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REACHLOCAL INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Edgar Glimpses Via Acquire Media NewsEdge) 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 2011 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. 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 2011 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
Our mission is to help small and medium-sized businesses, or SMBs, acquire,
maintain and retain customers via the Internet. We offer a comprehensive suite
of online marketing and reporting solutions, including search engine marketing
(ReachSearch), Web presence (ReachCast), display advertising (ReachDisplay),
display retargeting (ReachRetargeting), online marketing analytics (TotalTrack),
an out-of-the-box assisted chat service (TotalLiveChat), and other related
products and services, each targeted to the SMB market. We deliver these
solutions to SMBs through a combination of our proprietary platform, the RL
Platform, and our direct, "feet-on-the-street" sales force of Internet Marketing
Consultants, or IMCs, and select third-party agencies and resellers.
We use our RL Platform to create advertising campaigns for SMBs to target
potential customers in their geographic area, optimize those campaigns in real
time and track tangible results. Through a single Internet advertising budget,
we enable our clients to reach local customers-whether using traditional
computing devices or mobile devices-across the Internet, including through all
of the major search engines and leading general interest and vertically focused
online publishers. In 2010, we expanded the RL Platform to include ReachCast,
our full-service Web presence and social media solution, and in September 2012,
we launched ReachRetargeting, a ReachDisplay product targeting local consumers
who have recently searched for an SMB's business keywords as well as those who
have recently visited their website. We continue to expand the RL Platform to
include additional advertising products designed specifically for the needs of
our SMB clients. Empowered by the RL Platform, our IMCs, which are based in or
near the cities in which our clients operate, establish a direct consultative
relationship with our clients and provide our solutions to achieve their
marketing objectives.
We generate revenue by providing online advertising solutions for our clients
through our portfolio of online marketing and advertising solutions. We sell
ReachSearch and ReachDisplay based on a package pricing model in which our
clients commit to a fixed fee that includes the media; the optimization,
reporting and tracking technologies of the RL Platform; and the personnel
dedicated to support and manage their campaigns. We also generate revenue from
digital marketing solutions for our clients that do not include the purchase of
third-party media, including ReachCast, TotalTrack and TotalLiveChat. Generally,
our products are sold to our clients in a single budget to simplify the
purchasing process.
We offer our products and services through two primary channels. Our IMCs sell
our products and services directly to SMBs, which we refer to as our Direct
Local channel. We also sell our products and services through third-party
agencies and resellers, and to national or regional businesses with multiple
locations, such as franchisors, which we refer to as national brands. Because
the sale to agencies, resellers and national brands involves negotiations with
businesses that generally represent an aggregated group of SMB advertisers, we
group them together as our National Brands, Agencies and Resellers channel.
17
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In 2006, we entered our first market outside of North America through a joint
venture in Australia, and in 2009, we acquired the remaining interest in the
joint venture. We entered the United Kingdom and Canada in 2008, Germany and the
Netherlands in 2011, and Japan and Brazil in 2012. We also serve clients in New
Zealand, Slovakia and Poland through our resellers, including a franchisee. In
2010, we commenced campaign management and provisioning operations in India.
Business Model and Operating Metrics
Our Direct Local channel represents the majority of our revenue. As a percentage
of revenue, Direct Local revenue has increased to 79% for the nine months ended
September 30, 2012, from 78% for the nine months ended September 30, 2011.
Growth in Direct Local revenue is primarily driven by the growth in the number
of IMCs, the maturity of our IMCs, the increase in the number of international
IMCs as a percentage of our total IMCs, and the increase in IMC productivity.
Underclassmen expenses for the nine months ended September 30, 2012 and 2011
were $33.8 million and $32.7 million, respectively.
Number of IMCs
Our ongoing investment in increasing the number of our IMCs has been the
principal engine for our growth. Typically, each month, we hire 40-60 IMCs
worldwide, with the hiring weighted towards the first ten months of the year. We
refer to IMCs with 12 months or less of experience as Underclassmen. In
particular, our revenue growth is driven by the increase in the number of our
Upperclassmen, who are significantly more productive than our Underclassmen. As
such, we believe that our ability to grow our business is highly dependent on
our ability to grow the number of our Upperclassmen. Beyond our hiring
practices, which determine the number of IMCs to be hired as well as the rate at
which we hire them, the increase in the number of Upperclassmen depends
primarily on the productivity of Underclassmen, as the majority of Underclassmen
attrition has been involuntary and is based on performance relative to a
standard level of revenue growth and other performance metrics determined by us.
We do not expect all Underclassmen to become Upperclassmen, and our investment
decisions anticipate the cost of attrition. Our revenue growth is also driven by
the increase in the number of our international IMCs as our international IMCs
are on average more productive than our IMCs in North America, which we
attribute to lower levels of competition and lower existing online advertising
consumption by SMBs in those markets. The ongoing increase in the number of
international IMCs is a result of our international expansion.
At September 30, 2012, we had 407 Upperclassmen and 450 Underclassman, for a
total of 857 IMCs, as compared to 344 Upperclassmen and 464 Underclassman, for a
total of 808 IMCs, as of September 30, 2011.
Underclassmen Expense
Underclassmen do not, in the aggregate, make a positive contribution to
operating income. Our largest operating expenses include the hiring, training
and retention of Underclassmen in support of our goal of developing more
Upperclassmen.
Underclassmen Expense is a number we calculate to approximate our investment in
Underclassmen and is comprised of the selling and marketing expenses we allocate
to Underclassmen during a reporting period. The amount includes the direct
salaries and allocated benefits of the Underclassmen (excluding commissions),
training and sales organization expenses, including depreciation, allocated
based on relative headcount and marketing expenses allocated based on relative
revenue. While we believe that Underclassmen Expense provides useful information
regarding our approximate investment in Underclassmen, the methodology we use to
arrive at our estimated Underclassmen Expense was developed internally by
management, is not a concept or method recognized by GAAP and other companies
may use different methodologies to calculate or approximate measures similar to
Underclassmen Expense. Accordingly, our calculation of Underclassmen Expense may
not be comparable to similar measures used by other companies.
We determine the amount to invest in Underclassmen based on our objectives for
development of the business and the key factors affecting IMC productivity
described above. The increase in Underclassmen Expense for the nine months ended
September 30, 2012 as compared to the preceding year period was primarily
attributable to our international expansion, partially offset by a reduced
investment in North America.
18--------------------------------------------------------------------------------Active Advertisers and Active Campaigns
We track the number of Active Advertisers and Active Campaigns 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 Advertisers 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
Advertisers by adjusting the number of Active Campaigns to combine clients with
more than one Active Campaign as a single Active Advertiser. Clients with more
than one location are generally reflected as multiple Active Advertisers.
Because this number includes clients served through the National Brands,
Agencies and Resellers channel, Active Advertisers includes entities with which
we do not have a direct client relationship. Numbers are rounded to the nearest
hundred.
Active Campaigns is a number we calculate to approximate the number of
individual products or services we are managing under contract for Active
Advertisers. For example, if we were performing both ReachSearch and
ReachDisplay campaigns for a client, we consider that two Active Campaigns.
Similarly, if a client purchased ReachSearch campaigns for two different
products or purposes, we consider that two Active Campaigns. Numbers are rounded
to the nearest hundred.
At September 30, 2012, we had approximately 22,100 Active Advertisers and 32,900
Active Campaigns, as compared to approximately 18,700 Active Advertisers and
27,000 Active Campaigns as of September 30, 2011. Active Advertisers and Active
Campaigns increased over the period due to an increase in the number and
maturity of IMCs, an increase in the number of products available for our IMCs
to sell, and an increase in the productivity of our National Brands, Agencies
and Resellers channel.
Recent Transactions
On July 3, 2012, we acquired certain assets and liabilities and hired certain
employees of RealPractice, Inc. The acquisition provided us with a technology
team with expertise in marketing automation. At closing, we paid $2.6 million in
cash of the estimated $2.9 million purchase price. The remaining amount of $0.3
million is payable in cash on the 18-month anniversary of the closing date,
subject to adjustment. We issued 150,292 restricted stock units to the hired
employees.
On July 6, 2012, we completed a transaction with OxataSMB B.V., in which we
entered into a franchise agreement with OxataSMB permitting it to operate and
resell our services under the ReachLocal brand in Slovakia, Czech Republic,
Hungary, Poland and Russia. Pursuant to the franchise agreement, OxataSMB will
receive access to the RL platform, training, marketing and branding materials,
media purchasing, campaign management and provisioning, sourcing of telephony,
and technical support. In addition, we entered into a market development loan
agreement with OxataSMB pursuant to which we agreed to provide financing to
OxataSMB of up to €2.9 million ($3.7 million), of which €1.45 million ($1.9
million) has been advanced. The ability to draw down the remaining loan amount
is dependent on OxataSMB achieving certain milestones. The loan has a two-year
term and accrues interest at 4% per annum, but does not require principal or
interest payments for two years, and can be extended for an additional 24 months
based on achievement of certain milestones. In addition, we have an option to
buy OxataSMB at an independently-determined fair value at the end of the initial
loan term, subject to extension.
Basis of Presentation
Discontinued Operations
As a result of the winding down of the operations of Bizzy, we have reclassified
and presented all related historical financial information as "discontinued
operations" in the Consolidated Balance Sheets, Consolidated Statements of
Operations and Consolidated Statements of Cash Flows. In addition, we have
excluded all 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
advertising to our clients. Revenue includes (i) the sale of our ReachSearch,
ReachDisplay, 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 the RL Platform, and the personnel dedicated to
support and manage their campaigns; (ii) the sale of our ReachCast, TotalTrack,
TotalLiveChat, 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 sales force of IMCs, who are
focused on serving SMBs in their local markets through an in-person,
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 SMBs 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
ReachSearch, ReachDisplay and ReachCast products. Under our agreements, our SMB
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. Generally, when
at least 85% of requisite purchases and other services have occurred and an
additional campaign cycle remains under the agreement, we make an additional
billing or automatic collection for the next campaign cycle.
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 $4.0 million and $3.8 million
of accounts receivables related to our National Brands, Agencies and Resellers
at September 30, 2012 and December 31, 2011, 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 the Company 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 third-party telephone and information
services costs, data center and third-party hosting costs, credit card
processing fees, third-party content and other direct costs.
In addition, cost of revenue includes costs to initiate, operate and manage
clients' campaigns, other than costs associated with the Company's sales force,
which are reflected as selling and marketing expenses. Cost of revenue includes
salaries, benefits, bonuses and stock-based compensation for the related staff,
including the cost of Web Presence Professionals who are the principal service
providers for the Company's ReachCast product, and allocated overhead such as
depreciation expense, rent and utilities, as well as an allocable portion of our
technical operations costs. 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, 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 IMCs, sales management and other employees in the sales
organization is based on commissions. In addition, the cost of agency
commissions is included in selling and marketing expenses.
Product and Technology. Product and technology expenses consist primarily of
personnel and related expenses for our product development and technology staff,
including salaries, benefits, bonuses and stock-based compensation, and the cost
of 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 the RL Platform addresses all aspects of our activities,
including supporting the IMC 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.
20--------------------------------------------------------------------------------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.
General and Administrative. General and administrative expenses consist
primarily of personnel and related expenses for 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.
Critical Accounting Policies and Estimates
The preparation of our condensed consolidated financial statements in conformity
with 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 other significant accounting policies,
see our 2011 Annual Report on Form 10-K.
We believe that the following critical accounting policies involve our more
significant judgments, assumptions and estimates and, therefore, could have the
greatest potential impact on our condensed consolidated financial statements:
• Revenue recognition
• Software development costs
• Goodwill
• Long-lived and intangible assets
• Stock-based compensation
• Variable interest entities
Revenue Recognition
We recognize revenue for our services when all of the following criteria are
satisfied:
• persuasive evidence of an arrangement exists;
• services have been performed;
• the selling price is fixed or determinable; and
• collectability is reasonably assured.
We recognize revenue as the cost for the third-party media is incurred, which is
upon delivery of the advertising on behalf of our clients. We recognize revenue
for our ReachSearch product as clicks are recorded on sponsored links on the
various search engines and for our ReachDisplay products when the display
advertisements record impressions or as otherwise provided in our agreement with
the applicable publisher. We recognize revenue for our ReachCast product on a
straight line basis over the applicable service period for each campaign. We
recognize revenue when we charge set-up, management service or other fees on a
straight line basis over the term of the related campaign contract or the
completion of any obligation for services, if shorter. When we receive advance
payments from clients, we record these amounts as deferred revenue until the
revenue is recognized. When we extend credit, we record a receivable when the
revenue is recognized.
When we sell through agencies, we either receive payment in advance of services
or in some cases extend credit. We pay each agency an agreed-upon commission
based on the revenue we earn or cash we receive. Some agency clients that have
been extended credit may offset the amount otherwise due to us by any
commissions they have earned. We evaluate whether it is appropriate to record
the gross amount of campaign revenue or the net amount earned after commissions.
As we are the primary party obligated in the arrangement, subject to the credit
risk, with discretion over both price and media, management recognizes the gross
amount of such sales as revenue and any commissions are recognized as a selling
and marketing expense.
We also have a small number of resellers, including a franchisee. Resellers
integrate our services, including ReachSearch, ReachDisplay and TotalTrack, into
their product offerings. In each case, the resellers integrate with the our RL
Platform through a custom Application Programming Interface (API). Resellers are
responsible for the price and specifications of the integrated product offered
to their clients. Resellers pay us in arrears, net of commissions and other
adjustments. We recognize revenue generated under reseller agreements net of the
agreed-upon commissions and other adjustments earned or retained by the
reseller, as we believe that the reseller has retained sufficient control and
bears sufficient risks to be considered the primary obligor in those
arrangements.
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We offer future incentives to clients in exchange for minimum commitments. In
these circumstances, we estimate the amount of the future incentives that will
be earned by clients and defer a portion of the otherwise recognizable revenue.
Estimates are based upon a statistical analysis of previous campaigns for which
such incentives were offered. Should a client not meet its minimum commitment
and no longer qualify for the incentive, we recognize the revenue previously
deferred related to the estimated incentive.
Software Development Costs
We capitalize our costs to develop internal-use software when management has
determined the development efforts will result in new or additional
functionality or results in new products. Costs incurred prior to meeting these
criteria and costs associated with ongoing maintenance are expensed as incurred.
We track our costs by project and by each release and objectively determine
which projects resulted in additional functionality or new products for which we
can improve our offerings and market presence. Our developers, engineers and
quality assurance staff currently record their time spent on various projects on
a weekly basis so we may determine the approximate amount of costs that should
be capitalized. Our senior management team reviews these estimates to determine
the appropriate level of capitalization. We monitor our existing capitalized
software and reduce its carrying value as the result of releases that render
previous features or functions obsolete or otherwise reduce the value of
previously capitalized costs.
Costs capitalized as software development costs are amortized on a straight-line
basis over the estimated useful life of the software of three years.
Amortization of those costs is included in product and technology expenses as
the RL Platform addresses all aspects of our activities, including supporting
the IMC 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.
Goodwill
Our total goodwill of $42.1 million and $41.8 million as of September 30, 2012
and December 31, 2011, respectively, is related to our acquired businesses. In
accordance with Accounting Standards Codification ("ASC") 280, Segment
Reporting, and have identified one segment and two reporting units-North America
and Australia-for purposes of evaluating goodwill. These reporting units each
constitute a business or group of businesses for which discrete financial
information is available and is regularly reviewed by segment management. At
September 30, 2012 and December 31, 2011, assigned-goodwill was $9.7 million for
North America and $32.4 million for Australia, and $9.4 million for North
America and $32.4 million for Australia, respectively. We review the carrying
amounts of goodwill for possible impairment whenever events or changes in
circumstance indicate that the related carrying amount may not be
recoverable. We perform our annual assessment of goodwill impairment as of the
first day of each fourth quarter.
We apply the guidance of ASC 350-20, Intangibles - Goodwill and Other. Entities
are provided with the option of first performing a qualitative assessment on any
of its reporting units to determine whether further quantitative impairment
testing is necessary. An entity may also bypass the qualitative assessment for
any reporting unit in any period and proceed directly to the quantitative
impairment test. If an entity determines that it is more likely than not that
the fair value of a reporting unit is less than its carrying amount, then
performing a two-step impairment test is necessary. The first step of the
impairment test involves comparing the estimated fair values of each of our
reporting units with their respective carrying amounts, including goodwill. If
the estimated fair value of a reporting unit exceeds its carrying amount,
including goodwill, goodwill is considered not to be impaired and no additional
steps are necessary. If, however, the estimated fair value of the reporting unit
is less than its carrying amount, including goodwill, then the second step is
performed to compare the carrying amount of the goodwill with its implied fair
value. If the carrying amount of goodwill exceeds the implied fair value of that
goodwill, an impairment loss is recognized in an amount equal to the excess. We
estimate fair value utilizing the projected discounted cash flow method and
discount rate determined by management to commensurate the risk inherent in our
business model.
22--------------------------------------------------------------------------------Long-Lived and Intangible Assets
We report finite-lived, acquisition-related intangible assets at fair value, net
of accumulated amortization. Identifiable intangible assets are amortized on a
straight-line basis over their estimated useful lives of three years.
Straight-line amortization is used because no other pattern over which the
economic benefits will be consumed can be reliably determined.
Management reviews the carrying values of long-lived assets, including
intangible assets, for possible impairment whenever events or changes in
circumstance indicate that the related carrying amount may not be recoverable.
In our analysis of other finite lived amortizable intangible assets, we apply
the guidance of ASC 350-20, Intangibles - Goodwill and Other, in determining
whether any impairment conditions exist. An impairment loss is recognized to the
extent that the carrying amount exceeds the asset's fair value. Intangible
assets are attributable to the various developed technologies and client
relationships of the businesses we have acquired. Long-lived assets to be
disposed of are reported at the lower of carrying amount or estimated fair value
less cost to sell.
Stock-Based Compensation
We account for stock-based compensation based on fair value. We follow the
attribution method, which reduces current stock-based compensation expenses
recorded by the effect of anticipated forfeitures. We estimate forfeitures based
upon our historical experience.
The fair value of each award is estimated on the date of the grant and amortized
over the requisite service period, which is the vesting period. We use the
Black-Scholes option pricing model to estimate the fair value of stock-based
awards on the date of grant. Determining the fair value of stock-based awards at
the grant date under this model requires judgment, including estimating
volatility, expected term and risk-free interest rate. The assumptions used in
calculating the fair value of stock-based awards represent management's estimate
based on judgment and subjective future expectations. These estimates involve
inherent uncertainties. If any of the assumptions used in the Black-Scholes
model significantly changes, stock-based compensation for future awards may
differ materially from the awards granted previously.
Variable Interest Entities
In accordance with ASC 810, Consolidations, the applicable accounting guidance
for the consolidation of variable interest entities, or VIEs, we analyze our
interests, including agreements, loans, guarantees, and equity investments, on a
periodic basis to determine if such interests are variable interests. If
variable interests are identified, then the related entity is assessed to
determine if it is a VIE. Our analysis includes both quantitative and
qualitative reviews. We base our quantitative analysis on the forecasted cash
flows of the entity, and our qualitative analysis on the design of the entity,
its organizational structure including its decision-making authority, and
relevant agreements. If we determine that the entity is a VIE, we then assess if
we must consolidate the VIE as its primary beneficiary. Our determination of
whether we are the primary beneficiary is based upon qualitative and
quantitative analyses, which assess the purpose and design of the VIE, the
nature of the VIE's risks and the risks that we absorb, the power to direct
activities that most significantly impact the economic performance of the VIE,
and the obligation to absorb losses or the right to receive benefits that could
be significant to the VIE.
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Results of Operations
Comparison of the Three and Nine Months Ended September 30, 2012 and 2011
Three Months Ended Nine Months Ended
September 30, September 30,
2012 2011 2012 2011
(in thousands)
Revenue $ 118,891 $ 98,629 $ 335,106 $ 275,439
Cost of revenue (1) 59,500 50,265 167,546 141,363
Operating expenses:
Selling and marketing (1) 42,860 36,769 122,579 103,457
Product and technology (1) 5,448 4,257 14,180 10,800
General and administrative (1) 9,966 8,821 30,241 24,470
Total operating expenses 58,274 49,847 167,000 138,727
Income (loss) from continuing operations 1,117 (1,483 ) 560 (4,651 )
Other income, net 33 280 338 697
Income (loss) from continuing operations
before provision for income taxes 1,150 (1,203 ) 898 (3,954 )
Provision for income taxes 314 126 736 323
Income (loss) from continuing
operations, net of income taxes 836 (1,329 ) 162 (4,277 )
Loss from discontinued operations, net
of income taxes - (3,272 ) - (4,720 )
Net income (loss) $ 836 $ (4,601 ) $ 162 $ (8,997 )
(1) Stock-based compensation, net of capitalization, and depreciation and
amortization, included in the above line items (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
2012 2011 2012 2011
Stock-based compensation:
Cost of revenue $ 73 $ 60 $ 198 $ 176
Selling and marketing 437 325 1,122 1,068
Product and technology 488 421 868 976
General and administrative 1,597 1,525 4,741 4,096
$ 2,595 $ 2,331 $ 6,929 $ 6,316
Depreciation and amortization:
Cost of revenue $ 131 $ 194 $ 401 $ 551
Selling and marketing 457 413 1,576 1,080
Product and technology 2,385 1,862 6,435 5,033
General and administrative 536 359 1,257 971
$ 3,509 $ 2,828 $ 9,669 $ 7,635
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Revenue
Three Months Ended September 30, Nine Months Ended September 30,
2012-2011 2012-2011
2012 2011 % Change 2012 2011 % Change
(in thousands)
Direct Local $ 93,537 $ 76,814 21.8 % $ 263,534 $ 213,168 23. 6 %
National Brands,
Agencies and
Resellers 25,354 21,815 16.2 71,572 62,271 14.9
Total revenue $ 118,891 $ 98,629 20.5 % $ 335,106 $ 275,439 21.7 %
At period end:
Number of IMCs:
Upperclassmen 407 344 18.3 %
Underclassmen 450 464 (3.0 )
Total 857 808 6.1 %
Active Advertisers
(1) 22,100 18,700 18.2 %
Active Campaigns (2) 32,900 27,000 21.9 %
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(1) Active Advertisers 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 Advertisers by adjusting the number of Active Campaigns to
combine clients with more than one Active Campaign as a single Active
Advertiser. Clients with more than one location are generally reflected as
multiple Active Advertisers. Because this number includes clients served
through the National Brands, Agencies and Resellers channel, Active
Advertisers includes entities with which we do not have a direct client
relationship. Numbers are rounded to the nearest hundred.
(2) Active Campaigns is a number we calculate to approximate the number of
individual products or services we are managing under contract for Active
Advertisers. For example, if we were performing both ReachSearch and
ReachDisplay campaigns for a client, we consider that two Active Campaigns.
Similarly, if a client purchased ReachSearch campaigns for two different
products or purposes, we consider that two Active Campaigns. Numbers are
rounded to the nearest hundred.
The increase in Direct Local revenue of $16.7 million and $50.4 million for the
three and nine months ended September 30, 2012, respectively, compared to the
same periods in 2011 was largely attributable to an increase in the number of
Upperclassmen and the productivity of Upperclassmen driven by their increased
tenure. Also contributing to the increase was growth in the number of
international IMCs who, on average, are more productive than our IMCs in North
America.
The increase in National Brands, Agencies and Resellers revenue of $3.5 million
and $9.3 million for the three and nine months ended September 30, 2012,
respectively, compared to the same periods in 2011, was due to increases in
revenue from our domestic and international National Brands clients of $1.6
million and $4.9 million for the three and nine months ended September 30, 2012,
respectively, and increases in revenue of $2.0 million and $4.4 million from our
domestic and international Agencies and Resellers for the three and nine months
ended September 30, 2012, respectively. In each period, these increases were
primarily driven by increases in spend from existing National Brands clients and
existing Agencies and Resellers, as well as an increase in the number of
Agencies and Resellers.
Cost of Revenue
Nine Months Ended September
Three Months Ended September 30, 30,
2012-2011 2012-2011
2012 2011 % Change 2012 2011 % Change
(in thousands)
Cost of revenue $ 59,500 $ 50,265 18.4 % $ 167,546 $ 141,363 18.5 %
As a percentage of revenue: 50.0 % 51.0 % 50.0 % 51.3 %
25--------------------------------------------------------------------------------
The decrease in our cost of revenue as a percentage of revenue for the three
months ended September 30, 2012 compared to the same period in 2011 was
primarily due to an increase in publisher rebates and the change in our product
and service mix, partially offset by the change in our geographic mix. The
decrease for the nine months ended September 30, 2012, compared to the same
period in 2011, was primarily due to an increase in publisher rebates, partially
offset by the change in our geographic, product and service mix. As we enter new
markets the initial sales focus is on our ReachSearch product, which affects our
product and service mix.
Publisher rebates as a percentage of revenue increased to 4.5% of revenue in the
three months ended September 30, 2012 from 3.9% for the same period in 2011, and
to 4.6% of revenue in the nine months ended September 30, 2012 from 2.8% for the
same period in 2011, due to more favorable rebate terms from various publishers.
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 mix of
products and services we offer, our geographic mix, our media buying efficiency,
and the costs of support and delivery.
Operating Expenses
Over the past several years, we have significantly increased the scope of our
operations. We intend to continue to increase our sales force, product offerings
and the infrastructure to support them. In growing our business, particularly in
international markets, we are incurring expenses to support our long-term growth
plans, acknowledging that these investments may put pressure on near-term
periodic operating results and increase our operating expenses as a percentage
of revenue.
Selling and Marketing
Three Months Ended Nine Months Ended
September 30, September 30,
2012-2011 2012-2011
2012 2011 % Change 2012 2011 % Change
(in thousands)
Salaries, benefits
and other costs $ 30,305 $ 26,086 16.2 % $ 86,560 $ 73,047 18.5 %
Commission expense 12,555 10,683 17.5 % 36,037 30,410 18.5 %
Total selling and
marketing $ 42,860 $ 36,769 16.6 % $ 122,597 $ 103,457 18.5 %
Underclassmen Expense
included above,
excluding commissions
(1) $ 11,441 $ 11,591 (1.3 )% $ 33,824 $ 32,714 3.4 %
As a percentage of
revenue:
Salaries, benefits
and other costs 25.5 % 26.4 % 25.8 % 26.5 %
Commission expense 10.6 % 10.8 % 10.8 % 11.0 %
Total selling and
marketing 36.0 % 37.3 % 36.6 % 37.6 %
--------------------------------------------------------------------------------
(1) See "Non-GAAP Financial Measures" for our definition of Underclassmen Expense.
The increase in selling and marketing salaries, benefits and other costs in
absolute dollars for the three and nine months ended September 30, 2012,
compared to the same periods in 2011, was primarily due to an increase in our
IMC headcount and related recruiting, training and facilities costs. The
decrease in these costs as a percentage of revenue for the three and nine months
ended September 30, 2012, compared to the same periods in 2011, was primarily
due to increased productivity and operational scale in our established markets,
partially offset by expenses related to our entrance into new international
markets.
The increase in commission expense in absolute dollars for the three and nine
months ended September 30, 2012, compared to the same periods in 2011, was due
to increased sales. As a percentage of revenue, commission expense was slightly
lower compared to the prior periods. We do not expect continued decreases in
commission expense as a percentage of revenue due to an expected higher
percentage of Upperclassmen, who generally earn higher commission rates based on
increased productivity.
26--------------------------------------------------------------------------------
Underclassmen Expense for the three months ended September 30, 2012 was slightly
lower compared to the same period in 2011, primarily due to decreased IMC hiring
in our established markets, offset by increased hiring in our newer markets. The
increase for the nine months ended September 30, 2012, compared to the same
periods in 2011, was primarily due to increased IMC hiring in our newer markets,
partially offset by reduced IMC hiring in our established markets. As we
continue to invest in additional Underclassmen and retain additional
Upperclassmen, selling and marketing expenses will continue to increase in
absolute dollars.
Product and Technology
Three Months Ended Nine Months Ended
September 30, September 30,
2012-2011 2012-2011
2012 2011 % Change 2012 2011 % Change
(in thousands)
Product and
technology expenses $ 5,448 $ 4,257 28.0 % $ 14,180 $ 10,800 31.3 %
Capitalized software
development costs
from product and
technology resources 2,224 1,682 32.2 % 6,295 5,690 10.6 %
Total product and
technology expenses
and capitalized costs $ 7,672 $ 5,939 29.2 % $ 20,475 $ 16,490 24.2 %
As a percentage of
revenue:
Product and
technology
expensescosts 4.6 % 4.3 % 4.2 % 3.9 %
Capitalized software
development costs
from product and
technology resources 1.9 % 1.7 % 1.9 % 2.1 %
Total product and
technology costs
expensed and
capitalized 6.5 % 6.0 % 6.1 % 6.0 %
The increase in product and technology expenses in both absolute dollars and as
a percentage of revenue for the three months ended September 30, 2012, compared
to the same period in 2011, was primarily attributable to $0.8 million of
increased salaries and compensation expense as a result of increased headcount
related to the ongoing development of the RL Platform and new product
initiatives, in particular those resulting from the acquisition of RealPractice.
The increase in product and technology expenses in absolute dollars for the nine
months ended September 30, 2012, compared to the same period in 2011, was
primarily attributable to $2.8 million of increased salaries and compensation
expense as a result of increased headcount related to the ongoing development of
the RL Platform and new product initiatives, and $0.9 million of increased
amortization expense related to previously capitalized software development
costs. The increase as a percentage of revenue was primarily attributable to
increased salaries and compensation expense as a result of increased headcount
related to the ongoing development of the RL Platform and new product
initiatives.
The changes in the amount of capitalized software development costs in both
absolute dollars and as a percentage of revenues for the three and nine months
ended September 30, 2012, compared to the same periods in 2011, were primarily
due to the timing and mix of capitalizable and non-capitalizable projects.
General and Administrative
Three Months Ended Nine Months Ended
September 30, September 30,
2012-2011 2012-2011
2012 2011 % Change 2012 2011 % Change
(in thousands)
General and
administrative $ 9,966 $ 8,821 13.0 % $ 30,241 $ 24,470 23.6 %
As a percentage of
revenue: 8.4 % 8.9 % 9.0 % 8.9 %
27--------------------------------------------------------------------------------
The increase in general and administrative expenses in absolute dollars for the
three months ended September 30, 2012, compared to the same period in 2011, was
primarily due to $1.8 million of increased employee and facilities costs to
support the growth of the business, including our international expansion,
partially offset by $0.7 million of decreased professional fees, which consist
of tax, consulting, audit and legal fees. General and administrative expense
decreased slightly as a percentage of revenue for the three months ended
September 30, 2012 as a result of the aforementioned decrease in professional
fees.
The increase in general and administrative expenses in absolute dollars and as a
percentage of revenue for the nine months ended September 30, 2012, compared to
the same period in 2011, was primarily due to $5.3 million of increased employee
and facilities costs to support the growth of the business, including our
international expansion, and $0.6 million of increased stock-based compensation
expense, partially offset by $0.3 million of decreased professional fees, which
consist of tax, consulting, audit and legal fees.
We expect general and administrative expenses to increase in absolute dollars as
we continue to add personnel and incur additional professional fees and other
expenses to support our continued domestic and international growth.
Other Income , Net
Other income, net decreased for the three and nine months ended September 30,
2012 compared to the same periods in 2011 due to foreign exchange rate
fluctuations and lower interest rates on invested balances. Other income, net
primarily consists of interest income resulting from invested balances.
Provision for Income Taxes
The income tax provisions of $0.7 million and $0.3 million for the nine months
ended September 30, 2012 and 2011, respectively, relate to federal, state and
foreign income taxes, including the deferred tax impact of prior business
combinations.
Loss from Discontinued Operations
There was no activity in the discontinued operations of Bizzy during the three
and nine months ended September 30, 2012. The loss from discontinued operations
of $1.5 million and $4.7 million for the three and nine months ended September
30, 2011, respectively, was related to the wind-down of the operations of Bizzy.
Non-GAAP Financial Measures
In addition to our GAAP results discussed above, we believe Adjusted EBITDA and
Underclassmen Expense are useful to investors in evaluating our operating
performance. For the three and nine months ended September 30, 2012 and 2011,
our Adjusted EBITDA and Underclassmen Expense were as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2012 2011 2012 2011
(in thousands)
Adjusted EBITDA (1) $ 7,221 $ 4,530 $ 17,190 $ 10,674
Underclassmen Expense (2) $ 11,441 $ 11,591 $ 33,824 $ 32,714
(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), and amounts included in other non-operating
income or expense.
(2) Underclassmen Expense. We define Underclassmen Expense as our investment in
Underclassmen, which is comprised of the selling and marketing expenses we
allocate to Underclassmen during a reporting period. The amount includes the
direct salaries and allocated benefits of the Underclassmen (excluding
commissions), training and sales organization expenses including depreciation
allocated based on relative headcount and marketing expenses allocated based
on relative revenue. While we believe that Underclassmen Expense provides
useful information regarding our approximated investment in Underclassmen,
the methodology we use to arrive at our estimated Underclassmen Expense was
developed internally by the company, is not a concept or method recognized by
GAAP and other companies may use different methodologies to calculate or
approximate measures similar to Underclassmen Expense. Accordingly, our
calculation of Underclassmen Expense may not be comparable to similar
measures used by other companies.
28--------------------------------------------------------------------------------
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.
Our management believes 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, capital expenditures and investments in Underclassmen.
In addition, we believe 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 their 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.
29--------------------------------------------------------------------------------The following table presents a reconciliation of Adjusted EBITDA to our income
(loss) from operations for each of the periods indicated:
Three Months Ended Nine Months Ended
September 30, September 30,
2012 2011 2012 2011
(in thousands)
Income (loss) from continuing operations $ 1,117 $ (1,483 ) $ 560 (4,651 )
Add:
Depreciation and amortization 3,509 2,828 9,669 7,635
Stock-based compensation, net 2,595 2,331 6,929 6,316
Acquisition and integration costs - 854 32 1,374
Adjusted EBITDA $ 7,221 $ 4,530 $ 17,190 $ 10,674
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