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Table Of Contents

UNITED STATES

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 


FORM 10-Q


(Mark One)

 

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

 

For the quarterly period ended September 30, 2014

 

OR

 

 

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

 

For the transition period from              to            

 

Commission file number 001-34749

  


REACHLOCAL, INC.

(Exact name of registrant as specified in its charter)


Delaware 

20-0498783 

(State or other jurisdiction of incorporation

or organization) 

(I.R.S. Employer Identification No.) 

 

21700 Oxnard Street, Suite 1600

Woodland Hills, California 

91367 

(Address of principal executive offices) 

(Zip Code) 

 

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


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

 

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

 

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

 

Large accelerated filer ☐

Accelerated filer ☒

 

 

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

Smaller reporting company ☐

  

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 October 31, 2014 

Common Stock, $0.00001 par value

  

29,165,755

 

 
PAGE 1

Table Of Contents
 

 

INDEX

 

  

  

 

Page 

Part I.

Financial Information

3

 

Item 1.

Condensed Consolidated Financial Statements (unaudited)

  3

  

  

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

  3

  

  

Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2014 and 2013

  4

  

  

Condensed Consolidated Statements of Comprehensive Loss for the Three and Nine Months Ended September 30, 2014 and 2013

  5

  

  

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2014 and 2013

  6

  

  

Notes to the Condensed Consolidated Financial Statements

  7

  

Item 2.

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

  19

  

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

  33

  

Item 4.

Controls and Procedures

  33

  

  

  

Part II.

Other Information

35

  

Item 1.

Legal Proceedings

  35

  

Item 1A.

Risk Factors

  35

  

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

  35

  

Item 6.

Exhibits

  35

  

  

Signatures

  36

 

 
PAGE 2

Table Of Contents
 

 

PART I

 

FINANCIAL INFORMATION

 

Item 1.         FINANCIAL STATEMENTS

REACHLOCAL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

(Unaudited) 

 

   

September 30,

2014

   

December 31,

2013

 

Assets

               

Current Assets:

               

Cash and cash equivalents

  $ 51,717     $ 77,514  

Short-term investments

    259       260  

Accounts receivable, net of allowance for doubtful accounts of $3,576 and $2,212 at September 30, 2014 and December 31, 2013, respectively

    8,353       9,699  

Prepaid expenses and other current assets

    6,625       8,746  

Deferred tax assets

    1,893       1,250  

Assets of discontinued operations

    224       3,415  

Total current assets

    69,071       100,884  
                 

Property and equipment, net

    17,315       12,903  

Capitalized software development costs, net

    20,972       17,300  

Restricted deposits

    3,830       3,654  

Deferred tax assets

    2,560       1,883  

Intangible assets, net

    1,554       1,270  

Other assets

    13,409       6,032  

Goodwill

    44,198       42,083  

Total assets

  $ 172,909     $ 186,009  
                 

Liabilities and Stockholders’ Equity

               

Current Liabilities:

               

Accounts payable

  $ 34,399     $ 36,970  

Accrued compensation and benefits

    16,896       17,280  

Deferred revenue

    31,058       33,013  

Accrued restructuring

    2,767        

Other current liabilities

    14,068       15,089  

Liabilities of discontinued operations

    868       1,324  

Total current liabilities

    100,056       103,676  
                 

Deferred rent and other liabilities

    5,780       3,965  

Total liabilities

    105,836       107,641  
                 

Commitments and contingencies (Note 7)

               
                 

Stockholders’ Equity:

               

Common stock, $0.00001 par value—140,000 shares authorized; 29,192 and 28,259 shares issued and outstanding at September 30, 2014 and December 31, 2013, respectively

           

Receivable from stockholder

    (71

)

    (73

)

Additional paid-in capital

    128,232       111,934  

Accumulated deficit

    (57,111

)

    (29,559

)

Accumulated other comprehensive loss

    (3,977

)

    (3,934

)

Total stockholders’ equity

    67,073       78,368  

Total liabilities and stockholders’ equity

  $ 172,909     $ 186,009  

 

See notes to condensed consolidated financial statements.

 

 
PAGE 3

Table Of Contents
 

 

REACHLOCAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2014

   

2013

   

2014

   

2013

 

Revenue

  $ 117,623     $ 132,813     $ 365,912     $ 381,177  

Cost of revenue

    64,154       66,083       191,013       190,788  

Operating expenses:

                               

Selling and marketing

    45,479       47,291       140,386       136,021  

Product and technology

    6,746       5,582       20,521       16,728  

General and administrative

    12,183       11,282       40,877       30,405  

Restructuring charges

    518             4,567        

Total operating expenses

    64,926       64,155       206,351       183,154  

Operating income (loss)

    (11,457

)

    2,575       (31,452

)

    7,235  

Other income, net

    208       181       591       522  

Income (loss) from continuing operations before income taxes

    (11,249

)

    2,756       (30,861

)

    7,757  

Income tax provision (benefit)

    35       2,106       (2,938

)

    5,434  

Income (loss) from continuing operations

    (11,284

)

    650       (27,923

)

    2,323  

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

          (2,448

)

    593       (6,408

)

Income tax provision (benefit)

          (676

)

    222       (2,187

)

Net loss

  $ (11,284

)

  $ (1,122

)

  $ (27,552

)

  $ (1,898

)

                                 

Net income (loss) per share:

                               
                                 

Basic:

                               

Income (loss) from continuing operations

  $ (0.40

)

  $ 0.02     $ (0.98

)

  $ 0.08  

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

          (0.06

)

    0.01       (0.15

)

Net loss per share

  $ (0.40

)

  $ (0.04

)

  $ (0.97

)

  $ (0.07

)

                                 

Diluted:

                               

Income (loss) from continuing operations

  $ (0.40

)

  $ 0.02     $ (0.98

)

  $ 0.08  

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

          (0.06

)

    0.01       (0.15

)

Net loss per share

  $ (0.40

)

  $ (0.04

)

  $ (0.97

)

  $ (0.07

)

                                 

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

                               

Basic

    28,515       27,507       28,360       27,843  

Diluted

    28,515       28,652       28,360       29,303  

 

 See notes to condensed consolidated financial statements.

 

 
PAGE 4

Table Of Contents
 

 

REACHLOCAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS 

(in thousands)

(Unaudited)

  

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2014

   

2013

   

2014

   

2013

 

Net loss

  $ (11,284

)

  $ (1,122

)

  $ (27,552

)

  $ (1,898

)

Other comprehensive loss:

                               

Foreign currency translation adjustments

    (878

)

    241       (43

)

    (1,625

)

Comprehensive loss

  $ (12,162

)

  $ (881

)

  $ (27,595

)

  $ (3,523

)

 

See notes to condensed consolidated financial statements.

 

 
PAGE 5

Table Of Contents
 

 

REACHLOCAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS 

(in thousands)

(Unaudited) 

 

   

Nine Months Ended

September 30,

 
   

2014

   

2013

 

Cash flows from operating activities:

               

Income (loss) from continuing operations

  $ (27,923

)

  $ 2,323  

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

               

Depreciation and amortization

    12,595       11,374  

Stock-based compensation

    10,718       8,201  

Restructuring charges

    4,567        

Excess tax shortfalls (benefits) from stock-based awards

    1,185       (1,127 )

Provision for doubtful accounts

    1,568       513  

Non-cash interest income, net

    (243

)

     

Deferred taxes, net

    (1,325

)

     

Foreign currency unrealized loss, net

    110        

Changes in operating assets and liabilities:

               

Accounts receivable

    (728

)

    (4,908 )

Prepaid expenses and other current assets

    2,049       (5,163 )

Other assets

    (1,175

)

    (2,732 )

Accounts payable

    (3,075

)

    12,798  

Accrued compensation and benefits

    (119

)

    2,243  

Deferred revenue

    (1,938

)

    2,811  

Accrued restructuring

    (1,620

)

     

Deferred rent and other liabilities

    (413

)

    1,565  

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

    (5,767

)

    27,898  

Net cash used in operating activities, discontinued operations

    (1,402

)

    (3,499 )

Net cash provided by (used in) operating activities

    (7,169

)

    24,399  
                 

Cash flows from investing activities:

               

Additions to property, equipment and software

    (18,987

)

    (13,900 )

Acquisitions, net of acquired cash

    (1,789

)

    (363 )

Investment in partnership

    (2,000

)

    (2,500 )

Maturities of certificates of deposits and short-term investments

          2,566  

Purchases of certificates of deposits and short-term investments

    (85

)

    (2,891 )

Net cash used in investing activities, continuing operations

    (22,861

)

    (17,088 )

Net cash used in investing activities, discontinued operations

          (2,275 )

Net cash used in investing activities

    (22,861

)

    (19,363 )
                 

Cash flows from financing activities:

               

Proceeds from exercise of stock options

    6,438       5,333  

Excess tax benefits (shortfalls) from stock-based awards

    (1,185

)

    1,127  

Common stock repurchases

    (66

)

    (18,904 )

Principal payments on capital lease obligations

    (65

)

     

Net cash provided by (used in) financing activities

    5,122       (12,444 )
                 

Effect of exchange rate changes on cash and cash equivalents

    (889

)

    (2,282 )

Net change in cash and cash equivalents

    (25,797

)

    (9,690 )

Cash and cash equivalents—beginning of period

    77,514       92,320  

Cash and cash equivalents—end of period

  $ 51,717     $ 82,630  
                 

Supplemental disclosure of non-cash investing and financing activities:

               

Capitalized software development costs resulting from stock-based compensation

  $ 346     $ 317  

Deferred payment obligation decrease

  $ (290

)

  $ (122

)

Unpaid purchases of property and equipment

  $ 172     $ 256  

Investment related to the ClubLocal disposition

  $ 4,500     $  

Assets acquired under capital leases

  $ 823     $  

  

See notes to condensed consolidated financial statements.

 

 
PAGE 6

Table Of Contents
 

 

REACHLOCAL, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  

(UNAUDITED)

 

1. Organization and Description of Business

 

ReachLocal, Inc. (the “Company”) was incorporated in the state of Delaware in August 2003. The Company’s operations are located in the United States, Canada, Australia, New Zealand, Japan, the United Kingdom, Germany, the Netherlands, Austria, Belgium, Brazil, Mexico, and India. The Company’s mission is to deliver more customers to local business around the world. The Company offers a comprehensive suite of online marketing solutions, including a total digital marketing system that combines lead management, marketing automation, campaign analysis, responsive website design and a mobile app (ReachEdge™), search engine marketing (ReachSearch™), display advertising (ReachDisplay™), display retargeting (ReachRetargeting™), search engine optimization (ReachSEO™), Web presence (ReachCast™), online marketing analytics (TotalTrack®), an assisted chat service (TotalLiveChat™), and other products, each targeted to local business owners. The Company delivers its suite of services to local businesses through a combination of its proprietary technology platform, its sales force of outside and inside salespeople, and select third-party agencies and resellers. 

 

2. Summary of Significant Accounting Policies

 

Principles of Consolidation

 

The 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, 2013. The Condensed Consolidated Balance Sheet as of December 31, 2013 included herein was derived from the audited consolidated financial statements as of that date, but does not include all disclosures included in those audited consolidated financial statements.

 

The unaudited interim 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, 2014, the Company’s results of operations for the three and nine months ended September 30, 2014 and 2013 and the Company’s cash flows for the nine months ended September 30, 2014 and 2013. The results for the three and nine months ended September 30, 2014 are not necessarily indicative of the results to be expected for the year ending December 31, 2014. All references to the three and nine months ended September 30, 2014 and 2013 in the notes to the condensed consolidated financial statements are unaudited.

  

Reclassifications and Adjustments

 

Certain prior period amounts have been reclassified to conform to the current period presentation and certain adjustments related to prior reporting periods totaling $0.3 million have been recorded in other income, net, in the quarter ended September 30, 2014.

 

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.   

 

 
PAGE 7

Table Of Contents
 

 

Restricted Cash

 

Restricted cash represents certificates of deposit held at financial institutions, which are pledged as collateral for letters of credit related to lease commitments or as collateral for the Company’s merchant accounts. The restrictions will lapse when the letters of credit related to lease commitments expire at the end of the respective lease terms in 2021. The restrictions on the certificates of deposits related to the merchant accounts will lapse upon termination of the merchant accounts. Restricted certificates of deposit are classified as non-current assets. Restricted cash also includes $0.2 million of cash reserved to provide for potential liabilities for employee health care claims.

 

Commissions

 

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

 

Capital Leases

 

Assets held under capital leases are recorded at the lower of the net present value of the minimum lease payments or at the fair value of the leased asset at the inception of the lease. Amortization expense is computed using the straight-line method over the shorter of the estimated useful life of the asset or the period of the related lease. Principal payments on capital lease obligations are recorded as reduction of capital lease liability in the accompanying condensed consolidated balance sheets, and interest payments are recorded as interest expense which is included in other income, net in the accompanying condensed consolidated statements of operations.

 

    Self-Insurance

 

Beginning July 2, 2014, the Company implemented a self-insurance plan to provide for potential liabilities for employee health care claims. Liabilities associated with the risks are estimated, in part, by considering historical claims experience, demographic factors, severity factors, and other actuarial assumptions. The Company had insurance liabilities totaling approximately $0.8 million at September 30, 2014, which are included in accrued compensation and benefits in the accompanying condensed consolidated balance sheets.

 

Recent Accounting Pronouncements

 

In August 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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.

 

 
PAGE 8

Table Of Contents
 

 

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. This update supersedes some cost guidance included in ASC 605-35, Revenue Recognition - Construction-Type and Production-Type Contracts. In addition, the existing requirements for the recognition of a gain or loss on the transfer of nonfinancial assets that are not in a contract with a customer (for example, assets within the scope of ASC 360, Property, Plant, and Equipment, and intangible assets, within the scope of ASC 350, Intangibles - Goodwill and Other) are amended to be consistent with the guidance on recognition and measurement in this update. The standard will be effective for the Company as of January 1, 2017. Earlier adoption is not permitted for public entities. An entity can apply the revenue standard retrospectively to each prior reporting period presented (full retrospective method) or retrospectively with the cumulative effect of initially applying the standard recognized at the date of initial application in retained earnings (simplified transition method). The Company is currently assessing the impact of this update on its consolidated financial statements.

 

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

  

3. Fair Value of Financial Instruments

 

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

 

 

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

   

 

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

   

 

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

   

 
PAGE 9

Table Of Contents
 

 

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,

2014

   

Quoted Prices in Active Markets for Identical

Items

(Level 1)

   

Significant

Other

Observable Inputs (Level 2)

   

Significant Unobservable

Inputs

(Level 3)

 

Assets:

                               

Short-term investments

  $ 259     $ 259     $     $  

Loan receivable

  $ 350     $       350     $  

Restricted deposits

  $ 3,620     $     $ 3,620     $  
                                 

Liabilities:

                               

Contingent acquisition consideration

  $ 524     $     $     $ 524  

 

           

Basis of Fair Value Measurement

 
   

Balance at

December 31,

2013

   

Quoted Prices in Active Markets for Identical

Items

(Level 1)

   

Significant

Other

Observable Inputs (Level 2)

   

Significant Unobservable

Inputs

(Level 3)

 

Assets:

                               

Short-term investments

  $ 260     $ 260     $     $  

Restricted deposits

  $ 3,654     $     $ 3,654     $  

  

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

  

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 19.9% in an entity that was formally its ClubLocal business and the Company does not have significant influence over the entity. These investments are accounted for under the cost method and are periodically assessed for other-than-temporary impairment. If the Company determines that an other-than-temporary impairment has occurred, it will write-down the investments to their fair value. The fair value of a cost method investment is not evaluated if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value of the investment. However, if such significant adverse events were identified, the Company would estimate the fair value of its cost method investment considering available information at the time of the event, such as current cash position, earnings and cash flow forecasts, recent operational performance and any other readily available data. The carrying amounts of the Company’s cost method investments were each $4.5 million at September 30, 2014, and are included in “Other assets” in the accompanying Condensed Consolidated Balance Sheet.

 

In July 2014, the Company entered into a stock purchase agreement to acquire Kickserv, Inc. (“Kickserv”), a provider of cloud-based business management software for service businesses. The purchase price consists of $6.75 million of initial consideration, subject to a holdback and certain adjustments, and up to $4.0 million of earn-out consideration. The transaction is subject to certain closing conditions and is expected to close during the fourth quarter of 2014. Concurrently, the Company provided a loan to Kickserv of $0.4 million that will be assumed by the Company as part of the acquisition or will otherwise mature in July 2016. The loan accrues interest at 3% per annum, and under certain conditions, is convertible into equity securities of Kickserv. The loan receivable is not actively traded and its carrying value is considered to approximate its estimated fair value.

  

 
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4. Acquisitions

 

SureFire Acquisition

 

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

 

At closing, the Company 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 is deferred subject to meeting revenue targets and an indemnity holdback, which will be payable, if at all, after the 12-month anniversary of the closing date, and the 12- and 18-month anniversaries of the closing date, respectively. The maximum amount of contingent consideration payable is NZ$2.0 million ($1.6 million at September 30, 2014) 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 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 fair value of the contingent consideration at the date of acquisition was NZ$0.9 million ($0.8 million), and upon revaluation at September 30, 2014 was NZ$0.6 million ($0.5 million at September 30, 2014). The change in fair value upon revaluation of $0.3 million was recorded as other income during the three months ended September 30, 2014. The contingent consideration will continue to be revalued on a quarterly basis, with any change in the valuation recorded as other income or expense. The liability for the indemnity holdback was recorded based on the assumption that there will be no claims made against the holdback and that 65% of the indemnity holdback will be paid April 2015 with the remaining 35% to be paid October 2015. The fair value of the indemnity holdback at the date of acquisition was NZ$0.4 million ($0.4 million).

 

           The acquisition was accounted for using the acquisition method of accounting. The Company completed a preliminary purchase price allocation in the first quarter of 2014 and 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 for the nine months ended September 30, 2014. The revenues and results of operations of the acquired businesses for the periods post-acquisition were included in the condensed consolidated statements of operations and were immaterial for the period ended September 30, 2014. The pro forma results are not shown as the impact is not material.

 

 
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RealPractice Acquisition

 

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

 

Intangible Assets

 

At September 30, 2014, intangible assets from acquisitions included developed technology of $0.6 million (net of accumulated amortization of $1.9 million) and customer relationships of $0.9 million (net of accumulated amortization of $0.2 million), each amortized over three years. The carrying value of the customer relationships at September 30, 2014 includes effects of foreign currency translation. At December 31, 2013, intangible assets from acquisitions included developed technology of $1.3 million (net of accumulated amortization of $1.8 million) amortized over three years. Based on the current amount of intangibles subject to amortization, the estimated amortization expense over the remaining lives is as follows (in thousands):

 

Years Ending December 31,

       

Remainder of 2014

  $ 302  

2015

    793  

2016

    377  

2017

    82  

Total

  $ 1,554  

 

For each of the three months ended September 30, 2014 and 2013, amortization expense related to acquired intangibles was $0.3 million. For each of the nine months ended September 30, 2014 and 2013, amortization expense related to acquired intangibles was $0.9 million.

 

Goodwill

 

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

 

   

North America

   

Asia-Pacific

   

Total

 

Balance at December 31, 2013

  $ 9,695     $ 32,388     $ 42,083  

Goodwill acquired

          2,445       2,445  

Acquisition adjustments (1)

          (95

)

    (95

)

Foreign currency translation

          (235

)

    (235

)

Balance at September 30, 2014

  $ 9,695     $ 34,503     $ 44,198  

 

The North American region consists of the Company’s operations in the United States and Canada. The goodwill for the Asia-Pacific region, which includes the Company’s operations in Australia, New Zealand and Japan, includes $2.4 million related to the SureFire acquisition.

 


(1)

Represents adjustments to purchase accounting within a year of the acquisition.

 

5. Software Development Costs

 

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

 

   

September 30,

2014

   

December 31,

2013

 

Capitalized software development costs

  $ 53,348     $ 42,538  

Accumulated amortization

    (32,376

)

    (25,238

)

Capitalized software development costs, net

  $ 20,972     $ 17,300  

 

For the three months ended September 30, 2014 and 2013, the Company recorded amortization expense of $2.5 million and $2.0 million respectively. For the nine months ended September 30, 2014 and 2013, amortization expense related to software development costs was $7.2 million and $6.1 million, respectively. At September 30, 2014 and December 31, 2013, $4.5 million and $2.8 million, respectively, of capitalized software development costs were related to projects still in process.

  

 
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6. Variable Interest Entities

 

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

 

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

 

Effective September 2014, the franchise agreement was amended to be terminable by either party on 30 days’ written notice. In October 2014, OxataSMB formally notified the Company that it has appointed an insolvency specialist to dissolve its businesses. As a result of this notification, the Company terminated the franchise agreement and demanded repayment in full of all amounts loaned to OxataSMB.

 

 7. Commitments and Contingencies  

 

Capital Leases

 

The Company has entered into non-cancellable capital leases for computer equipment. At September 30, 2014, the Company had $0.8 million of capital leases included in other current liabilities and deferred rent and other liabilities in the accompanying condensed consolidated balance sheets. The interest rates on these leases range from 4.8% to 5.2%. As of September 30, 2014, future minimum payments under these leases are as follows (in thousands):

 

Years Ended December 31,

       

Remainder of 2014

  $ 79  

2015

    315  

2016

    315  

2017

    173  

Total minimum payments

    882  

Less amount representing interest

    (58

)

Present value of obligation

  $ 823  

 

Litigation

 

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

 

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

   

8. Stockholders’ Equity

 

Common Stock Repurchases

 

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

 

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

 

9. Stock-Based Compensation

 

Stock Options

 

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

  

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

 

   

Number of

Shares

   

Weighted

Average

Exercise

Price per

Share

   

Weighted

Average

Remaining Contractual

Life

(in years)

   

Aggregate

Intrinsic

Value

 

Outstanding at December 31, 2013

    6,733     $ 11.44                  

Granted

    2,499     $ 9.41                  

Exercised

    (718 )   $ 8.96                  

Forfeited

    (2,944 )   $ 11.94                  

Outstanding at September 30, 2014

    5,570     $ 10.58       5.5     $ 188  
                                 

Vested and exercisable at September 30, 2014

    2,571     $ 11.30       4.4     $ 188  
                                 

Unvested at September 30, 2014, net of estimated forfeitures

    2,683     $ 10.00       6.4     $  

 

 
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      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, 2014 and 2013.

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2014

   

2013

   

2014

   

2013

 

Expected dividend yield

    0

%

    0

%

    0

%

    0

%

Risk-free interest rate

    1.62

%

    1.36

%

    1.63

%

    0.92

%

Expected life (in years)

    4.75       4.75       5.08       4.81  

Expected volatility

    54

%

    57

%

    54

%

    59

%

 

The per-share weighted-average grant date fair value of options granted during the nine months ended September 30, 2014 was $4.37. The aggregate intrinsic value of stock options exercised during the nine months ended September 30, 2014 was $2.7 million.

   

Restricted Stock and Restricted Stock Units

 

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

 

   

Number of

shares

   

Weighted

Average Grant

Date Fair Value

 

Unvested at December 31, 2013

    1,157     $ 9.44  

Granted

    234     $ 7.59  

Forfeited

    (188 )   $ 12.41  

Vested

    (259 )   $ 12.29  

Unvested at September 30, 2014

    944     $ 9.03  

 

Stock-Based Compensation Expense

 

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

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2014

   

2013

   

2014

   

2013

 

Stock-based compensation

  $ 2,798     $ 3,266     $ 11,064     $ 8,518  

Less: Capitalized stock-based compensation

    127       126       346       317  

Stock-based compensation expense, net

  $ 2,671     $ 3,140     $ 10,718     $ 8,201  

  

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,

 
   

2014

   

2013

   

2014

   

2013

 

Stock-based compensation expense, net

                               

Cost of revenue

  $ 205     $ 171     $ 735     $ 442  

Selling and marketing

    616       720       2,352       2,214  

Product and technology

          165       608       427  

General and administrative

    1,850       2,084       7,023       5,118  
    $ 2,671     $ 3,140     $ 10,718     $ 8,201  

  

 Stock-based compensation for the nine months ended September 30, 2014 includes $1.9 million of expense related to the extension, on March 27, 2014, of time to exercise from seven years to ten years for certain options granted during 2008 and 2009, with a strike price of $10.91. Grants to 73 participants were modified. At September 30, 2014, there was $17.6 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 1.4 years. Future stock-based compensation expense for these awards may differ in the event actual forfeitures deviate from management’s estimates.

 

 
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On October 21, 2014, the Company filed its Notice of Special Meeting of Stockholders and Proxy Statement for the Special Meeting of Stockholders of the Company to be held on November 24, 2014, which contains a proposal submitted to the Company’s stockholders to approve a one-time stock option exchange for eligible employees. The proposed option exchange would permit 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 our common stock on the replacement grant date. The proposed option exchange is subject to approval of the Company’s stockholders and the Board of Directors, Compensation Committee and senior management retain the discretion not to commence the option exchange even if approved by the stockholders.

 

The proposed option exchange is a one-for-one exchange and therefore will not result in a reduction of the Company’s total number of outstanding options. If approved by the Company’s stockholders and the Board of Directors, Compensation Committee or senior management determine to implement the stock option exchange, it is expected to commence during the fourth quarter of 2014.

 

10. Restructuring Charges

 

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

 

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

  

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

 

   

Workforce Reduction Costs

   

Facility Closures
and Equipment
Write-downs

   

Total

 

Balance at December 31, 2013

  $     $     $  

Amounts accrued

    683       3,354       4,037  

Amounts paid

    (683

)

    (502

)

    (1,185

)

Accretion

          16       16  

Non-cash items

          (196

)

    (196

)

Balance at September 30, 2014

  $     $ 2,672     $ 2,672  

 

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

 

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

 

 
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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

 

Balance at December 31, 2013

  $  

Amounts accrued

    530  

Amounts paid

    (435

)

Balance at September 30, 2014

  $ 95  

 

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

 

 11. Income Taxes

 

The Company provides for income taxes in interim periods based on the estimated effective income tax rate for the complete fiscal year. For the quarter ended September 30, 2014, the Company’s provision for income taxes on a pre-tax loss from continuing operations of $11.2 million was due to a reduction of deferred tax assets related to post-vesting forfeitures of stock options. The income tax provision is computed on the year to date pretax income of the consolidated entities located within each taxing jurisdiction based on current tax law. Deferred tax assets and liabilities are determined based on the future tax consequences associated with temporary differences between income and expenses reported for financial accounting and tax reporting purposes. A valuation allowance for deferred tax assets is recorded to the extent the Company determines that it is more likely than not that the deferred tax assets will not be realized.

 

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

   

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.  

 

12. Net Income (Loss) Per Share

 

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

  

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

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2014

   

2013

   

2014

   

2013

 

Deferred stock consideration and unvested restricted stock

    893       403       739       304  

Stock options and warrant

    6,696       4,108       6,621       3,598  
      7,589       4,511       7,360       3,902  

 

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

  

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,

 
   

2014

   

2013

   

2014

   

2013

 

Numerator:

                               

Income (loss) from continuing operations

  $ (11,284

)

  $ 650     $ (27,923

)

  $ 2,323  

Denominator:

                               

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

    28,515       27,507       28,360       27,843  

Deferred stock consideration and unvested restricted stock

          318             287  

Stock options and warrant

          827             1,173  

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

    28,515       28,652       28,360       29,303  
                                 

Income (loss) per share from continuing operations, basic

  $ (0.40

)

  $ 0.02     $ (0.98

)

  $ 0.08  
                                 

Income (loss) per share from continuing operations, diluted

  $ (0.40

)

  $ 0.02     $ (0.98

)

  $ 0.08  

 

 13. Segment Information

 

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

 

14. Discontinued Operations

 

ClubLocal

 

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

 

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

 

Cautionary Notice Regarding Forward-Looking Statements

 

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

 

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

 

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

 

Overview

 

ReachLocal’s mission is to deliver more customers to local businesses around the world. We began in 2004 with the goal of helping local businesses move their advertising spend from traditional media and yellow pages to online search. While we have sold to a variety of local businesses and will continue to do so, our present focus is on 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 digital marketing needs. Our goal is to be the “one-stop shop” for local businesses’ online marketing needs.

 

With the rollout of ReachSearch in 2005, we pioneered the provisioning of search engine marketing services (SEM) on a mass scale for 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. This product enabled us to become one of the largest adTech companies focusing on local businesses. ReachSearch remains the leading SEM offering for local businesses in the market and was recently recognized by Google in the United States with its 2013 “Best Quality Accounts” award. However, ReachSearch only solves part of the marketing challenges of our 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. 

  

We also recognize that even successfully driving leads to our clients does not represent a complete solution to our local business owners’ digital marketing needs. This led to our next major product rollout—ReachEdge. The launch of ReachEdge in North America in 2013 was our first step to move beyond being a media-driven lead generation business to offer integrated solutions that address the majority of the digital marketing needs of our clients. ReachEdge is an integrated marketing solution that combines lead management, marketing automation, campaign analysis, responsive website design and a mobile app into a single package that helps local businesses take complete control of their digital marketing processes. ReachEdge represents a significant step to allow us to leverage our collection of critical lead generation and conversion data in order to enhance the performance of our online marketing services for the benefit of our clients. Each ReachEdge site also includes a mobile optimized version of the site reflecting that leads for local businesses are increasingly coming from mobile devices. We believe that ReachEdge can both significantly enhance a client’s ability to convert leads into customers and, over time, could substantially increase our share of our clients’ marketing expenditures. ReachEdge further enhances the ability of our clients to convert leads that we are generating for them through ReachSearch and our other products, while at the same time providing even further transparency into the efficacy of our advertising products. This automated platform will form the basis for a multiproduct engagement with our clients. We have introduced ReachEdge in Australia and the United Kingdom and will continue to introduce it in selected other of our international markets in the near term.

 

 
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We plan over time to add further dynamic optimization functionality to ReachEdge, as well as features that create a more seamless relationship between our clients and their customers, such as real-time appointment booking. Many local businesses already spend marketing dollars in these categories, and we hope to shift some of that spending to our integrated solutions. In 2014, we introduced ReachSEO, our search engine optimization product, in the US and Australia. ReachSEO drives organic search traffic to ReachEdge client websites with a range of features, including site optimization, custom content, and distribution of site listings across hundreds of directories.

 

During 2015 we plan to introduce a new product that allows local businesses to pair ReachEdge’s lead management, marketing automation, campaign analysis, and mobile app features with their own websites.

 

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

 

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

 

During 2013 we made significant changes to our Direct Local sales model. We expanded our inside sales force (a dedicated telemarketing sale force) in North America. Our inside sales force is designed to expand our geographic reach while reducing selling costs. 

 

We also commenced a significant realignment of our sales force in North America (which consists of the United States and Canada) beginning at the end of 2013. Historically, we sold our products directly, through our “feet-on-the-street” sales force of internet marketing consultants, or IMCs. Previously, IMCs both generated new business and remained the primary contact for their clients. This sales structure worked well for a company that was primarily selling one product and we believe that our substantial corps of experienced IMCs has historically provided us with a significant competitive advantage. As we move more deeply into integrated solutions, however, we believe we require more specialization within our sales structure and beginning in late 2013, we have shifted our North American sales organization to a hunter/farmer model. Our Sales Executives (SEs), our hunters, are product experts who are solely focused on new client generation, and they are compensated for generating new clients. Our Account Executives (AEs), our farmers, are solely focused on client retention and account growth, and they are compensated for retaining and upselling existing clients. This transition also occurred in some of our international markets. However, this transition has not proven effective and has affected our results adversely through September 30, 2014 and will likely continue to adversely affect our results in the near term. As a result, we are expending considerable time and resources to modify our go-to-market model and plan to launch a refined approach in North America during the first quarter of 2015.

 

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

 

In addition to our Direct Local channel, we also employ a separate sales channel targeting national brands, franchises and strategic accounts with operations in multiple local markets and select third-party agencies and resellers. We refer to this as our NBAR channel. In addition, we sell and provide access to our technology platform to select third-party agencies and resellers in customer segments where they have sales forces with established relationships with their local business client bases. We currently have over 600 agencies and resellers actively selling on our technology platform.

  

 
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Operating Metrics

 

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

 

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

 

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

 

At September 30, 2014, we had approximately 21,900 Active Clients and 33,200 Active Product Units, as compared to approximately 24,600 Active Clients and 36,400 Active Product Units at September 30, 2013. Active Clients and Active Product Units decreased over the three months ended September 30, 2014, primarily due to a decrease in the number of North American Direct Local clients, partially offset by an increase in the number of International Direct Local clients. Active Clients and Active Product Units decreased by 6% and 4%, respectively, compared to the period ended June 30, 2014. The decrease in the number of North American Direct Local clients was a result of decreased new customer acquisitions due to lower sales productivity and lower customer retention, both during the first half of the year and the quarter, which we believe are primarily attributable to our realignment of the North American Direct Local sales force.

 

 Basis of Presentation

 

Discontinued Operations

 

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

  

Sources of Revenue

 

We derive our revenue principally from the provision and sale of online marketing services to our clients. Revenue includes (i) the sale of our ReachSearch, ReachDisplay, ReachRetargeting and other products based on a package pricing model in which our clients commit to a fixed fee that includes the media, optimization, reporting and tracking technologies of our technology platform, and the personnel dedicated to support and manage their campaigns; (ii) the license (or sale) of our ReachEdge, ReachSEO, TotalLiveChat, ReachCast, TotalTrack, and other products and services; and (iii) set-up, management and service fees associated with these products and other services. We distribute our products and services directly through our outside and inside sales force that is focused on serving 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. 

 

 
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We typically enter into multi-month agreements for the delivery of our products. Under our agreements, our Direct Local clients typically pay, in advance, a fixed fee on a monthly basis, which includes all charges for the included technology and media services, management, third-party content and other costs and fees. We record these prepayments as deferred revenue and only record revenue for income statement purposes as we purchase media and perform other services on behalf of clients. Certain Direct Local clients are extended credit privileges, with payment generally due in 30 days. There were $4.6 million and $4.2 million of accounts receivable related to our Direct Local channel at September 30, 2014 and December 31, 2013, respectively.

 

Our National Brands, Agencies and Resellers clients enter into agreements of various lengths or that are indefinite. Our National Brands, Agencies and Resellers clients either pay in advance or are extended credit privileges with payment generally due in 30 to 60 days. There were $5.2 million and $4.6 million of accounts receivable related to our National Brands, Agencies and Resellers at September 30, 2014 and December 31, 2013, respectively.

  

Cost of Revenue

 

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

 

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

 

Operating Expenses

 

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

 

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

 

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

 

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

 

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

  

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 condensed consolidated financial statements and the reported amounts of revenue and expenses. We continually evaluate our estimates, judgments and assumptions based on available information and experience. Because the use of estimates is inherent in the financial reporting process, actual results could differ from those estimates.

 

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

 

Restricted Cash

 

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

 

Commissions

 

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

 

Capital Leases

 

Assets held under capital leases are recorded at the lower of the net present value of the minimum lease payments or at the fair value of the leased asset at the inception of the lease. Amortization expense is computed using the straight-line method over the shorter of the estimated useful lives of the asset or the period of the related lease. Principal payments on capital lease obligations are recorded as reduction of capital lease liability in the accompanying condensed consolidated balance sheets, and interest payments are recorded as interest expense which is included in other income, net in the accompanying condensed consolidated statements of operations.

 

 Self-Insurance

 

Beginning July 1, 2014, we implemented a self-insurance plan to provide for potential liabilities for employee health care claims. Liabilities associated with the risks are estimated, in part, by considering historical claims experience, demographic factors, severity factors and other actuarial assumptions.

 

 
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Restructuring Charges

 

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

  

Results of Operations

 

Comparison of the Three and Nine Months Ended September 30, 2014 and 2013

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2014

   

2013

   

2014

   

2013

 

(in thousands)

                               

Revenue

  $ 117,623     $ 132,813     $ 365,912     $ 381,177  

Cost of revenue (1)

    64,154       66,083       191,013       190,788  

Operating expenses:

                               

Selling and marketing (1)

    45,479       47,291       140,386       136,021  

Product and technology (1)

    6,746       5,582       20,521       16,728  

General and administrative (1)

    12,183       11,282       40,877       30,405  

Restructuring charges

    518             4,567        

Total operating expenses

    64,926       64,155       206,351       183,154  

Operating income (loss)

    (11,457

)

    2,575       (31,452

)

    7,235  

Other income, net

    208       181       591       522  

Income (loss) from continuing operations before income taxes

    (11,249

)

    2,756       (30,861

)

    7,757  

Income tax provision (benefit)

    35       2,106       (2,938

)

    5,434  

Income (loss) from continuing operations

    (11,284

)

    650       (27,923

)

    2,323  

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

          (2,448

)

    593       (6,408

)

Income tax provision (benefit)

          (676

)

    222       (2,187

)

Net loss

  $ (11,284

)

  $ (1,122

)

  $ (27,552

)

  $ (1,898

)

 

 


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

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2014

   

2013

   

2014

   

2013

 

Stock-based compensation:

                               

Cost of revenue

  $ 205     $ 171     $ 735     $ 442  

Selling and marketing

    616       720       2,352       2,214  

Product and technology

          165       608       427  

General and administrative

    1,850       2,084       7,023       5,118  
    $ 2,671     $ 3,140     $ 10,718     $ 8,201  

 

                               

Depreciation and amortization:

                               

Cost of revenue

  $ 161     $ 181     $ 507     $ 579  

Selling and marketing

    746       651       2,055       2,300  

Product and technology

    2,938       2,553       8,546       7,742  

General and administrative

    510       323       1,487       753  
    $ 4,355     $ 3,708     $ 12,595     $ 11,374  

        

 
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Revenue

 

   

Three Months Ended September 30,

           

Nine Months Ended September 30,

         
   

2014

   

2013

   

2014-2013

% Change

   

2014

   

2013

   

2014-2013

% Change

 

(in thousands)

                                               

Direct Local

  $ 91,914     $ 105,873       (13.2

)%

  $ 287,643     $ 304,321       (5.5

)%

National Brands, Agencies and Resellers

    25,709       26,940       (4.6

)%

    78,269       76,856       1.8

%

Total revenue

  $ 117,623     $ 132,813       (11.4

)%

  $ 365,912     $ 381,177       (4.0

)%

 

   

Three Months Ended September 30,

           

Nine Months Ended September 30,

         
   

2014

   

2013

   

2014-2013

% Change

   

2014

   

2013

   

2014-2013

% Change

 

(in thousands)

                                               

North America (1)

  $ 71,280     $ 88,167       (19.2

)%

  $ 225,336     $ 257,095       (12.4

)%

International (1)

    46,343       44,646       3.8

%

    140,576       124,082       13.3

%

Total revenue

  $ 117,623     $ 132,813       (11.4

)%

  $ 365,912     $ 381,177       (4.0

)%

 

   

September 30,

         
   

2014

   

2013

         

At period end:

                       

Active Clients (2)

    21,900       24,600       (11.0

)%

Active Product Units (3)

    33,200       36,400       (8.8

)%

 


(1)

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

 

(2)

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

 

(3)

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

 

The decreases in Direct Local revenue of $14.0 million and $16.7 million for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013 were primarily due to the continuing decline in North American revenue as a result of decreased new customer acquisitions due to lower sales productivity and lower customer retention during both the first half of the year and the three months ended September 30, 2014, which we believe are primarily attributable to our realignment of the North American Direct Local sales force. The decline in revenue was partially offset by an increase in the number of international Direct Local clients, including clients acquired as part of the SureFire acquisition in March 2014. Revenue from SureFire, previously one of our resellers, was historically reported as part of our National Brands, Agencies and Resellers channel. Revenue from SureFire clients included in Direct Local revenue that was not previously reported as part of our Direct Local channel was $2.2 million and $4.4 million for the three and nine months ended September 30, 2014, respectively.

 

 
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During the three and nine months ended September 30, 2014, North American Direct Local revenue decreased 25.1% and 17.2%, respectively, as compared to the prior year period, which we principally attribute to the realignment of our North American Direct Local sales force in late 2013 and its impact on sales force productivity and client experience. Since the realignment, we have continued to experience high attrition in our North American sales force, which had negatively impacted client retention and spending. North American Direct Local revenue during the three months ended September 30, 2014 decreased 9.3% from the three months ended June 30, 2014. Growth in our Direct Local channel in North America will depend on our ability to improve our go-to-market strategies and the introduction of new products. We believe the sales force realignment likely will continue to affect our results adversely in the near term, however, we plan to launch a refined approach in North America during the first quarter of 2015. Growth in our Direct Local channel generally will also depend on our success in our international markets and our ability to successfully launch new products internationally.

    

The decrease in National Brands, Agencies and Resellers revenue of $1.2 million for the three months ended September 30, 2014, compared to the same period in 2013, was due to a decline in the number of National Brands clients, slightly offset by the increase in the number of international Agencies and Resellers. The increase in National Brands, Agencies and Resellers revenue of $1.4 million for the nine months ended September 30, 2014, compared to the same period in 2013, was due to growth in the number of international Agencies and Resellers, partially offset by a decrease in the number of international National Brands clients. Due to the SureFire acquisition, SureFire-related revenue that had been reported as part of our National Brands, Agencies and Resellers channel prior to the acquisition is reported as part of our Direct Local channel post-acquisition. There was no revenue from SureFire included in National Brands, Agencies and Resellers for the three months ended September 30, 2014 as compared to $1.3 million in the prior-year period. Revenue from SureFire included in National Brands, Agencies and Resellers for the nine months ended September 30, 2014 was $1.3 million as compared to $3.6 million in the prior-year period.

 

  The impact of foreign currency translation during the three and nine months ended September 30, 2014 was not significant as a percentage of revenues.

 

Cost of Revenue

 

   

Three Months Ended September 30,

           

Nine Months Ended September 30,

         
   

2014

   

2013

   

2014-2013

% Change

   

2014

   

2013

   

2014-2013

% Change

 

(in thousands)

                                               

Cost of revenue

  $ 64,154     $ 66,083       (2.9

)%

  $ 191,013     $ 190,788       0.1

%

As a percentage of revenue:

    54.5

%

    49.8

%

            52.2

%

    50.1

%

 

 

 

 

 

The increases in our cost of revenue as a percentage of revenue for the three and nine months ended September 30, 2014, compared to the same periods in 2013, were primarily due to a decrease in publisher rebates as a result of our new agreement with Google which changed our rebate terms, an increase in service, support, and third party costs primarily related to the launch of our ReachEdge and ReachSEO products, and the change in our geographic, product and service mix. Publisher rebates as a percentage of revenue decreased to 0.6% and 3.0% of revenue during the three and nine months ended September 30, 2014, respectively, compared to 4.2% and 4.1% during the same periods in 2013, as more fully described below.

 

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

 

On June 27, 2014, we entered into a new global agreement with Google Inc. and certain of its affiliates that replaces our expiring Google agreement. The new Google agreement provides rebates based on overall global growth of our spending with Google, as opposed to commitments to enter new markets and market-specific growth targets. We did not receive rebates from Google during the three months ended September 30, 2014, and we do not expect to receive rebates from Google in the fourth quarter of 2014. However, the new Google agreement provides the opportunity for us to earn rebates in amounts similar to our previous Google agreement if our operating performance improves.

 

 
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Operating Expenses

 

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

 

Selling and Marketing 

  

   

Three Months Ended September 30,

    2014-2013    

Nine Months Ended September 30,

    2014-2013  
   

2014

   

2013

   

% Change

   

2014

   

2013

   

% Change

 

(in thousands)

                                               

Salaries, benefits and other costs

  $ 36,099     $ 33,632       7.3

%

  $ 109,613     $ 96,660       13.4

%

Commission expense

    9,380       13,659       (31.3

)%

    30,773       39,361       (21.8

)%

Total selling and marketing

  $ 45,479     $ 47,291       (3.8

)%

  $ 140,386     $ 136,021       3.2

%

                                                 

As a percentage of revenue:

                                               

Salaries, benefits and other costs

    30.7

%

    25.3

%

            30.0

%

    25.4

%

       

Commission expense

    8.0       10.3               8.4       10.3          

Total selling and marketing

    38.7

%

    35.6

%

            38.4

%

    35.7

%

       

 

The increase in selling and marketing salaries, benefits and other costs as a percentage of revenue for the three and nine months ended September 30, 2014, compared to the same periods in 2013, were primarily due to the decrease in revenue and increases in salaries and fixed costs as a result of partially replacing residual commissions with base compensation for most of our North American sales personnel under the recent realignment of that sales force. The increase in selling and marketing salaries, benefits and other costs in absolute dollars was primarily a result of the shift to base compensation from residual commissions.

 

The decreases in commission expense in absolute dollars and as a percentage of revenue for the three and nine months ended September 30, 2014, as compared to the same periods in 2013, were due to a decrease in sales activity and a change in compensation structure in North America in connection with the North American sales force realignment, and a higher percentage of revenue from our international Direct Local channel, for which we have historically paid lower commission rates.

 

As sales activity increases, we would expect increases in selling and marketing expenses, both in absolute dollars and as a percentage of revenue.

 

Product and Technology

 

   

Three Months Ended September 30,

    2014-2013    

Nine Months Ended September 30,

    2014-2013  
   

2014

   

2013

   

% Change

   

2014

   

2013

   

% Change

 

(in thousands)

                                               

Product and technology expenses

  $ 6,746     $ 5,582       20.8

%

  $ 20,521     $ 16,728       22.7

%

Capitalized software development costs from product and technology resources

    3,340       2,911       14.7

%

    10,472       8,267       26.7

%

Total product and technology expenses and capitalized costs

  $ 10,086     $ 8,493       18.8

%

  $ 30,993     $ 24,995       24.0

%

                                                 

Percentage of revenue:

                                               

Product and technology expenses costs

    5.7

%

    4.2

%

            5.6

%

    4.4

%

       

Capitalized software development costs from product and technology resources

    2.8       2.2               2.9       2.2          

Total product and technology costs expensed and capitalized

    8.5

%

    6.4

%

            8.5

%

    6.6

%

       

 

 
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The increases in product and technology expenses in absolute dollars and as a percentage of revenue for the three and nine months ended September 30, 2014, compared to the same periods in 2013, were primarily attributable to increased professional services costs of $0.9 and $3.8 million, respectively, and increased salaries and compensation expense of $0.3 million and $1.9 million, respectively, as a result of additional consultants and employees engaged in the ongoing development of our technology platform and new product initiatives. The increases were partially offset by $0.4 million and $2.2 million, respectively, of increased capitalization due to an increase in capitalizable projects, including those relating to our new product initiatives. The increases in product and technology expenses as a percentage of revenue were also a result of decreased revenue.

  

We expect our product and technology expenses to continue to increase in absolute dollars as we invest in new product initiatives, significantly improving and expanding our technology platform, and increasing the pace of international launches of new products and solutions.

 

General and Administrative

 

   

Three Months Ended September 30,

   

2014-2013

   

Nine Months Ended September 30,

   

2014-2013

 
   

2014

   

2013

   

% Change

   

2014

   

2013

   

% Change

 

(in thousands)

                                               

General and administrative

  $ 12,183     $ 11,282       8.0

%

  $ 40,877     $ 30,405       34.4

%

As a percentage of revenue:

    10.4

%

    8.5

%

            11.2

%

    8.0

%

       

 

The increases in general and administrative expenses in absolute dollars and as a percentage of revenue for the three months ended September 30, 2014, compared to the same period in 2013, were primarily due to a $0.8 million increase in employee-related costs primarily as a result of increased salaries and payroll costs. The increase in general and administrative expenses as a percentage of revenue was also a result of decreased revenue.

 

The increases in general and administrative expenses in absolute dollars and as a percentage of revenue for the nine months ended September 30, 2014, compared to the same period in 2013, were primarily due to a $2.6 million increase in legal fees and contingencies and a $1.1 million increase in bad debt expense, each primarily related to one of our international markets, a $3.3 million increase in employee-related costs largely as a result of increased salaries and payroll costs, and a $1.9 million increase in stock-based compensation expense as a result of extending, on March 27, 2014, the time to exercise from seven to ten years for certain options granted during 2008 and 2009 with a strike price of $10.91. The increase in general and administrative expenses as a percentage of revenue was also a result of decreased revenue.

 

Restructuring Charges

 

During the first quarter of 2014, we began implementing a restructuring plan to streamline operations and increase profitability. We recorded restructuring charges totaling $0.5 million during the three months ended September 30, 2014, related to employee termination costs and lease termination costs for certain facilities in North America. Restructuring charges for the three and nine months ended September 30, 2014 totaled $0.5 million and $4.6 million, respectively, consisting of $0.1 million and $1.2 million, respectively, of employee termination costs as a result of a reduction of our North American and international workforce, and $0.4 million and $3.4 million, respectively, of lease termination costs for certain facilities in North America and certain international markets. We expect the restructuring to result in operational savings, primarily in operating expenses, of approximately $9.0 million in 2014.

 

During the second quarter of 2014, we began implementing a business restructuring plan to further streamline operations and increase profitability. We have recorded restructuring charges totaling $0.5 million related to the elimination of certain senior management positions. We expect the actions already taken under the plan to result in operational savings, primarily in operating expenses, of approximately $1.3 million in 2014, and we expect to have continued activity under this plan throughout 2014.

 

 
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Other Income, Net

 

Other income, net remained relatively flat for the three and nine months ended September 30, 2014, respectively, compared to the same periods in 2013, and included the revaluation of the contingent consideration for SureFire, partially offset by a net foreign currency unrealized loss. Other income, net also consists of interest income resulting from invested balances. 

  

Provision for Income Taxes

 

The income tax provision of $35,000 for the three months ended September 30, 2014, the income tax benefit of $2.9 million for the nine months ended September 30, 2014, and the income tax expense of $2.1 million and $5.4 million for the three and nine months ended September 30, 2013, respectively, each relate to U.S. Federal and State taxes as well as certain foreign income taxes. The overall decreases in tax expense during the three and nine month periods ended September 30, 2014, were primarily due to lower operating performance in the United States compared to the same periods in 2013, offset by a reduction of deferred tax assets related to post-vesting forfeitures of stock options. In addition, the Company recognized the benefit of certain tax attributes in the current period which were subject to valuation allowances or otherwise not available in the prior year period.

 

Our effective tax rate differs from the federal statutory rate due to federal, state and foreign income taxes and significant permanent differences arising from research and development credits, foreign tax rate benefits, and stock-based compensation expense related to grants to foreign employees, offset by tax benefits from disqualifying dispositions.

 

Non-GAAP Financial Measures

 

In addition to our GAAP results discussed above, we believe Adjusted EBITDA is useful to investors in evaluating our operating performance. For the three and nine months ended September 30, 2014 and 2013, our Adjusted EBITDA was as follows: 

 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 
   

2014

   

2013

   

2014

   

2013

 

(in thousands)

                               

Operating income (loss)

  $ (11,457 )   $ 2,575     $ (31,452 )   $ 7,235  

Add:

                               

Depreciation and amortization

    4,355       3,708       12,595       11,374  

Stock-based compensation, net

    2,671       3,140       10,718       8,201  

Acquisition and integration costs

    70             86        

Restructuring charges

    518             4,567        

Adjusted EBITDA

  $ (3,843 )   $ 9,423     $ (3,486 )   $ 26,810  
 

(1)

Adjusted EBITDA. We define Adjusted EBITDA as net income (loss) from continuing operations before interest, income taxes, depreciation and amortization expenses, excluding, when applicable, stock-based compensation, the effects of accounting for business combinations (including any impairment of acquired intangibles and, in the case of the acquisition of SMB:LIVE, the deferred cash consideration), restructuring charges, and other non-operating income or expense.

 

Our management uses Adjusted EBITDA because (i) it is a key basis upon which our management assesses our operating performance; (ii) it may be a factor in the evaluation of the performance of our management in determining compensation; (iii) we use it, in conjunction with GAAP measures such as revenue and income (loss) from operations, for operational decision-making purposes; and (iv) we believe it is one of the primary metrics investors use in evaluating Internet marketing companies.

 

 
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We believe that Adjusted EBITDA permits an assessment of our operating performance, in addition to our performance based on our GAAP results that is useful in assessing the progress of the business. By excluding (i) the effects of accounting for business combinations and associated acquisition and integration costs, which obscure the measurable performance of the business operations; (ii) depreciation and amortization and other non-operating income and expense, each of which may vary from period to period without any correlation to underlying operating performance; and (iii) stock-based compensation, which is a non-cash expense, we believe that we are able to gain a fuller view of the operating performance of the business. We provide information relating to our Adjusted EBITDA so that investors have the same data that we employ in assessing our overall operations. We believe that trends in our Adjusted EBITDA are a valuable indicator of operating performance on a consolidated basis and of our ability to produce operating cash flow to fund working capital needs, and capital expenditures.

  

In addition, we believe that Adjusted EBITDA and similar measures are widely used by investors, securities analysts, ratings agencies and other interested parties in our industry as a measure of financial performance and debt-service capabilities. Our use of Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:

 

  

Adjusted EBITDA does not reflect our cash expenditures for capital equipment or other contractual commitments;

  

Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and Adjusted EBITDA does not reflect capital expenditure requirements for such replacements;

  

Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;

  

Adjusted EBITDA does not consider the potentially dilutive impact of issuing equity-based compensation to our management team and employees;

  

Adjusted EBITDA does not reflect the potentially significant interest expense or the cash requirements necessary to service interest or principal payments on indebtedness we may incur in the future;

  

Adjusted EBITDA does not reflect income and expense items that relate to our financing and investing activities, any of which could significantly affect our results of operations or be a significant use of cash;

  

Adjusted EBITDA does not reflect certain tax payments that may represent a reduction in cash available to us; and

  

Other companies, including companies in our industry, calculate Adjusted EBITDA measures differently, which reduces its usefulness as a comparative measure.

  

Adjusted EBITDA is not intended to replace operating income (loss), net income (loss) and other measures of financial performance reported in accordance with GAAP. Rather, Adjusted EBITDA is a measure of operating performance that you may consider in addition to those measures. Because of these limitations, Adjusted EBITDA should not be considered as a measure of discretionary cash available to us to invest in the growth of our business. We compensate for these limitations by relying primarily on our GAAP results, including cash flows provided by operating activities, and using total Adjusted EBITDA as a supplemental financial measure. 

 

Liquidity and Capital Resources

 

   

Nine Months Ended

September 30,

 

Consolidated Statements of Cash Flow Data:

 

2014

   

2013

 

(in thousands)

               

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

  $ (5,767 )   $ 27,898  

Net cash used in investing activities, continuing operations

  $ (22,861 )   $ (17,088 )

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

  $ 5,122     $ (12,444 )

Net cash used in discontinued operations

  $ (1,402 )   $ (5,774 )

  

Operating Activities

 

During the nine months ended September 30, 2014, we used $5.8 million of net cash in operating activities from continuing operations, due primarily to a loss of $27.9 million from continuing operations and changes in operating assets and liabilities of $7.0 million, partially offset by non-cash expenses of $29.2 million. Accounts payable decreased by $3.1 million due to a change in payment terms for certain vendors, deferred revenue decreased by $1.9 million, accrued restructuring decreased by $1.6 million, other assets increased by $1.2 million, and accounts receivable increased by $0.7 million. These unfavorable impacts to cash flows were partially offset by a decrease in prepaid expenses and other current assets of $2.0 million primarily due to decreased media rebates receivable as a result of our new contract with Google. Non-cash expenses included $12.6 million of depreciation and amortization, $10.7 million of stock-based compensation and $4.6 million of restructuring charges.

 

 
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Net cash used in operating activities increased by $33.7 million during the nine months ended September 30, 2014 compared to 2013, primarily as a result of lower operating performance. Income from continuing operations adjusted for non-cash items decreased by $20.0 million. In addition, cash flow from operating activities was unfavorably impacted by a decrease in accounts payable of $15.9 million compared to 2013 due to a change in credit terms for certain vendors, a decrease in deferred revenue of $4.7 million compared to 2013, a decrease in accrued compensation and benefits of $2.4 million as a result of decreased accruals for commissions, and restructuring payments of $1.6 million that did not occur in 2013, partially offset by a decrease in prepaid expenses and other current assets of $7.2 million compared to 2013, and a decrease in accounts receivable of $4.2 million compared to 2013.

  

Investing Activities

 

Our primary investing activities have consisted of capitalized software development costs, purchases of property and equipment, business acquisitions, investments in a partnership, and short-term investments. Purchases of property and equipment and capitalization of software costs will vary from period to period due to the timing of the expansion of our operations and our software development efforts.

  

During the nine months ended September 30, 2014, we invested an additional $2.0 million in a privately held partnership and used $1.5 million as part of the SureFire acquisition.

 

Net cash used in investing activities increased by $5.8 million during the nine months ended September 30, 2014 compared to the same period in 2013. In addition to the cash used as part of the investment in a privately held partnership and in the Surefire acquisition, net cash used in investing activities increased by $2.1 million due to increased capitalized software development costs compared to the same period in 2013, reflecting our increased investment in our products, technology, and facilities. We expect to increase the use of capital for acquisitions, purchases of property and equipment, and development of software.

  

Financing Activities

 

Our financing activities have consisted primarily of net proceeds from the exercise of stock options. During the nine months ended September 30, 2014, employees exercised stock options covering 718,000 shares and we received $6.4 million in proceeds.

 

Net cash provided by financing activities increased by $17.6 million during the nine months ended September 30, 2014 compared to the same period in 2013, primarily due to our share repurchases in the prior-year period and higher proceeds from the exercise of stock options in the current period.

 

Future cash flows from financing activities may be affected by our repurchases of our common stock. Our Board of Directors has authorized the repurchase of up to $47.0 million of our outstanding common stock. At September 30, 2014, we had executed repurchases of $36.3 million of our common stock under the program. Purchases may be made from time-to-time in open market or privately negotiated transactions as determined by our management. The amount and timing of the share repurchase will depend on business and market conditions, stock price, trading restrictions, acquisition activity, and other factors. The share repurchase program does not obligate us to acquire any particular amount of common stock, and the repurchase program may be suspended or discontinued at any time at our discretion.

 

Liquidity

 

At September 30, 2014, we had cash and cash equivalents of $51.7 million and short-term investments of $0.3 million. Cash and cash equivalents consist of cash, money market accounts and certificates of deposit. Short term investments consist of certificates of deposit with original maturities in excess of three months but less than twelve months. To date, we have experienced no loss of our invested cash, cash equivalents or short-term investments, although some of those balances are subject to foreign currency exchange risk (see Item 3, “Foreign Currency Exchange Risk,” for more information). We cannot, however, provide any assurances that access to our invested cash, cash equivalents and short-term investments will not be impacted by adverse conditions in the financial markets. At September 30, 2014, we had no long-term indebtedness for borrowed money and are not subject to any restrictive bank covenants. At September 30, 2014, we had $3.6 million in restricted deposits to secure letters of credit related to lease commitments or as collateral for customer accounts. 

 

 
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Due to our overall operating performance and capital expenditures, our cash balances at September 30, 2014, decreased approximately $25.8 million from December 31, 2013. Furthermore, as of September 30, 2014, our current liabilities exceed our current assets by approximately $31 million. However, we believe that our available cash and anticipated cost reductions will together be sufficient to satisfy our operating activities, working capital and planned investing and financing activities for at least the next 12 months. Although we expect that our existing cash and anticipated cost reductions will be sufficient to continue funding our business strategy, our negative cash flow from operating activities and our investments, including increased investments in developing new solutions for our clients or future acquisitions of businesses, solutions or technologies, could require us to seek additional equity or debt financing, which may not be available on terms favorable to us or at all, or could require us to alter our plans or operating activities based on available resources.

 

Off-Balance Sheet Arrangements

 

At September 30, 2014, we did not have any off-balance sheet arrangements.

  

Recent Accounting Pronouncements

 

In August 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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 us as of January 1, 2017. Early application is permitted. The adoption of this standard is not expected to have an impact on our 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. We are currently assessing the impact of this update, and believe that its adoption on January 1, 2016 will not have a material impact on our 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 will be effective for the Company as of January 1, 2017. Earlier adoption is not permitted for public entities. An entity can apply the revenue standard retrospectively to each prior reporting period presented (full retrospective method) or retrospectively with the cumulative effect of initially applying the standard recognized at the date of initial application in retained earnings (simplified transition method). We are currently assessing the impact of this update on our consolidated financial statements.

 

 
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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 changes the criteria for determining which disposals can be presented as discontinued operations and modifies related disclosure requirements. The guidance applies prospectively to new disposals and new classifications of disposal groups as held for sale after the effective date, and is effective for the Company as of January 1, 2015. However, all entities may early adopt the guidance for new disposals (or new classifications as held for sale) that has not been reported in financial statements previously issued or available for issuance. We will assess the impact of this guidance on our consolidated financial statements for any new disposals or new classification as held for sale after the effective date.

 

Item 3.          QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK  

 

We are exposed to market risk in the ordinary course of our business. These risks primarily include interest rate, foreign exchange and inflation risks.

  

Interest Rate Fluctuation Risk

 

We do not have any long-term indebtedness for borrowed money. Our investments include cash, cash equivalents and short-term investments. Cash and cash equivalents and short-term investments consist of cash, money market accounts and certificates of deposit. The primary objective of our investment activities is to preserve principal while maximizing income without significantly increasing risk. We do not enter into investments for trading or speculative purposes. Our investments are exposed to market risk due to a fluctuation in interest rates, which may affect our interest income and the fair market value of our investments. Due to the short-term nature of our investment portfolio, we do not believe an immediate 10% increase in interest rates would have a material effect on the fair market value of our portfolio, and therefore we do not expect our operating results or cash flows to be materially affected to any degree by a sudden change in market interest rates.

 

Foreign Currency Exchange Risk

 

We have foreign currency risks related to our investments, revenue and operating expenses denominated in currencies other than the U.S. dollar, including the Australian dollar, the British pound sterling, the Canadian dollar, the euro, the Japanese yen, the Indian rupee, and the Brazilian real. For the nine months ended September 30, 2014, a 10% strengthening of the U.S. dollar relative to those foreign currencies would have resulted in a decrease in revenue of $15.1 million, but an increase in operating income of $1.7 million. A 10% weakening of the U.S. dollar relative to those foreign currencies, however, would have resulted in an increase in revenue of $15.1 million, but a decrease in operating income of $1.7 million. As exchange rates vary, sales and other operating results, when translated, may differ materially from expectations. In addition, approximately 56% of our cash balances are denominated in currencies other than the U.S. dollar, and the value of such holdings will increase or decrease along with the weakness or strength of the U.S. dollar, respectively. We continue to review potential hedging strategies that may reduce the effect of fluctuating currency rates on our business, but there can be no assurances that we will implement such a hedging strategy or that once implemented, such a strategy would accomplish our objectives or not result in losses.

 

 Inflation Risk

 

We do not believe that inflation has had a material effect on our business, financial condition or results of operations. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, financial condition and results of operations.

 

Item 4.     CONTROLS AND PROCEDURES  

 

Disclosure Controls and Procedures

 

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(b) as of September 30, 2014. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in reports we file or submit under the Exchange Act is (1) recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (2) is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.

 

 
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Changes in Internal Control Over Financial Reporting

 

There were no changes in our internal control over financial reporting during the quarter ended September 30, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 
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PART II

 

OTHER INFORMATION

  

Item 1.

LEGAL PROCEEDINGS  

 

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

 

From time to time, we are involved in various other legal proceedings and claims arising in the ordinary course of business. Although occasional adverse decisions or settlements may occur, we believe that the final disposition of existing matters will not have a material adverse effect on our financial position, results of operations or cash flows.

 

Item 1A.

RISK FACTORS   

 

Investors should carefully consider the risk factors in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2013, in addition to the other information contained in our Annual Report and in this quarterly report on Form 10-Q.

 

Item 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS   

 

Our Board of Directors has authorized the repurchase of up to $47.0 million of our outstanding common stock.   At September 30, 2014, we had repurchased $36.3 million of our common stock in total under the program. There were no repurchases during the nine months ended September 30, 2014. Purchases may be made from time-to-time in open market or privately negotiated transactions as determined by our management. The amount and timing of the share repurchase will depend on business and market conditions, stock price, trading restrictions, acquisition activity, and other factors. The share repurchase program does not obligate us to acquire any particular amount of common stock, and the repurchase program may be suspended or discontinued at any time at our discretion.

 

Item 6.

EXHIBITS 

 

The exhibits listed in the Exhibit Index following the signature page to this report are filed as part of, or incorporated by reference into, this report. 

 

 
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SIGNATURES 

  

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

REACHLOCAL, INC. 

  

  

By:

/s/ Sharon T. Rowlands

Name:

Sharon T. Rowlands

Title:

Chief Executive Officer

  

  

By:

/s/ Ross G. Landsbaum

Name:

Ross G. Landsbaum

Title:

Chief Financial Officer

 

Date: November 5, 2014

 

 
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EXHIBIT INDEX

 

Exhibit No 

  

Description of Ex hibit 

10.01

 

Separation Agreement between ReachLocal, Inc. and Daniel Della Flora, dated November 3, 2014

     

31.01

  

Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

  

  

  

31.02

  

Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

  

  

  

32.01

  

Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

  

  

  

32.02

  

Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

  

  

  

101.INS

  

XBRL Instance Document

  

  

  

101.SCH

  

XBRL Taxonomy Extension Schema Document

  

  

  

101.CAL

  

XBRL Taxonomy Extension Calculation Linkbase Document

  

  

  

101.DEF

  

XBRL Taxonomy Extension Definition Linkbase Document

  

  

  

101.LAB

  

XBRL Taxonomy Extension Label Linkbase Document

  

  

  

101.PRE

  

XBRL Taxonomy Extension Presentation Linkbase Document

 

* Certain provisions of this exhibit have been omitted pursuant to a request for confidential treatment.

 

 

 

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