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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2013

OR

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

For the transition period from            to            

Commission file number 001-34749

REACHLOCAL, INC.

(Exact name of registrant as specified in its charter)

Delaware	20-0498783
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

21700 Oxnard Street, Suite 1600 Woodland Hills, California	91367
(Address of principal executive offices)	(Zip Code)

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

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

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

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

Large accelerated filer ☐ Accelerated filer ☒

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.):    Yes  ☐    No  ☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Title of Class	Number of Shares Outstanding on August 2, 2013
Common Stock, $0.00001 par value	28,055,551

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INDEX

				Page
Part I.	Financial Information			3
	Item 1.	Condensed Consolidated Financial Statements (unaudited)		3
			Condensed Consolidated Balance Sheets as of June 30, 2013 and December 31, 2012	3
			Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2013 and 2012	4
			Condensed Consolidated Statements of Comprehensive Loss for the Three and Six Months Ended June 30, 2013 and 2012	5
			Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2013 and 2012	6
			Notes to the Condensed Consolidated Financial Statements	7
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		18
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk		32
	Item 4.	Controls and Procedures		33
Part II.	Other Information
	Item 1.	Legal Proceedings		34
	Item 1A.	Risk Factors		34
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		34
	Item 6.	Exhibits		35
		Signatures		36

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PART I

FINANCIAL INFORMATION

Item 1.         FINANCIAL STATEMENTS

REACHLOCAL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

(Unaudited)

	June 30, 2013			December 31, 2012
Assets
Current Assets:
Cash and cash equivalents	$	81,437		$	92,336
Short-term investments		553			3,149
Accounts receivable, net of allowance for doubtful accounts of $238 and $259 at June 30, 2013 and December 31, 2012, respectively		8,320			5,689
Other receivables and prepaid expenses		10,616			8,957
Total current assets		100,926			110,131
Property and equipment, net		12,211			11,066
Capitalized software development costs, net		17,295			14,704
Restricted certificates of deposit		1,344			1,226
Intangible assets, net		1,780			2,442
Other assets		7,108			4,044
Goodwill		42,083			42,083
Total assets	$	182,747		$	185,696
Liabilities and Stockholders’ Equity
Current Liabilities:
Accounts payable	$	37,883		$	35,297
Accrued expenses		26,955			27,422
Deferred revenue and other current liabilities		35,067			36,304
Liabilities of discontinued operations		770			767
Total current liabilities		100,675			99,790
Deferred rent and other liabilities		4,698			4,020
Total liabilities		105,373			103,810
Commitments and contingencies (Note 8)
Stockholders’ Equity:
Common stock, $0.00001 par value—140,000 shares authorized; 28,062 and 28,154 shares issued and outstanding at June 30, 2013 and December 31, 2012, respectively		—			—
Receivable from stockholder		(76	)		(89	)
Additional paid-in capital		108,690			110,573
Accumulated deficit		(27,852	)		(27,076	)
Accumulated other comprehensive loss		(3,388	)		(1,522	)
Total stockholders’ equity		77,374			81,886
Total liabilities and stockholders’ equity	$	182,747		$	185,696

See notes to condensed consolidated financial statements.

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REACHLOCAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(Unaudited)

	Three Months Ended June 30,					Six Months Ended June 30,
	2013			2012		2013			2012
Revenue	$	127,055		$	112,212	$	248,875		$	216,215
Cost of revenue		64,247			55,656		125,800			108,046
Operating expenses:
Selling and marketing		46,791			41,176		91,490			79,719
Product and technology		5,497			4,399		11,673			8,732
General and administrative		9,987			10,468		19,212			20,275
Total operating expenses		62,275			56,043		122,375			108,726
Income (loss) from operations		533			513		700			(557	)
Other income, net		114			102		341			305
Income (loss) from operations before provision for income taxes		647			615		1,041			(252	)
Provision for income taxes		788			283		1,817			422
Net income (loss)	$	(141	)	$	332	$	(776	)	$	(674	)
Net income (loss) per share, basic	$	(0.01	)	$	0.01	$	(0.03	)	$	(0.02	)
Net income (loss) per share, diluted	$	(0.01	)	$	0.01	$	(0.03	)	$	(0.02	)
Weighted average common shares used in computation of net income (loss) per share, basic		27,910			28,375		28,011			28,367
Weighted average common shares used in computation of net income (loss) per share, diluted		27,910			28,905		28,011			28,367

See notes to condensed consolidated financial statements.

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REACHLOCAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(in thousands)

(Unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2013			2012			2013			2012
Net income (loss)	$	(141	)	$	332		$	(776	)	$	(674	)
Other comprehensive loss:
Foreign currency translation adjustments		(1,878	)		(345	)		(1,866	)		(248	)
Comprehensive loss	$	(2,019	)	$	(13	)	$	(2,642	)	$	(922	)

See notes to condensed consolidated financial statements.

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REACHLOCAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

	Six Months Ended June 30,
	2013			2012
Cash flow from operating activities:
Net loss	$	(776	)	$	(674	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		8,019			6,160
Stock-based compensation		5,222			4,334
Excess tax benefits from stock-based awards		(1,090	)		—
Provision for doubtful accounts		296			78
Changes in operating assets and liabilities:
Accounts receivable		(3,030	)		(246	)
Other receivables and prepaid expenses		(1,762	)		568
Other assets		(610	)		9
Accounts payable and accrued expenses		4,539			6,677
Deferred revenue, rent and other liabilities		1,003			5,651
Net cash provided by operating activities, continuing operations		11,811			22,557
Net cash used for operating activities, discontinued operations		—			(178	)
Net cash provided by operating activities		11,811			22,379
Cash flow from investing activities:
Additions to property, equipment and software		(11,272	)		(8,195	)
Acquisitions, net of acquired cash		(363	)		(1,074	)
Investment in partnership		(2,500	)		—
Maturities of certificates of deposits and short-term investments		2,569			701
Purchases of certificates of deposits and short-term investments		(230	)		—
Net cash used in investing activities		(11,796	)		(8,568	)
Cash flow from financing activities:
Proceeds from exercise of stock options		4,370			336
Excess tax benefits from stock-based awards		1,090			—
Common stock repurchases		(12,990	)		(4,025	)
Net cash used in financing activities		(7,530	)		(3,689	)
Effect of exchange rate changes on cash and cash equivalents		(3,384	)		(308	)
Net change in cash and cash equivalents		(10,899	)		9,814
Cash and cash equivalents—beginning of period		92,336			84,525
Cash and cash equivalents—end of period	$	81,437		$	94,339
Supplemental disclosure of non-cash investing and financing activities:
Capitalized software development costs resulting from stock-based compensation and deferred payment obligations	$	273		$	161
Deferred payment obligation decrease	$	(122	)	$	(243	)

See notes to condensed consolidated financial statements.

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REACHLOCAL, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1. Organization and Description of Business

ReachLocal, Inc. (the “Company”) was incorporated in the state of Delaware in August 2003. The Company’s operations are located in North America, Australia, the United Kingdom, the Netherlands, Germany, Austria, Japan, Brazil and India. The Company’s mission is to help small- and medium-sized businesses (“SMBs”) acquire, transact with, maintain and retain customers via the Internet. The Company offers a comprehensive suite of online marketing solutions, including search engine marketing (ReachSearch™), Web presence (ReachCast™), display advertising (ReachDisplay™), display retargeting (ReachRetargeting™), online marketing analytics (TotalTrack®), and assisted chat service (TotalLiveChat™), each targeted to the SMB market. In 2013, the Company expects to expand its product suite to include two software-as-a-service, or SaaS, products: ReachCommerce (supporting online booking, transaction and back office processes), and ReachEdge (a marketing system that combines an optimized website and automated lead management). The Company delivers this suite of services to SMBs through a combination of its proprietary technology platform, the RL Platform, its direct, “feet-on-the-street” sales force of Internet Marketing Consultants, or IMCs, and select third-party agencies and resellers. The Company also developed a new consumer service, ClubLocal™, through which it creates a direct relationship with consumers and provides home-related services by engaging third-party suppliers which perform the agreed services on the Company’s behalf.

2. Summary of Significant Accounting Policies

Principles of Consolidation

The condensed consolidated financial statements include the accounts of ReachLocal, Inc. and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

Basis of Presentation

The accompanying condensed consolidated financial statements are unaudited. These unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and applicable rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. Accordingly, these interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012. The Condensed Consolidated Balance Sheet as of December 31, 2012 included herein was derived from the audited consolidated financial statements as of that date, but does not include all disclosures, including notes required by GAAP.

The unaudited interim condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and include all adjustments (consisting only of normal recurring adjustments) necessary for the fair presentation of the Company’s statement of financial position at June 30, 2013, the Company’s results of operations for the three and six months ended June 30, 2013 and 2012, and the Company’s cash flows for the six months ended June 30, 2013 and 2012. The results for the three and six months ended June 30, 2013 are not necessarily indicative of the results to be expected for the year ending December 31, 2013. All references to the three and six months ended June 30, 2013 and 2012 in the notes to the condensed consolidated financial statements are unaudited.

Discontinued Operations

As a result of winding down and closing the operations of Bizzy, effective November 2011, the Company has reclassified and presented all related historical financial information as “discontinued operations” in the accompanying Condensed Consolidated Balance Sheets and Consolidated Statements of Cash Flows. In addition, all Bizzy-related activities have been excluded from the notes unless specifically referenced.

Reclassifications and Adjustments

Certain prior period amounts have been reclassified to conform to the current period.

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Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of income and expenses during the reporting period. These estimates are based on information available as of the date of the consolidated financial statements. Therefore, actual results could differ from those estimates.

Revenue Recognition

The Company recognizes revenue for its 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.

The Company recognizes revenue as the cost for the third-party media is incurred, which is upon delivery of the advertising on behalf of its clients. The Company recognizes revenue for its ReachSearch product as clicks are recorded on sponsored links on the various search engines and for its ReachDisplay and ReachRetargeting products when the display advertisements record impressions or as otherwise provided in its agreement with the applicable publisher. The Company recognizes revenue for its ReachCast and ReachEdge products on a straight line basis over the applicable service period for each campaign. The Company recognizes revenue when it charges 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 the Company receives advance payments from clients, management records these amounts as deferred revenue until the revenue is recognized. When the Company extends credit, management records a receivable when the revenue is recognized.

When the Company sells through agencies, it either receives payment in advance of services or in some cases extends credit. The Company pays each agency an agreed-upon commission based on the revenue it earns or cash it receives. Some agency clients who have been extended credit may offset the amount otherwise due to the Company by any commissions they have earned. Management evaluates whether it is appropriate to record the gross amount of campaign revenue or the net amount earned after commissions. As the Company is the primary party obligated in the arrangement, subject to the credit risk, with discretion over both price and media, management recognizes the gross amount of such sales as revenue and any commissions are recognized as a selling and marketing expense.

The Company also has a small number of resellers, including a franchisee. Resellers integrate the Company’s services, including ReachSearch, ReachDisplay, and TotalTrack, into their product offerings. In most cases, the resellers integrate with the Company’s 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 the Company in arrears, net of commissions and other adjustments. Management recognizes revenue generated under reseller agreements net of the agreed-upon commissions and other adjustments earned or retained by the reseller, as management believes that the reseller has retained sufficient control and bears sufficient risks to be considered the primary obligor in those arrangements.

The Company recently launched a new consumer service, ClubLocal, through which it creates a direct relationship with consumers and provides home-related services by engaging third-party suppliers who perform the agreed services on the Company’s behalf. Revenue is recognized when services have been provided. As the Company is the primary obligor under the arrangements, has discretion in supplier selection, has latitude in establishing prices, and bears the credit risk, it recognizes the gross amount of sales as revenue and records the cost of the service provided as cost of revenue.

The Company offers incentives to clients in exchange for minimum commitments. In these circumstances, management estimates the amount of the incentives that will be earned by clients and defers 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, management recognizes the revenue previously deferred related to the estimated incentive.

The Company accounts for sales and similar taxes imposed on its services on a net basis in the Condensed Consolidated Statements of Operations.

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Software Development Costs

The Company capitalizes costs to develop software when management has 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 Condensed Consolidated Statements of Operations. The Company monitors its existing capitalized software costs and reduces 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

The Company’s total goodwill of $42.1 million as of both June 30, 2013 and December 31, 2012, is related to the Company’s acquired businesses.   The Company operates in one reportable segment, in accordance with Accounting Standards Codification (“ASC”) 280, Segment Reporting, and has 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 reporting unit’s management. North America’s assigned goodwill was $9.7 million and Australia’s assigned goodwill was $32.4 million as of both June 30, 2013 and December 31, 2012. The Company reviews the carrying amounts of goodwill for possible impairment whenever events or changes in circumstances indicate that the related carrying amount may not be recoverable. The Company performs its annual assessment of goodwill impairment as of the first day of each fourth quarter.

The Company follows 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. The Company estimates fair value utilizing the projected discounted cash flow method and a discount rate determined by the Company to commensurate with the risk inherent in its business model.

Long-Lived and Intangible Assets      

The Company reports finite-lived, acquisition-related intangible assets at fair value, net of accumulated amortization. Identifiable intangible assets are amortized on a straight-line basis over their estimated useful lives of three years, or one year, in the case of certain customer relationships. Straight-line amortization is used because no other pattern over which the economic benefits will be consumed can be reliably determined.

The Company reviews the carrying values of long-lived assets, including intangible assets, for possible impairment whenever events or changes in circumstances indicate that the related carrying amount may not be recoverable. In its analysis of other finite lived amortizable intangible assets, the Company applies 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 the Company has 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

The Company accounts for stock-based compensation based on fair value. The Company follows the attribution method, which reduces current stock-based compensation expenses recorded by the effect of anticipated forfeitures. Management estimates forfeitures based upon its historical experience. 

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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. The Company uses 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. In addition, the Company uses a Monte Carlo simulation model to estimate the fair value of performance-vesting restricted stock and restricted stock units. Determining the fair value of these awards at the grant date under this model requires judgment, including estimating volatility, risk-free rate and expected future stock price. 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 or Monte Carlo simulation models significantly change, 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 (“VIE”), the Company analyzes its 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. The Company’s analysis includes both quantitative and qualitative reviews. The Company bases its quantitative analysis on the forecasted cash flows of the entity, and its qualitative analysis on the design of the entity, its organizational structure including its decision-making authority, and relevant agreements. If the Company determines that the entity is a VIE, the Company then assesses if it must consolidate the VIE as its primary beneficiary. The Company’s determination of whether it is 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 the Company absorbs, 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. See Note 6, “Variable Interest Entities”, for more information.

Loan Receivable

 The loan receivable is recorded at carrying value, net of potential allowance for losses. Losses on the receivable are recorded when probable and estimable. The Company routinely evaluates the receivable for potential collection issues that might indicate an impairment. Changes in such estimates can significantly affect the allowance and provision for losses. It is possible that the Company will experience losses that are different from its current estimates. Write-offs are deducted from the allowance for losses when the Company judges the principal to be uncollectible. Any subsequent recoveries are added to the allowance at the time cash is received on a written-off balance. Interest income on the loan receivable is accrued on a monthly basis over the life of the loan. See Note 6, “Variable Interest Entities”, for more information.

Investment in Partnership

The investment in partnership is accounted for under the cost method, which is periodically assessed for other-than-temporary impairment. If the Company determines that an other-than-temporary impairment has occurred, it will write-down the investment to its fair value. The fair value of a cost method investment is not evaluated if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value of the investment. However, if such significant adverse events were identified, the Company would estimate the fair value of its cost method investment considering available information at the time of the event, such as current cash position, earnings and cash flow forecasts, recent operational performance and any other readily available data.

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 recorded to additional paid-in capital.

Net Income (Loss) Per Share

Basic net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of common and potential dilutive shares outstanding during the period, to the extent such shares are dilutive. Potential dilutive shares are composed of incremental common shares issuable upon the exercise of stock options, warrants and unvested restricted shares using the treasury stock method. The Company was in a net loss position for each of the three and six-month periods ended June 30, 2013 and the six-month period ended June 30, 2012, and therefore the number of diluted shares was equal to the number of basic shares for each of these periods.

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The following table sets forth the computation of basic and diluted net income (loss) per share (in thousands, except per share amounts):

	Three Months Ended June 30,					Six Months Ended June 30,
	2013			2012		2013			2012
Numerator:
Net income (loss)	$	(141	)	$	332	$	(776	)	$	(674	)
Denominator:
Weighted average common shares used in computation of net income (loss) per share, basic		27,910			28,375		28,011			28,367
Deferred stock consideration and unvested restricted stock	—				80	—			—
Stock options and warrant	—				450	—			—
Weighted average common shares used in computation of net income (loss) per share, diluted		27,910			28,905		28,011			28,367
Net income (loss) per share, basic	$	(0.01	)	$	0.01	$	(0.03	)	$	(0.02	)
Net income (loss) per share, diluted	$	(0.01	)	$	0.01	$	(0.03	)	$	(0.02	)

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

	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Deferred stock consideration and unvested restricted stock		357		—		292		68
Stock options and warrant		3,797		6,874		3,721		7,029
		4,154		6,874		4,013		7,097

3. Fair Value of Financial Instruments

The following table summarizes the basis used to measure certain of the Company’s financial assets that are carried at fair value (in thousands):

			Basis of Fair Value Measurement
	Balance at June 30, 2013		Quoted Prices in Active Markets for Identical Items (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Certificates of deposit	$	1,897	$	1,897	$	—	$	—

			Basis of Fair Value Measurement
	Balance at December 31, 2012		Quoted Prices in Active Markets for Identical Items (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Certificates of deposit	$	4,375	$	4,375	$	—	$	—

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The following table provides information about assets not carried at fair value in the Company’s Condensed Consolidated Balance Sheets (in thousands):

	June 30, 2013				December 31, 2012
	Carrying amount		Estimated fair value		Carrying amount		Estimated fair value
Loan receivable	$	1,960	$	1,960	$	1,954	$	1,954

The OxataSMB B.V. (“OxataSMB”) loan receivable is not actively traded and its fair value is estimated based on valuation methodologies using current market interest rate data adjusted for inherent credit risk. See Note 6, “Variable Interest Entities”, for further information on the loan receivable.

The Company also has an investment in a privately held partnership, which is a service provider, in which the Company’s ownership is less than 20% and the Company does not have significant influence. The investment is accounted for under the cost method, which is periodically assessed for other-than-temporary impairment. If the Company determines that an other-than-temporary impairment has occurred, it will write-down the investment to its fair value. The fair value of a cost method investment is not evaluated if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value of the investment. However, if such significant adverse events were identified, the Company would estimate the fair value of its cost method investment considering available information at the time of the event, such as current cash position, earnings and cash flow forecasts, recent operational performance and any other readily available data. The carrying amount of the Company’s cost method investment was $2.5 million as of June 30, 2013, and is included in “Other assets” in the accompanying Condensed Consolidated Balance Sheet.

4. Acquisitions

Deferred Consideration

In connection with its 2012 RealPractice acquisition, the Company is obligated to pay an additional $0.3 million in cash on January 3, 2014, subject to adjustment.

Pursuant to the terms of its 2011 acquisition of DealOn, on February 8, 2012, the Company made a deferred payment in the amount of $0.5 million, net of the working capital adjustment and certain other adjustments, and issued 10,649 shares of its common stock. On August 8, 2012, the Company made an additional deferred payment in the amount of $0.4 million and issued 5,324 shares of its common stock. On February 8, 2013, the Company made the final deferred payment in connection with the DealOn acquisition in the amount of $0.4 million and issued 5,324 shares of its common stock.

As part of consideration paid to acquire SMB:Live Corporation (“SMB:Live”), on February 22, 2012, the Company paid $0.6 million in cash and issued 181,224 shares of its common stock as final payment in connection with the acquisition.

Intangible Assets

As of June 30, 2013, intangible assets from acquisitions included developed technology of $1.8 million (net of accumulated amortization of $1.3 million) amortized over three years. As of December 31, 2012, intangible assets from acquisitions included developed technology of $2.4 million (net of accumulated amortization of $2.9 million) amortized over three years, and customer relationships of $25,000 (net of accumulated amortization of $25,000) amortized over one year. Based on the current amount of intangibles subject to amortization, the estimated amortization expense over the remaining lives is as follows (in thousands):

Year Ending December 31,
2013 (6 months)	$	510
2014		853
2015		417
Total	$	1,780

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For the three months ended June 30, 2013 and 2012, amortization expense related to acquired intangibles was $0.3 million and $0.4 million, respectively. For the six months ended June 30, 2013 and 2012, amortization expense related to acquired intangibles was $0.7 million and $0.9 million, respectively.

5. Software Development Costs

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

	June 30, 2013			December 31, 2012
Capitalized software development costs	$	38,942		$	31,944
Accumulated amortization		(21,647	)		(17,240	)
Capitalized software development costs, net	$	17,295		$	14,704

The Company recorded amortization expense of $2.2 million and $1.6 million for the three months ended June 30, 2013 and 2012, respectively, and $4.4 million and $3.0 million for the six months ended June 30, 2013 and 2012, respectively. As of June 30, 2013 and December 31, 2012, $5.0 million and $3.3 million, respectively, of capitalized software development costs related to projects still in process.

6. Variable Interest Entities

On July 6, 2012, the Company completed a transaction with OxataSMB, in which the Company entered into a franchise agreement with OxataSMB permitting OxataSMB to operate and resell the Company’s services under the ReachLocal brand in Slovakia, Czech Republic, Hungary, Poland and Russia. Pursuant to the franchise agreement, OxataSMB receives access to the RL platform, training, marketing and branding materials, media purchasing, campaign management and provisioning, sourcing of telephony, and technical support. The Company does not anticipate OxataSMB will pursue activities other than as a franchisee. In addition, the Company entered into a market development loan agreement with OxataSMB pursuant to which the Company agreed to provide financing to OxataSMB of up to €2.9 million ($3.8 million), of which €1.45 million ($1.9 million) has been advanced. Oxata’s ability to draw down the remaining loan amount was dependent on OxataSMB achieving certain milestones by June 29, 2013. The remaining loan amount was not drawn as of June 30, 2013, but the Company retains the discretion to advance some or all of the remaining loan amount prior to December 29, 2013. The loan has a two-year term and accrues interest at 4% per annum, but does not require principal or interest payments for two years, and can be extended for an additional 24 months based on achievement of certain milestones. Prior to advancement of the loan, OxataSMB had €1.45 million ($1.9 million) of contributed capital. In addition, the Company has an option to buy OxataSMB at an independently-determined fair value at the end of the initial loan term, subject to extension.

OxataSMB is considered a VIE with respect to the Company because, depending on its performance, OxataSMB may not have sufficient equity to finance its activities without additional financial support. Based on the Company’s initial assessment in 2012, the Company was not the primary beneficiary of OxataSMB because it did not have: (1) the power to direct the activities that most significantly impact OxataSMB’s economic performance or (2) the obligation to absorb losses of OxataSMB or the right to receive benefits from OxataSMB that could potentially be significant. Therefore, the Company did not consolidate the results of OxataSMB, and transactions with OxataSMB results were accounted for similarly to the Company’s resellers. At June 30, 2013, the Company concluded no events or changes in circumstances have occurred that would change the Company’s initial assessment of OxataSMB’s VIE status and that the Company was not a primary beneficiary of OxataSMB. The loan receivable is included in “Other assets” in the accompanying Condensed Consolidated Balance Sheet. As of June 30, 2013, the Company’s maximum exposure to loss related to the unconsolidated VIE consisted of its loan and accumulated interest receivable of $2.0 million. No allowance for loan losses has been recorded against the loan receivable. However, should the operating and financial performance of OxataSMB not perform within expectations, a provision for loan loss may be necessary in the future.

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 7. Current Liabilities

Accrued expenses consisted of the following (in thousands):

	June 30, 2013		December 31, 2012
Accrued compensation and benefits	$	13,301	$	14,558
Other		13,654		12,864
Total accrued expenses	$	26,955	$	27,422

Deferred revenue and other current liabilities consisted of the following (in thousands):

	June 30, 2013		December 31, 2012
Deferred revenue	$	34,122	$	34,142
Other		945		2,162
Total deferred revenue and other current liabilities	$	35,067	$	36,304

 8. Commitments and Contingencies  

Litigation

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

9. Stockholders’ Equity

Common Stock Repurchases

On November 4, 2011, the Company announced that its Board of Directors authorized the repurchase of up to $20.0 million of the Company’s outstanding common stock. On December 13, 2012, the Company announced the Board of Directors increased the total authorized repurchase amount by $6.0 million, and on March 4, 2013, the Company announced that its Board of Directors increased the total authorized repurchase amount by an additional $21.0 million, to a total authorization of $47.0 million. At June 30, 2013, the Company had executed repurchases of 2.9 million shares of its common stock under the program for an aggregate of $30.4 million, of which $7.6 million or 536,000 shares were repurchased during the three months ended June 30, 2013, and $13.0 million or 921,000 shares were repurchased during the six months ended June 30, 2013. From July 1, 2013 to August 2, 2013, the Company repurchased an additional $3.6 million or 275,000 shares of its common stock under the program. Purchases may be made from time-to-time in open market or privately negotiated transactions as determined by the Company’s management. The amount and timing of the share repurchase will depend on business and market conditions, stock price, trading restrictions, acquisition activity, and other factors. The share repurchase program does not obligate the Company to acquire any particular amount of common stock, and the repurchase program may be suspended or discontinued at any time at the Company’s discretion.

10. Stock-Based Compensation

Stock Options

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

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

	Number of Shares			Weighted Average Exercise Price per Share		Weighted Average Remaining Contractual Life (in years)		Aggregate Intrinsic Value
Outstanding at December 31, 2012		7,052		$	10.71
Granted		976		$	13.26
Exercised		(488	)	$	8.95
Forfeited		(223	)	$	11.71
Outstanding at June 30, 2013		7,317		$	11.14		4.6	$	12,684
Vested and exercisable at June 30, 2013		4,165		$	10.60		3.6	$	9,048
Unvested at June 30, 2013, net of estimated forfeitures		3,152		$	11.84		6.1	$	3,636

The following table presents the weighted-average assumptions used to estimate the fair values of the stock options granted during the three and six months ended June 30, 2013 and 2012.

	Three Months Ended June 30,						Six Months Ended June 30,
	2013			2012			2013			2012
Expected dividend yield		0	%		0	%		0	%		0	%
Risk-free interest rate		0.80	%		0.80	%		0.85	%		0.86	%
Expected life (in years)		5.07			5.14			4.82			4.86
Expected volatility		60	%		60	%		60	%		58	%

The per-share weighted-average grant date fair value of options granted during the six months ended June 30, 2013 was $6.33. The aggregate intrinsic value of stock options exercised during the six months ended June 30, 2013 was $2.8 million.

Restricted Stock and Restricted Stock Units

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

	Number of shares			Weighted Average Grant Date Fair Value
Unvested at December 31, 2012		382		$	11.09
Granted		603		$	6.22
Forfeited		(78	)	$	8.83
Vested		(71	)	$	11.13
Unvested at June 30, 2013		836		$	7.77

Grants during the period included 506,000 performance-vesting shares of restricted stock and restricted stock units that will each vest based on achievement of both Company stock price targets and continued service. The grant date fair value of these awards were estimated using a Monte Carlo simulation model and were $5.52 per share.

Stock-Based Compensation Expense

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

	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Stock-based compensation	$	2,681	$	2,313	$	5,495	$	4,495
Less: Capitalized stock-based compensation		179		75		273		161
Stock-based compensation expense, net	$	2,502	$	2,238	$	5,222	$	4,334

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Stock-based compensation, net of capitalization, is included in the accompanying Condensed Consolidated Statements of Operations within the following captions (in thousands):

	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Stock-based compensation expense, net
Cost of revenue	$	159	$	71	$	295	$	125
Selling and marketing		801		385		1,631		685
Product and technology		33		131		262		380
General and administrative		1,509		1,651		3,034		3,144
	$	2,502	$	2,238	$	5,222	$	4,334

As of June 30, 2013, there was $22.5 million of unrecognized stock-based compensation related to restricted stock, restricted stock units and outstanding stock options, net of estimated forfeitures. This amount is expected to be recognized over a weighted average period of 1.5 years. Future stock-based compensation expense for these awards may differ in the event actual forfeitures deviate from management’s estimates.

11. Income Taxes

The Company follows ASC Topic 740-270, Income taxes—Interim Reporting, for the computation and presentation of its interim period tax provision. Accordingly, management estimates the effective annual tax rate and applies this rate to the year-to-date pre-tax book income or loss to determine the interim provision for income taxes. Additionally, unusual or infrequent items are booked in the period in which they occur. The Company’s policy is to recognize interest and penalties related to tax in income tax expense. For the three months ended June 30, 2013 and 2012, the income tax provisions were $0.8 million and $0.3 million, respectively, and for the six months ended June 30, 2013 and 2012, the income tax provisions were $1.8 million and $0.4 million, respectively. The income tax provision for the six months ended June 30, 2013 relates to federal, state and foreign income taxes, including the deferred tax impact of prior business combinations.

The Company and its subsidiaries file income tax returns in the U.S. federal, various state and foreign jurisdictions. With the use of net operating losses in recent periods and the filing in additional states, certain statutes will begin to expire as early as 2016, but the majority remain open at this time.

12. Segment Information

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

Revenue by geographic region with respect to the Direct Local and National Brands channels is based on the physical location of the sales office, and with respect to Agencies and Resellers, is based on the physical location of the agency or reseller. The following summarizes revenue and long-lived assets by geographic region (in thousands):

	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Revenue:
North America	$	86,307	$	82,676	$	169,440	$	159,152
International		40,748		29,536		79,435		57,063
	$	127,055	$	112,212	$	248,875	$	216,215

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	June 30,		December 31,
	2013		2012
Long-lived assets (excluding patents and other intangibles):
North America	$	6,749	$	6,395
International		5,465		4,671
	$	12,214	$	11,066

The results of the Australia geographic region have been included in the Company’s condensed consolidated financial statements and include revenues of $20.5 million and $17.2 million for the three months ended June 30, 2013 and 2012, respectively, and $40.7 million and $33.9 million for the six months ended June 30, 2013 and 2012, respectively. Long-lived assets of the Australia geographic region were $1.2 million and $1.7 million at June 30, 2013 and December 31, 2012, respectively.

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

Cautionary Notice Regarding Forward-Looking Statements

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

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our 2012 Annual Report on Form 10-K.

This quarterly report on Form 10-Q contains “forward-looking statements” that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are often identified by the use of words such as, but not limited to, “anticipate,” “believe,” “can,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “will,” “plan,” “project,” “seek,” “should,” “target,” “will,” “would,” and similar expressions or variations intended to identify forward-looking statements. These statements are based on the beliefs and assumptions of our management based on information currently available to management. Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Risk Factors” included in our 2012 Annual Report on Form 10-K. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

Overview

Our mission is to help small and medium-sized businesses, or SMBs, acquire, 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 two software-as-a-service, or SaaS, products: ReachCommerce (supporting online booking, transaction and back office processes), and ReachEdge (a marketing system that combines an optimized website and automated lead management).  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 have also developed a new consumer service, ClubLocal™, through which we create a direct relationship with consumers and provide home-related services by engaging third-party suppliers which perform the agreed services on our behalf. 

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.

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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, Japan and Brazil in 2012, and Austria in 2013. We also serve clients in New Zealand, Singapore, Slovakia, Poland, the Czech Republic and Russia through our resellers, including a franchisee. In 2010, we commenced campaign management and provisioning operations in India. 

Business Model and Operating Metrics

Our Direct Local channel represents the majority of our revenue. As a percentage of revenue, Direct Local revenue has increased to 80% for the six months ended June 30, 2013, from 79% for the six months ended June 30, 2012. Growth in Direct Local revenue is largely attributable to an increase in the number of Upperclassmen (as defined below) 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 North American IMCs.

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 and those with greater experience as Upperclassmen. 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 North American IMCs, which we attribute to lower levels of competition and lower existing online advertising consumption by SMBs in those markets.

At June 30, 2013, we had 459 Upperclassmen and 417 Underclassman, for a total of 876 IMCs, as compared to 397 Upperclassmen and 431 Underclassman, for a total of 828 IMCs, at June 30, 2012.

Total IMCs at June 30, 2013 increased from a year ago due to an increase in the number of Upperclassmen. This total includes those involved in our inside sales efforts. The number of Underclassmen at June 30, 2013 decreased from June 30, 2012 due to lower IMC hiring rates in North America than in the prior year period as we shifted IMC hiring to our newer international markets and focused on improving Upperclassmen productivity in our more established markets, and due to an increase in the number of Underclassmen that became Upperclassmen during the period compared to the prior year.

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.

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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. Underclassmen Expense for the six months ended June 30, 2013 and 2012 was $22.8 million and $22.4 million, respectively. The increase in Underclassmen Expense in the six months ended June 30, 2013, compared to the same period in 2012, was primarily attributable to our international expansion, partially offset by a reduced investment in North America. 

Active Advertisers and Active Campaigns

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

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

Active Campaigns is a number we calculate to approximate the number of individual products or services we are managing under contract for Active Advertisers. For example, if we were performing both ReachSearch and ReachDisplay campaigns for a client, we consider that two Active Campaigns. Similarly, if a client purchased ReachSearch campaigns for two different products or purposes, we consider that two Active Campaigns. Numbers are rounded to the nearest hundred.

At June 30, 2013, we had approximately 23,700 Active Advertisers and 35,100 Active Campaigns, as compared to approximately 21,300 Active Advertisers and 31,500 Active Campaigns as of June 30, 2012. Active Advertisers and Active Campaigns increased over the period due to an increase in the number of Upperclassmen and the productivity of Upperclassmen driven by their increased tenure, an increase in the number of products available for our IMCs to sell, and growth within our National Brands, Agencies and Resellers channel.

 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 accompanying Condensed Consolidated Balance Sheets 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, ReachEdge, 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, ReachCast and ReachEdge products. Under our agreements, our SMB clients typically pay, in advance, a fixed fee on a monthly basis, which includes all charges for the included technology and media services, management, third-party content and other costs and fees. We record these prepayments as deferred revenue and only record revenue for income statement purposes as we purchase media and perform other services on behalf of clients. Generally, when at least 85% of requisite purchases and other services have occurred and an additional campaign cycle remains under the agreement, we make an additional billing or automatic collection for the next campaign cycle.

Our National Brands, Agencies and Resellers clients enter into agreements of various lengths or that are indefinite. Our National Brands, Agencies and Resellers clients either pay in advance or are extended credit privileges with payment generally due in 30 to 60 days. There were $4.7 million and $3.8 million of accounts receivables related to our National Brands, Agencies and Resellers at June 30, 2013 and December 31, 2012, 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 third-party telephone and information services costs, data center and third-party hosting costs, credit card processing fees, third-party service providers and other direct costs. Cost of revenue also includes the cost of third-party suppliers related to our ClubLocal service.

In addition, cost of revenue includes costs to initiate, operate and manage clients’ campaigns, 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, 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 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 other significant accounting policies, see our 2012 Annual Report on Form 10-K.

We believe that the following critical accounting policies involve our more significant judgments, assumptions and estimates and, therefore, could have the greatest potential impact on our condensed consolidated financial statements:

•     Revenue recognition

•     Software development costs

•     Goodwill

•     Long-lived and intangible assets

•     Stock-based compensation

•     Variable interest entities

•     Loan receivable

•     Investment in partnership

•     Income taxes

•     Common stock repurchase and retirement

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.

We 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 records the cost of the service provided as cost of revenue.

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We offer incentives to clients in exchange for minimum commitments. In these circumstances, we estimate the amount of the 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 Condensed 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 Condensed Consolidated Statements of Operations. We monitor our existing capitalized software costs 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 both June 30, 2013 and December 31, 2012, 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 reporting unit’s management. North America’s assigned goodwill was $9.7 million and Australia’s assigned goodwill was $32.4 million as of both June 30, 2013 and December 31, 2013. We review the carrying amounts of goodwill for possible impairment whenever events or changes in circumstance indicate that the related carrying amount may not be recoverable. We perform our annual assessment of goodwill impairment as of the first day of each fourth quarter.

We follow 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 commensurate with the risk inherent in our business model.

Long-Lived and Intangible Assets      

We report finite-lived, acquisition-related intangible assets at fair value, net of accumulated amortization. Identifiable intangible assets are amortized on a straight-line basis over their estimated useful lives of three years, or one year, in the case of certain customer relationships. 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.

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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. In addition, the Company uses a Monte Carlo simulation to estimate the fair value of performance-vesting restricted stock and restricted stock units. Determining the fair value of these awards at the grant date under this model requires judgment, including estimating volatility, risk-free rate and expected future stock price. 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 or Monte Carlo simulation 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 VIE’s, 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.

Loan Receivable

The loan receivable is recorded at carrying value, net of potential allowance for losses. Losses on the receivable are recorded when probable and estimable. We routinely evaluate the receivable for potential collection issues that might indicate an impairment. Changes in such estimates can significantly affect the allowance and provision for losses. It is possible that we will experience losses that are different from our current estimates. Write-offs are deducted from the allowance for losses when we judge the principal to be uncollectible. Any subsequent recoveries are recorded as other income at the time cash is received on a written-off balance. Interest income on the loan receivable is accrued on a monthly basis over the life of the loan.

Investment in Partnership

The investment in partnership is accounted for under the cost method, which is periodically assessed for other-than-temporary impairment. If we determine that an other-than-temporary impairment has occurred, we will write-down the investment to its fair value. The fair value of a cost method investment is not evaluated if there are no identified events or changes in circumstances that may have a significant adverse effect on the fair value of the investment. However, if such significant adverse events were identified, we would estimate the fair value of its cost method investment considering available information at the time of the event, such as current cash position, earnings and cash flow forecasts, recent operational performance and any other readily available data.

Income Taxes

We record income taxes using the asset and liability method which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. In estimating future tax consequences, all expected future events other than enactments or changes in the tax law or rates are considered. Valuation allowances are provided when necessary to reduce deferred tax assets to the amount expected to be realized.

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We record tax benefits for income tax positions only if it is “more-likely-than-not” to be sustained based solely on its technical merits as of the reporting date. We consider many factors when evaluating and estimating tax positions and tax benefits, which may require periodic adjustments and which may differ from actual outcomes. We follow a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. Our policy is to recognize interest and penalties related to tax in income tax expense.

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 recorded as a reduction to additional paid-in capital.

Results of Operations

Comparison of the Three and Six Months Ended June 30, 2013 and 2012

	Three Months Ended June 30,					Six Months Ended June 30,
	2013			2012		2013			2012
(in thousands)
Revenue	$	127,055		$	112,212	$	248,875		$	216,215
Cost of revenue (1)		64,247			55,656		125,800			108,046
Operating expenses:
Selling and marketing (1)		46,791			41,176		91,490			79,719
Product and technology (1)		5,497			4,399		11,673			8,732
General and administrative (1)		9,987			10,468		19,212			20,275
Total operating expenses		62,275			56,043		122,375			108,726
Income (loss) from continuing operations		533			513		700			(557	)
Other income, net		114			102		341			305
Income (loss) from continuing operations before provision for income taxes		647			615		1,041			(252	)
Provision for income taxes		788			283		1,817			422
Net income (loss)	$	(141	)	$	332	$	(776	)	$	(674	)

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

	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Stock-based compensation:
Cost of revenue	$	159	$	71	$	295	$	125
Selling and marketing		801		385		1,631		685
Product and technology		33		131		262		380
General and administrative		1,509		1,651		3,034		3,144
	$	2,502	$	2,238	$	5,222	$	4,334
Depreciation and amortization:
Cost of revenue	$	188	$	148	$	407	$	270
Selling and marketing		689		601		1,668		1,119
Product and technology		2,762		2,081		5,487		4,050
General and administrative		349		366		457		721
	$	3,988	$	3,196	$	8,019	$	6,160

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Revenue

	Three Months Ended June 30,				2013-2012			Six Months Ended June 30,				2013-2012
	2013		2012		% Change			2013		2012		% Change
(in thousands)
Direct Local	$	101,354	$	88,246		14.9	%	$	198,960	$	169,986		17.0	%
National Brands, Agencies and Resellers		25,701		23,966		7.2			49,915		46,229		8.0
Total revenue	$	127,055	$	112,212		13.2	%	$	248,875	$	216,215		15.1	%
At period end:
Number of IMCs:
Upperclassmen									459		397		15.6	%
Underclassmen									417		431		(3.2	)%
Total									876		828		5.8	%
Active Advertisers (1)									23,700		21,300		11.3	%
Active Campaigns (2)									35,100		31,500		11.4	%

___________________

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

(2) Active Campaigns is a number we calculate to approximate the number of individual products or services we are managing under contract for Active Advertisers. For example, if we were performing both ReachSearch and ReachDisplay campaigns for a client, we consider that two Active Campaigns. Similarly, if a client purchased ReachSearch campaigns for two different products or purposes, we consider that two Active Campaigns. Numbers are rounded to the nearest hundred.

The increases in Direct Local revenue of $13.1 million and $29.0 million for the three and six months ended June 30, 2013, respectively, compared to the same periods in 2012, were largely driven by an increase in the number of Upperclassmen in our international markets, and an increase in the productivity of our IMCs in our domestic markets attributable to their increased tenure. Also contributing to the increase was growth in the number of international IMCs who, on average, are more productive than our North American IMCs, which we attribute to less competition and higher growth rates of online advertising demand by SMBs in those markets, partially offset by the general strengthening of the U.S. dollar compared to certain foreign currencies. Growth in our Direct Local channel is dependent on the size of our sales force, the number of our products that each of our advertisers purchases, and the overall consumption of online marketing services in our markets. Our future growth in this channel is therefore dependent on our continued investment in higher growth international markets and product expansion, and the general conditions of the markets in which we operate.

Total IMCs at June 30, 2013 increased from a year ago due to an increase in the number of Upperclassmen. This total includes those involved in our inside sales efforts. The number of Underclassmen at June 30, 2013 decreased from June 30, 2012 due to lower IMC hiring in North America than in the prior year period as we shifted our hiring of IMCs to our newer international markets and focused on improving Upperclassmen productivity in our more established markets, and due to an increase in the number of Underclassmen that became Upperclassmen during the period compared to the prior year. While we maintain flexibility in our IMC hiring strategy based on macroeconomic and market conditions, during 2013, we anticipate we will hire additional IMCs to support our international growth and North American sales initiatives.

The increases in National Brands, Agencies and Resellers revenue of $1.7 million for the three months ended June 30, 2013 and $3.7 million for the six months ended June 30, 2013, compared to the same period in 2012, were due to growth in the number of domestic National Brands clients and international Agencies and Resellers clients, partially offset by a decrease in the number of domestic Agencies and Resellers clients.

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Cost of Revenue

	Three Months Ended June 30,						2013-2012			Six Months Ended June 30,						2013-2012
	2013			2012			% Change			2013			2012			% Change
(in thousands)
Cost of revenue	$	64,247		$	55,656			15.4	%	$	125,800		$	108,046			16.4	%
As a percentage of revenue:		50.6	%		49.6	%					50.5	%		50.0	%

The increases in our cost of revenue as a percentage of revenue for the three and six months ended June 30, 2013, compared to the same periods in 2012, were primarily due to an increase in service and support costs and a decrease in publisher rebates, partially offset by the change in our geographic, product and service mix. Publisher rebates as a percentage of revenue decreased to 4.1% of revenue for the three months ended June 30, 2013 from 4.7% for the three months ended June 30, 2012, and to 4.0% of revenue for the six months ended June 30, 2013 from 4.6% for the six months ended June 30, 2012, as a result of a shift in product mix and settlements.

Our cost of revenue as a percentage of revenue will be affected in the future by the mix and relative amount of media and other services we purchase to fulfill service requirements, the availability and amount of publisher rebates, the mix of products and services we offer, our geographic mix, our media buying efficiency, and the costs of support and delivery.

Operating Expenses

Over the past several years, we have significantly increased the scope of our operations. We intend to continue to increase our sales force, product offerings and the infrastructure to support them. In growing our business, particularly in international markets, 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 

	Three Months Ended June 30,						2013-2012			Six Months Ended June 30,						2013-2012
	2013			2012			% Change			2013			2012			% Change
(in thousands)
Salaries, benefits and other costs	$	33,770		$	28,792			17.3	%	$	65,788		$	56,237			17.0	%
Commission expense		13,021			12,384			5.1	%		25,702			23,482			9.5	%
Total selling and marketing	$	46,791		$	41,176			13.6	%	$	91,490		$	79,719			14.8	%
Underclassmen Expense included above, excluding commissions (1)	$	11,337		$	11,328			0	%	$	22,831		$	22,383			2.0	%
As a percentage of revenue:
Salaries, benefits and other costs		26.6	%		25.7	%					26.4	%		26.0	%
Commission expense		10.2	%		11.0	%					10.3	%		10.9	%
Total selling and marketing		36.8	%		36.7	%					36.8	%		36.9	%

____________________

(1) See “Non-GAAP Financial Measures” for our definition of Underclassmen Expense.

The increases in selling and marketing salaries, benefits and other costs in absolute dollars for the three and six months ended June 30, 2013, compared to the same periods in 2012, were primarily due to increases in the number of IMCs and the proportion of international IMCs (who on average cost more than North American IMCs). The increases in these costs were primarily due to expenses related to our entrance into new international markets and new product initiatives.

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The increases in commission expense in absolute dollars for the three and six months ended June 30, 2013, compared to the same periods in 2012, were due to increased sales. As a percentage of revenue, commission expense decreased compared to the same periods in 2012 due to a higher percentage of revenue from our international Direct Local channel, for which we pay lower commission rates. 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 increased for the three and six months ended June 30, 2013, as compared to the same periods in 2012, reflecting increased hiring in our international markets, offset in part by reduced investment in IMC hiring in North America.  

Product and Technology

	Three Months Ended June 30,						2013-2012			Six Months Ended June 30,						2013-2012
	2013			2012			% Change			2013			2012			% Change
(in thousands)
Product and technology expenses	$	5,497		$	4,399			25.0	%	$	11,673		$	8,732			33.7	%
Capitalized software development costs from product and technology resources		3,739			2,208			69.3	%		6,626			4,072			62.7	%
Total product and technology expenses and capitalized costs	$	9,236		$	6,607			39.8	%	$	18,299		$	12,804			42.9	%
Percentage of revenue:
Product and technology expenses costs		4.3	%		3.9	%					4.7	%		4.0	%
Capitalized software development costs from product and technology resources		2.9	%		2.0	%					2.7	%		1.9	%
Total product and technology costs expensed and capitalized		7.3	%		5.9	%					7.4	%		5.9	%

The increase in product and technology expenses in both absolute dollars and as a percentage of revenue for the three months ended June 30, 2013, compared to the same period in 2012, was primarily attributable to $0.7 million of increased salaries and compensation expense as a result of increased headcount related to the ongoing development of the RL Platform and new commerce initiatives, and $0.4 million of increased amortization expense related to previously capitalized software development costs and acquired intangibles.

The increase in product and technology expenses in both absolute dollars and as a percentage of revenue for the six months ended June 30, 2013, compared to the same period in 2012, was primarily attributable to $1.8 million of increased salaries and compensation expense as a result of increased headcount related to the ongoing development of the RL Platform and the new commerce initiatives, and $1.2 million of increased amortization expense related to previously capitalized software development costs and acquired intangibles.

The increases in the amount of capitalized software development costs in both absolute dollars and as a percentage of revenues for the three and six months ended June 30, 2013, compared to the same periods in 2012, were primarily due to an increase in capitalizable projects, including those relating to our new product initiatives. 

General and Administrative

	Three Months Ended June 30,						2013-2012			Six Months Ended June 30,						2013-2012
	2013			2012			% Change			2013			2012			% Change
(in thousands)
General and administrative	$	9,987		$	10,468			(4.6	)%	$	19,212		$	20,275			(5.2	)%
As a percentage of revenue:		7.9	%		9.3	%					7.7	%		9.4	%

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The decrease in general and administrative expenses in absolute dollars for the three months ended June 30, 2013, compared to the same period in 2012, was primarily due to $0.5 million of decreased business and license taxes, professional fees (which consist of tax, consulting, audit and legal fees), and stock-based compensation.

The decrease in general and administrative expenses in absolute dollars for the six months ended June 30, 2013, compared to the same period in 2012, was primarily due to $0.6 million of decreased professional fees, which consist of tax, consulting, audit and legal fees, and $0.3 million of decreased business and license taxes.

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 increased for the three and six months ended June 30, 2013, compared to the same periods in 2012, due to foreign exchange rate fluctuations and higher yields on invested balances. Other income, net primarily consists of interest income resulting from invested balances. 

Provision for Income Taxes

The income tax provisions of $1.8 million and $0.4 million for the six months ended June 30, 2013 and 2012, respectively, relate to federal, state and foreign income taxes, including the deferred tax impact of prior business combinations.  The overall increase in tax expense for the first six months of 2013 compared to the same period in 2012 was primarily due to an increase in the income tax provision resulting from the realization of historic excess windfall tax benefits not previously recognized for financial statement purposes.

          Our effective tax rate differs from the federal statutory rate due to state taxes, significant permanent differences and adjustments to our valuation allowance. Significant permanent differences arise due to research and development credits, foreign tax rate benefits, and stock-based compensation expense that are not expected to generate a tax deduction, such as stock-based compensation expenses on 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 and Underclassmen Expense are useful to investors in evaluating our operating performance. For the three and six months ended June 30, 2013 and 2012, our Adjusted EBITDA and Underclassmen Expense were as follows:

	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
(in thousands)
Adjusted EBITDA (1)	$	7,023	$	5,947	$	13,941	$	9,969
Underclassmen Expense (2)	$	11,337	$	11,328	$	22,831	$	22,383

(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.

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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.

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, capital expenditures and investments in Underclassmen.

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.

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

	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
(in thousands)
Income (loss) from continuing operations	$	533	$	513	$	700	$	(557	)
Add:
Depreciation and amortization		3,988		3,196		8,019		6,160
Stock-based compensation, net		2,502		2,238		5,222		4,334
Acquisition and integration costs		—		—		—		32
Adjusted EBITDA	$	7,023	$	5,947	$	13,941	$	9,969

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Liquidity and Capital Resources

	Six Months Ended June 30,
Consolidated Statements of Cash Flow Data:	2013			2012
(in thousands)
Net cash provided by operating activities, continuing operations	$	11,811		$	22,557
Net cash used in investing activities	$	(11,796	)	$	(8,568	)
Net cash used by discontinued operations	$	—		$	(178	)
Net cash used in financing activities	$	(7,530	)	$	(3,689	)

At June 30, 2013, we had cash and cash equivalents of $81.4 million and short-term investments of $0.6 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 June 30, 2013, we had no long-term indebtedness for borrowed money and are not subject to any restrictive bank covenants. At June 30, 2013, we had $1.3 million in restricted certificates of deposit to secure letters of credit issued to landlords and others. 

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 during the six months ended June 30, 2013 resulted primarily from adjustments for non-cash expenses and increases in operating liabilities. Our net loss of $0.8 million was more than offset by non-cash depreciation and amortization of $8.0 million, non-cash stock-based compensation of $5.2 million, and increases in accounts payable and accrued expenses of $4.5 million due to fluctuation in timing of payments of certain vendors. Partially offsetting these increases in cash flow were increases in accounts receivable of $3.0 million primarily due to higher spending by certain advertisers on credit terms, and increases in other receivables and prepaid expenses of $1.8 million primarily due to renewal of a vendor contract. The decrease in cash flow from operating activities compared to the same period in 2012, was primarily due to smaller increases in operating liabilities, an increase in prepaid expenses benefitting future periods, and normalization of collections of vendor rebates.

Our cash flow from operating activities during the six months ended June 30, 2012 resulted primarily from adjustments for non-cash expenses and increases in accounts payable and accrued expenses, and deferred revenue, rent and other liabilities. Our loss from continuing operations, net of income taxes of $0.7 million was more than offset by non-cash depreciation and amortization of $6.2 million, and non-cash stock-based compensation of $4.3 million. Cash flow from operating activities also reflected increases in deferred revenue, rent and other liabilities of $5.7 million due to the growth of our business, and an increase in accounts payable and accrued expenses of $6.7 million due to the fluctuation in timing of payments to certain vendors, including the normalization of rebates receivable.

Investing Activities

Our primary investing activities have consisted of purchases of property and equipment, capitalized software development costs, short-term investments, and business acquisitions. During the six months ended June 30, 2013, our purchases of property and equipment and capitalization of software costs increased by $3.1 million year-over-year, 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.

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During the six months ended June 30, 2013, we also invested $2.5 million in a privately held partnership. We had maturities of certificates of deposits and short-term investments aggregating $2.6 million. In addition, we made a payment of $0.4 million on the deferred obligations related to the DealOn acquisition. The payment of deferred consideration for this acquisition represented the final payment.

During the six months ended June 30, 2012, we made payments on deferred obligations related to the DealOn and SMB:LIVE acquisitions totaling $1.1 million. The payment of deferred consideration for the SMB:LIVE acquisition represented the final payment. These uses of cash were partially offset by maturities of certificates of deposits and short-term investments of $0.7 million.

Financing Activities

Our cash used in financing activities during the six months ended June 30, 2013 resulted primarily from repurchases of our common stock of $13.0 million pursuant to our share repurchase program, partially offset by $4.4 million in proceeds from exercise of stock options, and $1.1 million of excess tax benefits from stock-based awards.

Our cash used in financing activities during the six months ended June 30, 2012 resulted primarily from repurchases of our common stock of $4.0 million pursuant to our share repurchase program, partially offset by $0.3 million proceeds from exercise of stock options. 

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 authorized repurchase amount by $6.0 million, and on March 4, 2013, we announced that our Board of Directors increased the authorized repurchase amount by an additional $21.0 million, to a total authorization of $47.0 million. At June 30, 2013, we had executed repurchases of $30.4 million of our common stock under the program. From July 1, 2013 to August 2, 2013, we repurchased of an additional $3.6 million or 275,000 shares 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.

Off-Balance Sheet Arrangements

At June 30, 2013, we did not have any off-balance sheet arrangements.

Item 3.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK  

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

Interest Rate Fluctuation Risk

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

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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 six months ended June 30, 2013, a 10% strengthening of the U.S. dollar relative to these foreign currencies would have resulted in a decrease in revenue of $8.7 million, but an increase in operating income of $0.5 million. A 10% weakening of the U.S. dollar relative to these foreign currencies, however, would have resulted in an increase in revenue of $8.7 million, but a decrease in operating income of $0.5 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.

Item 4.    CONTROLS AND PROCEDURES  

Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(b) as of June 30, 2013. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in reports we file or submit under the Exchange Act is (1) recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (2) is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during the quarter ended June 30, 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II

OTHER INFORMATION

Item 1.      LEGAL PROCEEDINGS 

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

Item 1A.    RISK FACTORS  

Investors should carefully consider the risk factors in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2012, in addition to the other information contained in our Annual Report and in this quarterly report on Form 10-Q.

Item 2.      UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS  

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 our share repurchase program by $6.0 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 June 30, 2013, we had executed repurchases of $30.4 million of our common stock under the program. From July 1, 2013 to August 2, 2013, we repurchased an additional $3.6 million or 275,000 shares 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.

Common stock repurchases during the quarter ended June 30, 2013 were as follows:

Period	Total Number of Shares Purchased		Average Price Paid Per Share		Total Number of Shares Purchased as Part of a Publicly Announced Program		Maximum Value of Shares That May Yet Be Purchased Under a Publicly Announced Program
April 2013		137,652	$	14.80		137,652	$	22,131,463
May 2013		216,324	$	14.31		216,324	$	19,029,668
June 2013		182,132	$	13.43		182,132	$	16,578,567

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 Item 6.          EXHIBITS  

Exhibit No	Description of Exhibit
10.01	Lease Agreement, dated June 17, 2013, between EPC-IBP 16, LLC and ReachLocal
10.02	Consolidated Amendment to Lease Agreement, dated June 17, 2013, among ARI-International Business Park, LLC, ARI-IBP 1, LLC, ARI-IBP 2, LLC, ARI-IBP 3, LLC, ARI-IBP 4, LLC, ARI-IBP 5, LLC, ARI-IBP 6, LLC, ARI-IBP 7, LLC, ARI-IBP 8, LLC, ARI-IBP 9, LLC, ARI-IBP 11, LLC, and ARI-IBP 12, LLC, acting by and through Billingsley Property Services, Inc., as agent for Landlord, and ReachLocal, Inc.
10.03	Side Letter, dated June 17, 2013, between EPC-IBP 16, LLC and ReachLocal, Inc.
10.04	Fifth Amendment to Lease Agreement, dated July 22, 2013, among ARI-International Business Park, LLC, ARI-IBP 1, LLC, ARI-IBP 2, LLC, ARI-IBP 3, LLC, ARI-IBP 4, LLC, ARI-IBP 5, LLC, ARI-IBP 6, LLC, ARI-IBP 7, LLC, ARI-IBP 8, LLC, ARI-IBP 9, LLC, ARI-IBP 11, LLC, and ARI-IBP 12, LLC, acting by and through Billingsley Property Services, Inc., as agent for Landlord, and ReachLocal, Inc.
31.01	Certifications of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.02	Certifications of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.01	Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.02	Certification of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema Document
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document
101.LAB	XBRL Taxonomy Extension Label Linkbase Document
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document

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SIGNATURES

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

REACHLOCAL, INC.
By:	/s/ Zorik Gordon
Name:	Zorik Gordon
Title:	Chief Executive Officer
By:	/s/ Ross G. Landsbaum
Name:	Ross G. Landsbaum
Title:	Chief Financial Officer

Date: August 7, 2013

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