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Local.com 10-K 2009
e10vkza
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
(Amendment No. 1)
     
þ   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2007
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number: 000-50989
LOCAL.COM CORPORATION
(Exact name of registrant as specified in its charter)
     
Delaware   33-0849123
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
One Technology Drive, Building G
Irvine, CA 92618

(Address of principal executive offices)(Zip Code)
(949) 784-0800
Registrant’s telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act:
     
Title of each class   Name of each exchange on which registered
     
Common Stock, par value $0.00001   Nasdaq Capital Market
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.00001
(Title of class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o     No þ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes o     No þ
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 þ     No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer o    Accelerated filer o    Non-accelerated filer   o
(Do not check if a smaller reporting company)
  Smaller reporting company þ 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o     No þ
The aggregate market value of voting and non-voting common equity held by non-affiliates of the issuer was approximately $63,446,144.56 based on the last reported sale price of registrant’s common stock on June 30, 2007 as reported by Nasdaq Capital Market.
As of February 29, 2008, the number of shares of the registrant’s common stock outstanding: 14,204,110
Documents incorporated by reference: None
 
 

 


 

EXPLANATORY NOTE
Local.com Corporation (the “Company”) is filing this Amendment No. 1 to Form 10-K on Form 10-K/A (this “Amendment”) to amend its Annual Report on Form 10-K for the fiscal year ended December 31, 2007, which was originally filed with the Securities and Exchange Commission on March 10, 2008 (the “Initial Filing”), to amend Item 8 and Item 9A(T) in the Initial Filing by replacing each such sections in their entirety with Item 8 and Item 9A(T), respectively, set forth in this Amendment.
The Company has revised its disclosure in the “Revenue recognition” and “Traffic acquisition costs” sections of Note 1 to the Company’s consolidated financial statements included in Item 8 of the Amendment to include expanded disclosure related to its accounting policies related to revenue recognition and traffic acquisition costs. In addition, the Amendment includes disclosure required by Item 9A(T) of Form 10-K that was inadvertently omitted in the Initial Filing. The cover page to this Amendment has also been revised to correct certain disclosures that were incorrect on the cover page of the Initial Filing due to clerical errors.
Pursuant to Rule 12b-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the Company has filed the certifications required by Rule 13a-14(a) or 15d-14(a) of the Exchange Act.
Except for the amended disclosure contained herein, this Amendment does not modify or update disclosures contained in the Initial Filing. This Amendment should be read in conjunction with the Company’s other filings made with the Securities and Exchange Commission subsequent to the date of the Initial Filing.

1


 

Item 8. Financial Statements and Supplemental Data
Our consolidated financial statements, including the report of our independent registered public accounting firm, are included beginning at page F-1 immediately following the signature page of this Report.
Item 9A(T). Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
As required by Securities and Exchange Commission Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2007. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of December 31, 2007.
 
In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and that our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
 
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is a process designed by, or under the supervision of, our principal executive and principal financial officer and effected by our board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2007. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based upon its assessment, management concluded that, as of December 31, 2007, our internal control over financial reporting was effective.
This Annual Report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit us to provide only management’s report in this Annual Report.
Changes in Internal Control over Financial Reporting
There have been no changes in our internal control over financial reporting during the last fiscal year that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

2


 

PART IV
Item 15. Exhibits, Financial Statement Schedules
     
Exhibit    
Number   Description
 
   
23.1*
  Consent of Haskell & White LLP, independent registered public accounting firm.
 
   
31.1*
  Certification of Principal Executive Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
   
31.2*
  Certification of Principal Financial Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
   
32.1*
  Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
*   Filed herewith.

3


 

SIGNATURES
In accordance with Section 13 or 15 (d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized as of the 3rd day of April, 2009.
         
  LOCAL.COM CORPORATION
 
 
  By: /s/ Heath B. Clarke    
  Heath B. Clarke   
  Chief Executive Officer and Chairman   
 
In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
         
Signature   Title   Date
 
       
/s/ Heath B. Clarke
 
Heath B. Clarke
  Chairman, Chief Executive Officer and Director    April 3, 2009
 
       
/s/ Brenda Agius
 
Brenda Agius
  Chief Financial Officer, Principal Accounting Officer and Secretary    April 3, 2009
 
       
*
 
Norman K. Farra Jr.
  Director    April 3, 2009
 
       
*
 
Philip K. Fricke
  Director    April 3, 2009
 
       
*
 
Theodore E. Lavoie
  Director    April 3, 2009
 
       
*
 
John E. Rehfeld
  Director    April 3, 2009
 
       
* /s/ Heath B. Clarke
 
      April 3, 2009
Heath B. Clarke attorney-in-fact
       

4


 

LOCAL.COM CORPORATION
INDEX TO FINANCIAL STATEMENTS
         
Consolidated Financial Statements:
       
 
       
    F-2  
    F-3  
    F-4  
    F-5  
    F-6  
    F-7  
 
       
Financial Statement Schedule:
       
 
       
    F-25  
 
       
Supplementary Financial Data:
       
 
       
    F-26  

F-1


 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Local.com Corporation
We have audited the accompanying consolidated balance sheets of Local.com Corporation (the “Company”) as of December 31, 2007 and 2006, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2007. Our audit also included the financial statement schedule listed in the index at F-1. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion of the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Local.Com Corporation as of December 31, 2007 and 2006, and the results of its consolidated operations and its cash flows for each of the years in the three-year period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As discussed at Note 1 “Stock-based Compensation,” to the consolidated financial statements, during the year ended December 31, 2006, the Company changed the manner in which it accounts for stock compensation costs. Also, as discussed in Note 4 to the consolidated financial statement, effective January 1, 2007, the company changed its methods of accounting for uncertain tax positions.
/s/ HASKELL & WHITE LLP
Irvine, California
March 7, 2008

F-2


 

LOCAL.COM CORPORATION
CONSOLIDATED BALANCE SHEETS
                 
    December 31,     December 31,  
    2007     2006  
    (in thousands, except share data)  
ASSETS
Current Assets:
               
Cash and cash equivalents
  $ 14,258     $ 3,264  
Restricted cash
    30       41  
Marketable securities
    1,999       1,972  
Accounts receivable, net of allowances of $15 and $9, respectively
    3,595       2,091  
Prepaid expenses and other current assets
    292       302  
 
           
 
Total current assets
    20,174       7,670  
 
               
Property and equipment, net
    1,473       2,028  
Intangible assets, net
    3,156       2,813  
Goodwill
    13,233       12,213  
Long-term restricted cash
    66       125  
Deposits
    12       42  
 
           
 
Total assets
  $ 38,114     $ 24,891  
 
           
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
               
Accounts payable
  $ 4,029     $ 2,851  
Accrued compensation
    456       328  
Deferred rent
    316       432  
Other accrued liabilities
    194       374  
Notes payable
          63  
Deferred revenue
    177       245  
 
           
 
Total liabilities, all current
    5,172       4,293  
 
           
 
               
Commitments and contingencies (Note 5)
               
 
               
Stockholders’ equity: (Notes 6, 7, 10, 11, 12 and 13)
               
Convertible preferred stock, $0.00001 par value; 10,000,000 shares authorized; none issued and outstanding for all periods presented
           
Common stock, $0.00001 par value; 30,000,000 shares authorized; 14,204,110 and 9,297,502 issued and outstanding, respectively
           
Additional paid-in capital
    82,176       51,657  
Accumulated other comprehensive loss
    (1 )     (27 )
Accumulated deficit
    (49,233 )     (31,032 )
 
           
 
               
Stockholders’ equity
    32,942       20,598  
 
           
 
               
Total liabilities and stockholders’ equity
  $ 38,114     $ 24,891  
 
           
The accompanying notes are an integral part of the consolidated financial statements.

F-3


 

LOCAL.COM CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
                         
    Years ended December 31,  
    2007     2006     2005  
    (In thousands, except share and per shares amounts)  
Revenue
  $ 21,525     $ 14,213     $ 18,139  
 
                 
 
Operating Expenses:
                       
Search serving
    3,862       4,960       10,707  
Sales and marketing
    20,268       13,169       6,025  
General and administrative
    4,890       5,881       4,025  
Research and development
    2,555       2,829       2,988  
Amortization and write-down of intangibles
    1,121       947       1,078  
 
                 
 
Total operating expenses
    32,696       27,786       24,823  
 
                 
 
Operating loss
    (11,171 )     (13,573 )     (6,684 )
 
                       
Interest and other income (expense)
    (7,030 )     288       680  
 
                 
 
Loss before income taxes
    (18,201 )     (13,285 )     (6,004 )
 
                       
Provision for income taxes
    1       1       498  
 
                 
 
Net loss
  $ (18,202 )   $ (13,286 )   $ (6,502 )
 
                 
 
                       
Per share data:
                       
 
                       
Basic net loss per share
  $ (1.58 )   $ (1.44 )   $ (0.75 )
 
                 
Diluted net loss per share
  $ (1.58 )   $ (1.44 )   $ (0.75 )
 
                 
 
                       
Basic weighted average shares outstanding
    11,499,879       9,249,973       8,658,069  
Diluted weighted average shares outstanding
    11,499,879       9,249,973       8,658,069  
The accompanying notes are an integral part of the consolidated financial statements.

F-4


 

LOCAL.COM CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
                                                                 
                                            Accumulated                
                    Convertible     Additional     Other             Total  
    Common Stock     Preferred Stock     Paid-in     Comprehensive     Accumulated     Stockholders’  
    Shares     Amount     Shares     Amount     Capital     Loss     Deficit     Equity  
    (in thousands)  
Balance at December 31, 2004
    7,954     $           $     $ 45,497     $ (36 )   $ (11,244 )   $ 34,217  
 
Common stock issued:
                                                               
Exercise of warrants
    629                         1,143                   1,143  
Exercise of options
    484                         1,426                   1,426  
Asset purchase
    104                         750                   750  
Non-cash equity based expense for services
                            95                   95  
Financing costs
                            (205 )                 (205 )
Comprehensive income:
                                                               
Net unrealized loss on marketable securities
                                  (109 )           (109 )
Foreign currency translation adjustments
                                  (6 )           (6 )
Net income
                                        (6,502 )     (6,502 )
 
                                                             
 
Comprehensive income
                                              (6,617 )
 
                                               
 
Balance at December 31, 2005
    9,171                         48,706       (151 )     (17,746 )     30,809  
 
                                                               
Common stock issued:
                                                               
Exercise of warrants
    43                         77                   77  
Exercise of options
    83                         345                   345  
Non-cash equity based expense for services
                            2,531                   2,531  
Financing costs
                            (3 )                 (3 )
Swing sale profit contribution
                            1                   1  
Comprehensive income:
                                                               
Net unrealized gain on marketable securities
                                  118             118  
Foreign currency translation adjustments
                                  6             6  
Net loss
                                        (13,286 )     (13,286 )
 
                                                             
 
Comprehensive loss
                                              (13,162 )
 
                                               
 
Balance at December 31, 2006
    9,297                         51,657       (27 )     (31,032 )     20,598  
 
                                                               
Common stock issued:
                                                               
Conversion of senior secured convertible notes
    1,990                         8,000                   8,000  
Private placement
    2,357                         12,963                   12,963  
Exercise of warrants
    366                         1,385                   1,385  
Exercise of options
    90                         343                   343  
Asset purchase
    104                         431                   431  
Issue of senior secured convertible notes and warrants
                            6,679                   6,679  
Non-cash stock based compensation
                            1,748                   1,748  
Financing costs
                            (1,035 )                 (1,035 )
Swing sale profit contribution
                            5                   5  
Comprehensive income:
                                                               
Net unrealized gain on marketable securities
                                  26             26  
Net loss
                                        (18,202 )     (18,202 )
 
                                                             
 
Comprehensive loss
                                              (18,176 )
 
                                               
 
                                                               
Balance at December 31, 2007
    14,204     $           $     $ 82,176     $ (1 )   $ (49,233 )   $ 32,942  
 
                                               
The accompanying notes are an integral part of the consolidated financial statements.

F-5


 

LOCAL.COM CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
                         
    Years ended December 31,  
    2007     2006     2005  
    (in thousands)  
Cash flows from operating activities:
                       
Net income (loss)
  $ (18,202 )   $ (13,286 )   $ (6,502 )
Adjustments to reconcile net income (loss) to cash (used in) provided by operating activities:
                       
Depreciation and amortization
    2,206       2,160       1,539  
Write-down of intangible asset
                337  
Provision for doubtful accounts
    14       (23 )     69  
Non-cash equity expense related to stock option issuances
    1,748       2,531       95  
Non-cash interest expense
    6,803              
Non-cash interest income
          (6 )     (15 )
Loss on disposal of property and equipment
          18       63  
Realized loss on marketable securities
          42       34  
Realized loss on foreign exchange translation
          4        
Cash received for lease incentive
                547  
Changes in operating assets and liabilities:
                       
Accounts receivable
    (1,391 )     (930 )     163  
Prepaid expenses and other
    (114 )     157       30  
Deferred income tax assets
                678  
Other non-current assets
    30       5       (5 )
Accounts payable and accrued liabilities
    873       138       (242 )
Deferred revenue
    (68 )     (50 )     (214 )
 
                 
 
                       
Net cash used in operating activities
    (8,101 )     (9,240 )     (3,423 )
 
                 
 
                       
Cash flows from investing activities:
                       
Capital expenditures
    (531 )     (487 )     (4,010 )
Purchases of marketable securities
                (7,982 )
Proceeds from sales of marketable securities
          11,354       4,998  
Decrease (increase) in restricted cash
    70       10       (112 )
Increase (decrease) in minority interest
          1       (1 )
Proceeds from sale of property and equipment
          6        
Acquisition, net of cash acquired
    (2,042 )     232       (15,329 )
 
                 
 
                       
Net cash provided by (used in) investing activities:
    (2,503 )     11,116       (22,436 )
 
                 
 
                       
Cash flows from financing activities:
                       
Proceeds from issuance of common stock:
                       
From private placement
    12,963              
Exercise of warrants
    1,385       77       1,143  
Exercise of options
    343       344       1,426  
Issuance of senior secured convertible notes
    8,000              
Payment of notes payable
    (63 )     (109 )     (41 )
Swing sale profit contribution
    5       1        
Payment of financing related costs
    (1,035 )     (3 )     (205 )
 
                 
 
                       
Net cash provided by financing activities
    21,598       310       2,323  
 
                 
 
                       
Effect of currency translation on cash
          3       (6 )
 
                 
 
Net increase (decrease) in cash and cash equivalents
    10,994       2,189       (23,542 )
Cash and cash equivalents, beginning of year
    3,264       1,075       24,617  
 
                 
 
                       
Cash and cash equivalents, end of year
  $ 14,258     $ 3,264     $ 1,075  
 
                 
 
                       
Supplemental Cash Flow Information:
                       
Interest paid
  $ 279     $ 5     $ 2  
 
                 
Income taxes paid
  $ 1     $ 1     $ 1  
 
                 
 
                       
Non-cash investing and financing transactions:
                       
Common stock issued for asset purchase
                  $ 750  
 
                     
Insurance financing
  $ 88     $ 88     $ 125  
 
                 
Debt discount related to issuance of senior secured convertible notes
  $ 6,221                  
 
                     
Conversion of senior secured convertible notes into common stock
  $ 8,000                  
 
                     
Warrants issued for financing costs
  $ 458                  
 
                     
Common stock issued for asset purchase
  $ 431                  
 
                     
The accompanying notes are an integral part of the consolidated financial statements.

F-6


 

LOCAL.COM CORPORATION
Notes to Consolidated Financial Statements
1. Nature of operations and summary of significant accounting policies
Nature of operations
Local.com Corporation, a Delaware corporation (the Company), is a provider of paid-search services on the Internet. The Company provides advertisers’ sponsored listings in response to local searches on the Company’s own web site, Local.com and other search engines that have integrated the Company’s search service into their web sites. The Company’s sponsored listings are comprised of subscription-based fixed placement advertisers and advertisers of other paid-search companies. Advertisers pay a specified bid price for each click-through on the advertisers’ sponsored listing. The Company operates in one reportable business segment.
On November 2, 2006, the Company changed its name from Interchange Corporation to Local.com Corporation. The Company amended its Amended and Restated Certificate of Incorporation in connection with a merger of a wholly-owned subsidiary of the Company with and into the Company in accordance with Section 253 of the Delaware General Corporation Law.
Certain reclassifications have been made to the prior year’s consolidated financial statements to conform to current year’s presentation. Accrued royalties of $19,000 as of December 31, 2006 is included in other accrued liabilities. Non-cash equity based expense of $95,000 for the year ended December 31, 2005 is included in general and administrative expense.
Principles of consolidation
Prior to January 1, 2007, the Company’s consolidated financial statements included the accounts of Local.com Corporation, its wholly-owned subsidiaries, Interchange Europe Holding Corporation, Interchange Internet Search GmbH, Inspire Infrastructure 2i AB, and Inspire Infrastructure (UK) Limited, along with its majority owned subsidiary Inspire Infrastructure Espana SL. From January 1, 2007 to June 30, 2007, the Company’s financial statements include only the accounts of Local.com Corporation as all of the Company’s subsidiaries had been dissolved. Subsequent to July 1, 2007, the Company’s financial statements include the accounts of Local.com Corporation and its wholly-owned subsidiary Local.com PG Acquisition Corporation. All intercompany balances and transactions were eliminated.
Foreign currency translation
The Company measures the financial statements for its foreign subsidiaries using the local currency as the functional currency. Current assets and current liabilities of these subsidiaries are translated at the exchange rate as of the balance sheet date, while long-term items are translated at historical rates. Revenues, costs and expenses are translated at the rates prevailing during the year. Translation adjustments from this process are included in stockholders’ equity. Any gains or losses from foreign currency transactions are included in other income.
Use of estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
Cash and cash equivalents
The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. Deposits held with banks may exceed the amount of insurance provided on such deposits. Generally, these deposits may be redeemed upon demand and therefore bear minimal risk.

F-7


 

Restricted cash
On June 26, 2002, the Company pledged $100,000 of cash for an irrevocable letter of credit related to the lease of office space that is classified as restricted cash on the balance sheet. The letter of credit was reduced to $40,960 on April 1, 2006. The letter of credit expired on April 1, 2007.
On April 22, 2005, the Company pledged $125,129 of cash for an irrevocable letter of credit related the lease of new office space that is classified as restricted cash on the balance sheet. The letter of credit was reduced to $96,397 on July 31, 2007 and will be reduced to $66,506 on July 31, 2008, and $35,448 on July 31, 2009. The letter of credit will expire on July 31, 2010.
Marketable securities
The Company carries marketable securities at fair value, with unrealized gains and losses, net of any tax, reported as a separate component of stockholders’ equity. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization is included in interest income. Realized gains and losses and declines in value judged to be other-than-temporary on short-term investments are included in interest and other income (expense). The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in interest income.
Accounts receivable
The Company’s accounts receivable are due primarily from customers located in the United States and are typically unsecured. Management specifically analyzes accounts receivable and historical bad debt, customer concentration, customer credit-worthiness, current economic trends and changes in customer payment terms when evaluating the adequacy of the allowance for doubtful accounts. If management believes that a customer’s financial condition has deteriorated such that it impairs its ability to make payments, additional allowances may be required. The Company’s subscription-based advertisers pay monthly in advance. In addition, the Company grants its advertiser partners net 30 terms. Of the customers that do not pay in advance, as of December 31, 2007 and 2006, one customer represented 62% and 52% of total accounts receivable, respectively and one additional customer represented 12% of total accounts receivable as of December 31, 2007 and another customer represented 11% of total accounts receivable as of December 31, 2006.
Property and equipment
Property and equipment are stated at cost, net of accumulated depreciation and amortization. Depreciation and amortization are calculated under the straight-line basis over the shorter of the estimated useful lives or the respective assets as follows:
         
Furniture and fixtures
  7 years
Office equipment
  5 years
Computer equipment
  3 years
Computer software
  3 years
Leasehold improvements
  5 years (life of lease)
Repairs and maintenance expenditures that do not significantly add to the value of the property, or prolong its life, are charged to expense, as incurred. Gains and losses on dispositions of property and equipment are included in the operating results of the related period.
Intangible assets
Developed technology arising from acquisitions is recorded at cost and amortized on a straight-line basis over five years. Accumulated amortization at December 31, 2007 was $1,265,367. Accumulated amortization at December 31, 2006 was $818,767.
Non-compete agreement arising from acquisitions is recorded at cost and amortized on a straight-line basis over two to three years. Accumulated amortization at December 31, 2007 was $245,400. Accumulated amortization at December 31, 2006 was $158,400.

F-8


 

Purchased technology arising from acquisitions is recorded at cost and amortized on a straight-line basis over three years. Accumulated amortization at December 31, 2007 was $1,056,794. Accumulated amortization at December 31, 2006 was $643,715.
Patents are recorded at cost and amortized on a straight-line basis over three years. Accumulated amortization at December 31, 2007 was $78,981.
Customer-related intangibles arising from acquisitions are recorded at cost and amortized on a straight-line basis over five years. Accumulated amortization at December 31, 2007 was $92,129.
The estimated total amortization expense for intangible asset over the next five years is as follows (in thousands):
         
For the years ending December 31,   Amortization Expense
2008
  $ 999  
2009
  $ 798  
2010
  $ 343  
2011
  $ 204  
2012
  $ 119  
Impairment of long-lived assets
The Company accounts for the impairment and disposition of definite life intangible and long-lived assets in accordance with Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for the Impairment of Disposal of Long-Lived Assets (SFAS No. 144). In accordance with SFAS No. 144, such assets to be held are reviewed for events, or changes in circumstances, which indicate that their carrying value may not be recoverable. The Company periodically reviews related carrying values to determine whether or not impairment to such value has occurred. During the year ended December 31, 2005, due to the deterioration of revenues in Europe since the acquisition of Inspire in February 2005, management believed that the carrying amount for customer contracts and relationships was impaired. The carrying amount of customer contracts and relationships exceeded the sum of the undiscounted cash flows expected and as a result, the Company wrote-down the remaining unamortized balance of $337,000. For the years ended December 31, 2007 and 2006, management had no evidence of impairment.
Goodwill and other intangible assets
Goodwill representing the excess of the purchase price over the fair value of the net tangible and intangible assets arising from acquisitions and purchased domain name are recorded at cost. Intangible assets, such as goodwill and domain name, which are determined to have an indefinite life, are not amortized in accordance with SFAS No. 142, Goodwill and Other Intangible Assets. The Company performs annual impairment reviews during the fourth fiscal quarter of each year, or earlier if indicators of potential impairment exist. For goodwill, the Company engages an independent appraiser to assist management in the determination of the fair value of its reporting unit and compares the resulting fair value to the carrying value of the reporting unit to determine if there is goodwill impairment. For other intangible assets with indefinite lives, the Company compares future undiscounted cash flow forecasts prepared by management to the carrying value of the related intangible asset group to determine if there is impairment. The Company performed its annual impairment analysis as of December 31, 2007 and determined that no impairment existed. Future impairment reviews may result in charges against earnings to write-down the value of intangible assets.
Fair value of financial instruments
The Company’s balance sheets include the following financial instruments: cash and cash equivalents, restricted cash, accounts receivable, accounts payable and accrued liabilities. The Company considers the carrying value of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities in the financial statements to approximate fair value for these financial instruments because of the relatively short period of time between origination of the instruments and their expected realization.
Deferred revenue
Deferred revenue represents deposits from direct advertisers for their advertising campaigns and is recognized as revenue upon a click-through.

F-9


 

Sales commissions
When an advertiser makes a deposit into its account with the Company, the Company’s applicable salesperson earns a commission, subject to certain criteria. The Company records sales commission expense in the period the deposit is received.
Refunds
Refunds of any remaining deposits paid by direct advertisers are available to those advertisers upon written request submitted between 30 and 90 days from the date of deposit.
Revenue recognition
Revenue is recognized when all of the following conditions are satisfied: (1) there is persuasive evidence of an arrangement; (2) the service has been provided to the customer; (3) the amount of fees to be paid by the customer is fixed or determinable; and (4) the collection of the Company’s fees is probable. The Company generates revenue when it is realizable and earned, as evidenced by click-throughs occurring on advertisers’ sponsored listings, the display of a banner advertisement or the fulfillment of subscription listing obligations. Management believes all four revenue recognition criteria are met as a result of each click-through, display of a banner advertisement or the fulfillment of subscription listing obligation (monthly). The Company enters into a contractual arrangement to distribute sponsored listings and banners from an advertiser or an Advertiser Network partner. The advertisers provide sponsored listings along with bid prices (what the advertisers are willing to pay for each click-through on those listings) to the Company. These sponsored listings and banners are then included as search results that the Company distributes in response to keyword searches performed by consumers on the Company’s web site. Depending on the source of the advertiser, the Company recognizes an applicable portion of the bid price for each click-through the Company delivers on advertisers’ sponsored listings. Revenue is recognized when earned based on click-through activity to the extent that collection is reasonably assured from credit worthy direct advertisers and Advertiser Network partners. Licensing revenue is recognized each month our customer utilizes our Local Connect platform. Payment is due thirty days following the end of the month in which the license was used.
One local advertising network partner represented 49%, 40% and 2% of the Company’s total revenue for the years ended December 31, 2007, 2006 and 2005, respectively, one local advertising network partner represented 15%, 3% and 0% of the Company’s total revenue for the years ended December 31, 2007, 2006 and 2005, respectively and one national advertising network partner represented 1%, 15% and 30% of the Company’s total revenue for the years ended December 31, 2007, 2006 and 2005, respectively.
Search serving
Search serving expenses consist primarily of revenue-sharing payments that the Company makes to its Distribution Network partners, and to a lesser extent, royalties, Internet connectivity costs, data center costs, amortization of certain software license fees and maintenance and depreciation of computer equipment used in providing the Company’s paid-search services.
Web site development costs and computer software developed for internal use
Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use (SOP 98-1), requires that costs incurred in the preliminary project and post-implementation stages of an internal use software project be expensed as incurred and that certain costs incurred in the application development stage of a project be capitalized. Emerging Issues Task Force Issue No. 00-02 Accounting for Web Site Development Costs (EITF 00-02), requires that costs incurred in the preliminary project and operating stage of web site development be expensed as incurred and that certain costs incurred in the development stage of web site development be capitalized and amortized over the estimated useful life. During the year ended December 31, 2007, the Company capitalized $330,000 related to web site development with an estimated useful life of three years. During the year ended December 31, 2007, amortization of capitalized web site costs was $187,000. During the year ended December 31, 2006, the Company capitalized $392,000 related to the web site development with an estimated useful life of three years. During the year ended December 31, 2006, amortization of capitalized web site costs was $174,000. During the year ended December 31, 2005, the Company capitalized $244,000 related to the web site development with an estimated useful life of three years. During the year ended December 31, 2005, amortization of capitalized web site costs was $34,000. Capitalized web site costs are included in property and equipment, net.

F-10


 

Research and development
Research and development expenses consist of expenses incurred by the Company in the development, creation and enhancement of its paid-search services. Research and development expenses include salaries and other costs of employment of the Company’s development staff as well as outside contractors and the amortization of capitalized web site development costs.
Traffic acquisition cost
The Company defines traffic acquisition cost (TAC) as the cost of advertising and promoting its website on other search engines. The Company advertises on other search engine web sites, primarily google.com, but also yahoo.com, msn.com and ask.com, by bidding on certain keywords it believes will drive traffic to its Local.com web site. Accordingly, the Company’s TAC is a sales and marketing expense as opposed to a cost of sales expense which is directly related to the generation of revenue. The Company pays TAC regardless of whether or not there is a revenue generating event. Other companies define TAC as the cost associated with driving traffic directly to affiliated advertisers. During the year ended December 31, 2007, approximately 92% of the traffic on our Local.com web site was acquired from other search engine web sites. During the year ended December 31, 2007, traffic acquisition costs (TAC) were $13.7 million of which $10.9 million was paid to Google, Inc and such amounts are included in sales and marketing in accompanying consolidated statements of operations. During the year ended December 31, 2006, traffic acquisition costs (TAC) were $7.7 million of which $6.9 million was paid to Google, Inc and such amounts are included in sales and marketing in accompanying consolidated statements of operations.
Income taxes
The Company follows the provisions of SFAS No. 109, Accounting for Income Taxes, which requires recognition of deferred income tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements and tax returns. Deferred income tax assets and liabilities are determined based upon the difference between the financial statement and tax bases of assets and liabilities, using the enacted tax rates in effect for the year in which the differences are expected to reverse. A valuation allowance is provided when it is more likely than not that deferred income tax assets will not be realized.
Comprehensive income (loss)
The Company accounts for comprehensive income (loss) using SFAS No. 130, Reporting Comprehensive Income (SFAS No. 130). SFAS No. 130 establishes standards for reporting comprehensive income (loss) and its components in financial statements. Comprehensive income (loss), as defined therein, refers to revenue, expenses, gains and losses that are not included in net income (loss) but rather are recorded directly in shareholders’ equity. For the year ended December 31, 2007, comprehensive income consisted of net loss plus unrealized gain on marketable securities. For the years ended December 31, 2006 and 2005, comprehensive loss consisted of net loss plus net unrealized gain/loss on marketable securities and foreign currency translation adjustments.
Supplemental comprehensive income (loss) information (in thousands):
                         
    Years ended December 31,  
    2007     2006     2005  
Foreign currency translation adjustments arising during period
  $     $ 10     $ (6 )
Reclassification adjustment for losses included in net loss
          (4 )      
 
                 
Foreign currency translation adjustments
  $     $ 6     $ (6 )
 
                 
 
                       
Unrealized holding gains (losses) arising during period
  $ 26     $ 160     $ (75 )
Reclassification adjustment for losses included in net loss
          (42 )     (34 )
 
                 
Net unrealized gain (loss) on marketable securities
  $ 26     $ 118     $ (109 )
 
                 

F-11


 

Stock-based compensation
In December 2004, the Financial Accounting Standard Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 123R, Share-Based Payment, which addresses the accounting for employee stock options. SFAS No. 123R requires that the cost of all employee stock options, as well as other equity-based compensation arrangements, be reflected in the financial statements based on the estimated fair value of the awards. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award—the requisite service period (usually the vesting period).
The Company adopted SFAS No. 123R on January 1, 2006, the beginning of its first quarter of fiscal 2006, using the modified-prospective transition method. Under the modified-prospective transition method prior periods of the Company’s financial statements are not restated for comparison purposes. In addition, the measurement, recognition and attribution provisions of SFAS No. 123R apply to new grants and grants outstanding on the adoption date. Estimated compensation expense for outstanding grants at the adoption date will be recognized over the remaining vesting period using the compensation expense calculated for the pro forma disclosure purposes under SFAS No. 123, Accounting for Stock-Based Compensation.
Total stock-based compensation expense recognized for the years ended December 31, 2007 and 2006 is as follows (in thousands, except per share amount):
                 
    Year ended December 31,  
    2007     2006  
Sales and marketing
  $ 544     $ 601  
General and administrative
    968       1,674  
Research and development
    236       256  
 
           
 
Total stock-based compensation expense
  $ 1,748     $ 2,531  
 
           
 
               
Basic and diluted net stock-based compensation expense per share
  $ 0.15     $ 0.27  
 
           
The fair values of these options were estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions:
                 
    Year ended December 31,
    2007   2006
Risk-free interest rate
    4.02 %     4.66 %
Expected lives (in years)
    7.0       6.5  
Expected dividend yield
  None   None
Expected volatility
    100.00 %     112.37 %
As of December 31, 2007, there was $3.4 million of unrecognized stock-based compensation expense related to outstanding stock options, net of forecasted forfeitures. This amount is expected to be recognized over a weighted average period of 1.5 years. The stock-based compensation expense for these awards will be different if the actual forfeiture rate is different from the Company’s forecasted rate.
Prior to the adoption of SFAS No. 123R the Company accounted for stock-based employee compensation under the recognition and measurement principles of Accounting Principles Board Opinion (APB) No. 25, Accounting for Stock Issued to Employees and the disclosure requirements of SFAS No. 123 and related SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure.

F-12


 

The following table illustrates the pro forma effect of the fair value recognition of stock-based compensation on net income (loss) and net income (loss) per share for the year ended December 31, 2005 (in thousands, except per share amounts):
         
    Year ended  
    December 31,  
    2005  
Net income (loss), as reported
  $ (6,502 )
Additional stock-based employee compensation expense determined under fair value based method for all awards, net of tax effects
    (4,725 )
 
     
 
Pro forma net income (loss)
  $ (11,227 )
 
     
 
       
Earnings (loss) per share:
       
Basic — as reported
  $ (0.75 )
 
     
Basic — pro forma
  $ (1.30 )
 
     
 
       
Earnings (loss) per share:
       
Diluted — as reported
  $ (0.75 )
 
     
Diluted — pro forma
  $ (1.30 )
 
     
The fair value of these options was estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions:
         
    Year ended
    December 31,
    2005
Risk free interest rate
    4.62 %
Expected lives (in years)
    9.3  
Dividend yield
  None
Expected volatility
    62 %
Net income (loss) per share
SFAS No. 128, Earnings per Share, establishes standards for computing and presenting earnings per share. Basic net income (loss) per share is calculated using the weighted average shares of common stock outstanding during the periods. Diluted net income (loss) per share is calculated using the weighted average number of common and potentially dilutive common shares outstanding during the period, using the treasury stock method for options and warrants.
For the year ended December 31, 2007, potentially dilutive securities, which consist of options to purchase 2,703,850 share of common stock at prices ranging from $0.40 to $16.59 and warrants to purchase 3,470,278 shares of common stock at prices ranging from $3.00 to $25.53 were not included in the computation of diluted net income per share because such inclusion would be antidilutive.
For the year ended December 31, 2006, potentially dilutive securities, which consist of options to purchase 1,933,363 share of common stock at prices ranging from $0.40 to $16.59 and warrants to purchase 1,043,664 shares of common stock at prices ranging from $3.00 to $25.53 were not included in the computation of diluted net income per share because such inclusion would be antidilutive.
For the year ended December 31, 2005, potentially dilutive securities, which consist of options to purchase 1,339,360 shares of common stock at prices ranging from $0.40 to $16.59 and warrants to purchase 1,279,575 shares of common stock at prices ranging from $2.00 to $25.53 were not included in the computation of diluted net income per share because such inclusion would be antidilutive.

F-13


 

The following table sets forth the computation of basic and diluted net income (loss) per share for the periods indicated (in thousands, except per share amounts):
                         
    Years ended December 31,  
    2007     2006     2005  
Numerator:
                       
Net income (loss)
  $ (18,202 )   $ (13,286 )   $ (6,502 )
 
                 
 
                       
Denominator:
                       
Denominator for historical basic calculation weighted average shares
    11,500       9,250       8,658  
Dilutive common stock equivalents:
                       
Options
                 
Warrants
                 
 
                 
Denominator for historical diluted calculation weighted average shares
    11,500       9,250       8,658  
 
                 
 
                       
Net income (loss) per share:
                       
Historical basic net income (loss) per share
  $ (1.58 )   $ (1.44 )   $ (0.75 )
 
                 
Historical diluted net income (loss) per share
  $ (1.58 )   $ (1.44 )   $ (0.75 )
 
                 
New accounting pronouncements
In December 2007, FASB issued SFAS No. 141R, Business Combinations (SFAS 141R), which retains the underlying concepts of SFAS 141 in that all business combinations are still required to be accounted for at fair value under the acquisition method of accounting but SFAS 141R changed the method of applying the acquisition method in a number of significant aspects. Acquisition costs will generally be expensed as incurred; noncontrolling interests will be valued at fair value at the acquisition date; in-process research and development will be recorded at fair value as an indefinite-lived intangible asset at the acquisition date; restructuring costs associated with a business combination will generally be expensed subsequent to the acquisition date; and changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date generally will affect income tax expense. The provision of SFAS 141R are effective for fiscal years beginning after December 15, 2008 with earlier adoption prohibited. The Company is currently analyzing the effect of adopting SFAS 141R.
In December 2007, FASB issued SFAS No. 160, Accounting and Reporting of Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB No. 51 (SFAS 160), which requires the recognition of a noncontrolling interest (minority interest) as equity in the consolidated financial statements and separate from the parent’s equity. The amount of net income attributable to the noncontrolling interest will be included in consolidated net income on the face of the income statement. It also amends certain aspects of ARB No. 51’s consolidation procedures for consistency with the requirements of SFAS 141R. This statement also includes expanded disclosure requirements regarding the interests of the parent and its noncontrolling interest. The provisions of SFAS 160 are effective for fiscal years beginning after December 15, 2008 with earlier adoption prohibited. The Company is currently analyzing the effect of adopting SFAS 160.

F-14


 

2. Composition of certain balance sheet and statement of operations captions
Property and equipment consisted of the following (in thousands):
                 
    December 31,     December 31,  
    2006     2006  
Furniture and fixtures
  $ 203     $ 201  
Office equipment
    119       91  
Computer equipment
    1,889       1,750  
Computer software
    1,841       1,473  
Leasehold improvements
    583       583  
 
           
 
    4,635       4,098  
 
               
Less accumulated depreciation and amortization
    (3,162 )     (2,070 )
 
           
Property and equipment, net
  $ 1,473     $ 2,028  
 
           
Intangible assets consisted of the following (in thousands):
                 
    December 31,     December 31,  
    2007     2006  
Developed technology
  $ 2,233     $ 2,233  
Non-compete agreements
    274       261  
Purchased technology
    1,239       1,239  
Customer-related
    1,020        
Patents
    431        
Domain name
    701       701  
 
           
 
    5,898       4,434  
 
               
Less accumulated amortization
    (2,742 )     (1,621 )
 
           
 
Intangible assets, net
  $ 3,156     $ 2,813  
 
           
Interest and other income (expense), net consisted of the following (in thousands):
                         
    Year ended December 31,  
    2007     2006     2005  
Interest income
  $ 536     $ 328     $ 600  
Interest expense
    (887 )     (5 )     45  
Interest expense — non-cash
    (6,679 )            
IRS penalty reversal
                132  
Net gain (loss) on sale of fixed assets
          7       (63 )
Realized loss on sale of marketable securities
          (42 )     (34 )
 
                 
 
Interest and other income (expense), net
  $ (7,030 )   $ 288     $ 680  
 
                 

F-15


 

3. Marketable securities
The following is a summary of marketable securities all of which are classified as available for sale (in thousands):
                         
            Gross     Estimated  
            Unrealized     Fair  
    Cost     Loss     Value  
As of December 31, 2007:
                       
 
                       
Mortgage backed government securities
  $ 2,000     $ (1 )   $ 1,999  
 
                 
 
                       
As of December 31, 2006:
                       
 
                       
Mortgage backed government securities
  $ 1,999     $ (27 )   $ 1,972  
 
                 
The contractual maturities of marketable securities are as follows (in thousands):
                         
            Gross     Estimated  
            Unrealized     Fair  
    Cost     Loss     Value  
As of December 31, 2007:
                       
 
                       
Maturities:
                       
Less than one year
  $ 2,000     $ (1 )   $ 1,999  
 
                 
 
                       
As of December 31, 2006:
                       
 
                       
Maturities:
                       
After one year through five years
  $ 1,999     $ (27 )   $ 1,972  
 
                 
4. Income taxes
The Company’s provision (benefit) for income taxes consists of the following (in thousands):
                         
    Years ended December 31,  
    2007     2006     2005  
Current:
                       
Federal
  $     $     $  
State
    1             (2 )
Foreign
          1       (27 )
 
                 
 
                       
Total current
    1       1       (29 )
 
                 
 
                       
Deferred:
                       
Federal
                412  
State
                115  
Foreign
                 
 
                 
 
                       
Total deferred
                527  
 
                 
 
                       
Total provision (benefit) for income taxes
  $ 1     $ 1     $ 498  
 
                 

F-16


 

The provision (benefit) for income taxes differs from the amount computed by applying the federal income tax rate as follows:
                         
    Years ended December 31,
    2007   2006   2005
Statutory federal tax rate
    34 %     34 %     34 %
State income taxes, net of federal benefit
                 
Stock option grants
    3       (4 )      
Change in valuation allowance
    (37 )     (30 )     (43 )
Other
                1  
 
                       
 
                       
 
    %     %     (8) %
 
                       
Deferred income taxes reflect the tax effect of temporary differences between the carrying amounts of assets and liabilities for reporting purposes and the amounts used for income tax purposes. The components of deferred tax assets and liabilities are as follows (in thousands):
                         
    Years ended December 31,  
    2007     2006     2005  
Deferred income tax assets:
                       
Net operating loss carryforwards
  $ 18,402     $ 10,730     $ 7,666  
Accrued expenses
    1,290       1,095       76  
Fixed assets/depreciation
    1,440       1,551       241  
 
                 
 
                       
Gross deferred tax assets
    21,132       13,376       7,983  
Valuation allowance
    (20,015 )     (11,808 )     (6,335 )
 
                 
 
    1,117       1,568       1,648  
 
                 
 
                       
Deferred income tax liabilities:
                       
Acquired intangibles
    (1,102 )     (1,285 )     (1,356 )
Fixed assets/depreciation
    (15 )            
Other
          (283 )     (292 )
 
                 
 
                       
 
    (1,117 )     (1,568 )     (1,648 )
 
                 
 
                       
Net deferred tax assets (liabilities)
  $     $     $  
 
                 
As of December 31, 2007, the Company has approximately $2.6 million of valuation allowance attributable to the tax benefit of exercised stock options and warrants issued for services, which will be credited directly to paid-in capital when the related deferred tax assets are realized.
As of December 31, 2007, the Company had $47.2 million and $40.6 million in net operating loss carryforwards for federal and state income tax purposes, respectively. The losses begin to expire in 2021 for federal and 2012 for state income tax purposes.
In June 2006, FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN48), which defines the threshold for recognizing the benefits of tax return positions in the financial statements as “more-likely-than-not” to be sustained by the taxing authority. A tax position that meet the “more-likely-than-not” criterion shall be measured at the largest amount of benefit that is more than 50% likely of being realized upon ultimate settlement. FIN48 applies to all tax positions accounted for under SFAS No. 109, Accounting for Income Taxes. FIN48 is effective for fiscal years beginning after December 15, 2006.
The Company adopted FIN48 as of January 1, 2007, the beginning of its current fiscal year. Based on the Company’s preliminary analysis, the Company believes that its income tax filing positions and deductions will be sustained on audit and does not anticipate any adjustments that will result in a material change to its financial position including its effective tax rate. Therefore, no reserves for uncertain income tax positions have been recorded pursuant to FIN 48 and the Company did not record a cumulative effect adjustment related to the adoption of FIN 48. In addition, the Company has not recorded any accrued interest and penalties related to income tax. It is the Company’s policy to classify interest and penalties related to income tax as income taxes in its financial statements.

F-17


 

The following tax years that remain subject to examination by major tax jurisdictions are as follows:
Federal — 2004, 2005 and 2006;
California (state) — 2004, 2005 and 2006;
Virginia (state) — 2004, 2005 and 2006.
5. Commitments and contingencies
Lease Commitments
The Company leases office space under an operating lease agreement that expires in June 2010. The future minimum lease payments under non-cancelable operating leases at December 31, 2007 are as follows (in thousands):
         
    Operating  
    Leases  
Years ending December 31,
       
2008
  $ 375  
2009
    389  
2010
    199  
 
     
 
Total minimum lease payments
  $ 963  
 
     
The Company recognizes rent expense on a straight-line basis over the life of the operating lease as the lease contains a fixed escalation rent clause. Rent expense for the years ended December 31, 2007, 2006 and 2005 was $249,000, $336,000 and $407,000, respectively.
401(k) Plan
The Company maintains a 401(k) plan for eligible employees. Employees become eligible to participate in the plan at the beginning of each calendar quarter (January, April, July, October) following their hire date. Employees may contribute amounts ranging from 1% to 15% or their annual salary, up to maximum limits set by the Internal Revenue Service. The Company may make matching contributions at its own discretion. Employees immediately vest 100% of their own contributions and 20% of the Company’s matching contributions for each year of service. Through December 31, 2007, the Company has made no matching contributions.
Employment Agreements
The Company has signed employment agreements with its three executive officers and six of its key employees. The agreements provide for the payments of annual salaries totaling $1.9 million and annual bonuses of up to $702,000 in the aggregate. The agreements have a term of one year and automatically renew for one year terms unless terminated on at least 30 days notice by either party. If the Company terminates one of these officers or key employees without cause, the Company is obligated to pay the terminated officer or key employee (i) his annual salary and other benefits earned prior to termination, (ii) the greater of such officer’s or key employee’s annual salary for the remaining term of the agreement or such officer’s or key employee’s annual salary, (iii) the average of all bonuses during the term of the employment agreement, (iv) the same benefits that such officer or key employee received prior to termination, for a period of 12 months following termination, and (v) the right to exercise all options, including any as yet unvested options, for a period of 12 months following termination.
Legal Proceedings
From time to time, however, the Company may be subject to a variety of legal proceedings and claims in the ordinary course of business.

F-18


 

6. Stockholders’ equity
The Company has authorized 30,000,000 shares of common stock and 10,000,000 shares of convertible preferred stock.
Warrants
Warrant activity for the years ended December 31, 2005, 2006 and 2007 was as follows:
                 
            Weighted Average  
    Shares     Exercise Price  
Outstanding at December 31, 2004
    2,088,194     $ 6.43  
Exercised
    (761,369 )     3.07  
Expired
    (47,250 )     14.58  
 
             
 
Outstanding at December 31, 2005
    1,279,575       8.13  
Exercised
    (159,682 )     3.91  
Expired
    (76,229 )     3.58  
 
             
 
Outstanding at December 31, 2006
    1,043,644       9.11  
Issued
    2,810,070       6.22  
Exercised
    (365,331 )     3.79  
Expired
    (18,125 )     7.31  
 
             
 
Outstanding at December 31, 2007
    3,470,278     $ 7.34  
 
           
Exercisable at December 31, 2007
    2,395,532     $ 6.79  
 
           
The weighted average fair value at grant date of the warrants granted during the year ended December 31, 2007 was $3.83. No warrants were issued during the years ended December 31, 2005 and 2006.
The following table summarizes information regarding warrants outstanding and exercisable at December 31, 2007:
                                         
    Warrants Outstanding     Warrants Exercisable  
            Weighted                      
            Average     Weighted             Weighted  
            Remaining     Average             Average  
            Contractual     Exercise             Exercise  
Range of Exercise Prices   Shares     Life     Price     Shares     Price  
$3.00 - $3.99
    173,124       0.6     $ 3.50       173,124     $ 3.50  
$4.00 - $4.99
    874,596       4.1     $ 4.36       874,596     $ 4.36  
$5.00 - $5.99
    867,662       4.1     $ 5.17       867,662     $ 5.17  
$7.00 - $7.99
    537,373       4.6     $ 7.89           $  
$9.00 - $9.99
    537,373       4.6     $ 9.26           $  
$10.00 - $19.99
    315,750       1.8     $ 10.00       315,750     $ 10.00  
$20.00 - $25.53
    164,400       2.0     $ 25.53       164,400     $ 25.53  
 
                                   
 
    3,470,278       3.8     $ 7.34       2,395,532     $ 6.79  
 
                             
7. Stock plans
In March 1999, the Company adopted the 1999 Equity Incentive Plan (1999 Plan). The 1999 Plan provides for the grant of non-qualified and incentive stock options to employees, directors and consultants of options to purchase shares of the Company’s stock. Options are granted at exercise prices equal to the fair market value of the common stock on the date of grant. Prior to 2006, 25% of the options were available for exercise at the end of nine months, while the remainder of the grant were exercisable ratably over the next 27 month period, provided the optionee remained in service to the Company. For options granted in 2006, 33.33% of the options are available for exercise at the end of one year, while the remainder of the grant is exercisable ratably over the next 8 quarters, provided the optionee remains in service to the Company. The options generally expire ten years from the date of grant. The Company has reserved 500,000 shares for issuance under the 1999 Plan, of which 188,469 were outstanding and 23 were available for future grant at December 31, 2007.

F-19


 

In March 2000, the Company adopted the 2000 Equity Incentive Plan (2000 Plan). The 2000 Plan provides for the grant of non-qualified and incentive stock options to employees, directors and consultants of options to purchase shares of the Company’s stock. Options are granted at exercise prices equal to the fair market value of the common stock on the date of grant. Prior to 2006, 25% of the options were available for exercise at the end of nine months, while the remainder of the grant were exercisable ratably over the next 27 month period, provided the optionee remained in service to the Company. For options granted in 2006, 33.33% of the options are available for exercise at the end of one year, while the remainder of the grant is exercisable ratably over the next 8 quarters, provided the optionee remains in service to the Company. The options generally expire ten years from the date of grant. The Company has reserved 500,000 shares for issuance under the 2000 Plan, of which 350,181 were outstanding and 42 were available for future grant at December 31, 2007.
In January 2004, the Company adopted the 2004 Equity Incentive Plan (2004 Plan), in August 2004, the Company amended the 2004 Plan and in September 2004, the stockholders of the Company approved the 2004 Plan, as amended. The 2004 Plan provides for the grant of non-qualified and incentive stock options to employees, directors and consultants of options to purchase shares of the Company’s stock. Options are granted at exercise prices equal to the fair market value of the common stock on the date of grant. Prior to 2006, 25% of the options were available for exercise at the end of nine months, while the remainder of the grant were exercisable ratably over the next 27 month period, provided the optionee remained in service to the Company. For options granted in 2006, 33.33% of the options are available for exercise at the end of one year, while the remainder of the grant is exercisable ratably over the next 8 quarters, provided the optionee remains in service to the Company. The options generally expire ten years from the date of grant. The Company has reserved 600,000 shares for issuance under the 2004 Plan, of which 463,940 were outstanding and 16,596 were available for future grant at December 31, 2007.
In August 2005, the Company adopted and the stockholders of the Company approved the 2005 Equity Incentive Plan (2005 Plan). The 2005 Plan provides for the grant of non-qualified and incentive stock options to employees, directors and consultants of options to purchase shares of the Company’s stock. Options are granted at exercise prices equal to the fair market value of the common stock on the date of grant. Prior to 2006, 25% of the options were available for exercise at the end of nine months, while the remainder of the grant were exercisable ratably over the next 27 month period, provided the optionee remained in service to the Company. For options granted in 2006 and thereafter, 33.33% of the options are available for exercise at the end of one year, while the remainder of the grant is exercisable ratably over the next 8 quarters, provided the optionee remains in service to the Company. The Company has reserved 1,000,000 shares for issuance under the 2005 Plan, of which 914,706 were outstanding and 4,693 were available for future grant at December 31, 2007.
In August 2007, the Company adopted and the stockholders of the Company approved the 2007 Equity Incentive Plan (2007 Plan). The 2007 Plan provides for the grant of non-qualified and incentive stock options to employees, directors and consultants of options to purchase shares of the Company’s stock. Options are granted at exercise prices equal to the fair market value of the common stock on the date of grant. 33.33% of the options are available for exercise at the end of one year, while the remainder of the grant is exercisable ratably over the next 8 quarters, provided the optionee remains in service to the Company. The options generally expire ten years from the date of grant. The Company has reserved 1,000,000 shares for issuance under the 2007 Plan, of which 786,554 were outstanding and 213,446 were available for future grant at December 31, 2007.

F-20


 

Stock option activity under the plans for the years ended December 31, 2005, 2006 and 2007 is as follows:
                         
                    Aggregate  
            Weighted Average     Intrinsic Value  
    Shares     Exercise Price     (in thousands) (1)  
Outstanding at December 31, 2004
    1,292,947     $ 3.19          
Granted
    773,814       9.61          
Exercised
    (484,211 )     2.94          
Canceled
    (243,190 )     8.91          
 
                     
 
Outstanding at December 31, 2005
    1,339,360       5.95          
Granted
    864,104       4.05          
Exercised
    (82,748 )     4.16          
Canceled
    (187,353 )     6.77          
 
                     
 
Outstanding at December 31, 2006
    1,933,363       5.10          
Granted
    1,001,054       4.89          
Exercised
    (90,016 )     3.81          
Canceled
    (140,551 )     5.62          
 
                     
 
Outstanding at December 31, 2007
    2,703,850     $ 5.04     $ 1,896  
 
                 
Exercisable at December 31, 2007
    1,347,613     $ 5.35     $ 1,389  
 
                 
The weighted-average fair value at grant date for the options granted during the years ended December 31, 2005, 2006 and 2007 was $9.01, $3.50, and $4.11 per option, respectively.
The aggregate intrinsic value of all options exercised during the years ended December 31, 2005, 2006 and 2007 was $2.1 million, $122,000 and $406,000, respectively.
The following table summarizes information regarding options outstanding and exercisable at December 31, 2007:
                                         
    Options Outstanding   Options Exercisable
            Weighted                
            Average   Weighted           Weighted
            Remaining   Average           Average
            Contractual   Exercise           Exercise
Range of Exercise Price   Shares   Life   Price   Shares   Price
$0.00 - $1.00
    18,625     0.3 years   $ 0.40       18,625     $ 0.40  
$1.01 - $2.00
    160,000     5.0 years     2.00       160,000       2.00  
$2.01 - $3.00
    141,028     4.4 years     2.25       141,028       2.25  
$3.01 - $4.00
    772,815     7.3 years     3.69       448,517       3.75  
$4.01 - $5.00
    938,388     9.6 years     4.67       66,164       4.58  
$5.01 - $6.00
    133,459     8.2 years     5.69       95,218       5.71  
$6.01 - $7.00
    117,773     7.9 years     6.39       97,657       6.39  
$7.01 - $8.00
    190,112     7.7 years     7.51       142,414       7.54  
$8.01 - $10.00
    120,000     8.3 years     8.76       68,333       9.18  
$15.01 - $16.59
    111,650     6.6 years     15.61       109,657       15.60  
 
                                       
 
    2,703,850     7.9 years   $ 5.04       1,347,613     $ 5.35  
 
                                       

F-21


 

8. Operating segment information
SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information (SFAS No. 131), requires that public business enterprises report certain information about operating segments. The Company has one reporting segment: paid-search. The following table presents summary operating geographic information as required by SFAS No. 131 (in thousands):
                         
    Years ended December 31,  
    2007     2006     2005  
Revenue by geographic region:
                       
United States
  $ 21,116     $ 14,069     $ 17,663  
Europe
    409       144       476  
 
                 
Total revenue
  $ 21,525     $ 14,213     $ 18,139  
 
                 
9. Inspire Infrastructure 2i AB acquisition
On February 28, 2005, the Company completed the acquisition, through a wholly owned subsidiary, of all of the outstanding capital stock of Inspire Infrastructure 2i AB (Inspire), a Swedish Internet and wireless local-search technology company for $15.0 million in cash and cash acquisition costs of $409,000. Under the terms of the acquisition, Inspire shareholders could have received additional consideration consisting of up to 447,067 shares of Local.com common stock, valued at $7.5 million based upon a 30-day moving average at the date of acquisition, which was payable upon the achievement of certain future business performance criteria.
On May 15, 2006, the Company entered into a Share Purchase Termination Agreement with Interchange Europe Holding Corporation, a wholly owned subsidiary of the Company, and the five former shareholders of Inspire Infrastructure 2i AB (Sellers) to terminate all provisions of the Share Purchase Agreement dated February 2, 2005, except for Provision 10 — Non-Compete and Section 11.7 — Confidentiality. As a result of this termination, $232,000 of the cash escrow was returned to the Company which reduced goodwill. In addition, the Sellers will not earn or receive the additional consideration of 447,067 shares of Local.com common stock.
On December 20, 2006, the Company entered into a Share Purchase Agreement with Starboard Finans AB to sell all of the outstanding capital stock of Interchange Europe AB (formerly Inspire Infrastructure 2i AB) it owns (1,000 shares) for $140 (SEK 1,000).
10. Senior Secured Convertible Notes
On February 22, 2007, the Company entered into a Purchase Agreement with two investors. Pursuant to this agreement, the investors purchased an aggregate of $8.0 million of 9% senior secured convertible notes and warrants to purchase shares of the Company’s common stock. The senior secured convertible notes are secured by the Company’s assets and were due on February 23, 2009. Each senior secured convertible note holder had the right, at any time, to convert their note into shares of the Company’s common stock at an initial conversion ratio of one share of common stock for each $4.02 of principal amount of their note. The Company recorded a beneficial conversion feature amount of $3.1 million as debt discount which was amortized into interest expense over the life of the notes. The Company also issued warrants to purchase an aggregate of 796,020 shares of common stock at an exercise price of $4.82 per share that expire five years from the date of issuance and warrants to purchase an aggregate of 796,020 shares of common stock at an exercise price of $5.63 per share that expire five years from the date of issuance. The relative fair value of these warrants, using the Black-Scholes model at the date of grant, was $3.1 million and was recorded as convertible debt discount and was amortized into interest expense over the life of the notes. The assumptions used in the Black-Scholes model were as follows: no dividend yield; 4.67% interest rate; five years contractual life; and volatility of 100%.
In connection with the issuance of the senior secured convertible notes, the Company paid $530,000 in cash for placement agent fees of which $205,000 was paid to a director of the Company. These fees are recorded in prepaid expenses and will be amortized into interest expense over the life of the notes. The Company also issued to the placement agents warrants to purchase an aggregate of 71,642 shares of common stock, of which 27,711 were issued to a director of the Company, at an exercise price of $4.82 per share that expire five years from the date of issuance and warrants to purchase an aggregate of 71,642 shares of common stock, of which 27,711 were issued to a director of the Company, at an exercise price of $5.63 per share that expire five years from the date of issuance. The fair value of these warrants, using the Black-Scholes model at the date of grant, was $458,000 and was recorded in prepaid expenses and will be amortized into interest expense over the life of the notes.

F-22


 

On March 29, 2007, the Company entered into Amendment No. 1 to the Purchase Agreement whereby the exercise date of the warrants issued to the investors was amended to be the six month anniversary of the closing date (February 23, 2007) of the Purchase Agreement.
During July 2007, the Investors converted all of the $8.0 million in aggregate principal amount of the Notes into an aggregate of 1,990,050 shares of the Company’s common stock.
On July 31, 2007, the Company entered into a Consent to Equity Sales agreements with the Investors whereby the Investors waived the application of Section 7.9 of the Convertible Note Agreement which prohibits the Company from selling securities under certain circumstances and the Strategic Investor waived their Right of First Refusal pursuant to Section 7.12 of the Convertible Note Agreement with respect to any equity transaction that occurs during the 90 day period following July 9, 2007. In addition, the Company agreed to amend the warrants issued to the Investors so that the exercise price of the Series A Warrant is decreased to $4.32 per share and the exercise price per share of the Series B Warrant is decreased to $5.13 per share. The difference of the fair value of the repriced warrants and the original warrants on the date of the repricing using the Black-Scholes model was $133,000 and was recorded as a private placement cost (Note 13). The assumptions used in the Black-Scholes model were as follows: no dividend yield; 4.6% interest rate; 4.58 years contractual life; and volatility of 100%.
11. Atlocal asset purchase
On June 9, 2005, the Company entered into an asset purchase agreement with Xiongwu Xia, an individual, to purchase the patent-pending Atlocal Search Engine Computer software, the Atlocal.com domain name, a computer server, and the Atlocal.com database for $500,000 in cash, cash acquisition costs of $3,238 and 104,311 unregistered shares of Local.com common stock valued at $750,000 based upon a 90-day moving average. In addition, the Company will issue Mr. Xia an additional 104,311 shares of unregistered Local.com common stock if the patent is issued for the Atlocal Search Engine Computer software before June 9, 2010.
On June 12, 2007, the Company was issued patent number 7,231,405, Methods and Apparatus of Indexing Web Pages of a Web Site for Geographical Searchine Based on User Location. The Company issued Mr. Xia the additional 104,311 shares of unregistered Local.com common stock valued at $431,000 based upon the closing price of the Company’s common stock of $4.13 and recorded the amount as an intangible asset and will amortize the value over three years.
12. PremierGuide, Inc. acquisition
On July 18, 2007, the Company completed the acquisition, through a wholly owned subsidiary, of all of the outstanding capital stock of PremierGuide, Inc. (PremierGuide), a Delaware corporation and provider of online business directories for an aggregate purchase price of $2.0 million in cash and cash acquisition costs of $81,000. The purchase price of $2.1 million was allocated as follows (in thousands):
         
Current assets
  $ 192  
Customer-related intangibles
    1,020  
Non-compete agreement
    13  
Goodwill
    1,020  
Liabilities assumed
    (139 )
 
     
 
Total purchase price
  $ 2,106  
 
     
PremierGuide’s operating results have been included in the Company’s consolidated financial statements from the date of acquisition. Customer-related intangibles are being amortized on a straight-line basis over five years. Non-compete agreement is being amortized on a straight-line basis over two years. Goodwill, which is determined to have an indefinite life, is not amortized in accordance with SFAS No. 142, Goodwill and Other Intangible Assets.

F-23


 

13. Private placement
On August 1, 2007, the Company issued 2,356,900 shares of its common stock, par value $0.00001 per share, for an aggregate purchase price of $12,962,950 to five institutional investors in a private placement transaction pursuant to a Securities Purchase Agreement, dated as of July 31, 2007 (Securities Purchase Agreement). In connection with the sale of the common stock, the Company also issued the investors warrants to purchase up to 471,380 shares of the Company’s common stock at an exercise price of $7.89 per share exercisable beginning February 1, 2008 and for a period of five years thereafter; and warrants to purchase up to 471,380 shares of the Company’s common stock at an exercise price of $9.26 per share exercisable beginning February 1, 2008 and for a period of six years thereafter. In connection with the transaction described herein, the Company also entered into a Registration Rights Agreement which obligates the Company to register the resale of the shares of common stock sold in the private placement and the shares of common stock issuable upon exercise of the warrants under the Securities Act of 1933, as amended and indemnifies the investors against any Claims, as defined in the Registration Rights Agreement, incurred as a result of any Violations, as defined in the Registration Rights Agreement. These shares were registered on a Form S-3 (Registration No. 333-145580) declared effective by the Securities and Exchange Commission on August 28, 2007.
In connection with the transaction, GunnAllen Financial Inc. (GunnAllen) acted as the Company’s placement agent. For payment for these services, the Company paid GunnAllen fees of $827,777 in cash, of which $250,000 was paid to Norman K. Farra Jr., a director of the Company and an employee of GunnAllen. In addition, the Company issued GunnAllen warrants to purchase up to 46,063 shares of the Company’s common stock at $7.89 per share and warrants to purchase up to 46,063 shares of the Company’s common stock at $9.26 per share. In addition, the Company issued Norman K. Farra Jr. warrants to purchase 19,930 shares of the Company’s common stock at $7.89 per share and warrants to purchase 19,930 shares of the Company’s common stock at $9.26 per share.
The fair value of all of the warrants issued, using the Black-Scholes model at the date of grant, was $4,648,108 and was recorded as a private placement cost. The assumptions used in the Black-Scholes model were as follows: no dividend yield; 4.6% interest rate; five years contractual life; and volatility of 100%.

F-24


 

Schedule II — Valuation and Qualifying Accounts
Years ended December 31, 2007, 2006 and 2005
                                 
    Balance at   Charges to           Balance at
    Beginning   Costs and           End of
Accounts receivable (in thousands):   of Period   Expenses   Deductions   Period
Year ended December 31, 2007
                               
Allowance for doubtful accounts
  $ 9     $ 14     $ (8 )   $ 15  
Year ended December 31, 2006
                               
Allowance for doubtful accounts
  $ 30     $ (23 )   $ 2     $ 9  
Year ended December 31, 2005
                               
Allowance for doubtful accounts
  $ 5     $ 69     $ (44 )   $ 30  

F-25


 

SELECTED QUARTERLY FINANCIAL DATA
(in thousands, except per share amounts)
(Unaudited)
                                                                 
    Quarters ended
    December 31,   September 30,   June 30,   March 31,   December 31,   September 30,   June 30,   March 31,
    2007   2007   2007   2007   2006   2006   2006   2006
Revenue
  $ 5,932     $ 5,614     $ 5,098     $ 4,881     $ 3,628     $ 4,059     $ 3,374     $ 3,151  
Operating loss
  $ (2,860 )   $ (2,879 )   $ (2,537 )   $ (2,894 )   $ (3,244 )   $ (2,886 )   $ (3,557 )   $ (3,887 )
Net loss
  $ (2,666 )   $ (9,297 )   $ (3,151 )   $ (3,087 )   $ (3,159 )   $ (2,832 )   $ (3,475 )   $ (3,783 )
Basic net loss per share
  $ (0.19 )   $ (0.71 )   $ (0.34 )   $ (0.33 )   $ (0.34 )   $ (0.31 )   $ (0.38 )   $ (0.41 )
Diluted net loss per share
  $ (0.19 )   $ (0.71 )   $ (0.34 )   $ (0.33 )   $ (0.34 )   $ (0.31 )   $ (0.38 )   $ (0.41 )

F-26


 

INDEX TO EXHIBITS
     
Exhibit    
Number   Description
 
 
   
23.1*
  Consent of Haskell & White LLP, independent registered public accounting firm.
 
   
31.1*
  Certification of Principal Executive Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
   
31.2*
  Certification of Principal Financial Officer Required by Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
   
32.1*
  Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
*   Filed herewith.

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