10-Q 1 salon_10q-063005.txt ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 ---------------- FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2005 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 0-26395 SALON MEDIA GROUP, INC. (Exact name of Registrant as specified in its charter) Delaware 94-3228750 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification Number) 101 Spear Street, Suite 203 San Francisco, CA 94105 (Address of principal executive offices) ---------------- (415) 645-9200 (Registrant's telephone number, including area code) ---------------- Securities registered pursuant to Section 12(b) of the Act: None ---------------- Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.001 Par Value (Title of Class) ---------------- Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Sections 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 [X] Indicate by check mark whether the Registrant is an accelerated filer as defined by Rule 12b-12 of the act. Yes [ ] No [X] The number of outstanding shares of the Registrant's Common Stock, par value $0.001 per share, on August 3, 2005 was 15,452,189 shares. ================================================================================ -------------------------------------------------------------------------------- FORM 10-Q SALON MEDIA GROUP, INC. INDEX -------------------------------------------------------------------------------- Page PART I FINANCIAL INFORMATION Number ITEM 1: Condensed Consolidated Financial Statements Condensed Consolidated Balance Sheets as of June 30, 2005 and March 31, 2005 (unaudited).................................... 3 Condensed Consolidated Statements of Operations for the three months ended June 30, 2005 and 2004 (unaudited) ............ 4 Condensed Consolidated Statements of Cash Flows for the three months ended June 30, 2005 and 2004 (unaudited) ............ 5 Notes to Condensed Consolidated Financial Statements (unaudited).. 6 ITEM 2: Management's Discussion and Analysis of Financial Condition and Results of Operations......................................... 12 ITEM 3: Quantitative and Qualitative Disclosures About Market Risk........ 26 ITEM 4: Controls and Procedures........................................... 27 PART II OTHER INFORMATION ITEM 1: Legal Proceedings................................................. 27 ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds....... 27 ITEM 3. Defaults upon Senior Securities................................... 27 ITEM 4. Submission of Matters to a Vote of Security Holders............... 28 ITEM 5. Other Information................................................. 28 ITEM 6: Exhibits and Reports on Form 8-K.................................. 28 Signatures........................................................ 28 -------------------------------------------------------------------------------- 2 PART I: FINANCIAL INFORMATION ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -------------------------------------------------------------------------------- SALON MEDIA GROUP, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except share and per share amounts)
June 30, March 31, 2005 2005 ------------ ------------ (Unaudited) Assets Current assets: Cash and cash equivalents $ 301 $ 686 Accounts receivable, net 866 623 Prepaid expenses and other current assets 166 232 ------------ ------------ Total current assets 1,333 1,541 Property and equipment, net 189 191 Prepaid advertising rights 3,926 3,970 Goodwill, net 200 200 Other assets 170 167 ------------ ------------ Total assets $ 5,818 $ 6,069 ============ ============ Liabilities and stockholders' equity Current liabilities: Accounts payable and accrued liabilities $ 633 $ 788 Deferred revenue 947 1,047 ------------ ------------ Total current liabilities 1,580 1,835 Long-term liabilities Other long-term liabilities 134 82 ------------ ------------ Total liabilities 1,714 1,917 ------------ ------------ Stockholders' equity: Preferred stock, $0.001 par value, 5,000,000 shares authorized, 8,386 shares issued and outstanding at June 30, 2005 and March 31, 2005 (liquidation value of $20,881 at June 30, 2005) - - Common stock, $0.001 par value, 600,000,000 shares authorized, 15,346,609 shares issued and outstanding at June 30, 2005 and 14,970,622 shares issued and outstanding at March 31, 2005 15 15 Additional paid-in-capital 95,531 95,430 Unearned compensation (33) Accumulated deficit (91,409) (91,293) ------------ ------------ Total stockholders' equity 4,104 4,152 ------------ ------------ Total liabilities and stockholders' equity $ 5,818 $ 6,069 ============ ============
The accompanying notes are an integral part of these condensed consolidated unaudited financial statements 3 SALON MEDIA GROUP, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data) (Unaudited)
Three Months Ended June 30, ------------------------ 2005 2004 ---------- ---------- Net revenues $ 1,630 $ 1,733 ---------- ---------- Operating expenses: Production and content 1,053 1,200 Sales and marketing 317 468 Research and development 184 135 General and administrative 211 228 ---------- ---------- Total operating expenses 1,765 2,031 ---------- ---------- Loss from operations (135) (298) Other income (expense), net 19 (273) ---------- ---------- Net loss (116) (571) Preferred deemed dividend - (593) ---------- ---------- Net loss attributable to common stockholders $ (116) $ (1,164) ========== ========== Basic and diluted net loss per share attributable to common stockholders $ (0.01) $ (0.08) Weighted average shares used in computing basic and diluted net loss per share 15,132 14,155
The accompanying notes are an integral part of these condensed consolidated unaudited financial statements 4 SALON MEDIA GROUP, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) (Unaudited)
Three Months Ended June 30, -------------------------- 2005 2004 ----------- ----------- Cash flows from operating activities: Net loss $ (116) $ (571) Adjustments to reconcile net loss to net cash used in operating activities: Warrant re-valuation - 490 Depreciation and amortization 21 94 Stock compensation expense 48 - Amortization of prepaid advertising rights 44 150 Changes in assets and liabilities: Accounts receivable (243) (515) Prepaid expenses, other current assets and other assets 63 42 Accounts payable, accrued liabilities and other long-term liabilities (103) (28) Deferred revenue (100) (12) ----------- ----------- Net cash used in operating activities (386) (350) ----------- ----------- Cash flows from investing activities: Purchase of property and equipment (19) (64) ----------- ----------- Net cash used by investing activities (19) (64) ----------- ----------- Cash flows from financing activities: Proceeds from issuance of common stock 20 - Proceeds from issuance of preferred stock, net - 491 Principal payments under capital lease obligations - (8) ----------- ----------- Net cash provided by financing activities 20 483 ----------- ----------- Net increase (decrease) in cash and cash equivalents (385) 69 Cash and cash equivalents at beginning of period 686 696 ----------- ----------- Cash and cash equivalents at end of period $ 301 $ 765 =========== =========== Supplemental schedule of non-cash investing and financing activities: Preferred deemed dividend in connection with preferred stock financing $ - $ 593
The accompanying notes are an integral part of these condensed consolidated unaudited financial statements 5 SALON MEDIA GROUP, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) (unaudited) 1. The Company Salon Media Group, Inc ("Salon") is an Internet media company that produces a content Website with eight primary subject-specific sections and two online communities. One of the sections provides audio streaming. Salon was originally incorporated in July 1995 in the State of California and reincorporated in Delaware in June 1999. Salon operates in one business segment. 2. Basis of Presentation These interim condensed consolidated financial statements are unaudited and have been prepared on the same basis as the annual financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments necessary to present fairly Salon's consolidated financial position, consolidated results of operations and consolidated cash flows for the periods presented. The condensed consolidated balance sheet data as of March 31, 2005 is derived from and should be read in conjunction with the audited financial statements, which are included in Salon's Annual Report on Form 10-K filed with the Securities and Exchange Commission, as amended. Pursuant to the rules of the Securities and Exchange Commission, these financial statements do not include all disclosures required by generally accepted accounting principles. The results for the three months ended June 30, 2005 are not necessarily indicative of the expected results for any other interim period or for the fiscal year ending March 31, 2006. These condensed consolidated financial statements contemplate the realization of assets and the satisfaction of liabilities in the normal course of business. Salon has incurred annual losses and negative cash flows from operations since inception and has an accumulated deficit at June 30, 2005 of $91,409. These factors raise substantial doubt about Salon's ability to continue as a going concern. Salon's independent accountants for the years ended March 31, 2003, 2004 and 2005 have included a paragraph in their reports indicating substantial doubt as to Salon's ability to continue as a going concern due to recurring operating losses and negative cash flows. Due to the recurring losses, Salon has reduced expenses that have resulted in the net cash used in operating activities decreasing from $5.0 million for the year ended March 31, 2002 to $2.9 million for the year ended March 31, 2003 and to $2.8 million for the year ended March 31, 2004. During this time period, advertisers were reluctant to place advertisements on Salon's Website due to concerns over Salon's ability to continue as a going concern. However, with the reduction in expenses, investors were willing to invest additional capital in Salon. The resulting infusion of cash from the issuance of convertible and promissory notes and preferred stock resulted in advertisers becoming more willing to place advertisements with Salon. As a consequence, advertising revenues increased from $1.8 million for the year ended March 31, 2004 to $3.6 million for the year ended March 31, 2005 and the net cash used in operations decreased to $0.8 million for the year ended March 31, 2005. Due to the increased willingness of advertisers to place advertisements on Salon's Website, Salon's forecast of a modest increase in advertising revenue to $4.1 million should be achievable. Salon's current forecast of total revenue of $7.0 million for the year ending March 31, 2006 includes $4.1 million of advertising revenue, $2.1 million of Salon Premium revenue and $0.5 million attributable to The Well on-line discussion forum. The current assumption in attaining $2.1 million of 6 SALON MEDIA GROUP, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) (unaudited) Salon Premium revenue assumes that Salon will not continue to experience an accelerated decline in Salon premium memberships that it has recently experienced. The revenue impact of a decline in Salon Premium memberships are mitigated as the revenues from this source are recognized ratably over the period the revenue is earned, generally over a one year period. Salon cannot accurately estimate at this time the future impact on cash flow or revenue recognition of the downward trend in Salon Premium memberships. Salon purchased The Well, an on-line community, in 1999. Even though this line of business has generated positive cash-flow since its acquisition, and is forecast to generate $0.5 million of revenue for the year ending March 31, 2006, Salon is evaluating what role, if any, this business will have in the future. As such, Salon has begun to explore the potential sale of the on-line community. The assets of The Well are predominately $0.2 million of goodwill. If The Well operation is sold, Salon will most likely not attain its forecasted revenue of $7.0 million. The potential sale of The Well is not driven by a need to generate cash to finance Salon's operations. Based on current forecasted advertising revenues and a weakening in Salon Premium memberships, Salon projects that it may experience a cash flow deficit of approximately $0.2 million for the year ending March 31, 2006 after deducting non-cash charges. Salon also forecasts that it will incur periods of limited cash, primarily in late August 2005 and early September 2005, during which total cash resources on hand may be less than $0.2 million. Salon cannot accurately predict the amount of near-term cash that it will have on hand after that point due to the unpredictability in securing advertising campaigns and the attrition being experienced in membership to Salon's subscription services. A major risk factor in attaining the $4.1 million in advertising revenue will be the ability of Salon to generate a sufficient number of advertising impressions from unique Website visitors to satisfy order requirements during the time periods that advertisements are slated to run on Salon's Website. Salon therefore has to increase the number of unique Website visitors who generate page views and resulting advertising impressions in order to lessen this potential limiting factor. Salon has recently finalized an agreement with Yahoo, Inc. in an attempt to increase the number of unique Website visitors to Salon's Website for which Salon will provide its content to Yahoo, Inc. In return, Yahoo, Inc. will include Salon's content in search results from its Yahoo News site, which when "clicked on" will divert a Yahoo Website visitor to a Salon webpage. In addition, Salon will implement a Yahoo search box on its web pages. Salon cannot predict what effect, if any, this agreement will have on Salon's results of operations or in increasing the number of unique visitors to Salon's Website. The "Purchase Agreement" and the "Certificate of Designation of Preferences and Rights of the Series D-1 Preferred Stock, Series D-2 Preferred Stock, Series D-3 Preferred Stock, Series D-4 Preferred Stock and Series D-5 Preferred Stock," collectively, the "Series D preferred stock," allow Salon to sell and issue an additional 1,251 shares of Series D preferred stock, for which Salon could receive approximately $1.5 million in cash. As Salon currently forecasts periods of limited cash and a cash flow deficit of $0.2 million for the year ending March 31, 2006 after deducting non-cash charges, Salon anticipates that it will seek purchasers for some or all of the remaining 1,251 shares of Series D-2 preferred stock. There is no guarantee that Salon will be successful in finding buyers for these securities. 7 SALON MEDIA GROUP, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) (unaudited) 3. Concentrations of Credit Risk No customers accounted for more than 10% of total revenue for the three-month periods ended June 30, 2005 and June 30, 2004. One customer accounted for 11% of the total accounts receivable balance as of June 30, 2005. Two customers accounted for 11% and 10%, respectively, of the total accounts receivable balance as of June 30, 2004. 4. Goodwill Amortization and Intangible Assets The following table sets forth information concerning Salon's goodwill and intangible assets as of June 30, 2005 and March 31, 2005:
Gross Net Carrying Accumulated Carrying Amount Amortization Amount ------------ ------------ ------------ Trade name $ 1,200 $ 1,200 $ - Proprietary technology 355 355 - Audio technology 158 158 - ------------ ------------ ------------ Total intangible assets subject to amortization $ 1,713 $ 1,713 $ - ============ ============ ============ Goodwill $ 3,555 $ 3,355 $ 200 ------------ ------------ ------------ Total intangible assets not subject to amortization $ 3,555 $ 3,355 $ 200 ============ ============ ============
5. Recent Accounting Pronouncements In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 123R (revised 2004), "Share-Based Payment" (SFAS 123R). In annual periods beginning after June 15, 2005, as amended by the Securities and Exchange Commission (SEC), SFAS 123R would eliminate the ability to account for equity-based compensation using the intrinsic value-based method under Accounting Principles Board (APB)25. SFAS 123R requires companies to calculate equity-based compensation expense for stock compensation awards based on the fair value of the equity instrument at the time of grant. Salon currently uses, and will upon adoption of SFAS 123R, utilize the Black-Scholes option pricing model to determine the value of its stock compensation awards, but may later determine that an alternative model may be more appropriate. Under SFAS 123R, public companies are allowed to select from three alternative transition methods: the Modified Prospective Application, which allows for the adoption of SFAS 123R without restatement of prior interim periods in the year of adoption; and the Modified Retrospective Application which allows companies to restate prior financial statements. Salon expects to adopt SFAS 123R beginning in the first quarter of fiscal year 2007, as required, using the Modified Prospective method, and will not restate prior periods for the adoption of SFAS 123R. Currently, Salon discloses pro forma net income (loss) and related pro forma net income (loss) per share in accordance with SFAS 123 "Accounting for Stock-Based Compensation" and SFAS 148 "Accounting for Stock-Based Compensation-Transition and Disclosure-An Amendment of FASB 8 SALON MEDIA GROUP, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) (unaudited) Statement No. 123". Under SFAS 123R, equity-based compensation expense is required to be recognized in companies' financial statements. The amounts disclosed within the footnotes are not necessarily indicative of the amounts that will be expensed upon the adoption of SFAS No. 123R. Compensation expense calculated under SFAS No. 123R may differ materially from amounts currently disclosed within the footnotes, as a result of changes in the fair value of our common stock, the term in which the options vest, changes in the number of options granted, the treatment of tax benefits that may result, and changes in interest rates or other factors. 6. Net Loss Per Share Basic loss per share is computed using the weighted average number of shares of common stock outstanding during the period. Diluted loss per share is computed using the weighted average number of common and common stock equivalents outstanding during the period, as follows:
Three Months Ended June 30, ------------------------------ 2005 2004 ------------- ------------- Numerator: Net loss attributable to common stockholders $ (116) $ (1,164) ============= ============= Denominator: Weighted average shares used in computing basic and diluted net loss per share 15,132,000 14,155,000 ============= ============= Basic and diluted net loss per share attributable to common stockholders $ (0.01) $ (0.08) ============= ============= Antidilutive securities including options, warrants and convertible preferred stock not included in net loss attributable to common stockholders per share calculation 238,572,838 205,229,651
In May 2005, Salon issued options to purchase 196,500 shares of common stock to two consultants. The options were granted at $0.26 per share, which was the closing price of Salon's common stock on the date of grant. Of the options granted, 50% of the shares subject to options vested on the date of grant and 50% of the shares subject to the options vest on February 7, 2006, as long as the named individuals continue to provide services as a consultant. The estimated grant date present value of $80 was calculated using the Black-Scholes option-pricing model with the following material assumptions: (i) a risk-free rate of 3.8%, (ii) expected volatility of 120%, (iii) expected life of 4 years, and (iv) no dividend. Of the $80 value, $48 was charged to operations and is included in the reported net loss of $116 for the three month period ended June 30, 2005. 9 SALON MEDIA GROUP, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) (unaudited) If Salon's compensation expense under its stock option plan had been determined pursuant to SFAS No. 123R, Salon's net loss per share would have been as follows:
Three Months Ended June 30, ------------------------ 2005 2004 ---------- ---------- Net loss attributable to common stockholders: As reported $ (116) $ (1,164) Add back: stock-based employee compensation expense included in reported net loss - - Deduct: total stock-based compensation expense determined under the fair value based method, net of related tax (1,159) (16) ---------- ---------- Pro forma net loss attributable to common stockholders $ (1,275) $ (1,180) ========== ========== Basic and diluted net loss per share attributable to common stockholders: As reported $ (0.01) $ (0.08) Pro forma net loss per share $ (0.08) $ (0.08)
7 Warrant Valuation Up until November 22, 2004, Salon had an inadequate number of authorized common shares to satisfy all convertible preferred shares, warrant agreements and option grants, which required Salon to record as an additional liability the value any new warrants issued, and to re-measure the value of all warrants issued at each balance sheet period, with such change recorded in Salon's results of operations. At Salon's Annual Meeting of Stockholders held on November 17, 2004, the stockholders approved an amendment to the certificate of incorporation to increase the number of authorized common shares from 50,000,000 to 600,000,000, with such certificate being filed by the Delaware Secretary of State on November 22, 2004. As of that day, Salon was relieved of the requirement to record the value of warrants as a long-term liability and corresponding charges or benefits to its results of operations. 10 SALON MEDIA GROUP, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) (unaudited) The June 30, 2004 re-measurement of value of all warrants then outstanding resulted in a non-cash charge to operations of $888 recapped as follows:
Three Months Ended ------------------ Purpose of issuance of warrants: Operating results affected June 30, 2004 ------------------ Editorial collaboration Production and content $ (72) Employee severance agreement General and administrative (35) Issuance of convertible notes Other income (expense), net (383) Issuance of preferred stock Preferred deemed dividend (398) ------------------ $ (888) ==================
11 Item 2. Management's Discussion and Analysis of Financial Conditions and Results of Operations This section and other parts of this Form 10-Q contain "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended (Exchange Act) that involve risks and uncertainties, including, but not limited to, statements regarding our strategy, plans, objectives, expectations, intentions, financial performance, cash-flow breakeven timing, financing, economic conditions, on-line advertising, market performance, subscription service plans, and revenue sources. Although Salon Media Group, Inc. (Salon) believes its plans, intentions and expectations reflected in such forward-looking statements are reasonable, Salon gives no assurance those plans, intentions or expectations will be achieved. Our actual results may differ significantly from those anticipated or implied in these forward-looking statements as a result of the factors set forth above and in Salon's public filings. Salon assumes no obligation to update any forward-looking statements as circumstances change. Salon's actual results may differ significantly from those anticipated or implied in these forward-looking statements as a result of the factors set forth below and in "Management's Discussion and Analysis of Financial Conditions and Results of Operations" and "Factors That May Affect Our Future Results and Market Price of Stock." In this report, the words "anticipates," "believes," "expects," "estimates," "forecast," "future," and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. Overview Salon is an Internet media company. The main entry and navigation point to Salon's eight primary subject-specific sections is Salon's home page at www.salon.com. The Website provides original investigative stories and provocative personal essays along with quick-take commentary and staff-written Weblogs about politics, technology, culture and entertainment. Committed to interactivity, the Website also hosts two online communities, Table Talk and The Well, a user blogging program, a daily music download column Audiofile, and the Daou Report, an opinionated guide to the blogosphere. Salon believes that its original, award-winning content allows it to attract and retain users who are more affluent, better educated and more likely to make online purchases than typical Internet users. Salon believes its user profile makes its Website a valuable media property for advertisers and retailers who are allocating marketing resources to target consumers online. This section and other parts of this Form 10-Q should be considered in conjunction with the audited financial statements, which are included in Salon's Annual Report on Form 10-K, as amended, filed with the Securities and Exchange Commission. Matters of interest therein include, but are not limited to, Salon's disclosure of critical accounting policies. Results of Operations for the Three Months Ended June 30, 2005 Compared To the Three Months Ended June 30, 2004 Net revenues: Net revenues decreased 6% to $1.6 million for the three months ended June 30, 2005 from $1.7 million for the three months ended June 30, 2004. Advertising revenues decreased to $0.9 million for the three months ended June 30, 2005 from $1.0 million for the three months ended June 30, 2004. The $0.1 million decrease reflects the adverse 12 effect of the medical leave of absence of Salon's Senior Vice President effective June 1, 2005. Subsequent to June 30, 2005, Salon promoted a staff member to a sales position and a second individual accepted a similar sales position. Included in the results for the three months ended June 30, 2005 is $13,000 of barter revenue. Salon does not anticipate incurring barter revenue next quarter. Salon estimates that advertising revenues for the three months ended September 30, 2005 will be approximately $0.7 - $0.9 million. Salon Premium subscription revenues for the three months ended June 30, 2005 and June 30, 2004 were constant at $0.5 million. Total paid subscriptions dropped from approximately 20,900 for the three months ended June 30, 2004 to approximately 15,300 for the three months ended June 30, 2005. The downward trend in subscriptions resulted in the total number of active subscribers declining from approximately 84,500 as of March 31, 2005, to approximately 80,600 as of June 30, 2005 and to approximately 78,900 as of this filing. Even though the renewal rate for one year paid subscriptions stayed constant at 69% as of June 30, 2004 and March 31, 2005, the rate declined to approximately 66% as of June 30, 2005, reflecting the recent decline of subscribers. Salon cannot predict if these trends will continue. Salon estimates that it will recognize $0.5 million of Salon Premium revenue for the three months ended September 30, 2005. Revenues from all other sources were $0.2 million for the three months ended June 30, 2005 and June 30, 2004. Salon does not anticipate material changes to this amount for the three months ended September 30, 2005. Production and content: Production and content expenses during the three months ended June 30, 2005 were $1.1 million compared to $1.2 million for the three months ended June 30, 2004, a decline of $0.1 million or 12%. The decline between periods reflects reduced ad serving charges and the absence of warrant related charges this year as compared to last year. The current quarter results include nominal charges for the value of stock options that were granted to consultants. Salon does not anticipate material changes to production and content expenditures in the near future. Sales and marketing: Sales and marketing expenses during the three months ended June 30, 2005 were $0.3 million compared to $0.5 million for the three months ended June 30, 2004, a decline of $0.2 million or 32%. The decline between periods reflects utilizing $0.1 million fewer adverting credits this quarter compared to last year and $0.1 million from reduced payroll related costs. The current period results include $13,000 of barter related expenses. Salon does not anticipate incurring barter related expenses in future period results and does not expect material changes to sales and marketing expenditures in the near future. Research and development: Research and development expenses during the three months ended June 30, 2005 of $184,000 were comparable to the $135,000 incurred for the three months ended June 30, 2004. The nominal change between periods reflects the addition of an additional staff member between periods and expenses to re-design Salon's Website. Salon does not anticipate material future changes in research and development expenditures. 13 General and administrative: General and administrative expenses for the three months ended June 30, 2005 and June 30, 2004 were $0.2 million. Salon does not anticipate material future changes in general and administrative expenditures. Other income (expense), net: The results for the three months ended June 30, 2004 include a non-cash charge of $0.4 million due to a change in value of warrants issued to former convertible note holders, offset by $0.1 million of realized income, derived from grant monies received by Salon to finance editorial content, for which Salon's obligation was met during the period. No comparable amounts were incurred during the three months ended June 30, 2005. Preferred deemed dividend: On June 4, 2004 Salon issued 417 shares of Series D-1 preferred stock and received net proceeds of approximately $0.5 million. The transaction resulted in a $0.2 million non-cash charge ensuing from the difference between the offering price of Salon's Series D-1 preferred stock and the fair value of Salon's common stock into which the preferred stock is convertible on the date of the transaction and the warrants issued. The results for the three months ended June 30, 2004 also includes a non-cash charge of $0.4 million resulting from revaluing warrants issued to preferred stockholders. The change in value charge was precipitated by Salon not having at that time an adequate number of authorized common shares to satisfy all convertible preferred shares, warrant agreements and option grants, which therefore required Salon to re-measure the value of warrants issued at each balance sheet period, with the difference being charged to operating results. The charge for the three months ended June 30, 2004 was primarily driven by an increase in Salon's per share market price of $0.14 per share on March 31, 2004 to $0.18 per share on June 30, 2004. Net loss attributable to common stockholders: As a result of the above factors, Salon recorded a net loss attributable to common stockholders of $0.1 million, or ($0.01) per share for the three months ended June 30, 2005 compared to a net loss attributable to common stockholders of $1.2 million, or ($0.08) per share for the three months ended June 30, 2004. Liquidity and capital resources: As of June 30, 2005, Salon had approximately $0.3 million in available cash. Net cash used in operations was $0.4 million for the three months ended June 30, 2005 and June 30, 2004. The principal use of cash during the three months ended June 30, 2005 was to fund the $0.1 million net loss for the period and the $0.2 million increase in accounts receivable, offset by $0.1 million of non-cash charges. The principal use of cash during the three months ended June 30, 2004 was to fund the $0.6 million net loss for the period and the $0.5 million increase in accounts receivable, offset by $0.7 million of non-cash charges. 14 Net cash used in investing activities was an immaterial amount during the three months ended June 30, 2005 and $0.1 million for the three months ended June 30, 2004 to acquire computer related equipment. Net cash from financing activities provided an immaterial amount for the three months ended June 30, 2005 and $0.5 million for the three months ended June 30, 2004. For the three months ended June 30, 2004, Salon received $0.5 million from the issuance of Series D-1 preferred stock, practically all of which was from related parties. Salon's independent accountants for the years ended March 31, 2003, 2004 and 2005 have included a paragraph in their reports indicating substantial doubt as to Salon's ability to continue as a going concern due to recurring operating losses and negative cash flows. Due to the recurring losses, Salon has reduced expenses that have resulted in the net cash used in operating activities decreasing from $5.0 million for the year ended March 31, 2002 to $2.9 million for the year ended March 31, 2003 and to $2.8 million for the year ended March 31, 2004. During this time period, advertisers were reluctant to place advertisements on Salon's Website due to concerns over Salon's ability to continue as a going concern. However, with the reduction in expenses, investors were willing to invest additional capital in Salon. The resulting infusion of cash from the issuance of convertible and promissory notes and preferred stock resulted in advertisers becoming more willing to place advertisements with Salon. As a consequence, advertising revenues increased from $1.8 million for the year ended March 31, 2004 to $3.6 million for the year ended March 31, 2005 and the net cash used in operations decreased to $0.8 million for the year ended March 31, 2005. Due to the increased willingness of advertisers to place advertisements on Salon's Website, Salon's forecast of a modest increase in advertising revenue to $4.1 million should be achievable. Salon's current forecast of total revenue of $7.0 million for the year ending March 31, 2006 includes $4.1 million of advertising revenue, $2.1 million of Salon Premium revenue and $0.5 million attributable to The Well on-line discussion forum. The current assumption in attaining $2.1 million of Salon Premium revenue assumes that Salon will not continue to experience an accelerated decline in Salon premium memberships that it has recently experienced. The revenue impact of a decline in Salon Premium memberships are mitigated as the revenues from this source are recognized ratably over the period the revenue is earned, generally over a one year period. Salon cannot accurately estimate at this time the future impact on cash flow or revenue recognition of the downward trend in Salon Premium memberships. Salon purchased The Well, an on-line community, in 1999. Even though this line of business has generated positive cash-flow since its acquisition, and is forecast to generate $0.5 million of revenue for the year ending March 31, 2006, Salon is evaluating what role, if any, this business will have in the future. As such, Salon has begun to explore the potential sale of the on-line community. The assets of The Well are predominately $0.2 million of goodwill. If The Well operation is sold, Salon will most likely not attain its forecasted revenue of $7.0 million. The potential sale of The Well is not driven by a need to generate cash to finance Salon's operations. Based on current forecasted advertising revenues and a weakening in Salon Premium memberships, Salon projects that it may experience a cash flow deficit of approximately $0.2 million for the year ending March 31, 2006 after deducting non-cash charges. Salon also forecasts that it will incur periods of limited cash, primarily in late August 2005 and early September 2005, during which total cash resources on hand may be less than $0.2 million. Salon cannot accurately predict the amount of near-term cash that it will have on hand after that point due to the unpredictability in securing advertising campaigns and the attrition being experienced in membership to Salon's subscription services. 15 A major risk factor in attaining the $4.1 million in advertising revenue will be the ability of Salon to generate a sufficient number of advertising impressions from unique Website visitors to satisfy order requirements during the time periods that advertisements are slated to run on Salon's Website. Salon therefore has to increase the number of unique Website visitors who generate page views and resulting advertising impressions in order to lessen this potential limiting factor. Salon has recently finalized an agreement with Yahoo, Inc. in an attempt to increase the number of unique Website visitors to Salon's Website for which Salon will provide its content to Yahoo, Inc. In return, Yahoo, Inc. will include Salon's content in search results from its Yahoo News site, which when "clicked on" will divert a Yahoo Website visitor to a Salon webpage. In addition, Salon will implement a Yahoo search box on its web pages. Salon cannot predict what effect, if any, this agreement will have on Salon's results of operations or in increasing the number of unique visitors to Salon's Website. The "Purchase Agreement" and the "Certificate of Designation of Preferences and Rights of the Series D-1 Preferred Stock, Series D-2 Preferred Stock, Series D-3 Preferred Stock, Series D-4 Preferred Stock and Series D-5 Preferred Stock," collectively, the "Series D preferred stock," allow Salon to sell and issue an additional 1,251 shares of Series D preferred stock, for which Salon could receive approximately $1.5 million in cash. As Salon currently forecasts periods of limited cash and a cash flow deficit of $0.2 million for the year ending March 31, 2006 after deducting non-cash charges, Salon anticipates that it will seek purchasers for some or all of the remaining 1,251 shares of Series D-2 preferred stock. There is no guarantee that Salon will be successful in finding buyers for these securities. Recent Accounting Pronouncements In December 2004, the Financial Accounting Standards Board (FASB) issued Standard Financial Accounting Standard (SFAS) No. 123R (revised 2004), "Share-Based Payment" (SFAS 123R). In annual periods beginning after June 15, 2005, as amended by the Securities and Exchange Commission (SEC), SFAS 123R would eliminate the ability to account for equity-based compensation using the intrinsic value-based method under Accounting Principles Board (APB) Opinion No. 25. SFAS 123R requires companies' to calculate equity-based compensation expense for stock compensation awards based on the fair value of the equity instrument at the time of grant. Salon currently uses, and will upon adoption of SFAS 123R, utilize the Black-Scholes option pricing model to determine the value of its stock compensation awards, but may later determine that an alternative model may be more appropriate. Under SFAS 123R, public companies are allowed to select from three alternative transition methods: the Modified Prospective Application, which allows for the adoption of SFAS 123R without restatement of prior interim periods in the year of adoption and the Modified Retrospective Application which allows companies to restate prior financial statements. Salon expects to adopt SFAS 123R beginning in the first quarter of fiscal year 2007, as required, using the Modified Prospective method, and will not restate prior periods for the adoption of SFAS 123R. Currently, Salon discloses pro forma net income (loss) and related pro forma net income (loss) per share in accordance with SFAS 123 and SFAS 148 "Accounting for Stock-Based Compensation-Transition and Disclosure - An Amendment of FASB Statement No. 123". Under SFAS 123R, equity-based compensation expense is required to be recognized in companies' financial statements. The amounts disclosed within the footnotes are not necessarily indicative of the amounts that will be expensed upon the adoption of SFAS123R. Compensation expense calculated under SFAS No. 123R may differ materially from amounts currently disclosed within the footnotes, as a result of changes in the fair value of our common stock, the term in which the options vest, changes in the number of options granted, the treatment of tax benefits that may result, and changes in interest rates or other factors. 16 RISK FACTORS Factors That May Affect Salon's Future Results and Market Price of Stock Salon's projected cash flows may not meet expectations Salon relies on projections of cash to be generated from operations to run its operations. The most significant component of its cash projections is cash to be generated from advertising sales, and to a lesser extent, cash projected to be generated from subscription services. Forecasting cash receipts from advertising sales for an extended period of time is problematic due to the short duration of most advertising sales. If projected amounts of cash do not meet expectations, Salon's ability to continue as a going concern may be adversely affected. If Salon forecasts that it will experience periods of limited, or diminishing cash resources, Salon may need to issue additional securities. There is no guarantee that Salon will be able to issue additional securities in future periods to meet cash needs, and if it is unable to raise additional cash, Salon's ability to continue as a going concern may be adverse affected. Salon may issue additional preferred stock at effective prices lower than current common stock market prices that may result in non-cash charges to operations The certificate of designation and preferences and rights of the Series D preferred stock stipulates that the Series D conversion price will be equal to 70% of the average closing sales price of Salon's common stock for the thirty days prior to the date the issue of Series D preferred stock is called by Salon. Such a discount may trigger a non-cash preferred deemed dividend charge. Salon cannot predict to what extent it may incur preferred deemed dividend charges for subsequent issuances of Series D preferred stock, if any. Salon has relied on related parties for significant investment capital Salon has been relying on cash infusions from related parties to fund operations. The related parties are primarily John Warnock, a Director of Salon, and William Hambrecht. William Hambrecht is the father of Salon's President and Chief Executive Officer. Curtailment of cash investments by related parties could detrimentally impact Salon's cash availability and its ability to fund its operations. Salon's principal stockholders can exercise a controlling influence over Salon's business affairs and they may make business decisions with which non-principal stockholders disagree that may affect the value of their investment The holders of Salon's Series A, B, C and D preferred stock collectively own approximately 95% of all voting securities as of June 30, 2005. These stockholders therefore own a controlling interest in Salon. Of this amount, approximately 69% is held by related parties, including former directors, of which approximately 21% is controlled directly or indirectly by William Hambrecht and approximately 41% by Director John Warnock. Therefore, related parties by themselves own a controlling interest in Salon. If these stockholders were to act together, they would be able to exercise control over all matters requiring approval by other stockholders, including the election of directors and approval of significant corporate transactions. This concentration of ownership could also have the effect of delaying or preventing a change in control of Salon, which could cause Salon's stock price to decline. 17 Salon's preferred stockholders are entitled to potentially significant liquidation preferences of Salon's assets over common stockholders in the event of such an occurrence Salon's Series A, B, C and D preferred stockholders have liquidation preferences to common stockholders of the first approximately $20.9 million in potential sales proceeds as of June 30, 2005, which includes the effect of undeclared dividends of $1.8 million. If a liquidation event were to occur, and preferred stock dividends were declared, the holders of preferred stock would be entitled to the first $20.9 million of cash distributions, while the holders of common stock would receive none of this amount. If a liquidation event were to occur in excess of $20.9 million and if preferred stock dividends were to be declared, the holders of preferred stock would be entitled to receive a relatively large distribution than the holders of common stock would be entitled to receive. Salon has historically lacked significant revenues and has a history of losses Salon has a history of significant losses and expects to incur a loss from operations for its fiscal year ending March 31, 2006 and potentially in future years. Once Salon attains profitability, it may not be able to sustain or increase profitability on a quarterly or annual basis in the future. If revenues grow slower than Salon anticipates or operating expenses exceed expectations, financial results will most likely be severely harmed and the ability of Salon to continue its operations will be seriously jeopardized. Burr, Pilger & Mayer LLP, Salon's independent registered public accounting firm for the years ended March 31, 2004 and March 31, 2005, included a "going-concern" audit opinion on the consolidated financial statements for those years. The audit opinions report substantial doubt about Salon's ability to continue as a going concern, citing issues such as the history of losses and absence of current profitability. As a result of the "going-concern" opinions, Salon's stock price and investment prospects have been and will continue to be adversely affected, thus limiting financing choices and raising concerns about the realization of value on assets and operations. Salon's operations require attractive content, subscriber interest, and confidence by subscribers and suppliers that the subscription offering warrants their long-term support and investment. The absence of any of these factors could impair the results, revenue and cash flow from subscriptions. Salon is under severe budgetary constraints to limit expenditures. These constraints affect editorial staffing levels and the purchase of content from freelance writers. These constraints affect the amount and quality of content published on Salon's Website and consequently, the positive experience of Website visitors. The positive experience leads to recurring Website visits, new subscriptions to Salon Premium, and corresponding high renewal rates of Salon Premium subscribers. As of June 30, 2005 Salon's renewal rate for one-year paid subscription to Salon Premium was approximately 66%. Salon cannot predict if this rate will continue in the future or how many new Salon Premium subscriptions it will acquire. Salon has depended on advertising sales for much of its revenues, and its inability to maintain or increase advertising revenues will harm its business Maintaining or increasing Salon's advertising revenues depends upon many factors, including whether it will be able to: o successfully sell and market its Website Site Pass advertisements; 18 o entice non Salon Premium Website visitors to view and advertisers to sell new ad units and formats; o maintain a significant number of unique Website visitors and corresponding significant reach of Internet users; o maintain a significant number of sellable impressions generated from Website visitors available to advertisers; o successfully sell and market its network to advertisers; o increase the amount of the advertising order it receives; o increase awareness of the Salon brand; o improve the technology for serving advertising on our Website; o handle temporary high volume traffic spikes to its Website; o accurately measure the number and demographic characteristics of its users; and o attract and retain key sales personnel. Legislative Action and Potential New Accounting Pronouncements are likely to cause our general and administrative expenses and other operating expenses to increase In order to comply with the newly adopted Sarbanes-Oxley Act of 2002 and proposed accounting changes by the Securities and Exchange Commission, Salon may be required to hire additional personnel and utilize additional outside legal, accounting and advisory services, all of which will cause our general and administrative costs to increase. Recently adopted changes in the accounting rules for employee stock options as a compensation expense, among other accounting rule, could materially increase the expenses that we report under generally accepted accounting principles and adversely affect our operating results. Complying with the Data Security Standard known as the Payment Card Industry Data Security Standard is likely to cause our general and administrative expenses and other operating expenses to increase and potential financial harm to Salon for non-compliance in the event of a breach in credit card data security Salon, as a merchant who conducts business with credit card data, must comply with the Payment Card Industry (PCI) Data Security Standard as promulgated by all major issuers of credit cards. The deadline for compliance of June 30, 2005 was not met by Salon, which could cause severe harm to Salon if a breach in credit card data were to occur before Salon attains compliance. Salon's credit card processor for its Salon Premium services has requested for it to comply by September 30, 2005. At this time, Salon is seeking an extension to this deadline, which it may not be able to do so. Not attaining an extension may adversely affect our cash position and results of operations. Salon is taking steps to comply with the PCI Data Security Standard and to minimize its exposure to unauthorized access to credit card data. Complying with the directive could materially increase the expenses that we report under generally accepted accounting principles and adversely affect our operating results. 19 Hackers may attempt to penetrate Salon's security system; online security breaches could harm its business Consumer and supplier confidence in Salon's Website depends on maintaining relevant security features. Security breaches also could damage our reputation and expose us to a risk of loss or litigation. Experienced programmers or "hackers" have successfully penetrated sectors of our systems and Salon expects that these attempts will continue to occur from time to time. Because a hacker who is able to penetrate network security could misappropriate proprietary information or cause interruptions in its products and services, Salon may have to expend significant capital and resources to protect against or to alleviate problems caused by these hackers. Additionally, Salon may not have a timely remedy against a hacker who is able to penetrate its network security. Such security breaches could materially affect Salon. In addition, the transmission of computer viruses resulting from hackers or otherwise could expose us to significant liability. Salon's insurance policies may not be adequate to reimburse us for losses caused by security breaches. Salon also faces risks associated with security breaches affecting third parties with whom it has relationships. The length of Salon's sales cycle is uncertain and variable and may lead to shortfalls in revenues and fluctuations in its operating results Salon's dependence on advertising subjects it to the risk of revenue shortfalls because the sales cycles for advertising vary significantly, and during these cycles Salon may expend substantial funds and management resources while not obtaining advertising revenues. If sales are delayed or do not occur, Salon's financial results for a particular period may be harmed. The time between the date of initial contact with a potential customer and the signing of an advertising order may range from as little as one week to up to several months. Sales of advertising are subject to factors, over which Salon has little or no control, including: o advertisers' budgets; o the acceptability of the Website Site Pass and other forms of rich media advertisements; o internal acceptance reviews by advertisers and their agencies; o the possibility of cancellation or delay of projects by advertisers. Salon's stock has been and will likely continue to be subject to substantial price and volume fluctuations due to a number of factors, many of which will be beyond our control, that may prevent our stockholders from reselling our common stock at a profit The securities markets have experienced significant price and volume fluctuations. This market volatility, as well as general economic, market or political conditions have, and may continue to reduce the market price of our common stock, regardless of our operating performance. In addition, Salon's operating results could be below the expectations of public market analysts and investors, and in response, the market price of our common stock could decrease significantly. With a volatile share price, Salon may be the targets of securities litigation, which is costly and time-consuming to defend In the past, following periods of market volatility in the price of a company's securities, security holders have instituted class action litigation. Our share price has, in the past, experienced price volatility, 20 and may continue to do so in the future. Many companies have been subject to this type of litigation. If the market value of our common stock experiences adverse fluctuations and we become involved in this type of litigation, regardless of the merits or outcome, we could incur substantial legal costs and our management's attention could be diverted, causing our business, financial condition and operating results to suffer. To date, Salon has not been subject to such litigation. Salon's quarterly operating results are volatile and may adversely affect its common stock price Salon's future revenues and operating results are likely to vary significantly from quarter to quarter due to a number of factors, many of which are outside Salon's control, and any of which could severely harm Salon's business. These factors include: o Salon's ability to attract and retain advertisers and subscribers; o Salon's ability to attract and retain a large number of users; o the introduction of new Websites, services or products by Salon or by its competitors; o the timing and uncertainty of Salon's advertising sales cycles; o the mix of advertisements sold by Salon or its competitors; o the economic and business cycle and the recovery speed; o the level of Internet usage; o Salon's ability to attract, integrate and retain qualified personnel; o technical difficulties or system downtime affecting the Internet generally or the operation of Salon's Website; and o the amount and timing of operating costs. Due to the factors noted above and the other risks discussed in this section, one should not rely on quarter-to-quarter comparisons of Salon's results of operations as an indication of future performance. It is possible that in some future periods results of operations may be below the expectations of public market analysts and investors. If this occurs, the price of its common stock may decline. The controversial content of Salon's Website may limit its revenues Salon's Website contains, and will continue to contain, content that is politically and culturally controversial. As a result of this content, current and potential advertisers, potential Salon Premium subscribers, or third parties who contemplate aggregating content, may refuse to do business with Salon. Salon's outspoken stance on political issues has and may continue to result in negative reactions from some users, commentators and other media outlets. From time to time, certain advocacy groups have successfully targeted Salon's advertisers in an attempt to persuade such advertisers to cease doing business with Salon. These efforts may be a material impediment to Salon's ability to grow and maintain advertising revenue. 21 Salon's promotion of the Salon brand must be successful in order to attract and retain users as well as advertisers and strategic partners The success of the Salon brand depends largely on its ability to provide high quality content and services. If Internet users do not perceive Salon's existing content and services to be of high quality, or if it introduces new content and services or enters into new business ventures that are not favorably perceived by users, it may not be successful in promoting and maintaining our brand. Any change in the focus of its operations creates a risk of diluting our brand, confusing consumers and decreasing the value of our user base to advertisers. If Salon is unable to maintain or grow the Salon brand, its business could be severely harmed. Salon needs to hire, integrate and/or retain qualified personnel because these individuals are important to its growth Salon's success significantly depends on key personnel. In addition, because Salon's users must perceive the content of Salon's Website as having been created by credible and notable sources, Salon's success also depends on the name recognition and reputation of its editorial staff. Due to Salon's history of losses, Salon may experience difficulty in hiring and retaining highly skilled employees with appropriate qualifications. Salon may be unable to retain its current key employees or attract, integrate or retain other qualified employees in the future. If Salon does not succeed in attracting new personnel or retaining and motivating its current personnel, its business could be harmed. Salon may expend significant resources to protect its intellectual property rights or to defend claims of infringement by third parties, and if Salon is not successful it may lose rights to use significant material or be required to pay significant fees Salon's success and ability to compete are significantly dependent on its proprietary content. Salon relies exclusively on copyright law to protect its content. While Salon actively take steps to protect its proprietary rights, these steps may not be adequate to prevent the infringement or misappropriation of its content, which could severely harm its business. Salon also licenses content from various freelance providers and other third-party content providers. While Salon attempts to ensure that this content may be freely licensed to us, other parties may assert claims of infringement against us relating to this content. Salon may need to obtain licenses from others to refine, develop, market and deliver new services. Salon may not be able to obtain any such licenses on commercially reasonable terms or at all or rights granted pursuant to any licenses may not be valid and enforceable. In April 1999 Salon acquired the Internet address www.salon.com. Because www.salon.com is the address of the main home page to its Website and incorporates its company name, it is a vital part of our intellectual property assets. Salon does not have a registered trademark on the address, and therefore it may be difficult for us to prevent a third party from infringing on our intellectual property rights in the address. If Salon fails to adequately protect its rights in the Website address, or if a third party infringes its rights in the address, or otherwise dilutes the value of www.salon.com, its business could be harmed. Salon's technology development efforts may not be successful in improving the functionality of its network, which could result in reduced traffic on its network or a loss of Salon Premium subscribers Salon has developed a proprietary online publishing system and has developed software to manage its Salon Premium subscription service. If these systems do not work as intended, or if Salon is unable to 22 continue to develop these systems to keep up with the rapid evolution of technology for content delivery and subscription management, its Website or subscription management systems may not operate properly, which could harm Salon's business. Additionally, software product design, development and enhancement involve creativity, expense and the use of new development tools and learning processes. Delays in software development processes are common, as are project failures, and either factor could harm Salon's business. Moreover, complex software products like its online publishing and subscription management systems frequently contain undetected errors or shortcomings, and may fail to perform or scale as expected. Although Salon has tested and will continue to test its systems, errors or deficiencies may be found in these systems that may impact its business adversely. Salon relies on software, purchased from an independent supplier, to deliver and report some of its advertising, the failure of which could impair our business Salon uses software, purchased from an independent supplier, to manage and measure the delivery of advertising on its Website. The software is essential to Salon whenever an advertiser does not stipulate ad serving from a third party such as Doubleclick. This type of software may fail to perform as expected. If this software malfunctions, advertisements may not be served correctly on our Website, or if the software does not accurately capture impression information, then Salon's advertising revenues could be reduced, and its business could be harmed. Measurement standards for Internet based advertising may not evolve to the extent necessary to support Internet advertising, thereby creating uncertainty about the viability of Salon's business model It is important to Salon's advertisers that Salon accurately presents the demographics of its user base and the delivery of advertisements on its Website. Salon depends on third parties to provide certain of the advertiser-requested services. If they were unable to provide these services in the future, Salon would need to perform this function itself or obtain them from another provider, if available. This could cause Salon to incur additional costs or lose revenue due to a lower level of service. Companies may choose to not advertise on Salon or may pay less for advertising if they do not perceive our measurements or measurements made by third parties to be reliable. Increasing competition among Internet content providers could reduce Salon's advertising sales or market share, thereby harming its business The market for Internet content is relatively new, rapidly changing and intensely competitive. Salon expects competition for Internet content to continue to increase, and if it cannot compete effectively, its business could be harmed. The number of Websites competing for the attention and spending of users and advertisers may continue to increase with the most trafficked Websites receiving a disproportionate share of advertising dollars. Salon is not one of the most trafficked Websites, or even one of the top fifty Websites. Increased competition could result in advertising price reductions or loss of market share, any of which could harm Salon's business. Competition is likely to increase significantly as new companies enter the market and current competitors expand their services. Many of Salon's present and potential competitors are likely to enjoy substantial competitive advantages over Salon. If Salon does not compete effectively or if it experiences any pricing pressures or loss of market share resulting from increased competition, its business could be harmed. 23 Salon may be held liable for content or third party links on its Website or content distributed to third parties As a publisher and distributor of content over the Internet, including user-generated content on Salon's online communities and links to third party Websites that may be accessible through Salon.com, Salon faces potential liability for defamation, negligence, copyright, patent or trademark infringement and other claims based on the nature, content or ownership of the material that is published on or distributed from its Website. These types of claims have been brought, sometimes successfully, against online services, Websites and print publications in the past. Other claims may be based on errors or false or misleading information provided on linked Websites, including information deemed to constitute professional advice such as legal, medical, financial or investment advice. Other claims may be based on links to sexually explicit Websites. Although Salon carries general liability insurance, its insurance may not be adequate to indemnify Salon for all liabilities imposed. Any liability that is not covered by its insurance or is in excess of its insurance coverage could severely harm its financial condition and business. Implementing measures to reduce its exposure to these forms of liability may require Salon to spend substantial resources and limit the attractiveness of Salon's service to users. Concerns about transactional security may hinder electronic commerce on Salon's Website and may expose Salon to potential liability A significant barrier to sale of subscriptions and electronic commerce is the secure transmission of confidential information over public networks. Any breach in Salon's security could expose it to a risk of loss or litigation and possible liability. Salon relies on encryption and authentication technology licensed from third parties to provide secure transmission of confidential information. As a result of advances in the capabilities of Internet hackers, or other developments, a compromise or breach of the algorithms we use to protect customer transaction data may occur. A compromise of Salon's security could severely harm its business. A party who is able to circumvent our security measures could misappropriate proprietary information, including customer credit card information, or cause interruptions in the operation of its Website. Salon may be required to expend significant capital and other resources to protect against the threat of security breaches or to alleviate problems caused by these breaches. However, protection may not be available at a reasonable price or at all. Concerns over the security of electronic commerce and the privacy of users may also inhibit the growth of the Internet as a means of conducting commercial transactions. Salon's internally developed software and software platforms provided by a third party to manage Salon's subscription business might fail resulting in lost subscription income Salon's software to manage its subscription business was developed internally to interface with the software provided by a third party. The third party's software provides a gateway to authenticate credit card transactions. If these systems were to fail or not function as intended, credit card transactions might not be processed and Salon's cash resources and revenues would therefore be harmed. Salon's systems may fail due to natural disasters, telecommunications failures and other events, any of which would limit user traffic Substantially all of Salon's communications hardware and computer hardware operations for its Website are in facilities in San Francisco, California. Fire, floods, earthquakes, power loss, telecommunications failures, break-ins, supplier failure to meet commitments, and similar events could damage these systems and cause interruptions in its services. Computer viruses, electronic break-ins or 24 other similar disruptive problems could cause users to stop visiting Salon's Website and could cause advertisers to terminate any agreements with Salon. In addition, Salon could lose advertising revenues during these interruptions and user satisfaction could be negatively impacted if the service is slow or unavailable. If any of these circumstances occurred, Salon's business could be harmed. Salon's insurance policies may not adequately compensate it for any losses that may occur due to any failures of or interruptions in our systems. Salon does not presently have a formal disaster recovery plan. Salon's Website must accommodate a high volume of traffic and deliver frequently updated information. It is possible that it will experience systems failures in the future and that such failures could harm its business. In addition, its users depend on Internet service providers, online service providers and other Website operators for access to its Website. Many of these providers and operators have experienced significant outages in the past, and could experience outages, delays and other difficulties due to system failures unrelated to its systems. Any of these system failures could harm its business. Privacy concerns could impair Salon's business Salon has a policy against using personally identifiable information obtained from users of its Website and services without the user's permission. In the past, the Federal Trade Commission has investigated companies that have used personally identifiable information without permission or in violation of a stated privacy policy. If Salon uses this information without permission or in violation of its policy, Salon may face potential liability for invasion of privacy for compiling and providing information to its corporate customers and electronic commerce merchants. In addition, legislative or regulatory requirements may heighten these concerns if businesses must notify Internet users that the data may be used by marketing entities to direct product promotion and advertising to the user. Other countries and political entities, such as the European Union, have adopted such legislation or regulatory requirements. The United States may adopt similar legislation or regulatory requirements. If consumer privacy concerns are not adequately addressed, our business, financial condition and results of operations could be materially harmed. Possible state sales and other taxes could adversely affect Salon's results of operations Salon generally does not collect sales or other taxes from individuals who sign up for Salon subscriptions. During the year ended March 31, 2003, the State of California audited Salon's sales tax returns and found Salon in compliance with its filings and did not object to the fact that it did not collect sales tax on subscriptions. However, one or more other states may seek to impose sales tax collection obligations on out-of-state companies, including Salon, which engage in or facilitate electronic commerce. State and local governments have discussed and made proposals imposing taxes on the sale of goods and services through the Internet. Such proposals, if adopted, could substantially impair the growth of electronic commerce and could reduce Salon's ability to derive revenue from electronic commerce. Moreover, if any state or foreign country were to assert successfully that Salon should collect sales or other taxes on the exchange of merchandise on its network or to tax revenue generated from Salon subscriptions, its financial results could be harmed. Provisions in Delaware law and our charter, stock option agreements and offer letters to executive officers may prevent or delay a change of control Salon is subject to the Delaware anti-takeover laws regulating corporate takeovers. These anti-takeover laws prevent Delaware corporations from engaging in a merger or sale of more than 10% of its assets with any stockholder, including all affiliates and associates of the stockholder, who owns 15% or more of the corporation's outstanding voting stock, for three years following the date that the stockholder acquired 15% or more of the corporation's assets unless: 25 o the board of directors approved the transaction where the stockholder acquired 15% or more of the corporation's assets; o after the transaction where the stockholder acquired 15% or more of the corporation's assets, the stockholder owned at least 85% of the corporation's outstanding voting stock, excluding shares owned by directors, officers and employee stock plans in which employee participants do not have the right to determine confidentially whether shares held under the plan will be tendered in a tender or exchange offer; or o on or after this date, the merger or sale is approved by the board of directors and the holders of at least two-thirds of the outstanding voting stock that is not owned by the stockholder. A Delaware corporation may opt out of the Delaware anti-takeover laws if its certificate of incorporation or bylaws so provide. We have not opted out of the provisions of the anti-takeover laws. As such, these laws could prohibit or delay mergers or other takeover or change of control of Salon and may discourage attempts by other companies to acquire Salon. Salon's certificate of incorporation and bylaws include a number of provisions that may deter or impede hostile takeovers or changes of control or management. These provisions include: o Salon's board is classified into three classes of directors as nearly equal in size as possible with staggered three year-terms; and o special meetings of the stockholders may be called only by the Chairman of the Board, the Chief Executive Officer or the Board of Directors. These provisions may have the effect of delaying or preventing a change of control. Salon's certificate of incorporation and bylaws provide that it will indemnify officers and directors against losses that they may incur in investigations and legal proceedings resulting from their services to Salon, which may include services in connection with takeover defense measures. These provisions may have the effect of preventing changes in Salon's management. In addition, offer letters with executive officers, though none are in effect as of March 31, 2005, may provide for the payment of severance and acceleration of options upon the termination of these executive officers following a change of control of Salon. These provisions in offer letters could have the effect of discouraging potential takeover attempts. Item 3. Qualitative and Quantitative Disclosure About Market Risk Salon maintains all of its cash in immediately available cash deposits at its bank. These funds are not subject to market risk and no interest is paid on such funds. Salon has no debt arrangements that expose Salon to market risk in the event of changes in interest rates. As Salon conducts all of its business in the United States, Salon is not subject to foreign exchange risk. 26 Item 4. Controls and Procedures Evaluation of Our Disclosure Controls and Internal Controls Our management evaluated, with the participation of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. Changes in internal controls over financial reporting There was no change in our internal controls over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting. -------------------------------------------------------------------------------- PART II: OTHER INFORMATION -------------------------------------------------------------------------------- Item 1. Legal Proceedings. Not applicable. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. During the three months ending June 30, 2005, warrants to acquire 125,950 shares of common stock with an exercise price of $0.09 per share were exercised by three investors for which Salon received $11,310 in cash. The funds received will be used for working capital and other general corporate purposes. The investors included John Warnock, a Director of Salon, who received 99,345 shares of common stock and Brian Dougherty, who served as a Director of Salon until April 2003, who received 25,000 shares of common stock. During the three months ending June 30, 2005, warrants for 314,172 shares of common stock were converted to 186,037 shares of common stock by four investors for which Salon did not receive any consideration. The exercise prices per share of the shares converted were $0.11 for 200,000 shares and $0.09 for 114,172 shares. The securities were issued to "accredited investors" as that term is defined in Rule 501(a) under the Securities Act. of 1933 and pursuant to an exemption from the registration requirements of the Securities Act of 1933 set forth in Section 506 of Regulation D. Item 3. Default upon senior securities. Not applicable. 27 Item 4. Submission of Matters to a Vote of Security Holders. Not applicable. Item 5. Other Information. Not applicable. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits. 99.4(1) Press Release dated May 17, 2005. 31.1 Certification of Elizabeth Hambrecht, President and Chief Executive Officer of the Registrant pursuant to Section 302, as adopted pursuant to the Sarbanes-Oxley Act of 2002 31.2 Certification of Conrad Lowry, Chief Financial Officer and Secretary of the Registrant pursuant to Section 302, as adopted pursuant to the Sarbanes-Oxley Act of 2002 32.1 Certification of Elizabeth Hambrecht, President and Chief Executive Officer of the Registrant pursuant to Section 906, as adopted pursuant to the Sarbanes-Oxley Act of 2002 32.2 Certification of Conrad Lowry, Chief Financial Officer and Secretary of the Registrant pursuant to Section 906, as adopted pursuant to the Sarbanes-Oxley Act of 2002 (1) Incorporated by reference to the exhibit filed with the Registrant's Current Report on Form 8-K filed on May 18, 2005. Signatures Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SALON MEDIA GROUP, INC. Dated: 8/15/05 /s/ Elizabeth Hambrecht -------------------------------------- Elizabeth Hambrecht President and Chief Executive Officer Dated: 8/15/05 /s/ Conrad Lowry -------------------------------------- Conrad Lowry Chief Financial Officer and Secretary 28