-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Lkq66leqsnsKBVYFpvIw7ZekB0oC8Nw6P42+SnQJRpdIsLij9JJdjSA3eJaUZjs4 W5UbwbgoxEzoRlj9XI+dDQ== 0001266454-06-000459.txt : 20061031 0001266454-06-000459.hdr.sgml : 20061031 20061031120415 ACCESSION NUMBER: 0001266454-06-000459 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20060331 FILED AS OF DATE: 20061031 DATE AS OF CHANGE: 20061031 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SALON MEDIA GROUP INC CENTRAL INDEX KEY: 0001084332 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-ADVERTISING [7310] IRS NUMBER: 943228750 STATE OF INCORPORATION: DE FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: 1934 Act SEC FILE NUMBER: 000-26395 FILM NUMBER: 061174600 BUSINESS ADDRESS: STREET 1: 101 SPEAR STREET STREET 2: SUITE 203 CITY: SAN FRANCISCO STATE: CA ZIP: 94105 BUSINESS PHONE: 4158828720 MAIL ADDRESS: STREET 1: 101 SPEAR STREET STREET 2: SUITE 203 CITY: SAN FRANCISCO STATE: CA ZIP: 94105 FORMER COMPANY: FORMER CONFORMED NAME: SALON COM DATE OF NAME CHANGE: 20000322 FORMER COMPANY: FORMER CONFORMED NAME: SALON INTERNET INC DATE OF NAME CHANGE: 19990415 10-K/A 1 salon_10ka1-033106.txt SALON MEDIA ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-K/A (Amendment No. 1) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended March 31, 2006 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 of Incorporation) (IRS Employer Identification No.) 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 if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [X] No [ ] Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X] 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 [X] No [ ] 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 amendments to this Form 10-K. [X] Indicate by check mark whether the registrant is an accelerated filer as defined in Rule 12b-2 of the Act. Large Accelerated Filer |_| Accelerated Filer |_| Non-Accelerated Filer |X| The number of outstanding shares of the Registrant's Common Stock, par value $0.001 per share, on June 23, 2006 was 29,988,439 shares. ================================================================================ ================================================================================ FORM 10-K/A The undersigned registrant hereby amends the following items of its Annual Report on Form 10-K for the fiscal year ended March 31, 2006, filed with the Securities and Exchange Commission on June 28, 2006, as follows: 1. Part I, Item 1A. Risk Factors 2. Part II, Item 6. Selected Consolidated Financial Data 3. Part II, Item 7. Management Discussion and Analysis of Financial Condition and Results of Operations 4. Part II, Item 8. Consolidated Financial Statements and Supplementary Data 5. Part II, Item 9A. Controls and Procedures The purpose of the amendment is to correct the accounting for the value of the beneficial conversion feature of the Series C preferred stock issued on February 10, 2004 and the shares of Series D preferred stock issued on December 21, 2005. The values of the beneficial conversion feature were recorded as preferred deemed dividends in the statement of operations. The results of the re-calculations were reductions in charges for preferred deemed dividends from $2,615,000 to $936,000 for the year ended March 31, 2004 and from $1,040,000 to $227,000 for the year ended March 31, 2006. These corrections had the effect of: 1. Reducing the net loss attributable to common stockholders for the year ended March 31, 2006 from $2,162,000 to $1,349,000; 2. Reducing the basic and diluted net loss per share attributable to common stockholders for the year ended March 31, 2006 from ($0.13) to ($0.08); 3. Reducing the net loss attributable to common stockholders for the year ended March 31, 2004 from $8,661,000 to $6,982,000; 4. Reducing the basic and diluted net loss per share attributable to common stockholders for the year ended March 31, 2004 from ($0.61) to ($0.50). With the exception of the foregoing, no other information in the registrants Annual Report on Form 10-K has been supplemented, updated or amended. Pursuant to Rule 12b-5 under the Securities Exchange Act of 1934, as amended, the complete text of each amended item is set forth below. As a result of management's internal review, the registrant has identified material weaknesses in its internal control over financial reporting, including controls over the accounting for issuances of preferred stock. The registrant is actively engaged in the implementation of remediation efforts to address these material weaknesses in internal controls over financial reporting. See Part II, Item 9A, "Controls and Procedures." 2 - -------------------------------------------------------------------------------- FORM 10-K/A SALON MEDIA GROUP, INC. INDEX - -------------------------------------------------------------------------------- Page PART I Number ITEM 1A. Risk Factors................................................... 4 PART II ITEM 6. Selected Consolidated Financial Data........................... 14 ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations...................................... 15 ITEM 8. Consolidated Financial Statements and Supplementary Data....... 26 ITEM 9A. Controls and Procedures........................................ 57 PART IV ITEM 15. Exhibits and Financial Statement Schedules..................... 58 SIGNATURES ............................................................... 58 PART I ITEM 1A. 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 cash projections to run its business. The most significant component of Salon's cash projections is cash to be generated from advertising sales and, to a lesser extent, cash to be generated from Salon Premium. 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 cash inflows and outflows do not meet expectations, Salon's ability to continue as a going concern may be adversely affected. If Salon forecasts or experiences 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 adversely 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 Salon provides notice to purchasers of its intent to sell additional shares of Series D preferred stock. Such a discount, and the time lag between the date of the notice and the date a transaction is consummated, may trigger a non-cash preferred deemed dividend charge. In connection with the sale of 209 shares of Series D-3 in December 2005, it incurred a preferred deemed dividend charge of $0.2 million. Currently, there are 1,042 shares of authorized and unissued shares of Series D preferred that it may sell. Salon cannot predict to what extent it may incur future preferred deemed dividend charges, 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. Subsequent to March 31, 2006, these two related parties, in conjunction with affiliated entities, exercised warrants for which Salon received $0.5 million. In addition, William Hambrecht and John Warnock have committed to provide Salon with $0.4 million in cash in July 2006 from the exercise of outstanding warrants and from the purchase of additional shares of Series D preferred stock. 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 Based on information available to Salon, the holders of Salon's Series A, B, C and D preferred stock collectively own approximately 95% of all voting securities as of May 15, 2006. These stockholders therefore own a controlling interest in Salon. Of this amount, approximately 69% is held by related 4 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 accelerating, delaying or preventing a change in control of Salon, which could cause Salon's stock price to decline. Future sales of Salon's common stock by principal stockholders of significant number of shares of its stock could cause its stock price to decline. Salon's preferred stock holders can convert 8,558 shares of preferred stock to approximately 183 million shares of common stock at their discretion, and as a group, hold over 18 million shares of common stock. Even though only one shareholder during the year ended March 31, 2006 converted one share of Series A preferred stock and 36 shares of Series C preferred stock to 760,173 shares of common stock, other more significant holders of preferred stock could convert their holdings to common stock. If these stockholders convert their shares of preferred stock to common stock and sell the resulting shares, such an inflow of common stock into the securities market may cause the price of Salon's common stock to decline. 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 $21.7 million in potential sales proceeds as of March 31, 2006, which includes the effect of undeclared dividends of $2.4 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 $21.7 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 $21.7 million and if preferred stock dividends were to be declared, the holders of preferred stock would be entitled to receive a relatively larger 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, based on generally accepted accounting principals, for its fiscal year ending March 31, 2007 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, March 31, 2005, and March 31, 2006, 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. 5 Salon's Site Pass advertising model may inhibit traffic to its Website, which would harm its revenues and business As a result of analyzing the traffic patterns to Salon's Website, Salon believes that its Site Pass advertising model, which Salon credits as instrumental in increasing advertising revenues, and driving memberships to Salon Premium, inhibits growth in traffic to its Website. Salon contemplates further analysis of these relationships and may adjust its Site Pass advertising model to attract a wider audience. While a wider audience is intended to increase the supply of advertising impressions, and to introduce more potential members to Salon Premium, Salon cannot estimate when, or if, membership to Salon Premium will again increase or if it will be successful in adjusting its Site Pass to achieve desired results. Salon's operations require attractive content, subscriber interest, and confidence by subscribers that the subscription offering warrants their long-term support and investment Salon is under budgetary constraints to control expenditures. These constraints affect editorial staffing levels and the purchase of content from freelance writers. These constraints affect the quantity of content published on Salon's Website and consequently, a positive experience of Website visitors. The positive experience leads to recurring Website visits and new subscriptions to Salon Premium. The absence of any of these factors could impair the results, revenue and cash flow from subscriptions. Salon cannot predict how many new Salon Premium subscriptions it will acquire. Salon Premium memberships have been declining and may continue to decline, adversely affecting revenues and available cash Salon has been relying on the revenues and cash generated from Salon Premium subscriptions since its implementation in April 2002. Salon Premium subscriptions grew from nothing to a high of approximately 89,100 as of December 31, 2004. However, since the high experienced in December 31, 2004, subscriptions have been declining to approximately 65,500 as of March 31, 2006. If this decline were to continue, Salon's operations and available cash could be adversely affected. 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 or other rich media advertisements; 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 dollar amount of the advertising orders it receives; 6 o increase awareness of the Salon brand; o improve the technology for serving advertising on its 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 its general and administrative expenses and other operating expenses to increase To comply with the 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 its general and administrative costs to increase. Recently adopted changes in the accounting rules for employee stock options as a compensation expense, among other accounting rules, could materially increase the expenses that it reports under generally accepted accounting principles and adversely affect its operating results. 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 its reputation and expose it to a risk of loss or litigation. Experienced programmers or "hackers" have successfully penetrated sectors of its 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 it to significant liability. Salon's insurance policies may not be adequate to reimburse it for losses caused by security breaches. Salon also faces risks associated with security breaches affecting third parties with whom it has relationships. 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 its control, that may prevent its stockholders from reselling its 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 its common stock, regardless of its 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 its common stock could decrease significantly. 7 With a volatile share price, Salon may be the target 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. Salon's share price has in the past experienced price volatility, and may continue to do so in the future. Many companies have been subjected to this type of litigation. If the market value of its common stock experiences adverse fluctuations and it becomes involved in this type of litigation, regardless of the merits or outcome, Salon could incur substantial legal costs and our management's attention could be diverted, causing its business, financial condition and operating results to suffer. To date, Salon has not been subjected 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, both GAAP and non GAAP, 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; 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 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. 8 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. Salon's promotion of the Salon brand must be successful 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 Salon introduces new content and services or enters into new business ventures that are not favorably perceived by users, Salon may not be successful in promoting and maintaining the Salon brand. Any change in the focus of its operations creates a risk of diluting its brand, confusing consumers and decreasing the value of its 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 takes 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 such content may be freely licensed to it, other parties may assert claims of infringement against it relating to such 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 its intellectual property assets. Salon does not have a registered trademark on the address, and therefore it may be difficult for it to prevent a third party from infringing on its intellectual property rights in the address. If Salon fails to adequately protect its rights in the Website 9 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 Website or a loss of Salon Premium subscribers Salon has developed a proprietary online publishing system and has developed, and continues to improve, the software to manage its Salon Premium subscription service. If these systems do not work as intended, or if Salon is unable to 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 its 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 its 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 advertiser-requested services. If such third parties are unable to provide these services in the future, Salon will need to perform this function itself or obtain such services 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 not to advertise on Salon or may pay less for advertising if they do not perceive its 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 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. 10 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 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. 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, links to third party Websites that may be accessible through Salon.com, or content that includes links or references to a third party's Website, 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 and media 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 Salon uses 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. Protection may not be available at a reasonable price or at all. 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. Even though Salon is Payment Card Industry (PCI) compliant, 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. 11 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 a facility in San Francisco, California that has been extensively retrofitted to withstand a major earthquake. 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 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 its 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 Salon 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 personal 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, its 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 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. 12 Provisions in Delaware law and Salon's 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: 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. Salon has 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, an employment agreement with an executive officer subsequent to March 31, 2006 provides for the payment of severance and acceleration of the vesting of options in the event of termination of the executive officer following a change of control of Salon. These provisions in offer letters could have the effect of discouraging potential takeover attempts. 13 PART II ITEM 6. Selected Consolidated Financial Data
Dollar amounts in thousands, except per share ---------------------------------------------------- Year Ended March 31, 2006 2005 2004 2003 2002 - -------------------------------------- -------- -------- -------- -------- -------- (Restated) (Restated) - -------------------------------------- -------- -------- -------- -------- -------- Net revenues $ 6,516 $ 6,628 $ 4,499 $ 4,003 $ 3,619 Net loss (1) $ 1,122 $ 518 $ 6,046 $ 5,597 $ 8,000 Net loss attributable to common stockholders (2) (Restated) $ 1,349 $ 358 $ 6,982 $ 5,678 $ 11,286 Basic and diluted net loss per share attributable to common stockholders (Restated) $ 0.08 $ 0.02 $ 0.50 $ 0.41 $ 0.83 Weighted average common shares outstanding used in computing per share amounts (thousands) 16,188 14,390 14,099 13,938 13,547 Cash and cash equivalents $ 441 $ 686 $ 696 $ 162 $ 1,542 Prepaid advertising rights $ 3,718 $ 3,970 $ 4,430 $ 5,480 $ 6,266 Total assets $ 5,304 $ 6,069 $ 6,270 $ 7,590 $ 11,342 Capital leases - long-term portion $ - $ - $ - $ 18 $ 77 Total long-term liabilities (3) $ 120 $ 82 $ 2,621 $ 569 $ 229
(1) The net loss for the year ended March 31, 2003 includes write-down of long-lived assets of $345 related to certain leasehold improvements. The net loss for the year ended March 31, 2002 includes a write-down of long-lived assets of $782 due to impairments. (2) The net loss attributable to common stockholders for the year ended March 31, 2006 includes a preferred deemed dividend charge of $227 from the issuance of Series D preferred stock. The charge represents the difference between the offering price of Salon's Series D preferred stock and the fair value of Salon's common stock into which the preferred stock was convertible on the date of the transaction and the value of the warrants issued in the transaction. The net loss attributable to common stockholders for the fiscal year ended March 31, 2005 includes a net preferred deemed dividend benefit of $160 derived from a benefit of $470 from a decrease in value of warrants previously issued to preferred stockholders and a charge of $310 from the issuance of Series D-1 and D-2 preferred stock during the year. The charge represents the difference between the offering price of Salon's Series D preferred stock and the fair value of Salon's common stock into which the preferred stock was convertible on the date of the transaction and the value of the warrants issued in the transaction. The net loss attributable to common stockholders for the fiscal year ended March 31, 2004 includes a preferred deemed dividend of $936 that included $361 resulting from the difference between the offering price of Salon's Series C preferred stock and warrants sold in February 2004 and the deemed fair value of Salon's common stock on the date of the transaction and $575 from the change in value during the year ended March 31, 2004 of warrants issued 14 to preferred stockholders. The net loss attributable to common stockholders for the fiscal year ended March 31, 2002 includes a preferred deemed dividend of $3,189 which was the difference between the offering price of Salon's Series A preferred stock sold in August and September 2001 and the deemed fair value of Salon's common stock on the date of the transaction. (3) From July 2003 through November 2004, Salon has had an insufficient number of authorized shares to satisfy all obligations under convertible instruments, warrant agreements and options. As a consequence, the value of warrants issued was classified as a long-term liability, with the fair value re-measured at each balance sheet period. The March 31, 2004 balance of $2,621 represents such value and $354 was the value of the warrants as of March 31, 2003. In November 2004, Salon amended its Certificate of Incorporation, increasing the number of authorized shares from 50,000,000 to 600,000,000, thereby relieving the requirement for Salon to record the value of warrants as a long-term liability. ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Overview Salon is an Internet media company that produces a content Website with ten subject-specific sections, and two online communities - The Well and Table Talk. Salon was incorporated in July 1995 and launched its initial Website in November 1995. A significant portion of Salon's revenues is derived from advertising revenues from the sale of promotional space on its Website. The sale of promotional space is generally less than ninety days in duration. Advertising units sold include "rich media" streaming advertisements, as well as traditional banner and pop-up advertisements. Salon also derives a significant portion of its revenues from its Salon Premium subscription program. Subscriptions to Salon Premium are generally $35 for one year. Salon Premium revenue is recognized ratably over the period that services are provided. During the years ended March 31, 2006 and 2005, Salon received $1.8 million and $2.3 million in cash and recognized $2.0 million and $2.2 million of revenue for this service, respectively. Through March 31, 2004, Salon offered The Well and Table Talk online discussion forums as monthly subscription services. During the year ended March 31, 2005, Salon made access to Table Talk free to Salon Premium members. Revenue from the on-line discussion forums has been recognized ratably over the subscription period. Salon generates nominal revenue from the licensing of content that previously appeared in Salon's Website and for hosting links to a third party's personals/dating Website. Production and content expenses consist primarily of salaries and related expenses for Salon's editorial, artistic, and production staff, online communities' staff, payments to freelance writers and artists, bandwidth costs associated with serving pages and hosting our online communities on our Website, credit card transaction costs and costs of serving ads. Sales and marketing expenses consist primarily of salaries, commissions and related personnel costs, travel, and other costs associated with Salon's sales force, business development efforts and its Salon premium service. It also includes advertising, promotional and distribution costs and the amortization of prepaid advertising rights. Information technology support expenses consist primarily of salaries and related personnel costs associated with the development, testing and enhancement of Salon's software to manage its Website, and 15 to maintain and enhance the software utilized in managing Salon Premium, as well as supporting marketing and sales efforts. General and administrative expenses consist primarily of salaries and related personnel costs, accounting and legal fees, and other fees associated with operating a publicly traded company. Salon has incurred significant net losses and negative cash flows from operations since its inception. As of March 31, 2006, Salon had an accumulated deficit of $91.0 million. These losses have been funded primarily through the issuance of common stock from Salon's initial public offering in June 1999, issuance of preferred stock, and from the issuance of convertible notes payable. Burr, Pilger & Mayer LLP, Salon's independent accountants for the years ended March 31, 2006, March 31, 2005 and March 31, 2004 have included a paragraph in their report indicating that substantial doubt exists as to Salon's ability to continue as a going concern because of Salon's recurring operating losses, negative cash flow and accumulated deficit. Salon has not recorded a provision for federal or state income taxes since inception due to reoccurring operating losses. At March 31, 2006 Salon had net operating loss carryforwards of $64.1 million for federal income tax purposes that begin to expire in March 2015, and $33.1 million for California income tax purposes that began to expire for the year ended March 31, 2006. Utilization of Salon's net operating loss carryforwards may be subject to a substantial annual limitation due to ownership change limitations provided by the Internal Revenue Code and similar California state provisions. Such an annual limitation could result in the expiration of the net operating loss carryforwards before utilization. A valuation allowance has been established and, accordingly, no benefit has been recognized for such operating losses and other deferred tax assets. The net valuation allowance increased $0.3 million during the year ended March 31, 2006 to $25.0 million. Salon believes that, based on a number of factors, the availability of objective evidence creates sufficient uncertainty regarding the realization of the deferred tax assets such that a full valuation allowance has been recorded. These factors include Salon's history of net losses since inception and expected near-term future losses. Critical Accounting Policies The preparation of financial statements in conformity with generally accepted accounting principles requires Salon to utilize accounting policies and make estimates and assumptions that affect our reported amounts. Salon's significant accounting policies are described in Note 2 to the consolidated financial statements. Salon believes accounting policies and estimates related to revenue recognition and prepaid advertising rights are the most critical to Salon's financial statements. Future results may differ from current estimates if different assumptions or conditions were to prevail. Revenue Recognition Salon recognizes revenues once persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collectibility is reasonably assured. Revenues are recognized ratably in the period over which Salon's obligations are fulfilled. Payments received before Salon's obligations are fulfilled are classified as "Deferred revenue" in Salon's consolidated balance sheet. Advertising revenues, derived from the sale of promotional space on its Website, comprised 57% and 54% of Salon's revenues, respectively for the years ended March 31, 2006 and 2005. The duration of the advertisements are generally short term, usually less than ninety days. Revenues derived from such arrangements are recognized during the period the advertising space is provided. Salon's obligations 16 typically include the guarantee of a minimum number of impressions, a set number of Site Pass advertisement viewed, or a set number of days that a Site Pass advertisement will run. To the extent minimum guaranteed amounts are not achieved, Salon defers recognition of the corresponding revenue until the remaining guaranteed amounts are provided, if mutually agreeable with an advertiser. If these "make good" impressions are not agreeable to an advertiser, no further revenue is recognized. Salon Premium, a pay for online content service, provides unrestricted access to Salon's content with no banners, pop-ups or site pass advertisements, and includes free magazine subscriptions, free access to Table Talk, an on-line forum, and the ability to download easily content in text or PDF format, a convenience that enables readers to view Salon's content when not connected to the Internet. The subscription duration for Salon Premium is generally one year. Non Salon Premium subscribers can gain access to Salon's content after viewing some form of advertisement. Salon offers The Well as a monthly subscription service for access to on-line discussion forums. Revenue is recognized ratably over the subscription period. Prepaid Advertising Rights In January 2000, Salon sold 1,125,000 shares of common stock to Rainbow Media Holdings and received $11.8 million of advertising credits that were to be utilized for up to ten years. As the per share price of Salon's common stock declined from the time the agreement was made and the date the agreement was finalized and signed, the advertising credits were valued for financial reporting purposes at $8.1 million. As of March 31, 2006, Salon has $5.4 million advertising credits resulting from the transaction, valued at $3.7 million for financial reporting purposes. The common stock sale agreement stipulates that the advertising credits be utilized through December 31, 2009. Salon therefore contemplates accelerating the use of these credits in future years. Results of Operations Fiscal Years Ended March 31, 2006 and 2005 Net Revenues Salon's net revenue decreased 2% to $6.5 million in the year ended March 31, 2006 from $6.6 million in the year ended March 31, 2005. Advertising revenues increased 3% to $3.7 million for the year ended March 31, 2006 from $3.6 million for the year ended March 31, 2005. The increase in advertising sales reflects an industry wide trend of corporations earmarking more funds for Internet advertising. Salon Premium subscription revenues decreased by 8% to $2.0 million for the year ended March 31, 2006 from $2.2 million for the year ended March 31, 2005. The drop in Salon Premium revenues recognized for the year ended March 31, 2006 compared to the year ended March 31, 2005 is attributable to a substantial reduction in the number of new subscribers. Paid one year subscriptions were approximately 58,700 for the year ended March 31, 2006 compared to approximately 79,100 for the year ended March 31, 2005. The larger number of paid one year subscribers during the year ended March 31, 2005 was primarily attributable to capitalizing on reader interest in Salon's political coverage during the 2004 election year, with no comparable event taking place this year. The drop in paid one year subscribers negatively impacted our renewal rate which declined from approximately 69% as of March 31, 2005 to approximately 62% as of March 31, 2006. In addition, paid one month subscriptions declined 17 to approximately 3,900 for the year ended March 31, 2006 compared to approximately 5,000 for the year ended March 31, 2005. As a result of these factors, the number of paid subscribers decreased from approximately 84,500 at March 31, 2005 to approximately 65,500 at March 31, 2006. As of June 25, 2006, Salon had approximately 62,000 paid subscribers. In analyzing the traffic patterns on its Website, Salon believes that its Site Pass advertising model, which Salon credits as instrumental in increasing advertising revenues, and driving memberships to Salon Premium, inhibits a growth in traffic to its Website. Salon contemplates further analysis of these relationships and may adjust its Site Pass advertising model to attract a wider audience. While a wider audience is intended to increase the supply of advertising impressions, and to introduce more potential members to Salon Premium, Salon cannot estimate when, or if, membership to Salon Premium will again increase or if it will be successful in adjusting its Site Pass to achieve desired results. All other sources of revenue were $0.8 million for the year ended March 31, 2006 and the year ended March 31, 2005. Approximately $0.5 million of this revenue was derived from the Well, an online discussion forum. During Salon's second quarter ended September 30, 2005, Salon announced that it was seeking a buyer for this business. Production and Content Production and content expenses during the year ended March 31, 2006 were $4.5 million versus $4.4 million for the year ended March 31, 2005, an increase of $0.1 million. The nominal 1% increase primarily reflects recognizing $0.1 million of stock compensation expense this year and none last year, $0.1 million of additional salary related costs from an increase in staff, offset by a $0.1 million reduction in ad serving costs. Sales and Marketing Expenses Sales and marketing expenses during the year ended March 31, 2006 were $1.5 million versus $1.9 million for the year ended March 31, 2005, a decrease of $0.4 million. The 20% decrease primarily reflects utilizing $0.2 million fewer advertising credits this year compared to last year, salary related costs declining by $0.1 million as the amounts of commissions earned were less than last year and a business development position was unfilled for most of the year. In addition, the results for the year ended March 31, 2005 included a $0.1 million charge related to the issuance of a warrant to purchase common stock that was granted as part of a separation agreement. As of March 31, 2006, Salon has $5.4 million of advertising credits that it has valued at $3.7 million. The agreement that allows for the utilization of the advertising credits will expire on December 31, 2009. Therefore, Salon anticipates accelerating the utilization of these credits in the coming years. Information Technology Support Expenses Information technology support expenses during the year ended March 31, 2006 were $0.7 million versus $0.6 million for the year ended March 31, 2005, an increase of $0.1 million. The 10% increase was primarily attributable to hiring technical consultants and the value of a warrant issued as part of a severance agreement. 18 General and Administrative Expenses General and administrative expenses the year ended March 31, 2006 were $1.0 million versus $0.8 million for the year ended March 31, 2005, an increase of $0.2 million. The 26% increase primarily resulted from a $0.1 million increase in salary related costs attributable to raises awarded to two officers in February 2005, an addition of one staff member and $0.1 million is attributable to a general increase in other corporate expenses. Interest and other income (expense) Interest and other income (expense) for the year ended March 31, 2006 was essentially nil compared to a benefit of $0.6 million for the year ended March 31, 2005. The results for the year ended March 31, 2005 included benefits of $0.4 million from a decrease in value of warrants previously issued to convertible note holders and approximately $0.2 million from monies received to finance editorial content. During the year ended March 31, 2005, Salon amended its Certificate of Incorporation, increasing the number of authorized shares from 50,000,000 to 600,000,000, thereby relieving the requirement for Salon to record charges or benefits in future periods relating to the value of warrants. Preferred Deemed Dividend During the year ended March 31, 2006, Salon sold 209 shares of Series D-3 preferred stock that were convertible to common stock at an effective price less than the fair market value of Salon's common stock on the commitment date. Salon valued the beneficial conversion feature of the preferred stock sold at $0.2 million. As the shares of preferred stock were immediately convertible, for its year ended March 31, 2006, Salon recorded a $0.2 million non-cash preferred deemed dividend, representing the value of the beneficial conversion feature of the shares issued. The non-cash preferred deemed dividend benefit of $0.2 million for the year ended March 31, 2005 includes a benefit of $0.5 million from a decrease in value of warrants previously issued to preferred stockholders and a charge of $0.3 million from the issuance of Series D preferred stock during the year. During the year ended March 31, 2005, Salon sold 417 shares of Series D-1 and 417 shares of Series D-2 preferred stock at an effective price less than the fair market value of Salon's common stock on the commitment dates. Salon valued the beneficial conversion feature of the preferred stock sold at $0.3 million. As the shares of preferred stock were all immediately convertible, for its year ended March 31, 2005, Salon recorded a $0.3 million non-cash preferred deemed dividend, representing the value of the beneficial conversion feature of the shares issued. 19 Fiscal Years Ended March 31, 2005 and 2004 Net Revenues Salon's net revenue increased 47% to $6.6 million in the year ended March 31, 2005 from $4.5 million in the year ended March 31, 2004. Advertising revenues increased 103% to $3.6 million for the year ended March 31, 2005 from $1.8 million for the year ended March 31, 2004. The increase in advertising revenues reflected the success of Salon's site pass advertisement format, which generated the majority of the ad revenue, in conjunction with traditional advertising banners. This combination of advertisements gained wide acceptance with advertisers. The increase also reflects the overall increase in advertising dollars being allocated to Internet properties by companies that wish to brand their products and services. Salon Premium subscription revenues increased by 20% to $2.2 million for the year ended March 31, 2005 from $1.8 million for the year ended March 31, 2004. The revenue increase reflected a greater number of individuals signing up for this service, as new and renewed subscriptions during the year ended March 31, 2005 were approximately 84,200 compared to approximately 77,700 during the year ended March 31, 2004. The increase in the number of subscribers acquired during the year ended March 31, 2005 compared to the prior year is largely attributed to reader interest in Salon's political coverage during the 2004 presidential campaign, which created opportunities to promote membership drives, either singly or in conjunction with third parties. During the year ended March 31, 2005, membership to Salon Premium decreased, the first time since inception. The number of subscribers to Salon Premium at March 31, 2004 was approximately 72,000 and increased during the year to approximately 89,100 on December 31, 2004 and subsequently decreased to approximately 84,500 as of March 31, 2005. This trend also mirrored Salon's renewal rate for one year paid subscriptions to Salon Premium, which began the year at approximately 64%, increased to approximately 73% as of December 31, 2004, and dropped to approximately 69% as of March 31, 2005. All other sources of revenue accounted for $0.8 million for the year ended March 31, 2005 compared to $0.9 million for the year ended March 31, 2004. The decrease of $0.1 is primarily attributable to a decrease in membership to The Well. Salon recognized $0.1 million of revenue for its year ended March 31, 2005 for hosting links to a third party's personals/dating Website. Production and Content Production and content expenses during the year ended March 31, 2005 were $4.4 million versus $4.6 million for the year ended March 31, 2004, a decrease of $0.2 million. The 4% decrease reflects, among other items, recognizing $0.2 million related to the value of warrants issued for editorial collaboration with a print publisher during the year ended March 31, 2004, with no comparable amounts during the year ended March 31, 2005. During the year ended March 31, 2005, salary related expenses increased by $0.2 million due to the opening of an office in Washington, DC, ad serving charges increased by $0.1 million from an increase in the number of ads served, while purchased content was reduced by $0.1 million, depreciation decreased by $0.1 million as assets became more fully depreciated, and other general expenditures were cut by $0.1 million. 20 Sales and Marketing Expenses Sales and marketing expenses during the year ended March 31, 2005 were $1.9 million versus $2.4 million for the year ended March 31, 2004, a decrease of $0.5 million or 21%. The decrease primarily reflects utilizing $0.6 million fewer advertising credits for the year ended March 31, 2005 versus the year ended March 31, 2004, offset by a $0.1 million charge from the value of warrants issued to a former employee. Information Technology Support Expenses Information technology support expenses for the years ended March 31, 2005 and March 31, 2004 were $0.6 million. General and Administrative Expenses General and administrative expenses for the year ended March 31, 2005 were $0.8 million versus $1.4 million for the year ended March 31, 2004, a decrease of $0.6 million or 45%. The decrease reflects $0.4 million in reduction in salary related costs from the elimination of three positions and $0.1 million reduction in general operating costs. The March 31, 2004 results include a charge of $0.1 million related to the issuance of warrants to a former employee with no comparable charge during the year ended March 31, 2005. Amortization of Intangibles Salon did not recognize any amortization of intangibles for its year ended March 31, 2005 as all amounts required to be amortized have previously been charged to operations. For the year ended March 31, 2004, Salon amortized $0.4 million of intangible assets. Interest and other income (expense) Net interest and other income (expense) for the year ended March 31, 2005 was a benefit of $0.6 million compared to a charge of $1.2 million for the year ended March 31, 2004. The results for the year ended March 31, 2005 includes a benefit of $0.4 million from a decrease in value of warrants previously issued to convertible note holders and approximately $0.2 million from monies received to finance editorial content. The results for the year ended March 31, 2004 include a charge of $0.8 million related to the revaluation of warrants held by convertible note holders, a charge of $0.2 million of interest on convertible notes and other interest related charges, and $0.3 million related to amortizing the initial value of warrants issued to the then holders of convertible notes. Salon converted all outstanding convertible notes to preferred stock on December 30, 2003. The results for the year ending March 31, 2004 also includes a benefit of $0.1 million from monies received to finance editorial content. During the year ended March 31, 2005, Salon amended its Certificate of Incorporation, increasing the number of authorized shares from 50,000,000 to 600,000,000, thereby relieving the requirement for Salon to record charges or benefits in future periods relating to the value of warrants. 21 Preferred Deemed Dividend The non-cash preferred deemed dividend benefit of $0.2 million for the year ended March 31, 2005 includes a benefit of $0.5 million from a decrease in value of warrants previously issued to preferred stockholders and a charge of $0.3 million from the issuance of Series D preferred stock during the year. During the year ended March 31, 2005, Salon sold 417 shares of Series D-1 and 417 shares of Series D-2 preferred stock at an effective price less than the fair market value of Salon's common stock on the commitment dates. Salon valued the beneficial conversion feature of the preferred stock sold at $0.3 million. As the shares of preferred stock were all immediately convertible, for its year ended March 31, 2005, Salon recorded a $0.3 million non-cash preferred deemed dividend, representing the value of the beneficial conversion feature of the shares issued. The non-cash preferred deemed dividend charge of $0.9 million for the year ended March 31, 2004 includes a charge of $575,000 from an increase in value of warrants previously issued to preferred stockholders and a charge of $361,000 from the issuance of Series C preferred stock during the year. During the year ended March 31, 2004 Salon sold 500 shares of Series C preferred stock that were sold at an effective price less than the fair market value of Salon's common stock on the commitment date. Salon valued the beneficial conversion feature of the preferred stock sold at $361,000. As the shares of preferred stock were all immediately convertible, Salon recorded a $361,000 non-cash preferred deemed dividend representing the value of the beneficial conversion feature of the shares issued. Liquidity and Capital Resources Net cash used in operations was $0.6 million for the year ended March 31, 2006, $0.8 million for the year ended March 31, 2005 and $2.8 million for the year ended March 31, 2004. The principal use of cash during the year ended March 31, 2006 was to fund the $1.1 million net loss, less $0.5 million of non-cash charges, and a $0.2 million decrease in deferred revenue, all offset by a reduction of $0.2 million of accounts receivable, prepaid expenses and other current assets and other assets. The principal use of cash during the year ended March 31, 2005 was to fund the $0.5 million net loss, less non-cash charges of $0.5 million, a $0.3 million increase in accounts receivable and the $0.3 million decrease in accounts payable. The principal use of cash during the year ended March 31, 2004 was to fund the $6.0 million net loss for the period, offset partly by non-cash charges of $3.4 million, and use of assets and liabilities of $0.1 million. Net cash used in investing activities was $0.1 million for the year ended March 31, 2006 for the purchase of computer related equipment. Net cash used in investing activities was $0.2 million for the year ended March 31, 2005 to fund the acquisition of computer equipment, and for leasehold improvements. Net cash used in investing activities was immaterial for the years ended March 31, 2004. Salon anticipates capital expenditures of $0.1 million during the year ending March 31, 2007 for computer related equipment. For the year ended March 31, 2006, net cash provided from financing activities was $0.4 million from the issuance of Series D preferred stock, and the exercise of common stock options and warrants. For the year ended March 31, 2005, net cash from financing activities was $1.0 million primarily from the issuance of Series D preferred stock. For the year ended March 31, 2004, net cash from financing activities was $3.3 million, which was comprised of $2.5 million from the issuance of notes payable, $0.9 million from the issuance of Series C preferred stock and $0.2 million from bank borrowings, offset by $0.2 million of re-payments to the bank and $0.1 million of payments under capital leases. Salon, as permitted under Delaware law and in accordance with its Bylaws, indemnifies its officers and directors for certain events or occurrences, subject to certain limits, while the officer is or 22 was serving at Salon's request in such capacity. The term of the indemnification period is for the officer's, or director's lifetime. The maximum amount of potential future indemnification is unlimited; however, Salon does have a Director and Officer Insurance Policy that limits Salon's exposure and enables Salon to recover a portion of any future amounts paid. As a result of the insurance policy coverage, Salon believes the fair value of these indemnification agreements is minimal. As of March 31, 2006, Salon has no outstanding capital leases and does not anticipate entering into similar debt instruments during its year ending March 31, 2007. The following summarizes Salon's contractual obligations as of March 31, 2006, and the effect these contractual obligations are expected to have on Salon's liquidity and cash flows in future periods (in thousands): Payments Due By Period ------------------------------------------------- 1 Year 1 - 3 More than Total or Less Years 3 Years ---------- ---------- ---------- ---------- Operating leases $ 799 $ 308 $ 491 $ - ---------- ---------- ---------- ---------- Total $ 799 $ 308 $ 491 $ - ========== ========== ========== ========== Salon's independent accountants for the years ended March 31, 2004, 2005 and 2006 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. To address the negative cash flows, Salon reduced expenses, evidenced by net cash used in operating activities decreasing from $5.0 million for the year ended March 31, 2002 to $2.8 million for the year ended March 31, 2004. The reduction in use of cash facilitated raising capital during this period, which in turn facilitated being awarded a greater number of advertisements, as advertisers gained confidence in Salon's survivability. The resurgence of the Internet ad market positively influenced Salon, as 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 which in turn caused the net cash used in operations to decrease to $0.8 million for the year ended March 31, 2005. This trend has continued for the year ended March 31, 2006 as the cash used in operations decreased to $0.6 million. As a result of the cash used in operations, $0.4 million from financing activities and the use of $0.1 million for capital expenditures, Salon's available cash at March 31, 2006 was $0.4 million. Subsequent to March 31, 2006, Salon received $0.6 million from the exercise of warrants to purchase 9.8 million shares of common stock. The investors included John Warnock, a Director of Salon, William Hambrecht, the father of Elizabeth Hambrecht, Salon's CEO and President, and two entities that William Hambrecht and Elizabeth Hambrecht have an ownership interest in. Based on cash proceeds from the exercise of warrants subsequent to March 31, 2006 and forecasted trade receivable receipts, cash payments, advertising revenues of a potential high of $5.4 million and total revenues of a potential high of $8.1 million, Salon estimates that its cash on hand may be $0.1 million at March 31, 2007. Due to seasonality of advertising sales, Salon forecasts that it will sustain a cash deficit of approximately $0.1 million by July 2006 that will increase to an expected high of approximately $0.4 million by October 2006 before diminishing. If the anticipated revenue expectations are not met, Salon's cash on hand could be significantly less. To address the projected shortfall, Salon has received commitments from two investors, one of which is a Director of Salon and the other is the father of Salon's CEO and President, to provide Salon with approximately $0.4 million in cash in July 2006 from the exercise of an outstanding warrant and from the purchase of Series D preferred stock. There is no certainty that Salon will be able to attain any of the above mentioned projected revenue amounts. 23 If anticipated cash balances are not realized, Salon may need to raise additional working capital. Salon may secure additional working capital from: (1) the exercise of outstanding warrants, (2) the sale of 1,042 authorized and unissued shares of Series D preferred stock as of this filing, (3) selling the Well, or (4) the issuance of securities to a strategic investor. Salon has outstanding warrants that expire between the date of this filing and March 31, 2007, from which Salon estimates it could potentially receive cash of up to $0.8 million from their exercise. However, with the exception of a commitment to exercise a warrant for approximately $0.1 million subsequent to this filing, the actual amount could be considerably less, or nothing at all, as the terms of the warrants allow for cashless exercise. Except for a commitment by the two investors noted above to purchase approximately $0.3 million of Series D preferred stock, the potential to raise additional working capital from the issuance of additional shares of currently authorized shares of Series D preferred stock, though viable, is not certain. In addition, Salon may explore amending the "Securities Purchase Agreement", as amended to date, 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) to allow for the sale of additional shares of Series D than the 1,042 currently authorized and unissued as of this filing. There is no certainty that Salon will be able to amend these documents or sell any such additional shares. Salon is currently attempting to sell The Well, an on-line community it purchased in 1999. As of this filing, Salon has not found a suitable buyer for this asset, which has a book value of approximately $0.2 million, most of which is goodwill. The potential sale of The Well is not primarily driven by a need to generate cash to finance Salon's operations, but is intended to free management to concentrate on Salon's core operations. From time to time, Salon has explored the possibilities of aligning itself with a strategic investor, a strategic partner, or being acquired by a third party. Though these possibilities exist, there is no certainty that any of these alternatives may come to fruition. Off-Balance Sheet Arrangements Salon has no off-balance sheet arrangements. Reverse Stock Split In October 2005, Salon's stockholders granted to its Board of Directors the right to effect a reverse stock split of Salon's common stock in four ratios between 1-for-10 and 1-for-20. The right is to expire the earlier of Salon's 2006 Annual Meeting of Stockholders or December 31, 2006. At present, Salon's Board of Directors does not plan to exercise such right and effect a reverse stock split. 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) 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 use upon 24 adoption of SFAS 123R, 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 two 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 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. In May 2005, the FASB issued SFAS 154 "Accounting Changes and Error Corrections." which replaces APB Opinion No. 20 "Accounting Changes" and SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements--An Amendment of APB Opinion No. 20." SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. Specifically, this statement requires "retrospective application" of the direct effect for a voluntary change in accounting principle to prior periods' financial statements, if it is practicable to do so. SFAS 154 also strictly redefines the term "restatement" to mean the correction of an error by revising previously issued financial statements. SFAS 154 replaces APB No. 20, which requires that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. SFAS 154 is effective for accounting changes and correction of errors made in fiscal years beginning after December 15, 2005 and is required to be adopted by Salon in the first quarter of fiscal 2007. Salon does not currently believe adoption will have a material impact on its results of operations, financial position or cash flows. 25 ITEM 8. Consolidated Financial Statements and Supplementary Data Page Reports of Independent Registered Public Accounting Firm ....................27 Consolidated Balance Sheets as of March 31, 2006, 2005, and 2004.............28 Consolidated Statements of Operations for the years ended March 31, 2006, 2005, and 2004 .........................................29 Consolidated Statements of Stockholders' Equity for the years ended March 31, 2006, 2005, and 2004 .........................................30 Consolidated Statements of Cash Flows for the years ended March 31, 2006, 2005, and 2004 .........................................31 Notes to Consolidated Financial Statements...................................32 Selected Quarterly Financial Data (unaudited)................................56 26 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders Salon Media Group, Inc. We have audited the accompanying consolidated financial statements of Salon Media Group, Inc. and its subsidiaries (the "Company") as of March 31, 2006, 2005 and 2004, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended March 31, 2006. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated 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 consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Salon Media Group, Inc. and its subsidiaries as of March 31, 2006 and 2005, and the results of their operations and their cash flows for each of the of the three years in the period ended March 31, 2006 in conformity with accounting principles generally accepted in the United States of America. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has suffered recurring losses and negative cash flows from operations and has an accumulated deficit of $91.0 million at March 31, 2006. These conditions raise substantial doubt about its ability to continue as a going concern. Management's plans regarding those matters also are described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. /S/ Burr, Pilger & Mayer LLP San Francisco, California May 4, 2006, except for the restatement discussed in Note 1 and in the thirteenth paragraph of Note 12 to the financial statements, as to which the date is October 25, 2006 27 SALON MEDIA GROUP, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except share and per share amounts)
March 31, -------------------------------------- 2006 2005 2004 ---------- ---------- ---------- Assets (Restated) (Restated) (Restated) Current assets: Cash and cash equivalents $ 441 $ 686 $ 696 Accounts receivable, net 502 623 306 Prepaid expenses and other current assets 184 232 432 ---------- ---------- ---------- Total current assets 1,127 1,541 1,434 Property and equipment, net 155 191 89 Prepaid advertising rights 3,718 3,970 4,430 Goodwill, net 200 200 200 Other assets 104 167 117 ---------- ---------- ---------- Total assets $ 5,304 $ 6,069 $ 6,270 ========== ========== ========== Liabilities and stockholders' equity Current liabilities: Accounts payable and accrued liabilities $ 747 $ 788 $ 1,125 Deferred revenue 820 1,047 1,107 Capital lease obligations, current - - 18 ---------- ---------- ---------- Total current liabilities 1,567 1,835 2,250 Warrants payable - - 2,621 ---------- ---------- ---------- Other long-term liabilities 120 82 - ---------- ---------- ---------- Total liabilities 1,687 1,917 4,871 ---------- ---------- ---------- Commitments and Contingencies (Note 8) Stockholders' equity: Preferred stock, $0.001 par value, 5,000,000 shares authorized, 8,558 shares issued and outstanding at March 31, 2006, 8,386 shares issued and outstanding at March 31, 2005 and 7,552 issued and outstanding at March 31, 2004 (aggregate liquidation preference of $21,655 at March 31, 2006, $20,686 at March 31, 2005 and $18,926 at March 31, 2004) - - - Common stock, $0.001 par value, 600,000,000 shares authorized, 19,129,012 shares issued and outstanding at March 31, 2006 , 14,970,622 shares issued and outstanding at March 31, 2005 and 14,155,276 issued and outstanding at March 31, 2004 19 15 14 Additional paid-in capital (Restated) 94,601 93,751 90,641 Unearned compensation (40) - - Accumulated deficit (Restated) (90,963) (89,614) (89,256) ---------- ---------- ---------- Total stockholders' equity 3,617 4,152 1,399 ---------- ---------- ---------- Total liabilities and stockholders' equity $ 5,304 $ 6,069 $ 6,270 ========== ========== ==========
See accompanying notes to Consolidated Financial Statements 28 SALON MEDIA GROUP, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data)
Year Ended March 31, -------------------------------------- 2006 2005 2004 -------------------------------------- (Restated) (Restated) ---------- ---------- ---------- Net revenues $ 6,516 $ 6,628 $ 4,499 ---------- ---------- ---------- Operating expenses: Production and content 4,505 4,446 4,647 Sales and marketing 1,515 1,891 2,393 Information technology support 676 617 614 General and administrative 964 766 1,386 Amortization of intangibles - - 353 ---------- ---------- ---------- Total operating expenses 7,660 7,720 9,393 Loss from operations (1,144) (1,092) (4,894) Interest and other income (expense) 22 574 (1,152) ---------- ---------- ---------- Net loss (1,122) (518) (6,046) Preferred deemed dividend (Restated) (227) 160 (936) ---------- ---------- ---------- Net loss attributable to common stockholders (Restated) $ (1,349) $ (358) $ (6,982) ========== ========== ========== Basic and diluted net loss per share attributable to common stockholders (Restated) $ (0.08) $ (0.02) $ (0.50) Weighted average shares used in computing basic and diluted net loss per share attributable to common stockholders 16,188 14,390 14,099
See accompanying notes to Consolidated Financial Statements 29 SALON MEDIA GROUP, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands, except Preferred Stock Shares)
Preferred Common Stock Stock Additional Total ---------------------------------------------- Paid-In Unearned Accumulated Stockholders' Shares Amount Shares Amount Capital Compensation Deficit Equity -------------------------------------------------------------------------------------------------- (Restated) (Restated) -------------------------------------------------------------------------------------------------- Balance, March 31, 2003 934 - 14,155 14 85,283 - (82,274) 3,023 Value of contingent shares issued in conjunction with acquisition - - - - 5 - - 5 Series C convertible preferred stock and common stock warrants issued from conversion of convertible notes payable 5,493 - - - 4,394 - - 4,394 Series C convertible preferred stock and common stock warrants issued for cash 1,125 - - - 892 - - 892 Preferred deemed dividend on issuance of Series C Convertible preferred stock (Restated) - - - - 361 - (361) - Preferred deemed dividend from revaluation of warrants issued to preferred stock holders - - - - - - (575) (575) Reclassification of warrants to liabilities - - - - (294) - - (294) Net loss - - - - - - (6,046) (6,046) -------------------------------------------------------------------------------------------------- Balance, March 31, 2004 (Restated) $ 7,552 - 14,155 $ 14 $ 90,641 $ - $ (89,256) $ 1,399 Shares issued under employee stock plans - - 399 - 55 - - 55 Value of shares issued to settle amounts owed a trade payable - - 417 1 41 - - 42 Value of warrants issued - - - - 100 - - 100 Series D convertible preferred stock and common stock warrants issued for cash 834 - - - 1,207 - (310) 897 Preferred deemed dividend from revaluation of warrants issued to preferred stock holders - - - - - - 470 470 Extinguishment of warrant liability - see Note 12 - - - - 1,707 - - 1,707 Net loss - - - - - - (518) (518) -------------------------------------------------------------------------------------------------- Balance, March 31, 2005 (Restated) $ 8,386 - 14,971 $ 15 $ 93,751 $ - $ (89,614) $ 4,152 Shares issued under employee stock plans - - 520 - 72 - - 72 Shares issued under warrant agreements - - 2,878 3 63 - - 66 Value of warrants issued - - - - 55 - - 55 Preferred stock converted to common stock (37) - 760 1 (1) - - - Amortization of unearned compensation - - - - 183 (40) - 143 Series D convertible preferred stock and common stock warrants issued for cash 209 - - - 251 - - 251 Preferred deemed dividend on issuance of Series D Convertible preferred stock (Restated) - - - - 227 - (227) - Net loss - - - - - - (1,122) (1,122) -------------------------------------------------------------------------------------------------- Balance, March 31, 2006 (Restated) 8,558 $ - 19,129 $ 19 $ 94,601 $ (40) $ (90,963) $ 3,617
See accompanying notes to Consolidated Financial Statements 30 SALON MEDIA GROUP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
Year Ended March 31, -------------------------------- 2006 2005 2004 -------- -------- -------- Cash flows from operating activities: Net loss $ (1,122) $ (518) $ (6,046) Adjustments to reconcile net loss to net cash used in operating activities: Loss from retirement of assets - - 43 Stock-based compensation 143 - - Warrant re-valuation - (541) 1,037 Depreciation and amortization 143 495 1,285 Allowance for (recovery of) doubtful accounts (1) 2 (10) Operating lease incentives - 65 - Gain on issuance of common stock for trade payable - (25) - Prepaid advertising rights usage 252 460 1,050 Changes in assets and liabilities: Accounts receivable 122 (319) (69) Prepaid expenses, other current assets and other assets 111 (130) (59) Accounts payable, accrued liabilities and other long-term liabilities (3) (254) (180) Deferred revenue (227) (60) 189 -------- -------- -------- Net cash used in operating activities (582) (825) (2,760) -------- -------- -------- Cash flows from investing activities: Purchase of property and equipment (52) (217) (35) Proceeds from asset sales - - 15 -------- -------- -------- Net cash used in investing activities (52) (217) (20) -------- -------- -------- Cash flows from financing activities: Proceeds from issuance of preferred stock, net 251 995 892 Proceeds from issuance of common stock, net 138 55 - Proceeds from bank borrowings - - 182 Repayment of short-term borrowings - - (182) Proceeds from issuance of notes payable, net - - 2,513 Principal payments under capital leases - (18) (91) -------- -------- -------- Net cash provided by financing activities 389 1,032 3,314 -------- -------- -------- Net increase (decrease) in cash and cash equivalents (245) (10) 534 Cash and cash equivalents at beginning of period 686 696 162 -------- -------- -------- Cash and cash equivalents at end of period $ 441 $ 686 $ 696 ======== ======== ======== Amount paid for interest $ - $ - $ 6 Supplemental schedule of non-cash investing and financing activities: Warrants issued in connection with issuance of convertible notes payable $ - $ - $ 263 Issuance of stock and warrants in connection with acquisition - - 5 Issuance of warrants in connection with agreements 55 100 100 Preferred deemed dividend (Restated) 227 (160) 936 Conversion of notes payable and accrued interest to preferred stock - - 4,394 Issuance of common stock for trade payable - 42 -
See accompanying notes to Consolidated Financial Statements 31 SALON MEDIA GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) Note 1. The Company Salon Media Group, Inc ("Salon") is an Internet media company that produces a content Website with ten subject-specific sections, which includes two online communities. The Website also allows for audio downloads and video clips. 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. The financial statements contained herein have been restated to correct the accounting for the beneficial conversion features of certain of Series C and Series D preferred stock issued on February 10, 2004 and December 21, 2005. Salon originally recorded the full intrinsic value of the aforementioned beneficial conversion features as preferred deemed dividends. The amounts recorded as preferred deemed dividends should have been limited to the proceeds received from the transactions which were attributable to the preferred stock issued. This resulted in overstating the amount of their preferred deemed dividends and the net loss attributable to common stockholders in the statement of operations for fiscal years ended March 31, 2004, March 31, 2006 and the stockholders equity section of the balance sheet as of March 31, 2004, 2004 and 2006. These were non-cash charges which had no impact on Salon's statement of cash flows or cash position. The effect of the correction on the Consolidated Statement of Operations is as follows: As Recorded As Restated ------------ ------------ Year-ended March 31, 2004 Preferred deemed dividend $ (2,615) $ (936) Net loss attributable to common stockholders (8,661) (6,982) Basic and diluted net loss per share attributable to common stockholders (0.61) (0.50) Year-ended March 31, 2006 Preferred deemed dividend $ (1,040) $ (227) Net loss attributable to common stockholders (2,162) (1,349) Basic and diluted net loss per share attributable to common stockholders (0.13) (0.08) 32 SALON MEDIA GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) The cumulative effect of the correction on the Consolidated Balance Sheet is as follows: As Reported As Restated ----------- ----------- As of March 31, 2004 Additional paid-in capital $ 92,320 $ 90,641 Accumulated deficit $ (90,935) $ (89,256) Total stockholders' equity $ 1,399 $ 1,399 As of March 31, 2005 Additional paid-in capital $ 95,430 $ 93,751 Accumulated deficit $ (91,293) $ (89,614) Total stockholders' equity $ 4,152 $ 4,152 As of March 31, 2006 Additional paid-in capital $ 97,093 $ 94,601 Accumulated deficit $ (93,455) $ (90,963) Total stockholders' equity $ 3,617 $ 3,617 Note 2. Summary of Significant Accounting Policies Basis of presentation These consolidated financial statements contemplate the realization of assets and the satisfaction of liabilities in the normal course of business. Salon has incurred losses and negative cash flows from operations since inception and has an accumulated deficit at March 31, 2006 of $90,963. 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, 2004, 2005 and 2006 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. To address the negative cash flows, Salon reduced expenses, evidenced by net cash used in operating activities decreasing from $5.0 million for the year ended March 31, 2002 to $2.8 million for the year ended March 31, 2004. The reduction in use of cash facilitated raising capital during this period, which in turn facilitated being awarded a greater number of advertisements, as advertisers gained confidence in Salon's survivability. The resurgence of the Internet ad market positively influenced Salon, as 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 which in turn caused the net cash used in operations to decrease to $0.8 million for the year ended March 31, 2005. This trend has continued for the year ended March 31, 2006 as the cash used in operations decreased to $0.6 million. 33 SALON MEDIA GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) As a result of the cash used in operations, $0.4 million from financing activities and the use of $0.1 million for capital expenditures, Salon's available cash at March 31, 2006 was $0.4 million. Subsequent to March 31, 2006, Salon received $0.6 million from the exercise of warrants to purchase 9.8 million shares of common stock. The investors included John Warnock, a Director of Salon, William Hambrecht, the father of Elizabeth Hambrecht, Salon's CEO and President, and two entities that William Hambrecht and Elizabeth Hambrecht have an ownership interest in. Based on cash proceeds from the exercise of warrants subsequent to March 31, 2006 and forecasted trade receivable receipts, cash payments, advertising revenues of a potential high of $5.4 million and total revenues of a potential high of $8.1 million, Salon estimates that its cash on hand may be $0.1 million at March 31, 2007. Due to seasonality of advertising sales, Salon forecasts that it will sustain a cash deficit of approximately $0.1 million by July 2006 that will increase to an expected high of approximately $0.4 million by October 2006 before diminishing. If the anticipated revenue expectations are not met, Salon's cash on hand could be significantly less. To address the projected shortfall, Salon has received commitments from two investors, one of which is a Director of Salon and the other is the father of Salon's CEO and President, to provide Salon with approximately $0.4 million in cash in July 2006 from the exercise of an outstanding warrant and from the purchase of Series D preferred stock. There is no certainty that Salon will be able to attain any of the above mentioned projected revenue amounts. If anticipated cash balances are not realized, Salon may need to raise additional working capital. Salon may secure additional working capital from: (1) the exercise of outstanding warrants, (2) the sale of 1,042 authorized and unissued shares of Series D preferred stock as of this filing, (3) selling the Well, or (4) the issuance of securities to a strategic investor. Salon has outstanding warrants that expire between the date of this filing and March 31, 2007, from which Salon estimates it could potentially receive cash of up to $0.8 million from their exercise. However, with the exception of a commitment to exercise a warrant for approximately $0.1 million subsequent to this filing, the actual amount could be considerably less, or nothing at all, as the terms of the warrants allow for cashless exercise. Except for a commitment by the two investors noted above to purchase approximately $0.3 million of Series D preferred stock, the potential to raise additional working capital from the issuance of additional shares of currently authorized shares of Series D preferred stock, though viable, is not certain. In addition, Salon may explore amending the "Securities Purchase Agreement", as amended to date, 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) to allow for the sale of additional shares of Series D than the 1,042 currently authorized and unissued as of this filing. There is no certainty that Salon will be able to amend these documents or sell any such additional shares. Salon is currently attempting to sell The Well, an on-line community it purchased in 1999. As of this filing, Salon has not found a suitable buyer for this asset, which has a book value of approximately $0.2 million, most of which is goodwill. The potential sale of The Well is not primarily driven by a need to generate cash to finance Salon's operations, but is intended to free management to concentrate on Salon's core operations. 34 SALON MEDIA GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) From time to time, Salon has explored the possibilities of aligning itself with a strategic investor, a strategic partner, or being acquired by a third party. Though these possibilities exist, there is no certainty that any of these alternatives may come to fruition. Principles of consolidation The consolidated financial statements include the accounts of Salon and its wholly owned subsidiaries, which are not active. All material intercompany accounts and transactions have been eliminated in the consolidated financial statements. Segment and enterprise-wide reporting Salon discloses segment enterprise-wide information in accordance with Statement of Financial Accounting Standard (SFAS) SFAS No.131 "Disclosures about Segments of Enterprises and Related Information." Based upon definitions contained within SFAS No. 131, management has determined that Salon operates in one segment. In addition, virtually all revenues are in North America, and all of the long-lived assets are located within the United States. Use of estimates The preparation of financial statements in conformity with generally accepted accounting principles 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. Accounts receivable Accounts receivable are stated net of doubtful accounts. Salon estimates the uncollectibility of the accounts receivable balance and maintains allowances for estimated losses. Salon analyzes accounts receivable, historical bad debts, receivable aging, customer credit-worthiness, and current economic trends when evaluating the adequacy of the allowance for doubtful accounts. Property and equipment Property and equipment are recorded at cost. Maintenance, repairs and minor renewals are expensed as incurred. Depreciation is provided on a straight-line basis over the useful lives of the asset, principally three years for computer hardware and software, and five years for furniture and office equipment. Depreciation of leasehold improvements is provided on a straight-line basis over the useful life of the asset or the term of the lease, whichever is shorter. When property and equipment is retired or otherwise disposed of, the cost and accumulated depreciation are relieved from the accounts and the net gain or loss is included in the determination of income. Prepaid advertising rights Prepaid advertising rights are carried at cost less accumulated amortization, with amortization commensurate to the usage of such rights, and expire on December 31, 2009. 35 SALON MEDIA GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) Goodwill and intangible assets Goodwill is not amortized, but instead is tested for impairment at least annually during the quarter ending March 31, or earlier as warranted by events or changes in circumstances. Intangible assets are amortized over their respective estimated useful lives. Impairment of long-lived assets Salon periodically evaluates the potential impairment of its long-lived assets whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. At the occurrence of an event or change in circumstances, Salon evaluates the potential impairment of an asset based on the estimated future undiscounted cash flows attributable to such assets. In the event impairment exists, Salon will measure the amount of such impairment based on the present value of the estimated future cash flows using a discount rate commensurate with the risks involved. Revenue recognition Salon's revenues are primarily from the sale of advertising space on its Website and the sale of subscriptions to individuals. Salon recognizes advertising revenue once persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collectibility is reasonably assured. Revenues are recognized ratably in the period over which Salon's obligations are fulfilled. Payments received before Salon's obligations are fulfilled are classified as "Deferred revenue" in Salon's consolidated balance sheet. Advertisement sales agreements are generally short-term agreements, usually less than ninety days. Revenues derived from such arrangements are recognized during the period the advertising space is provided, as long as no significant obligations remain at the end of the period. Salon's obligations may include a fixed number of days that a Salon Site Pass advertisement is run, the guarantee of a minimum number of times that an advertisement appears in a page viewed by a visitor to Salon's Website, or a set number of Site Pass advertisements viewed by a Website visitor. To the extent the minimum guaranteed amounts are not delivered, Salon defers recognition of the corresponding revenue until the remaining guaranteed amounts are achieved, if mutually agreeable with an advertiser. If these "make good" impressions are not agreeable to an advertiser, no further revenue is recognized. Revenue from Salon's subscription services, which includes Salon Premium, The Well and Table Talk, is recognized ratably over the subscription period. Subscription revenues from Table Talk were eliminated during the year ended March 31, 2005 and became a no-cost benefit to Salon Premium subscribers. Salon Premium subscriptions are generally for one month or one year periods. Well subscriptions are generally only for one month. Advertising costs Salon expenses advertising costs as they are incurred. Advertising expense was $271, $471, and $1,056, for the fiscal years ended March 31, 2006, 2005, and 2004. 36 SALON MEDIA GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) Comprehensive loss Comprehensive loss is defined as the change in equity of a business enterprise during a period from non-owner sources. There were no differences between the net loss for the years ended March 31, 2006, 2005 and 2004 and comprehensive loss for those periods. Financial instruments The carrying amounts of Salon's financial instruments, including cash and cash equivalents, accounts receivable, and accounts payable, approximate fair value because of their short maturities. Fair value of capital lease obligations, if any, approximates carrying value since they bear interest at current market rates. Income taxes Salon recognizes deferred taxes by the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred income taxes are recognized for differences between the financial statement and tax basis of assets and liabilities at enacted statutory tax rates in effect for the years in which the differences are expected to reverse. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. Concentrations of credit risk Financial instruments that potentially subject Salon to concentrations of credit risk consist principally of trade accounts receivable. Salon performs ongoing credit evaluations of its customers, but does not require collateral. Salon provides an allowance for credit losses that it periodically adjusts to reflect management's expectations of future losses. One customer accounted for 11% of total trade accounts receivable at March 31, 2006 and two customers accounted for 19% and 15%, respectively, of total trade accounts receivable at March 31, 2005. Two customers accounted for 20% and 12%, respectively, of total trade accounts receivable at March 31, 2004. No customer accounted for 10% or more of total revenue for the fiscal years ended March 31, 2006, 2005 and 2004 respectively. Stock-based compensation Salon accounts for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board (APB) Opinion No. 25 and Financial Accounting Standards Board (FASB) Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation - an Interpretation of APB No. 25" (FIN 44), and complies with the disclosure provisions of Statement of Financial Accounting Standard (SFAS) 123, as amended by SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure-amendment to FASB Statement No. 123, Accounting for Stock-Based Compensation." Under APB 25, compensation expense is based on the difference, if any, on the date of the grant, between the fair value of Salon's stock and the exercise price. Salon accounts for stock issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force (EITF) Issue No. 96-18, "Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling Goods or Services." If Salon's 37 SALON MEDIA GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) compensation expense under its stock option plan had been determined pursuant to SFAS 123, Salon's net loss and net loss per share would have been as follows:
Year Ended March 31, -------------------------------------- 2006 2005 2004 ---------- ---------- ---------- (Restated) (Restated) ---------- ---------- ---------- Net loss attributable to common stockholders: As reported (Restated) $ (1,349) $ (358) $ (6,982) 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 (2,321) (1,390) (219) ---------- ---------- ---------- Pro forma net loss attributable to common stockholders (Restated) $ (3,670) $ (1,748) $ (7,201) ========== ========== ========== Basic and diluted net loss per share attributable common stockholders: As reported (Restated) $ (0.08) $ (0.02) $ (0.50) Pro forma net loss per share (Restated) $ (0.23) $ (0.12) $ (0.51)
The fair value of the options was estimated at the date of grant using the Black-Scholes option-pricing model. No options were granted during the year ended March 31, 2004. Salon determined the estimated fair value of its options granted for the years ended March 31, 2006, and 2005, using the following assumptions: Year Ended March 31, -------------------------------------------- 2006 2005 2004 ------------ ------------ ------------ Risk-free interest rates 3.80 - 4.30% 3.40% N/A Expected lives (in years) 4 4 N/A Expected volatility 120% 120% N/A Dividend yield 0.0% 0.0% N/A The weighted average grant date fair value per share of options granted during the years ended March 31, 2006, 2005, and 2004 was $0.19, $0.11 and none, respectively. 38 SALON MEDIA GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) 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:
Year Ended March 31, ----------------------------------------------- 2006 2005 2004 ------------- ------------- ------------- (Restated) (Restated) ------------- ------------- ------------- Numerator: Net loss attributable to common stockholders (Restated) $ (1,349) $ (358) $ (6,982) ============= ============= ============= Denominator: Weighted average shares outstanding 16,188,000 14,390,000 14,155,000 Weighted average shares held in escrow 0 0 (56,000) ------------- ------------- ------------- Weighted average shares used in computing basic and diluted net loss per share attributable to common stockholders 16,188,000 14,390,000 14,099,000 ============= ============= ============= Basic and diluted net loss per share attributable to common stockholders (Restated) $ (0.08) $ (0.02) $ (0.50) ============= ============= ============= Antidilutive securities including options, warrants and convertible preferred stock not included in loss per share calculation 237,979,000 232,006,000 199,312,000 ============= ============= =============
Recent accounting pronouncements In December 2004, the FASB issued 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 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 use upon adoption of SFAS 123R, 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 two alternative transition methods: the Modified Prospective Application, which allows for the adoption of SFAS 123R without restatement of prior annual 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 39 SALON MEDIA GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) 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 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. In May 2005, the FASB issued SFAS 154 "Accounting Changes and Error Corrections." which replaces APB Opinion No. 20 "Accounting Changes" and SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements--An Amendment of APB Opinion No. 20." SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. Specifically, this statement requires "retrospective application" of the direct effect for a voluntary change in accounting principle to prior periods' financial statements, if it is practicable to do so. SFAS 154 also strictly redefines the term "restatement" to mean the correction of an error by revising previously issued financial statements. SFAS 154 replaces APB No. 20, which requires that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. SFAS 154 is effective for accounting changes and correction of errors made in fiscal years beginning after December 15, 2005 and is required to be adopted by Salon in the first quarter of fiscal 2007. Salon does not currently believe adoption will have a material impact on its results of operations, financial position or cash flows. Note 3. Balance Sheet Components
Year Ended March 31, -------------------------------------- 2006 2005 2004 ---------- ---------- ---------- Accounts receivable, net: Accounts receivable $ 532 $ 653 $ 336 Less: allowance for doubtful accounts (30) (30) (30) ---------- ---------- ---------- $ 502 $ 623 $ 306 ========== ========== ========== Prepaid expenses and other current assets Prepaid lease termination fees $ - $ - $ 192 Receivable from employees 48 89 92 Prepaid expenses 40 88 79 Short-term deposits 96 54 49 Other receivables - 1 20 ---------- ---------- ---------- $ 184 $ 232 $ 432 ========== ========== ==========
40 SALON MEDIA GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data)
Year Ended March 31, -------------------------------------- Balance sheet components (continued) 2006 2005 2004 ---------- ---------- ---------- Property and equipment, net Computer hardware and software $ 1,263 $ 1,316 $ 1,392 Leasehold improvements 67 67 34 Furniture and office equipment 242 243 258 ---------- ---------- ---------- 1,572 1,626 1,684 Less: accumulated depreciation (1,417) (1,435) (1,595) ---------- ---------- ---------- $ 155 $ 191 $ 89 ========== ========== ========== Other assets Long-term deposits $ 104 $ 167 $ 65 Other - - 52 ---------- ---------- ---------- $ 104 $ 167 $ 117 ========== ========== ========== Accounts payable and accrued liabilities Accounts payable $ 253 $ 216 $ 348 Salaries and wages payable 290 270 162 Accrued services 88 92 68 Reserve for claims 75 151 181 Rent expense normalization - - 302 Other accrued expenses 41 59 64 ---------- ---------- ---------- $ 747 $ 788 $ 1,125 ========== ========== ==========
Depreciation expense for the years ended March 31, 2006, 2005 and 2004 was $88, $115, and $347 respectively. Note 4. Employee Stock Purchase Plan The Salon.com, Inc. 1999 Employee Stock Purchase Plan (the "ESPP") was established to provide substantially all employees whose customary employment is more than 20 hours per week for more than five months in any calendar year, eligibility to purchase shares of its common stock through payroll deductions, up to 10% of eligible compensation. The purchase price of each share of stock to be acquired is established at the discretion of Salon's Board of Directors, but in no event shall the price be set at the lesser of 85% of the fair market value of shares on either the first day or the last day of the designated payroll deduction period (the Offering Period), as chosen by the Board of Directors at its discretion, whichever is lower. The ESPP operation was suspended on March 1, 2001. The aggregate number of shares purchased by an employee may not exceed 2,000 shares in any one Offering Period, generally six months 41 SALON MEDIA GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) (subject to limitations imposed by the Internal Revenue Code). A total of 500,000 shares are available for purchase under the ESPP. Note 5. 401(k) Savings Plan Salon's 401(k) Savings Plan (the "401(k) Plan") is a defined contribution retirement plan intended to qualify under Sections 401(a) and 401(k) of the Internal Revenue Code. All full-time employees of Salon are eligible to participate in the 401(k) Plan pursuant to its terms. Participants may contribute from 1% to 20% of compensation, subject to statutory limitations. Employer matching contributions are discretionary based on a certain percentage of a participant's contributions as determined by management of Salon. Salon has not made any discretionary contributions to the 401(k) Plan through March 31, 2006. Note 6. Bank Line of Credit In October 2002, Salon entered into an Accounts Receivable Purchase Agreement with a bank. Under the terms of the agreement, the bank could make advances of 60% or 80% of the face value of acceptable receivables from Salon, depending on the nature of the receivable. The aggregate advances on receivables outstanding under the agreement could not exceed $1,000, however the amount was capped at $300 until such time as Salon had $2,500 of unrestricted cash. Amounts advanced under this agreement accrued interest at prime plus 1% per annum on the average daily balance outstanding and were subject to a fee of 1.25% per month on the average daily balance outstanding. Upon collection of the outstanding receivable used as collateral for the advance, the corresponding advance was paid back to the bank along with applicable fees. As part of the agreement, Salon issued 37,500 warrants to the bank. The warrants were valued at an immaterial amount using the Black-Scholes option-pricing model, applying a contractual life of seven years, a weighted average risk-free rate of 4.375%, an expected dividend yield of 0%, a volatility of 120% and a deemed fair value of common stock of seven cents. During the year ended March 31, 2003, Salon borrowed and repaid $82 leaving no amounts owed at the end of the year. During the year ended March 31, 2004, Salon borrowed and repaid $182. The agreement expired in January 2004 with no amounts owed and was not renewed. Note 7. Related Party Transactions On October 10, 2000, Salon loaned its Chairman $75 with an agreed 6.3% annual interest rate with no due date. A balance of $48 remains outstanding as of March 31, 2006 and is included as a component of "Prepaid expenses and other current assets" in Salon's Consolidated Balance Sheets. During the year ended March 31, 2006, $45 of interest and principal was paid to Salon. From July 24, 2002 through December 31, 2003 Salon issued $4,227 of promissory and convertible promissory notes to various investors and issued warrants to purchase 10,146,036 shares of common stock. The promissory notes were converted to 5,493 shares of Series C preferred stock in December 2003. 42 SALON MEDIA GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) Related parties pertaining to the issuance of notes were comprised of the following:
Promissory Series C Note Warrants Shares Name Amount Issued Issued - ------------------------------------------ ------------ ------------ ------------ The Hambrecht 1980 Revocable Trust $ 50 150,000 64 WR Hambrecht + Co., LLC 50 150,000 64 The Sarah & William Hambrecht Foundation 80 40,107 108 HAMCO Capital Corporation 100 300,000 127 Ironstone Group, Inc 650 1,950,000 843 ------------ ------------ ------------ Total William Hambrecht related entities 930 2,590,107 1,206 John Warnock 2,199 5,649,345 2,849 Wenner Media LLC 200 600,000 250 Robert McKay 117 58,423 158 Brian Dougherty 50 25,000 67 Elizabeth Hambrecht 25 75,000 31 ------------ ------------ ------------ Total all $ 3,521 8,997,875 4,561 ============ ============ ============
Elizabeth Hambrecht has an ownership interest in WR Hambrecht + Co., LLC and in HAMCO Capital Corporation. William Hambrecht has an ownership interest in HAMCO Capital Corporation and Ironstone Group, Inc. Jann Wenner, who served as a Director of Salon from January 2004 through February 2006, has a controlling interest and is the Chairman and President of Wenner Media LLC. Robert McKay is a Director of Salon. Brian Dougherty served as a Director of Salon until April 2003. In addition to converting promissory notes to shares of Series C preferred stock in December 2003, Salon received $500 from Director John Warnock for which Salon issued 625 shares of Series C preferred stock and granted warrants to purchase 1,500,000 shares of common stock. In February 2004, Salon issued 125 shares of Series C preferred stock and warrants to purchase 300,000 shares of common stock to The Hambrecht 1980 Revocable Trust and issued 125 shares of Series C preferred stock and warrants to purchase 300,000 shares of common stock to WR Hambrecht + Co, Inc. In December 2003, Wenner Media LLC received a warrant to purchase 2,600,000 shares of common stock, of which 2,000,000 was part of an editorial collaboration agreement. Former Salon director Jann Wenner is the Chairman and President of Wenner Media LLC. During the years ended March 31, 2006 and March 31, 2005, Salon received $4 and $17 respectively, from Wenner Media for editorial collaboration. 43 SALON MEDIA GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) On June 4, 2004, September 30, 2004 and February 2, 2005, Salon issued a total of 834 shares of Series D preferred stock and warrants to purchase 1,489,457 shares of common stock. The related parties in these transactions were: Series D Shares Warrants Purchase Name Issued Issued Price - ---------------------------------------- ---------- ---------- ---------- The Hambrecht 1980 Revocable Trust $ 334 590,216 401 HAMCO Capital Corporation 63 115,653 76 ---------- ---------- ---------- Total William Hambrecht related entities 397 705,869 477 John Warnock 416 742,943 499 ---------- ---------- ---------- Total all $ 813 1,448,812 976 ========== ========== ========== During the year ended March 31, 2006, John Warnock, a Director of Salon, exercised the following outstanding warrants and received common stock of Salon: Date Number Exercise Cash Received Exercised Of Shares Price per share by Salon - ----------------------------------------------------------------------------- 5/24/2005 99,345 0.08979801 9 1/23/2006 150,000 0.04505918 6 1/23/2006 300,000 0.04168543 13 1/23/2006 300,000 0.04168543 13 -------------- -------------- 849,345 41 ============== ============== Brian Dougherty, a former Director of Salon, exercised a warrant on May 17, 2005 for 25,000 shares of common stock for which Salon received $2. On July 20, 2005, Robert McKay, a Director of Salon, through the Elaine McKay Family Partnership, exercised a warrant for 58,423 shares of common stock for which Salon received $5. The Sarah and William Hambrecht Foundation, for which William Hambrecht and Elizabeth Hambrecht, Salon's CEO and President and daughter of William Hambrecht serve as Directors, exercised a warrant on July 22, 2006 for 40,107 shares of common stock for which Salon received $4. On each of February 7, 2006, March 7, 2006 and March 20, 2006, Ironstone Group, Inc. converted warrants for 300,000 shares of common stock to 262,450, 255,337 and 249,977 shares of common stock for which Salon received no cash. William Hambrecht has an ownership interest in Ironstone Group, Inc. On October 7, 2005, Michael O'Donnell, a former CEO and President of Salon, converted a warrant for 1,000,000 shares of common stock to 642,857 shares of common stock for which Salon received no cash. 44 SALON MEDIA GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) Note 8. Commitments and Contingencies Salon has a non-cancelable operating lease agreement for its office space in San Francisco, CA that expires in February 2009, for its office in New York, NY that expires in May 2006, for its office in Washington, D.C. that expires in May 2007 and to host its servers in San Francisco, CA that expires in September 2007. Rent expense under operating lease agreements was $396, $634, and $625, for the years ended March 31, 2006, 2005, and 2004, respectively. In May 2003, Salon subleased its former office in New York. The sublease agreement, which expired in December 2004, resulted in a charge to rent expense of $180 that was included in Salon's results of operations for the year ended March 31, 2004. Salon has no capital leases as of March 31, 2006. Total future minimum rental payments under capital leases and non-cancelable operating leases in effect at March 31, 2006 are as follows: Operating Year Ending March 31, Leases ------------- 2007 $ 308 2008 262 2009 229 2010 - ------------- Total lease payments 799 ============= Subsequent to March 31, 2006, Salon extended its lease agreement for its office in New York to expire in May 2007. Salon, as permitted under Delaware law and in accordance with its Bylaws, indemnifies its officers and directors for certain events or occurrences, subject to certain limits, while the officer is or was serving at Salon's request in such capacity. The term of the indemnification period is for the officer's or director's lifetime. The maximum amount of potential future indemnification is unlimited; however, Salon does have a Director and Officer Insurance Policy that limits Salon's exposure and enables Salon to recover a portion of any future amounts paid. As a result of the insurance policy coverage, Salon believes the fair value of these indemnification agreements is minimal. Note 9. Goodwill and Intangible Assets In accordance with FASB No. 142, "Goodwill and Other Intangible Assets" (SFAS No. 142), goodwill amortization was discontinued as of March 31, 2002. The carrying value of goodwill at March 31, 2006 and March 31, 2005 was $200 and has been found not to be impaired. 45 SALON MEDIA GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) The following table sets forth information concerning Salon's intangible assets as of March 31, 2006, 2005 and 2004:
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 ========== ========== ==========
Note 10. Income Taxes Salon has not recorded a provision or benefit for federal or state income taxes for any period since inception due to incurring operating losses. At March 31, 2006, Salon has net operating loss carry-forwards of $64,075 and $33,137 for Federal and California purposes, respectively, available to reduce future taxable income, if any. During the year ended March 31, 2006, $375 of California net operating loss carry-forwards expired and additional $1,297 is due to expire as of March 31, 2007, with the balance expiring over time thereafter if not utilized beforehand. The federal net operating loss carry-forwards begin to expire on March 31, 2016 if not utilized beforehand. At March 31, 2006, Salon has research and development credit carry-forwards of $12 and $9 for Federal and California income tax purposes, respectively. The research and development credit carry-forwards expire beginning in the year 2011. The Tax Reform Act of 1986 limits the use of net operating loss and tax credit carry-forwards in certain situations where changes occur in the stock ownership of a company. In the event Salon has incurred a change in ownership, utilization of the carry-forwards could be significantly restricted. Temporary differences and other sources of deferred tax assets that give rise to significant portions of deferred tax assets and liabilities are as follows: Year Ended March 31, -------------------------------- 2006 2005 2004 -------- -------- -------- Net operating losses $ 23,719 $ 23,274 $ 22,496 Other 1,309 1,483 1,702 -------- -------- -------- Total deferred tax assets 25,028 24,757 24,198 Valuation allowance (25,028) (24,757) (24,198) -------- -------- -------- Net deferred tax asset$ $ - $ - $ - ======== ======== ======== 46 SALON MEDIA GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) Due to the uncertainty of realizing the benefits attributable to the aforementioned deferred tax assets, Salon has provided a valuation allowance against the net deferred tax assets. The difference between Salon's effective income tax rate and the federal statutory (34%) rate is as follows: Year Ended March 31, -------------------------------- 2006 2005 2004 -------- -------- -------- Statutory tax benefit $ (735) $ (122) $ (2,945) State taxes, net of federal benefit (126) (21) (505) Permanent differences 493 (244) 1,608 Other 97 (172) 330 -------- -------- -------- Total (271) (559) (1,512) Change in valuation allowance 271 559 1,512 -------- -------- -------- $ - $ - $ - ======== ======== ======== Note 11. Employee Stock Option Plan Salon has two stock option plans approved by shareholders. The Salon Internet, Inc. 1995 Stock Option Plan (the 1995 Plan) was terminated in November 2004 and the Salon Media Group, Inc. 2004 Stock Plan (the 2004 Plan) that was approved by Salon's stockholders in November 2004 (the Plans). In October 2005, Salon's stockholders approved an amendment to the 2004 Plan to increase the maximum number of shares of common stock that may be issued under the plan by 16,000,000 to a total of 46,000,000. Under the 2004 Plan, incentive and nonqualified stock options may be granted to officers, employees, directors and consultants of Salon. Options generally vest over periods of one to four years and have terms of ten years. However, in the case of 20,910,000 options granted on February 7, 2005 and 7,641,000 options granted on May 16, 2005, half vested on the date of grant, and the remaining half vested on February 7, 2006. The exercise price of options is determined by the Board of Directors and is generally at least equal to the fair market value of the stock on the grant date. On February 7, 2005, Salon granted its Chairman 1,000,000 options from a plan not approved by shareholders. At March 31, 2006 and 2005, Salon had 17,364,000 and 9,090,000 shares of common stock authorized and available for grants under the 2004 Plan and at March 31, 2004 had 3,336,000 shares of common stock authorized and available for grants under the 1995 Plan. 47 SALON MEDIA GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) The following table summarizes activity under Salon's Plans from March 31, 2003 through March 31, 2006: Weighted Average Number of Exercise shares Price ----------- ----------- Balance March 31, 2003 6,136,000 $ 1.62 Options granted - $ - Options terminated (2,185,000) $ 1.83 Options exercised - $ - ----------- Balance March 31, 2004 3,951,000 $ 1.50 Options granted 21,910,000 $ 0.14 Options terminated (663,000) $ 1.27 Options exercised (399,000) $ 0.14 ----------- Balance March 31, 2005 24,799,000 $ 0.33 Options granted 10,792,000 $ 0.24 Options terminated (3,533,000) $ 0.33 Options exercised (520,000) $ 0.14 ----------- Balance March 31, 2006 31,538,000 $ 0.30 =========== The following table summarizes information about stock options outstanding at March 31, 2006:
Options Outstanding Options Exercisable ---------------------------------------------- ----------------------------- Weighted Average Weighted Weighted Number of Remaining Average Number of Average Range of Shares Contractual Exercise Shares Exercise Exercise Prices Outstanding Life (Years) Price Exercisable Price ----------------- ---------------- ------------- ------------ --------------- ----------- $0.06 - $ 0.06 8,000 6.5 $ 0.06 7,000 $ 0.06 $0.12 - $ 0.14 22,384,000 8.7 0.14 20,766,000 0.14 $0.19 - $ 0.26 7,191,000 8.9 0.26 6,840,000 0.26 $0.32 - $ 0.37 1,269,000 8.0 0.36 455,000 0.36 $0.52 - $ 0.52 18,000 2.6 0.52 18,000 0.52 $1.38 - $ 2.00 257,000 4.4 1.88 257,000 1.88 $2.92 - $ 3.63 40,000 3.0 2.96 40,000 2.96 $5.06 - $ 5.25 30,000 3.6 5.22 30,000 5.22 $8.50 - $10.06 341,000 3.4 9.67 341,000 9.67 --------------- --------------- 31,538,000 8.6 $ 0.30 28,754,000 $ 0.31 =============== ===============
At March 31, 2005 and 2004 options to purchase 13,605,000 and 3,061,000 shares of common stock, respectively, were exercisable. 48 SALON MEDIA GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) Note 12. Stockholders' Equity Preferred stock Salon has 5,000,000 shares of preferred stock, authorized in April 1999, whose preferences, rights and privileges may be amended by the Board of Directors and by no less than a majority vote by each series of A, B, C or D preferred stock. A summary of the series of shares of preferred stock that Salon has outstanding, corresponding warrants issued, and common stock equivalents, follows as of March 31, 2006:
Warrants Outstanding Conversion Common Per Share Exercise Rate to Equivalent Series Shares Price Number Price (1) Common (2) Shares - -------- ---------- --------- ------------- ----------- ----------- -------------- A(3,4) 808 $4,000 6,272,000 $0.10942 0.09957 32,459,897 B 125 $4,000 1,414,827 $0.08980 0.08003 6,247,750 C(3,5) 6,582 $800 2,700,000 $0.03450 0.04000 131,640,000 D-1 417 $1,200 807,095 $0.13742 0.09300 5,380,642 D-2 208 $1,200 340,363 $0.12650 0.11000 2,269,090 D-2 209 $1,200 341,999 $0.16100 0.11000 2,279,999 D-3 209 $1,200 404,516 $0.54050 0.09300 2,696,774 ---------- ------------- -------------- D total 1,043 1,893,973 12,626,505 ---------- ------------- -------------- 8,558 12,280,800 182,974,152 ========== ============= ==============
(1) Exercise Prices of Series A, B and D-1 have been adjusted as of March 31, 2006 pursuant to an antidilution provision of the underlying security. (2) Rates of conversion to common stock of the Series A and B preferred stock has been adjusted as of March 31, 2006 pursuant to an antidilution provision of the underlying security. (3) Reflects conversion by an investor in January 2006 of one share Series A preferred stock to 40,173 shares of common stock and thirty-six shares of Series C preferred stock to 720,000 shares of common stock. (4) Subsequent to March 31, 2006 warrants to purchase 1,600,000 share of common stock were exercised by two investors. One of the investors was a foundation in which Salon's CEO and president serves as a Director. (5) Subsequent to March 31, 2006 warrants to purchase 1,800,000 share of common stock were exercised by two investors. The investors included a Director of Salon and the father of Salon's CEO and President. As of March 31, 2006, the Purchase Agreement, as amended, and the Certificate of Designation of Preferences and Rights of the Series D-1, D-2, D-3, D-4 and D-5, collectively "Series D," preferred stock allow the sale and issuance of an additional 1,042 shares of Series D preferred stock and stipulate that the conversion price to common stock be equal to 70% of the average closing price of Salon's common stock for the thirty days prior to the date the Series D preferred offering is made. 49 SALON MEDIA GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) The holders of the Series A, B, and C preferred stock are entitled dividends of 8.0%, as and if declared by the Board of Directors, and the holders of the Series D preferred stock are entitled dividends of 5.0%, as and if declared by the Board of Directors. As of March 31, 2006, no cash dividend has been declared or paid. In event of a liquidation occurrence, the holders of Series D preferred stock and the holders of the Series C preferred stock rank in parity, and are entitled to receive, prior and in preference to any distribution of any assets or property of Salon to the holders of common stock, Series A and B preferred stock. The holders of Series D preferred stock are entitled to an amount per share equal to $1,200 plus an amount equal to all declared but unpaid dividends, and in the case of the Series C Preferred Stock, $1,600 per share, plus an amount equal to all declared but unpaid dividends. If the assets and funds available for distribution are insufficient to permit the payment to the holders of Series C and D Preferred Stock of their full preferential amounts, then the entire assets and funds of Salon legally available for distribution to stockholders is to be distributed among the holders of Series C and D Preferred Stock ratably in proportion to the full preferential amounts which they are entitled to receive. After an initial distribution to the holders of Series C and D preferred stock, the holders of the Series A and B preferred stock, who rank in parity, are entitled to receive, prior and in preference to any distribution of any assets or property of Salon to the holders of common stock, an amount per share equal to $8,000 plus an amount equal to all declared but unpaid dividends. If, after the initial distribution to holders of Series C and D Preferred Stock, the remaining assets and funds available for distribution are insufficient to permit the payment to the holders of Series A and B preferred stock of the full preferential amounts, then the entire remaining assets and funds of Salon legally available for distribution to stockholders will be distributed among the holders of Series A and B preferred stock ratably in proportion to the full preferential amounts which they are entitled to receive. If, after initial preferential liquidation payments to the holders of Series A, B, C and D preferred stock holders, any assets remain available for distribution, such assets are to be distributed ratably among the holders of common stock and preferred stock, based on to the shares of common stock then held by them and issuable upon conversion of the shares of preferred stock then held by them until aggregate distributions per share reach $12,000 for the holders of Series A and B preferred stock, $2,400 for the holders of Series C preferred stock and $3,600 for the holders of Series D preferred stock. If, after payment has been made to the holders of common stock and holders of preferred stock mentioned above, any assets remain available for distribution, such assets are to be distributed ratably among the holders of common stock and the holders of Series C preferred stock, based on the number of shares of common stock then held by them and issuable upon conversion of the Series C preferred stock then held by them. The holders of Series C Preferred Stock hold approximately 87% of this group of securities. The holders of preferred stock are entitled to vote together with the holders of Salon's common stock as though part of that class, and are entitled to vote on all matters and to that number of votes equal to the largest number of whole shares of common stock into which the shares of preferred stock could be converted. Subsequent to March 31, 2006, the preferred stockholders as a group control approximately 95% of all voting securities of Salon. The aggregate liquidation preferences of all preferred stockholders as of March 31, 2006 were $19,247 excluding the effect of undeclared dividends, and $21,655 including the effect of undeclared 50 SALON MEDIA GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) dividends. The aggregate liquidation preferences of all preferred stockholders as of March 31, 2005 were $19,062 excluding the effect of undeclared dividends, and $20,686 including the effect of undeclared dividends. On November 22, 2005, Salon amended its Certificate of Incorporation to increase the number of authorized shares of common stock from 50,000,000 shares to 600,000,000 thereby allowing the holders of all series of preferred stockholders, at their option, to convert their shares to common stock at any time. Prior to that date, only the holders of Series A and B could convert their shares of preferred stock to common stock. As of March 31, 2006, one share of Series A preferred stock was converted to 40,173 shares of common stock and 36 shares of Series C preferred stock was converted to 720,000 shares of common stock. No shares of preferred stock were converted to common stock in prior years. The Series A, B, C and D preferred stock conversion price is subject to a downward adjustment anti-dilution provision under certain circumstances related to subsequent Salon stock issuances. The effect of this provision through March 31, 2006, has been to reduce the Series A conversion rate from an original 0.25 to 0.09957, and the series B conversion rate from an original 0.1767 to 0.08003. The exercise price of warrants issued in conjunction with the issuance of Series A, B, C and D are also subject to a downward adjustment anti-dilution provision under certain circumstances related to subsequent Salon warrant issuances. The effect of this provision through March 31, 2006, was to reduce the per share exercise price of warrants issued to Series A preferred stockholders from an original $0.2875 to $0.10942, the series B conversion price from an original $0.21 to $0.08980, and the Series D-1 shares issued on June 4, 2004 from an original $0.13800 to $0.13742. Salon issued 500 shares of Series C preferred stock during the year ended March 31, 2004, 417 shares of Series D-1 and 417 shares of Series D-2 during the year ended March 31, 2005 and 209 shares of Series D-3 during the year ended March 31, 2006. All such shares issued were in the money on their respective commitment dates, and the non-detachable conversion feature was also effective on the commitment date. The value of the beneficial conversion feature was $2,040 for the shares issued during the year ended March 31, 2004, $310 for the shares issued during the year ended March 31, 2005 and $1,040 for the shares issued during the year ended March 31, 2006. As the proportional consideration attributable to the shares issued during the years ended March 31, 2004 and March 31, 2006 was $361 and $227, respectively, a limiting factor of $1,679 and $813 was applied, and the value of the beneficial conversion feature was therefore limited to $361 and $227 for the years ended March 31, 2004 and March 31, 2006, respectively. As the proportional consideration attributable to the shares issued during the year ended March 31, 2005 was in excess of the value determined for the beneficial conversion feature, no such limiting factor was applicable that year. As a result, Salon recorded preferred deemed dividends, representing the value of the beneficial conversion feature, of $361, $310 and $227 for the years ended March 31, 2004, March 31, 2005 and March 31, 2006, respectively. The preferred deemed dividend charge of $310 in conjunction with a benefit of $470 from a change in value of warrants issued to preferred stockholders is reflected in the results of operations for the year ended March 31, 2005. The preferred deemed dividend charge of $361 in conjunction with a charge of $576 from a change in value of warrants issued to preferred stockholders is reflected is reflected in the results of operations for the year ended March 31, 2004. 51 SALON MEDIA GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) Neither the Series A, B, C or D preferred stock, the associated warrants, nor the underlying shares of common stock have been registered for sale under the Securities Act of 1933, as amended, and may not be offered or sold in the United States absent registration under such act or an applicable exemption from registration requirements. Stock warrants In September 1998, Salon issued warrants to purchase up to 220,000 shares of common stock at an exercise price of $0.52 per share in connection with the sale of pre-IPO Series C convertible preferred stock offering. Upon completion of the initial public offering, the warrant was converted to the right to purchase an equivalent number of Salon's common stock at the same exercise price per share. The warrants may be exercised at any time within 10 years after issuance and expire in September 2008. As of March 31, 2006, warrants to purchase 172,529 shares of common stock remain exercisable. In August 2001 and September 2001, Salon issued warrants to purchase a total of 6,472,000 shares of common stock in conjunction with the issuance of Series A preferred stock, all with a five year life. Due to an anti-dilution provision of the warrants, the exercise price of the warrants has been reduced to $0.10942 as of March 31, 2006. During the year ended March 31, 2006, a warrant to purchase 200,000 shares of common stock was converted to 112,464 shares of common stock under the net exercise provision of the warrant. Accordingly, Salon did not receive any cash consideration. Subsequent to March 31, 2006, two warrant to purchase 1,600,000 shares of common stock were exercised for which Salon received $175 in cash. One of the warrants was exercised by a foundation for which Salon's CEO and President serves as a Director. Subsequent to March 31, 2006, warrants to purchase 3,168,000 shares of common stock remain exercisable and expire on August 9, 2006 and warrants to purchase 1,504,000 shares of common stock remain exercisable and expire on September 13, 2006. In January 2002, Salon issued warrants to purchase 30,000 shares of common stock at an exercise price of $0.15 per share and a five year life. The warrants have not been exercised as of March 31, 2006. In March 2002, Salon issued a warrant to purchase 1,414,827 shares of common stock in conjunction with the issuance of Series B preferred stock. The warrant may be exercised at any time within five years and have not been exercised as of March 31, 2006. Due to an anti-dilution provision of the warrant, the exercise price of each warrant share has been reduced from $0.21 to $0.0898 as of March 31, 2006. In October 2002, Salon issued a warrant to purchase 37,500 shares of common stock at an exercise price of $0.05 per share with a seven year life. The subsequent issuance of Series C preferred stock triggered an anti-dilution provision of the warrant agreement, increasing the number of warrants to 44,285 and lowering the exercise price to $0.0431. The warrant has not been exercised as of March 31, 2007. In October 2003, Salon issued warrants to purchase 1,000,000 shares of common stock at an exercise price of $0.05 per share to its former President and Chief Executive Officer. Salon valued the warrant using the Black-Scholes option-pricing model, applying a contractual life of 2 years, a weighted average risk-free interest rate of 1.625%, an expected dividend yield of 0%, a volatility of 120% and a deemed fair value of common stock of $0.05. The fair market value of the warrant of $31 was amortized through Salon's fiscal year ending March 31, 2004 as a component of general and administrative expense 52 SALON MEDIA GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) in the Consolidated Statement of Operations. In October 2005, the warrant was converted to 642,857 shares of common stock in which Salon did not receive any cash consideration. In December 2003, Salon issued a warrant to purchase 2,600,000 shares of common stock with a three year life as part of an editorial collaboration agreement with a publisher and a convertible note. Due to an anti-dilution provision of the warrant, the exercise price of each warrant share has been reduced from $0.0575 to $0.04506 as of March 31, 2006. The Chairman and President of the publisher served as a Director of Salon from January 2004 through February 2006. The warrant has not been exercised as of March 31, 2006. In December 2003, Salon issued a warrant to purchase 1,500,000 shares of common stock at an initial exercise price of $0.0345 per share in conjunction with the issuance of 625 shares of Series C preferred stock. In addition, in February 2004, Salon issued three warrants to purchase 1,200,000 shares of common stock at an initial exercise price of $0.0345 per share in conjunction with the additional issuance of 500 shares of Series C preferred stock. These warrants have a five year life. Subsequent to March 31, 2006, the warrant originally issued in December 2003 was exercised by a Director of Salon for which Salon received $52 and a warrant to purchase 300,000 shares of common stock was exercised by the father of Salon's CEO and President for which Salon received $10. Subsequent to March 31, 2006 two warrants to purchase 900,000 shares of common stock remain outstanding that expire in February 2007. In June 2004, Salon issued warrants to purchase 807,095 shares of common stock in conjunction with the issuance of 417 shares Series D-1 preferred stock. As the transaction resulted in a $195 preferred deemed dividend in Salon's consolidated statement of operations for the year ended March 31, 2005, Salon valued the warrants using the Black-Scholes option-pricing model, applying a contractual life of 3 years, a weighted average risk-free interest rate of 3.19%, an expected dividend yield of 0%, a volatility of 120%, a deemed fair value of common stock of $0.12 and an exercise price of $0.138 per share. Subsequent to March 31, 2006, warrants to purchase 363,870 shares of common stock were exercised by two investors for which Salon received $50. The two investors included the father of Salon's CEO and President and an entity in which the father of Salon's CEO and President and Salon's CEO and President both have an ownership interest. Subsequent to March 31, 2006, warrants to purchase 443,225 shares of common stock remain outstanding. In September 2004, Salon issued a warrant to purchase 340,363 shares of common stock to a Director of Salon in conjunction with the issuance of 208 shares of Series D-2 preferred stock. As the transaction resulted in a $23 preferred deemed dividend in Salon's consolidated statement of operations for the year ended March 31, 2005, Salon valued the warrants using the Black-Scholes option-pricing model, applying a contractual life of 3 years, a weighted average risk-free interest rate of 2.792%, an expected dividend yield of 0%, a volatility of 120%, a deemed fair value of common stock of $0.11 and an exercise price of $0.1265 per share. This warrant has not been exercised as of March 31, 2006. In February 2005, Salon issued to two investors warrants to purchase 341,999 shares of common stock in conjunction with the issuance of an additional 209 shares of Series D-2 preferred stock. The investors included the father of Salon's CEO and President and an entity in which the father of Salon's CEO and President and Salon's CEO and President both have an ownership interest. As the transaction resulted in a $92 preferred deemed dividend in Salon's consolidated statement of operations for the year ended March 31, 2005, Salon valued the warrants using the Black-Scholes option-pricing model, applying 53 SALON MEDIA GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) a contractual life of 3 years, a weighted average risk-free interest rate of 3.327%, an expected dividend yield of 0%, a volatility of 120%, a deemed fair value of common stock of $0.14 and an exercise price of $0.161 per share. Subsequent to March 31, 2006, these warrants were exercised for which Salon received $55. In March 2005, Salon issued a warrant to purchase 600,000 shares of common stock at an exercise price of $0.27 per share to its former Senior Vice President-Business Operations. Salon valued the warrants using the Black-Scholes option-pricing model, applying a contractual life of 2 years, a weighted average risk-free interest rate of 3.75%, an expected dividend yield of 0%, a volatility of 120% and a deemed fair value of common stock of $0.27. The fair market value of the warrants of $100 was amortized through Salon's fiscal year ending March 31, 2005 as a component of Sales and marketing expense in the Consolidated Statement of Operations. The warrants may be exercised at any time within two years after issuance and expires in March 2007. The warrant has not been exercised as of March 31, 2006. From July 2002 through December 2003, Salon issued warrants to purchase 10,146,036 shares of common stock in conjunction with the issuance of convertible notes payable and a promissory note. Salon valued the warrants using the Black-Scholes option-pricing model, applying a contractual life of 3 years, a weighted average risk-free interest rate ranging from 1.625% to 2.75%, an expected dividend yield of 0%, a volatility of 120% and a deemed fair value of common stock ranging from $0.03 to $0.07 per share. The fair market value of the warrants of $324 was amortized during Salon's fiscal years ending March 31, 2003 and March 31, 2004 as a component of Interest and other expense in the Consolidated Statement of Operations. During the year ended March 31, 2006, warrants to purchase 1,027,541 shares of common stock were converted to 848,387 shares of common stock for which Salon did not receive any consideration under the net exercise provision of the warrant. Of the total warrants tendered for conversion, 900,000 was from an entity that the father of Salon's CEO and President has an ownership interest therein and were converted to 767,764 shares of common stock. In addition, warrants to purchase 1,274,480 shares of common stock were exercised for which Salon received $65 and a warrant to purchase 5,000 shares of common stock expired. Subsequent to March 31, 2006, warrants to purchase 1,344,015 shares of common stock were converted to 1,053,558 shares of common stock for which Salon did not receive any consideration under the net exercise provision of the warrant, and included an investor that the father of Salon's CEO and President has an ownership interest therein. In addition, subsequent to March 31, 2006, warrants to purchase 5,700,000 shares of common stock were exercised for which Salon received $248. The investors in these transactions included a Director of Salon, the father of Salon's CEO and President, and two entities that the father of Salon's CEO and President and Salon's CEO and President have an ownership interest therein. Subsequent to March 31, 2006, warrants to purchase 195,000 shares of common stock at an exercise price of $0.0345 per share and a warrant to purchase 600,000 shares of common stock, all issued in conjunction with the issuance of convertible notes payable, remain outstanding. In August 2005, Salon issued a warrant to purchase 400,000 shares of common stock as part of an employee separation agreement. Salon valued the warrants using the Black-Scholes option-pricing model, applying a contractual life of 1 year, a weighted average risk-free interest rate of 3.625%, an expected dividend yield of 0%, a volatility of 120% and a deemed fair value of common stock of $0.18. The fair market value of the warrants of $33 was amortized during Salon's fiscal year ending March 31, 2006 as a component of Information technology support in the Consolidated Statement of Operations. The warrant remains outstanding as of March 31, 2006. 54 SALON MEDIA GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (amounts in thousands, except share and per share data) In February 2006, Salon issued a warrant to purchase 100,000 shares of common stock to a consultant. Salon valued the warrants using the Black-Scholes option-pricing model, applying a contractual life of 2 years, a weighted average risk-free interest rate of 4.38%, an expected dividend yield of 0%, a volatility of 120% and a deemed fair value of common stock of $0.36. The fair market value of the warrants of $22 was amortized during Salon's fiscal year ending March 31, 2006 as a component of General and administrative expenses in the Consolidated Statement of Operations. Convertible securities issued in excess of then authorized shares of common stock On July 24, 2002, Salon issued convertible promissory notes that did not stipulate a maximum number of shares of common stock that they could be converted into. As the 50,000,000 shares of common stock then authorized were deemed to be insufficient to satisfy all obligations under convertible instruments, warrant agreements and options, Salon recorded the fair value of the then outstanding warrants of $175 as a long-term liability. The inadequacy of the number of authorized shares of common stock was exasperated by the issuance of 6,618 shares of Series C preferred stock, which could be converted to 132,360,000 shares of common stock, except for a lack in a sufficient number of authorized shares of common stock. From July 24, 2002, at each measurement period (the last day of each fiscal quarter), through November 22, 2004, Salon re-measured the value of its outstanding warrants. For the year ended March 31, 2004, the re-measurement of warrants resulted in a charge of $1,610, of which $575 related to warrants issued in conjunction with the issuances of preferred stock, and was recorded as a preferred deemed dividend in Salon's results of operations for the year then ended. From June 30, 2004 through November 22, 2004, the re-measurement of warrants resulted in a benefit of $1,011, of which $470 related to warrants issued in conjunction with the issuances of preferred stock, and was recorded as a preferred deemed dividend in Salon's results of operations for the year then ended. On November 22, 2004, Salon amended its Certificate of Incorporation, increasing the number of authorized shares of common stock from 50,000,000 to 600,000,000. As of that date, Salon has had a sufficient number of authorized shares of common stock to satisfy all obligations under convertible instruments, warrant agreements and options, and relieved its then cumulative $1,707 warrant long-term liability to a component of additional paid-in-capital. Common stock issued for prepaid advertising rights In December 1999, Salon issued 1,125,000 shares of common stock, representing approximately 10% of Salon's then outstanding common stock to a broadcasting company in exchange for $11,812 in advertising and promotional time to be delivered over ten years. Based on the then closing price of Salon's common stock, Salon recorded the value of the services to be rendered at $8,100 that it is amortizing as used. To date, the broadcasting company has delivered $6,383 of advertising and promotion time. 55 Selected Quarterly Financial Data (unaudited) (in thousands, except per share data)
(Restated) (Restated) First Second Third Fourth Quarter Quarter Quarter Quarter ---------- ---------- ---------- ---------- 2006: Net revenue $ 1,630 $ 1,654 $ 2,069 $ 1,163 Gross margin 577 614 886 (66) Net loss attributable to common stockholders (116) (160) (132) (941) Basic net loss per share attributable to common stockholders (0.01) (0.01) (0.01) (0.05) Diluted net loss per share attributable to common stockholders (0.01) (0.01) (0.01) (0.05) Shares used in per share calculation Basic 15,132 15,428 16,129 18,028 Diluted 15,132 15,428 16,129 18,028 2005: Net revenue $ 1,733 $ 1,256 $ 2,150 $ 1,489 Gross margin 533 252 1,019 378 Net income (loss) attributable to common stockholders (1,164) 1,018 395 (607) Basic net income (loss) per share attributable to common stockholders (0.08) 0.07 0.03 (0.04) Diluted net income (loss) per share attributable to common stockholders (0.08) 0.00 0.00 (0.04) Shares used in per share calculation Basic 14,155 14,161 14,507 14,743 Diluted 14,155 205,148 203,387 14,743 2004: Net revenue $ 1,045 $ 1,086 $ 1,273 $ 1,095 Gross margin (144) 130 204 (338) Net loss attributable to common stockholders (1,320) (1,198) (1,187) (3,277) Basic net loss per share attributable to common stockholders (0.09) (0.09) (0.08) (0.23) Diluted net loss per share attributable to common stockholders (0.09) (0.09) (0.08) (0.23) Shares used in per share calculation Basic 13,997 14,090 14,155 14,155 Diluted 13,997 14,090 14,155 14,155
56 ITEM 9A. Controls and Procedures Evaluation of Our Disclosure Controls and Internal Controls Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted an evaluation of our disclosure controls and procedures as of March 31, 2006. Our disclosure controls and procedures are intended to ensure that the information we are required to disclose in the reports that we file or submit under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms and (ii) accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as the principal executive and financial officers, respectively, to allow final decisions regarding required disclosures. Our management has concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were not effective. Notwithstanding the material weaknesses discussed below, our management has concluded that the financial statements included in this Form 10-K/A present fairly, in all material respects our financial position, results of operations and cash flows for the periods presented in conformity with generally accepted accounting principles. Management has determined that it has a material weakness in determining the value of the beneficial conversion feature of shares of preferred stock that it issues. To remedy this material weakness, Salon intends to take the following actions: 1. Add an additional layer to the preparation and review of similar transactions, 2. Increase the level of training of its finance staff, and 3. Acquire a readily accessible comprehensive data base of generally accepted accounting principles These changes either have been, or are in the process of being implemented. We believe the planned and implemented changes to our system of internal controls and our disclosure controls and procedures will be adequate to provide reasonable assurance that the 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 Principal Accounting Officer, as appropriate, to allow timely decisions regarding required disclosure based closely on the definition of "disclosure controls and procedures" in Rule 13-a-14(c). However, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple error or mistake. 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 Annual Report on Form 10-K/A that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting. 57 PART IV ITEM 15. Exhibits and Financial Statement Schedules The following Exhibits are filed as part of, or incorporated by reference into, this Report. Exhibit Number Description of Document - ------ ----------------------- 23.5 Consent of Burr, Pilger & Mayer LLP, Independent Registered Public Accounting Firm dated October 27, 2006. 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. SIGNATURE Pursuant to the requirements of Section 13 or 15(d) of the Securities and 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. October 31, 2006 By: /s/ Elizabeth Hambrecht ------------------------------------- Elizabeth Hambrecht President and Chief Executive Officer 58 EX-23.5 2 salon_10ka1-ex2305.txt CONSENT EXHIBIT 23.5 CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 No. 333-122044 of Salon Media Group, Inc. of our report dated May 4, 2006, except for the restatement discussed in Note 1 and in the thirteenth paragraph of Note 12 to the financial statements, as to which the date is October 25, 2006, relating to the financial statements of Salon Media Group, Inc. which appears in this Annual Report on Form 10-K/A. /s/ Burr, Pilger & Mayer LLP San Francisco, California October 27, 2006 EX-31.1 3 salon_ex3101.txt CERTIFICATION EXHIBIT 31.1 CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Elizabeth Hambrecht, certify that: 1. I have reviewed this Form 10-K/A of Salon Media Group, Inc.: 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/ Elizabeth Hambrecht ----------------------- October 31, 2006 Elizabeth Hambrecht Chief Executive Officer and President EX-31.2 4 salon_ex3102.txt CERTIFICATION EXHIBIT 31.2 CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Conrad Lowry, certify that: 1. I have reviewed this Form 10-K/A of Salon Media Group, Inc.: 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. /s/ Conrad Lowry ---------------- October 31, 2006 Conrad Lowry Chief Financial Officer and Secretary EX-32.1 5 salon_ex3201.txt CERTIFICATION EXHIBIT 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Salon Media Group, Inc. (the "Company") on Form 10-K/A for the period ended March 31, 2006, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Elizabeth Hambrecht, Chief Executive Officer and President of the Company, certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Elizabeth Hambrecht ----------------------- October 31, 2006 Elizabeth Hambrecht Chief Executive Officer and President EX-32.2 6 salon_ex3202.txt CERTIFICATION EXHIBIT 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Salon Media Group, Inc. (the "Company") on Form 10-K/A for the period ended March 31, 2006, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Conrad Lowry, Chief Financial Officer and Secretary of the Company, certify pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/ Conrad Lowry ---------------- October 31, 2006 Conrad Lowry Chief Financial Officer and Secretary -----END PRIVACY-ENHANCED MESSAGE-----