4,263        6.4     4,900        7.2     (13.0 )% 

Amortization of intangibles

    119        0.7     225        1.0     (47.1 )%      569        0.9     687        1.0     (17.2 )% 

Income from settlement and patent licensing

    (700     (3.9 )%      —          —       NM        (700     (1.0 )%      —          —       NM   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

  $ 19,195        105.8   $ 24,221        103.2     (20.8 )%    $ 70,445        105.4   $ 70,944        105.0      (0.7 )% 
 

 

 

     

 

 

       

 

 

     

 

 

     

 

 

 

Cost of revenues

Cost of revenues for the three and nine months ended September 30, 2014, decreased by 9.7% and increased by 6.8%, respectively, compared to the same periods in 2013. The decrease in cost of revenues during the three months ended September 30, 2014, compared to the same period in 2013 is due to a decrease in the revenue share as network revenue continued to decrease. The decrease in revenue share is partially offset by an increase in traffic acquisition cost. The increase in cost of revenues during the nine months ended September 30, 2014, compared to the same period in 2013 is primarily due to an increase in traffic acquisition cost.

Sales and marketing

Sales and marketing expenses for the three and nine months ended September 30, 2014, decreased 27.2% and 17.3%, respectively, compared to the same periods in 2013. The decrease is mainly due to a decrease in personnel-related costs as part of our continued cost savings efforts. The reduction in personnel related costs was partially offset by severance costs. In January 2013, we made a decision to eliminate our direct sales efforts of our SMB product suite to small and medium size businesses.

General and administrative

General and administrative expenses for the three and nine months ended September 30, 2014, decreased by 46.8% and 10.9%, respectively, compared to the same periods in 2013. The decrease in general and administrative expenses are due to a decrease in personnel related costs, consulting and professional fees. During the prior period, we incurred consulting and legal expenses relating to our efforts to secure financing as well as legal costs relating to litigation and the accrual of a legal settlement of $550,000. The decrease was partially offset by a severance charge of $1.5 million of which the majority related to the departure of our Chief Executive Officer and Chief Operating Officer during the first half of 2014.

Research and development

Research and development expenses for the three and nine months ended September 30, 2014, decreased by 12.7% and 13.0%, respectively, compared to the same periods in 2013. The decrease is due to higher capitalization of personnel related costs as we continue to invest in new initiatives, including mobile and local shopping, together with a reduction in consulting fees as part of our continued operating efficiency improvements.

The following table sets forth research and development expenses, additional capitalized website development costs and amortization of capitalized website development costs for the periods indicated (in thousands):

 

     Three Months Ended September 30,      Nine Months Ended September 30,  
     2014      2013      2014      2013  

Research and development expense

   $ 1,452       $ 1,664       $ 4,263       $ 4,900   

Capitalized website development costs

   $ 405       $ 531       $ 1,455       $ 1,595   

Amortization of capitalized website development costs

   $ 788       $ 648       $ 2,009       $ 1,893   

 

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Amortization of intangibles

Amortization of intangibles expense was $119,000 and $569,000 for the three and nine months ended September 30, 2014, respectively, compared to $225,000 and $687,000 for the same periods in 2013.

Income from settlement and patent licensing

During the third quarter of fiscal 2014, we reached a settlement agreement in the patent infringement action against Fry’s Electronics, Inc. As part of the settlement agreement, we received a one-time patent license fee payment of $700,000 related to prior infringement of our patent.

Interest and other income (expense), net

Interest and other income (expense), net were ($539,000) and ($1.6 million) for the three and nine months ended September 30, 2014, respectively, compared to ($537,000) and ($1.8 million) for the same periods in 2013. The decrease in interest expense for the nine months ended September 30, 2014 compared to the same period in 2014 is due to a $723,000 charge related to the loss on exchange of warrants recorded in the first quarter of fiscal 2013. The decrease is partially offset by an increase in interest expense related to the convertible notes the Company entered into in April 2013. The interest relating to the convertible notes include cash and non-cash interest expense.

Provision for income taxes

Provision (benefit) for income taxes was $0 and $96,000 for the three and nine months ended September 30, 2014, and ($109,000) and $121,000 for the three and nine months ended September 30, 2013. Taxes are primarily due to anticipated tax amortization on indefinite-lived assets, partially offset by California research and development credits.

Liquidity and Capital Resources

Liquidity and capital resources highlights (in thousands):

 

     September 30,     December 31,  
   2014     2013  

Cash and cash equivalents

   $ 4,311      $ 5,069   
  

 

 

   

 

 

 

Working capital (deficit)

   $ (10,794   $ (2,304
  

 

 

   

 

 

 

Cash flow highlights (in thousands):

 

     Nine Months Ended September 30,  
     2014     2013  

Net cash provided by operating activities

   $ 6,694      $ 326   

Net cash used in investing activities

     (2,513     (2,337

Net cash (used in) provided by financing activities

     (4,939     3,162   

We have funded our business, to date, primarily from issuances of equity securities as well as through debt facilities. Cash was $4.3 million as of September 30, 2014, and $5.1 million as of December 31, 2013. We had a working capital deficit of ($10.8 million) as of September 30, 2014, and a working capital deficit of ($2.3 million) as of December 31, 2013. As of September 30, 2014, we had a total of $4.3 million outstanding on the revolving credit facility with Square 1 Bank, with no additional availability as of September 30, 2014. On March 27, 2014, we entered into an Amendment with Square 1 Bank, pursuant to which we paid off the entire term loan with Square 1 Bank using the availability under our revolving credit facility. The increase in the working capital deficit is largely due to a decrease in accounts receivable due to the decrease in revenue together with the reclassification of the senior secured convertible notes, with a balance of $4.9 million, from non-current to current liabilities, partially offset by a decrease in the Square 1 Bank line of credit.

Net cash provided by operating activities was $6.7 million for the nine months ended September 30, 2014. Net loss adjusted for non-cash charges (adding back depreciation and amortization, provision for doubtful accounts, stock-based compensation expense, non-cash interest expense, change in fair value of warrant and conversion option liabilities and deferred income taxes) resulted in cash provided of approximately $356,000, and changes in operating assets and liabilities provided cash of $6.3 million for the nine months ended September 30, 2014. Net cash provided by operating activities was $326,000 for the nine months ended September 30, 2013. Net loss adjusted for non-cash charges (adding back depreciation and amortization, stock-based compensation expense, change in fair value of warrant and conversion option liabilities, non-cash interest expense, loss on exchange of warrants, provision for doubtful accounts and asset impairment) was cash provided of approximately $1.2 million. Changes in operating assets and liabilities used cash of $917,000 for the nine months ended September 30, 2013.

 

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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 nine months ended September 30, 2014, the terms of our accounts receivable and accounts payable remained unchanged.

The table below substantiates the change in net cash provided by (used in) operating activities for the nine months ended September 30, 2014 and 2013 (in thousands):

 

     Nine Months Ended September 30,        
     2014     2013     Change  

Net loss

   $ (5,466   $ (8,683   $ 3,217   

Non-cash (1)

     5,822        9,926        (4,104
  

 

 

   

 

 

   

 

 

 

Subtotal

     356        1,243        (887

AR, AP and Other

     6,338        (917     7,255   
  

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) operations

   $ 6,694      $ 326      $ 6,368   
  

 

 

   

 

 

   

 

 

 

 

(1) Includes depreciation, amortization, change in fair value of conversion option and warrant liability, asset impairment, non-cash expense related to stock-based compensation and interest, loss on exchange of warrants, non-cash interest expense and provision for doubtful accounts.

Net cash used in investing activities was $2.5 million for the nine months ended September 30, 2014, and consisted of $2.9 million of capital expenditures, primarily related to website development costs and computer hardware purchases, partially offset by proceeds from escrow of $390,000, related to the sale of the Rovion assets. Net cash used in financing activities was $4.9 for the nine months ended September 30, 2014, primarily related to the repayment of the Square 1 Bank line of credit offset by net draws on the revolving credit facility. Net cash used in investing activities was $2.3 million for the nine months ended September 30, 2013, and consisted of $2.4 million of capital expenditures, primarily related to website development costs. Net cash provided by financing activities was $3.2 million for the nine months ended September 30, 2013, and primarily consisted of proceeds of $5.0 million from the issuance of secured convertible notes offset by the $1.3 million repayment of a portion of the outstanding balance on the Square 1 Bank line of credit and term loan and $527,000 of financing related cost.

Although the Company has been able to generate positive cash flow from operations of $6.7 million in 2014, the decrease in the Company’s revenue during the third quarter of fiscal 2014, resulted in the decrease in the Company’s borrowing base on the Square 1 Bank line of credit. As a result, the Company was required to make payments on the line of credit with Square 1 Bank of approximately $4.5 million during the third quarter of fiscal 2014.

The Company expects to increase revenue from its O&O and Network businesses which will result in a corresponding increase in the Company’s borrowing base, but there is no guarantee we will be able to do so. The Company also continues to focus on generating new revenue streams through various initiatives. However, if our revenue does not grow, we may continue to experience losses in one or more future periods. We continue to evaluate our operating plan and manage our costs in line with estimated revenues and have recently undertaken cost reductions to better manage our costs in light of our recent revenue trends. However, if there are further decreases in our revenue, we may not be able to reduce or maintain our expenses, which may impact our ability to implement our business strategy and adversely affect our financial condition.

Management believes that, based upon projected operating needs, the combination of cash from operations, availability on our revolving credit facility, and an anticipated refinancing of our credit facility and/or our convertible notes in the near term and prior to their respective maturity dates will be sufficient to fund our operations for at least the next 12 months. However, if the projections and assumptions used by management to form its opinion prove incorrect, then we may require additional capital to fund our operations over the next 12 months. Management cannot provide assurances that, if required, any additional equity or debt arrangements will be available to us in the future or that the required capital would be available on terms acceptable to us, if at all, or that any such activity would not be dilutive to our stockholders.

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.

 

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes in our disclosures regarding market risk since December 31, 2013. See also Item 7A in our Annual Report on Form 10-K for the year ended December 31, 2013, filed with the Securities and Exchange Commission on March 28, 2014, for further sensitivity analysis regarding our market risk related to interest rates and derivative liabilities.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

In accordance with Rule 13a-15 of the Securities Exchange Act of 1934 (the “Exchange Act”), as of the end of the period covered by this Quarterly Report on Form 10-Q, our management evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act). Based upon their evaluation of these disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer have concluded that the disclosure controls and procedures were effective as of the end of the period covered by this report.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

From time to time we may initiate or be subject to a variety of legal proceedings and claims in the ordinary course of business, including claims seeking to enforce our intellectual property rights, claims that allege we infringe the intellectual property rights of another party and claims arising in connection in the ordinary course of business. Other than the litigations discussed below, we are not currently a party to any material legal proceedings.

Fry’s Electronics Litigation

On June 18, 2012, we filed a lawsuit against Fry’s Electronics, Inc. (“Fry’s”) alleging that Fry’s violates our registered U.S. Patent No. 7,062,453, which is entitled “Methods and systems for dynamic networked commerce architecture.” We settled with Fry’s on August 29, 2014 and Fry’s licensed our patent. We received a one-time patent license fee of $700,000 in August 2014 related to prior infringement of our patent.

Shopping Cheapest Litigation

On April 24, 2014, a lawsuit was filed in the Superior Court of California, County of Orange against Local Corporation by Shopping Cheapest, LLC, a purported UK limited liability company (“Shopping Cheapest”). This lawsuit was dismissed by Shopping Cheapest on August 4, 2014 and our countersuit against Shopping Cheapest was dismissed on September 9, 2014. On November 3, 2014, an individual named Ying Jian Liu filed a lawsuit in the United States District Court for Central District of California purporting to be doing business as Shopping Cheapest, LLC. The complaint alleges that Local Corporation breached its contract with Shopping Cheapest and seeks an award of damages of approximately $1.1 million plus attorney fees. We do not believe this lawsuit has any merit and intend to vigorously defend ourselves.

 

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Item 1A. Risk Factors

Information on risk factors can be found in “Part I, Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2013, filed with the Securities and Exchange Commission on March 28, 2014. There were no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013, except as follows:

Our financial resources are limited and we may need to raise additional capital in the future to continue our business.

As of September 30, 2014, we had cash of $4.3 million. We may be required to raise additional capital to permit us to conduct our business and to achieve our strategic growth opportunities. If we are required to raise additional capital, we cannot ensure that additional funding will be available, or if it is available, that it can be obtained on terms and conditions we will deem acceptable. Our business is subject to risks and uncertainties that may prevent us from raising additional capital or may cause the terms upon which we raise additional capital, if additional capital is available, to be less favorable to us than would otherwise be the case. If we needed to raise additional capital and were unable to do so, we may not be able to continue our business as currently contemplated. If this were to happen our shares could lose all or substantially all of their market value.

If we are unable to raise additional capital as needed, we may not be able to grow our company and satisfy our obligations as they become due.

We have historically relied on offerings of our equity and borrowings under our debt facility and our Notes to fund our operations. On January 20, 2011, we completed an 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 August 3, 2011, we entered into a Loan and Security Agreement with Square One Bank. The Square One Agreement, as amended, provides us with a revolving credit facility of up to $12.0 million. The maturity date of the facility is April 2, 2015. As of September 30, 2014, we had $4.3 million in borrowings outstanding under the facility and $0 availability. On April 11, 2013, we entered into an agreement to sell $5 million of the Notes, the entirety of which remain outstanding and which mature on April 11, 2015. We may need to raise additional capital or obtain additional credit to fund our operations in the future. The failure to raise capital, or obtain credit when needed, on acceptable terms, could have a material adverse effect on our business, prospects, financial condition and results of operations.

The assessment of our liquidity is based upon significant judgments or estimates that could prove to be materially incorrect.

In assessing our current financial position and developing operating plans for the future, we have made significant judgments and estimates with respect to the potential financial and liquidity effects of our risks and uncertainties, including but not limited to:

 

    our ability to meet our current projections with respect to our results of operations;

 

    our ability to refinance our credit facility with Square 1 Bank and/or our Note holders in the short term;

 

    our ability to continue to monetize our O&O and Network sites at present levels or better;

 

    our ability to maintain traffic levels to our O&O and Network sites at present levels or better;

 

    our ability to control expenses effectively, including through any fluctuations in our financial performance;

 

    our ability to comply with our debt covenants to Square 1 Bank; and

 

    the potential for additional, unforeseen cash demands, including without limitation traffic acquisition costs, litigation costs, personnel costs, and development costs.

In our liquidity assessment, we assumed that our operations will continue without further disruptions through the next twelve months, including disruptions of the sort we recently experienced in the first half of 2011, the second half of 2012, and throughout 2013 and 2014 in which changes made by our primary search monetization partners, primary traffic acquisition partners, and major search engines that index our content affected the RPC we received for advertisements on our sites, our ability to buy traffic for our sites, and the levels of organic traffic and traffic quality received by our sites. We intend to support operations and repay obligations with one or more of the following: cash on hand; cash from operations; credit line extensions; additional debt; and offerings of our securities.

It is possible that the actual outcome of one or more of our plans could be materially different than expected, or that one or more of our significant judgments, or estimates about the potential effects of these risks and uncertainties could prove to be materially incorrect. If one or more of these possible outcomes is realized and third-party financing is not available, substantial doubt could exist about our ability to continue as a going concern.

 

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3. Defaults Upon Senior Securities

None

Item 4. Mine Safety Disclosures

None

Item 5. Other Information

None

 

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Table of Contents

Item 6. Exhibits

 

Exhibit

Number

  

Description

    3.1(1)

   Amended and Restated Certificate of Incorporation of the Registrant.

    3.2(2)

   Amendment to Restated Certificate of Incorporation of the Registrant.

    3.3(3)

   Amended and Restated Bylaws of the Registrant.

    3.4(4)

   Certificate of Ownership and Merger of Interchange Merger Sub, Inc. with and into Interchange Corporation.

    3.5(5)

   Certificate of Designation of Rights, Preferences and Privileges of Series A Participating Preferred Stock of Local.com Corporation.

    3.6(6)

   Certificate of Ownership and Merger Merging Wide Out Corporation Into Local.com Corporation.

    4.1(5)

   Preferred Stock Rights Agreement, dated as of October 15, 2008, by and between Local.com Corporation and Computershare Trust Company, N.A., as Rights Agent (which includes the form of Certificate of Designation of Rights, Preferences and Privileges of Series A Participating Preferred Stock of Local.com Corporation as Exhibit A thereto, the form of Rights Certificate as Exhibit B thereto, and the Stockholder Rights Plan, Summary of Rights as Exhibit C thereto).

  10.2(7)†

   Amendment Number 9 dated March 19, 2014, to Yahoo! Publisher Network Contract, as amended, dated August 30, 2010, by and among the Registrant, Yahoo! Inc., and Yahoo! SARL.

  10.3(8)

   Eighth Amendment, dated March 27, 2014, to Loan and Security Agreement dated August 3, 2011, by and among the Registrant, Krillion, Inc., Screamin Media Group, Inc. and Square 1 Bank.

  10.7(9)

   Ninth Amendment, dated September 2, 2014, to Loan and Security Agreement dated August 3, 2011, by and among the Registrant, Krillion, Inc., Screamin Media Group, Inc. and Square 1 Bank.

  31.1*

   Certification of Principal Executive Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

  31.2*

   Certification of Principal Financial and Accounting Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

  32.1*

   Certification of Principal Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS*

   XBRL Instance Document.

101.SCH*

   XBRL Taxonomy Extension Schema Document.

101.CAL*

   XBRL Taxonomy Extension Calculation Linkbase Document.

101.DEF*

   XBRL Taxonomy Extension Definition Linkbase Document.

101.LAB*

   XBRL Taxonomy Extension Label Linkbase Document.

101.PRE*

   XBRL Taxonomy Extension Presentation Linkbase Document.

 

* Filed herewith.
# Indicates management contract or compensatory plan.
Application has been made with the Securities and Exchange Commission to seek confidential treatment of certain provisions. Omitted material for which confidential treatment has been requested has been filed separately with the Securities and Exchange Commission.
(1) Incorporated by reference from the Registrant’s Statement on Form SB-2, Amendment No. 2, filed with the Securities and Exchange Commission on September 16, 2004.
(2) Incorporated by reference from the Registrant’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on August 17, 2009
(3) Incorporated by reference from the Registrant’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on November 2, 2007.
(4) Incorporated by reference from the Registrant’s Current Report on Form 8-K/A, filed with the Securities and Exchange Commission on November 2, 2006.
(5) Incorporated by reference from the Registrant’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on October 15, 2008.

 

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(6) Incorporated by reference from the Registrant’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on September 19, 2012.
(7) Incorporated by reference from the Registrant’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on March 21, 2014.
(8) Incorporated by reference from the Registrant’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on March 28, 2014.
(9) Incorporated by reference from the Registrant’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on September 5, 2014.

 

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SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

      LOCAL CORPORATION
November 12, 2014      

/s/ Fred Thiel

Date       Fred Thiel
      Chief Executive Officer
      (principal executive officer) and Chairman
November 12, 2014      

/s/ Kenneth S. Cragun

Date       Kenneth S. Cragun
      Chief Financial Officer (principal financial
      and accounting officer) and Secretary

 

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INDEX TO EXHIBITS

 

Exhibit

Number

  

Description

    3.1 (1)

   Amended and Restated Certificate of Incorporation of the Registrant.

    3.2(2)

   Amendment to Restated Certificate of Incorporation of the Registrant.

    3.3(3)

   Amended and Restated Bylaws of the Registrant.

    3.4(4)

   Certificate of Ownership and Merger of Interchange Merger Sub, Inc. with and into Interchange Corporation.

    3.5(5)

   Certificate of Designation of Rights, Preferences and Privileges of Series A Participating Preferred Stock of Local.com Corporation.

    3.6(6)

   Certificate of Ownership and Merger Merging Wide Out Corporation Into Local.com Corporation.

    4.1(5)

   Preferred Stock Rights Agreement, dated as of October 15, 2008, by and between Local.com Corporation and Computershare Trust Company, N.A., as Rights Agent (which includes the form of Certificate of Designation of Rights, Preferences and Privileges of Series A Participating Preferred Stock of Local.com Corporation as Exhibit A thereto, the form of Rights Certificate as Exhibit B thereto, and the Stockholder Rights Plan, Summary of Rights as Exhibit C thereto).

  10.2(7)†

   Amendment Number 9 dated March 19, 2014, to Yahoo! Publisher Network Contract, as amended, dated August 30, 2010, by and among the Registrant, Yahoo! Inc., and Yahoo! SARL.

  10.3(8)

   Eighth Amendment, dated March 27, 2014, to Loan and Security Agreement dated August 3, 2011, by and among the Registrant, Krillion, Inc., Screamin Media Group, Inc. and Square 1 Bank.

  10.7(9)

   Ninth Amendment, dated September 2, 2014, to Loan and Security Agreement dated August 3, 2011, by and among the Registrant, Krillion, Inc., Screamin Media Group, Inc. and Square 1 Bank.

  31.1*

   Certification of Principal Executive Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

  31.2*

   Certification of Principal Financial and Accounting Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

  32.1*

   Certification of Principal Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS*

   XBRL Instance Document.

101.SCH*

   XBRL Taxonomy Extension Schema Document.

101.CAL*

   XBRL Taxonomy Extension Calculation Linkbase Document.

101.DEF*

   XBRL Taxonomy Extension Definition Linkbase Document.

101.LAB*

   XBRL Taxonomy Extension Label Linkbase Document.

101.PRE*

   XBRL Taxonomy Extension Presentation Linkbase Document.

 

* Filed herewith.
# Indicates management contract or compensatory plan.
Application has been made with the Securities and Exchange Commission to seek confidential treatment of certain provisions. Omitted material for which confidential treatment has been requested has been filed separately with the Securities and Exchange Commission.
(1) Incorporated by reference from the Registrant’s Statement on Form SB-2, Amendment No. 2, filed with the Securities and Exchange Commission on September 16, 2004.
(2) Incorporated by reference from the Registrant’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on August 17, 2009
(3) Incorporated by reference from the Registrant’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on November 2, 2007.
(4) Incorporated by reference from the Registrant’s Current Report on Form 8-K/A, filed with the Securities and Exchange Commission on November 2, 2006.
(5) Incorporated by reference from the Registrant’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on October 15, 2008.

 

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(6) Incorporated by reference from the Registrant’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on September 19, 2012.
(7) Incorporated by reference from the Registrant’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on March 21, 2014.
(8) Incorporated by reference from the Registrant’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on March 28, 2014.
(9) Incorporated by reference from the Registrant’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on September 5, 2014.

 

33