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EX-31.02 - SECTION 302 CERTIFICATION OF CFO - ReachLocal Incex31-02.htm
EX-10.08 - CONSULTING AGREEMENT - ReachLocal Incex10-08.htm
EX-32.01 - SECTION 906 CERTIFICATION OF CEO - ReachLocal Incex32-01.htm
EX-10.07 - CONSULTING AGREEMENT - ReachLocal Incex10-07.htm
EX-21.01 - LIST OF SUBSIDIARIES - ReachLocal Incex21-01.htm
EX-10.12 - NON-EMPLOYEE DIRECTOR COMPENSATION PLAN - ReachLocal Incex10-12.htm
EX-10.33 - ADDENDUM TO GOOGLE AGREEMENT - ReachLocal Incex10-33.htm
EX-31.01 - SECTION 302 CERTIFICATION OF CEO - ReachLocal Incex31-01.htm
EX-23.01 - CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - ReachLocal Incex23-01.htm
EXCEL - IDEA: XBRL DOCUMENT - ReachLocal IncFinancial_Report.xls
EX-32.02 - SECTION 906 CERTIFICATION OF CFO - ReachLocal Incex32-02.htm
Table Of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

_________________

FORM 10-K

_________________

 

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

 

For the fiscal year ended December 31, 2014

 

OR

 

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

 

For the transition period from              to             

 

Commission file number: 001-34749

 

_________________

REACHLOCAL, INC.

(Exact name of registrant as specified in its charter)

_________________

 

Delaware

20-0498783

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

  

  

21700 Oxnard Street, Suite 1600

Woodland Hills, California

91367

(Address of principal executive offices)

(Zip Code)

 

(818) 274-0260

(Registrant’s telephone number, including area code)

 

None

(Former name, former address and former fiscal year, if changed since last report)

  ________________

 

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

 

Title of each class

Name of each

exchange on which registered

Common Stock, $0.00001 par value per share

The NASDAQ Stock Market LLC

 

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

None

 

(Title of Class)

  

(Title of Class)

 

 
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Table Of Contents
 

  

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

 

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

  

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

 

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

 

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

 

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

 

Large accelerated filer

Accelerated filer

  

  

  

  

Non-accelerated filer

  (Do not check if a smaller reporting company)

Smaller reporting company

 

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

 

As of June 30, 2014, the aggregate market value of the common stock held by non-affiliates of the registrant was $94,387,740 based on a closing price of $7.03 on the NASDAQ Global Market on such date.

 

Class

Outstanding at March 6, 2015

Common Stock, $0.00001 par value per share

29,298,113 shares

 

Documents Incorporated by Reference

 

Portions of the registrant’s Proxy Statement relating to the registrant’s 2015 Annual Meeting of Stockholders are incorporated by reference into Part III of this Annual Report on Form 10-K where indicated.

 

 
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REACHLOCAL, INC.

 

INDEX TO FORM 10-K

 

 

 

Page

Part I

 

 

Item 1.

Business

4

Item 1A.

Risk Factors

10

Item 1B.

Unresolved Staff Comments

27

Item 2.

Properties

27

Item 3.

Legal Proceedings

28

Item 4.

Mine Safety Disclosures

28

 

 

  

Part II

 

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities

29

Item 6.

Selected Financial Data

31

Item 7.

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

34

Item 7A.

Quantitative and Qualitative Disclosure About Market Risk

53

Item 8.

Financial Statements and Supplementary Data

54

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

54

Item 9A.

Controls and Procedures

54

Item 9B.

Other Information

55

 

 

 

Part III

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

56

Item 11.

Executive Compensation

56

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

56

Item 13.

Certain Relationships and Related Transactions, and Director Independence

56

Item 14.

Principal Accounting Fees and Services

56

 

 

  

Part IV

 

 

Item 15.

Exhibits, Financial Statement Schedules

F-1

 

  

Exhibit Index

58

Signatures

60

 

 
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PART I

 

CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS

 

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

 

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

 

Item 1. Business.

 

Business Overview

 

ReachLocal’s mission is to provide more customers to local businesses around the world. We began in 2004 with the goal of helping local businesses move their advertising spend from traditional media and yellow pages to online search. While we have sold to a variety of local businesses and will continue to do so, our present focus is on small to medium-sized businesses (SMBs) and in particular, what we refer to as Premium SMBs. A Premium SMB generally has 10 to 30 employees, $1 to $10 million in annual revenue and spends approximately $40,000 annually on marketing. Premium SMBs have become increasingly sophisticated in their understanding of online marketing. However, we believe that as a result of the increasing complexity of online advertising options, Premium SMBs want a single, unified solution to their marketing needs more than ever. Our goal is to provide a total digital marketing solution that will address the bulk of Premium SMBs’ online marketing needs. Our total digital marketing solution consists of products and solutions in three categories: software (ReachEdge™ and Kickserv™), digital advertising (including ReachSearch™, ReachDisplay™ and ReachRetargeting™), and web presence (including ReachSite + ReachEdge™, ReachSEO™, ReachCast™ and TotalLiveChat™).

 

We began by offering online advertising solutions with the rollout of ReachSearch in 2005, when we pioneered the provisioning of search engine marketing services (SEM) on a mass scale for SMBs through the use of our technology platform. ReachSearch combines search engine marketing optimized across multiple publishers, call tracking and call recording services, and industry leading campaign performance transparency. ReachSearch remains a leading SEM offering for local businesses and has won numerous awards since its rollout. However, ReachSearch does not solve all of the online advertising challenges of our local business clients. We have therefore added additional elements to our platform including our display product, ReachDisplay, our behavioral targeting product, ReachRetargeting, and other products that are primarily focused on leveraging third-party media to drive leads to our clients.

 

To complement our online digital advertising solutions, we have launched a number of web presence solutions. These solutions include websites, social, search engine optimization (SEO), chat and other products and solutions, all focused on expanding and leveraging our clients’ web presence. Often these products are designed to work in concert with our digital advertising products with a goal of enhancing the return to our clients.

 

We also recognize that even successfully driving leads to our clients does not represent a complete solution to local businesses’ online marketing needs. To better respond to our clients’ online marketing needs, we expanded into lead conversion software with the introduction of ReachEdge. The launch of ReachEdge in 2013 was our first step to move beyond being a media-driven lead generation business to offer integrated solutions for our clients. ReachEdge is marketing automation and lead conversion software designed to enhance lead tracking and conversion, and includes tools for capturing web traffic information and converting leads into new customers for our clients. Initially, ReachEdge only came bundled with a responsive website. However, beginning in the first quarter of 2015 clients have been able to license ReachEdge’s lead conversion software without having to also purchase a website. ReachEdge now refers only to the lead conversion software and ReachSite + ReachEdge refers to the combination of ReachEdge with a responsive website. We believe that this disaggregation of the solution will enable us to expand the market opportunity by enabling us to sell ReachEdge to those who do not need a new website.

 

 
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Over time, we plan to add additional dynamic optimization functionality to ReachEdge, as well as features that create a more seamless relationship between our clients and their customers. For instance, in the fourth quarter of 2014, we acquired Kickserv, a provider of cloud-based business management software for service businesses. With this addition, we now have the ability to provide an end-to-end solution to our clients that starts with lead generation (ReachSearch, ReachDisplay and ReachSEO), includes lead conversion software (ReachEdge), and then closes and manages the business relationship (Kickserv). Local businesses already spend marketing dollars in these categories with a significant number of providers in a highly fragmented and confusing marketplace. Our integrated total marketing solution seeks to address this broad array of business needs with a simple integrated solution.

 

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

 

From 2013 through the beginning of 2014, we commenced a significant realignment of our sales force in North America into a hunter/farmer sales approach. Certain sales personnel dedicated to bringing in new clients, and others focused on servicing the clients and upselling and cross selling. However, in mid-2014, we concluded that this structure did not work and, we believe that our revenue decline in 2014 was largely attributable to the failure of this new sales structure. Accordingly, commencing in 2015, we are further refining the structure of our North American sales force to combine what we have determined to be the best elements of both our original sales model and the hunter/farmer model. Under this new model, our sales personnel (now called Digital Marketing Consultants or DMCs) will both generate the sale and manage the relationship. However, each DMC will be pared with a Marketing Expert (or ME) that will provide day-to-day campaign management. This approach will enable clients to have an ongoing relationship with their DMC, but with the support of the ME, the DMC will be able to focus on selling and managing relationships. We use a variety of sales models in our international markets based on regional factors.

 

We operate on five continents, and we served approximately 20,800 clients around the world with approximately 31,400 active product units at December 31, 2014. We had revenues of $474.9 million in 2014 and $514.1 million in 2013, representing a decline of 7.6%; Adjusted EBITDA of $(9.4) million in 2014 and $32.8 million in 2013, representing a decline of 128.7%; $46.1million of operating loss in 2014 and $6.2 million of operating income in 2013; and a $45.0 million net loss in 2014 and a $2.5 million net loss in 2013.  For more financial information, see our Consolidated Financial Statements and the notes thereto beginning on page F-1. For our definition of Adjusted EBITDA, why we present it, and a reconciliation of our Adjusted EBITDA to loss from operations for each of the periods presented, see Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Non-GAAP Financial Measures.”

 

Industry Overview

 

Over the past decade, the market for online marketing services for SMBs and other local businesses has undergone rapid and fundamental changes. The delivery and consumption of local online marketing services, like all media, has become fragmented and digitized. Consumers are searching on Google, checking reviews on Yelp and Citysearch, buying coupons on Groupon, and asking their friends for their opinions through Facebook and Twitter. Accordingly, for SMBs to prosper in this evolving world, they need to possess a tool kit that enables them to reach and interact with consumers in the same manner that consumers are seeking their services. This consumer-led digital transformation has profoundly disrupted the ways that businesses of all sizes need to acquire, transact with, maintain and retain their customers. As the Internet continues to grow and evolve, we believe that these trends will accelerate. To keep pace with this transformation, we believe that local businesses need to follow their customers and move an increasing portion of their marketing efforts and spend online. Accordingly, we believe that the market opportunity is huge and as we expand our product suite we will further differentiate our company from competitors.

 

 
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The ReachLocal Solution

 

We provide local businesses with a suite of products that are optimized for their needs. Our products are designed to work the way that local businesses—and in particular, SMBs—work. They are easy to use and value-added solutions to enable our clients to acquire, maintain and retain customers. While we have sold to a wide variety of local businesses and will continue to do so, we target what we refer to as the Premium SMB. A Premium SMB generally has 10 to 30 employees, $1 to $10 million in annual revenue and spends approximately $40,000 annually on marketing. In addition, we have begun focusing on certain core verticals, which include Home Services (such as plumbers), Professional Services (such as lawyers and accountants), Specialty Services (such as travel agents) and Healthcare (such as doctors and dentists). We also provide solutions to multi-location advertisers, such as franchises and other businesses that have multiple locations across a number of cities and states.

 

Our Products

 

We offer a comprehensive technology suite of online marketing and reporting solutions designed to deliver efficacy and insight to our clients.

 

Our products are organized into three categories: Software, Digital Advertising and Web Presence:

 

 

Software. Our software products are designed to enable our clients to both easily assess the efficacy of their marketing efforts and to facilitate their interactions with their customers.

 

ReachEdge. In 2013, we introduced ReachEdge, our most important new product introduction to date. ReachEdge is a marketing automation platform that includes tools for capturing web traffic information and converting leads into new customers for our clients. With ReachEdge, we are working to solve the critical problem of lead conversion. While we have proven quite adept at generating leads for our clients, with ReachEdge, we are now able to provide our clients with tools designed to significantly improve their conversion of those leads to customers. ReachEdge manages the leads generated by our other products. For example, ReachEdge notifies our client of new leads in real time via text message, email or the ReachLocal mobile app, so that the client is able to follow up within minutes. ReachEdge also helps the client stay top of mind during the customer decision-making process by using integrated marketing automation to send new prospects targeted emails and alerts to the client’s staff reminding them to follow up on each lead.

 

KickServ. With the completion of the acquisition of Kickserv in the fourth quarter of 2014, we enhanced our offerings with a provider of cloud-based business management software for service businesses. With this addition, we now have the ability to ultimately provide an end-to-end solution to our clients that starts with lead generation (ReachSearch, ReachDisplay and ReachSEO), includes lead conversion (ReachEdge), and then closes and manages the business relationship (Kickserv).

   
 

Digital Advertising. Our digital advertising products are designed to drive customers to our clients in an efficient and cost-effective manner.

 

ReachSearch. Our award-winning ReachSearch is focused on assuring that our clients’ advertisements appear prominently among the search results when local consumers enter certain keywords on leading local search sites such as Google, Yahoo! and Bing. ReachSearch is optimized for local markets in each of our territories. ReachSearch accounted for 86% of our revenue in 2014 and 87% of our revenue during each of 2012 and 2013. In addition, starting in 2013, we commenced providing mobile optimized websites to all of our clients that purchase ReachSearch, because over a third of searches are now being conducted through mobile devices (smartphones and tablets).

 

ReachDisplay. Our ReachDisplay product is primarily focused on maximizing the exposure for local businesses by displaying their ads on websites, that in the aggregate, reach an estimated 90% of the U.S. online audience. We offer a number of display advertising products across a wide variety of publishing partners, including multiple display networks and demand-side platforms. Our ReachDisplay product was introduced in 2009 and we continue to add new publishers and options as display advertising on the Internet evolves.

 

ReachRetargeting. Our ReachRetargeting products allow us to target consumers who have previously visited a specific client’s website, either through a ReachSearch campaign or a ReachDisplay campaign, or who have previously searched for a client’s keywords. When the potential customer visits any other site within our retargeting network, we can market to the target customer on behalf of that client.

   
 

Web Presence. Our suite of web presence products are designed to enhance the profile of our clients on the Internet.

 

ReachSite + ReachEdge. Our ReachSite + ReachEdge solution provides a professionally designed, mobile-responsive web site optimized to enhance lead generation, paired with our ReachEdge lead conversion software.  

 

ReachCast. Our ReachCast solution was introduced in 2010 and combines a proprietary technology platform with an expert service team to help local businesses build and optimize their Web presence for the purpose of driving online search discovery, powering reputation management, and managing social media marketing. We substantially revamped this solution in 2014.

 

ReachSEO. Our ReachSEO solution is designed to boost the visibility of our ReachSite + ReachEdge clients on the top search engines.

 

TotalLiveChat™. Our TotalLiveChat™ widget gives our clients the ability to interact with new website visitors and collect their contact information so they can follow up with them later.

 

 
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Our Distribution Approach

 

Sales Organization

 

In 2006, we executed on a strategy to build the first pure-play online advertising sales force, our Internet Marketing Consultants (IMCs). Our IMCs historically sold and provided service to our target clients in what we refer to as our Direct Local channel. Our IMCs were the principal driver of our revenue growth through 2013. However, in view of sales challenges we were confronting, particularly in North America, and the substantial expansion in our product suite with the introduction of ReachEdge, we determined in 2013 to make significant changes to our go-to-market strategy.

  

From 2013 through the beginning of 2014, we undertook a significant realignment of our sales force in North America. As we moved more deeply into integrated solutions, we believed we required more specialization within our sales structure and therefore we shifted our North American sales organization to a hunter/farmer model. However, during 2014, we concluded that this structure did not work and, we believe that our revenue decline in 2014 was largely attributable to the failure of this new sales structure. Accordingly, commencing in 2015, we are further refining the structure of our North American sales force to combine what we consider the best elements of both our original sales model and the hunter/farmer model. Under this new model, a marriage of the best elements of the prior sales models, our sales personnel (now called Digital Marketing Consultants or DMCs) will both generate the sale and manage the relationship. However, each DMC will be pared with a Marketing Expert (or ME), who will provide day-to-day campaign management. This approach will enable clients to have an ongoing relationship with their DMC, but with the support of the ME, the DMC will be able to focus on selling and maintaining relationships.

 

We have also continued to modify and refine our approach to inside sales (our dedicated telemarketing sales force). Our inside sales force was designed to expand our geographic reach while reducing selling costs. However, the performance of this sales force has not met our expectations and, as a result, in 2014 and thus far in 2015, we have reduced its size. With the expansion of our product suite, including our software products, we are continuing to explore opportunities to leverage inside sales techniques to address the needs of our target clients.

 

We have also historically focused on international expansion. Our first expansion was in Australia in 2006. We have subsequently entered Europe (the United Kingdom, Germany, the Netherlands and Austria), Japan, Brazil, Mexico and New Zealand. However, we intend to focus in 2015 on growing our operations in our existing large market locations including Germany, Brazil and Japan, which we believe present substantially larger market opportunities than Australia, currently our largest international market. We use a variety of sales models in our international markets based on regional factors.

 

We also employ a separate sales channel targeting national brands, franchises and strategic accounts with operations in multiple local markets and select third-party agencies and resellers. We refer to this as our NBAR channel. The sales process for the NBAR channel typically has substantially longer lead times than in our Direct Local channel. In addition, national brand clients often involve complexity due to operational and marketing requirements that are not normally required by our Direct Local clients. Our third-party agencies and reseller partners use our technology platform in customer segments where they have sales forces with established relationships with their client bases. We currently have over 700 agencies and resellers actively selling on our technology platform. We have a team that is responsible for identifying potential agencies and resellers, training their sales forces to sell our products and services and supporting the relationships on an ongoing basis.

 

Customer Service

 

Our customer service organization is responsible for providing ongoing support to our sales forces, clients and resellers, including technical assistance with the use of our platform, as well as providing product- and campaign-specific technical assistance and recommendations to our local business clients. We also field an advanced campaign management team that is responsible for supporting and optimizing the overall performance of the products on a category-by-category level. With a combination of employees in each of our regional markets and India, we have a dedicated team focused on the provisioning and review of campaigns before they are deployed. As part of the continued refinement of our North American sales force, we are introducing the role of Marketing Experts (or MEs) that will provide the first line of customer support.

 

 
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Our Strategy

 

We believe that the market for online marketing solutions for local businesses is still in its early stages and the market is still highly fragmented, providing us with significant opportunities for growth. Our strategy for pursuing this opportunity includes the following key components:

 

 

Great Products. We plan to offer our clients a total digital marketing system with lead conversion software at its core that shows them how their marketing is working and helps them more effectively turn leads into customers. Our software will be supported and enhanced by our core digital advertising solutions (search, display, retargeting, social media and mobile advertising) and our web presence solutions (websites, SEO, chat). During 2015 we plan to deliver more new offerings than ever before and will focus on driving licenses of our software solutions to increase penetration, client engagement and client retention.

     
 

Great Client Experience. We believe that the continued refinement of the structure of our sales force will enable us to strengthen our relationships with our clients. Taking a more proactive approach to client support should both increase client retention and improve our reputation. We also believe, based on our experience with the historic IMC model, that our new model will produce more client referrals.

 

 

 

    

Great Reputation. If we build great products and provide great client experience, a great reputation will follow. Our reputation will be built on the way we sell and service our clients and the strength of our products. It comes from doing the right thing for the client every time. We’re building a culture that thinks client-first in everything we do.

   

Product and Technology Development and Technology Operations

 

We devote a substantial portion of our resources to developing new solutions and enhancing existing solutions, conducting product and quality assurance testing, and improving our core technology.  We have approximately 180 product and engineering professionals located in various locations in the United States and India.

 

Our technology platform has been built to scale globally. We have a large number of customer facing services which reside in eight data centers spanning five countries and we keep more than a 99.9% service availability. Our primary data center hardware is co-located in El Segundo, California. We also maintain smaller regional data centers, including redundant facilities at various locations to support our domestic and international operations. We continuously monitor the performance and availability of our products and have well documented procedures to respond to incidents. In addition, we utilize cloud computing providers for certain of our products and services.

 

We architect our applications to enable us to scale our operations quickly while reducing deployment costs. We have a highly-available, scalable infrastructure that employs hardware load-balancers, redundant interconnected network switches and firewalls, replicated databases and fault-tolerant storage devices. Our research and development expenses were $15.5 million, $9.5 million, and $8.9 million, during 2014, 2013 and 2012, respectively, and our capitalized software development costs were $13.5 million, $11.5 million, and $7.6 million during 2014, 2013 and 2012, respectively. Research and development expenses are included in product and technology expenses in the accompanying consolidated statements of operations. We have also done a number of acquisitions to accelerate our product paths, increase our core competencies and otherwise expand or accelerate various technology initiatives. We expect our research and development expenses and capitalized software development costs to continue to increase as we invest in new product initiatives, significantly improving and expanding our technology platform, and increasing the pace of international launches of new products and solutions. 

 

Intellectual Property

 

Our success and ability to compete is dependent in part on our ability to develop and maintain the proprietary aspects of our technology and operate without infringing upon the proprietary rights of others. We have patents in certain foreign jurisdictions and patent applications pending on some of our technology, but rely primarily on a combination of copyright, trade secret and trademark laws, confidentiality procedures, contractual provisions and other similar measures to protect our proprietary technology and information. Among other practices, we enter into confidentiality agreements with our employees, consultants and business partners, and we control access to and distribution of our proprietary information.

 

 
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We consider trademark registration for some of our product names, slogans and logos in the United States and in some foreign countries. ReachLocal and TotalTrack are registered U.S. trademarks on an ongoing basis. We have also registered ReachLocal, ReachCast and TotalTrack as trademarks in a number of international territories. Other trademarks we use are ReachSearch, ReachDisplay, ReachRetargeting, and ReachEdge.

 

We are the registrant of the Internet domain name for our websites as well as for our proxy services, in addition to the international extensions of those domains. The information on, or accessible through, our websites does not constitute part of, and is not incorporated into, this Annual Report.

 

We also participate actively in free and open-source software (FOSS) programs, which afford us opportunities to lead technology discussions in the industry and across leading technology conferences.

  

Clients

 

We currently primarily sell to SMB clients, national brands, agencies and resellers. No single client, national brand, agency or reseller represents more than 10% of our total consolidated revenue. 

 

Competition

 

The market for local online advertising solutions is intensely competitive and rapidly changing, and with the introduction of new technologies and market entrants, we expect competition to intensify in the future. Many of our current and potential competitors enjoy substantial competitive advantages, such as greater name recognition, longer operating histories and larger marketing budgets, as well as substantially greater financial, technical and other resources. In addition, many of our current and potential competitors have established marketing relationships and access to larger customer bases.

 

Our competitors include:

 

 

Online Publishers. We compete with large Internet marketing providers such as Google, Yahoo! and Microsoft. These providers typically offer their products and services through disparate, online-only, self-service platforms.

 

 

Traditional, Offline Media Companies. We compete with traditional yellow page, newspaper, television and radio companies that, in many cases, have large, direct sales forces and digital publishing properties.

 

 

Local SMB Marketing Providers. The market for internet marketing services is highly fragmented and there are a number of smaller companies which provide internet marketing services and may be able to offer such services at highly competitive prices.

 

 

SMB Marketing Technology Providers. We also compete with technology companies providing online marketing platforms focused on the SMB market such as Angie’s List, Groupon, Intuit, Web.com, Wix, and Yelp, and, in some cases, building significant direct sales forces.

 

 

New Competitors in New Markets. With the expansion of our product suite that came with the introduction of our ReachEdge and ReachSite + ReachEdge solutions, and the acquisition of Kickserv, we will encounter new competitors. While we believe that there are no competitors that offer an integrated solution similar to ours, there are a number of companies that offer various related services, such as Hubspot, Web.com, Wix and Constant Contact, as well as smaller start-ups.

 

Government Regulation

 

We are subject to general business regulations and laws as well as regulations and laws specifically governing the Internet. Existing and future laws and regulations may impede the growth of the Internet or other online services. These regulations and laws may cover taxation, tariffs, user privacy, data protection, pricing, content, copyrights, distribution, electronic contracts and other communications, consumer protection, broadband residential Internet access and the characteristics and quality of services. It is not clear how existing laws governing issues such as property ownership, sales and other taxes, libel and personal privacy apply to the Internet. Unfavorable resolution of these issues may substantially harm our business and operating results. For more information about laws and regulations that affect us and our business, including privacy and data protection laws and regulations, see Item 1A. Risk Factors below.

 

 
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The Company

 

ReachLocal, Inc. was incorporated as a Delaware corporation in 2003. In 2006, we entered our first market outside of North America through a joint venture in Australia, and in 2009, we acquired the remaining interest in the joint venture. We entered the United Kingdom and Canada in 2008, Germany and the Netherlands in 2011, Japan and Brazil in 2012, Austria in 2013, and Mexico and New Zealand in 2014. We also serve clients in certain other countries through our resellers.

 

For information about revenues from external customers and long-lived assets by geographic area, see Note 15 to our Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K.

 

Employees

 

At December 31, 2014, we had approximately 1,900 employees worldwide. Approximately 85 of our employees in Brazil were subject to a collective bargaining agreement. None of our other employees are subject to a collective bargaining agreement. We believe that relations with our employees are good.

 

Available Information

 

We file reports with the Securities and Exchange Commission (the “SEC”), including annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any other filings required by the SEC. We make available free of charge in the investor relations section of our corporate website (http://investors.reachlocal.com) our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. References to the Company’s corporate website address in this report are intended to be inactive textual references only, and none of the information contained on our website is part of this report or incorporated in this report by reference.

  

Item 1A. Risk Factors.

 

You should carefully consider the risks described below and the other information in this Annual Report on Form 10-K.

 

Risks Related to Our Business

 

Our operations and financial results are subject to various risks and uncertainties, including declining revenue, that could adversely affect our business, financial condition, results of operations, and the trading price of our common stock.

 

Our current business and future prospects are difficult to evaluate. We commenced operations in late 2004 in North America, and developed a strategy for taking advantage of what we believe is a shift of local marketing budgets from traditional media formats to digital media formats. Our strategy allowed us to grow rapidly.  However, our growth rate slowed over a number of years and in 2014 our revenue declined 7.6% as compared to 2013. In 2014, our North America revenue, which accounted for 62% of our 2014 revenue, declined by 14.2% versus 4.5% and 13.1% growth in 2013 and 2012, respectively. We are introducing products internationally, continuing to refine the structure of our North American sales force and introducing new go-to-market strategies, and developing new products to continue to grow our business, but we cannot assure you that our strategy will be successful and that our revenue will not decline further. In particular, although our international salespeople have historically been considerably more productive than our North American salespeople, as those markets mature over time, our international salespeople’s productivity may decline further, putting further pressure on our results of operations.

 

You must also consider our business and prospects in light of the risks and difficulties we encounter as a company in the rapidly evolving online marketing industry. These risks and difficulties include:

 

 

our limited number of product offerings and the difficulties and risks associated with developing and selling new products and solutions, including, in particular, new subscription and software-as-a-service (SaaS) products;

 

 

successfully executing new sales and go-to-market strategies and approaches, including the realignment of our North American sales force;

 

 

successfully entering new markets, domestically and internationally;

 

 

maintaining the effectiveness of our technology platform, and adapting our technology to new market opportunities and challenges;

  

 
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competition from existing and new competitors, technologies, and products;

 

 

reaching and maintaining profitability;

 

 

acquiring additional capital, if necessary;

 

 

continuing to attract new clients, many of which have not previously advertised online and may not understand the value to their businesses of our products and services; and

 

 

effectively managing our sales force, personnel and operations.

 

Failing to successfully address these challenges or others could significantly harm our business, financial condition, results of operations and the trading price of our common stock. 

 

We have incurred significant operating losses in the past and may incur significant operating losses in the future.

 

At December 31, 2014, we had an accumulated deficit of approximately $74.6 million, and we may incur net operating losses in the future. In addition, our cash and cash equivalents decreased from $77.5 million as of December 31, 2013 to $43.7 million as of December 31, 2014. Although we are attempting to reduce our operating expenses, we may not be successful or our operating expenses may increase in the future as we expand our operations. In addition, our business strategy contemplates making substantial investments in new and existing products, which will require significant expenditures. If our expenses don’t decrease according to our plan, we will not be profitable and our liquidity and financial condition will be adversely affected. We also expect that a variety of factors, including increased competition and the maturation of our business, may continue to put pressure on our revenue, and we cannot assure you that our revenue will not continue to decline. As a result, you should not consider our historical revenue growth as indicative of our future performance.

  

We cannot be certain that the significant steps that we have taken to strengthen our North American market will work.

 

Commencing in the fourth quarter of 2013, we realigned our sales infrastructure in North America, which we believe significantly contributed to our 2014 revenue decline. Commencing in 2015, we are further refining the structure of our sales force to combine the best elements of our original sales model and our more recent sales model. We cannot be certain that this continued evolution will slow the declines and ultimately return our North American operations to growth.

  

We depend on key personnel to operate our business, and our workforce has undergone significant disruption which may adversely affect performance and tenure.

 

We believe that our future success is highly dependent on the contributions of our executive officers, as well as our ability to attract and retain highly skilled managerial, sales, technical and finance personnel. Qualified individuals are in high demand, and we may incur significant costs to attract them. All of our U.S. officers and other U.S. employees are at-will employees, which means they may terminate their employment relationship with us at any time, and their knowledge of our business and industry would be extremely difficult to replace. If we are unable to attract and retain our executive officers and key employees, our business, operating results and financial condition will be harmed.

 

2014 was a very difficult year for our business. Our operating and stock price performance have resulted in a drop in morale within our work force. While we have taken reasonable steps to ensure that our key people are adequately incented to stay with the company, we cannot be certain that such incentives will be sufficient to keep our top performers.

 

Volatility or lack of performance in our stock price and limitations imposed by the size of our equity plan may also affect our ability to attract and retain our key employees. In addition, as some of our executive officers become vested in a substantial amount of stock or stock options, if our stock price appreciates significantly they may be more likely to leave us as their equity holdings become valuable.

 

 
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Our product roadmap relies on developing a total marketing solution—of which our current version of ReachEdge is a first step—which is a somewhat untested product concept that may not gain market acceptance or may not perform as we intend.

 

ReachEdge, our lead conversion software, is our initial step towards our goal of offering a total marketing solution. In addition, we recently acquired Kickserv, a business management platform for service businesses that we will ultimately integrate with ReachEdge. The success of this new product strategy is subject to numerous risks and uncertainties, such as uncertain customer acceptance, the difficulties of designing a complex software product, integrating our software products with our existing technology and third-party service providers, training our salespeople to sell software products, and gaining market acceptance. Because our software products are complex and incorporate a variety of proprietary and third-party software, they may have errors or defects that could result in unanticipated downtime for our customers and harm to our reputation and our business. Internet-based services frequently contain undetected errors when first introduced or when new versions or enhancements are released. In addition, our customers may use our software products in unanticipated ways that may cause a disruption in service for other customers attempting to access their data. Since our customers may use this product for important aspects of their business, such as lead generation, lead management, scheduling, and other services, any errors, defects, disruptions in service or other performance problems, could damage our customers’ businesses and result in financial losses, which would hurt our reputation. As a result, customers could elect to not renew, or delay or withhold payment to us, we could lose future sales or customers may make warranty or other claims against us. In addition, our total marketing solution is a relatively new solution for the marketplace and, therefore, wide market acceptance cannot be assured. Substantial components of our software products may be outsourced to third parties. While we believe that our relationships with these third parties are sound, if one of those relationships were to deteriorate, our ability to sell and maintain our software products could be substantially degraded.

 

We purchase most of our media from Google, and our business could be adversely affected if Google takes actions that are adverse to our interests or if we fail to meet advertiser or spend targets necessary for receiving rebates from Google. Similar actions from Yahoo!, Microsoft and other media providers could adversely affect our business, though to a lesser degree.

 

Nearly all of our cost of revenue is for the purchase of media, and a substantial majority of the media we purchase is from Google. Google accounts for a large majority of all U.S. searches, and Google’s share in foreign markets is often even greater. As a result, we expect that our business will depend upon media purchases from Google for the foreseeable future. This dependence makes us vulnerable to actions that Google may take to change the manner in which it sells AdWords, as described below, or conducts its business on a number of levels:

 

 

• 

Google Can Choose to Change the Terms and Conditions Upon Which it Does Business with Us and our Clients. Google can act unilaterally to change the terms and conditions for our purchase of media or the purchase of Google products, and Google has done so in the past. Future changes by Google to the terms and conditions upon which we purchase media could materially and adversely affect our business.

 

 

Competitive Risk. Google offers its products directly to local businesses through an online self-service option. Google enjoys substantial competitive advantages over us, such as substantially greater financial, technical and other resources. In addition, Google continues to launch products that are targeted directly at SMBs, which Google does not always make available to third parties. While we cannot assess at this time the effect of Google’s offering such products directly to SMBs, the prices charged by Google for direct service are lower than the prices we charge for the same media.

 

 

Technology Risk. Our technology platform interacts with Google through publicly available application programming interfaces, or APIs. If Google were to discontinue the availability of all or a portion of these APIs to us, we may have to change our technology, incur additional costs or discontinue certain products or services that we currently offer our clients. Any of these changes could adversely affect our ability to provide effective online marketing and reporting solutions to our clients. In addition, Google may decide to alter the amount it charges us for the right to use its APIs, which would decrease our gross margin absent any change in our pricing to our customers.

 

 

Editorial Control. Google closely monitors the experience of end-users, and from time-to-time, its editorial personnel request that companies alter their services based on Google’s determination that aspects of such services could adversely affect the end-user experience and/or avoid providing Google-dependent services to certain types of clients. For example, each of our media products includes TotalTrack, a tracking service powered by our proprietary reverse proxy technology and tracking code. If Google were to determine that the tracking URLs utilized by our TotalTrack service adversely affects the end-user’s experience, Google could require us to alter or suspend the way we implement our tracking solutions. Such a change would significantly decrease our ability to optimize our clients’ advertising campaigns and limit our ability to provide the level of campaign performance reporting that we currently provide to our clients.

 

 

Rebate/Incentive Risk. Google retains broad authority with respect to its rebate programs and has, from time to time, canceled rebate programs. During 2014, we entered into a new global agreement with Google that provides rebates based on overall global growth of our spending with Google. We did not receive rebates from Google during the second half of 2014 and we do not expect to qualify for rebates from Google during 2015. The agreement is subject to broad mutual termination rights and there is no assurance of renewal. If we earn rebates from Google in the future, termination of those agreements would negatively affect our cost of revenue.

 

 
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In addition, any new developments or rumors of developments regarding Google’s business practices that affect the local online advertising industry may create perceptions with our customers or investors that our ability to compete has been impaired.

 

The above risks also apply to other publishers from whom we purchase media, including Yahoo! and Microsoft.

  

We purchase a significant majority of our media from Google, Microsoft and Yahoo! in an auction marketplace. If we are unable to purchase media from any one of these companies, if prices for media significantly increase or if the manner in which the media is sold changes, our business could be adversely affected.

 

            Our success depends on our ability to purchase media from Google, Microsoft and Yahoo! at reasonable prices so that we can provide our clients with a reasonable return on the advertising expenditures they make through us. We generally purchase this media in an auction marketplace. Increased competition or other factors may cause the cost of the media that we purchase from Google, Yahoo! and Microsoft to rise. In particular, if our expectation that local SMB advertising will increasingly migrate to the Internet is correct, the marketing budget available to bid in these auctions will increase and the price of media may increase substantially. An increase in the cost of media in these marketplaces without a corresponding increase in our media buying efficiency could result in an increase in our cost of revenue as a percentage of revenue even if our business expands. In addition, such an increase could result in an increase in the prices we must charge our clients or a decrease in our ability to fulfill our clients’ service expectations. Furthermore, the Internet search companies that operate these media marketplaces may change the operating rules or bidding procedures in ways that decrease the effectiveness of the technology that we use to optimize our purchases or otherwise prevent us from purchasing media at reasonable prices or at all. Any change in our ability to provide effective online marketing campaigns to our clients may adversely affect our ability to attract and retain clients.

 

The market in which we participate is intensely competitive, and if we do not compete effectively, our operating results could be harmed.

 

The market for online marketing solutions is intensely competitive and rapidly changing, and with the emergence of new technologies and market entrants, we expect competition to intensify in the future.

 

Our competitors include:

 

 

Internet Online Publishers. We compete with large Internet marketing providers such as Google, Yahoo! and Microsoft. These providers typically offer their products and services through disparate, online-only, self-service platforms.

 

 

Traditional, Offline Media Companies. We compete with traditional yellow page, newspaper, television and radio companies that, in many cases, have large, direct sales forces and digital publishing properties.

 

 

Local SMB Marketing Providers. The market for internet marketing services is highly fragmented and there are a number of smaller companies which provide internet marketing services and may be able to offer such services at highly competitive prices.

 

 

SMB Marketing Technology Providers. We also compete with technology companies providing online marketing platforms focused on the SMB market such as Angie’s List, Groupon, Intuit, Web.com, Wix, and Yelp, and, in some cases, building significant direct sales forces.

 

 

New Competitors in New Markets. In late 2013 we launched ReachEdge, our lead conversion software-as-a-service, or SaaS, product, and in late 2014, we acquired Kickserv, business management software for service businesses. We are also developing other new subscription and SaaS products designed to provide SMBs additional tools to convert leads to customers, retain customers, and transact with customers. In each case, as we enter new markets we will encounter new competitors.

 

 
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Many of our current and potential competitors enjoy substantial competitive advantages, such as greater name recognition, longer operating histories, substantially greater financial, technical and other resources and, in some cases, the ability to combine their online marketing products with traditional offline media such as newspapers or yellow pages. These companies may use these advantages to offer products similar to ours at a lower price, develop different products to compete with our current solutions and respond more quickly and effectively than we can to new or changing opportunities, technologies, standards or client requirements. In particular, if major Internet search companies such as Google, Yahoo! and Microsoft decide to devote greater resources to develop and market online advertising offerings directly to SMBs, greater numbers of our clients and potential clients may choose to purchase online advertising services directly from these competitors, particularly if and as the ease of their self-service models increases. In addition, many of our current and potential competitors have established marketing relationships with and access to larger client bases and are heavily investing in recruiting sales personnel, which might affect our ability to achieve our salespeople hiring targets. 

 

As the market for local online advertising increases, we expect new competitors, business models and solutions to emerge, some of which may be superior to ours. We also believe that the marketplace for online media is more transparent than other media marketplaces. Our competitors may use information available to them to price their products at a discount to the prices that we currently offer. Clients and potential clients might adopt competitive products and services in lieu of purchasing our solutions, even if our online marketing and reporting solutions are more effective than those offered by our competitors, if we are not able to differentiate our products and convince clients that our products are more effective than our competitors’ offerings. For all of these reasons, we may not be able to compete successfully against our current and potential competitors.

 

Our future success depends in part on our ability to effectively develop and sell additional products and solutions.

 

We invest in the development of new products and solutions with the expectation that we will be able to effectively offer them to our clients. We are developing, and may in the future develop or acquire, other products and solutions that address new segments of local companies’ marketing activities. We are also developing subscription and SaaS products, such as ReachEdge and Kickserv, which present different challenges from those we have faced in the past. Our future revenue depends in part on our ability to stay competitive with our product and service offerings, including providing integrated solutions to our clients. Our ability to develop and launch new products on our expected timelines, or at all, is subject to numerous risks and uncertainties, such as the difficulties of designing complex software products, achieving desired functionality and integrating the new products with our existing technology.

 

The sale of new or additional features, products and services, the value or utility of which may be different from our current products and services or less easily understood by our clients, may require increasingly sophisticated and costly sales efforts and increased operating expenses, as well as additional training of our salespeople and education for our SMB clients. New product launches require the investment of resources in advance of any revenue generation. If new products fail to achieve market acceptance, we may never realize a return on this investment. If these efforts are not successful, our business may suffer. Many SMBs have modest advertising budgets. Accordingly, we cannot assure you that our SMB clients will increase their aggregate spending as a result of the introduction of new products and services or that the successful introduction of new products or services will not adversely affect sales of our current products and services through cannibalization of our current products or disharmony created by consumer offerings that could be perceived as in competition with our current customers. Any such adverse impact on our current media products could also adversely affect our publisher rebates.

 

We may require additional capital to respond to business opportunities, challenges, acquisitions or unforeseen circumstances. If capital is not available to us, our business, operating results and financial condition may be harmed.

 

We may require additional capital to operate or expand our business. In addition, some of our product development initiatives may require substantial additional capital resources before they begin to generate material revenue. Additional funds may not be available when we need them, on terms that are acceptable to us, or at all. Any debt financing secured by us in the future could involve restrictive covenants relating to our capital raising activities and other financial and operational matters, which may make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions. If we do not have funds available to enhance our solutions, maintain the competitiveness of our technology or pursue business opportunities, we may not be able to service our existing clients or acquire new clients, which would have an adverse effect on our business, operating results and financial condition.

 

 
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Client complaints or negative publicity about our customer service or other business practices could adversely affect our reputation and brand.

 

Client complaints or negative publicity about our technology, personnel or customer service could severely diminish confidence in and the use of our products and services. For example, we have experienced negative publicity in the United Kingdom due to false and defamatory statements made by a competitor, which negatively impacted our business in that region. Effective customer service requires significant personnel expense, and this expense, if not managed properly, could significantly impact our operating results. Moreover, failure to provide our clients with high-quality customer experiences for any reason could substantially harm our reputation and our brand and adversely affect our efforts to develop as a trusted provider of lead generation and conversion solutions for local businesses.

 

We may be unsuccessful in managing or growing our international operations, which could harm our business, operating results and financial condition.

 

We currently have international sales operations in Australia, the United Kingdom, Canada, Germany, the Netherlands, Japan, Brazil, Austria and Mexico, and campaign support services in India. Revenue from international operations outside North America accounted for 38%, 33.5% and 28.1% of total revenue for the years ended December 31, 2014, 2013 and 2012, respectively. Over the long term, we intend to expand our international operations. We may incur losses or otherwise fail to enter new markets successfully.

 

Our ability to operate internationally involves various risks, including the need to invest significant resources, the possibility that returns on such investments will not be achieved in the near future and competitive environments with which we are unfamiliar. Our international operations may not prove to be successful in certain or any markets. In addition, we have incurred and expect to continue to incur significant expenses as we attempt to establish our presence in particular international markets. Our current and any future international expansion plans will require management attention and resources and may be unsuccessful. Furthermore, in many international markets, we would not be the first entrant, and greater competition may exist with stronger brand recognition than we have faced in our current markets. Different privacy, censorship and liability standards and regulations and different intellectual property laws in foreign countries may cause our business and operating results to suffer.

 

Our international operations may also fail to succeed due to other risks inherent in foreign operations, including:

 

 

difficulties or delays in developing a network of clients in one or more international markets;

 

 

legal, political or systemic restrictions on the ability of U.S. companies to market products and services or otherwise do business in foreign countries;

 

 

different regulatory requirements, including regulation of internet services, privacy and data protection, banking and money transmitting, and selling, that may limit or prevent the offering of our products in some jurisdictions;

   

 

international intellectual property laws that may be insufficient to protect our intellectual property or permit us to successfully defend ourselves or our intellectual property in international lawsuits;

 

 

different employee/employer relationships and the existence of workers’ councils and labor unions, which could make it more difficult to terminate underperforming salespeople;

 

 

difficulties in staffing and managing foreign operations;

 

 

greater difficulty in accounts receivable collection;

 

 

currency fluctuations or a weakening U.S. dollar, which can increase costs of international expansion;

 

 

potential adverse tax consequences, including the difficulty of repatriating money;

 

 

lack of infrastructure to adequately conduct electronic commerce transactions; and

 

 

price controls or other restrictions on foreign currency.

 

As a result of these obstacles, we may find it impossible or prohibitively expensive to continue or expand our international operations and replicate our business model, which could harm our business, operating results and financial condition.

 

 
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Failure to adequately recruit, train and retain our salespeople would impede our strategy and could harm our business, operating results and financial condition.

 

Our ability to maintain or grow revenue and achieve profitability will depend, in part, on the size and effectiveness of our direct sales force. Beginning in the fourth quarter of 2013, we realigned our sales infrastructure in North America, and the change was highly disruptive to our North American productivity and results of operations throughout 2014. In 2015, we are further refining the structure of our North American sales force to combine the best elements of our original sales model and our more recent sales model. However, if many of our salespeople do not perform well in their new roles, or are unhappy with the new structure, we may experience greater than anticipated attrition. If our salespeople attrition is greater than anticipated, our business will be harmed. In addition, as more companies seek to capitalize on the shift to online media, competition for knowledgeable and qualified online media sales personnel will increase, and hiring salespeople may be more difficult than it has been historically. Moreover, employees that we hire from our competitors have in the past, and may in the future, be subject to claims of breach of noncompetition and non-solicitation obligations owed to their former employers, which could impact our ability to attract and hire high-quality candidates and potentially subject us to litigation. If we are unable to effectively recruit, train and retain salespeople, we may not be able to grow our sales force, our revenue may suffer or our costs may increase.

 

One of our international growth strategies has been to enter new international markets through franchise or reseller arrangements, but that strategy is subject to risks.

 

As we expand into other international markets, in addition to entering markets directly, we may enter through a franchisee or a reseller (as we did in New Zealand and Eastern Europe and are currently operating in Singapore). The success of this strategy will depend on a number of factors, including whether our franchisees and resellers have the experience and financial resources to be effective operators and remain aligned with us on operating, promotional and capital-intensive initiatives, and the potential impact on us if they experience operational problems or project a brand image inconsistent with our values, particularly if our contractual and other rights and remedies are limited by local law or otherwise, or are costly to exercise. Difficulties of one or more of our international franchisee or reseller arrangements could result in losses stemming from related strategic investments, delay penetration into and/or negatively affect our brand in certain international markets, and distract management and absorb product development resources.  For example, in July 2012, the Company entered into a franchise agreement with OxataSMB B.V. permitting it to operate and resell our services under the ReachLocal brand in Slovakia, Czech Republic, Hungary, Poland and Russia. At the same time, we entered into a market development loan agreement with OxataSMB pursuant to which we agreed to provide financing to OxataSMB of up to €2.9 million ($3.7 million), of which €1.45 million ($1.9 million) was immediately advanced and €0.92 million ($1.2 million) was advanced in August 2013. The OxataSMB operations did not perform as contemplated, and as a result, the Company recorded a $3.3 million impairment of the loan receivable and related interest from OxataSMB and a $1.6 million provision for bad debt related to the trade receivable from OxataSMB. In October 2014, OxataSMB formally notified us that it had appointed an insolvency specialist to dissolve its businesses and, as a result, we terminated the franchise agreement and demanded repayment in full of all amounts loaned to OxataSMB.

 

More consumers are using devices other than personal computers to access the Internet and accessing new platforms to make search queries. If we are unable to effectively reach consumers on the Internet on behalf of our customers, our business could be adversely affected.

 

The number of people who access the internet through devices other than personal computers, including mobile phones and tablets, has increased dramatically in the past few years. Mobile search advertising is growing very rapidly and may offer lower conversion rates for our customers, which if not offset by lower costs, may make search engine marketing less attractive for our customers. In addition, the lower resolution, functionality, and memory associated with some alternative devices may alter consumers’ use of the Internet, including search engines and other websites where we publish advertisements on behalf of customers. For example, search queries are increasingly being undertaken via “apps” tailored to particular devices or niches, or via social media platforms, which could affect our ability to deliver advertising results to our clients if we are unable to effectively reach consumers via those apps.

  

The impact of worldwide economic conditions, including the resulting effect on advertising budgets, may adversely affect our business, operating results and financial condition.

 

Our performance is subject to worldwide economic conditions and their impact on levels of advertising. In addition, as we increase our international footprint, we will become more sensitive to economic conditions outside of North America. We believe that the economic conditions remain challenging in North America and internationally, which have adversely affected our business.

 

 
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To the extent that economic difficulties continue, or worldwide economic conditions materially deteriorate, our existing and potential clients may no longer consider investment in our online marketing solutions a necessity, or may elect to reduce advertising budgets. Historically, economic downturns have resulted in overall reductions in advertising spending. In particular, online marketing advertising solutions may be viewed by some of our existing and potential clients as a lower priority and may be among the first expenditures reduced as a result of unfavorable economic conditions. These developments could cause us to respond by temporarily reducing hiring or taking other measures and could have an adverse effect on our business, operating results and financial condition.

 

We are exposed to fluctuations in currency exchange rates.

 

Because we conduct a significant and growing portion of our business outside the United States but report our financial results in U.S. dollars, we face exposure to adverse movements in currency exchange rates. Our foreign operations are exposed to foreign exchange rate fluctuations as the financial results are translated from the local currency into U.S. dollars upon consolidation. If the U.S. dollar weakens against foreign currencies, the translation of these foreign currency denominated transactions will result in increased revenue, operating expenses and net income (or loss). If the U.S. dollar strengthens against foreign currencies, however, the translation of these foreign currency denominated transactions will result in decreased revenue, operating expenses and net income (or loss). For example, the strengthening of the U.S. dollar against the foreign currencies in which we do business resulted in a reduction in 2014 revenue of $5.8 million, principally driven by a 6% reduction in the average value of the Australian dollar relative to the prior year. As exchange rates vary, sales and other operating results, when translated, may differ materially from expectations. In addition, approximately 49% of our cash balances are denominated in currencies other than the U.S. dollar, and the value of such holdings will increase or decrease along with the weakness or strength of the U.S. dollar, respectively. We continue to review potential hedging strategies that may reduce the effect of fluctuating currency rates on our business, but there can be no assurances that we will implement such a hedging strategy or that once implemented, such a strategy would accomplish our objectives or not result in losses.

 

If we fail to increase the number of our clients or retain existing clients, our revenue and our business will be harmed.

 

Our ability to grow our business depends in large part on maintaining and expanding our client base. To do so, we must convince prospective clients of the benefits of our technology platform and existing clients of the continuing value of our products and services. As the online media options for SMBs proliferate and our clients become more familiar with such options, we cannot assure you that we will be successful in maintaining or expanding our client base. 

  

SMB marketing and advertising campaigns are often sporadic and difficult to predict, as they may be driven by seasonal promotions or business dynamics, evolving product and service offerings, available budgets and other factors. Some SMBs advertise only periodically, such as to promote sales or special offers. Because we need to address these business considerations of our clients, we do not require clients to enter into long-term obligations to purchase our products and services. Many cancel soon after completing their initial contract terms and some cancel early. We must continually add new clients both to replace clients who choose to cancel or not to renew their advertising campaigns and to grow our business beyond our current client base. A client’s decision to cancel or not to renew may be based on a number of factors, including dissatisfaction with our products and services, inability to continue operations and spending levels or because their campaigns were event-driven or otherwise intentionally limited in scope or duration. If our clients increasingly fail to fulfill their contracts or increasingly do not renew their advertising campaigns with us, or if we are unable to attract new clients in numbers greater than the number of clients that we lose, our client base will decrease and our business, financial condition and operating results will be adversely affected.

  

A significant portion of our revenue is generated by our national brands, agencies and resellers. If we are not able to maintain relationships with one or more of them, our sales may suffer and our revenue may decline.

 

We distribute our products and services through a separate sales force for national brands with operations in multiple local markets, as well as select third-party agencies and resellers. More generally, because national brands, agencies and resellers typically represent an aggregated group of SMB clients, if our relationship with one or more of these persons or companies were restricted or terminated, our sales would decrease and our revenue would be adversely affected, potentially materially. In addition, our strategy of distributing our products and services to our clients through our Direct Local channel and through our National Brands, Agencies and Resellers channel may result in distribution channel conflicts. Our Direct Local sales efforts may compete with our third-party agency and resellers and, to the extent different third-party agencies and resellers target the same clients, they may also come into conflict with each other. While we have certain policies in place to address these potential conflicts, there can be no assurance that these channel conflicts will not materially adversely affect our relationship with existing third-party agencies and resellers or adversely affect our ability to attract new third-party agencies and resellers. In the event that any of our relationships with existing third-party agencies and resellers are terminated or we are unable to attract new third-party agencies and resellers as a result of these distribution channel conflicts, our sales may suffer and our revenue may decline.

 

 
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If SMBs increasingly opt to perform advertising tasks on their own, their demand for our products and services would decrease, negatively affecting our revenue.

 

Large Internet marketing providers such as Google, Yahoo! and Microsoft offer online advertising products and services through self-service platforms. As SMBs become more familiar with and experienced in interacting online, they may prefer to actively manage their own Internet presence and their demand for our products and services may decrease. We cannot predict the evolving experiences and preferences of SMBs, which may become more fully integrated into digitized modes of commerce and communication, and cannot assure you that we can develop our products and services in a manner that will suit their needs and expectations faster or more effectively than our competitors, or at all. If we are not able to do so, our results of operations would suffer.

 

We expect a number of factors to cause our operating results to fluctuate on a quarterly and annual basis, which may make it difficult to predict our future performance.

 

Our revenue and operating results could vary significantly from quarter-to-quarter and year-to-year because of a variety of factors, many of which are outside of our control. As a result, comparing our operating results on a period-to-period basis may not be meaningful. In addition to other risk factors discussed in this section, factors that may contribute to the variability of our quarterly and annual results include:

 

 

unilateral actions taken by Google or other media providers;

 

 

seasonal variations in advertising budgets and media pricing;

 

 

seasonal variations in salespeople hiring;

 

 

the rate at which SMBs migrate their advertising spending online;

   

 

the timing and stage of product and technology development;

 

 

our ability to develop, introduce and manage SaaS products;

 

 

the impact of fluctuations in currency exchange rates, particularly the relative strength of the US Dollar to the currencies in the countries in which we do business and its impact on our consolidated revenues and results of operations;

 

 

the impact of worldwide economic conditions on our revenue and expenses;

 

 

the timing of and our ability to enter new markets and manage expansion in new markets;

 

 

our ability to appropriately set the price of non-media products;

 

 

our ability to accurately forecast revenue and appropriately plan our expenses;

 

 

the attraction and retention of qualified employees and key personnel;

 

 

the effectiveness of our internal controls;

 

 

our ability to effectively manage our growth;

 

 

our ability to successfully manage any future acquisitions of businesses, solutions or technologies;

 

 

interruptions in service and any related impact on our reputation;

 

 

the effects of natural or man-made catastrophic events; and

 

 

changes in government regulation affecting our business.

 

As a result of these and other factors, the results of any prior quarterly or annual periods should not be relied upon as indications of our future operating performance. In addition, our operating results may not meet the expectations of investors.

 

 
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Growth may place significant demands on our management and our infrastructure.

 

We have experienced substantial growth in the size and complexity of our business. This growth has placed and may continue to place significant demands on our management and our operational and financial infrastructure. As our operations grow in size, scope and complexity, we will need to improve and upgrade our systems and infrastructure to offer an increasing number of clients enhanced solutions, features and functionality. The expansion of our systems and infrastructure will require us to commit substantial financial, operational and technical resources in advance of an increase in the volume of business, with no assurance that the volume of business will increase. Continued growth could also strain our ability to maintain reliable service levels for our clients, develop and improve our operational, financial and management controls, enhance our reporting systems and procedures and recruit, train and retain highly skilled personnel. Managing our growth will require significant expenditures and allocation of valuable management resources. If we fail to maintain the necessary level of discipline and efficiency in our organization as it grows, our business, operating results and financial condition would be harmed.

 

Our ability to introduce new solutions and features is dependent on adequate research and development resources. If we do not adequately fund our research and development efforts, we may not be able to compete effectively and our business and operating results may be harmed.

 

To remain competitive, we must continue to develop new solutions, features and enhancements to our marketing system. Maintaining adequate research and development personnel and resources to meet the demands of the market is essential. If we are unable to develop our solutions internally due to certain constraints, such as high employee turnover, lack of management ability or a lack of other research and development resources, we may miss market opportunities. Further, many of our competitors expend a considerably greater amount of funds on their research and development programs, and those that do not may be acquired by larger companies that would allocate greater resources to our competitors’ research and development programs. Our failure to maintain adequate research and development resources or to compete effectively with the research and development programs of our competitors could materially adversely affect our business.

 

Our ability to deliver our products depends upon the quality, availability, policies and prices of certain third-party service providers.

 

We rely on third parties to provide technology and services that are integrated into our solutions. Examples include our call tracking and recording services, and certain aspects of our software products. In certain geographies, we rely on a single service provider for some of these services. In the event the provider were to terminate our relationship or stop providing these services, our ability to provide the affected products could be impaired. We may not be able to find an alternative provider in time to avoid a disruption of our services or at all, and we cannot be certain that such provider’s services would be compatible with our products without significant modifications or cost, if at all. Our proxy servers, which underlie key elements of our tracking services, require the use of various domains and IP address blocks. If domain registrars, website hosting companies or Internet service providers determined that our use of such domains and IP blocks were in violation of their terms of service or internet policies, such companies could elect to block our traffic. For example, several website hosting companies have blocked traffic from our reverse proxy servers for a group of our SMB clients, resulting in our inability to provide our full tracking services to those clients. Our ability to address or mitigate these risks may be limited. The failure of all or part of our tracking services could result in a loss of clients and associated revenue and could harm our results of operations. 

 

We rely on bandwidth providers, data centers and other third parties for key aspects of the process of providing online marketing solutions to our clients, and any failure or interruption in the services provided by these third parties could harm our ability to operate our business and damage our reputation.

 

We rely on third-party vendors, including data center, software as a service, cloud computing Internet infrastructure and bandwidth providers. Any disruption in the services provided by these third-party providers or any failure of these third-party providers to handle current or higher volumes of use could significantly harm our business. Any financial or other difficulties our providers face may have negative effects on our business, the nature and extent of which we cannot predict. We exercise little control over these third-party vendors, which increases our vulnerability to problems with the services they provide. We have experienced and expect to continue to experience interruptions and delays in service and availability for such elements. Any errors, failures, interruptions or delays experienced in connection with these third-party technologies and information services could negatively impact our relationship with our clients and adversely affect our brand and our business and could expose us to liabilities to third parties.

 

 
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Rapid technological changes may render our lead generation and conversion solutions obsolete or decrease the attractiveness of our solutions to our clients.

 

To remain competitive, we must continue to enhance and improve the functionality and features of our technology platform. The Internet, access to the Internet and the online marketing and advertising industry are rapidly changing. Our competitors are constantly developing new products and services in online marketing and advertising. As a result, we must continue to invest significant resources in order to enhance our existing products and services and introduce new products and services that clients can easily and effectively use. If competitors introduce new solutions embodying new technologies, or if new industry practices emerge, our existing technology may become obsolete. Our future success will depend on our ability to:

 

 

enhance our existing solutions;

 

 

develop new solutions and technologies that address the increasingly sophisticated and varied needs of our prospective clients; and

 

 

respond to technological advances and emerging industry practices on a cost-effective and timely basis.

 

Developing our online marketing and reporting solutions and the underlying technology entail significant technical and business risks. We may use new technologies ineffectively, or we may fail to adapt our technology platform and network infrastructure to client requirements or emerging industry practices. If we face material delays in introducing new or enhanced solutions, our clients may forego the use of our solutions in favor of those of our competitors.

 

Future acquisitions could disrupt our business and harm our financial condition and operating results.

 

Our success will depend, in part, on our ability to expand our offerings and markets and grow our business in response to changing technologies, client demands and competitive pressures. In some circumstances we may determine to do so through the acquisition of complementary businesses, solutions or technologies rather than through internal development. The identification of suitable acquisition candidates can be difficult, time-consuming and costly, and we may not be able to successfully complete identified acquisitions. Furthermore, even if we successfully complete an acquisition, we may not be able to successfully assimilate and integrate the business, technologies, solutions, personnel or operations of the company that we acquired, particularly if key personnel of an acquired company decide not to work for us. We may also inherit liability for activities of the acquired company before the acquisition, including violations of laws, rules and regulations, intellectual property disputes, commercial disputes, tax liabilities and other known and unknown liabilities. In addition, we may borrow to complete an acquisition, which would increase our costs, or issue equity securities, which would dilute our stockholders’ ownership and could adversely affect the price of our common stock. Historically, we have primarily grown organically, rather than through acquisitions. As a result, we have somewhat limited experience in identifying and executing acquisition opportunities. Acquisitions may also involve the entry into geographic or business markets in which we have little or no prior experience. Consequently, we may not achieve anticipated benefits of the acquisitions which could harm our operating results.

 

We make strategic investments from time to time and if they are unsuccessful, it could harm our financial condition.

 

We have made strategic investments in the past, such as the market development loan to OxataSMB, a franchisee, and may make additional similar or different strategic investments in the future. Such investments may not prove profitable or successful for us and may result in the partial or total loss of our invested capital. For example, the OxataSMB operations did not perform as contemplated, and as a result, at December 31, 2013, the Company recorded a $3.3 million impairment of the OxataSMB loan receivable and related interest and a $1.6 million provision for bad debt related to a trade receivable from OxataSMB. In addition, strategic investments, such as with OxataSMB, may involve future commitments to provide further capital and we cannot assure you any such further investments will be desirable if, and when made, or will prove profitable over the long term.

 

 
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Our business is subject to the risks of earthquakes, fires, floods and other natural catastrophic events and to interruption by man-made problems such as computer viruses or terrorism.

 

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

 

If our security measures are breached and unauthorized access is obtained to a client’s data, our service may be perceived as not being secure and clients may curtail or stop using our service.

 

Our service involves the storage and transmission of clients’ proprietary information, such as credit card and bank account numbers, and security breaches could expose us to a risk of loss of this information, litigation and possible liability. Our payment services may be susceptible to credit card and other payment fraud schemes, including unauthorized use of credit cards, debit cards or bank account information, identity theft or merchant fraud.

 

If our security measures are breached in the future as a result of third-party action, employee error, malfeasance or otherwise, and as a result, someone obtains unauthorized access to our clients’ data, our reputation will be damaged, our business may suffer and we could incur significant liability. Because techniques used to obtain unauthorized access or to sabotage systems change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures. If an actual or perceived breach of our security occurs, the market perception of the effectiveness of our security measures could be harmed and we could lose sales and clients.

 

We provide services to clients in regulated industries (such as healthcare, financial and legal) in the United States and internationally. Clients in these regulated industries often have additional country-specific statutory and customer-specific contractual requirements. If we are not able to meet these changing requirements we could face litigation and could lose customers in those industries.

 

We are subject to a number of risks related to credit card payments we accept. If we fail to be in compliance with applicable credit card rules and regulations, we may incur additional fees, fines and ultimately, the revocation of the right to use the credit card company, which would have a material adverse effect on our business, financial condition or results of operations.

 

A majority of our clients’ campaigns were paid for using a credit card or debit card. For credit and debit card payments, we pay interchange and other fees, which may increase over time and raise our operating expenses and adversely affect our results of operations. We are also subject to payment card association operating rules, certification requirements and rules governing electronic funds transfers, which could change or be reinterpreted to make it difficult or impossible for us to comply. We believe we are compliant with the Payment Card Industry Data Security Standard, which incorporates Visa’s Cardholder Information Security Program, MasterCard’s Site Data Protection standard, and American Express' Data Security Operating Policy and Discover Information Security & Compliance (DISC) program. However, there is no guarantee that we will maintain such compliance or that compliance will prevent illegal or improper use of our payment system. If we fail to comply with these rules or requirements, we may be subject to fines and higher transaction fees and lose our ability to accept credit and debit card payments from our clients. A failure to adequately control fraudulent credit card transactions would result in significantly higher credit card-related costs and could have a material adverse effect on our business, financial condition or results of operations.

 

 
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Our revenue may be negatively affected if we are required to charge sales tax or other transaction taxes on all or a portion of our past and future sales to customers located in jurisdictions where we are currently not collecting and reporting tax.

 

We have not historically collected, or had imposed upon us, sales or other transaction taxes related to the products and services we sell, except for certain corporate level taxes and transaction level taxes outside of the United States. However, sales of our new ReachEdge product are taxable in many state, local, and foreign jurisdictions, of which one or more may seek to impose additional sales or other transaction tax obligations on us in the future. A successful assertion by any state, local jurisdiction or country in which we do business that we should be collecting sales or other transaction taxes on the sale of our products or services could result in substantial tax liabilities related to past sales, create increased administrative burdens or costs, discourage clients from purchasing products or services from us, decrease our ability to compete or otherwise substantially harm our business and results of operations. The imposition of new laws requiring the collection of sales or other transaction taxes on the sale of our products or services (or the introduction of new products or services that are subject to existing transaction taxes) could create increased administrative burdens or costs, discourage clients from purchasing products or services from us, decrease our ability to compete or otherwise substantially harm our business and results of operations.

 

The intended tax benefits of our corporate structure and intercompany arrangements depend on the application of the tax laws of various jurisdictions and on how we operate our business.

 

Our corporate structure and intercompany arrangements, including the manner in which we develop and use our intellectual property and the transfer pricing of our intercompany transactions, are intended to reduce our worldwide effective tax rate. The application of the tax laws of various jurisdictions, including the United States, to our international business activities is subject to interpretation and depends on our ability to operate our business in a manner consistent with our corporate structure and intercompany arrangements. The taxing authorities of the jurisdictions in which we operate may challenge our methodologies for valuing developed technology or intercompany arrangements, including our transfer pricing, or determine that the manner in which we operate our business does not achieve the intended tax consequences, which could increase our worldwide effective tax rate and harm our financial position and results of operations.

 

Our corporate structure includes legal entities located in jurisdictions with income tax rates lower than the U.S. statutory tax rate. Our intercompany arrangements allocate income to such entities in accordance with arm’s-length principles and commensurate with functions performed, risks assumed and ownership of valuable corporate assets. We believe that income taxed in certain foreign jurisdictions at a lower rate relative to the U.S. statutory rate will have a beneficial impact on our worldwide effective tax rate.

 

Significant judgment is required in evaluating our tax positions and determining our provision for income taxes. During the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain. For example, our effective tax rates could be adversely affected by earnings being lower than anticipated in countries where we have lower statutory rates and higher than anticipated in countries where we have higher statutory rates, by changes in foreign currency exchange rates or by changes in the relevant tax, accounting and other laws, regulations, principles and interpretations. As we operate in numerous taxing jurisdictions, the application of tax laws can be subject to diverging and sometimes conflicting interpretations by tax authorities of these jurisdictions. It is not uncommon for taxing authorities in different countries to have conflicting views, for instance, with respect to, among other things, the manner in which the arm’s length standard is applied for transfer pricing purposes, or with respect to the valuation of intellectual property. In addition, tax laws are dynamic and subject to change as new laws are passed and new interpretations of the law are issued or applied. In particular, there is uncertainty in relation to the U.S. tax legislation in terms of the future corporate tax rate but also in terms of the U.S. tax consequences of income derived from intellectual property related income earned overseas in low tax jurisdictions.

 

Our existing corporate structure and intercompany arrangements have been implemented in a manner we believe is in compliance with current prevailing tax laws. However, the tax benefits which we intend to eventually derive could be undermined if we are unable to adapt the manner in which we operate our business and due to changing tax laws.

 

Failure to adequately protect our intellectual property could substantially harm our business and operating results.

 

Because our business is heavily dependent on our intellectual property, including our proprietary technology, the protection of our intellectual property rights is crucial to the success of our business. We rely on a combination of intellectual property rights, including trade secrets, patent applications, copyrights and trademarks, as well as contractual restrictions, to safeguard our intellectual property. These afford only limited protection. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our online marketing and reporting solutions, technology, software and functionality or obtain and use information that we consider proprietary. Moreover, policing our proprietary rights is difficult and may not always be effective. In particular, because we sell our solutions internationally, we may need to enforce our rights under the laws of countries that do not protect proprietary rights to as great an extent as do the laws of the United States.

 

Our proprietary technology is not currently protected by any issued patents, and policing our rights to such technology may be hindered if we are unable to obtain any patents. In addition, the type and extent of patent claims that may be issued to us in the future is uncertain, and any patents that are issued may not contain claims that permit us to stop competitors from using similar technology. In light of the costs of obtaining patent protection, at times we may choose not to protect certain innovations that later on prove to be highly important. To the extent that the various technologies underlying any patent applications are determined to be business methods, the law around these types of patents is rapidly developing, and pending changes may impact our ability to protect our technology and proprietary use thereof through patents.

 

 
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We have registered ReachLocal and other trademarks as trademarks in the United States and in certain other countries. Some of our trade names are not eligible to receive trademark protection. Also, trademark protection may not be available, or sought by us, in every country in which our technology and products are available online. Competitors may adopt service names similar to ours, or purchase our trademarks and confusingly similar terms as keywords in Internet search engine advertising programs, thereby impeding our ability to build brand identity and possibly leading to client confusion. In addition, there could be potential trade name or trademark infringement claims brought by owners of other registered trademarks or trademarks that incorporate variations of the term ReachLocal or our other trademarks.

 

Litigation or proceedings before the U.S. Patent and Trademark Office or other governmental authorities and administrative bodies in the United States and abroad may be necessary in the future to enforce our intellectual property rights, to protect our patent rights, trade secrets and domain names and to determine the validity and scope of the proprietary rights of others. Our efforts to enforce or protect our proprietary rights may be ineffective and could result in substantial costs and diversion of resources and could substantially harm our operating results.

 

Confidentiality agreements with employees and others may not adequately prevent disclosure of trade secrets and other proprietary information.

 

In order to protect our proprietary technology and processes, we rely in part on confidentiality agreements with our employees, licensees, independent contractors and other advisors. These agreements may not effectively prevent disclosure of confidential information and may not provide an adequate remedy in the event of unauthorized disclosure of confidential information. In addition, others may independently discover trade secrets and proprietary information, and in such cases, we could not assert any trade secret rights against such parties. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could adversely affect our competitive business position. 

  

Assertions by third parties of infringement by us of their intellectual property rights could result in significant costs and substantially harm our business and operating results.

 

Companies in the Internet, technology and media industries own large numbers of patents, copyrights, trademarks and trade secrets and frequently litigate or threaten litigation based on allegations of infringement or other violations of intellectual property rights. Other parties have asserted, and may in the future assert, that we have infringed their intellectual property rights. These types of litigations may involve patent holding companies or other adverse patent owners who have no relevant product revenue, and therefore our own issued and pending patents, if any, may provide little or no deterrence. In addition, we have been and could in the future become involved in disputes over the use of keywords by our clients, to the extent such clients’ competitors allege the use of such keywords on our technology platform violates such competitors’ trademark rights. We cannot predict whether assertions of third-party intellectual property rights or claims arising from such assertions will substantially harm our business and operating results. If we are forced to defend against any infringement claims, whether they are with or without merit or are determined in our favor, we may face costly litigation and diversion of technical and management personnel. Furthermore, an adverse outcome of a dispute may require us to pay damages, potentially including treble damages and attorneys’ fees, if we are found to have willfully infringed a party’s patent or copyright rights; cease making, licensing or using solutions that are alleged to incorporate the intellectual property of others; expend additional development resources to redesign our solutions; and enter into potentially unfavorable royalty or license agreements in order to obtain the right to use necessary technologies. Royalty or licensing agreements, if required, may be unavailable on terms acceptable to us, or at all. Over time, we expect that we will increasingly be subject to infringement claims as the number of competitors in our industry segment grows or as our presence and visibility within the industry increases.

 

We could lose clients if we or our media partners fail to detect click-through or other fraud on advertisements in a manner that is acceptable to our clients.

 

We are exposed to the risk of fraudulent clicks or actions on our third-party publishers’ websites. We may lose clients, or in the future, we may have to refund revenue that our clients have paid to us and that was later attributed to, or suspected to be caused by, click-through fraud. Click-through fraud occurs when an individual clicks on an ad displayed on a website or an automated system is used to create such clicks with little to no intent of viewing the underlying content. If fraudulent clicks are not detected, the affected clients may become dissatisfied with our campaigns, which in turn may lead to loss of clients and the related revenue.

 

 
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Our business is subject to complex and evolving U.S. and foreign laws and regulations regarding privacy, data protection, and other matters. Many of these laws and regulations are subject to change and uncertain interpretation, and could result in claims, changes to our business practices, increased cost of operations, or otherwise harm our business.

 

We are subject to a variety of laws and regulations in the United States and abroad that involve matters central to our business, including user privacy, rights of publicity, data protection, content, intellectual property, distribution, electronic contracts and other communications, competition, protection of minors, consumer protection, taxation, and online payment services. Foreign data protection, privacy, and other laws and regulations are often more restrictive than those in the United States. These U.S. federal and state and foreign laws and regulations are constantly evolving and can be subject to significant change. In addition, the application and interpretation of these laws and regulations are often uncertain. These laws and regulations could have a significant impact on online advertising services depending on how these laws and regulations are interpreted and enforced.  It is also clear that the laws and regulations are intending to regulate behavioral targeting, the availability of which could become highly limited are eliminated entirely.  Our product suite does not rely heavily on the use of behavioral targeting, but we do offer a display remarketing product, which involves showing a consumer an ad for the website of a client that the consumer has previously visited.

 

In addition, a number of proposals are pending before federal, state, and foreign legislative and regulatory bodies that could significantly affect our business. For example, a revision to the 1995 European Union Data Protection Directive is currently being considered by European legislative bodies that may include more stringent operational requirements for data processors and significant penalties for non-compliance. Similarly, there have been a number of recent legislative proposals in the United States, at both the federal and state level, that would impose new obligations in areas such as privacy, data protection and data breach notifications.  Some of the proposed changes to U.S. and European law could require that we obtain prior consent before using cookies or other tracking technologies or provide a “do not track” mechanism  in certain circumstances. These existing and proposed laws and regulations can be costly to comply with and can delay or impede the development of new products, result in negative publicity, increase our operating costs, require significant management time and attention, and subject us to claims or other remedies, including fines or demands that we modify or cease existing business practices.

 

We process, store and use personal information and other data, which subjects us to governmental regulation and other legal obligations related to privacy. Our actual or perceived failure to comply with such obligations could harm our business.

 

We receive, store and process personal information and other user data, including credit card information for certain users. There are numerous federal, state and local laws around the world regarding privacy and the storing, sharing, use, processing, disclosure and protection of personal information and other user data, the scope of which are changing, subject to differing interpretations, and may be inconsistent between countries or conflict with other rules. It is possible that these obligations may be interpreted and applied in a manner that is inconsistent from one jurisdiction to another and may conflict with other rules or our practices. Any failure or perceived failure by us to comply with our privacy policies, our privacy-related obligations to users or other third parties, or our privacy-related legal obligations, or any compromise of security that results in the unauthorized release or transfer of personally identifiable information or other user data, may result in governmental enforcement actions, litigation or negative publicity and could cause our clients to lose trust in us, which could have an adverse effect on our business. Additionally, if third parties with whom we work, such as our publishers or our providers of telephony services, violate applicable laws or our policies, such violations may also put our users’ information at risk and could have an adverse effect on our business.

  

 Some of our services may utilize “open source” software, and any failure to comply with the terms of one or more of these open source licenses could negatively affect our business.

 

Some of our services may utilize software licensed by its authors or other third parties under so-called “open source” licenses, including, but not limited to, the GNU General Public License and the GNU Lesser General Public License. Some of those licenses may require that we make available source code for modifications or derivative works we create using the open source software, that we provide notices with our products and that we license any modifications or derivative works under an open source license or rights of further use to third parties. If we combine our proprietary software with open source software, we could be required to release the source code of our proprietary software. Although we take steps to ensure that our software engineers properly isolate our proprietary software they design from open source software components, we may not control the product development efforts of our engineers and we cannot be certain that they have not inappropriately incorporated open source software into our proprietary technologies. If an author or other third party that distributes open source software were to obtain a judgment against us based on allegations that we had not complied with the terms of any applicable open source license, we could be subject to liability for copyright infringement damages and breach of contract. In addition, we could be enjoined from selling our services that contained the open source software and required to make the source code for the open source software available, to grant third parties certain rights of further use of our software or to remove the open source software from our services, which could disrupt our distribution and sale of some of our services.

 

 
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Government regulation of the Internet is evolving, and unfavorable changes could substantially harm our business and operating results.

 

We are subject to general business regulations and laws as well as regulations and laws specifically governing the Internet. Existing and future laws and regulations may impede the growth in use of the Internet and online services. The application of existing laws to the Internet and online services governing issues such as property ownership, sales and other taxes, libel and personal privacy has not yet been settled. Unfavorable resolution of these issues may substantially harm our business and operating results. Other laws and regulations that have been adopted, or may be adopted in the future, that may affect our business include those covering user privacy, data protection, spyware, “do not email” lists, access to high speed and broadband service, pricing, taxation, tariffs, patents, copyrights, trademarks, trade secrets, export of encryption technology, electronic contracting, click-fraud, acceptable content, search terms, lead generation, behavioral targeting, consumer protection, and quality of products and services. Any changes in regulations or laws that hinder growth of the Internet generally or that decrease the acceptance of the Internet as a communications, commercial and advertising medium could adversely affect our business. See also Part 1, Item 1A, “Risk Factors—Our business is subject to complex and evolving U.S. and foreign laws and regulations regarding privacy, data protection, and other matters. Many of these laws and regulations are subject to change and uncertain interpretation, and could result in claims, changes to our business practices, increased cost of operations, or otherwise harm our business.”

 

Risks Related to Owning Our Common Stock

 

Our stock price may be volatile, and the value of an investment in our common stock may decline.

 

Shares of our common stock were sold in our initial public offering in May 19, 2010 at a price of $13.00 per share, and our common stock has subsequently traded as high as $28.39 and as low as $2.98. An active, liquid and orderly market for our common stock may not be sustained, which could depress the trading price of our common stock. The trading price of our common stock may be subject to wide fluctuations in response to various factors, some of which are beyond our control, including:

 

 

our operating performance and the operating performance of similar companies;

 

 

the overall performance of the equity markets;

  

 

the number of shares of our common stock publicly owned and available for trading;

 

 

changes in the amounts and frequency of share repurchases;

   

 

threatened or actual litigation;

 

 

changes in laws or regulations relating to our solutions;

 

 

any major change in our board of directors or management;

 

 

publication of research reports about us or our industry or changes in recommendations or withdrawal of research coverage by securities analysts;

 

 

large volumes of sales of our shares of common stock by existing stockholders; and

 

 

general political and economic conditions.

 

 
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In addition, the stock market in general, and the market for Internet-related companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Securities class action litigation has often been instituted against companies following periods of volatility in the overall market and in the market price of a company’s securities. This litigation, if instituted against us, could result in very substantial costs, divert our management’s attention and resources and harm our business, operating results and financial condition. In addition, the recent distress in the financial markets has also resulted in extreme volatility in security prices.

 

Future sales of shares of our common stock by stockholders could depress the price of our common stock.

 

As of March 6, 2015, approximately 55% of our common stock is held by our directors, officers and entities affiliated with our directors, including approximately 43% beneficially owned by VantagePoint Capital Partners and approximately 9.5% beneficially owned by Rho Ventures. In addition, these percentages may increase if we repurchase shares of our common stock pursuant to our $47 million share repurchase program, of which approximately $10.7 million was available for repurchase as of February 27, 2015 (see Part II, Item 5, “Common Stock Repurchases”). Such shares have not been subject to lock-up agreements since November 2010. VantagePoint and Rho Ventures were our two primary venture capital investors and have owned their shares for a considerable length of time. If either VantagePoint or Rho Ventures decides to exit its investment in us, it could negatively impact the price of our common stock. During February and March of 2014, Rho Ventures sold an aggregate of approximately 187,000 shares of our common stock.

 

If there are substantial sales of our common stock in the public market, the trading price of our common stock could decline significantly. In addition, as of December 31, 2014, approximately 6.1 million shares subject to outstanding options and RSUs under our 2004 Stock Plan, our Amended and Restated 2008 Stock Incentive Plan and inducement awards, are potentially eligible for sale in the public market in the future. If these additional shares are sold, or if it is perceived that they will be sold, in the public market, the price of our common stock could decline substantially.

 

 If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.

 

The trading market for our common stock depends in part on the research and reports that securities or industry analysts publish about us or our business. If one or more of the analysts who cover us downgrade our stock or publish inaccurate or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, demand for our stock could decrease, which might cause our stock price and trading volume to decline.

   

Investment funds managed by VantagePoint Capital Partners own a substantial amount of our stock and have significant influence over our business. In the aggregate, insiders own a majority of our outstanding stock.

 

As of March 6, 2015, VantagePoint Capital Partners, one of our early venture capital investors, beneficially owned approximately 43% of our outstanding common stock. As a result, VantagePoint has significant influence over the outcome of matters submitted to our stockholders for approval, including the election of directors. VantagePoint’s significant ownership also could affect the market price of our common stock by, for example, delaying, deferring or preventing a change in corporate control, impeding a merger, consolidation, takeover or other business combination involving us, or discouraging a potential acquiror from making a tender offer or otherwise attempting to obtain control of us. Alan Salzman, the Chief Executive Officer of Vantage Point, serves as a member of our board of directors.

 

As of March 6, 2015, our current directors and executive officers as a group beneficially owned approximately 55% of our outstanding common stock (including all shares issuable with respect to options held by such holders).

 

 
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Certain provisions in our charter documents and Delaware law could discourage takeover attempts and lead to management entrenchment.

 

Our certificate of incorporation and bylaws contain provisions that could have the effect of delaying or preventing changes in control or changes in our management without the consent of our board of directors, including, among other things:

 

 

a classified board of directors with three-year staggered terms, which may delay the ability of stockholders to change the membership of a majority of our board of directors;

 

 

no cumulative voting in the election of directors, which limits the ability of minority stockholders to elect director candidates;

 

 

the ability of our board of directors to determine to issue shares of preferred stock and to determine the price and other terms of those shares, including preferences and voting rights, without stockholder approval, which could be used to significantly dilute the ownership of a hostile acquirer;

 

 

the exclusive right of our board of directors to elect a director to fill a vacancy created by the expansion of our board of directors or the resignation, death or removal of a director, which prevents stockholders from being able to fill vacancies on our board of directors;

 

 

a prohibition on stockholder action by written consent, which forces stockholder action to be taken at an annual or special meeting of our stockholders;

 

 

the requirement that a special meeting of stockholders may be called only by the chairman of our board of directors, the Chief Executive Officer, the president (in absence of a Chief Executive Officer) or our board of directors, which may delay the ability of our stockholders to force consideration of a proposal or to take action, including the removal of directors;

 

 

the requirement for the affirmative vote of holders of at least 66 2/3% of the voting power of all of the then outstanding shares of the voting stock, voting together as a single class, to amend the provisions of our certificate of incorporation relating to the issuance of preferred stock and management of our business or our bylaws, which may inhibit the ability of an acquiror from amending our certificate of incorporation or bylaws to facilitate a hostile acquisition;

 

 

the ability of our board of directors, by majority vote, to amend the bylaws, which may allow our board of directors to take additional actions to prevent a hostile acquisition and inhibit the ability of an acquiror from amending the bylaws to facilitate a hostile acquisition; and

 

 

advance notice procedures that stockholders must comply with in order to nominate candidates to our board of directors or to propose matters to be acted upon at a stockholders’ meeting, which may discourage or deter a potential acquiror from conducting a solicitation of proxies to elect the acquiror’s own slate of directors or otherwise attempting to obtain control of us.

   

We are also subject to certain anti-takeover provisions under Delaware law. Under Delaware law, a corporation may not, in general, engage in a business combination with any holder of 15% or more of its capital stock unless the holder has held the stock for three years or, among other things, our board of directors has approved the transaction.

 

Item 1B. Unresolved Staff Comments.

 

None.

 

Item 2. Properties.

 

We do not own any real estate. We lease 38,592 square feet and 90,000 square feet for our corporate and sales offices in Woodland Hills, California, and in Plano, Texas, respectively. We also have over 50 leases for sales offices, support facilities and data centers in other locations in North America and overseas.

 

Item 3. Legal Proceedings.

 

On May 2, 2014, a lawsuit, purporting to be a class action, was filed by one of our former clients in the United States District Court in Los Angeles. The complaint alleges breach of contract, breach of the implied covenant of good faith and fair dealing, and violation of California’s unfair competition law. The complaint seeks monetary damages, restitution and attorneys’ fees. We filed a motion to dismiss on June 20, 2014, which was denied on December 4, 2014. While the case is at an early stage, we believe that the case is substantively and procedurally without merit. Our insurance carrier is providing us with a defense under a reservation of rights.

 

 
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From time to time, we are involved in legal proceedings arising in the ordinary course of our business. Over the past 18 months we have been involved in disputes with former customers in the United Kingdom, which allege that the Company was not fully transparent in its pricing.

 

We believe that there is no litigation pending that is likely to have a material adverse effect on our financial position, results of operations or cash flows. 

 

Item 4. Mine Safety Disclosures.

 

Not applicable.  

 

 
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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

Our common stock has been traded on The NASDAQ Global Select Market since May 20, 2010 under the symbol “RLOC.” The following table sets forth the high and low sales prices for our common stock as reported by The NASDAQ Global Select Market for the period indicated.

 

   

2013

   

2014

 
   

High

   

Low

   

High

   

Low

 

First quarter

  $ 15.08     $ 11.76     $ 14.27     $ 9.70  

Second quarter

  $ 17.39     $ 12.05     $ 10.59     $ 5.87  

Third quarter

  $ 14.45     $ 10.27     $ 7.65     $ 3.60  

Fourth quarter

  $ 13.15     $ 11.41     $ 4.67     $ 3.08  

 

At March 6, 2015, we had 27 stockholders of record of our common stock. We have never declared or paid, and do not anticipate declaring or paying, any cash dividends on our common stock. Any future determination as to the declaration and payment of dividends, and share repurchases, if any, will be at the discretion of our board of directors and will depend on then existing conditions, including our financial condition, operating results, contractual restrictions, capital requirements, business prospects and other factors our board of directors may deem relevant.

 

Stock Price Performance Graph

 

This performance graph shall not be deemed “soliciting material” or to be “filed” with the Securities and Exchange Commission for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of ReachLocal, Inc. under the Securities Act or the Exchange Act.

 

 
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The following graph compares, for the period from May 20, 2010 through December 31, 2014, the total cumulative stockholder return on our common stock with the total cumulative return of the NASDAQ Composite Index and the RDG Internet Composite Index. The graph assumes a $100 investment at the beginning of the period in our common stock, the stocks represented in the NASDAQ Composite Index and the stocks represented in the RDG Internet Composite Index, and reinvestment of any dividends. Historical stock price performance should not be relied upon as an indication of future stock price performance:

 

 *$100 invested on 5/20/10 in stock or 4/30/10 in index, including reinvestment of dividends.

 

   

5/20/10

   

6/10

   

12/10

   

6/11

   

12/11

   

6/12

   

12/12

   

6/13

   

12/13

   

6/14

   

12/14

 
                                                                                         

ReachLocal, Inc.

    100.00       86.58       132.91       139.05       41.26       73.43       86.18       81.84       84.85       46.93       22.96  

NASDAQ Composite

    100.00       86.58       108.81       114.36       109.81       123.97       128.60       146.81       182.09       192.59       206.99  

RDG Internet Composite

    100.00       85.37       120.67       126.27       122.58       132.76       147.00       170.99       239.78       236.28       234.60  

 

Recent Sales of Unregistered Securities

 

On February 8, 2011, we agreed to issue up to 21,297 shares of common stock as partial deferred consideration for the acquisition of DealOn, LLC, and on February 8, 2012, August 8, 2012 and February 8, 2013, we issued 10,649, 5,324 and 5,324, respectively, of such shares of our common stock.

 

On February 22, 2010, we agreed to issue up to 364,632 shares of common stock as partial deferred consideration for the acquisition of SMB:LIVE Corporation, and on February 22, 2011, August 22, 2011 and February 22, 2012, we issued 90,062, 93,346 and 181,224, respectively, of such shares of our common stock.

 

 
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Common Stock Repurchases

 

On November 4, 2011, we announced that our Board of Directors authorized the repurchase of up to $20.0 million of our outstanding common stock.  On December 13, 2012, we announced that our Board of Directors increased our share repurchase program by $6.0 million, and on March 4, 2013, we announced that our Board of Directors increased our share repurchase program by an additional $21.0 million, to a total authorization of $47.0 million. At December 31, 2014, we had executed repurchases of $36.3 million of our common stock under the program. There were no repurchases during the year ended December 31, 2014. Purchases may be made from time-to-time in open market or privately negotiated transactions as determined by our management. The amount and timing of the share repurchase will depend on business and market conditions, stock price, trading restrictions, acquisition activity, and other factors. The share repurchase program does not obligate us to acquire any particular amount of common stock, and the repurchase program may be suspended or discontinued at any time at our discretion.

 

The Company is also deemed to repurchase common stock surrendered by participants to cover tax withholding obligations with respect to the vesting of restricted stock and restricted stock units.

  

Item 6. Selected Financial Data.

 

The data set forth below are qualified in their entirety by reference to, and should be read in conjunction with Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements, related notes and other financial information included elsewhere in this report. The consolidated statements of operations data for the years ended December 31, 2014, 2013 and 2012 and the consolidated balance sheet data as of December 31, 2014 and 2013 are derived from our audited consolidated financial statements included elsewhere in this report. The consolidated statements of operations data for the years ended December 31, 2011 and 2010 and the consolidated balance sheet data as of December 31, 2012, 2011 and 2010 are derived from our audited consolidated financial statements not included in this report. In addition, as a result of the disposal of our ClubLocal business and the winding down of the operations of Bizzy, we have reclassified and presented all related historical financial information as “discontinued operations” in the accompanying Consolidated Balance Sheets, Consolidated Statements of Operations and Consolidated Statements of Cash Flows. Historical results are not necessarily indicative of the results to be expected in the future.

  

   

Years Ended December 31,

 
   

2014

   

2013

   

2012

   

2011

   

2010

 

(in thousands, except per share data)

                                       

Consolidated Statements of Operations:

                                       

Revenue

  $ 474,921     $ 514,070     $ 454,957     $ 375,241     $ 291,689  

Cost of revenue (1)

    252,721       256,450       226,482       190,559       159,018  

Operating expenses:

                                       

Selling and marketing (1)

    182,720       182,854       164,168       139,929       108,529  

Product and technology (1)

    27,510       22,240       18,980       15,602       9,957  

General and administrative (1)

    52,155       46,362       40,378       33,470       23,880  

Restructuring charges

    5,927                          

Total operating expenses

    268,312       251,456       223,526       189,001       142,366  

Operating income (loss)

    (46,112

)

    6,164       4,949       (4,319

)

    (9,695

)

Other income (expense), net

    936       586       556       928       601  

Income (loss) from continuing operations before income taxes

    (45,176

)

    6,750       5,505       (3,391

)

    (9,094

)

Income tax provision (benefit)

    484       3,699       1,340       735       (540

)

Income (loss) from continuing operations

    (45,660

)

    3,051       4,165       (4,126

)

    (8,554

)

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

    650       (5,534

)

    (4,397

)

    (6,215

)

    (2,844

)

Net loss

  $ (45,010

)

  $ (2,483

)

  $ (232

)

  $ (10,341

)

  $ (11,398

)

                                         

Net income (loss) per share:

                                       
                                         

Basic:

                                       

Income (loss) from continuing operations

  $ (1.60

)

  $ 0.11     $ 0.15     $ (0.14

)

  $ (0.43

)

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

    0.02       (0.20

)

    (0.16

)

    (0.22

)

    (0.14

)

Net loss per share (2)

  $ (1.58

)

  $ (0.09

)

  $ (0.01

)

  $ (0.36

)

  $ (0.57

)

                                         

Diluted:

                                       

Income (loss) from continuing operations

  $ (1.60

)

  $ 0.11     $ 0.14     $ (0.14

)

  $ (0.43

)

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

    0.02       (0.20

)

    (0.15

)

    (0.22

)

    (0.14

)

Net loss per share (2)

  $ (1.58

)

  $ (0.09

)

  $ (0.01

)

  $ (0.36

)

  $ (0.57

)

                                         

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

                                       

Basic

    28,461       27,764       28,348       28,974       19,867  

Diluted

    28,461       29,051       28,896       28,974       19,867  

 _____________

(1) 

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

  

 
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Years Ended December 31,

 
   

2014

   

2013

   

2012

   

2011

   

2010

 

Stock-based compensation:

                                       

Cost of revenue

  $ 932     $ 697     $ 258     $ 200     $ 244  

Selling and marketing

    2,959       3,040       1,756       1,402       1,202  

Product and technology

    825       627       1,194       1,387       1,104  

General and administrative

    8,544       7,141       6,261       5,549       3,374  
    $ 13,260     $ 11,505     $ 9,469     $ 8,538     $ 5,924  

 

   

Years Ended December 31,

 
   

2014

   

2013

   

2012

   

2011

   

2010

 

Depreciation and amortization:

                                       

Cost of revenue

  $ 674     $ 761     $ 706     $ 645     $ 364  

Selling and marketing

    3,041       2,925       2,418       1,443       1,038  

Product and technology

    11,730       10,214       8,924       6,764       3,822  

General and administrative

    1,949       1,196       1,554       1,422       1,078  
    $ 17,394     $ 15,096     $ 13,602     $ 10,274     $ 6,302  

 

   

December 31,

 
   

2014

   

2013

   

2012

   

2011

   

2010

 

(in thousands)

                                       

Consolidated Balance Sheet Data:

                                       

Cash, cash equivalents and short-term investments

  $ 44,624     $ 77,774     $ 95,469     $ 85,169     $ 88,114  

Working capital

  $ (44,760

)

  $ (2,792

)

  $ 11,513     $ 17,524     $ 27,082  

Total assets

  $ 173,070     $ 186,009     $ 185,696     $ 166,437     $ 151,399  

Total capital leases

  $ 1,727     $     $     $     $  

Total liabilities

  $ 120,146     $ 107,641     $ 103,810     $ 84,150     $ 69,383  

Total stockholders’ equity

  $ 52,924     $ 78,368     $ 81,886     $ 82,287     $ 82,016  

  

   

Year Ended December 31,

 
   

2014

   

2013

   

2012

   

2011

   

2010

 

(in thousands)

                                       

Other Financial Data:

                                       

Net cash provided by (used in) operating activities

  $ (2,318

)

  $ 26,686     $ 42,343     $ 18,522     $ 17,675  

Capital expenditures (3)

  $ 25,735     $ 19,748     $ 15,013     $ 11,974     $ 8,526  

Non-GAAP Financial Measures:

                                       

Adjusted EBITDA (4)

  $ (9,410

)

  $ 32,801     $ 28,052     $ 15,915     $ 3,133  

 

 
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December 31,

 
   

2014

   

2013

   

2012

   

2011

   

2010

 

Other Operational Data:

                                       

Active Clients (5)

    20,800       23,900       22,000       19,100       16,900  

Active Product Units (6)

    31,400       35,200       32,500       27,500       22,700  

 

______________

(2) 

See Note 2 to our consolidated financial statements for an explanation of the method used to calculate basic and diluted net income per share of common stock.

(3)

Represents purchases of property and equipment and the amount of software development costs capitalized, in aggregate, excluding capital expenditures related to the discontinued operations of Bizzy and ClubLocal.

(4)

See Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Non-GAAP Financial Measures” for our definition of Adjusted EBITDA, why we present it and for a reconciliation of our Adjusted EBITDA to loss from operations for the years ended December 31, 2014, 2013 and 2012.

(5)

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

(6)

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

 

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

 

You should read the following discussion together with Part II, Item 6, “Selected Financial Data” and our consolidated financial statements and the related notes included elsewhere in this Annual Report. This discussion contains forward-looking statements about our business and operations. Our actual results may differ materially from those we currently anticipate as a result of many factors, including those we describe in Part I, Item 1A, “Risk Factors” and elsewhere in this Annual Report. See Part I, “Cautionary Notice Regarding Forward-Looking Statements.”

 

Overview

 

ReachLocal’s mission is to provide more customers to businesses around the world. We began in 2004 with the goal of helping local businesses move their advertising spend from traditional media and yellow pages to online search. While we have sold to a variety of local businesses and will continue to do so, our present focus is on small to medium-sized businesses (SMBs) and in particular, what we refer to as Premium SMBs. A Premium SMB generally has 10 to 30 employees, $1 to $10 million in annual revenue and spends approximately $40,000 annually on marketing. Premium SMBs have become increasingly sophisticated in their understanding of online marketing. However, we believe that Premium SMBs have not changed their desire for a single, unified solution to their marketing needs. Our goal is to provide a total digital marketing solution that will address the bulk of Premium SMBs’ online marketing needs. Our total digital marketing solution consists of products and solutions in three categories: software (ReachEdge™ and Kickserv™), digital advertising (including ReachSearch™, ReachDisplay™ and ReachRetargeting™), and web presence (including ReachSite + ReachEdge™, ReachSEO™, ReachCast™ and TotalLiveChat™).

 

We began by offering online advertising solutions with the rollout of ReachSearch in 2005, when we pioneered the provisioning of search engine marketing services (SEM) on a mass scale for SMBs through the use of our technology platform. ReachSearch combines search engine marketing optimized across multiple publishers, call tracking and call recording services, and industry leading campaign performance transparency. ReachSearch remains a leading SEM offering for local businesses and has won numerous awards since its rollout. However, ReachSearch does not solve all of the online advertising challenges of our local business clients. We have therefore added additional elements to our platform including our display product, ReachDisplay, our behavioral targeting product, ReachRetargeting, and other products that are primarily focused on leveraging third-party media to drive leads to our clients.

 

To complement our online digital advertising solutions, we have also launched a number of presence solutions. These solutions include websites, social, search engine optimization (SEO), chat and other products and solutions, all focused on expanding and leveraging our clients’ web presence. Often these products are designed to work in concert with our digital advertising products with a goal of enhancing the return to our clients.

 

We also recognize that even successfully driving leads to our clients does not represent a complete solution to local businesses’ online marketing needs. To better respond to our clients’ online marketing needs, we expanded into lead conversion software with the introduction of ReachEdge. The launch of ReachEdge in 2013 was our first step to move beyond being a media-driven lead generation business to offer integrated solutions for our clients. ReachEdge is marketing automation and lead conversion software designed to enhance lead tracking and conversion, and includes tools for capturing web traffic information and converting leads into new customers for our clients. Initially, ReachEdge only came bundled with a responsive website. However, beginning in the first quarter of 2015, clients have been able to license ReachEdge’s lead conversion software without having to also purchase a website. ReachEdge now refers only to the lead conversion software and ReachSite + ReachEdge refers to the combination of ReachEdge with a responsive website. We believe that this disaggregation of the solution will enable us to expand the market opportunity by enabling us to sell ReachEdge to those who do not need a new website.

  

Over time, we plan to add additional dynamic optimization functionality to ReachEdge, as well as features that create a more seamless relationship between our clients and their customers. For instance, in the fourth quarter of 2014, we acquired Kickserv, a provider of cloud-based business management software for service businesses. With this addition, we now have the ability to provide an end-to-end solution to our clients that starts with lead generation (ReachSearch, ReachDisplay and ReachSEO), includes lead conversion software (ReachEdge), and then closes and manages the business relationship (Kickserv). Local businesses already spend marketing dollars in these categories with a significant number of providers in a highly fragmented and confusing marketplace. Our integrated total marketing solution seeks to address this broad array of business needs with a simple integrated solution.

 

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

 

From 2013 through the beginning of 2014, we commenced a significant realignment of our sales force in North America into a hunter/farmer sales approach. Certain sales personnel dedicated to bringing in new clients, and others focused on servicing the clients and upselling and cross selling. However, in mid-2014, we concluded that this structure did not work and, we believe that our revenue decline in 2014 was largely attributable to the failure of this new sales structure. Accordingly, commencing in 2015, we are further refining the structure of our North American sales force to combine what we have determined to be the best elements of both our original sales model and the hunter/farmer model. Under this new model, our sales personnel (now called Digital Marketing Consultants or DMCs) will both generate the sale and manage the relationship. However, each DMC will be pared with a Marketing Expert (or ME) that will provide day-to-day campaign management. This approach will enable clients to have an ongoing relationship with their DMC, but with the support of the ME, the DMC will be able to focus on selling and managing relationships.

 

We have also continued to modify and refine our approach to inside sales (our dedicated telemarketing sales force). Our inside sales force was designed to expand our geographic reach while reducing selling costs. However, the performance of this sales force has not met our expectations and, as a result, in 2014 and thus far in 2015, we have reduced its size. With the expansion of our product suite, including our software products, we are continuing to explore opportunities to leverage inside sales techniques to address the needs of our target clients.

 

We have also historically focused on international expansion. Our first expansion was in Australia in 2006. We have subsequently entered Europe (the United Kingdom, Germany, the Netherlands and Austria), Japan, Brazil, Mexico and New Zealand. However, we intend to focus in 2015 on growing our operations in our existing large market locations including Germany, Brazil and Japan, which we believe present substantially larger market opportunities than Australia, currently our largest international market.

 

We also employ a separate sales channel targeting national brands, franchises and strategic accounts with operations in multiple local markets and select third-party agencies and resellers. We refer to this as our NBAR channel. The sales process for the NBAR channel typically has substantially longer lead times than in our Direct Local channel. In addition, national brand clients often involve complexity due to operational and marketing requirements that are not normally required by our Direct Local clients. Our third-party agencies and reseller partners use our technology platform in customer segments where they have sales forces with established relationships with their client bases. We currently have over 700 agencies and resellers actively selling on our technology platform. We have a team that is responsible for identifying potential agencies and resellers, training their sales forces to sell our products and services and supporting the relationships on an ongoing basis.

  

Operating Metrics

 

We regularly review a number of financial and operating metrics to evaluate our business, determine the allocation of resources and make decisions regarding business strategies.

 

The following table shows certain key operating metrics for the three years ended December 31, 2014, 2013 and 2012.

 

   

December 31,

 
   

2014

   

2013

   

2012

 

Active Clients (at period end) (1)

    20,800       23,900       22,000  

Active Product Units (at period end) (2)

    31,400       35,200       32,500  

 

(1)

See Part II, Item 6, “Selected Financial Data” for our definition of Active Clients.

 

(2)

See Part II, Item 6, “Selected Financial Data” for our definition of Active Product Units.

   

Active Clients and Active Product Units

 

We track the number of Active Clients and Active Product Units to evaluate the growth, scale and diversification of our business. We also use these metrics to determine the needs and capacity of our sales forces, our support organization and other personnel and resources. Active Clients and Active Product Units decreased in 2014 as a result of decreased new customer acquisitions due to lower sales productivity and lower customer retention, which we believe are primarily attributable to the realignment of our North American Local sales force in the fourth quarter of 2013.

 

 
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 Basis of Presentation

 

Discontinued Operations

 

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

 

Sources of Revenue

 

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

 

We typically enter into multi-month agreements for the delivery of our products. Under our agreements, our Direct Local clients typically pay, in advance, a fixed fee on a monthly basis, which includes all charges for the included technology and any media services, management, third-party content and other costs and fees. We record these prepayments as deferred revenue and only record revenue for income statement purposes as we purchase media and perform other services on behalf of clients. Certain Direct Local clients are extended credit privileges, with payment generally due in 30 days. Revenue from the licensing of our products is recognized on a straight line basis over the applicable license or service period. There were $3.2 million and $4.2 million of accounts receivable related to our Direct Local channel at December 31, 2014 and 2013, respectively.

 

Our National Brands, Agencies and Resellers clients enter into agreements of various lengths or that are indefinite. Our National Brands, Agencies and Resellers clients either pay in advance or are extended credit privileges with payment generally due in 30 to 60 days. There were $5.0 million and $4.6 million of accounts receivables related to our National Brands, Agencies and Resellers at December 31, 2014 and 2013, respectively.

 

Cost of Revenue

 

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

 

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

 

 
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Operating Expenses

 

Selling and Marketing. Selling and marketing expenses consist primarily of personnel and related expenses for our selling and marketing staff, including salaries and wages, commissions and other variable compensation, benefits, bonuses and stock-based compensation; travel and business costs; training, recruitment, marketing and promotional events; advertising; other brand building and product marketing expenses; and occupancy, technology and other direct overhead costs. A portion of the compensation for employees in the sales organization is based on commissions. In addition, the cost of agency commissions is included in selling and marketing expenses. Generally, commissions are expensed as earned. However, commencing in 2014, we began paying commissions to certain sales people for the acquisition of new clients. Client contracts are generally not cancelable without a penalty, and we defer those commissions and amortize them over the initial contract term. 

  

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

 

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

 

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

 

Restructuring Charges. Restructuring charges consist of costs associated with the realignment and reorganization of our operations. Restructuring charges include employee termination costs, facility closure and relocation costs, and contract termination costs. The timing of associated cash payments is dependent upon the type of exit cost and can extend over a 12-month period or longer. We record liabilities related to restructuring charges in accrued restructuring in the consolidated balance sheet. See further discussion in Note 11 of the Notes to the Consolidated Financial Statements.

 

Critical Accounting Policies and Estimates

 

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

 

We believe that the following critical accounting policies involve our more significant judgments, assumptions and estimates and, therefore, could have the greatest potential impact on our consolidated financial statements:

 

 

Accounts receivable

 

 

Software development costs

 

 

Loan receivables

 

 

• 

Investments in third parties

 

 

• 

Variable interest entities

 

 
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• 

Finite-lived intangible assets and other long-lived assets

   

 

• 

Goodwill

 

 

• 

Common stock repurchase and retirement

 

 

• 

Revenue recognition

 

 

• 

Restructuring charges

 

  Stock-based compensation

   

 

• 

Income taxes

 

 Accounts Receivable 

 

We perform ongoing credit evaluations of our customers and adjust credit limits based upon payment history, the customer’s creditworthiness and various other factors, as determined by our review of their credit information. We monitor collections and payments from our customers and maintain an allowance for estimated credit losses based on our historical experience and any customer-specific collection issues that we have identified.

 

Software Development Costs

 

Costs to develop software for internal use are capitalized when we have determined that the development efforts will result in new or additional functionality or new products. Costs incurred prior to meeting these criteria and costs associated with ongoing maintenance are expensed as incurred and included in product and technology expenses, in addition to amortization of capitalized software development costs, in the accompanying consolidated statements of operations. We monitor our existing capitalized software costs and reduce its carrying value as the result of releases that render previous features or functions obsolete or otherwise reduce the value of previously capitalized costs. Costs capitalized as internal use software are amortized on a straight-line basis over an estimated useful life of three years.

 

Loan Receivables

 

We record loan receivables at carrying value, net of potential allowance for losses. Losses on receivables are recorded when probable and estimable. Interest income on loan receivables is accrued on a monthly basis over the life of the loan, and interest recognition is suspended upon impairment of loan principal.

 

Investments in Third Parties

 

We account for investments in third parties under the cost method, which are periodically assessed for other-than-temporary impairment. The fair value of a cost method investment is not evaluated if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value of the investment. However, if a significant adverse event were identified, we would estimate the fair value of its cost method investment considering available information at the time of the event, such as current cash position, earnings and cash flow forecasts, recent operational performance and any other readily available data. If we determine that an other-than-temporary impairment has occurred, the investment is written-down to its fair value.

 

Variable Interest Entities

 

In accordance with Accounting Standards Codification (“ASC”) 810, Consolidations, the applicable accounting guidance for the consolidation of variable interest entities (“VIE”), we analyze our interests, including agreements, loans, guarantees, and equity investments, on a periodic basis to determine if such interests are variable interests. If variable interests are identified, then the related entity is assessed to determine if it is a VIE. Our analysis includes both quantitative and qualitative reviews. We base our quantitative analysis on the forecasted cash flows of the entity, and our qualitative analysis on the design of the entity, its organizational structure including its decision-making authority, and relevant agreements. If we determine that the entity is a VIE, we then assesses if we must consolidate the VIE as our primary beneficiary. Our determination of whether we are the primary beneficiary is based upon qualitative and quantitative analyses, which assess the purpose and design of the VIE, the nature of the VIE’s risks and the risks that we absorb, the power to direct activities that most significantly impact the economic performance of the VIE, and the obligation to absorb losses or the right to receive benefits that could be significant to the VIE.

 

 
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Finite-Lived Intangible Assets and Other Long-Lived Assets

 

Finite-lived intangible assets are attributable to the various developed technologies, trade names, and customer relationships of the businesses we have acquired. We report finite-lived, acquisition-related intangible assets at acquisition date fair value, net of accumulated amortization. Finite-lived intangible assets are amortized on a straight-line basis over their estimated useful lives, ranging from three to ten years. Straight-line amortization is used as another pattern over which the economic benefits will be consumed cannot be reliably determined. We review the carrying values of long-lived assets, including intangible assets, for possible impairment whenever events or changes in circumstances indicate that the related carrying amount may not be recoverable. In our analysis of other finite-lived amortizable intangible assets, we apply the guidance of ASC 350-20, Intangibles – Goodwill and Other, in determining whether any impairment conditions exist. An impairment review is performed whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Recoverability of an intangible asset is measured by comparing its carrying amount to the expected future undiscounted cash flows that the asset is expected to generate, if it is determined that an asset is not recoverable. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. Long-lived assets to be disposed of are reported at the lower of carrying amount or estimated fair value less cost to sell.

 

At December 31, 2014 and 2013, there were no indications of impairment of our finite-lived intangible assets or other long-lived assets.

 

Goodwill

 

Goodwill represents the excess of the purchase price of our acquired businesses over the fair value of the net tangible and intangible assets acquired. We account for goodwill in accordance with ASC 350, Intangibles—Goodwill and Other, which addresses financial accounting and reporting requirements for acquired goodwill. ASC 350 prohibits the amortization of goodwill and requires us to test goodwill at the reporting unit level for impairment at least annually.

 

We test the goodwill of our reporting units for impairment annually on the first day of the fourth quarter, and whenever events occur or circumstances change that would more likely than not indicate that the goodwill might be impaired. Events or circumstances which could trigger an impairment review include, but are not limited to, a significant adverse change in the legal or business climate, an adverse action or assessment by a regulator, unanticipated competition, a loss of key management or other personnel, significant changes in the manner of our use of the acquired assets or the strategy for the acquired business or our overall business, significant negative industry or economic trends, or significant underperformance relative to expected historical or projected future results of operations.

 

Testing goodwill for impairment involves a two-step quantitative process. However, prior to performing the two-step quantitative goodwill impairment test, we have the option to first assess qualitative factors to determine whether or not it is necessary to perform the two-step quantitative goodwill impairment test for selected reporting units. If we choose the qualitative option, we are not required to perform the two-step quantitative goodwill impairment test unless we have determined, based on the qualitative assessment, that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The first step of the impairment test involves comparing the estimated fair values of a reporting unit with its respective carrying amount, including goodwill. If the estimated fair value of a reporting unit exceeds its carrying amount, including goodwill, goodwill is considered not to be impaired and no additional steps are necessary. If, however, the estimated fair value of the reporting unit is less than its carrying amount, including goodwill, then the second step is performed to compare the carrying amount of the goodwill with its implied fair value, which is determined by deducting the aggregate fair value of the reporting unit's identifiable assets and liabilities from the fair value of the reporting unit. If the carrying amount of goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to the excess.         

 

The process of estimating the fair value of goodwill is subjective and requires us to make estimates that may significantly impact the outcome of the analyses. The estimated fair value for each reporting unit is determined using both an income-based valuation approach, as well as a market-based valuation approach. Under the income approach, each reporting unit’s fair value is estimated using the discounted cash flow method. The discounted cash flow method is dependent upon a number of factors, including projections of the amounts and timing of future revenues and cash flows, assumed discount rates determined to be commensurate with the risks inherent in its business model, and other assumptions. Under the market-based valuation approach, each reporting unit’s fair value is estimated based on industry multiples of revenues and operating earnings. The income-based approach is weighted between 50.0% and 66.7% depending on the amount and timing of projected operating earnings attributable to each reporting unit.

 

 
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We operate in one reportable segment, in accordance with ASC 280, Segment Reporting, which is the basis that financial results are regularly reviewed by our chief operating decision maker in deciding how to allocate resources and assess performance. We have identified our reporting units as North America, Asia Pacific, Latin America, and Europe. These reporting units each constitute a business or group of businesses for which discrete financial information is available and is regularly reviewed by each reporting unit’s management. Our goodwill is comprised of balances in both the North America and Asia Pacific reporting units.

 

Annual Goodwill Impairment Assessment

 

For the year-ended December 31, 2013, we performed a qualitative assessment and determined that it was more likely than not that there was no impairment of goodwill. For the year-ended December 31, 2014, as a result of the decline in operating results, the Company did not perform a qualitative assessment to determine whether it is more likely than not that goodwill is impaired, and performed the quantitative assessment. The first step of the quantitative goodwill impairment test resulted in the determination that the estimated fair values of the Company’s North America reporting unit substantially exceeded its carrying amount, including goodwill. Accordingly, the second step was not required.

 

The first step of the goodwill impairment test for the Asia Pacific reporting unit reflected that the fair value of the Asia Pacific reporting unit exceeded its carrying amount by approximately 18%. The amount of goodwill assigned to the Asia Pacific reporting unit at December 31, 2014 was $34.5 million. The inputs for the fair value calculations of the reporting unit included a conservative 3% growth rate to calculate the terminal value and a discount rate of 17%. In addition, we assumed revenue growth and applied margin and other cost assumptions consistent with the reporting unit's historical trends. Factors that have the potential to create variances in the estimated fair value of the Asia Pacific reporting unit include, but are not limited to, fluctuations in (i) number of clients and active campaigns, which can be driven by multiple external factors affecting demand, including macroeconomic factors, competitive dynamics and changes in consumer preferences; (ii) marketing costs to generate new campaigns; and (iii) equity valuations of peer companies. An increase of 100 basis points in the discount rate for the Asia Pacific reporting unit would have resulted in a decrease in the income approach valuation of the Asia Pacific reporting unit of $2.1 million. A decrease of 100 basis points in the terminal growth rate would have resulted in a decrease in the income approach valuation of the Asia Pacific reporting unit of $3.1 million. Neither a 100 basis point increase in the discount rate nor a 100 basis point decrease in the terminal growth rate would have caused the Asia Pacific reporting unit to fail the first step of the goodwill impairment test.

 

Common Stock Repurchase and Retirement

 

Common stock repurchased is retired, and the excess of the cost over the par value of the common shares repurchased is recorded as a reduction to additional paid-in capital.

 

Revenue Recognition

 

We apply the provisions of ASC 605, Revenue Recognition, and recognize revenue for our products and solutions when persuasive evidence of an arrangement exists, services have been performed, the selling price is fixed or determinable, and collectability is reasonably assured. We recognize revenue for search engine marketing as clicks are recorded on sponsored links on the various search engines and for our display advertising and retargeting when the display advertisements record impressions or as otherwise provided in our agreement with the applicable publisher. We recognize revenue for lead conversion software, web presence and other products with a defined license or service period on a straight line basis over the applicable license or service period. We recognize revenue when we charge set-up, management service or other fees on a straight line basis over the term of the related contract or the completion of any obligation for services, if shorter. We account for sales and similar taxes imposed on our services on a net basis in the consolidated statements of operations.

 

When we receive advance payments from clients, we record these amounts as deferred revenue until the revenue is recognized. From time to time, we offer incentives to clients in exchange for minimum commitments. In these circumstances, we estimate the amount of the incentives that will be earned by clients and adjust the recognition of revenue to reflect such incentives. Estimates are either based upon a statistical analysis of previous campaigns for which such incentives were offered, or calculated on a straight-line basis over the life of the campaign.

 

 
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When we sell through agencies, we either receive payment in advance of the delivery of our products or solutions or in some cases extend credit. We pay each agency an agreed-upon commission based on the revenue we earn or cash we receive. Some agency clients that have been extended credit may offset the amount otherwise due to us by any commissions they have earned. We evaluate whether it is appropriate to record the gross amount of campaign revenue or the net amount earned after commissions. As we are generally the primary party obligated in the arrangement, subject to the credit risk, with discretion over both price and media, we typically recognize the gross amount of such sales as revenue and any commissions are recognized as a selling and marketing expense. 

 

We also have a small number of resellers. Resellers integrate our products and solutions, including branded search engine marketing, display advertising and online marketing analytics, into their product offerings. In most cases, the resellers integrate with our technology platform through a custom Application Programming Interface (API). Resellers are responsible for the price and specifications of the integrated product offered to their clients. Resellers pay us in arrears, net of commissions and other adjustments. We recognize revenue generated under reseller agreements net of the agreed-upon commissions and other adjustments earned or retained by the reseller, as we believe that the reseller has retained sufficient control and bears sufficient risks to be considered the primary obligor in those arrangements. 

  

Restructuring Charges

 

We record costs associated with exit activities related to restructuring plans in accordance with the ASC Topic 420, Exit or Disposal Obligations. Liabilities for costs associated with an exit or disposal activity are recognized in the period in which the liability is incurred. Restructuring charges consist of costs associated with the realignment and reorganization of our operations. Restructuring charges include employee termination costs, facility closure and relocation costs, and contract termination costs. The timing of associated cash payments is dependent upon the type of exit cost and can extend over a 12-month period. We record restructuring charge liabilities in accrued restructuring in the consolidated balance sheet.

   

Stock-Based Compensation

 

We account for stock-based compensation based on the fair market value of the equity award on the date of grant. We follow the attribution method, which reduces current stock-based compensation expenses recorded by the effect of anticipated forfeitures. We estimate forfeitures based upon our historical experience. 

  

The fair value of each award is estimated on the date of the grant and amortized over the requisite service period, which is the vesting period. We use the Black-Scholes option pricing model to estimate the fair value of stock option awards on the date of grant. Determining the fair value of stock option awards at the grant date under this model requires judgment, including estimating volatility, expected term and the risk-free interest rate. The fair value of restricted stock and restricted stock unit awards is based on the closing market price of our common stock on the date of grant. In addition, we use a Monte Carlo simulation model to estimate the fair value of market-based performance-vesting restricted stock and restricted stock units. Determining the fair value of these awards at the grant date under this model requires judgment, including estimating volatility, risk-free rate and expected future stock price. We determine the probability of achievement of performance milestones for non-market based performance vesting restricted stock and restricted stock units, and recognize expense based on the fair value of the award if it is probable that the performance milestone will be achieved. The assumptions described above rely on management estimates based on judgment and subjective future expectations, which may result in stock-based compensation for future awards that differs significantly from the awards granted previously.

 

The fair value of modifications to stock-based awards is generally estimated using the Black-Scholes option pricing model. If a stock-based compensation award is modified after the grant date, incremental compensation expense is recognized in an amount equal to the excess of the fair value of the modified award over the fair value of the original award immediately before the modification. Incremental compensation expense for fully vested awards is recognized immediately. For unvested awards, the sum of the incremental compensation expense and the remaining unrecognized compensation expense for the original award on the modification date is recognized over the modified service period.

 

 
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Income Taxes

 

We use the asset and liability method of accounting for income taxes. Significant judgment is required in determining the consolidated provision for income taxes and evaluating our tax positions. In the ordinary course of business, there are many transactions and calculations for which the ultimate tax settlement is uncertain. As a result, we recognize tax liabilities based on estimates of whether additional taxes and interest will be due. These tax liabilities are recognized when, despite our belief that our tax return positions are supportable, we believe that it is more likely than not that those positions may not be fully sustained upon review by tax authorities.

 

For the periods presented, income tax expense represents income taxes imposed by federal, state, foreign and local tax jurisdictions applicable to our activities. We are also generating net operating losses in certain tax jurisdictions in which we operate. We believe that it is likely that taxes imposed by state, local and foreign jurisdictions will increase in magnitude, particularly to the extent we become profitable in certain foreign jurisdictions before the time we obtain profitability on a consolidated basis.

 

During the quarter ended December 31, 2014, we evaluated the need for a valuation allowance against our domestic net deferred tax assets, excluding indefinite lived assets. In evaluating both positive and negative evidence, we have determined that the negative evidence was more persuasive, which lead us to record a full valuation allowance against our domestic net deferred tax assets, excluding indefinite lived assets, in the amount of $4.3 million. We continue to monitor the valuation allowance at each reporting period, and at this time, it is uncertain when a release will occur.

 

The value of our investments in foreign subsidiaries exceeds our tax basis in those subsidiaries by $0.8 million. However, we have not recognized deferred income taxes on the associated gain because the gain only becomes taxable upon a repatriation of assets from the subsidiary or a sale or liquidation of the subsidiary and these amounts are expected to be reinvested indefinitely outside of the U.S.

 

We are required to file income tax returns in the United States and various foreign jurisdictions, which requires us to interpret the applicable tax laws and regulations in effect in such jurisdictions. Such returns are, and from time to time have been, subject to audit by the various federal, state and foreign taxing authorities, which may disagree with our tax positions. We believe that our accruals for tax liabilities are adequate for all open audit years based on our assessment of many factors, including past experience and interpretations of tax law. We review and update our estimates in light of changing facts and circumstances, such as the closing of a tax audit, the lapse of a statute of limitations or a material change in estimate. To the extent that the final tax outcome of these matters differs from our expectations, such differences will impact income tax expense in the period in which such determination is made.  

 

 
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Results of Operations

 

Comparison of the Years Ended December 31, 2014, 2013 and 2012

 

   

Years Ended December 31,

 
   

2014

   

2013

   

2012

 

(in thousands, except per share data)

                       

Revenue

  $ 474,921     $ 514,070     $ 454,957  

Cost of revenue (1)

    252,721       256,450       226,482  

Operating expenses:

                       

Selling and marketing (1)

    182,720       182,854       164,168  

Product and technology (1)

    27,510       22,240       18,980  

General and administrative (1)

    52,155       46,362       40,378  

Restructuring charges

    5,927              

Total operating expenses

    268,312       251,456       223,526  

Operating income (loss)

    (46,112

)

    6,164       4,949  

Other income, net

    936       586       556  

Income (loss) from continuing operations before income taxes

    (45,176

)

    6,750       5,505  

Income tax provision

    484       3,699       1,340  

Income (loss) from continuing operations

    (45,660

)

    3,051       4,165  

Income (loss) from discontinued operations, net of income tax of $11, $3,036, and $186 for the years ended December 31, 2014, 2013, and 2012

    650       (5,534

)

    (4,397

)

Net loss

  $ (45,010

)

  $ (2,483

)

  $ (232

)

                         

Net income (loss) per share:

                       
                         

Basic:

                       

Income (loss) from continuing operations

  $ (1.60

)

  $ 0.11     $ 0.15  

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

    0.02       (0.20

)

    (0.16

)

Net loss per share

  $ (1.58

)

  $ (0.09

)

  $ (0.01

)

                         

Diluted:

                       

Income (loss) from continuing operations

  $ (1.60

)

  $ 0.11     $ 0.14  

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

    0.02       (0.20

)

    (0.15

)

Net loss per share

  $ (1.58

)

  $ (0.09

)

  $ (0.01

)

                         

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

                       

Basic

    28,461       27,764       28,348  

Diluted

    28,461       29,051       28,896  

______________

(1)

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

 

   

Years Ended December 31,

 
   

2014

   

2013

   

2012

 

Stock-based compensation:

                       

Cost of revenue

  $ 932     $ 697     $ 258  

Selling and marketing

    2,959       3,040       1,756  

Product and technology

    825       627       1,194  

General and administrative

    8,544       7,141       6,261  
    $ 13,260     $ 11,505     $ 9,469  
                         

Depreciation and amortization:

                       

Cost of revenue

  $ 674     $ 761     $ 706  

Selling and marketing

    3,041       2,925       2,418  

Product and technology

    11,730       10,214       8,924  

General and administrative

    1,949       1,196       1,554  
    $ 17,394     $ 15,096     $ 13,602  

 

 
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Revenue

 

   

Years Ended December 31,

                 
   

2014

   

2013

   

2012

   

2014-2013

% Change

   

2013-2012

% Change

 

(in thousands)

                                       

Direct Local

  $ 372,822     $ 410,278     $ 359,119       (9.1

)%

    14.2

%

National Brands, Agencies and Resellers

    102,099       103,792       95,838       (1.6

)%

    8.3

%

Total revenue

  $ 474,921     $ 514,070     $ 454,957       (7.6

)%

    13.0

%

 

  

   

Years Ended December 31,

                 
   

2014

   

2013

   

2012

   

2014-2013

% Change

   

2013-2012

% Change

 

(in thousands)

                                       

North America (1)

  $ 293,096     $ 341,737     $ 327,124       (14.2

)%

    4.5

%

International (1)

    181,825       172,333       127,833       5.5

%

    34.8

%

Total revenue

  $ 474,921     $ 514,070     $ 454,957       (7.6

)%

    13.0

%

                                         
                                         
   

December 31,

      2014-2013       2013-2012  
   

2014

   

2013

   

2012

      % Change       % Change  

Active Clients

    20,800       23,900       22,000       (13.0

)%

    8.6

%

Active Product Units

    31,400       35,200       32,500       (10.8

)%

    8.3

%

 

Direct Local revenue decreased by $37.5 million in 2014 compared to 2013. The decrease was primarily due to a 19.3% decline of North American Direct Local revenue compared to the prior year period as a result of decreased new customer acquisitions due to lower sales productivity, lower customer retention and fewer salespeople selling our products during 2014, each of which we believe are primarily attributable to the realignment of our North American Direct Local sales force. Since the realignment of our North American sales force in late 2013, we experienced high attrition in our North American sales force, which negatively impacted client acquisition and retention. The decline in our North American Direct Local revenue was partially offset by growth in our international markets. We experienced this growth notwithstanding negative impact from the substantial strengthening of the U.S. dollar compared to certain foreign currencies, particularly the Australian dollar.

 

Direct Local and National Brands, Agencies and Resellers revenue were both impacted as SureFire-related revenue that was reported as part of our National Brands, Agencies and Resellers channel prior to our acquisition of SureFire is now reported as part of our Direct Local channel. As a result, $6.4 million of SureFire revenue is included in Direct Local for 2014 instead of National Brands, Agencies and Resellers.

  

Growth in our Direct Local channel in North America will depend on the success of our 2015 initiatives to improve our go-to-market approach and the introduction of new products. Growth in our Direct Local channel generally will also depend on our success in our international markets and our ability to successfully launch new products internationally.

 

The decrease in National Brands, Agencies and Resellers revenue of $1.7 million in 2014 compared to 2013 was primarily due to reporting revenue from Surefire clients in the Direct Local channel rather than in National Brands, Agencies and Resellers. Revenue from SureFire included in National Brands, Agencies and Resellers for 2014 was $1.3 million as compared to $5.0 million in the prior-year period.

 

 
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Table Of Contents
 

 

Direct Local revenue increased by $51.2 million in 2013 compared to 2012. The increase was largely driven by an increase in the number of salespeople in our international markets, and the productivity of our expanded North American inside sales force. Our revenue growth in international markets was partially offset by the substantial strengthening of the U.S. dollar compared to certain foreign currencies, particularly the Australian Dollar, and the loss of a large advertiser in the UK during the second quarter of 2013. Total salespeople increased in 2013 as compared to the preceding year due to an increase in the number of international salespeople as we continued to grow internationally.

 

The increases in National Brands, Agencies and Resellers revenue of $8.0 million in 2013 compared to 2012 was due to growth in the number of international Agencies and Resellers clients and domestic National Brands clients, partially offset by a decrease in the number of domestic Agencies and Resellers clients.

  

Cost of Revenue

 

   

Years Ended December 31,

                   

Years Ended December 31,

 
   

2014

   

2013

   

2012

   

2014-2013

% Change

   

2013-2012

% Change

   

2014