reachlocal_10k-123112.htm

	Year Ended December 31,
	2012			2011			2010			2009			2008
(in thousands, except per share data)
Consolidated Statements of Operations:
Revenue	$	455,354		$	375,241		$	291,689		$	203,117		$	146,687
Cost of revenue (1)		227,336			190,559			159,018			112,218			77,496
Operating expenses:
Selling and marketing (1)		167,424			139,929			108,529			76,089			61,054
Product and technology (1)		19,776			15,602			9,957			4,657			2,938
General and administrative (1)		40,471			33,470			23,880			15,731			12,128
Total operating expenses		227,671			189,001			142,366			96,477			76,120
Income (loss) from operations		347			(4,319	)		(9,695	)		(5,578	)		(6,929	)
Gain on acquisition of ReachLocal Australia		—			—			—			16,223			—
Equity in losses of ReachLocal Australia		—			—			—			—			(813	)
Other income (expense), net		575			928			601			(7	)		889

Income (loss) before provision (benefit) for income taxes		922			(3,391	)		(9,094	)		10,638			(6,853	)
Provision (benefit) for income taxes		1,154			735			(540	)		217			145
Income (loss) from continuing operations, net of income taxes		(232	)		(4,126	)		(8,554	)		10,421			(6,998	)
Loss from discontinued operations, net of income taxes		—			(6,215	)		(2,844	)		(601	)		—
Net income (loss)		(232	)		(10,341	)		(11,398	)		9,820			(6,998	)
Undistributed income attributable to preferred stockholders		—			—			—			8,638			—
Net income (loss) available to common stockholders	$	(232	)	$	(10,341	)	$	(11,398	)	$	1,182		$	(6,998	)

Income (loss) per share from continuing operations, basic	$	(0.01	)	$	(0.14	)	$	(0.43	)	$	0.28		$	(1.23	)
Loss per share from discontinued operations, basic		—			(0.21	)		(0.14	)		(0.10	)		—
Net income (loss) per share, basic (2)	$	(0.01	)	$	(0.36	)	$	(0.57	)	$	0.19		$	(1.23	)

Income (loss) per share from continuing operations, diluted	$	(0.01	)	$	(0.14	)	$	(0.43	)	$	0.23		$	(1.23	)
Loss per share from discontinued operations, diluted		—			(0.21	)		(0.14	)		(0.07	)		—
Net income (loss) per share, diluted (2)	$	(0.01	)	$	(0.36	)	$	(0.57	)	$	0.15		$	(1.23	)

Weighted average common shares used in the computation of net income (loss) per share:
Basic		28,348			28,974			19,867			6,283			5,667
Diluted		28,348			28,974			19,867			7,901			5,667

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

	Year Ended December 31,
	2012		2011		2010		2009		2008
Stock-based compensation:
Cost of revenue	$	297	$	200	$	244	$	86	$	34
Selling and marketing		1,742		1,402		1,202		566		338
Product and technology		1,204		1,387		1,104		117		73
General and administrative		6,261		5,549		3,374		2,347		1,366
	$	9,504	$	8,538	$	5,924	$	3,116	$	1,811

	Year Ended December 31,
	2012		2011		2010		2009		2008
Depreciation and amortization:
Cost of revenue	$	706	$	645	$	364	$	261	$	186
Selling and marketing		2,436		1,443		1,038		889		596
Product and technology		9,056		6,764		3,822		1,741		916
General and administrative		1,554		1,422		1,078		430		154
	$	13,752	$	10,274	$	6,302	$	3,321	$	1,852

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	December 31,
	2012		2011		2010		2009			2008
(in thousands)
Consolidated Balance Sheet Data:
Cash, cash equivalents and short-term investments	$	95,485	$	85,169	$	88,114	$	43,416		$	39,127
Working capital	$	10,341	$	17,524	$	27,082	$	(6,606	)	$	15,256
Total assets	$	185,696	$	166,437	$	151,399	$	97,761		$	51,124
Total liabilities	$	103,810	$	84,150	$	69,383	$	55,643		$	28,610
Total stockholders’ equity	$	81,886	$	82,287	$	82,016	$	42,118		$	22,514

	Year Ended December 31,
	2012		2011		2010		2009		2008
(in thousands)
Other Financial Data:
Net cash provided by operating activities	$	42,359	$	18,989	$	17,675	$	14,308	$	12,062
Capital expenditures (3)	$	16,336	$	12,441	$	8,526	$	4,613	$	5,152
Non-GAAP Financial Measures:
Adjusted EBITDA (4)	$	23,635	$	15,915	$	3,133	$	1,920	$	(3,266	)
Underclassmen Expense (5)	$	45,250	$	44,488	$	36,073	$	26,824	$	27,886

	December 31,
	2012		2011		2010		2009		2008
Other Operational Data:
Number of IMCs:
Upperclassmen		419		372		286		235		80
Underclassmen		405		424		379		280		337
Total		824		796		665		515		417
Active Advertisers (6)		22,000		19,100		16,900		14,700		11,600
Active Campaigns (7)		32,500		27,500		22,700		18,600		13,500

(2)	See Note 2 to our consolidated financial statements for an explanation of the method used to calculate basic and diluted net income per share of common stock.

(3)

Represents purchases of property and equipment and the amount of software development costs capitalized, in aggregate, excluding stock-based compensation and the acquisition of ReachLocal Australia in September 2009, and excluding capital expenditures related to the discontinued operations of Bizzy.

(4)

See Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Non-GAAP Financial Measures” for our definition of Adjusted EBITDA, why we present it and for a reconciliation of our Adjusted EBITDA to loss from operations for the years ended December 31, 2012, 2011 and 2010.

(5)	See Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Non-GAAP Financial Measures” for our definition of Underclassmen Expense.

(6)

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.

(7)

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.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

You should read the following discussion together with Part II, Item 6, “Selected Financial Data” and our consolidated financial statements and the related notes included elsewhere in this Annual Report. This discussion contains forward-looking statements about our business and operations. Our actual results may differ materially from those we currently anticipate as a result of many factors, including those we describe in Part I, Item 1A, “Risk Factors” and elsewhere in this Annual Report. See Part I, “Cautionary Notice Regarding Forward-Looking Statements.”

Overview

Our mission is to help small and medium-sized businesses, or SMBs, acquire, transact with, maintain and retain customers via the Internet. We offer a comprehensive suite of online marketing and reporting solutions, including ReachSearch™ (search engine marketing), ReachCast™ (Web presence), ReachDisplay™ (display advertising), ReachRetargeting™ (display retargeting), online marketing analytics, and other related products and solutions, each targeted to the SMB market. In 2013, we expect to expand our product suite to include ReachSite (website solution) and two software-as-a-service, or SaaS, products ReachConvert (marketing automation and lead conversion) and ReachCommerce (supporting online booking, transaction and back office processes). 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, resellers and a franchisee.

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, ReachDisplay and ReachRetargeting 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.

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, Poland and Czech Republic through our resellers, including a franchisee. In 2010, we commenced campaign management and provisioning operations in India.

Business Model

Our Direct Local channel represents the majority of our revenue. As a percentage of revenue, Direct Local revenue has increased to 79% for the year ended December 31, 2012, from 78% for the year ended December 31, 2011. Growth in Direct Local revenue is 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.

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Typically, each month we hire 40-50 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. With each new class of Underclassmen, we track how they are performing relative to a standard level of revenue growth and other performance metrics for each month after their training. Understanding the performance of past and current Underclassmen allows us to adjust our investment in additional Underclassmen in the event we detect significant changes in their productivity.

We believe the key factors that affect the productivity of our IMCs are:

•

IMC Tenure. As IMCs mature, they, on average, grow their advertiser base or sell additional products to existing advertisers, resulting in greater revenue productivity. In particular, Upperclassmen, those IMCs with more than 12 months of employment, are more productive than Underclassmen. As more and more IMCs mature and become Upperclassmen, as Upperclassmen become a higher percent of total IMCs, and as existing Upperclassmen mature, we expect overall IMC productivity to increase.

•

Macroeconomic and Business Conditions. Macroeconomic conditions directly impact the amount of money SMBs allocate to market their business. Commencing in mid-2008, IMC productivity was significantly impacted by the economic recession as some of our SMB clients were forced to close or temporarily suspend their operations, while others curtailed their marketing expenditures in light of a contraction in consumer spending. From the end of 2009 through 2012, our IMC productivity remained higher than those levels experienced at the end of 2008. However, we believe the economic conditions remain challenging, particularly in North America. In addition, our IMCs’ productivity is affected by the amount of competition and online advertising consumption by SMBs. For example, our international IMCs have on average been more productive, which we attribute to lower levels of competition and online advertising consumption by SMBs in those markets.

•

Number of Products. We believe that expanding our comprehensive suite of online marketing and reporting products and services will allow us to generate more revenue from each SMB relationship. Prior to 2009, we primarily offered a single product, ReachSearch. Since then, we launched our ReachDisplay and remarketing products in 2009, our TotalLiveChat and ReachCast products in 2010, our search retargeting and international ReachCast products in 2011, and our ReachRetargeting product in 2012.

•

IMC Capacity. We continually endeavor to enhance the productivity of our IMCs. Our business model therefore contemplates additional investments in technology and support personnel to assist our IMCs in managing and maintaining existing clients in order to increase their capacity to acquire new clients. For example, we are in the process of organizing our sales and service organization into verticals so that we can leverage greater subject matter expertise, we continue to explore different staffing approaches to enhance the IMC’s opportunity to focus on new client acquisition, and we are deploying additional technology to make the selling process more efficient.

•

Client Tenure. One of the most time-consuming activities for our IMCs is the process of prospecting, arranging a time to visit and obtaining the first order for our products and services from a new client. A key factor in IMC productivity is therefore the success of our efforts to continue to sell our products and services to existing clients, which requires significantly less of an IMC’s time. We believe that a measure of the success of these efforts is the percentage of our revenue generated by sales to clients with different tenures. For this purpose, on an annual basis, we divide our clients into three groups to measure their revenue contribution:

•

Trial Period Clients. We characterize a client’s initial four months as the “trial period” because that is generally the minimum term for a new client’s first agreement, and we believe that four months is the shortest period in which performance of an advertising campaign can be fully assessed.

•

First-Year Post-Trial Clients. We characterize a client that continues to advertise through us after its four-month trial period and for up to one year after its trial period as a First-Year Post-Trial Client.

•

Long-Term Clients. We characterize clients that continue to advertise through us for more than one year after their trial period as Long-Term Clients.

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The chart below presents the percentage of total revenues represented by our trial period, first-year post-trial, and long-term clients for the years ended December 31, 2010 to 2012.

Operating Metrics

We regularly review a number of other financial and operating metrics to evaluate our business, determine the allocation of resources and make decisions regarding business strategies. The following table shows certain key operating metrics for the three years ended December 31, 2012, 2011 and 2010.

	December 31,
	2012		2011		2010
Number of IMCs (at period end):
Upperclassmen		419		372		286
Underclassmen		405		424		379
Total		824		796		665

Underclassmen Expense for the year ended (in thousands) (1)	$	45,250	$	44,488	$	36,073

Active Advertisers (at period end) (2)		22,000		19,100		16,900

Active Campaigns (at period end) (3)		32,500		27,500		22,700

(1)	See Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Non-GAAP Financial Measures” for our definition of Underclassmen Expense.

(2)	See Part II, Item 6, “Selected Financial Data” for our definition of Active Advertisers.

(3)	See Part II, Item 6, “Selected Financial Data” for our definition of Active Campaigns.

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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 40-50 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. Total IMCs in 2012 increased as compared to the preceding year due to the increase in the number of Underclassmen becoming Upperclassmen. The number of Underclassmen at the end of 2012 was slightly lower than at the end of 2011 due to slightly lower IMC hiring rates in 2012. During 2012, our strategy regarding hiring and maturation of IMCs was to maintain a more constant level of IMC hiring globally—as opposed to prior years when we sought to increase our number of Underclassmen more substantially—while shifting the hiring to our newer international markets and focusing on improving Upperclassmen productivity in our more established markets.

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 and other variable compensation), 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 in 2012 as compared to the preceding year was primarily attributable to our international expansion, partially offset by a reduced investment in North America. Underclassmen expense slightly increased as compared to the preceding year due to increased hiring in our international markets, though the increase was offset by a reduced investment in Underclassmen recruitment in North America. The increase in Underclassmen Expense from 2011 to 2012 was lower than the increase from 2010 to 2011 as a result of our strategy to maintain a more constant level of IMC hiring globally—as opposed to prior years when we sought to increase Underclassmen hiring more substantially—while shifting the hiring to our newer international markets and focusing on improving Upperclassmen productivity in our more established markets.

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 and Active Campaigns increased in 2012 due to an increase in the number of Upperclassmen and the productivity of Upperclassmen driven by their increased tenure, and an increase in the number of products available for our IMCs to sell.

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, 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 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, ReachRetargeting 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 $3.8 million and $3.3 million of accounts receivables related to our National Brands, Agencies and Resellers at December 31, 2012 and 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. Cost of revenue also includes the cost of service providers related to our ClubLocal service.

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 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 IMCs, sales management and other employees in the sales organization is based on commissions and other variable compensation. 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.

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.

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Critical Accounting Policies and Estimates

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

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 consolidated financial statements:

•

Revenue recognition

•

Software development costs

•

Goodwill

•

Long-lived and intangible assets

•

Stock-based compensation

•

Variable interest entities

•

Income taxes

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 and ReachRetargeting product 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, we recognize 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 most cases, the resellers integrate with 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 have recently launched a new consumer service, ClubLocal, through which we create a direct relationship with consumers and provide home-related services by engaging third-party suppliers who perform the agreed services on our behalf . Revenue is recognized when services have been provided. As we are the primary obligor under the arrangements, have discretion in supplier selection, have latitude in establishing prices, and bear the credit risk, we recognize the gross amount of sales as revenue and the cost of the service provided is recorded as cost of revenue.

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.

We account for sales and similar taxes imposed on our services on a net basis in the consolidated statements of operations.

Software Development Costs

We capitalize costs to develop software when we have determined that the development efforts will result in new or additional functionality or new products. Costs capitalized as internal use software are amortized on a straight-line basis over the estimated three-year useful life. Costs incurred prior to meeting these criteria and costs associated with ongoing maintenance are expensed as incurred and are recorded along with amortization of capitalized software development costs as product and technology expenses within the accompanying consolidated statements of operations. 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.

Goodwill

We have total goodwill of $42.1 million as of December 31, 2012 and $41.8 million as of December 31, 2011 related to our acquired businesses. We operate in one reportable segment, in accordance with ASC 280, Segment Reporting, and have identified 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 each segment’s management. North America’s assigned goodwill was $9.7 million as of December 31, 2012 and $9.4 million as of December 31, 2011. Australia’s assigned goodwill was $32.4 million as of December 31, 2012 and 2011. 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.

For the year ended December 31, 2012, we followed the amended guidance for assessing qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, in accordance with 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.

We performed our annual assessment of goodwill impairment as of the first day of the fourth quarter of 2012 and 2011, and determined that it was more likely than not that there was no impairment of goodwill. Accordingly, no impairment of goodwill was recorded as of December 31, 2012 and 2011.

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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 one or 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.

In connection with our entrance into a franchise agreement with OxataSMB on July 6, 2012, we entered into a market development loan agreement with OxataSMB pursuant to which the Company agreed to provide financing to OxataSMB of up to €2.9 million ($3.7 million), of which €1.45 million ($1.9 million) has been advanced. We have determined that OxataSMB is considered a VIE, but that we are not the primary beneficiary of OxataSMB and, therefore, we did not consolidate the results of OxataSMB.

Deferred Consideration

Deferred purchase consideration that is fixed and determinable and expected to be settled in cash is accrued as a liability as of the date of the respective acquisition. Deferred purchase consideration that is fixed and determinable and expected to be settled in common stock is recorded as an increase to additional paid-in capital as of the date of acquisition. Deferred stock-based compensation issued to employees in connection with acquisitions is measured at fair value on the date of grant/acquisition and recognized over the vesting period of the instruments in accordance with our Stock-Based Compensation policy.

Common Stock Repurchase and Retirement

Common stock repurchased is retired and the excess of the cost over the par value of the common shares repurchased is charged to additional paid-in capital.

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Income Taxes

We use the liability method of accounting for income taxes. Significant judgment is required in determining the consolidated provision for income taxes and evaluating our tax positions. In the ordinary course of business, there are many transactions and calculations for which the ultimate tax settlement is uncertain. As a result, we recognize tax liabilities based on estimates of whether additional taxes and interest will be due. These tax liabilities are recognized when, despite our belief that our tax return positions are supportable, we believe that it is more likely than not that those positions may not be fully sustained upon review by tax authorities.

For the periods presented, income tax expense represents income taxes imposed by state, foreign and local tax jurisdictions applicable to our activities. We are otherwise generating net operating losses in the various tax jurisdictions in which we operate. We believe that it is likely that taxes imposed by state, local and foreign jurisdictions will increase in magnitude, particularly to the extent we become profitable in certain foreign jurisdictions before the time we obtain profitability on a consolidated basis.

Due to a history of losses, we have provided a valuation allowance against our deferred tax assets as more fully described in Note 12 of the consolidated financial statements. The ability to utilize these losses, any future losses and any other tax credits or attributes may be restricted or eliminated by changes in our ownership, including potentially as a result of our public offering, changes in legislation and other rules affecting the ability to offset future taxable income with losses from prior periods. Future determinations on the need for a valuation allowance on our net deferred tax assets will be made on a quarterly basis, and our assessment at December 31, 2012 reflects a continued need for a valuation allowance.

U.S. income and foreign withholding taxes have not been recognized on the excess of the amount for financial reporting over the tax basis of investments in foreign subsidiaries in the amount of $1.1 million that are essentially permanent in duration. This amount becomes taxable upon a repatriation of assets from the subsidiary or a sale or liquidation of the subsidiary. Determination of the amount of any unrecognized deferred income tax liability on this temporary difference is not practicable because of the complexities of the hypothetical calculation.

As a result of the acquisition of SMB:LIVE on February 22, 2010, we recorded a one-time discrete deferred tax benefit of $0.7 million from intangible assets recorded on the date of acquisition.

We are required to file income tax returns in the United States and various foreign jurisdictions, which requires us to interpret the applicable tax laws and regulations in effect in such jurisdictions. Such returns are, and from time to time, have been subject to audit by the various federal, state and foreign taxing authorities, which may disagree with our tax positions. We believe that our accruals for tax liabilities are adequate for all open audit years based on our assessment of many factors, including past experience and interpretations of tax law. We review and update our estimates in light of changing facts and circumstances, such as the closing of a tax audit, the lapse of a statute of limitations or a material change in estimate. To the extent that the final tax outcome of these matters differs from our expectations, such differences will impact income tax expense in the period in which such determination is made.

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Results of Operations

Comparison of the Years Ended December 31, 2012, 2011 and 2010

	Year Ended December 31,
	2012			2011			2010
(in thousands, except per share data)
Revenue	$	455,354		$	375,241		$	291,689
Cost of revenue (1)		227,336			190,559			159,018
Operating expenses:
Selling and marketing (1)		167,424			139,929			108,529
Product and technology (1)		19,776			15,602			9,957
General and administrative (1)		40,471			33,470			23,880
Total operating expenses		227,671			189,001			142,366
Income (loss) from operations		347			(4,319	)		(9,695	)
Other income, net		575			928			601
Income (loss) before provision for (benefit from) income taxes		922			(3,391	)		(9,094	)
Provision for (benefit from) income taxes		1,154			735			(540	)
Loss from continuing operations, net of income taxes		(232	)		(4,126	)		(8,554	)
Loss from discontinued operations, net of income taxes		—			(6,215	)		(2,844	)
Net loss	$	(232	)	$	(10,341	)	$	(11,398	)

Net loss:
Loss from continuing operations, net of income taxes	$	(232	)	$	(4,126	)	$	(8,554	)
Loss from discontinued operations, net of income taxes		—			(6,215	)		(2,844	)
Net loss	$	(232	)	$	(10,341	)	$	(11,398	)

Net loss per share, basic and diluted:
Loss per share from continuing operations, basic and diluted	$	(0.01	)	$	(0.14	)	$	(0.43	)
Loss per share from discontinued operations, basic and diluted		—			(0.21	)		(0.14	)
Net loss per share, basic and diluted	$	(0.01	)	$	(0.36	)	$	(0.57	)

Weighted average common shares used in the computation of net income (loss) per share:
Basic		28,348			28,974			19,867
Diluted		28,348			28,974			19,867

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

	Year Ended December 31,
	2012		2011		2010
Stock-based compensation:
Cost of revenue	$	297	$	200	$	244
Selling and marketing		1,742		1,402		1,202
Product and technology		1,204		1,387		1,104
General and administrative		6,261		5,549		3,374
	$	9,504	$	8,538	$	5,924


Depreciation and amortization:
Cost of revenue	$	706	$	645	$	364
Selling and marketing		2,436		1,443		1,038
Product and technology		9,056		6,764		3,822
General and administrative		1,554		1,422		1,078
	$	13,752	$	10,274	$	6,302

Revenue

	Year Ended December 31,
	2012		2011		2010		2012-2011 % Change			2011-2010 % Change
(in thousands)
Direct Local	$	359,505	$	291,444	$	217,846		23.4	%		33.8	%
National Brands, Agencies and Resellers		95,849		83,797		73,843		14.4	%		13.5	%
Total revenue	$	455,354	$	375,241	$	291,689		21.3	%		28.6	%

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	December 31,
	2012	2011	2010
(in thousands)
Number of IMCs:
Upperclassmen	419	372	286	12.6	%	30.1	%
Underclassmen	405	424	379	(4.0)	%	11.9	%
Total	824	796	665	3.8	%	19.7	%
Active Advertisers	22,000	19,100	16,900	15.2	%	13.0	%
Active Campaigns	32,500	27,500	22,700	18.2	%	21.1	%

The increase in Direct Local revenue of $68.1 million in 2012 compared to 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, which we attribute to lower levels of competition and growing online advertising demand by SMBs in those markets. Total IMCs in 2012 increased as compared to the preceding year due to the increase in the number of Underclassmen becoming Upperclassmen. The number of Underclassmen at the end of 2012 was slightly lower than at the end of 2011 due to slightly lower IMC hiring rates in 2012. During 2012, our strategy regarding hiring and maturation of IMCs was to maintain a more constant level of IMC hiring globally—as opposed to prior years when we sought to increase Underclassmen more substantially—while shifting the hiring to our newer international markets and focusing on improving Upperclassmen productivity in our more established markets. While we maintain flexibility in our IMC hiring strategy based on macroeconomic and market conditions, we anticipate that we will pursue a level of Underclassmen hires similar to 2012, while focusing on Upperclassmen productivity improvements in the near-term.

The increase in National Brands, Agencies and Resellers revenue of $12.1 million in 2012 compared to 2011 was due to an increase in revenue from our domestic and international National Brands clients of $5.6 million, and an increase in revenue of $6.4 million from our domestic and international Agencies and Resellers. These increases were primarily driven by increases in expenditures by existing National Brands clients and existing Agencies and Resellers, as well as an increase in the number of Agencies and Resellers.

The increase in Direct Local revenue of $73.6 million in 2011 compared to 2010 was largely attributable to the increase in productivity of our IMCs as a result of the increases in the number of Upperclassmen, the tenure of our Upperclassmen, and the number of international IMCs as a percentage of our total IMCs as our international IMCs are on average more productive, which we attribute to lower levels of competition and online advertising consumption by SMBs in those markets.

The increase in National Brands, Agencies and Resellers revenue of $10.0 million in 2011 compared to 2010 was primarily due to $10.4 million in higher revenue from our domestic and international National Brands clients during 2011, and $1.2 million from our international Agencies and Resellers, which we attribute to greater success in these portions of the channel. This increase was offset in part by a decrease of $1.7 million in revenue from North American Agencies and Resellers during 2011, which was due to a decrease in spending from advertisers who advertised with us in both 2010 and 2011, and a decrease in the number of agencies advertising with us, partially offset by an increase in revenue from new agencies.

Cost of Revenue

	Year Ended December 31,												Year Ended December 31,
	2012		2011		2010		2012-2011 % Change			2011-2010 % Change			2012			2011			2010
(in thousands)													(as a percentage of revenue)
Cost of revenue	$	227,336	$	190,559	$	159,018		19.3	%		19.8	%		50.0	%		50.8	%		54.5	%

The decrease in our cost of revenue as a percentage of revenue in 2012 compared to 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 and has a higher cost of revenue than our other products. Publisher rebates as a percentage of revenue increased to 4.6% of revenue in 2012 from 3.2% in 2011.

The decrease in our cost of revenue as a percentage of revenue in 2011 compared to 2010 was primarily due to changes in geographic, product and service mix, including increased international sales and sales of ReachCast and ReachDisplay, improved media buying efficiencies introduced in late 2010 related to our core products, an increase in publisher and vendor rebates, and economies of scale in our operations and service infrastructure. Publisher rebates as a percentage of revenue increased to 3.2% of revenue in 2011 from 1.9% in 2010, due to more favorable rebate terms, primarily from our reseller agreements with Google.

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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 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, 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 periodic operating results and increase our operating expenses as a percentage of revenue.

Selling and Marketing

	Year Ended December 31,												Year Ended December 31,
	2012		2011		2010		2012-2011 % Change			2011-2010 % Change			2012			2011			2010
(in thousands)													(as a percentage of revenue)
Salaries, benefits and other costs	$	118,458	$	98,784	$	74,195		20.0	%		33.1	%		26.0	%		26.3	%		25.4	%
Commission expense		48,966		41,145		34,334		19.0	%		19.8	%		10.8			11.0			11.8

Total selling and marketing	$	167,424	$	139,929	$	108,529		19.7	%		28.9	%		36.8	%		37.3	%		37.2	%

Underclassmen Expense included above, excluding commissions	$	45,250	$	44,488	$	36,073		1.7	%		23.3	%

The increase in selling and marketing salaries, benefits and other costs in absolute dollars in 2012 compared to 2011 was primarily due to an increase in our IMC headcount and related recruiting, training and facilities costs, as well as increased advertising costs, including for ClubLocal. The slight decrease in these costs as a percentage of revenue 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 and new product initiatives, including for ClubLocal.

The increase in commission expense in absolute dollars for 2012 compared to 2011 was due to increased sales. As a percentage of revenue, commission expense was slightly lower compared to the prior year. Commission expense includes commissions and other variable compensation. 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.

Underclassmen expense slightly increased as compared to the preceding year due to increased hiring in our international markets, though the increase was offset by a reduced investment in Underclassmen recruitment in North America. The increase in Underclassmen Expense from 2011 to 2012 was lower than the increase from 2010 to 2011 as a result of our strategy to maintain a more constant level of IMC hiring globally – as opposed to prior years where we were aggressively ramping up Underclassmen hiring – while shifting the hiring to emerging international markets and focusing on improving Upperclassmen productivity in our more established markets.

The increase in selling and marketing salaries, benefits and other costs in absolute dollars in 2011 compared to 2010 was primarily due to an increase in our IMC headcount and related recruiting, training and facilities costs. The increase as a percentage of revenue in 2011 compared to 2010 was due primarily to the entrance into new international markets, partially offset by economies of scale in our established markets.

The increase in commission expense in absolute dollars for 2011 compared to 2010 was due to increased sales. As a percentage of revenue, commission expense decreased due to a higher percentage of revenue from our Direct Local channel, for which we pay lower commission rates.

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The increase in Underclassmen Expense in 2011 compared to 2010 was primarily due to increased IMC hiring, particularly in international markets.

Product and Technology

	Year Ended December 31,												Year Ended December 31,
	2012		2011		2010		2012-2011 % Change			2011-2010 % Change			2012			2011			2010
(in thousands)													(as a percentage of revenue)
Product and technology expenses	$	19,776	$	15,602	$	9,957		26.8	%		56.7	%		4.3	%		4.2	%		3.4	%
Capitalized software development costs from product and technology resources		8,912		6,776		6,884		31.5	%		(1.6	)%		2.0			1.8			2.4

Total product and technology costs expensed and capitalized	$	28,688	$	22,378	$	16,841		28.2	%		32.9	%		6.3	%		6.0	%		5.8	%

The increase in product and technology expenses in absolute dollars in 2012 compared to 2011 was primarily attributable to $1.6 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 $1.6 million of increased amortization expense related to previously capitalized software development costs and acquired intangibles. 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, including ClubLocal.

The changes in the amount of capitalized software development costs in both absolute dollars and as a percentage of revenues in 2012 compared to 2011 were primarily due to an increase in capitalizable projects, including those relating to our new product initiatives.

The increase in product and technology expenses in both absolute dollars and as a percentage of revenue in 2011 compared to 2010 was primarily attributable to $3.5 million of increased salaries and compensation expense as a result of increased headcount related to the ongoing development of the RL Platform, including ReachCast, and $2.1 million of increased amortization expense related to previously capitalized software development costs.

Capitalized software development costs were essentially flat between 2011 and 2010.

General and Administrative

	Year Ended December 31,												Year Ended December 31,
	2012		2011		2010		2012-2011 % Change			2011-2010 % Change			2012			2011			2010
(in thousands)													(as a percentage of revenue)
General and administrative	$	40,471	$	33,470	$	23,880		20.9	%		40.2	%		8.9	%		8.9	%		8.2	%

The increase in general and administrative expenses in absolute dollars in 2012 compared to 2011 was primarily due to $6.8 million of increased employee and facilities costs to support the growth of the business, including our international expansion, and $0.7 million of increased stock-based compensation expense, partially offset by $0.5 million of decreased professional fees, which consist of tax, consulting, audit and legal fees.

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The increase in general and administrative expenses in absolute dollars and as a percentage of revenue in 2011 compared to 2010 was primarily due to $2.9 million of increased employee costs to support the growth of the business, $2.3 million of increased tax, consulting and legal professional fees, including costs to support our Sarbanes-Oxley compliance efforts and our international expansion initiatives, $2.2 million of increased stock-based compensation expense, and $1.8 million of increased facilities and related costs supporting the growth of the business and the requirements associated with being a public company.

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 in 2012 compared to 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.

The increase in other income in both absolute dollars and as a percentage of revenue in 2011 compared to 2010 was attributable to an increase in interest income resulting from higher invested balances.

Provision for (Benefit from) Income Taxes

The income tax provision of $1.2 million and $0.7 million for 2012 and 2011, respectively, relates to federal, state and foreign income taxes, including the deferred tax impact of prior business combinations. The income tax benefit of $0.5 million for 2010 was primarily attributable to the acquisition of SMB:LIVE, in which we recorded one-time discrete tax benefit of $0.7 million, which was partially offset by state, local and foreign income taxes of $0.2 million.

Loss from Discontinued Operations

On November 1, 2011, we announced that we would wind down the operations of Bizzy and determined that Bizzy would be considered a discontinued operation as of the third quarter of 2011. In connection with this decision, we recorded a charge of $4.0 million in 2011 to reflect the impairment of capitalized software development costs, personnel and severance costs, operating losses, facilities and other costs.

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 years ended December 31, 2012, 2011 and 2010, our Adjusted EBITDA and Underclassmen Expense were as follows:

	Year Ended December 31,
Non-GAAP Financial Measures (unaudited):	2012		2011		2010
(in thousands)
Adjusted EBITDA (1)	$	23,635	$	15,915	$	3,133
Underclassmen Expense (2)	$	45,250	$	44,488	$	36,073

(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 and other variable compensation), 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.

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

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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, our management believes 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.

The following table presents a reconciliation of Adjusted EBITDA to our loss from operations for each of the periods indicated:

	Year Ended December 31,
	2012		2011			2010
(in thousands)
Income (loss) from operations	$	347	$	(4,319	)	$	(9,695	)
Add:
Stock-based compensation, net		9,504		8,538			5,924
Depreciation and amortization		13,752		10,274			6,302
Acquisition and integration costs		32		1,422			602
Adjusted EBITDA	$	23,635	$	15,915		$	3,133

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Liquidity and Capital Resources

	Year Ended December 31,
Consolidated Statements of Cash Flow Data:	2012			2011			2010
(in thousands)
Net cash provided by operating activities, continuing operations	$	42,588		$	20,861		$	19,805
Net cash used in investing activities, continuing operations	$	(24,598	)	$	(11,708	)	$	(16,924	)
Net cash used by discontinued operations	$	(229	)	$	(3,012	)	$	(3,533	)
Net cash provided by (used in) financing activities	$	(9,180	)	$	(973	)	$	44,097

At December 31, 2012 and 2011, we had cash and cash equivalents of $92.3 million and short-term investments of $3.1 million. Cash and cash equivalents consist of cash, money market accounts and certificates of deposit. Short term investments consist of certificates of deposit with original maturities in excess of three months but less than 12 months. To date, we have experienced no loss of our invested cash, cash equivalents or short-term investments. We cannot, however, provide any assurances that access to our invested cash, cash equivalents and short-term investments will not be impacted by adverse conditions in the financial markets. At December 31, 2012, we had no long-term indebtedness for borrowed money and are not subject to any restrictive bank covenants. At December 31, 2012, we had $1.2 million in restricted certificates of deposit to secure letters of credit issued to landlords and others.

At December 31, 2012 and 2011, we did not have contractual or purchase commitments for capital expenditures that were not reflected on our balance sheet as a liability. In addition, at December 31, 2012, we had significant internal product and technology resources working on projects that met the criteria for capitalization as software development costs and others that did not, although none of the projects in process were long-term projects (greater than one year). The amount capitalized for such projects in future periods will be evaluated by management and will impact the portion of costs for those internal resources that reduces net cash provided by operating activities and the portion of such costs used in investing activities. Funding for the committed capital expenditures, including software development costs, is expected to be provided by operating cash flows.

We have financed our operations, our expansion of our IMC sales force and the extension of our Direct Local channel into new territories through cash provided by operations. Deferred revenue arising from prepayment by the great majority of our clients and vendor trade financing, principally for the purchase of media, are major components of our cash flow from operations, and the cash provided by deferred revenue and accounts payable has increased as our business has continued to grow. In general, to the extent our revenue from our Direct Local channel continues to grow, we would expect both the amount of deferred revenue from customer prepayments and the amount of vendor financing for purchased media to increase, which, subject to offset from changes in other operating costs, cash demands or vendor terms, would result in an increase in net cash provided by operations. Should revenue from the Direct Local channel decrease, the amount of deferred revenue and vendor financing would likely decrease, which, subject to changes in other accounts, would cause net cash provided by operations to be reduced.

Although we expect that cash flow from operations and our existing cash balances will be sufficient to continue funding our expansion activities, these investments, including investments in developing new products and services for our clients, could require us to seek additional equity or debt financing, and that financing may not be available on terms favorable to us or at all. In addition, we intend to continue to increase our investment in Underclassmen and in the development of new products and services for our clients, which could require significant capital and entail non-capitalized expenses that could decrease our income from operations.

Operating Activities

Our cash flow from operating activities for 2012 resulted primarily from adjustments for non-cash expenses and increases in operating liabilities. Our loss from continuing operations, net of income taxes, of $0.2 million, was more than offset by non-cash depreciation and amortization of $13.8 million, and non-cash stock-based compensation of $9.5 million. Cash flow from operating activities also reflected increases in accounts payable and accrued expenses of $12.9 million due to growth of the business and the fluctuation in timing of payments to certain vendors, including the normalization of rebates receivable, and increases in deferred revenue, rent and other liabilities of $7.7 million due to the growth of our business.

Our cash flow from operating activities for 2011 resulted primarily from adjustments for non-cash expenses and increases in operating liabilities. Our loss from continuing operations of $4.1 million was offset by non-cash depreciation and amortization of $10.3 million, and non-cash stock-based compensation of $8.5 million. The loss was also offset by increases in accounts payable and accrued expenses of $7.1 million, reflecting a return to more normalized accounts payable levels as compared to 2010 due to the change in timing of payments to certain vendors, and $5.5 million of increases in deferred revenue and deferred payment obligations, both due to the growth of our business. The increases were partially offset by an increase in other receivables and prepaid expenses of $5.7 million, primarily related to an increase in vendor rebates of $6.3 million.

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Our cash flow from operating activities for 2010 resulted primarily from changes in our operating assets and liabilities, with accounts payable and accrued liabilities increasing $11.2 million and deferred revenue and rent increasing $7.9 million, both due to the growth of our business. We had a net loss in 2010 of $8.6 million, which included non-cash depreciation and amortization of $6.3 million and non-cash stock-based compensation of $5.9 million.

Investing Activities

Our primary investing activities have consisted of purchases of property and equipment, capitalized software development costs, short-term investments, and business acquisitions. Our purchases of property and equipment and capitalization of software costs increased by $3.9 million year-over-year from in 2012 from 2011 reflecting our increased investment in our products, technology, facilities, and in newer markets. Purchases of property and equipment and capitalization of software costs will vary from period to period due to the timing of the expansion of our operations and our software development efforts. We expect to continue to use capital for acquisitions, purchases of property and equipment, and development of software.

On June 29, 2012, 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. In addition, during 2012, we made acquisition related payments of $4.2 million, consisting of payments on deferred obligations related to the DealOn and SMB:LIVE acquisitions totaling $1.6 million, and payment for the RealPractice acquisition of $2.6 million. We have remaining obligations totaling $0.8 million related to these acquisitions. We also purchased certificates of deposits and short-term investments of $9.1 million, offset by maturities aggregating $6.6 million.

On February 8, 2011, we acquired DealOn for up to approximately $9.7 million in cash and stock. On the closing date, we paid $5.8 million in cash and issued 82,878 shares of our common stock. The balance of the purchase price was estimated to total up to $1.5 million, payable in cash, and 22,095 common shares of our stock, payable in three installments, with 50% (10,649 shares of common stock) paid in February 2012, 25% paid August 2012 and 25% paid February 2013.

In 2010, we invested $2.8 million, net of cash acquired, in the purchase of SMB:LIVE. The terms of our purchase agreement required us to make additional payments in 2011 of $0.4 million and in 2012 of $0.6 million. In 2009, we acquired the remaining interest of ReachLocal Australia and invested $8.9 million in net cash. Of this investment, $3.1 million was paid, net of cash acquired, in 2009 and the balance of $5.8 million was paid in conjunction with our initial public offering in 2010.

Financing Activities

During 2012, our financing activities primarily consisted of using $11.0 million of cash to settle the purchase of shares of our common stock pursuant to our share repurchase program, partially offset by $1.8 million in proceeds from exercise of stock options. Our cash flow used in financing activities for 2011 resulted primarily from settlements of repurchases of our common stock of $6.5 million, partially offset by $5.5 million in proceeds from the exercise of stock options. In May 2010, we received $43.0 million in proceeds, after deducting underwriting discounts and commissions and estimated offering costs payable by us, from the sale of shares of common stock in connection with our initial public offering.

Future cash flows from financing activities may also be affected by our repurchases of our common stock. On November 4, 2011, we announced that our Board of Directors authorized the repurchase of up to $20.0 million of our outstanding common stock. On December 13, 2012, we announced that our Board of Directors increased the total authorized repurchase amount to $26.0 million, and on March 4, 2013, we announced that our Board of Directors increased the total authorized repurchase amount by an additional $21.0 million, to a total authorization of $47.0 million. At December 31, 2012, we had executed repurchases of $17.4 million of our common stock under the program. From January 1, 2013 to March 5, 2013, we executed repurchases of an additional $1.5 million of our common stock under the program. Purchases may be made from time-to-time in open market or privately negotiated transactions as determined by our management. The amount and timing of the share repurchase will depend on business and market conditions, stock price, trading restrictions, acquisition activity, and other factors. The share repurchase program does not obligate us to acquire any particular amount of common stock, and the repurchase program may be suspended or discontinued at any time at our discretion.

Balance Sheet Arrangements

At December 31, 2012, we did not have any off-balance sheet arrangements.

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Contractual Obligations

At December 31, 2012, the remaining deferred payment obligation under the DealOn acquisition agreement included approximately $0.4 million in cash and 5,324 shares of our common stock, both of which were paid on February 8, 2013. The remaining deferred payment obligation related to the RealPractice acquisition was $0.3 million.

We lease our primary office space in Woodland Hills, California; Plano, Texas; and other locations under various cancelable and non-cancelable operating leases that will expire between 2012 and 2021. We have no debt obligations. All property and equipment have been purchased for cash, and we have no capital lease obligations recorded in the financial statements. We have a long-term purchase obligation outstanding with a vendor, of which $1.4 million is due within a year, and $3.5 million is due between 1 to 3 years.

As of December 31, 2012, future minimum payments under non-cancelable operating leases are as follows (in thousands):

	Payments Under Operating Leases
Less than 1 year	$	10,508
1-3 years		15,210
3-5 years		7,862
More than 5 years		6,687
Total future minimum payments	$	40,267

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

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

Interest Rate Fluctuation Risk

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

Foreign Currency Exchange Risk

We have foreign currency risks related to our investments, revenue and operating expenses denominated in currencies other than the U.S. dollar, principally the Australian dollar, the British pound sterling, the Canadian dollar, the euro, the Japanese yen, the Indian rupee, and the Brazilian real. For the year ended December 31, 2012, a 10% strengthening of the U.S. dollar relative to these foreign currencies would have resulted in a decrease in revenue of $14.1 million, but an increase in operating income of $0.9 million. A 10% weakening of the U.S. dollar relative to these foreign currencies, however, would have resulted in an increase in revenue of $14.1 million, but a decrease in operating income of $0.9 million. We currently do not hedge or otherwise manage our currency exposure. As our international operations expand to more countries and mature, our risks associated with fluctuations in currency rates will become greater, and we will continue to reassess our approach to managing this risk. In addition, currency fluctuations or a weakening U.S. dollar can increase the costs of our international expansion.

Inflation Risk

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

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Item 8. Financial Statements and Supplementary Data.

Please refer to Item 15—Exhibits and Financial Statement Schedules.

Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.

None.

Item 9A. Controls and Procedures.

(a)	Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures pursuant to Exchange Act Rules 13a-15(e) and 15d-15(e) as of December 31, 2012. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in reports we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (2) is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

(b)	Management’s Annual Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on criteria established in the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2012.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect all misstatements. A control system no matter how well designed and operated, can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Grant Thornton LLP, an independent registered public accounting firm, has audited the effectiveness of our internal control over financial reporting as of December 31, 2012, as stated in their report, which is included in Item 8 of this Annual Report on Form 10-K.

(c)	Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Item 9B. Other Information.

None.

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PART III

Item 10. Directors, Executive Officers and Corporate Governance.