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TMCNet:  LOCAL CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

[November 09, 2012]

LOCAL CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

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

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the attached condensed consolidated financial statements and related notes thereto, and with the audited consolidated financial statements and related notes thereto as of December 31, 2011, and for the year ended December 31, 2011, included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 15, 2012.

Overview We are a local media company that specializes in connecting local businesses with online consumers. We reach consumers on our proprietary sites, as well as third-party sites (collectively, "Consumer Properties"), which includes our Owned & Operated web sites such as Local.com and Krillion.com (collectively, "O&O"), as well as our network of over 1,000 third-party U.S. regional media websites (collectively, "Network"). We provide a variety of digital media services to small and medium sized businesses ("SMBs") to enable these customers to reach consumers both on our Consumer Properties as well as on the major search engines (collectively, "Business Solutions") and we also enable third parties to distribute their advertiser listings on our Consumer Properties, for which we generate ad revenues. We generate revenue from performance ad units such as daily deals, pay-per-click, pay-per-call and lead generation, subscription ad units, and CPM ad units, among others.

Our Consumer Properties serve over 30 million consumers each month. We use patented and proprietary search technologies and systems to provide users of our O&O websites and our Network with relevant search results for local businesses, products and services, incorporating daily deals, event information, ratings and reviews, driving directions and more. By distributing this information across our Consumer Properties we are able to reach users that our direct advertisers and advertising partners desire to reach.

Our Business Solutions offer a variety of digital media products. The products are sold primarily via telesales. Our sales efforts focus principally around our Launch by Local product suite, which offers a variety of digital media features including web hosting, search engine optimization services, display ads, mobile ads, and social media presence management. Approximately 900 direct SMB customers are enrolled in our new Launch by Local product. An average Launch by Local subscription generates approximately the same monthly revenue as six legacy customers. Our Business Solutions technologies also power a variety of platform products targeted towards larger businesses such as regional media publishers and ad agencies. Over 6,000 of our direct SMB customers use a legacy web hosting and/or listing solution that will be phased out by the end of 2012.

18 -------------------------------------------------------------------------------- Table of Contents We regularly develop and deploy new products and product features based on our powerful technology platform, for which we have 9 issued patents and 11 pending.

We have a long-term focus on building three key drivers for our business - traffic, technology and advertisers. Our traffic is at record levels, our technology platform has been dramatically expanded, and we are generating record revenues from our own direct Launch by Local customers. We also recently launched our Local.com mobile device application with the intent to capitalize on an ever expanding mobile device market.

Recent Developments On March 28, 2012, we entered into the First Amendment to the Loan and Security Agreement with Square One Bank, which amends the Loan and Security Agreement by and between us and Square One Bank dated August 3, 2011 ("Loan Agreement"). The First Amendment to the Loan Agreement modifies the borrowing base eligibility criteria under the Loan Agreement, provides a five (5) day cure period for any liquidity ratio violations before any such violation would be deemed an event of default under the Loan Agreement, and establishes certain Adjusted EBITDA financial covenant, as defined, levels for fiscal 2012 pursuant to the Loan Agreement. On April 11, 2012, we entered into the Second Amendment to Loan Agreement with Square One Bank, which amends the Loan Agreement by and among the Company and Square One Bank dated August 3, 2011. The Second Amendment of the Loan Agreement modifies the maximum allowable borrowings under the non-formula line by increasing the maximum to $5.0 million from $3.0 million under certain circumstances. Additionally, it redefines the liquidity ratio to provide that non-formula borrowings only require a 1.0:1.0 ratio, rather than the 1.25:1.0 ratio. On August 17, 2012, we entered into the Third Amendment of the Loan Agreement to lower the maintenance limits for its depository and operating accounts to 90% and to amend the definition of Adjusted EBITDA to exclude any non-cash expenses, as well as to provide a waiver of a technical violation of the Adjusted EBITDA covenant described in Section 6.7(a) of the Agreement that occurred prior to the definition amendment noted above.

During the second quarter 2012, we decided to sell all assets relating to the Rovion business. The Rovion business, which is considered a usage model, did not align with our intent to become both a local media publisher and local advertising sales and marketing organization. On October 19, 2012, we sold all assets relating to the Rovion business. We licensed the Rovion technology as part of the asset purchase agreement and will continue to use the technology in its Launch by Local product offering.

At June 30, 2012, we performed an impairment valuation of goodwill as it relates to the Spreebird business unit. The evaluation was triggered by the continued decline in the market capitalization of comparable public companies and lower than expected financial performance of the Spreebird business unit during the second quarter of 2012. The evaluation resulted in an estimated impairment charge of $5.5 million to goodwill. The goodwill impairment valuation was finalized in the third quarter and no additional impairment charges were recorded. During the second quarter of 2012, we also recorded an impairment charge relating to intangible assets and capitalized software of the Spreebird business unit for $799,000 and $152,000, respectively.

On September 14, 2012, we changed our name from Local.com Corporation to Local Corporation. We amended our Amended and Restated Certificate of Incorporation in connection with a merger of our wholly-owned subsidiary with and into us in accordance with Section 253 of the Delaware General Corporation Law.

During the third quarter 2012, revenue from our LEC-billed subscriber bases decreased significantly due to a decision by certain LEC's to no longer provide billing services for our products and services. The majority of the LEC billing ceased at the end of August 2012 and we expect the remainder of the LEC billing to cease at the end of November 2012. In connection therewith, we accelerated the amortization of our subscriber base to align with the expected related future cash flows.

On November 1, 2012, we entered into a new Yahoo! Publisher Network Agreement with Yahoo! Inc., which provides for the distribution of Yahoo! Inc.'s paid search results by us for which we are compensation a certain percentage of the adjusted gross revenue (as defined in the agreement) derived by Yahoo! from such paid search results. The agreement with Yahoo ends on October 31, 2017, unless earlier terminated by the parties.

Outlook for Our Business According to BIA/Kelsey, the U.S. online advertising market is an over $47 billion a year industry. "Local search," that is, searches for products, services and businesses within a geographic region is an increasingly significant segment of the online advertising industry. Local search allows consumers to search for local businesses' products or services by including geographic area, zip code, city and other geographically targeted search parameters in their search requests. According to a May 2011 study, BIA/Kelsey estimates that the local search market in the United States will grow from $5.1 billion in 2010, to $8.2 billion by 2015. Consumers who conduct local searches on the Internet ("local searchers") tend to convert into buying customers at a higher rate than other types of Internet users. As a result, advertisers often pay a significant premium to place their ads in front of local searchers on websites like those powered by our Consumer Properties business, including Local.com or our network partners' websites. Additionally, local SMBs that would not normally compete at the national level for advertising opportunities are increasingly engaging in and competing for local advertising opportunities, including local search, to promote their products and services.

19-------------------------------------------------------------------------------- Table of Contents Local online search is still relatively new, and as a result, it is difficult to determine our current market share, or predict our future market share. However, we have a number of competitors that have announced an intention to increase their focus on local search with regard to U.S. online advertising, including some of the leading online advertising companies in the world, including Google, Yahoo!, and Microsoft, among many others, with greater experience and resources than we have.

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

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

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

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

As we continue to invest in our core offerings, while pursuing the acquisitions noted above, we have increased our operating expenses, mainly related to traffic acquisition costs, the deployment of new features and functionality across our business and the support of our acquired companies. We cannot give assurances that our efforts to improve our results of operations through this strategy will be successful.

Sources of Revenue We generate revenue primarily on our Consumer Properties from both direct and indirect advertiser relationships, via: • click-throughs on sponsored listings; • calls to cost-per-call advertiser listings; • lead generation; • banner ads; • subscription advertiser listings; • domain sales and services; • web hosting services; and • daily deal offerings.

Operating Expenses Cost of Revenues Cost of revenues consists of traffic acquisition costs, revenue sharing payments that we make to our network partners, and other cost of revenues. Traffic acquisition costs consist primarily of campaign costs associated with driving consumers to our Local.com website, including personnel costs associated with managing traffic acquisition programs. Other cost of revenues consists of Internet connectivity costs, data center costs, amortization of certain software license fees and maintenance, depreciation of computer equipment used in providing our paid-search services, and payment processing fees (credit cards and fees for LEC billings). We advertise on large search engine websites such as Google, Yahoo!, MSN/Bing and Ask.com, as well as other search engine websites, by bidding on certain keywords we believe will drive traffic to our Local.com website. During the three and nine months ended September 30, 2012, approximately 61% and 62%, of our overall traffic was purchased from other search engine websites. During the three and nine months ended September 30, 2012, advertising 20 -------------------------------------------------------------------------------- Table of Contents costs to drive consumers to our Local.com website were $15.2 million and $46.4 million respectively. Of the total advertising cost for the three and nine months ended September 30, 2012, $10.3 million and $32.1 million were attributable to Google, Inc. and $4.3 million and $12.7 million were attributable to Yahoo!, respectively. During the three and nine months ended September 30, 2011, approximately 68% and 66% respectively, of our overall traffic was purchased from other search engine websites. During the three and nine months ended September 30, 2011, advertising costs to drive consumers to our Local.com website were $9.4 million and $25.0 million respectively. Of the total advertising cost for the three and nine months ended September 30, 2011, $6.6 million and $18.4 million were attributable to Google, Inc. and $1.3 million and $4.1 million were attributable to Yahoo!, respectively.

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

General and Administrative General and administrative expenses consist of salaries and other costs associated with employment of our executive, finance, human resources and information technology staff, legal, tax and accounting, and professional service fees.

Research and Development Research and development expenses consist of salaries and other costs of employment of our development staff, outside contractor costs and amortization of capitalized website development costs.

Critical Accounting Policies The preparation of our consolidated financial statements in conformity with U.S.

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

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

We generate revenue when it is realizable and earned, as evidenced by click-throughs occurring on advertisers' sponsored listings, the display of a banner advertisement, the fulfillment of subscription listing obligations, the sale of deal of the day vouchers, or the delivery of Exact Match products to our customers. We enter into contracts to distribute sponsored listings and banner advertisements with our direct and indirect advertisers. Most of these contracts are short-term, do not contain multiple elements and can be cancelled at anytime. Our indirect advertisers provide us with sponsored listings with bid prices (for example, what their advertisers are willing to pay for each click-through on those listings). We recognize our portion of the bid price based upon the execution of our contractual obligations. Sponsored listings and banner advertisements are included within pages that display search results, among others, in response to keyword searches performed by consumers on our Local.com website and network partner websites. Revenue is recognized when earned based on click-through and impression activity to the extent that collection is reasonably assured from credit worthy advertisers. Management has analyzed our revenue recognition and determined that our web hosting revenue is recognized net of direct costs.

During the year ended December 31, 2010, we entered into multiple-deliverable arrangements for the sale of domains and for providing services relating to such domains. Management evaluated the agreements in accordance with the provision of the revenue recognition topic that addresses multiple-deliverable revenue arrangements. The multiple-deliverable arrangements entered into consisted of various units of accounting such as the sale of domains, website development fees, content delivery and hosting fees. Such elements were considered separate units of accounting due to each element having value to the 21-------------------------------------------------------------------------------- Table of Contents customer on a stand-alone basis. The selling price for each of the units of accounting was determined using a combination of vendor-specific objective evidence and management estimates. Revenue relating to domains was recognized with the transfer of title of such domains. Revenue for website development, content delivery and hosting fees are recognized as such services are performed or delivered. The agreements did not include any cancellation, termination or refund provisions that we consider probable. Subsequent to December 31, 2010, we did not enter into any significant multiple deliverable arrangements.

We launched our Spreebird daily deals business in May 2011. Revenue relating to the Spreebird daily deals business is recorded exclusive of the portion of gross billings paid as merchant revenue share, since we generally act as the agent, rather than the principal, when connecting merchants with online customers.

Spreebird deal vouchers are sold primarily through email marketing and our www.spreebird.com website. Revenue for our Spreebird business is recognized when earned. Revenue is considered to be earned once all revenue recognition criteria have been satisfied.

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

Allowance for Doubtful Accounts Our management estimates the losses that may result from that portion of our accounts receivable that may not be collectible as a result of the inability of our customers to make required payments. Management specifically analyzes accounts receivable and historical bad debt, customer concentration, customer credit-worthiness, current economic trends and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. If we believe that our customers' financial condition has deteriorated such that it impairs their ability to make payments to us, additional allowances may be required. We review past due accounts on a monthly basis and record an allowance for doubtful accounts generally equal to any accounts receivable that are over 90 days past due and for which collectability is not reasonably assured.

As of September 30, 2012 and December 31, 2011, two customers, Yahoo! and Google represented 56% and 47% of our total accounts receivable, respectively. These customers have historically paid within the payment period provided for under their contracts and management believes these customers will continue to do so.

Goodwill and Other Intangible Assets Goodwill representing the excess of the purchase price over the fair value of the net tangible and intangible assets arising from acquisitions and purchased domain names are recorded at cost. Intangible assets, such as goodwill and domain names, which are determined to have an indefinite life, are not amortized. The first step in determining if there is any goodwill impairment is a comparison of the estimated fair value of an internal reporting unit with its carrying amount, including goodwill. If the estimated fair value of the reporting unit exceeds its carrying value, goodwill of the reporting unit is not considered impaired and the second step is unnecessary. If the carrying value of the reporting unit exceeds its estimated fair value, the second step is performed to measure the amount of impairment by comparing the carrying amount of the goodwill to a determination of the implied value of the goodwill. If the carrying amount of goodwill is greater than the implied value, an impairment charge is recognized for the difference. We engage an independent appraiser to assist management in the valuation. We perform annual impairment reviews during the fourth fiscal quarter of each year or earlier if indicators of potential impairment exist. For other intangible assets with indefinite lives, we compare the fair value of related assets to the carrying value to determine if there is impairment. For other intangible assets with definite lives, we compare future undiscounted cash flow forecasts prepared by management to the carrying value of the related intangible asset group to determine if there is impairment. We performed our annual impairment analysis as of December 31, 2011, and determined that the estimated fair value of the reporting units exceeded its carrying value and therefore no impairment existed. The Spreebird business unit was identified as a separate reporting unit for evaluation of goodwill impairment. Due to lower than expected financial performance by the Spreebird business unit and a significant decrease in the market capitalization of comparable public companies during the second quarter of fiscal 2012, we determined that there were potential indicators of impairment at June 30, 2012. Goodwill was tested for impairment by estimating the fair value of the reporting unit using a consideration of market multiples (Level 3 Fair Value Measurement) and was written down to its estimated implied fair value, which was approximately $6.7 million as of June 30, 2012, resulting in an estimated impairment charge of approximately $5.5 million, which is included in Impairment of goodwill and intangible assets in the accompanying condensed consolidated statements of operations. We finalized the goodwill impairment review of the 22-------------------------------------------------------------------------------- Table of Contents Spreebird business unit and the related impairment charge recorded in the second quarter 2012 during the third quarter 2012. The finalization of the Spreebird goodwill impairment review did not result in any adjustments to the initial impairment charge recorded in the second quarter 2012. The Company noted no potential indicators of impairment related to the Spreebird goodwill as of September 30, 2012.

Stock Based Compensation Total stock-based compensation expense related to continuing operations recognized for the three and nine months ended September 30, 2012 and 2011, is as follows (in thousands, except per share amount): Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 2012 2011 Cost of revenues $ 22 $ 12 $ 61 $ 165 Sales and marketing 261 306 846 955 General and administrative 320 491 988 1,427 Research and development 63 87 163 313 Total stock-based compensation expense $ 666 $ 896 $ 2,058 $ 2,860 Basic and diluted net stock-based compensation expense per share $ 0.03 $ 0.04 $ 0.09 $ 0.14 Results of Operations The following table sets forth our historical operating results as a percentage of revenue for the three and nine months ended September 30, 2012 and 2011: Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 2012 2011 Revenue 100.0 % 100.0 % 100.0 % 100.0 % Operating expenses: Cost of revenues 74.5 60.4 72.6 64.7 Sales and marketing 16.8 28.5 18.8 25.2 General and administrative 10.2 14.4 10.0 16.8 Research and development 5.0 7.3 4.8 8.3 Amortization of intangibles 7.5 6.1 4.7 6.8 Impairment of goodwill and intangible assets - - 8.4 - Total operating expenses 114.0 116.7 119.3 121.7 Operating income (loss) (14.0 ) (16.7 ) (19.3 ) (21.7 ) Interest and other income (expense), net (0.5 ) (1.1 ) (0.4 ) (0.6 ) Change in fair value of warrant liability 0.3 2.5 0.2 4.7 Income (loss) from continuing operations before income taxes (14.2 ) (15.3 ) (19.5 ) (17.6 ) Provision for income taxes 0.1 0.2 0.2 0.2 Net income (loss) from continuing operations (14.3 ) (15.5 ) (19.6 ) (17.8 ) Income (loss) from discontinued operations (net of taxes) (1.0 ) (4.0 ) (1.6 ) (2.5 ) Net income (loss) (15.3 )% (19.5 )% (21.3 )% (20.3 )% 23 -------------------------------------------------------------------------------- Table of Contents Three and nine months ended September 30, 2012 and 2011 Revenue (dollars in thousands): Three Months Ended September 30, Percent Nine Months Ended September 30, Percent 2012 (*) 2011 (*) change 2012 (*) 2011 (*) change Owned and operated $ 18,340 74.0 % $ 13,457 65.0 % 36.3 % $ 56,791 73.9 % $ 33,200 62.7 % 71.1 % Network 4,961 20.0 % 4,364 21.1 % 13.7 % 13,289 17.3 % 11,805 22.3 % 12.6 % Business solutions 1,470 5.9 % 2,867 13.9 % -48.7 % 6,795 8.8 % 7,955 15.0 % -14.6 % Total revenue $ 24,771 100.0 % $ 20,688 100.0 % 19.7 % $ 76,875 100.0 % $ 52,960 100.0 % 45.2 % (*) - Percent of total revenue Owned and operated revenue for the three and nine months ended September 30, 2012, increased 36.3% and 71.1%, respectively, compared to the same periods in 2011. The increase in revenue for the three and nine months ended September 30, 2012, compared to the same period in 2011 is mainly due to increased traffic to our Local.com website, together with an increase in monetization as our revenue per thousand visitors ("RKV") increased to $276 and $287, respectively for the three and nine months ended September 30, 2012, from $254 and $220, respectively for the three and nine months ended September 30, 2011. The increase in RKV was primarily a result of changes made to our advertising partner relationships. The increase in RKV due to a new advertising partner relationship was partially offset by a significant decrease in revenue from one of our large advertising partners. The lower RKV for the three and nine months ended September 30, 2011, was primarily due to the Yahoo!/Bing alliance, which resulted in changes to the Yahoo! search and advertising platform. Starting in August 2011 we entered into a new advertising partner relationship that resulted in a significant increase in monetization of traffic to our owned and operated properties. The increase in RKV due to a new advertising partner relationship was partially offset by a significant decrease in revenue from one of our large advertising partners. The increase in traffic to our owned and operated properties are the result of higher cost of revenues to attract users as well as increased organic search traffic over the same period.

As noted above, in August 2011, we entered into an agreement with a new advertising partner. The revenue generated from such partner has been subject to seasonality, which has similarly subjected all of our owned and operated revenue results to seasonality. As such, owned and operated revenue was seasonally lower for the third quarter of fiscal 2012 compared to the first and second quarter of fiscal 2012.

Periodically traffic providers will make changes to their policies and guidelines. These changes could impact both our advertising campaigns to purchase traffic and the monetization of our search results pages. During October 2012, our largest traffic provider made certain changes to their policies and guidelines. We are working closely with this traffic provider to refine our traffic acquisition approach and user experience on our search results pages. We are assessing the impact and expect see a reduction in both traffic and monetization, which will have a negative impact on our fourth quarter of fiscal 2012 revenue and results of operations.

Network revenue for the three and nine months ended September 30, 2012, increased 13.7% and 12.6%, compared to the same periods in 2011. The increase is primarily due to increased traffic to our network partner websites and the increase in revenue per click ("RPC") from our advertising partner feed. The increase in traffic is a combination of increased cost of revenues to attract users to the network partner sites together with an increase in organic traffic over the same period.

Business Solutions revenue for the three and nine months ended September 30, 2012, decreased 48.7% and 14.6%, respectively compared to the same periods in 2011. The decrease in revenue is due to a decrease in revenue from our LEC-billed subscriber bases, partially offset by an increase in revenue from our Launch by Local product suite and revenue from our Spreebird business. The decrease in revenue from our LEC-billed subscriber bases are due to a decision by certain LEC's to no longer provide billing services for our products and services. The majority of the LEC billing ceased at the end of August 2012 and we expect the remainder of the LEC billing to cease at the end of November 2012.

We remain focused on selling our new products from our Launch by Local product suite, which are billed via credit card and are entirely unaffected by LEC billing. As of September 30, 2012, we had over 800 Launch by Local customers which are billed monthly at an average charge that is approximately six times as much as one legacy subscription customer. There can be no assurance that our efforts to secure new Launch by Local customers will be capable of offsetting the revenue and net income losses we experience from the loss of our revenue and net income by our legacy subscribers.

24-------------------------------------------------------------------------------- Table of Contents The growth in small business subscribers in prior years was a result of acquisitions of subscriber bases and internal and outsourced sales efforts. The following table provides the revenue relating to the acquisition of subscriber bases and revenue relating to internal and outsourced sales efforts (dollars in thousands): Three Months Ended September 30, Percent Nine Months Ended September 30, Percent 2012 (*) 2011 (*) change 2012 (*) 2011 (*) change Revenue from internal and outsourced sales $ 1,002 68.2 % $ 1,507 52.6 % -33.5 % $ 4,203 61.9 % $ 3,109 39.1 % 35.2 % Revenue from acquired bases 468 31.8 % 1,360 47.4 % -65.6 % 2,592 38.1 % 4,846 60.9 % -46.5 % Total sales and advertiser services revenue $ 1,470 100.0 % $ 2,867 100.0 % -48.7 % $ 6,795 100.0 % $ 7,955 100.0 % -14.6 % Based on the above, total revenue for the three and nine months ended September 30, 2012, increased 19.7% and 45.2%, respectively, compared to the same periods in 2011.

The following table identifies our major customers that represented greater than 10% of our total revenue in the periods presented: Percentage of Total Revenue Percentage of Total Revenue Three Months Ended September 30, Nine Months Ended September 30,Customer 2012 2011 2012 2011 Google, Inc 44.3 % 21.7 % 45.0 % 9.3 % Yahoo! Inc. 20.2 % 16.2 % 18.3 % 28.0 % SuperMedia Inc. 1.8 % 25.4 % 1.8 % 23.8 % Operating expenses: Operating expenses were as follows (dollars in thousands): Three Months Ended September 30, Nine Months Ended September 30, Percent of Percent of Percent of Percent of Total Total Percent Total Total Percent 2012 Revenue 2011 Revenue Change 2012 Revenue 2011 Revenue Change Cost of revenues $ 18,463 74.5 % $ 12,487 60.4 % 47.9 % $ 55,798 72.6 % $ 34,273 64.7 % 62.8 % Sales and marketing $ 4,152 16.8 % $ 5,905 28.5 % (29.7 )% $ 14,443 18.8 % $ 13,340 25.2 % 8.3 % General and administrative $ 2,522 10.2 % $ 2,975 14.4 % (15.2 )% $ 7,706 10.0 % $ 8,882 16.8 % (13.2 )% Research and development $ 1,227 5.0 % $ 1,511 7.3 % (18.8 )% $ 3,684 4.8 % $ 4,396 8.3 % (16.2 )% Amortization of intangibles $ 1,865 7.5 % $ 1,255 6.1 % 48.6 % $ 3,608 4.7 % $ 3,585 6.8 % 0.6 % Impairment of goodwill and intangible assets $ - - % $ - - % NM $ 6,451 8.4 % $ - NM NM Total operating expenses $ 28,229 114.0 % $ 24,133 116.7 % 17.0 % $ 91,690 119.3 % $ 64,476 121.7 % 42.2 % Cost of revenues Cost of revenues for the three and nine months ended September 30, 2012, increased by 47.9% and 62.8%, respectively, compared to the same periods in 2011. The increase during the three and nine months ended September 30, 2012 compared to the same periods in 2011 is due to an increase in traffic acquisition costs associated with driving consumers to our Local.com website.

The increase of cost of revenues as a percentage of total revenues is mainly due to a decrease in high margin LEC revenues as well as a decrease in high margin revenue from one of our advertising partners. Included in cost of revenues for the three and nine months ended September 30, 2012 is $56,000 and $166,000, respectively, relating to the Daily Deals segment. Included in cost of revenues for the three and nine months ended September 30, 2011 is $208,000 and $238,000, respectively, relating to the Daily Deals segment, which commenced operations in May 2011.

Sales and marketing Sales and marketing expenses for the three months ended September 30, 2012, decreased 29.7% compared to the same period in 2011. The decrease is mainly due to a decrease in personnel-related cost as part of our continued cost savings efforts. Sales and marketing expenses for the nine months ended September 30, 2012, increased 8.3% compared to the same period in 2011. The increase in due to acquisitions that occurred in the second half of 2011, partially offset by decreases in personnel related cost as part of our continued cost savings efforts. Included in sales and marketing expense for the three and nine months ended September 30, 2012 is $617,000 and $2.9 million, respectively, relating to the Daily Deals segment. Included in sales and marketing expense for the three and nine months ended September 30, 2011 is $2.6 million and $3.1 million, respectively, relating to the Daily Deals segment, which commenced operations in May 2011. The reduction in sales and marketing expense for the Daily Deals segment is mainly due to a reduction in personal related cost.

General and administrative General and administrative expenses for the three and nine months ended September 30, 2012, decreased by 15.2% and 13.2%, respectively, compared to the same periods in 2011. The decrease was mainly due to a decrease in compensation expense for the quarter, partially offset by an increase in personnel related cost due to acquisitions. Costs incurred related to the Daily Deals segment was immaterial for the three and nine months ended September 30, 2012 and 2011.

25-------------------------------------------------------------------------------- Table of Contents Research and development Research and development expenses for the three and nine months ended September 30, 2012, decreased by 18.8% and 16.2%, respectively, compared to the same periods in 2011. The decrease is mainly due to our effort to reduce technology related costs together with a larger percentage of total technology related cost being capitalized as we invest in improving existing and newly acquired technologies.

The following table sets forth research and development expenses, additional capitalized website development costs and amortization of capitalized website development costs for the periods indicated (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 2012 2011 Research and development expense $ 1,227 $ 1,511 $ 3,684 $ 4,396 Capitalized website development costs $ 457 $ 668 $ 1,704 $ 2,397 Amortization of capitalized website development costs $ (606 ) $ (552 ) $ (1,649 ) $ (1,357 ) Amortization of intangibles Amortization of intangibles expense was $1.9 million and $3.6 million for the three and nine months ended September 30, 2012, respectively, compared to $1.3 million and $3.6 million for the same periods in 2011. The increase in amortization expense was primarily due to the acceleration of amortization related to the LEC-billed subscriber bases, as the majority of billings relating to such subscriber bases ceased due to LEC's decision not to provide future billing services as it relates to our products.

Impairment of goodwill and intangible assets During the second quarter 2012, we recorded an impairment charge of $6.5 million, which consisted of the impairment of goodwill, intangible assets and capitalized software related to the Spreebird business unit.

Interest and other income (expense), net Interest and other income (expense), net were ($131,000) and ($325,000) for the three and nine months ended September 30, 2012, respectively, compared to ($227,000) and ($312,000) for the same periods in 2011. The decrease for the quarter is due to an increase in interest expense for the third quarter 2011, as all prepaid finance charges relating to the Silicon Valley Bank line of credit were expensed when the line of credit was cancelled.

Provision for income taxes Provision for income taxes was $22,000 and $121,000 for the three and nine months ended September 30, 2012 and $47,000 and $107,000 for the three and nine months ended September 30, 2011. Taxes are primarily due to anticipated tax amortization on indefinite-lived assets, partially offset by California research and development credits.

Liquidity and Capital Resources Liquidity and capital resources highlights (in thousands): September 30, December 31, 2012 2011 Cash and cash equivalents $ 3,706 $ 10,394 Working capital (deficit) $ (1,806 ) $ 1,540 Cash flow highlights (in thousands): Nine Months Ended September 30, 2012 2011Net cash (used in) provided by operating activities $ (3,747 ) $ (2,191 ) Net cash used in investing activities (2,585 ) (19,875 ) Net cash provided by financing activities (356 ) 19,106 26 -------------------------------------------------------------------------------- Table of Contents We have funded our business, to date, primarily from issuances of equity securities as well as through debt facilities. Cash was $3.7 million as of September 30, 2012, and $10.4 million as of December 31, 2011. We had a working capital deficit of $1.8 million as of September 30, 2012, and working capital of $1.5 million as of December 31, 2011. As of September 30, 2012, we had a total of $7.6 million outstanding on the revolving credit facility with Square 1 Bank.

The decrease in working capital is largely due to a decrease in cash of approximately $6.7 million, which was mainly due to the payment of expenses accrued for at December 31, 2011, and capital expenditures during the first three quarters of 2012. This decrease was partially offset by the timing of payments to vendors and cash receipts from customers. Working capital excludes the warrant liability and includes assets and liabilities held for sale.

Net cash used in operating activities was $3.7 million for the nine months ended September 30, 2012. Net loss adjusted for non-cash charges (adding back depreciation and amortization, stock-based compensation expense, change in fair value of warrant liability and asset impairment) used was approximately $1.2 million, and changes in operating assets and liabilities used cash of $2.6 million for the nine months ended September 30, 2012. Net cash used in operating activities was $2.2 million for the nine months ended September 30, 2011. Net loss adjusted for non-cash charges (adding back depreciation and amortization, stock-based compensation expense, change in fair value of warrant liability and asset impairment) used was approximately $4.3 million. Changes in operating assets and liabilities provided cash of $2.1 million.

There are four primary drivers that affect cash provided by or (used in) operations: net income (loss); non-cash adjustments to net income (loss); changes in accounts receivable; and changes in accounts payable. For the nine months ended September 30, 2012, the terms of our accounts receivable and accounts payable remained unchanged.

The table below substantiates the change in net cash provided by (used in) operating activities for the nine months ended September 30, 2012 and 2011 (in thousands): Nine Months Ended September 30, 2012 2011 Change Net income (loss) $ (16,351 ) $ (10,753 ) $ (5,598 ) Non-cash (1) 15,173 6,471 8,702 Subtotal (1,178 ) (4,282 ) 3,104 AR, AP and Other (2,569 ) 2,091 (4,660 ) Net cash (used in) provided by operations $ (3,747 ) $ (2,191 ) $ (1,556 ) (1) Includes depreciation, amortization, change in fair value of warrant liability, asset impairment, non-cash expense related to stock-based compensation and provision for doubtful accounts.

Net cash used in investing activities was $2.6 million for the nine months ended September 30, 2012, and consisted of $2.6 million of capital expenditures, primarily related to website development costs. Net cash used in financing activities was $356,000 for the nine months ended September 30, 2012, and consisted of a repayment on the Square 1 Bank line of credit of $1.4 million, partially offset by a draw on the line of credit of $1.0 million.

Net cash used in investing activities was $19.9 million for the nine months ended September 30, 2011, and consisted of $3.1 million for capital expenditures, $16.0 million acquisition related cost and $0.8 million for purchases of customer-related intangible assets. Net cash provided by financing activities was $19.1 million for the nine months ended September 30, 2011, primarily consisted of $18.2 million from a public offering of the Company's common stock, $8.0 million drawn on the our new revolving credit facility with Square 1 Bank, partially offset by the repayment of the $7.0 million outstanding balance of the revolving credit facility with SVB.

During the second half of 2011, and continuing through the third quarter 2012, we were able to reduce our operating losses (excluding impairment charges) through the restructuring of agreements with current partners, entering into agreements with new partners and continued efforts to optimize monetization on our O&O and Network properties. These changes resulted in a significant improvement in monetization compared to the prior quarters. Part of the improvement related to a new significant ad partner which was effective August 1, 2011. We have been able to increase traffic to our O&O and Network sites resulting in record traffic for the past twelve months. During October 2012, our largest traffic partner made changes to their policies and guidelines.

We expect that these changes will have a negative impact on our revenues and results of operations for the fourth quarter 2012. Although we have increased investments in recently acquired businesses, much of the investment became discretionary marketing spend beginning in the second quarter of 2012, and is accordingly now controlled based on available working capital. On October 19, 2012, we sold the Rovion business for $3.9 million. Of the $3.9 million sales price, we received $3.5 million in cash on the date of sale, while the remaining balance will be held in escrow for eighteen months and released based on the terms as stipulated in the sales agreement. The additional cash and the cost savings from the sale of Rovion should have a positive impact on our cash flow and liquidity in the fourth quarter of 2012.

27-------------------------------------------------------------------------------- Table of Contents Management believes that based upon projected operating needs, cash from operations and investing activities and availability on our revolving credit facility will be sufficient to fund our operations for at least the next 12 months. However, we continue to evaluate our operating plan and manage our cost in line with estimated revenues, including contingencies for further cost reductions if projected revenue and improvements in operating results are not fully realized. Furthermore, if the projections and assumptions used by management to form its opinion prove incorrect, then we may require additional capital to fund our operations over the next 12 months. Management cannot provide assurances that, if required, any additional equity or debt arrangements will be available to us in the future or that the required capital would be available on terms acceptable to us, if at all, or that any such activity would not be dilutive to our stockholders.

Shelf Registration Statement On January 14, 2011, we filed a new shelf registration statement with the Securities and Exchange Commission pursuant to which we registered 8,000,000 shares of our common stock. On March 23, 2011, we filed an amendment to the new shelf registration statement with an effective date of April 12, 2011. The new shelf registration statement is set to expire in April 2014. We may periodically offer all or a portion of the shares of common stock registered on the new shelf registration statement, when it becomes effective, at prices and on terms to be announced when and if the shares of common stock are so offered. The specifics of any future offerings, along with the use of proceeds of any common stock offered, will be described in detail in a prospectus supplement, or other offering materials, at the time of the offering. Our ability to sell our common stock, including on terms and at prices that are acceptable to the Company, is subject to market conditions and other factors, such as contractual commitments of our previously issued warrants.

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

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