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REACHLOCAL INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
[November 06, 2014]

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 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.

PAGE 19-------------------------------------------------------------------------------- Table Of Contents 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.

PAGE 20-------------------------------------------------------------------------------- Table Of Contents 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.

PAGE 21-------------------------------------------------------------------------------- Table Of Contents 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.

PAGE 22-------------------------------------------------------------------------------- Table Of Contents 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.

PAGE 23 -------------------------------------------------------------------------------- Table Of Contents 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 Nine Months Ended September 30, 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 Nine Months Ended September 30, 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 PAGE 24-------------------------------------------------------------------------------- Table Of Contents Revenue Three Months Ended Nine Months Ended September September 30, 30, 2014-2013 2014-2013 2014 2013 % Change 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 Nine Months Ended September September 30, 30, 2014-2013 2014-2013 2014 2013 % Change 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.

PAGE 25-------------------------------------------------------------------------------- Table Of Contents 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 Nine Months Ended September Three Months Ended September 30, 30, 2014-2013 2014-2013 2014 2013 % Change 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.

PAGE 26-------------------------------------------------------------------------------- Table Of Contents 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 % PAGE 27-------------------------------------------------------------------------------- Table Of Contents 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.

PAGE 28-------------------------------------------------------------------------------- Table Of Contents 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.

PAGE 29-------------------------------------------------------------------------------- Table Of Contents 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.

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