Attached files

file filename
EX-10.1 - EMPLOYMENT LETTER AMENDMENT - ReachLocal Incex10-1.htm
EX-32.2 - SECTION 906 CERTIFICATION OF CFO - ReachLocal Incex32-2.htm
EX-31.1 - SECTION 302 CERTIFICATION OF CEO - ReachLocal Incex31-1.htm
EX-31.2 - SECTION 302 CERTIFICATION OF CFO - ReachLocal Incex31-2.htm
EX-32.1 - SECTION 906 CERTIFICATION OF CEO - ReachLocal Incex32-1.htm
Table Of Contents

UNITED STATES

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 


FORM 10-Q


(Mark One)

 

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

 

For the quarterly period ended September 30, 2015

 

OR

 

 

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

 

For the transition period from              to            

 

Commission file number 001-34749

  


REACHLOCAL, INC.

(Exact name of registrant as specified in its charter)


Delaware 

20-0498783 

(State or other jurisdiction of incorporation or organization) 

(I.R.S. Employer Identification No.) 

 

21700 Oxnard Street, Suite 1600

Woodland Hills, California 

91367 

(Address of principal executive offices) 

(Zip Code) 

 

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


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

 

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

 

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

 

Large accelerated filer ☐

Accelerated filer ☒

 

 

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

Smaller reporting company ☐

  

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

 

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

 

Title of Class 

  

Number of Shares Outstanding on November 6, 2015 

Common Stock, $0.00001 par value

  

29,421,308

 

 

INDEX

 

  

  

 

Page 

Part I.

Financial Information

 

 

Item 1.

Condensed Consolidated Financial Statements (unaudited)

  3

  

  

Condensed Consolidated Balance Sheets as of September 30, 2015 and December 31, 2014

  3

  

  

Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2015 and 2014

  4

  

  

Condensed Consolidated Statements of Comprehensive Loss for the Three and Nine Months Ended September 30, 2015 and 2014

  5

  

  

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2015 and 2014

  6

  

  

Notes to the Condensed Consolidated Financial Statements

  7

  

Item 2.

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

  24

  

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

  40

  

Item 4.

Controls and Procedures

  40

  

 

 

Part II.

Other Information

  41

  

Item 1.

Legal Proceedings

  41

  

Item 1A.

Risk Factors

  41

  

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

  41

  

Item 6.

Exhibits

  41

  

  

Signatures

  42

 

 

PART I

 

FINANCIAL INFORMATION

 

Item 1.         FINANCIAL STATEMENTS

REACHLOCAL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

(Unaudited) 

 

   

September 30,

2015

   

December 31,

2014

 

Assets

               

Current Assets:

               

Cash and cash equivalents

  $ 17,813     $ 43,720  

Short-term investments

    81       904  

Accounts receivable, net of allowance for doubtful accounts of $860 and $961 at September 30, 2015 and December 31, 2014, respectively

    6,689       7,844  

Prepaid expenses and other current assets

    8,476       9,620  

Total current assets

    33,059       62,088  
                 

Property and equipment, net

    15,547       19,639  

Capitalized software development costs, net

    21,155       21,555  

Restricted cash—term loan (Note 11)

    17,500        

Restricted cash

    3,267       3,589  

Intangible assets, net

    4,210       5,492  

Non-marketable investments

    9,000       9,000  

Other assets

    3,405       3,518  

Goodwill

    19,989       48,189  

Total assets

  $ 127,132     $ 173,070  
                 

Liabilities and Stockholders’ Equity

               

Current Liabilities:

               

Accounts payable

  $ 33,484     $ 44,874  

Accrued compensation and benefits

    14,188       15,972  

Deferred revenue

    25,824       29,016  

Accrued restructuring

    3,857       3,196  

Term loan

    5,877        

Capital lease

    690       624  

Other current liabilities

    11,454       12,316  

Liabilities of discontinued operations

    779       850  

Total current liabilities

    96,153       106,848  
                 

Term loan

    18,687        

Capital lease

    662       1,103  

Deferred rent and other liabilities

    11,640       12,195  

Total liabilities

    127,142       120,146  
                 

Commitments and contingencies (Note 7)

               
                 

Stockholders’ Equity:

               

Common stock, $0.00001 par value—140,000 shares authorized; 29,419 and 29,269 shares issued and outstanding at September 30, 2015 and December 31, 2014, respectively

           

Receivable from stockholder

    (52 )     (65

)

Additional paid-in capital

    138,572       132,080  

Accumulated deficit

    (133,581 )     (74,569

)

Accumulated other comprehensive loss

    (4,949 )     (4,522

)

Total stockholders’ equity

    (10 )     52,924  

Total liabilities and stockholders’ equity

  $ 127,132     $ 173,070  

 

See notes to condensed consolidated financial statements. 

 

 

REACHLOCAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2015

   

2014

   

2015

   

2014

 

Revenue

  $ 95,282     $ 117,623     $ 293,620     $ 365,912  

Cost of revenue

    53,671       64,154       165,278       191,013  

Operating expenses:

                               

Selling and marketing

    30,634       45,479       99,964       140,386  

Product and technology

    6,947       6,746       21,450       20,521  

General and administrative

    9,310       12,183       29,933       40,877  

Restructuring charges

    983       518       5,571       4,567  

Impairment of goodwill

    27,800             27,800        

Total operating expenses

    75,674       64,926       184,718       206,351  
                                 

Operating loss

    (34,063

)

    (11,457

)

    (56,376

)

    (31,452

)

Other income (expense), net

    (1,179

)

    208       (2,182

)

    591  

Loss from continuing operations before income taxes

    (35,242

)

    (11,249

)

    (58,558

)

    (30,861

)

Income tax provision (benefit)

    395       35       454       (2,938

)

Loss from continuing operations

    (35,637

)

    (11,284

)

    (59,012

)

    (27,923

)

Income from discontinued operations, net of income tax of $222 for the nine months ended September 30, 2014

                      371  

Net loss

  $ (35,637

)

  $ (11,284

)

  $ (59,012

)

  $ (27,552

)

                                 

Net loss per share:

                               
                                 

Basic:

                               

Loss from continuing operations

  $ (1.22

)

  $ (0.40

)

  $ (2.03

)

  $ (0.98

)

Income from discontinued operations, net of income taxes

                      0.01  

Net loss per share

  $ (1.22

)

  $ (0.40

)

  $ (2.03

)

  $ (0.97

)

                                 

Diluted:

                               

Loss from continuing operations

  $ (1.22

)

  $ (0.40

)

  $ (2.03

)

  $ (0.98

)

Income from discontinued operations, net of income taxes

                      0.01  

Net loss per share

  $ (1.22

)

  $ (0.40

)

  $ (2.03

)

  $ (0.97

)

                                 

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

                               

Basic

    29,194       28,515       29,120       28,360  

Diluted

    29,194       28,515       29,120       28,360  

 

 See notes to condensed consolidated financial statements.

 

 

REACHLOCAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS 

(in thousands)

(Unaudited)

  

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2015

   

2014

   

2015

   

2014

 

Net loss

  $ (35,637

)

  $ (11,284

)

  $ (59,012

)

  $ (27,552

)

Other comprehensive income (loss):

                               

Foreign currency translation adjustments

    (358

)

    (878 )     (428

)

    (43 )

Comprehensive loss

  $ (35,995

)

  $ (12,162

)

  $ (59,440

)

  $ (27,595

)

 

See notes to condensed consolidated financial statements.

 

 

REACHLOCAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS 

(in thousands)

(Unaudited) 

 

   

Nine Months Ended

September 30,

 
   

2015

   

2014

 

Cash flows from operating activities:

               

Loss from continuing operations

  $ (59,012

)

  $ (27,923

)

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

               

Depreciation and amortization

    14,995       12,595  

Stock-based compensation

    6,556       10,718  

Restructuring charges

    5,571       4,567  

Impairment of goodwill

    27,800        

Loss on disposal of fixed assets

    135        

Excess tax shortfalls from stock-based awards

          1,185  

Provision for doubtful accounts

    (12 )     1,568  

Non-cash interest expense, net

    387       (243

)

Deferred taxes, net

          (1,325

)

Changes in operating assets and liabilities:

               

Accounts receivable

    789       (728

)

Prepaid expenses and other current assets

    938       2,049  

Other assets

    13       (1,175

)

Accounts payable

    (9,803

)

    (3,075

)

Accrued compensation and benefits

    (1,574

)

    (119

)

Deferred revenue

    (2,170

)

    (1,938

)

Accrued restructuring

    (4,405

)

    (1,620

)

Deferred rent and other liabilities

    91       (303

)

Net cash used in operating activities, continuing operations

    (19,701

)

    (5,767

)

Net cash used in operating activities, discontinued operations

    (70

)

    (1,402

)

Net cash used in operating activities

    (19,771

)

    (7,169

)

                 

Cash flows from investing activities:

               

Additions to property, equipment and software

    (11,171

)

    (18,987

)

Maturities of certificates of deposits and short-term investments

    582        

Purchases of certificates of deposits and short-term investments

          (85

)

Acquisitions, net of acquired cash

          (1,789

)

Investment in non-marketable securities

          (2,000

)

Net cash used in investing activities, continuing operations

    (10,589

)

    (22,861

)

                 

Cash flows from financing activities:

               

Proceeds from term loan, net

    24,700        

Restricted cash—term loan

    (17,500

)

     

Payment of deferred and contingent consideration

    (529

)

     

Proceeds from exercise of stock options

    7       6,438  

Excess shortfalls from stock-based awards

          (1,185

)

Principal payments on capital lease obligations

    (504

)

    (65

)

Debt issuance costs

    (194

)

     

Common stock repurchases

    (5

)

    (66

)

Net cash provided by financing activities

    5,975       5,122  
                 

Effect of exchange rate changes on cash and cash equivalents

    (1,522

)

    (889

)

Net change in cash and cash equivalents

    (25,907

)

    (25,797

)

Cash and cash equivalents—beginning of period

    43,720       77,514  

Cash and cash equivalents—end of period

  $ 17,813     $ 51,717  

 

 See notes to condensed consolidated financial statements.

 

   

REACHLOCAL, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  

(UNAUDITED)

 

1. Organization and Description of Business

 

ReachLocal, Inc.’s (the “Company”) operations are located in the United States, Canada, Australia, New Zealand, Japan, the United Kingdom, Germany, the Netherlands, Austria, Brazil, Mexico, and India. The Company’s mission is to provide more customers to local businesses around the world. The Company offers online marketing products and solutions in three categories: software (ReachEdge™ and Kickserv™), web presence (including ReachSite + ReachEdge™, ReachSEO™, ReachCast™, and TotalLiveChat™), and digital advertising (including ReachSearch™, ReachDisplay™, ReachRetargeting™, and ReachDisplay InAppTM). The Company delivers its suite of products and solutions to local businesses through a combination of its proprietary technology platform, its direct inside and outside sales force, and select third-party agencies and resellers. 

 

Liquidity and Capital Resources

 

 During the first nine months of 2015, the Company experienced declining revenues as a result of challenging market conditions and worse than expected performance in the Company’s international markets. In conjunction with the Company’s initiatives to transform the business and focus on profitable revenue, these conditions have had a significant negative impact on its operating results and cash flows. As a result the Company has taken a number of steps to reduce expenses and improve its business through, for example, its 2015 Restructuring Plan, including significant cost-saving measures such as workforce reductions, downsizing certain facilities in North America, as well as reductions of general corporate expenses and capital expenditures.

 

In order to provide further liquidity to meet working capital and capital resource requirements, on April 30, 2015 the Company entered into a Loan and Security Agreement (the “Loan Agreement”) for a $25.0 million term loan. See Note 11, Term Loan, for more information. The Company received $24.7 million of net proceeds from the term loan, $17.5 million of which is considered restricted cash required under the terms of the Loan Agreement. The Company’s overall performance and capital expenditures more than offset the $7.2 million of net unrestricted cash from the term loan, resulting in cash balances at September 30, 2015, that decreased $25.9 million from December 31, 2014. The Company’s current liabilities exceeded its current assets by $63.1 million at September 30, 2015, and it has incurred an operating loss of $56.4 million for the nine months then ended.

 

Under the Loan Agreement, the Company is required to maintain minimum cash in North America in an amount equal to $17.5 million at all times, unless the Company achieves positive “Adjusted EBITDA” as defined in the Loan Agreement for three consecutive quarters, in which case the minimum cash balance decreases to $12.5 million. The Company achieved positive “Adjusted EBITDA” during the quarter ended September 30, 2015, which qualifies as the potential first of the required three consecutive quarters. The Loan Agreement includes covenants applicable to the Company and its subsidiaries, which include restrictions on transferring collateral, incurring additional indebtedness, creating liens, selling assets, and undergoing a change in control, in each case subject to certain exceptions, as well as financial covenant requirements to maintain certain minimum levels of revenue and earnings during each three-month period, tested monthly, during the term. The Loan Agreement also contains a subjective acceleration clause that can be triggered if the Company experiences a Material Adverse Effect, as defined in the Loan Agreement, which would be considered an event of default. On August 3, 2015, the Company entered into an amendment to the Loan Agreement, which reduced the Loan Agreement’s covenant thresholds for revenue for the months ending September 30, 2015 through December 31, 2015. On November 9, 2015, the Company entered into an amendment to the Loan Agreement with Hercules, which waives compliance with the term loan’s revenue and earnings covenant thresholds for November and December 2015. In connection with the amendment, the Company (i) paid Hercules a one-time fee of $0.2 million, (ii) reset the schedule of prepayment fees to begin from the November 9, 2015, instead of April 30, 2016, and (iii) agreed to amend the Hercules warrant as described below no later than November 16, 2016. As of September 30, 2015, the Company was in compliance with all financial covenants of the Loan Agreement.

 

The Company will need to make further cost reductions in its operating expenses and capital expenditures to maintain a sufficient cash balance to fund its operations and maintain compliance with the minimum cash balance requirement under the Loan Agreement. Management is committed to execute further cost reductions throughout all aspects of the business, including in the areas of product and technology, sales and marketing, service and support, and general corporate expenses. These additional cost-saving measures are estimated to result in expense reductions of approximately $24.0 million during the next twelve months, although some of these cost-saving measures are expected to negatively impact revenues. The Company will continue to evaluate the extent and effectiveness of its cost-saving measures and monitor its expenses compared to revenue and intends to implement additional cost reductions in future periods if and as circumstances warrant.

 

 

The Company believes that it will be able to maintain compliance with the minimum cash balance in North America in excess of $17.5 million in addition to the other financial covenants contained in the Loan Agreement through 2016 as a result of its cost control measures. The Company believes that it will be able to achieve the revenue and earnings targets under the Loan Agreement during the fourth quarter of 2015, as well as the revenue and earnings targets for 2016, which will equal 90% and 80% of the respective amounts contained in the Company’s 2016 operating plan, when approved by the Company’s board of directors. However, there can be no assurance that these actions will be successful or that further adverse events outside of the Company’s control may arise that would result in the Company’s inability to comply with the Loan Agreement’s covenants. If an event of default were to occur, the Company may be required to obtain a further amendment or a waiver to the Loan Agreement, refinance the term loan, divest non-core assets or operations and/or obtain additional equity or debt financing. If the Company was unable to obtain such a waiver or amendment, or consummate such transactions, the administrative agent could exercise remedies against the Company and the collateral securing the term loan, including potential foreclosure against the Company’s assets securing the Loan Agreement, including the Company’s cash.

 

In consideration of these conditions, the Company currently anticipates that funds expected to be generated from operations, including cost-saving measures the Company has taken and intends to take, will be sufficient to meet the Company’s anticipated cash requirements for at least the next twelve months. However, there is no assurance that the results of operations and cash flows expected during that period of time will be achieved. 

 

2. Summary of Significant Accounting Policies

 

Principles of Consolidation

 

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

 

Basis of Presentation

 

The accompanying condensed consolidated financial statements are unaudited. These unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and applicable rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been or omitted pursuant to such rules and regulations. Accordingly, these interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2014. The Condensed Consolidated Balance Sheet as of December 31, 2014 included herein was derived from the audited consolidated financial statements as of that date, but does not include all disclosures included in those audited consolidated financial statements.

 

The unaudited interim condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and include all adjustments (consisting only of normal recurring adjustments) necessary for the fair presentation of the Company’s statement of financial position at September 30, 2015, the Company’s results of operations for the three and nine months ended September 30, 2015 and 2014 and the Company’s cash flows for the nine months ended September 30, 2015 and 2014. The results for the three and nine months ended September 30, 2015 are not necessarily indicative of the results to be expected for the year ending December 31, 2015. All references to the three and nine months ended September 30, 2015 and 2014 in the notes to the condensed consolidated financial statements are unaudited.

 

 

 Use of Estimates

 

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

 

Reclassifications and Adjustments

 

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

 

Cash and Cash Equivalents

 

The Company reports all highly liquid short-term investments with original maturities of three months or less at the time of purchase as cash equivalents. As of September 30, 2015 and December 31, 2014, cash equivalents consist of demand deposits and money market accounts. Cash equivalents are stated at cost, which approximates fair value.

 

Restricted CashTerm Loan

 

Under the terms of the Loan Agreement, the Company is required to maintain, at all times, cash in North America of at least $17.5 million, unless the Company achieves positive “Adjusted EBITDA” as defined in the Loan Agreement for three consecutive quarters, in which case the minimum cash balance decreases to $12.5 million. Restricted cash—term loan represents the required minimum compensating balance to secure the term loan. See Note 11, Term Loan, for more information.

 

   Restricted Cash

 

Restricted cash represents certificates of deposit held at financial institutions that are pledged as collateral for letters of credit related to lease commitments, collateral for the Company’s merchant accounts, and cash deposits in a restricted account in accordance with the Company’s employee health care self-insurance plan. The letters of credit will lapse at the end of the respective lease terms through 2024 and the certificates of deposit automatically renew for successive one-year periods over the duration of the lease term. The restrictions related to merchant accounts and the Company’s self-insurance plan will lapse upon termination of the respective underlying arrangements. At September 30, 2015 and December 31, 2014, the Company had restricted cash in the amount of $3.3 million and $3.6 million, respectively, of which, $0.2 million, related to the employee health care self-insurance plan.

 

Recent Accounting Pronouncements

 

In September 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2015-16, Business Combinations. The amendments in this update require that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. The amendments require that the acquirer record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. The amendments in this Update require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The amendments in this update are effective for the Company as of January 1, 2016. The amendments in this update should be applied prospectively to adjustments to provisional amounts that occur after the effective date. Early adoption is permitted. The Company is currently assessing the impact of this update, and believes that its adoption on January 1, 2016 will not have a material impact on its consolidated financial statements.

 

In April 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2015-05, Intangibles-Goodwill and Other-Internal-Use Software. The amendments in this update provide guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The amendments in this update are effective for the Company as of January 1, 2016. Early adoption is permitted. The Company is currently assessing the impact of this update on its consolidated financial statements.

 

 

In April 2015, the FASB issued ASU No. 2015-03, Interest- Imputation of Interest. The amendments in this update require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of the corresponding debt liability, consistent with debt discounts. The amendments in this update are effective for the Company as of January 1, 2016. Early adoption is permitted for financial statements that have not been previously issued. The Company early adopted this update in the second quarter of 2015.

 

In February 2015, the FASB issued ASU No. 2015-02, Consolidation. The amendments in this update require management to reevaluate whether certain legal entities should be consolidated. Specifically, the amendments (1) modify the evaluation of whether limited partnerships and similar legal entities are variable interest entities (VIEs) or voting interest entities, (2) eliminate the presumption that a general partner should consolidate a limited partnership, (3) affect the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships, and (4) provide a scope exception from consolidation guidance for reporting entities with interests in legal entities that are required to comply with or operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940 for registered money market funds. The amendments in this update are effective for the Company as of January 1, 2016. Early adoption is permitted. The Company is currently assessing the impact of this update, and believes that its adoption on January 1, 2016 will not have a material impact on its consolidated financial statements.

 

In August 2014, the FASB issued ASU No. 2014-15, Presentation of Financial Statements – Going Concern. The amendments in this update require management to assess an entity’s ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. Specifically, the amendments (1) provide a definition of the term substantial doubt, (2) require an evaluation every reporting period including interim periods, (3) provide principles for considering the mitigating effect of management’s plans, (4) require certain disclosures when substantial doubt is alleviated as a result of consideration of management’s plans, (5) require an express statement and other disclosures when substantial doubt is not alleviated, and (6) require an assessment for a period of one year after the date that the financial statements are issued (or available to be issued). The amendments in this update are effective for the Company as of January 1, 2017. Early application is permitted. The adoption of this standard is not expected to have an impact on the Company’s consolidated financial condition and results of operations.

 

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

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers. The guidance in this update supersedes the revenue recognition requirements in ASC 605, Revenue Recognition, and most industry-specific guidance throughout the Codification. Additionally, this update supersedes some cost guidance included in ASC 605-35, Revenue Recognition - Construction-Type and Production-Type Contracts. In addition, the existing requirements for the recognition of a gain or loss on the transfer of nonfinancial assets that are not in a contract with a customer (for example, assets within the scope of ASC 360, Property, Plant, and Equipment, and intangible assets, within the scope of ASC 350, Intangibles - Goodwill and Other) are amended to be consistent with the guidance on recognition and measurement in this update. The standard was to be effective for the Company as of January 1, 2017, but in August 2015, the FASB delayed the effective date of the new revenue accounting standard to January 1, 2019, and will permit early adoption as of the original effective date. Earlier adoption is not otherwise permitted for public entities. An entity can apply the revenue standard retrospectively to each prior reporting period presented (full retrospective method) or retrospectively with the cumulative effect of initially applying the standard recognized at the date of initial application in retained earnings (simplified transition method). The Company is currently assessing the impact of this update on its consolidated financial statements.

 

 

In April 2014, the FASB issued ASU No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. The amendments in this update change the criteria for determining which disposals can be presented as discontinued operations and modify related disclosure requirements. The guidance applies prospectively to new disposals and new classifications of disposal groups as held for sale after the effective date, and was effective for the Company as of January 1, 2015. The Company will apply this guidance to its consolidated financial statements for any new disposals or new classification as held for sale after the effective date.

 

3. Fair Value of Financial Instruments

 

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

 

 

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

   

 

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

   

 

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

   

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

 

           

Basis of Fair Value Measurement

 
   

Balance at

September 30,

2015

   

Quoted Prices

in Active

Markets for

Identical

Items

(Level 1)

   

Significant

Other

Observable Inputs

(Level 2)

   

Significant Unobservable

Inputs

(Level 3)

 

Assets:

                               

Cash and cash equivalents

  $ 17,813     $ 17,813     $     $  

Restricted cash—term loan

  $ 17,500     $ 17,500     $     $  

Short-term investments

  $ 81     $ 81     $     $  

Restricted cash

  $ 3,062     $     $ 3,062     $  

 

 

           

Basis of Fair Value Measurement

 
   

Balance at

December 31,

2014

   

Quoted Prices

in Active

Markets for

Identical

Items

(Level 1)

   

Significant

Other

Observable Inputs

(Level 2)

   

Significant Unobservable

Inputs

(Level 3)

 

Assets:

                               

Cash and cash equivalents

  $ 43,720     $ 43,720     $     $  

Short-term investments

  $ 904     $ 904     $     $  

Restricted cash

  $ 3,416     $     $ 3,416     $  
                                 

Liabilities:

                               

Acquisition-related contingent consideration

  $ 349     $     $     $ 349  

  

 

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

 

On April 10, 2015, ReachLocal New Zealand Limited (“RL NZ”) paid NZ$0.4 million ($0.3 million) of earn-out consideration due, offset by NZ$0.2 million ($0.1 million) pursuant to a net working capital adjustment in the Company’s favor. On September 18, 2015, RL NZ made the final payment of $0.1 million for the indemnity holdback.

 

The Company also has an investment in a privately held partnership that is one of its service providers. During March 2013, the Company invested $2.5 million for a 4% equity interest in the service provider, and in March 2014, the Company invested $2.0 million for an additional 3.2% equity interest. The Company does not have significant influence over the entity. In addition, the Company has an equity interest of 14.2% in SERVIZ, Inc., the entity that acquired its former ClubLocal business, and does not have significant influence over the entity. The carrying amounts of the Company’s cost method investments were each $4.5 million at September 30, 2015, and are included in non-marketable investments in the accompanying condensed consolidated balance sheet.

  

 

4. Acquisitions

 

Acquisition of Kickserv

 

On November 21, 2014, the Company acquired Kickserv, Inc. (“Kickserv”) as part of the Company’s continued effort to expand its product offerings. Kickserv is a provider of cloud-based business management software for service businesses.

 

The purchase price consisted of $6.75 million of initial consideration, subject to a holdback and certain adjustments, and up to $4.0 million of earn-out consideration. At closing, the Company paid $5.3 million in cash with the remaining balance of the initial purchase price payable after the 18-month anniversary of the closing date, subject to certain conditions. The Company also issued 250,000 restricted stock units to the hired employees, which are accounted for as stock-based compensation over the period in which they are earned. A liability was not recorded for the earn-out consideration as the financial targets, as defined in the purchase agreement, are not expected to be achieved. Any changes in the fair value of the earn-out consideration will be recorded as other income or expense. There has been no change in the fair value since the date of acquisition.

 

           The acquisition was accounted for using the acquisition method of accounting. The Company completed and finalized the purchase price allocation in the fourth quarter of 2014. The Company recorded assets acquired and liabilities assumed at their respective fair values. The following table summarizes the final fair value of assets acquired and liabilities assumed (in thousands):

 

Assets acquired:

       

Cash and cash equivalents

  $ 58  

Intangible assets

    4,280  

Goodwill

    3,985  

Total assets acquired

    8,323  

Liabilities assumed:

       

Non-interest bearing liabilities

    24  

Long-term debt

    350  

Deferred tax liabilities

    1,249  

Total liabilities assumed

    1,623  

Total fair value of net assets acquired

  $ 6,700  

 

Intangible assets acquired from Kickserv included software technology of $3.0 million, trade names of $0.6 million and customer relationships of $0.7 million, amortized over eight, ten, and four years, their respective estimated useful lives, using the straight-line method. The estimated useful life of the technology was determined based on assumptions of its remaining economic life. The estimated useful life of trade names was determined based on assumptions of revenue attributable to the trade name, and the estimated useful life of the customer relationships was determined based on assumptions of customer attrition rates. The fair value of the intangible assets were determined by applying the income approach and based on significant inputs that are not observable in the market. Key assumptions include estimated future revenues from acquired customers and a discount rate of 15%, comprised of an estimated internal rate of return for this transaction and a weighted average cost of capital for comparable companies. The goodwill arising from the acquisition consists largely of the synergies expected from combining the operations of Kickserv and the Company. The acquired goodwill is not expected to be deductible for tax purposes.

 

 

Acquisition costs in connection with the Kickserv acquisition were immaterial. The revenues and results of operations of the acquired businesses for the post-acquisition period were included in the consolidated statements of operations and were immaterial for the period ended September 30, 2015. The pro forma results are not shown as the impact is not material.

 

Acquisition of SureFire

 

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

 

At closing, RL NZ paid NZ$1.7 million ($1.5 million) in cash of the estimated NZ$2.8 million ($2.4 million) purchase price. The remaining balance of the estimated purchase price was deferred subject to meeting revenue targets and an indemnity holdback, payable, if at all, after the 12-month anniversary of the closing date, and the 12- and 18-month anniversaries of the closing date, respectively. The maximum amount of contingent consideration payable was NZ$2.0 million and the fair value of the contingent consideration was recorded as an accrued expense. The fair value of the earn-out consideration under the income approach was determined at the time of acquisition by using the Black-Scholes option pricing model. This approach is based on significant inputs that are not observable in the market, which are considered Level 3 inputs. Key assumptions include forecasted first year revenue, volatility of 30% based on volatilities of selected comparable companies, and a risk-free rate of 0.14% based on a one-year U.S. treasury yield rate. The liability for the indemnity holdback was recorded based on the assumption that there would be no claims made against the holdback and that 65% ($0.2 million) of the indemnity holdback would be paid April 2015 and the remaining 35% ($0.1 million) would be paid October 2015. The fair value of the indemnity holdback at the date of acquisition was NZ$0.4 million ($0.3 million). On April 10, 2015, RL NZ paid NZ$0.6 million ($0.4 million), which included NZ $0.4 million ($0.3 million) of earn-out consideration due and NZ $0.3 million ($0.2 million) for the 12-month indemnity holdback release, offset by NZ $0.2 million ($0.1 million) to a net working capital adjustment in the Company’s favor. On September 18, 2015, RL NZ made the final payment of $0.1 million for the indemnity holdback.

 

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

 

Assets acquired:

       

Goodwill

  $ 2,350  

Intangible assets

    1,280  

Accounts receivable

    330  

Property and equipment

    13  

Total assets acquired

    3,973  

Liabilities assumed:

       

Deferred tax liabilities

    358  

Deferred revenue

    284  

Accrued compensation and benefits

    111  

Other

    782  

Total liabilities assumed

    1,535  

Total fair value of net assets acquired

  $ 2,438  

 

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

 

 

Acquisition costs in connection with the SureFire acquisition were immaterial. The revenues and results of operations of the acquired businesses for the periods post-acquisition were included in the consolidated statements of operations and were immaterial for the period ended September 30, 2015. The pro forma results are not shown as the impact is not material.

 

Acquisition of RealPractice

 

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

 

5. Goodwill and Finite-Lived Intangible Assets 

 

Goodwill represents the excess of the purchase price of our acquired businesses over the fair value of the net tangible and intangible assets acquired. The Company accounts for goodwill in accordance with ASC 350, Intangibles—Goodwill and Other, which addresses financial accounting and reporting requirements for goodwill and requires testing of goodwill at the reporting unit level for impairment at least annually. The Company’s goodwill is comprised of balances in both the North America and Asia-Pacific reporting units. The Company tests the goodwill of its 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.

 

The goodwill impairment test involves a two-step process. However, for the annual goodwill assessment prior to performing the two-step quantitative test, the Company has the option to first assess qualitative factors. In the first step, the Company compares the fair value of each reporting unit to its carrying value. If the fair value of the reporting unit exceeds its carrying value, goodwill is not impaired and no further testing is required. If the fair value of the reporting unit is less than the carrying value or if the carrying value of the reporting unit is negative, the Company must perform the second step of the impairment test to measure the amount of impairment loss. In the second step, the reporting unit's fair value is allocated to the assets and liabilities of the reporting unit, including any unrecognized intangible assets, in a hypothetical analysis that calculates the implied fair value of goodwill in the same manner as if the reporting unit was being acquired in a business combination. If the implied fair value of the reporting unit's goodwill is less than the carrying value, the difference is recorded as an impairment loss.

 

Impairment of Goodwill

 

During the quarter ended September 30, 2015, due to a decline in internal projections for the Asia-Pacific reporting unit of both revenue and profitability as a result of recent declines in its financial performance, the Company determined that sufficient indicators of potential impairment existed to require an interim quantitative goodwill impairment test for the Asia-Pacific reporting unit as of August 31, 2015. The amount of goodwill assigned to the Asia-Pacific reporting unit at August 31, 2015 was $32.4 million. Due to the complexity and the effort required to estimate the fair value of the Asia-Pacific reporting unit in step one of the impairment test and to estimate the fair value of all assets and liabilities of the Asia-Pacific reporting unit in step two of the test, the fair value estimates were derived based on preliminary assumptions and analysis that are subject to change. Based on the Company’s revised forecasts, the carrying value of goodwill exceeded the implied fair value of goodwill for the Asia-Pacific reporting unit. As a result, the Company recorded a preliminary impairment charge of $27.8 million for the goodwill in the Asia-Pacific reporting unit during the quarter ended September 30, 2015, which is included in impairment of goodwill in the accompanying consolidated statements of operations. Any adjustment to the estimated impairment charge will be recorded in the fourth quarter of 2015. The Company did not identify an impairment of its finite-lived intangible assets or other long-lived assets based on its estimates included in the second step of the quantitative test.

 

The process of estimating the fair value of goodwill is subjective and requires the Company to make estimates that may significantly impact the outcome of the analyses. The estimated fair value of the Asia-Pacific reporting unit was determined using both an income-based valuation approach, and a market-based valuation approach, each weighted 50%. Under the income approach, fair value of the reporting unit 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. The future cash flows for the reporting unit were projected based on the Company’s estimates, at that time, of future revenues, operating income and other factors (such as working capital and capital expenditures). The Company took into account expected competitive global industry and market conditions. Under the market-based valuation approach, each reporting unit’s fair value is estimated based on industry multiples of revenues and operating earnings.

 

 

The inputs of the discounted cash flow method used to determine the fair value of the Asia-Pacific reporting unit included a conservative average 3% growth rate to calculate the terminal value and a discount rate of 17%. 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.

 

The changes in the carrying amount of goodwill for the nine months ended September 30, 2015 were as follows (in thousands):

 

   

North America

   

Asia-Pacific

   

Total

 

Goodwill at December 31, 2014

  13,680     34,509     48,189  

Accumulated impairment loss

          (27,800

)

    (27,800

)

Foreign currency translation

          (400

)

    (400

)

Balance at September 30, 2015

  $ 13,680     $ 6,309     $ 19,989  

  

 Finite-Lived Intangible Assets

 

At September 30, 2015 and December 31, 2014, finite-lived intangible assets consisted of the following (in thousands):

 

   

September 30, 2015

 
   

Useful Life

(years)

   

Gross Value

   

Accumulated Amortization

   

Net

 

Developed technology

  3 - 8     $ 5,490     $ (2,827

)

  $ 2,663  

Customer contracts and relationships

  2 - 4       1,658       (631

)

    1,027  

Trade names

      10       570       (50

)

    520  

Total

            $ 7,718     $ (3,508

)

  $ 4,210  

 

    December 31, 2014  
   

Useful Life

(years)

   

Gross Value

   

Accumulated Amortization

   

Net

 
                                   

Developed technology

  3 - 8     $ 5,490     $ (2,130

)

  $ 3,360  

Customer contracts and relationships

  2 - 4       1,875       (306

)

    1,569  

Trade names

      10       570       (7

)

    563  

Total

            $ 7,935     $ (2,443

)

  $ 5,492  

  

Based on the current amount of intangibles subject to amortization, the estimated amortization expense over the remaining lives is as follows (in thousands):

 

Years Ending December 31,

       

Remaining 2015

  $ 234  

2016

    935  

2017

    675  

2018

    584  

2019

    431  

Thereafter

    1,351  

Total

  $ 4,210  

 

For the three months ended September 30, 2015 and 2014, amortization expense related to acquired intangible assets was $0.2 million and $0.3 million, respectively. For the nine months ended September 30, 2015 and 2014, amortization expense related to acquired intangible assets was $1.2 million and $0.9 million, respectively

 

 

 

6. Software Development Costs

 

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

 

   

September 30,

2015

   

December 31,

2014

 

Capitalized software development costs

  $ 65,019     $ 56,498  

Accumulated amortization

    (43,864

)

    (34,943

)

Capitalized software development costs, net

  $ 21,155     $ 21,555  

 

For the three months ended September 30, 2015 and 2014, the Company recorded amortization expense of $2.8 million and $2.5 million, respectively. For the nine months ended September 30, 2015 and 2014, the Company recorded amortization expense of $8.6 million and $7.2 million, respectively. At September 30, 2015 and December 31, 2014, $2.7 million and $5.0 million, respectively, of capitalized software development costs were related to projects still in process.

 

7. Commitments and Contingencies  

 

Legal Matters

 

From time to time, the Company is involved in legal proceedings arising in the ordinary course of its business. The Company believes that there is no litigation or claims pending or threatened that are likely to have a material adverse effect on its financial position, results of operations or cash flows.

 

North America

 

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

 

Europe

 

Over the past 21 months, the Company’s United Kingdom subsidiary (“RL UK”), has been involved in a number of disputes with former clients that allege RL UK made misrepresentations in connection with sales to those clients. The Company resolved a number of these disputes in 2014 and believes it may face similar claims in the future. On June 15, 2015, one former client filed a lawsuit in the High Court of Justice alleging fraudulent misrepresentations and breach of contract. The Company’s insurance carrier is providing a defense under a reservation of rights. The Company has adequately reserved for this matter based on the current estimate of outcomes.

 

Other Commitments

 

The Company engaged a third party facilitator to provide direct support in the execution of its 2015 Restructuring Plan. In addition to fees incurred during the nine months ended September 30, 2015, the Company will continue to make payments for the final committed fees based on the future projected value of results achieved by the facilitator-led program. See Note 10, Restructuring Charges, for more information.

 

 

8. Stockholders’ Equity

 

Common Stock Repurchases

 

The Company’s Board of Directors previously authorized the repurchase of up to $47.0 million of the Company’s outstanding common stock. At December 31, 2014, the Company had executed repurchases of 3.4 million shares of its common stock under the program for an aggregate of $36.3 million. There were no repurchases under the program during 2015. On April 29, 2015, the Board of Directors terminated the Company’s repurchase program.

 

The Company is 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.

 

9. Stock-Based Compensation

 

Stock Options

 

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

 

   

Number of

Shares

   

Weighted

Average

Exercise

Price per

Share

   

Weighted

Average

Remaining Contractual

Life

(in years)

   

Aggregate

Intrinsic

Value

 

Outstanding at December 31, 2014

    6,096     $ 9.48                  

Granted

    5,571     $ 4.43                  

Exercised

    (31

)

  $ 0.24                  

Forfeited

    (4,398

)

  $ 9.67                  

Outstanding at September 30, 2015

    7,238     $ 5.52       6.5     $  
                                 

Vested and exercisable at September 30, 2015

    1,961     $ 8.87       5.4     $  
                                 

Unvested at September 30, 2015, net of estimated forfeitures

    4,194     $ 4.28       6.9     $  

  

      The following table presents the weighted-average assumptions used to estimate the fair values of the stock options granted during the three and nine months ended September 30, 2015 and 2014:

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2015

   

2014

   

2015

   

2014

 

Expected dividend yield

    0

%

    0

%

    0

%

    0

%

Risk-free interest rate

    1.68

%

    1.62

%

    1.54

%

    1.63

%

Expected life (in years)

    4.75       4.75       4.92       5.08  

Expected volatility

    57

%

    54

%

    57

%

    54

%

 

The per-share weighted average grant date fair value of options granted during the nine months ended September 30, 2015 was $2.31. The aggregate intrinsic value of stock options exercised during the nine months ended September 30, 2015 and 2014, were $0.1 million and $2.7 million, respectively.

 

 

Restricted Stock and Restricted Stock Units 

 

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

 

   

Number of

shares

   

Weighted

Average Grant

Date Fair Value

 

Unvested at December 31, 2014

    912     $ 5.98  

Granted

        $  

Forfeited

    (88

)

  $ 9.80  

Vested

    (192

)

  $ 10.48  

Unvested at September 30, 2015

    632     $ 6.64  

 

Stock-Based Compensation Expense

 

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

  

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2015

   

2014

   

2015

   

2014

 

Stock-based compensation

  $ 2,281     $ 2,798     $ 6,861     $ 11,064  

Less: Capitalized stock-based compensation

    86       127       305       346  

Stock-based compensation expense, net

  $ 2,195     $ 2,671     $ 6,556     $ 10,718  

  

Stock-based compensation, net of capitalization, is included in the accompanying condensed consolidated statements of operations within the following captions (in thousands):

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2015

   

2014

   

2015

   

2014

 

Stock-based compensation expense, net

                               

Cost of revenue

  $ 115     $ 205     $ 405     $ 735  

Selling and marketing

    400       616       1,306       2,352  

Product and technology

    197             491       608  

General and administrative

    1,483       1,850       4,354       7,023  
    $ 2,195     $ 2,671     $ 6,556     $ 10,718  

 

At September 30, 2015, there was $13.2 million of unrecognized stock-based compensation related to restricted stock, restricted stock units and outstanding stock options, net of estimated forfeitures. This amount is expected to be recognized over a weighted average period of 1.53 years. Future stock-based compensation expense for these awards may differ to the extent actual forfeitures vary from management estimates.

 

Stock-based compensation for the nine months ended September 30, 2014 includes $1.9 million of expense related to modification of grants to 73 option holders in March 2014, which extended the time to exercise from seven years to ten years for certain options granted during 2008 and 2009 with an exercise price of $10.91.

 

Commencing in 2015, 50% of the Company’s annual corporate bonus plan for certain executives and senior level employees will be settled with fully vested restricted stock units, and is payable in the first quarter of the following fiscal year. The plan does not limit the number of shares that can be issued to settle the obligation. During the three and nine months ended September 30, 2015, the Company has recognized stock-based compensation expense related to this plan of $0.2 million and $0.6 million, respectively. As of September 30, 2015, 295,000 shares would be required to satisfy the obligation relating to the 2015 annual corporate bonus plan.

 

 

Stock Option Exchange

 

On December 2, 2014, the Company commenced an option exchange to permit employee option holders to surrender certain outstanding stock options for cancellation in exchange for the grant of new replacement options to purchase an equal number of shares having an exercise price equal to the greater of $6.00 and the fair market value of the Company’s common stock on the replacement grant date. The option exchange was completed on January 9, 2015. Exchanged options were cancelled at that time and immediately thereafter, the Company granted replacement options under the Amended and Restated ReachLocal 2008 Stock Incentive Plan with exercise prices of $6.00 per share. A total of 2.8 million options were exchanged. The Company will amortize the incremental expense of $1.5 million in addition to the remaining expense attributable to the exchanged awards over the vesting period of the new awards.

 

10. Restructuring Charges

 

The Company has implemented various restructuring plans to reduce its cost structure, align resources with its product strategy, improve operating efficiency and implement cost savings, which have resulted in workforce reductions and the consolidation of certain real estate facilities and data centers.

 

2015 Restructuring Plan

 

In accordance with the Company’s ongoing efforts to reduce expenses and improve the operating performance of its business, the Company commenced its 2015 Restructuring Plan. The initiative is focused on enhancing earnings through an analysis of opportunities to both improve revenue performance and reduce costs. Operational efficiency improvements under the 2015 Restructuring Plan are identified and implemented through strategic realignment and targeted cost reductions, including workforce costs, facility-related expenditures and other operating expenses. The charges incurred during the nine months ended September 30, 2015 primarily involved down-sizing certain facilities in North America, costs to utilize a third party facilitator to aid execution of the plan, and a reduction of the Company’s North American and international workforces. The Company expects to have continued restructuring activity under this plan, including estimated additional expenses relating to facilitation and execution of the plan of $1.2 million, estimated to be incurred through the third quarter of 2016.

 

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

 

   

Workforce Reduction

Costs

   

Facility Closures

and Equipment

Write-downs

   

Other

Associated

Costs

   

Total

 

Balance at December 31, 2014

  $     $     $     $  

Amounts accrued

    1,376       1,148       3,236       5,760  

Amounts paid

    (1,041 )     (157

)

    (2,248

)

    (3,446

)

Accretion

          11             11  

Non-cash items

    (3 )     (574

)

          (577

)

                                 

Balance at September 30, 2015

  $ 332     $ 428     $ 988     $ 1,748  

 

The Company expects the facility closures and equipment write-downs to be paid through the third quarter of 2024 and the workforce reduction costs to be paid through the fourth quarter of 2015.

 

2014 Restructuring Plans

 

As a result of declining performance in the Company’s North American operations during the first quarter of 2014, the Company implemented a restructuring plan which primarily involved a reduction of the Company’s North American and international workforces as well as the closure of facilities in North America and certain international markets. The Company does not expect to have continued restructuring activity under this plan, other than settlement of associated liabilities.

 

 

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

 

   

Facility Closures
and Equipment
Write-downs

   

Total

 

Balance at December 31, 2014

  $ 2,519     $ 2,519  

Amounts paid

    (548

)

    (548

)

Accretion

    33       33  

Balance at September 30, 2015

  $ 2,004     $ 2,004  

 

The Company expects the facility closures and equipment write-downs to be paid through the third quarter of 2024.

 

During the second quarter of 2014, the Company implemented a business restructuring plan which involved the elimination of certain senior management positions, a reduction of international workforce, as well as the closure of facilities in certain international markets. The Company does not expect to have continued restructuring activity under this plan, other than settlement of associated liabilities.

 

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

 

   

Workforce

Reduction Costs

   

Facility

Closures

   

Total

 

Balance at December 31, 2014

  $ 51     $ 626     $ 677  

Amounts accrued

          (189

)

    (189

)

Amounts paid

    (50

)

    (361

)

    (411

)

Non-cash items

    (1

)

    29       28  

Balance at September 30, 2015

  $     $ 105     $ 105  

 

The Company expects the facility costs to be paid through the second quarter of 2016.

 

 

11. Term Loan

 

On April 30, 2015, the Company entered into the Loan Agreement with its direct and indirect domestic subsidiaries, as co-borrowers, Hercules Technology Growth Capital, Inc. (“Hercules”), as administrative agent, and the lenders party thereto from time to time (the “Lenders”), including Hercules, pursuant to which the Lenders agreed to make a term loan available to the Company for working capital and general business purposes, in a principal amount of $25.0 million. The term loan has an annual interest rate equal to the greater of (i) 11.75% and (ii) the sum of (a) the prime rate, plus (b) 8.50%. On the closing date the Company paid a fee of $0.3 million, which is to be credited against the final payment, and debt issuance costs of $0.2 million. Debt issuance costs will be amortized over the life of the loan of 3 years and calculated using the effective interest method.    

 

The Company is required to make interest-only payments on the term loan through May 1, 2016, though such payments may be extended through August 1, 2016 and November 1, 2016 if the Company remains in continuous compliance with the financial covenants under the Loan Agreement through April 1, 2016 and July 1, 2016, respectively, and no default or event of default has occurred and is continuing on such dates. The term loan will begin amortizing at the end of the applicable interest-only period, with monthly payments of principal and interest to the Lenders in consecutive monthly installments following the end of such interest-only period. The term loan matures on April 1, 2018; provided, however, that if the interest-only payments are extended through November 1, 2016, the term loan will instead mature October 1, 2018. Upon repayment of the term loan, the Company is also required to make a final payment to the Lenders equal to $1.5 million, which is accrued as interest based on the effective interest method over the 3-year term of the Loan Agreement. The term loan is secured by substantially all of the Company’s personal property, including its intellectual property.

 

 

At the Company’s option, the outstanding principal balance of the term loan may be prepaid in whole, or in part in a minimum amount of $2.5 million, subject to a prepayment fee of 3% of any amount prepaid if the prepayment occurs on or prior to April 30, 2016, or 2% of the amount prepaid if the prepayment occurs after April 30, 2016 but on or prior to April 30, 2017. If the prepayment occurs after April 30, 2017, there is no prepayment fee.

 

The Loan Agreement includes covenants applicable to the Company and its subsidiaries, which include restrictions on transferring collateral, incurring additional indebtedness, engaging in mergers or acquisitions, paying dividends or making other distributions, making investments, creating liens, selling assets, and undergoing a change in control, in each case subject to certain exceptions, as well as financial covenant requirements to maintain certain minimum levels of revenue and earnings during each three-month period, tested monthly, during the term. The Company is also required to maintain minimum cash in North America in an amount equal to $17.5 million at all times, unless the Company achieves positive “Adjusted EBITDA” as defined in the Loan Agreement for three consecutive quarters, in which case the minimum cash balance decreases to $12.5 million. The Loan Agreement also includes events of default, the occurrence and continuation of which provide Hercules, as administrative agent, with the right to exercise remedies against the Company and the collateral securing the term loan, including potential foreclosure against the Company’s assets securing the Loan Agreement, including the Company’s cash. The Loan Agreement contains a subjective acceleration clause that can be triggered if the Company experiences a Material Adverse Effect, as defined in the Loan Agreement, which would be considered an event of default. On August 3, 2015, the Company entered into an amendment to the Loan Agreement with Hercules, which reduced the term loan’s covenant thresholds for revenue for the months ending September 30, 2015 through December 31, 2015. On November 9, 2015, the Company entered into an amendment to the Loan Agreement with Hercules, which waives compliance with the term loan’s revenue and earnings covenant thresholds for November and December 2015. In connection with the amendment, the Company (i) paid Hercules a one-time fee of $0.2 million, (ii) reset the schedule of prepayment fees to begin from the November 9, 2015, instead of April 30, 2016, and (iii) agreed to amend the Hercules warrant as described below no later than November 16, 2016. As of September 30, 2015, the Company was in compliance with all of the financial covenants of the Loan Agreement.

 

Warrant

 

Concurrently with entrance into the Loan Agreement, the Company issued to Hercules, as the sole lender on the closing date, a warrant to purchase up to 177,304 shares of the Company’s common stock at an exercise price of $2.82 per share. In connection with the November 9, 2015 Loan Agreement amendment, the Company agreed to amend the warrant to increase the number of shares to 300,000 and reduce the exercise price to $0.85. The warrant would be exercisable in full and not in part. In addition, if upon the sale of all shares issued upon exercise of the warrant, or in the case of a merger or sale transaction involving other securities in whole or in part, upon the sale of such securities, the absolute return on the warrant exceeds $2.55 per share underlying the warrant, the warrant holder will pay to the Company the excess in cash. The warrant may be exercised either for cash or on a cashless basis. The warrant expires April 30, 2022. The Company estimated the fair value of the warrant to be $0.3 million based on its relative fair value to the term loan using a Black-Sholes pricing model and accounted for the warrant as a component of additional paid-in capital. The warrant will be amortized in the income statement as a component of debt issuance cost.

 

12. Income Taxes

 

The Company provides for income taxes in interim periods based on the estimated effective income tax rate for the complete fiscal year. For the three months and nine months ended September 30, 2015, the Company recorded provisions for income taxes of $0.4 million and $0.5 million, respectively. This is compared to a provision for income taxes of $35,000 for the three months ended September 30, 2014 and a benefit from income taxes of $2.9 million for the nine months ended September 30, 2014. The Company’s tax provision notwithstanding pre-tax losses is due to its full valuation allowance against its net deferred tax assets in the US and certain foreign jurisdictions. Generally, a full valuation allowance will result in a zero net tax provision, since the income tax expense or benefit that would otherwise be recognized is offset by the change in the valuation allowance. However, the income tax provisions for the three and nine months ended September 30, 2015 relate primarily to income taxes in the Company’s state and foreign jurisdictions and a non-cash income tax liability related to tax deductible goodwill that cannot be considered when determining a need for a valuation allowance.

 

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

 

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

 

 

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

 

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

 

13. Net Loss Per Share

 

 Basic net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of common and potential dilutive shares outstanding during the period, to the extent such shares are dilutive. Potential dilutive shares are composed of incremental common shares issuable upon the exercise of stock options, warrants and unvested restricted shares using the treasury stock method. Basic income (loss) from continuing operations per share is computed by dividing income (loss) from continuing operations for the period by the weighted average number of common shares outstanding during the period. Shares of unvested restricted stock are excluded from the calculation of basic weighted average shares outstanding, but their dilutive impact is added back in the calculation of diluted weighted average shares outstanding. Diluted income (loss) from continuing operations per share is computed by dividing income (loss) from continuing operations for the period by the weighted average number of common and potentially dilutive securities outstanding during the period, to the extent such shares are dilutive. The Company had a loss from continuing operations for the three and nine months ended September 30, 2015 and 2014, and therefore the number of diluted shares was equal to the number of basic shares for the period. 

 

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

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2015

   

2014

   

2015

   

2014

 

Deferred stock consideration and unvested restricted stock

    656       893       664       739  

Stock options and warrant

    7,504       6,696       6,982       6,621  
      8,160       7,589       7,646       7,360  

 

 

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

 

   

Three Months Ended
September 30,

   

Nine Months Ended
September 30,

 
   

2015

   

2014

   

2015

   

2014

 

Numerator:

                               

Loss from continuing operations

  $ (35,637

)

  $ (11,284

)

  $ (59,012

)

  $ (27,923

)

Denominator:

                               

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

    29,194       28,515       29,120       28,360  
                                 

Loss per share from continuing operations, basic

  $ (1.22

)

  $ (0.40

)

  $ (2.03

)

  $ (0.98

)

                                 

Loss per share from continuing operations, diluted

  $ (1.22

)

  $ (0.40

)

  $ (2.03

)

  $ (0.98

)

 

 

14. Segment Information

 

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

 

15. Supplemental Cash Flow Information

 

The following table sets forth supplemental cash flow disclosures (in thousands):

 

   

Nine Months Ended September 30,

 
   

2015

   

2014

 

Non-cash investing and financing activities:

               

Capitalized software development costs resulting from stock-based compensation and deferred payment obligations

  $ 305     $ 346  

Deferred payment obligation decrease

  $     $ (290

)

Unpaid purchases of property and equipment

  $ 113     $ 172  
                 

Assets acquired under capital leases

  $ 130

 

  $ 823  

Investment related to the ClubLocal disposition

  $     $ 4,500  

Issuance of warrant

  $ 250     $  

 

16. Discontinued Operations

 

ClubLocal

 

In the fourth quarter of 2013, the Company’s Board of Directors approved a plan to dispose of the Company’s ClubLocal business, and on February 18, 2014, the Company closed a transaction in which it transferred its ClubLocal business to SERVIZ, Inc. in exchange for a minority equity interest. The Company has an equity interest in the new entity of 14.2%, with a recorded fair value of $4.5 million. As a result of the disposition, the Company recorded a gain on disposal of $0.8 million, net of income tax of $0.4 million in the first quarter of 2014. This business has been accounted for as discontinued operations.

 

 

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

 

Cautionary Notice Regarding Forward-Looking Statements

 

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

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our 2014 Annual Report on Form 10-K.

 

This quarterly report on Form 10-Q contains “forward-looking statements” that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements are often identified by the use of words such as, but not limited to, “anticipate,” “believe,” “can,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “will,” “plan,” “project,” “seek,” “should,” “target,” “will,” “would,” and similar expressions or variations intended to identify forward-looking statements. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Risk Factors” included in our 2014 Annual Report on Form 10-K and Quarterly Report on Form 10-Q for the quarter ended March 31, 2015. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

 

Overview

 

ReachLocal’s mission is to 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™, ReachDisplay InAppTM and ReachRetargeting™), and web presence (including ReachSite ™, 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 local businesses 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. These products are generally available in North America and selectively available in our international markets.

 

 

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 website. Our aim in this disaggregation is to enable us to expand the market opportunity by allowing us to sell ReachEdge to local businesses who do not need a new website or who purchase their website from another provider.

  

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 example, 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.

 

We sell our products and solutions directly, through our inside and outside sales forces, in what we refer to as our Direct Local channel. Each of our regional markets employs a somewhat different sales model tailored to that market. In North America we have recently transitioned our direct sales force to a new model where our sales personnel (now called Digital Marketing Consultants or DMCs) will both generate the sale and manage the relationship. However, each DMC will be paired with a Marketing Expert (or ME) who will provide day-to-day campaign management. We believe that 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 primarily on selling and managing relationships.

 

We refer to our separate sales channel targeting national brands, franchises and strategic accounts with operations in multiple local markets, and select third-party agencies and resellers 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 400 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.   

 

In addition to the United States and Canada, we have sales operations in Australia, New Zealand, Japan, the United Kingdom, Germany, the Netherlands, Austria Brazil and Mexico. We are currently reviewing our international operations in order to rationalize our underperforming markets and optimize operations in our primary markets.

 

Operating Metrics

 

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

 

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

 

 

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

 

At September 30, 2015, we had approximately 18,500 Active Clients and 29,700 Active Product Units, as compared to approximately 21,900 Active Clients and 33,200 Active Product Units at September 30, 2014. Active Clients decreased by 5.1% and Active Product Units increased by 0.3%, compared to at June 30, 2015. The decrease in the number of Active Clients and Active Product Units is primarily due to an overall decrease in salespeople in both the Direct Local and NBAR channel as we decreased the size of our salesforce in an effort to focus on more productive salespeople,, partially offset by the addition of Kickserv clients and increased client retention in the Direct Local channel. The productivity of our current sales force improved compared to the prior-year period, but not enough to offset the decrease in number of sales people, which we attribute to more difficult selling environments in most of our markets.

 

 Basis of Presentation

 

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, ReachSite, 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 $4.2 million and $3.2 million of accounts receivable related to our Direct Local channel at September 30, 2015 and December 31, 2014, 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 $3.5 million and $5.0 million of accounts receivable related to our National Brands, Agencies and Resellers at September 30, 2015 and December 31, 2014, 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, including our marketing experts who manage client accounts and provide client-facing support, 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.

 

 

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. We pay commissions to certain sales people for the acquisition of new clients. Because client contracts are generally not cancelable without a penalty, 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, contract termination costs and costs associated with utilizing a third party consultant to facilitate the execution of the plan. 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 condensed consolidated balance sheets. See further discussion in Note 10 of the Notes to the Condensed Consolidated Financial Statements.

 

Goodwill Impairment. During the quarter ended September 30, 2015, due to a decline in internal projections for the Asia-Pacific reporting unit of both revenue and profitability as a result of recent declines its financial performance, we determined that sufficient indicators of potential impairment existed to require an interim quantitative goodwill assessment for the Asia-Pacific reporting unit as of August 31, 2015. The amount of goodwill assigned to the Asia-Pacific reporting unit at August 31, 2015 was $32.4 million. Due to the complexity and the effort required to estimate the fair value of the Asia-Pacific reporting unit in step one of the impairment test and to estimate the fair value of all assets and liabilities of the Asia-Pacific reporting unit in step two of the test, the fair value estimates were derived based on preliminary assumptions and analysis that are subject to change. Based on our revised forecasts, the carrying value of goodwill exceeded the implied fair value of goodwill for the Asia-Pacific reporting unit. As a result, we recorded a preliminary impairment charge of $27.8 million for the goodwill in the Asia-Pacific reporting unit during the quarter ended September 30, 2015, which is included in impairment of goodwill in the accompanying condensed consolidated statements of operations. Any adjustment to the estimated impairment charge will be recorded in the fourth quarter of 2015. We did not identify an impairment of our finite-lived intangible assets or other long-lived assets based on our estimates included in the second step of the quantitative test.

 

 

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 of the Asia-Pacific reporting unit was determined using both an income-based valuation approach, and a market-based valuation approach, each weighted 50%. Under the income approach, fair value of the reporting unit 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 our business model, and other assumptions. The future cash flows for the reporting unit was projected based on our estimates, at that time, of future revenues, operating income and other factors (such as working capital and capital expenditures). We took into account expected competitive global industry and market conditions. Under the market-based valuation approach, each reporting unit’s fair value is estimated based on industry multiples of revenues and operating earnings.

 

The inputs of the discounted cash flow method used to determine the fair value of the Asia-Pacific reporting unit included a conservative average 3% growth rate to calculate the terminal value and a discount rate of 17%. 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.

 

Discontinued Operations

 

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

  

Critical Accounting Policies and Estimates

 

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

 

There have been no material changes to our critical accounting policies. For further information on our critical and significant accounting policies, see our 2014 Annual Report on Form 10-K. 

 

 

Results of Operations

 

Comparison of the Three and Nine Months Ended September 30, 2015 and 2014

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2015

   

2014

   

2015

   

2014

 

(in thousands)

                               

Revenue

  $ 95,282     $ 117,623     $ 293,620     $ 365,912  

Cost of revenue (1)

    53,671       64,154       165,278       191,013  

Operating expenses:

                               

Selling and marketing (1)

    30,634       45,479       99,964       140,386  

Product and technology (1)

    6,947       6,746       21,450       20,521  

General and administrative (1)

    9,310       12,183       29,933       40,877  

Restructuring charges

    983       518       5,571       4,567  

Impairment of goodwill

    27,800             27,800        

Total operating expenses

    75,674       64,926       184,718       206,351  

Operating loss

    (34,063

)

    (11,457

)

    (56,376

)

    (31,452

)

Other income (expense), net

    (1,179

)

    208       (2,182

)

    591  

Loss from continuing operations before income taxes

    (35,242

)

    (11,249

)

    (58,558

)

    (30,861

)

Income tax provision (benefit)

    395       35       454       (2,938

)

Loss from continuing operations

    (35,637

)

    (11,284

)

    (59,012

)

    (27,923

)

Income from discontinued operations, net of income tax of $222 for the nine months ended September 30,2014