10-K 1 salon_10k-033107.htm ANNUAL REPORT Annual Report


SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 2007
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 [  ] No [X]

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. [  ]

Indicate by check mark whether the registrant is an accelerated filer as defined in Rule 12b-2 of the Act.
Large Accelerated Filer o          Accelerated Filer o          Non-Accelerated Filer þ

Indicate by check mark whether the registrant is a shell company (as defined by Exchange Act Rule 12b-2).Yes [  ] No [X]

The aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $1,655,000 based on the closing sale price of the registrant’s common stock on September 30, 2006, which was the last business day of the registrant’s most recently completed second fiscal quarter. Shares of common stock held by each then current executive officer and director and by each person who is known by the registrant to own 5% or more of the outstanding common stock have been excluded from this computation in that such persons may be deemed to have been affiliates of Salon. This determination of affiliate status is not a conclusive determination for other purposes.

The number of outstanding shares of the Registrant's Common Stock, par value $0.001 per share, on June 11, 2007 was 1,939,572 shares.



 

 

FORM 10-K
SALON MEDIA GROUP, INC.
INDEX


   
Page
PART I
 
Number
ITEM 1.
Business
4
 
ITEM 1A.
Risk Factors
13
 
ITEM 1B.
Unresolved Staff Comments
23
 
ITEM 2.
Properties
23
 
ITEM 3.
Legal Proceedings
23
 
ITEM 4.
Submission of Matters to a Vote of Security Holders
23
 
       
PART II
     
ITEM 5.
Market for Registrant’s Common Equity and Related Stockholder Matters
24
 
ITEM 6.
Selected Consolidated Financial Data
27
 
ITEM 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
29
 
ITEM 7A.
Quantitative and Qualitative Disclosures about Market Risk
38
 
ITEM 8.
Financial Statements and Supplementary Data
39
 
ITEM 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
66
 
ITEM 9A.
Controls and Procedures
66
 
ITEM 9B.
Other Information
66
 
       
PART III
 
 
 
ITEM 10.
Directors and Executive Officers of the Registrant
67
 
ITEM 11.
Executive Compensation
71
 
ITEM 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
80
 
ITEM 13.
Certain Relationships and Related Transactions
87
 
ITEM 14.
Principal Accountant Fees and Services
89
 
 

   
 
 

FORM 10-K
SALON MEDIA GROUP, INC.
INDEX - (continued)

 
PART IV
     
ITEM 15.
Exhibits, Financial Statement Schedules and Reports on Form 8-K
90
 
SIGNATURES
99
 
 

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PART I
 
This report contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) that involve risks and uncertainties, including but not limited to statements regarding our strategy, plans, objectives, expectations, intentions, financial performance, cash-flow breakeven timing, financing, economic conditions, Internet advertising market performance, subscription service plans, non-web opportunities and revenue sources. Although Salon Media Group, Inc. (Salon) believes its plans, intentions and expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such plans, intentions or expectations will be achieved. Salon’s actual results may differ significantly from those anticipated or implied in these forward-looking statements as a result of the factors set forth above and in Salon’s public filings. Salon assumes no obligation to update any forward-looking statements as circumstances change.
 
Salon’s actual results may differ significantly from those anticipated or implied in these forward-looking statements as a result of the factors set forth below and in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Factors That May Affect Salon’s Future Results and Market Price of Stock." In this report, the words “anticipates,” “believes,” “expects,” “estimates,” “intends,” “future,” and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof.

ITEM 1. Business
 
Overview

Salon was originally incorporated in July 1995 in the State of California and reincorporated in Delaware in June 1999. On June 22, 1999, Salon had its initial public offering, with its common stock quoted on the NASDAQ National Market under the symbol SALN. Effective May 16, 2001, Salon adopted the name Salon Media Group, Inc. Due to Salon’s inability to meet the continued listing requirements of the NASDAQ Market, on November 21, 2002, Salon’s common stock began trading in the OTC (Over-The-Counter) Bulletin Board marketplace under the symbol SALN.OB. Pursuant to the authority granted to the Board of Directors (the “Board”) by the stockholders of Salon at its Annual Meeting of Stockholders held on October 20, 2005, on November 14, 2006 the Board approved a reverse stock split of Salon’s authorized and outstanding shares of common stock at a ratio of 20:1. The reverse stock split was effective November 15, 2006, the date Salon’s Certificate of Amendment of Restated Certificate of Incorporation was filed with the Delaware Secretary of State and Salon’s stock trading symbol was changed to SLNM.OB from SALN.OB.

Salon is an Internet publishing pioneer. Salon’s award-winning journalism combines original investigative stories and provocative personal essays along with quick-take commentary and staff-written Weblogs about politics, technology, culture and entertainment. Committed to interactivity, the Website also hosts two online communities, Table Talk and The Well, and hosts some user blogs. In 2005, the site automated its “Letters to the Editor” feature so that readers can post their own comments to stories directly. During the year ended March 31, 2007, Salon added a daily blog by the independent blogger Glenn Greenwald, a weekly column by founding member Gary Kamiya, a weekly food feature "Eat and Drink," brought back culture writer Camille Paglia to do a monthly column, Literary Guide to the World, and a daily blog by Editor-in-Chief Joan Walsh. In its editorial product Salon balances two crucial missions: (1) providing original and provocative content on topics that the mainstream media overlook, and (2) filtering through the media chatter and clutter to help readers find the stories that matter.
 
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The main entry and navigation point to Salon's ten primary subject-specific sections is Salon's home page at www.salon.com. Built around ten daily features - War Room, Audiofile, the Blog Report, King Kaufman’s Sports Daily, Since you Asked, Broadsheet, How the World Works, Video Dog and daily blogs by Glenn Greenwald and Joan Walsh, Salon provides a constantly updated array of news, features, interviews, columnists and blogs, including the following:

News & Politics
 
Salon News & Politics features breaking stories, investigative journalism and commentary, as well as interviews with newsmakers, politicians and pundits. News features Salon’s War Room, a daily politics blog by political writer Tim Grieve.
   
Opinion
Opinion features provocative commentary on timely issues, including daily blogs by Glenn Greenwald and Joan Walsh, and weekly columns by Gary Kamiya, Sidney Blumenthal, Joe Conason and Garrison Keillor. It also features the Blog Report, an opinionated guide to the blogosphere, and a monthly column by Camille Paglia.
   
Technology & Business
Technology & Business provides smart, opinionated coverage of Internet news and digital culture from today's best technology writers, along with in-depth features about the business world and the economy. It features Patrick Smith's regular Ask the Pilot column and Andrew Leonard’s How the World Works blog, and since March 31, 2007, added Machinist by Farhad Manjoo.
   
Arts & Entertainment
Arts & Entertainment stages music and television reviews and interviews. The section includes frequent television features, and Audiofile, a daily music download column. In 2006 the Website added Video Dog, a video blog comprised of user generated video clips, as well as regular podcasts. Anchored by television critic Heather Havrilesky.
   
Movie Page
Launched in May 2007, Salon’s Movie Page spotlights film reviews, especially critics’ picks, and provides readers an ability to check movie show times, buy tickets or rent DVDs. Features film critics Andrew O’Hehir and Stephanie Zacharek.
   
Life
Life features articles by thought-provoking writers about family life, motherhood and women's lives and issues, as well as the women’s news digest Broadsheet. Cary Tennis' popular advice column, Since You Asked, appears daily.
   
Books
Books includes ahead-of-the-curve daily book reviews and interviews with today's most interesting writers. Nationally renowned critics Laura Miller and Andrew O’Hehir anchor this site. During the year ended March 31, 2007, Salon launched the Literary Guide to the World which features books by geographical destinations.
   
Comics
The Comics section features the works of comic luminaries Tom Tomorrow, Ruben Bolling, Carol Lay and Keith Knight.
   
Sports
King Kaufman’s Sports Daily provides sports news and commentary with an edge.
 
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Salon has two online communities, The Well and Table Talk, which allow users to discuss Salon content and interact with other users. The Well is a subscription member-only discussion community in which members use their real names to post and only members can view the postings had approximately 2,700 paying subscribers as of May 31, 2007. Table Talk is available to all Internet users.
 
Salon believes that its original, award-winning content allows Salon to attract and retain users who are more affluent, better educated and more likely to make online purchases than typical Internet users. Salon believes its user profile makes its Website a valuable media property for advertisers and retailers who are allocating marketing resources to target consumers online. According to the Spring 2007 results from @Plan, an independent syndicated research firm, Salon’s user base has the following characteristics: (a) 60% are between the ages of 25 and 49, with an overall mean average of 45; (b) an average household income of $87,700; (c) 76% have earned a college degree; (d) 49% have professional or managerial positions; and (e) 85% are online every day.
 
Revenue Sources
 
No customer accounted for over 10% of either total revenue or advertising revenue for the years ended March 31, 2007, March 31, 2006, or March 31, 2005, which were as follows (in thousands):
 
   
Year Ended March 31,
 
   
2007  
 
2006  
 
2005  
 
   
Amount
 
%
 
Amount
 
%
 
Amount
 
%
 
Advertising
 
$
5,409
   
70%
 
$
3,685
   
57%
 
$
3,567
   
54%
 
Salon Premium
   
1,546
   
20%
 
 
2,036
   
31%
 
 
2,207
   
33%
 
All Other
   
793
   
10%
 
 
795
   
12%
 
 
854
   
13%
 
Total
 
$
7,748
   
100%
 
$
6,516
   
100%
 
$
6,628
   
100%
 

Salon has generated Internet advertising revenues since its inception. To offset the precipitous drop in advertising revenues experienced in 2000 from the downturn in the economy, the company launched Salon Premium, a subscription service, in April 2001. Since that time, the market for Internet advertising has improved; according to the Interactive Adverting Bureau, from $9.6 billion in 2004 to $12.5 billion in 2005, and an estimated $16.8 billion in 2006. The market for Internet advertising is expected to continue to grow to over $80 billion by 2011 according to a report by Piper Jaffray & Co. Central to Salon’s strategy is to capitalize on the expected continued upsurge in Internet advertising.

An important factor in increasing advertising revenues in future periods, including Salon’s peak third quarter ending December 31, is attracting more unique visitors to Salon’s Website. Attracting more unique Website visitors is important to Salon as they generate page views, and each page view becomes a potential platform for serving advertisements. Ultimately, Salon charges advertisers for a set number of ad impressions viewed by a Website visitor. Due to various factors, including concerted efforts to make Salon’s content more accessible to readers by automatically launching its Site Pass advertisement, formatting content to maximize the potential for Salon’s content to show up in search engine results, and marketing campaigns with a select few Websites, the average number of unique monthly Website visitors for the year ended March 31, 2007 increased 43% to 3.3 million from the year ended March 31, 2006, and attained a record high of 4.4 million in March 2007. Aiding the continued growth in unique visitors to Salon’s Website is the general migration of readers to the Internet from print newspapers. The table in the following page reflects unique monthly visitors to Salon’s Website.

6

 
 
Salon has evaluated the balance between its subscription and advertising businesses and has shifted emphasis toward advertising. Until recently, a Website visitor was given a choice of: (1) becoming a Salon Premium subscriber to avoid having to view advertisements on future visits to Salon’s Website or (2) viewing an advertisement to gain access to all of Salon’s content. This strategy has been found to impede access to Salon’s Website and its ability to generate advertising impressions. During the quarter ended December 31, 2006, Salon changed its Site Pass model to automatically serve advertisements, enabling a Website visitor to gain more seamless access to Salon’s content. This change has produced an increase in the number of ad impressions that Salon can serve and improved Salon’s potential to generate an even greater amount of advertising revenues, offsetting a drop in Salon Premium subscriptions that traditionally were solicited from the Site Pass and the relatively smaller amount of revenue they generate.

Most advertising campaigns are of short duration, generally less than ninety days. Salon’s obligations may include a guaranteed minimum number of impressions, or views by Website visitors of an advertisement, a set number of “Site Pass” advertisements viewed by Website visitors or a set number of days that a Site Pass advertisement is to run. To the extent the 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” amounts are not agreeable with an advertiser, no further revenue is recognized.

Generally, subscriptions to Salon Premium with no advertisement were $35 for an annual subscription through March 2007 and $45 thereafter. Benefits of Salon Premium include unrestricted access to Salon’s content with no banners, pop-ups or site pass advertisements, free magazine subscriptions, free access to the Table Talk on-line discussion forum, and the ability to download content in text or PDF format.

Salon Premium revenue is recognized ratably over the period that services are provided. For the year ended March 31, 2007, Salon received $1.5 million in cash and recognized $1.5 million of revenue for this service primarily from approximately 44,200 paid new and renewed one year subscriptions and from approximately 5,000 monthly subscriptions. For the year ended March 31, 2006, Salon received
 
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$1.8 million in cash and recognized $2.0 million of revenue for this service primarily from approximately 58,700 paid new and renewed one year subscriptions and from approximately 3,900 monthly subscriptions. For the year ended March 31, 2005, Salon received $2.3 million in cash and recognized $2.2 million of revenue for this service primarily from approximately 79,100 paid new and renewed one year subscriptions and from approximately 5,000 monthly subscriptions.
 
Due 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, Salon reached a peak of approximately 89,100 paid subscribers in December 2004. Since that time, paid subscriptions have continued to decline, to approximately 65,500 as of March 31, 2006 and declined further to approximately 47,200 as of March 31, 2007. The drop is expected to continue during the next year as Salon emphasizes advertising revenue over Salon Premium revenues as previously mentioned.
 
The other sources of revenue are primarily from The Well, an on-line discussion forum. Revenue is recognized ratably over the subscription period. The revenues recognized was $0.4 million for the year ended March 31, 2007 and $0.5 million each for the years ended March 31, 2006 and March 31, 2005. Salon generates nominal revenue from the licensing of content that previously appeared in Salon and for providing links to a third party’s Website. The third party’s Website offers personals/dating services.

Sales and Marketing
 
Salon has sales offices in New York City and San Francisco with ten active advertising sales employees as of March 31, 2007, of which five actively solicit orders. As of March 31, 2007, Salon has two employees associated with Salon Premium membership activities.
 
Salon incurred advertising expenses of $0.4 million, $0.3 million and $0.5 million for the years ended March 31, 2007, 2006, and 2005, respectively. These advertising expenses primarily represent non-cash expenses from the utilization of advertising credits which Salon acquired in January 2000 from the sale of common stock to Rainbow Media Holdings (“Rainbow”). During the year ended March 31, 2003, Rainbow transferred a portion of its obligation to provide Salon with advertising credits to NBC’s Bravo channel, while still retaining a portion of the overall obligation. The transfer occurred due to the sale by Cablevision, which owns Rainbow Media Holdings, of its Bravo channel to NBC. As of March 31, 2007, Salon has $4.8 million in advertising credits, of which approximately $2.9 million remain with Rainbow and approximately $1.9 million are with NBC, all of which will expire in December 2009. Since their acquisition, Salon has used the advertising credits for television advertisements which were determined to be ineffective in driving traffic to its Website. As a result, during the last quarter of its year ended March 31, 2007, Salon began using its NBC credits for banner type ads on NBC’s Websites, and contemplates using its remaining NBC credits in a similar fashion. Salon intends to utilize the NBC credits on a pro-rata basis during the remaining term of the agreement; however, it may test running ad units on a greater than pro-rata basis in the quarter ending June 30, 2007 to determine the effectiveness of greater volume of online ads. This greater than pro-rata usage is unlikely to continue after this test.
 
Salon has determined that running banner ads on Rainbow’s on-line properties will be ineffective in driving traffic to Salon’s Website. Salon has therefore been exploring utilization of this portion of the credits toward other marketing and promotional efforts before they expire and may not be successful in this endeavor. Salon expects to recover the full value of all the advertising credits through usage or settlement in cash, per the terms of the agreement, but here can be no absolute assurance as to any potential cash settlement.
 
8

Competition
 
Salon competes for advertising revenues with numerous Websites, with the 50 largest companies attracting an estimated 94% of all the advertising dollars according to a study by PricewaterhouseCoopers LLC and sponsored by the Interactive Advertising Bureau. These companies have Websites that include major portals such as Yahoo, major search engines such as Google and major online media publications such as CNN.com.
 
Salon competes with many Websites for subscribers. However, most other Websites charge subscribers for access to: (1) archived stories, such as the Washington Post; (2) financial news, such as The Wall Street on-line edition; or (3) product reviews, such as Consumer Reports. Salon feels that individuals subscribe to its Salon Premium service primarily to support Salon.
 
Salon’s Strategy
 
Continued focus on growing Salon’s audience

Increasing unique visitors to Salon’s Website and the resulting page views that serve as a platform for advertising impressions is key to Salon’s revenue growth. In addition to the revenue generated from advertising, an increase in unique visitors could increase revenue from subscriptions as each new visitor to Salon’s Website is a potential new subscriber to Salon Premium. As a result, audience growth will continue to be a primary business goal for Salon in FY08.

Salon’s strategy to grow its audience combines both editorial and business planning. In terms of editorial planning, Salon has continued to add new writers, and enhance or create new content areas for its readers. Highlights in FY07 included adding acclaimed politics blogger Glenn Greenwald, monthly columnist Camille Paglia, launching a Food & Wine section called “Eat & Drink”, as well as a daily blog authored by Editor-in-Chief, Joan Walsh. For FY08, we have planned the following editorial launches:
 
 
·
Primary Sources: Launched in May 2007, it presents original source materials that Salon’s reporters have come across in their research - reports released by Congress, and non-governmental organizations, and transcripts of Congressional testimony and press briefings.
 
 
·
Movies Review: Launched in May 2007, Salon's Movie Page spotlights film reviews, especially Salon’s critics' picks, and lets readers check movie show times, buy tickets or rent DVDs from third party providers.
 
 
·
Machinist - Inside tech: Gizmos, people and big ideas. Launched in June 2007, this daily blog/ weekly column reviews products, looks into the mysteries of innovation and progress, and explores the offbeat corners of tech culture online.
 
 
·
Politics 2008: Expected to be launched during the summer of 2007, Salon will collect growing coverage of Democratic and Republican presidential candidates - including articles, blog posts and videos - in one convenient location and provide readers with other election-related features.
 
 
·
Expanded video content: Anticipated to be launched during calendar year 2007 in partnership with a television company, a series of television news updates highlighting Salon stories and video blogging entries by Salon writers are to be shown on both the television channel and Salon’s Website. A second partnership with a web video producer, launched in May 2007, allows Salon to access its video library, while it also produces video clips around Salon writers who have speaking or other public engagements.
 
9

 
 
·
OpenSalon: Salon plans to develop a new service for its users allowing them to post user profiles; contribute blogs and other content; and collecting all their contributions to Salon, including Letters to the Editor, in one place.

In terms of business planning, Salon’s strategies to continue to grow its audience encompasses partnership formation to deliver Salon’s content to a broader audience, a search engine optimization plan, and an integrated marketing plan that includes mostly online advertising. In the last several years Salon has not allocated, and does not currently contemplate in its next fiscal year allocating any significant cash resources towards such efforts; however, Salon has formed and continues to form partnerships and alliances to deliver Salon’s award-winning, unique, and compelling content to a broader audience. Strategies to grow Salon’s audience include:

 
·
Structuring content to take advantage of search engine optimization (SEO). In December 2006, Salon initiated a relationship with a SEO agency to assess and apply techniques to make its content more available to search engines. In February 2007, Salon began implementing industry best practices, such as on-page optimization and a search friendly architecture to maximize the number of times that Salon’s content is included in search results, and will continue to apply search engine optimization through the remainder of the calendar year.

 
·
Continuing to implement a no Site-Pass required “Blogger Outreach” marketing program with key and influential bloggers to encourage more linkages from their Websites back to Salon’s Website. The rollout of this program began in February 2006, and has contributed a significant number of new readers to Salon’s Website since then.

 
·
Reinvigorating its marketing efforts that began in February 2007, with a coordinated advertising campaign that exchanges unsold Salon ad inventory, or utilizes Salon’s advertising credits with NBC, for print and online advertising space for a Salon awareness campaign. As part of this effort, Salon has or will run advertisements in print magazines, such as the Christian Science Monitor and the New Republic and, online on CNET, Nerve.com, iVillage, Bravotv and NBCsports.com, among others. As part of its online advertising campaign, Salon is using a “content widget,” which is a series of ad banners that display current Salon headlines. When clicked, these banners will direct users to recently published articles on Salon. Initial widgets will distribute Salon news headlines, but later versions will promote headlines from a single Salon section or contributor.
 
 
·
Continuing to take advantage of new distribution technology. In FY07, Salon implemented an RSS strategy, enabling the availability of many segments of its content through an RSS content feed. Using RSS, Salon’s content summaries are sent, or fed, directly to end users. Also, during the year, it added social networking buttons, building on the success of its “MyYahoo” button, such as “Digg It” and “Del.ioui.us” widgets to the site. During FY08, Salon will continue to look for new distribution technology, and has recently experimented with making Salon headlines available on Twitter and others.

 
·
Initiating content distribution programs. Salon is looking to syndicate its content to other Websites with audiences with distinct demographics, such as college portals and affinity sites. Also, Salon has forged several agreements to syndicate articles to mobile devices, including smart phones and other mobile readers.


10


Focus on advertising revenue opportunity while Premium subscriber base declines

Salon generates revenue from advertising on its Website as well as through subscribers who pay to read its content without ads. However, as Salon increased its number of readers to its Website, Salon has determined that if its advertising sales team can sell most of its inventory, it will be more profitable for Salon to drive its readers to its advertising supported Website rather than to a subscription, without-ads Website. Salon recognizes that its subscription model will continue to be preferred by a minority of its readers, and will therefore continue the subscription program, with emphasis on “Premium with ads” as a means of increasing potential ad impressions. Additionally, Salon will continue efforts to increase the average value per subscriber by bundling third-party services with subscriptions, and intends to offer other products and services to current subscribers.
 
Salon increased emphasis on advertising revenues during FY07 and will continue to do so in FY08. In FY08, Salon plans to increase the size of its sales team, focus on broadening its advertiser base to include luxury items, apparel, home furnishings and packaged goods, and intends to expand into other advertising categories as well.
 
Develop Web 2.0 site and additional interactive functionality to increase reader participation

As previously mentioned, Salon has plans to build out a user generated site, to be called OpenSalon. This site will be an extension to Salon’s highly popular “Letters to the Editor” function, which allows readers to react to a story and begin a conversation with both the writer and the audience who is reading the story. This site will be rolled out during the course of FY08.

Salon also plans to engage readers with Web 2.0 tools that enhance their experience on the main Salon Website. As an example, one social media application under development is the Sphere “widget,” a configurable pop-up feature activated by links embedded in articles on Salon.com. These widgets will contain links to related stories on Salon and on other sites. Sphere widgets contain ad inventory that Salon’s sales team will bundle with other advertising opportunities. This feature is not expected to generate significant revenue, but is likely to drive additional page views to archived content, increase the average time spent on our Website and streamline the editorial process by obviating the need to hand-select related stories.

Overall, social media applications will be more organically integrated into Salon’s content. A “share this article” link will expose users to a variety of single-click tools that permit content to be shared, tagged and distributed outside Salon’s domain.

Develop content partnerships

Salon believes it needs fresh content and new ideas to continue to attract readers to its Website. To this end, Salon has made efforts to initiate partnerships to create content particularly in areas where Salon does not have facilities or experience, such as video content. Additionally, Salon has made efforts to identify bloggers who might have a strong affinity with its readers, and who might be interested in moving their sites to Salon in order to gain a greater reach of readership, and to gain infrastructure support.

New Channels of Content Distribution

To meet the growing demand for mobile content, Salon has revamped its presence on AvantGo, the largest mobile content platform. Salon’s new AvantGo presence will be featured on the top level of the service’s Technology channel, one of its most popular feeds. Even though increased mobile usage is
 
11

expected to generate minimal additional revenue, this channel is primarily an opportunity for Salon to extend its presence beyond a Web browser.

Infrastructure and Operations
 
Salon has created a flexible publishing structure that enables it to develop its content while responding quickly to news events and take advantage of the ease of distribution provided by the Internet. Salon content is deployed on its proprietary software platform and captured in a database for reuse in Web and other formats. In the last year, the content on Salon’s Website has been structured to facilitate being found by search engines, a key driver in increasing traffic to Salon’s Website. During the last two years, Salon has improved the look and feel of its Website to increase appeal to its audience and contemplates continued changes to its Website.

Salon’s Website is supported by a variety of servers using the Solaris and Linux operating systems. Salon’s top technical priority is the fast delivery of pages to its users. Salon’s systems are designed to handle traffic growth by balancing the amount of traffic among multiple servers. Salon relies on server redundancy to help achieve its goal of 24 hours, seven-days-a-week Website availability. Regular automated backups protect the integrity of Salon’s data. Salon servers are maintained at a third-party facility in San Francisco, in a building capable of withstanding a major earthquake. The third-party facility provides continuous monitoring of the servers.

Software to maintain and manage Salon Premium was created in-house and upgraded in 2003 and again during the year ended March 31, 2007.

Proprietary Rights
 
Salon’s success and ability to compete is dependent in part on the goodwill associated with its trademarks, trade names, service marks and other proprietary rights and on its ability to use U.S. laws to protect its intellectual property, including its original content, content provided by third parties, and content provided by columnists. Salon has a registered trademark on its name and is securing a registered trademark on its logo.

Salon owns the Internet address www.salon.com. Because www.salon.com is the address of the main home page to Salon’s Website and incorporates Salon’s company name, it is a vital part of Salon’s intellectual property assets. Salon does not have a registered trademark on the address, and therefore it may be difficult for Salon to prevent a third party from infringing its intellectual property rights to the address.

Employees
 
As of March 31, 2007, Salon has 64 full-time employees. Salon believes its employee relations are good. No employees of Salon are represented by a labor union or are subject to a collective bargaining agreement. Salon’s future success is highly dependent on the ability to attract, hire, retain and motivate qualified personnel.

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ITEM 1A. Risk Factors
 
Factors That May Affect Salon’s Future Results and Market Price of Stock

Salon’s business faces significant risks. The risks described below may not be the only risks Salon faces. Additional risks that are not yet known or that are currently immaterial may also impair its business operations or have a negative impact on its stock price. If any of the events or circumstances described in the following risks actually occurs, its business, financial condition or results of operations could suffer, and the trading price of its common stock could decline.

Salon’s projected cash flows may not meet expectations

Salon relies on cash projections to run its business and changes such projections as new information is made available or events occur. 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 advertising revenues and resulting cash receipts 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. The sale of preferred stock on December 21, 2005 resulted in a non-cash preferred deemed dividend charge of $0.2 million. The sale of preferred stock on July 27, 2006, September 21, 2006 and December 18, 2006, resulted in non-cash preferred deemed dividend charges of a total of $0.3 million. Salon cannot predict to what extent it may incur future preferred deemed dividend charges, if any, from the remaining 292 unissued shares of Series D preferred stock if they were to be issued.

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, Chairman of the Board of Salon, and William Hambrecht. William Hambrecht is the father of Salon’s President and Chief Executive Officer. During the year ended March 31, 2007, these related parties invested $0.9 million in Salon. In May 2007, John Warnock guaranteed an agreement between Salon and Deutsche Bank Securities, Inc. that will allow Salon to borrow up to $1.0 million at an interest rate of prime less 0.25%.

Curtailment of cash investments and borrowing guarantees by related parties could detrimentally impact Salon’s cash availability and its ability to fund its operations.
 
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Salon’s principal stockholders can exercise a controlling influence over Salon’s business affairs and may make business decisions with which non-principal stockholders disagree and 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 92% of all voting securities. These stockholders therefore own a controlling interest in Salon. Of this amount, approximately 70% is held by former Directors and related parties, approximately 19% is controlled directly or indirectly by William Hambrecht and approximately 42% by Chairman and 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 significant number of shares of Salon’s common stock by principal stockholders could cause its stock price to decline

Salon’s preferred stockholders can convert their 9,183 shares of preferred stock to approximately 9.5 million shares of common stock. As Salon’s common stock is normally thinly traded, if these stockholders were to convert their shares of preferred stock to common stock and sell the resulting shares, the per share price of Salon’s common stock may be adversely affected. For example, effective July 31, 2006, a Series A preferred stockholder converted 62 shares of Series A preferred stock to 124,536 shares of common stock, and shortly thereafter converted a warrant to 7,840 shares of common stock, for a total of 132,376 shares of common stock. Between July 31, 2006 and October 30, 2006, the shareholder sold approximately 84,460 of these shares, and during the same period of time, Salon’s common stock dropped from $3.20 to $1.80 per share.

Salon may not be able to receive the full value of its advertising credits
 
As of March 31, 2007, Salon has $4.8 million of advertising credits for which it has valued at $3.3 million that expire on December 31, 2009. Of the $4.8 million, approximately $2.9 million are the obligation of Rainbow Media Holdings (“Rainbow”) and approximately $1.9 million are the obligation of NBC. Salon feels that it should be able fully utilize the credits with NBC before they expire and may not be able to fully utilize the credits that are the obligation of Rainbow. Salon is currently exploring ways of fully utilizing the Rainbow credits before they expire and may not be successful in this endeavor. Salon expects to recover the full value of all the advertising credits through usage or settlement in cash, per the terms of the agreement, but here can be no absolute assurance as to any potential cash settlement.
 
Salon’s stock has been and will likely continue to be subjected to substantial price and volume fluctuations due to a number of factors, many of which will be beyond its control and 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
 
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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.

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 over common stockholders of the first approximately $22.3 million in potential sales proceeds as of March 31, 2007, which includes the effect of undeclared dividends of $3.2 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 $22.3 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 $22.3 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, 2008 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, 2005, March 31, 2006, and March 31, 2007, included a “going-concern” audit opinion on the consolidated financial statements for those years. The audit opinions report substantial doubt about Salon’s ability to continue as a going concern, citing issues such as the history of losses and absence of current profitability. As a result of the “going-concern” opinions, Salon’s stock price and investment prospects have been and will continue to be adversely affected, thus limiting financing choices and raising concerns about the realization of value on assets and operations.
 
Salon 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 47,200 as of March 31, 2007. Salon forecasts that these memberships will continue to decline to approximately 36,000 as of March 31, 2008. If the decline were to be in excess of anticipated amounts, Salon’s operations and available cash could be adversely affected.
 

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Salon has depended on advertising sales for much of its revenues, and its inability to maintain or increase advertising revenues could harm its business
 
Maintaining or increasing Salon’s advertising revenues depends upon many factors, including whether it will be able to:
 
 
·
successfully sell and market its Website auto start Site Pass or other rich media advertisements;
 
 
·
entice non Salon Premium Website visitors to view and advertisers to sell new ad units and formats;
 
 
·
maintain a significant number of unique Website visitors and corresponding significant reach of Internet users;
 
 
·
maintain a significant number of sellable impressions generated from Website visitors available to advertisers;
 
 
·
successfully sell and market its network to advertisers;
 
 
·
increase the dollar amount of the advertising orders it receives;
 
 
·
increase awareness of the Salon brand;
 
 
·
improve the technology for serving advertising on its Website;
 
 
·
handle temporary high volume traffic spikes to its Website;
 
 
·
accurately measure the number and demographic characteristics of its users; and
 
 
·
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.

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
 
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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.
 
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 its 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:
 
 
·
Salon’s ability to attract and retain advertisers and subscribers;
 
 
·
Salon’s ability to attract and retain a large number of users;
 
 
·
the introduction of new Websites, services or products by Salon or by its competitors;
 
 
·
the timing and uncertainty of Salon’s advertising sales cycles;
 
 
·
the mix of advertisements sold by Salon or its competitors;
 
 
·
the economic and business cycle;
 
 
·
Salon’s ability to attract, integrate and retain qualified personnel;
 
 
·
technical difficulties or system downtime affecting the Internet generally or the operation of Salon’s Website; and
 
 
·
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.

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The controversial content of Salon’s Website may limit its revenues
 
Salon’s Website contains, and will continue to contain, content that is politically and culturally controversial. As a result of this content, current and potential advertisers, potential Salon Premium subscribers, or third parties who contemplate aggregating content, may refuse to do business with Salon. Salon’s outspoken stance on political issues has and may continue to result in negative reactions from some users, commentators and other media outlets. From time to time, certain advocacy groups have successfully targeted Salon’s advertisers in an attempt to persuade such advertisers to cease doing business with Salon. These efforts may be a material impediment to Salon’s ability to grow and maintain advertising revenue.
 
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.

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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 to the address. If Salon fails to adequately protect its rights to the Website address, or if a third party infringes its rights to 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, reduced advertising revenues, or a loss of Salon Premium subscribers

Salon is constantly upgrading its technology to manage its Website and its Salon Premium program, and during the last year redesigned its Website homepage. In addition, it is creating technology for new products that Salon hopes to launch during its next fiscal year. 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 such as 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 adversely impact its business.

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.

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
 
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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 Salon’s 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’s system to manage its Salon Premium program is Payment Card Industry (PCI) compliant, if this system were to fail or not function as intended, credit card transactions might not be processed and Salon’s cash resources and revenues would therefore be harmed.

Salon’s systems may fail due to natural disasters, telecommunications failures and other events, any of which would limit user traffic

Substantially all of Salon’s communications hardware and computer hardware operations for its Website are in 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 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.

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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.
 
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:
 
 
·
the Board of Directors approved the transaction in which the stockholder acquired 15% or more of the corporation’s assets;

 
·
after the transaction in which 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

 
·
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.
 
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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:
 
 
·
Salon’s Board is classified into three classes of Directors as nearly equal in size as possible with staggered three year-terms; and

 
·
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 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.
 

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ITEM 1B. Unresolved Staff Comments
 
None.
 
ITEM 2. Properties
 
Salon leases 8,623 square feet of office space at 101 Spear Street, San Francisco, California. Approximately two years remain on the lease, which terminates in February 2009.
 
Salon leases nominal office space at 41 East 11th Street, 11th Floor, New York, NY and at 3417 ½ M Street NW, Washington, DC. The lease for the New York office terminates on May 31, 2008. Salon also leases minimal space to host its servers with the lease expiring in September 2007.
 
Salon believes that its existing properties are in good condition and are suitable for the conduct of its business.
 
ITEM 3. Legal Proceedings
 
Salon is not a party to any pending legal proceedings that it believes will materially affect its financial condition or results of operations.
 
ITEM 4. Submission of Matters to a Vote of Security Holders
 
No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended March 31, 2007.
 

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PART II
 
ITEM 5. Market for Registrant’s Common Equity and Related Stockholder Matters
 
On June 22, 1999, Salon had its initial public offering, with its common stock quoted on the NASDAQ National Market under the symbol SALN. Due to Salon’s inability to meet the continued listing requirements of the NASDAQ Market, on November 21, 2002 Salon’s common stock instead began trading in the OTC (Over-The-Counter) Bulletin Board marketplace under the symbol SALN.OB. Pursuant to the authority granted to the Board of Directors (the “Board”) by the stockholders of Salon at its Annual Meeting of Stockholders held on October 20, 2005, on November 14, 2006 the Board approved a reverse stock split of Salon’s authorized and outstanding shares of common stock at a ratio of 20:1. The reverse stock split was effective November 15, 2006, the date Salon’s Certificate of Amendment of Restated Certificate of Incorporation was filed with the Delaware Secretary of State and Salon’s stock trading symbol was changed to SLNM.OB from SALN.OB. In the reverse stock split, each 20 outstanding shares common stock (“old common stock”) was automatically reduced into one share of new common stock. Holders of fractional interest in old common stock following the reverse stock split received cash in lieu of any fractional shares upon presentation for exchange of the old common stock.

Information with respect to the quarterly high and low sales prices for Salon’s common stock for its fiscal years 2007 and 2006, based on sales transactions reported by the OTC (Over-The-Counter) Bulletin Board and revised pursuant to the 20:1 reverse stock split, is provided below:
 
     
Fiscal Year Ended
 
Fiscal Year Ended
     
March 31, 2007
 
March 31, 2006
For the quarter ended
 
High
 
Low
 
High
 
Low
 
June 30
 
5.80
 
3.20
 
6.00
 
3.00
 
September 30
 
3.60
 
1.40
 
4.00
 
2.60
 
December 31
 
2.55
 
0.90
 
10.20
 
2.20
 
March 31
 
2.45
 
1.20
 
11.00
 
3.60
 
There were 172 holders of record of Salon common stock as of June 11, 2007. This number was derived from Salon’s stockholder records, and does not include beneficial owners of Salon’s voting common stock whose shares are held in the names of various dealers, clearing agencies, banks, brokers, and other fiduciaries. The closing price of Salon’s common stock on June 11, 2007 was $1.40 per share.
 
Salon has never declared or paid any cash dividends on its capital stock and does not expect to pay any cash dividends in the foreseeable future.
 
Salon has never repurchased any of its equity securities.

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Equity Compensation Plan Information
 
The following table provides information about Salon’s common stock that may be issued upon the exercise of options, warrants and rights under all of Salon’s existing equity compensation plans as of March 31, 2007, including the Salon Internet, Inc. 1995 Stock Option Plan, the Salon Media Group, Inc. 2004 Stock Plan, the Salon Media Group, Inc. Non-Plan Stock Agreement and the 1999 Employee Stock Purchase Plan.
 
Plan category
Number of securities to
Weighted-average
Number of securities
 
be issued upon exercise
exercise price of
remaining available for
 
of outstanding options,
outstanding options,
future issuance under
 
warrants and rights
warrants and rights
equity compensation
 
 
 
plans, excluding
 
 
 
securities reflected in
 
 
 
column (a)
 
 
 
 
 
(a)
(b)
(c)
 
 
 
 
Equity compensation plans
2,080,040
$4.80
312,239
approved by security
     
holders
 
 
 
 
 
 
 
Equity compensation plans
125,000
$2.61
None
not approved by security
 
 
 
holders
 
 
 
Total
2,205,040
N/A
312,239

 
Equity Compensation Plans Not Approved by Security Holders

In February 2005, Salon entered into a Non-Plan Stock Agreement with its then Chairman, pursuant to which Salon granted such person non-qualified options to purchase 50,000 shares of common stock at an exercise price of $2.80 per share. Such option grant did not receive stockholder approval. 50% of the shares subject to the option vested on the date of grant and 50% of the shares subject to the option vested in February 2006.
 
In June 2006, Salon entered into a Non-Plan Stock Agreement with its Senior Vice President - Publisher, pursuant to which Salon granted such person non-qualified options to purchase 50,000 shares of common stock at an exercise price of $3.20 per share. Such option grant did not receive stockholder approval. 25% of the shares subject to the option vest after one year and 1/48th vest per month thereafter. In December 2006, Salon entered into another Non-Plan Stock Agreement with its Senior Vice President - Publisher, pursuant to which Salon granted such person non-qualified options to purchase 25,000 shares of common stock at an exercise price of $1.05 per share. Such option grant did not receive stockholder approval. 25% of the shares subject to the option vest after one year and 1/48th vest per month thereafter.

25


Stock Performance Graph
 
The line graph below compares the total stockholder return of Salon’s common stock with the cumulative total return of the NASDAQ Composite Index, a new peer group and an old peer group, for the five years ended March 31, 2007. The graph and table assume that $100 was invested on March 31, 2002 (the last day of trading for the fiscal year ended March 31, 2002) in each of Salon’s common stock, the NASDAQ Composite Index, the new peer group and the old peer group, and that all dividends were reinvested.
 
 
Companies in the New Self-Determined Peer Group:
Companies in Old Self-Determined Peer Group:
CNET Networks, Inc.
CNET Networks, Inc.
Planetout, Inc.
Planetout, Inc.
Thestreet.com Inc.
Thestreet.com Inc.
Audible Inc.
iVillage, Inc.
Answers Corporation
Realnetworks, Inc.
Quepasa Corporation
Valueclick, Inc.
Tucows Inc.
Yahoo, Inc.

26

ITEM 6. Selected Consolidated Financial Data
 
   
Dollar amounts in thousands, except per share
 
Year Ended March 31,
 
2007
 
2006
 
2005
 
2004
 
2003
 
                                 
Net revenues
 
$
7,748
 
$
6,516
 
$
6,628
 
$
4,499
 
$
4,003
 
Net loss (1)
 
$
1,566
 
$
1,122
 
$
518
 
$
6,046
 
$
5,597
 
Net loss attributable to common
                               
stockholders (2)
 
$
1,861
 
$
1,349
 
$
358
 
$
6,982
 
$
5,678
 
Basic and diluted net loss per share
                               
attributable to common
                               
stockholders (3)
 
$
1.10
 
$
1.67
 
$
0.50
 
$
9.90
 
$
8.15
 
Weighted average common shares
                               
outstanding used in computing
                               
per share amounts (thousands)(3)
   
1,692
   
809
   
720
   
705
   
697
 
Cash and cash equivalents
 
$
829
 
$
441
 
$
686
 
$
696
 
$
162
 
Prepaid advertising rights
 
$
3,267
 
$
3,718
 
$
3,970
 
$
4,430
 
$
5,480
 
Total assets
 
$
5,605
 
$
5,304
 
$
6,069
 
$
6,270
 
$
7,590
 
Capital leases - long-term portion
 
$
-
 
$
-
 
$
-
 
$
-
 
$
18
 
Total long-term liabilities (4)
 
$
85
 
$
120
 
$
82
 
$
2,621
 
$
569
 
 
(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.

(2) The net loss attributable to common stockholders for the year ended March 31, 2007 includes a preferred deemed dividend charge of $295 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 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
 
27

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 to preferred stockholders.

(3) The share and per share results for the years other than March 31, 2007 reflect a reverse stock split effective as of November 15, 2006. In the reverse stock split, each 20 outstanding shares common stock (“old common stock”) was automatically reduced into one share of new common stock.

(4) 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 shown under long-term liabilities on the balance sheet 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.
 

28


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

Overview
 
Salon is an Internet publishing pioneer. Salon’s award-winning journalism combines original investigative stories and provocative personal essays along with quick-take commentary and staff-written Weblogs about politics, technology, culture and entertainment. Committed to interactivity, the Website also hosts two online communities, Table Talk and The Well, and hosts some user blogs. In 2005, the site automated its “Letters to the Editor” feature so that readers can post their own comments to stories directly. During the year ended March 31, 2007, Salon added a daily blog by the independent blogger Glenn Greenwald, a weekly column by founding member Gary Kamiya, a weekly food feature "Eat and Drink," brought back culture writer Camille Paglia to do a monthly column, Literary Guide to the World, and a daily blog by Editor-in-Chief Joan Walsh. In its editorial product Salon balances two crucial missions: (1) providing original and provocative content on topics that the mainstream media overlook, and (2) filtering through the media chatter and clutter to help readers find the stories that matter.

Sources of Revenue
 
The most significant portion of Salon’s revenues is derived from advertising 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. Prior to March 2007, subscriptions to Salon Premium were generally $35 for one year with no ads, and during March 2007, the rate was increased to $45. Salon Premium revenue is recognized ratably over the period that services are provided. This source of revenue has been decreasing since Salon’s quarter ended December 31, 2004 when paid subscriptions peaked at approximately 89,100 and decreased to approximately 47,200 as of March 31, 2007. Salon expects this downward trend to continue, as it is placing greater emphasis on its advertising sales to generate revenue.
 
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.
 
Expenses
 
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 ad serving costs.
 
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 subscription service. It also includes advertising, promotional 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
 
29

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.
 
On April 1, 2006 Salon adopted the provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, or SFAS 123R, which requires companies to expense their stock option awards. Salon adopted SFAS 123R using the modified prospective transition method and therefore did not restate results for prior periods. Salon’s expenses include stock-based expenses related to stock option grants to employees, non-employee Directors and consultants.

Salon has incurred significant net losses and negative cash flows from operations since its inception. As of March 31, 2007, Salon had an accumulated deficit of $92.8 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, 2007, March 31, 2006 and March 31, 2005 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 recurring operating losses. At March 31, 2007 Salon had net operating loss carryforwards of $65.7 million for federal income tax purposes that begin to expire in March 2016, and $33.1 million for California income tax purposes. As Salon has been incurring tax losses, $1.3 million of California net operation loss carryforwards expired as of March 31, 2007, and if Salon were to incur a tax loss for the year ending March 31, 2008, an additional $3.3 million operating loss carryforward will expire. 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 $0.4 million during the year ended March 31, 2007 to $25.5 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.

30


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 70%, 57% and 54% of Salon’s revenues, respectively for the years ended March 31, 2007, 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 typically include a guaranteed 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 to 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 (“Rainbow”) and received $11.8 million of advertising credits that were to be utilized by December 2009. 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, 2007, Salon has $4.8 million advertising credits resulting from the transaction, valued at $3.3 million for financial reporting purposes. Of the $4.8 million of advertising credits, approximately $2.9 million remain with Rainbow and approximately $1.9 million are with NBC. Salon believes that it should be able to utilize all the credits with NBC before they expire on December 31, 2009, but may not be able to fully utilize the credits that are the obligation of Rainbow. Salon is currently exploring ways of fully utilizing the Rainbow credits before they expire and may not be successful in this endeavor. Salon expects to recover the full value of all the advertising credits through usage or settlement in cash, per the terms of the agreement, but here can be no absolute assurance as to any potential cash settlement.

Goodwill

Salon has $0.2 million of goodwill remaining from a purchase in March 1999. This asset is tested for impairment at least annually and has been found not to be impaired.

31


Results of Operations
 
Fiscal Years Ended March 31, 2007 and 2006

Net Revenues

Salon’s net revenue increased 19% to $7.7 million in the year ended March 31, 2007 from $6.5 million in the year ended March 31, 2006.

Advertising revenues increased 47% to $5.4 million for the year ended March 31, 2007 from $3.7 million for the year ended March 31, 2006. The increase in advertising sales reflects an industry wide trend of corporations earmarking more funds for Internet advertising.

Salon Premium subscription revenues decreased by 24% to $1.5 million for the year ended March 31, 2007 from $2.0 million for the year ended March 31, 2006. The drop in Salon Premium revenues recognized for the year ended March 31, 2007 compared to the year ended March 31, 2006 is attributable to a substantial reduction in the number of new subscribers. Salon acquired approximately 44,200 paid one-year subscriptions for the year ended March 31, 2007 compared to approximately 58,700 for the year ended March 31, 2006. As a result, the number of paid subscribers decreased from approximately 65,500 at March 31, 2006 to approximately 47,200 at March 31, 2007. As of June 1, 2007, Salon had approximately 44,900 paid subscribers.

An important factor in increasing advertising revenues in future periods, including Salon’s peak third quarter ending December 31, is attracting more unique visitors to Salon’s Website. Attracting more unique Website visitors is important to Salon as they generate page views, and each page view becomes a potential platform for serving advertisements. Ultimately, Salon charges advertisers based on a set number of impressions viewed by a Website visitor. Due to various factors, including concerted efforts to make Salon’s content more accessible to readers by auto launching the site pass, a better optimized Website to facilitate appearance in search engine results, and marketing campaigns with select Websites, the average number of unique monthly Website visitors for the year ended March 31, 2007 increased 43% to 3.3 million from the year ended March 31, 2006, and attained a record high of 4.4 million in March 2007. Aiding the continued growth in unique visitors to Salon’s Website is the migration of readers to the Internet from print newspapers.

Salon has evaluated the balance between its subscription and advertising businesses and has shifted emphasis toward advertising. Until recently, a Website visitor was given a choice of: (1) becoming a Salon Premium subscriber to avoid having to view advertisements on Salon’s Website or (2) viewing an advertisement to gain access to all of Salon’s content. This strategy was found to impede access to Salon’s Website and its ability to generate advertising impressions. During the quarter ended December 31, 2006, Salon changed its Site Pass model to automatically serve advertisements, enabling a Website visitor to gain a more seamless access to Salon’s content. This change has produced an increase in the number of ad impressions that Salon can serve and improved Salon’s potential to generate an even greater amount of advertising revenues, offsetting a drop in Salon Premium subscriptions that traditionally were solicited from the Site Pass and the relatively small revenue they generate.

All other sources of revenue were $0.8 million each for the years ended March 31, 2007 and March 31, 2006. Approximately half of this revenue was derived from the Well, an online discussion forum.

32


Production and Content
 
Production and content expenses during the year ended March 31, 2007 were $5.2 million versus $4.5 million for the year ended March 31, 2006, an increase of $0.7 million. The 16% increase primarily reflects an increase in staff and benefit costs.

Sales and Marketing Expenses

Sales and marketing expenses during the year ended March 31, 2007 were $2.0 million versus $1.5 million for the year ended March 31, 2006, an increase of $0.5 million. The 31% increase primarily reflects utilizing an additional $0.2 million advertising credits this year compared to last year and a $0.2 million increase in commission expenses.

Information Technology Support Expenses
 
Information technology support expenses during the year ended March 31, 2007 were $0.8 million versus $0.7 million for the year ended March 31, 2006, an increase of $0.1 million. The 22% increase primarily reflects the temporary retention of contractors to augment Salon’s salaried staff.

General and Administrative Expenses
 
General and administrative expenses during the year ended March 31, 2007 were $1.3 million versus $1.0 million for the year ended March 31, 2006, an increase of $0.3 million. The 33% increase is primarily attributable to hiring a Publisher in June 2006 with no comparable position in the prior year period and a raise awarded an officer in October 2005.

Preferred Deemed Dividend

Salon sold 208 shares of Series D-3 preferred stock and 42 shares of Series D-4 preferred stock on July 27, 2006, 333 shares of Series D-4 preferred on September 21, 2006, and 42 shares of Series D-4 preferred stock and 125 shares of Series D-5 preferred stock on December 18, 2006. All the shares sold are convertible to common stock at an effective price less than the fair market value of Salon’s common stock on the commitment date of the respective transaction. Salon valued the beneficial conversion feature of these shares of preferred stock at $0.3 million. As the shares of preferred stock sold were immediately convertible, Salon recorded a total of $0.3 million non-cash preferred deemed dividend for the year ended March 31, 2007, representing the value of the beneficial conversion feature of the shares issued.

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.

33


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 reflected 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 in 2006. Paid one month subscriptions declined 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.

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.

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.

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%
 
34

increase was primarily attributable to hiring technical consultants and the value of a warrant issued as part of a severance agreement.

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.

Liquidity and Capital Resources

Net cash used in operations was $1.2 million for the year ended March 31, 2007, $0.6 million for the year ended March 31, 2006, and $0.8 million for the year ended March 31, 2005. The principal use of cash during the year ended March 31, 2007 was to fund the $1.6 million net loss and reflects accounts receivable increasing by $0.5 million, less $0.8 million of non-cash charges. 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
 
35

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.

Net cash used in investing activities was immaterial for the years ended March 31, 2007 and March 31, 2006. 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.

For the year ended March 31, 2007, net cash provided from financing activities was $1.7 million, which includes $0.8 million from the exercise of warrants and $0.9 million from the issuance of 750 shares of preferred stock. 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.

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.

As of March 31, 2007, Salon has no outstanding capital leases and does not anticipate entering into similar debt instruments during its year ending March 31, 2008. The following summarizes Salon’s contractual obligations as of March 31, 2007, 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
 
   
Total
 
1 Year or Less
 
1 - 3 Years
 
More than 3 Years
 
Operating leases
 
$
783
 
$
470
 
$
313
 
$
-
 
Total
 
$
783
 
$
470
 
$
313
 
$
-
 

Capital requirements

Salon has a history of significant losses and expects to incur a net loss from operations for its year ending March 31, 2008. Because of past losses, an anticipated loss next year and a history of negative cash flows from operations, Salon’s independent registered public accounting firm for the years ended March 31, 2005, March 31, 2006 and March 31, 2007 have included a paragraph in its reports indicating substantial doubt as to Salon’s ability to continue as a going concern. During the last three years, Salon has relied on cash from the issuance of preferred stock and from the exercise of warrants to meet its cash requirements. Based on current cash projections for next year, including $8.1 million of advertising revenues and $10.4 million of total revenues, Salon estimates it will require an additional $0.6 million cash inflow to meet operating needs. If planned revenues are less than expected, the cash shortfall may be higher.
 
Even though Salon received $0.8 million in cash this year from the exercise of warrants, it will likely not receive any cash from the exercise of warrants during the next year. In anticipation of the cash
 
36

shortfall, Salon completed an agreement in May 2007 with Deutsche Bank Securities, Inc. that enables Salon to borrow up to $1.0 million in cash. The cash shortfall is expected to commence in June 2007 and continue through August 2007. Salon projects that it should be able to repay the borrowed amounts between January 2008 and February 2008 and have approximately $0.9 million of cash on hand as of March 31, 2008.

Off-Balance Sheet Arrangements

Salon has no off-balance sheet arrangements.

Reverse Stock Split

Pursuant to the authority granted to the Board of Directors (the “Board”) by the stockholders of Salon at its Annual Meeting of Stockholders held on October 20, 2005, the Board on November 14, 2006 approved a reverse stock split of Salon’s authorized and outstanding shares of common stock at a ratio of 20:1. The reverse stock split was effective November 15, 2006, the date Salon’s Certificate of Amendment of Restated Certificate of Incorporation was filed with the Delaware Secretary of State and Salon’s stock trading symbol was changed to SLNM.OB from SALN.OB.

Recent Accounting Pronouncements

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes,” and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. Salon does not currently believe adoption will have a material impact on its results of operations, financial position, or cash flows.

In September 2006, the FASB issued Statement of Financial Accounting Standard No. 157, “Fair Value Measurements,” (SFAS 157). SFAS 157 addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. Salon, who will adopt SFAS 157 as of April 1, 2007, does not currently believe adoption will have a material impact on its results of operations, financial position, or cash flows.

In September 2006, the FASB issued Statement of Financial Accounting Standard No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R),” (SFAS 158). SFAS 158 improves financial reporting by requiring an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income of a business entity or changes in unrestricted net assets of a not-for-profit organization. SFAS 158 also improves financial reporting by requiring an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. SFAS 158 is effective for fiscal years ending after December 15, 2006. Salon does not currently believe adoption will have a material impact on its results of operations, financial position, or cash flows.

37

In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108 on Quantifying Financial Statement Misstatements (SAB 108). SAB 108 sets forth the SEC staff's views that registrants should quantify errors using both a balance sheet and an income statement approach, and evaluate whether either approach results in quantifying a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. SAB108 is effective the first fiscal year ending after November 15, 2006. Salon does not currently believe adoption will have a material impact on its results of operations, financial position, or cash flows.

In February 2007, the FASB issued Statement of Financial Accounting Standard No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment to FASB Statement No. 115,” (SFAS 159). Under SFAS 159 entities will be permitted to measure financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis (the fair value option). SFAS 159 is effective for fiscal years beginning after December 15, 2007 and allows for early adoption. Salon, who will adopt SFAS 159 as of April 1, 2007, does not believe its adoption of SFAS159 will have a material impact on its results of operations, financial position, or cash flows.

ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
 
Salon maintains all of its cash in immediately available cash deposits at its bank. These funds are not subject to market risk and no interest is paid on such funds. Subsequent to March 31, 2007, Salon entered into a credit agreement with Deutsche Bank Securities, Inc. that allows Salon to borrow up to $1.0 million at a rate of prime less 0.25% which will subject Salon to interest rate risk. Salon feels that the risk of a rate increase is minimal, and that interest rates will decline a marginal amount during the year ending March 31, 2008. If rates were to increase or decrease, the effect on Salon would be minor as Salon contemplates having a cumulative $0.5 million of debt outstanding starting in June 2007 through February 2008. As Salon conducts all of its business in the United States, Salon is not subject to foreign exchange risk.


38


ITEM 8. Consolidated Financial Statements and Supplementary Data

 
 Page
   
Reports of Independent Registered Public Accounting Firm
40
   
Consolidated Balance Sheets as of March 31, 2007 and 2006
41
   
Consolidated Statements of Operations for the years ended March 31, 2007
 
2006, and 2005
42
   
Consolidated Statements of Stockholders’ Equity for the years ended March 31, 2007
 
2006, and 2005
43
   
Consolidated Statements of Cash Flows for the years ended March 31, 2007
 
2006, and 2005
44
   
Notes to Consolidated Financial Statements
45
   
Selected Quarterly Financial Data (unaudited)
65
 

39


Report of independent registered public accounting firm


To the Board of Directors and Stockholders
Salon Media Group, Inc.

We have audited the accompanying consolidated balance sheets of Salon Media Group, Inc. and its subsidiaries (the “Company”) as of March 31, 2007 and 2006 and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended March 31, 2007. 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. The Company is not required to have, nor have we been engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the 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, 2007 and 2006, and the results of their operations and their cash flows for each of the of the three years in the period ended March 31, 2007 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 $92.8 million at March 31, 2007. 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.

As discussed in Note 2 to the consolidated financial statements, on April 1, 2006 the Company changed its method of accounting for stock-based compensation as a result of adopting Statement of Financial Accounting Standard No. 123 (revised 2004), “Share Based Payments” applying the modified prospective method.


/S/ Burr, Pilger & Mayer LLP
San Francisco, California
June 25, 2007

40

 
SALON MEDIA GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
 
   
March 31,
 
   
2007
 
2006
 
Assets
             
Current assets:
             
Cash and cash equivalents
 
$
829
 
$
441
 
Accounts receivable, net
   
1,007
   
502
 
Prepaid expenses and other current assets
   
53
   
184
 
Total current assets
   
1,889
   
1,127
 
               
Property and equipment, net
   
115
   
155
 
Prepaid advertising rights
   
3,267
   
3,718
 
Goodwill, net
   
200
   
200
 
Other assets
   
134
   
104
 
Total assets
 
$
5,605
 
$
5,304
 
               
Liabilities and stockholders’ equity
             
Current liabilities:
             
Accounts payable and accrued liabilities
 
$
762
 
$
747
 
Deferred revenue
   
792
   
820
 
Total current liabilities
   
1,554
   
1,567
 
               
Other long-term liabilities
   
85
   
120
 
               
Total liabilities
   
1,639
   
1,687
 
Commitments and Contingencies (Note 9)
             
               
Stockholders’ equity:
             
Preferred stock, $0.001 par value, 5,000,000 shares authorized, 9,183 shares
             
issued and outstanding at March 31, 2007 and 8,558 shares issued and
           
outstanding at March 31, 2006
             
(aggregate liquidation preference of $22,344 at March 31, 2007 and
             
$21,655 at March 31, 2006)
   
-
   
-
 
               
Common stock, $0.001 par value, 30,000,000 shares authorized, 1,939,572
             
shares issued and outstanding at March 31, 2007 and 956,387 shares
           
issued and outstanding at March 31, 2006
   
2
   
1
 
Additional paid-in capital
   
96,788
   
94,619
 
Unearned compensation
   
-
   
(40
)
Accumulated deficit
   
(92,824
)
 
(90,963
)
Total stockholders’ equity
   
3,966
   
3,617
 
Total liabilities and stockholders’ equity
 
$
5,605
 
$
5,304
 
 
See accompanying notes to Consolidated Financial Statements

41


SALON MEDIA GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
 
   
Year Ended March 31,
 
   
2007
 
2006
 
2005
 
               
Net revenues
 
$
7,748
 
$
6,516
 
$
6,628
 
                     
Operating expenses:
                   
Production and content
   
5,223
   
4,505
   
4,446
 
Sales and marketing
   
1,978
   
1,515
   
1,891
 
Information technology support
   
828
   
676
   
617
 
General and administrative
   
1,286
   
964
   
766
 
Total operating expenses
   
9,315
   
7,660
   
7,720
 
                     
Loss from operations
   
(1,567
)
 
(1,144
)
 
(1,092
)
                     
Interest and other income
   
1
   
22
   
574
 
 Net loss
   
(1,566
)
 
(1,122
)
 
(518
)
Preferred deemed dividend
   
(295
)
 
(227
)
 
160
 
Net loss attributable to common stockholders
 
$
(1,861
)
$
(1,349
)
$
(358
)
                     
Basic and diluted net loss per share attributable to
                   
common stockholders
 
$
(1.10
)
$
(1.67
)
$
(0.50
)
                     
Weighted average shares used in computing basic
                   
and diluted net loss per share attributable
                   
to common stockholders
   
1,692
   
809
   
720
 
 
 
See accompanying notes to Consolidated Financial Statements

42

SALON MEDIA GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands, except Preferred Stock Shares)
 
                                           
                       
Additional
           
Total
 
   
Preferred Stock
 
Common Stock
 
Paid-In
 
Unearned
 
Accumulated
 
Stockholders’
 
   
Shares
 
Amount
 
Shares
 
Amount
 
Capital
 
Compensation
 
Deficit
 
Equity
 
Balance, March 31, 2004
   
7,552
 
$
-
   
708
 
$
1
 
$
90,654
 
$
-
 
$
(89,256
)
$
1,399
 
                                                   
Shares issued under employee stock plans
   
-
   
-
   
20
   
-
   
55
   
-
   
-
   
55
 
Value of shares issued to settle amounts
                                                 
owed a trade payable
   
-
   
-
   
21
   
-
   
42
   
-
   
-
   
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
   
-
   
-
   
-
   
-
   
1,707
   
-
   
-
   
1,707
 
Net loss
   
-
   
-
   
-
   
-
   
-
   
-
   
(518
)
 
(518
)
                                                   
Balance, March 31, 2005
   
8,386
 
$
-
   
749
 
$
1
 
$
93,765
 
$
-
 
$
(89,614
)
$
4,152
 
                                                   
Shares issued under employee stock plans
   
-
   
-
   
26
   
-
   
73
   
-
   
-
   
73
 
Shares issued under warrant agreements
   
-
   
-
   
144
   
-
   
65
   
-
   
-
   
65
 
Value of warrants issued
   
-
   
-
   
-
   
-
   
55
   
-
   
-
   
55
 
Preferred stock converted to common stock
   
(37
)
 
-
   
38
   
-
   
-
   
-
   
-
   
-
 
Share-based 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
   
-
   
-
   
-
   
-
   
227
   
-
   
(227
)
 
-
 
Net loss
   
-
   
-
   
-
   
-
   
-
   
-
   
(1,122
)
 
(1,122
)
                                                   
 Balance, March 31, 2006
   
8,558
 
$
-
   
957
 
$
1
 
$
94,619
 
$
(40
)
$
(90,963
)
$
3,617
 
                                                   
Shares issued under employee stock plans
   
-
   
-
   
2
   
-
   
6
   
-
   
-
   
6
 
Shares issued under warrant agreements
   
-
   
-
   
730
   
1
   
778
   
-
   
-
   
779
 
Preferred stock converted to common stock
   
(125
)
 
-
   
251
   
-
   
-
   
-
   
-
   
-
 
Series D convertible preferred stock and
                                                 
common stock warrants issued for cash
   
750
   
-
   
-
   
-
   
900
   
-
   
-
   
900
 
Preferred deemed dividend on issuance of
                                                 
Series D Convertible preferred stock
   
-
   
-
   
-
   
-
   
295
   
-
   
(295
)
 
-
 
Share-based compensation
   
-
   
-
   
-
   
-
   
190
   
40
   
-
   
230
 
Net loss
   
-
   
-
   
-
   
-
   
-
   
-
   
(1,566
)
 
(1,566
)
                                                   
Balance, March 31, 2007
   
9,183
 
$
-
   
1,940
 
$
2
 
$
96,788
 
$
-
 
$
(92,824
)
$
3,966
 
 
See accompanying notes to Consolidated Financial Statements
43

 
SALON MEDIA GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
 
   
Year Ended March 31,
 
   
2007
 
2006
 
2005
 
Cash flows from operating activities:
                   
Net loss
 
$
(1,566
)
$
(1,122
)
$
(518
)
Adjustments to reconcile net loss to net cash used in operating activities:
                   
Share-based compensation
   
230
   
143
   
-
 
Warrant re-valuation
   
-
   
-
   
(541
)
Depreciation and amortization
   
89
   
143
   
495
 
Allowance for (recovery of) doubtful accounts
   
-
   
(1
)
 
2
 
Operating lease incentives
   
-
   
-
   
65
 
Gain on issuance of common stock for trade payable
   
-
   
-
   
(25
)
Prepaid advertising rights usage
   
451
   
252
   
460
 
Changes in assets and liabilities:
                   
Accounts receivable
   
(505
)
 
122
   
(319
)
Prepaid expenses, other current assets and other assets
   
101
   
111
   
(130
)
Accounts payable, accrued liabilities and other long-term liabilities
   
(21
)
 
(3
)
 
(254
)
Deferred revenue
   
(28
)
 
(227
)
 
(60
)
Net cash used in operating activities
   
(1,249
)
 
(582
)
 
(825
)
Cash flows from investing activities:
                   
Purchase of property and equipment
   
(48
)
 
(52
)
 
(217
)
Net cash used in investing activities
   
(48
)
 
(52
)
 
(217
)
Cash flows from financing activities:
                   
Proceeds from issuance of preferred stock, net
   
900
   
251
   
995
 
Proceeds from issuance of common stock, net
   
785
   
138
   
55
 
Principal payments under capital leases
   
-
   
-
   
(18
)
Net cash provided by financing activities
   
1,685
   
389
   
1,032
 
Net increase (decrease) in cash and cash equivalents
   
388
   
(245
)
 
(10
)
Cash and cash equivalents at beginning of period
   
441
   
686
   
696
 
Cash and cash equivalents at end of period
 
$
829
 
$
441
 
$
686
 
                     
Amount paid for interest
 
$
-
 
$
-
 
$
-
 
Amount paid for taxes
   
-
   
-
   
-
 
Supplemental schedule of non-cash investing and financing activities:
                   
Issuance of warrants in connection with agreements
 
$
-
 
$
55
 
$
100
 
Preferred deemed dividend
   
295
   
227
   
(160
)
Issuance of common stock for trade payable
   
-
   
-
   
42
 
 
 
See accompanying notes to Consolidated Financial Statements

44

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.
 
Pursuant to the authority granted to the Board of Directors (the “Board”) by the stockholders of Salon at its Annual Meeting of Stockholders held on October 20, 2005, the Board on November 14, 2006 approved a reverse stock split of Salon’s authorized and outstanding shares of common stock at a ratio of 20:1. The reverse stock split was effective November 15, 2006, the date Salon’s Certificate of Amendment of Restated Certificate of Incorporation was filed with the Delaware Secretary of State and Salon’s stock trading symbol was changed to SLNM.OB from SALN.OB. Accordingly all issued and outstanding shares and per share amounts in the accompanying consolidated financial statements have been retroactively restated to reflect the reverse stock split.
 
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, 2007 of $92,824. In addition, Salon expects to incur a net loss from operations for its year ending March 31, 2008. Because of past losses, an anticipated loss next year and a history of negative cash flows from operations, Salon’s independent registered public accounting firm for the years ended March 31, 2005, March 31, 2006 and March 31, 2007 have included a paragraph in its reports indicating substantial doubt as to Salon’s ability to continue as a going concern. During the last three years, Salon has relied on cash from the issuance of preferred stock and from the exercise of warrants to meet its cash requirements. Based on current cash projections for next year, including $8.1 million of advertising revenues and $10.4 million of total revenues, Salon estimates it will require an additional $0.6 million cash inflow to meet operating needs. If planned revenues are less than expected, the cash shortfall may be higher.
 
Even though Salon received $0.8 million in cash this year from the exercise of warrants, it will likely not receive any cash from the exercise of warrants during the next year. In anticipation of the cash shortfall, Salon completed an agreement in May 2007 with Deutsche Bank Securities, Inc. (see Note 3 “Borrowing Agreement”) that will enable Salon to borrow up to $1.0 million in cash. The cash shortfall is expected to commence in June 2007 and continue through August 2007. Salon projects that it should be able to repay the borrowed amounts between January 2008 and February 2008 and have approximately $0.9 million of cash on hand as of March 31, 2008.

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.

45

SALON MEDIA GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data)
 
Segment and enterprise-wide reporting
 
Salon discloses segment enterprise-wide information in accordance with Statement of Financial Accounting Standard (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. In the event that the rights are not fully utilized prior to their expiration, Salon has the right to receive cash for the unused value.
 
Goodwill
 
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.
 
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
 
46

SALON MEDIA GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data)
 
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 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 from Salon Premium and The Well are recognized ratably over the subscription period. 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 $448, $271, and $471, for the fiscal years ended March 31, 2007, 2006, and 2005.

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, 2007, 2006 and 2005 and comprehensive loss for those periods.

Stock-based compensation
 
On April 1, 2006, Salon adopted the provisions of, and accounted for stock-based compensation in accordance with, the Financial Accounting Standards Board’s (FASB) Statement of Financial Accounting Standards No. 123 - revised 2004, “Share Based Payment” (SFAS 123R), which replaced SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS 123) and supersedes Accounting Principals Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25). Under the fair value provisions of this statement, stock-based compensation cost is measured at the grant date
47

SALON MEDIA GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data)
 
based on the fair value of the award and is recognized as expense over the requisite service period, which is the vesting period. Salon uses the Black-Scholes option-pricing model to determine the fair-value of stock-based awards under SFAS 123R, consistent with that used for pro forma disclosures under SFAS 123. Prior to the adoption of SFAS 123R, Salon accounted for stock-based awards to employees using the intrinsic value method in accordance with APB No. 25 as allowed under SFAS 123. Under the intrinsic value method, no stock-based compensation expense had been recognized in Salon’s consolidated statement of operations, other than as related to non-employees, because the exercise price of its stock options granted to employees equaled the fair market value of the underlying stock at the date of grant. Salon recognizes compensation cost related to stock options granted prior to the adoption of SFAS 123R on an accelerated basis over the applicable vesting period using the methodology described in FASB Interpretation No. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans” (FIN 28). Salon recognizes compensation cost related to options granted subsequent to the adoption of SFAS 123R on a straight-line basis over the applicable vesting period.

Salon utilized the modified prospective transition method, which requires that stock-based compensation expense be recorded for all new and unvested stock options and employee stock purchase plan shares that are ultimately expected to vest as the requisite service is rendered beginning on April 1, 2006, the first day of Salon’s 2007 fiscal year. The consolidated financial statements as of and for the year ended March 31, 2007 reflect the impact of SFAS 123R. In accordance with the modified prospective transition method, Salon’s consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123R. Stock-based compensation expense recognized under SFAS 123R for the year ended March 31, 2007 was $230, which consisted solely of stock-based compensation expense related to stock options. See Note 7: “Employee Stock Option Plan” to the financial statements for additional information.

As of March 31, 2007, the aggregate stock compensation remaining to be amortized to expenses was $771. Salon expects this stock compensation balance to be amortized as follows: $234 during fiscal 2008; $239 during fiscal 2009; $226 during fiscal 2010; and $72 during fiscal 2011. The expected amortization reflects only outstanding stock awards as of March 31, 2007.

No amounts were recorded relating to excess tax benefits from the exercise of stock-based compensation awards during the year ended March 31, 2007, and as a result there were no differences in net cash used in operating and financing activities due to the implementation of SFAS 123R.
 
The fair value of each option grant was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions and fair value per share:
 
   
Year Ended March 31,
   
2007
 
2006
 
2005
Risk-free interest rates
 
4.47 - 4.97%
 
3.80 - 4.30%
 
3.40%
Expected lives (in years)
 
4
 
4
 
4
Expected volatility
 
107 - 129 %
 
120%
 
120%
Dividend yield
 
0.0%
 
0.0%
 
0.0%

The expected term of the options of four years represents the estimated period of time until exercise and is based on historical experience of similar awards, including the contractual terms, vesting schedules and expectations of future employee behavior. For the year ended March 31, 2007, expected
 
 
48

SALON MEDIA GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data)
 
stock price volatility is based on historical volatility of Salon’s stock. The risk-free interest rate is based on the implied yield available on U.S. Treasury securities with a term equivalent to the vesting period of the stock options, or four years. Salon has not paid dividends in the past.

The following table illustrates the effect on net loss and net loss per share if Salon had applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation during the years ended March 31, 2006 and March 31, 2005:
 
   
Year Ended March 31,
 
   
2006
 
2005
 
Net loss attributable to common stockholders:
             
As reported
 
$
(1,349
)
$
(358
)
Add back: share-based employee compensation
             
expense included in reported net loss
   
-
   
-
 
               
Deduct: share-based employee compensation
             
expense determined under the fair value based method,
             
net of related tax
   
(2,321
)
 
(1,390
)
Pro forma net loss attributable to common stockholders
 
$
(3,670
)
$
(1,748
)
               
Basis and diluted net loss per share attributable to
             
common stockholders:
             
As reported
 
$
(1.67
)
$
(0.50
)
Pro forma
 
$
(4.54
)
$
(2.43
)

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,
 
   
2007
 
2006
 
2005
 
Numerator:
                   
Net loss attributable to common stockholders
 
$
(1,861
)
$
(1,349
)
$
(358
)
                     
Denominator:
                   
Weighted average shares used in
                   
computing basic and diluted net loss per
                   
share attributable to common stockholders
   
1,692,000
   
809,000
   
720,000
 
                     
Basic and diluted net loss per share attributable
                   
to common stockholders
 
$
(1.10
)
$
(1.67
)
$
(0.50
)
                     
Antidilutive securities including options,
                   
warrants and convertible preferred stock
                   
not included in loss per share calculation
   
11,868,000
   
11,899,000
   
11,600,000
 
 
49

SALON MEDIA GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data)
 
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. No customer accounted for 10% or more of the total trade accounts receivable at March 31, 2007 and one customer accounted for 11% of total trade accounts receivable at March 31, 2006. No customer accounted for 10% or more of total revenue for the fiscal years ended March 31, 2007, 2006 and 2005 respectively.

Recent accounting pronouncements
 
In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes,” and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. Salon does not currently believe adoption will have a material impact on its results of operations, financial position, or cash flows.

In September 2006, the FASB issued Statement of Financial Accounting Standard No. 157, “Fair Value Measurements,” (SFAS 157). SFAS 157 addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. Salon, who will adopt SFAS 157 as of April 1, 2007, does not currently believe adoption will have a material impact on its results of operations, financial position, or cash flows.

50


SALON MEDIA GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data)
 
In September 2006, the FASB issued Statement of Financial Accounting Standard No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R),” (SFAS 158). SFAS 158 improves financial reporting by requiring an employer to recognize the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income of a business entity or changes in unrestricted net assets of a not-for-profit organization. SFAS 158 also improves financial reporting by requiring an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions. SFAS 158 is effective for fiscal years ending after December 15, 2006. Salon does not currently believe adoption will have a material impact on its results of operations, financial position, or cash flows.

In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 108 on Quantifying Financial Statement Misstatements (SAB 108). SAB 108 sets forth the SEC staff's views that registrants should quantify errors using both a balance sheet and an income statement approach, and evaluate whether either approach results in quantifying a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. SAB108 is effective the first fiscal year ending after November 15, 2006. Salon does not currently believe adoption will have a material impact on its results of operations, financial position, or cash flows.

In February 2007, the FASB issued Statement of Financial Accounting Standard No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment to FASB Statement No. 115,” (SFAS 159). Under SFAS 159 entities will be permitted to measure financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis (the fair value option). SFAS 159 is effective for fiscal years beginning after December 15, 2007 and allows for early adoption. Salon, who will adopt SFAS 159 as of April 1, 2007, does not believe its adoption of SFAS159 will have a material impact on its results of operations, financial position, or cash flows.

Note 3. Borrowing Agreement

In May 2007, Salon finalized a borrowing agreement with Deutsche Bank Securities, Inc. that will allow Salon to borrow up to $1,000 at a rate of prime less 0.25%. The agreement is guaranteed in its entirety by Salon’s Chairman. Even though the agreement does not stipulate a termination date, Salon expects the agreement to terminate within one year, unless mutually agreed by Deutsche Bank Securities, Inc., Salon and Salon’s Chairman. Salon contemplates drawing $600 from the credit agreement between May 2007 and August 2007, and repaying such amounts between January 2007 and February 2008.

Note 4. Goodwill

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, 2007 and March 31, 2006 was $200 and has been found not to be impaired.


51


SALON MEDIA GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data)
 
Note 5. Balance Sheet Components
 
   
Year Ended March 31,
 
   
2007
 
2006
 
Accounts receivable, net:
             
Accounts receivable
 
$
1,037
 
$
532
 
Less: allowance for doubtful accounts
   
(30
)
 
(30
)
   
$
1,007
 
$
502
 
               
Prepaid expenses and other current assets
             
Receivable from employees (1)
 
$
-
 
$
48
 
Prepaid expenses
   
53
   
40
 
Short term deposits
   
-
   
96
 
   
$
53
 
$
184
 
Property and equipment, net
             
Computer hardware and software
 
$
1,277
 
$
1,263
 
Leasehold improvements
   
67
   
67
 
Furniture and office equipment
   
243
   
242
 
     
1,587
   
1,572
 
Less accumulated depreciation and amortization
   
(1,472
)
 
(1,417
)
   
$
115
 
$
155
 
               
Other assets
             
Long-term deposits
 
$
134
 
$
104
 
   
$
134
 
$
104
 
               
Accounts payable and accrued liabilities
             
Accounts payable
 
$
269
 
$
253
 
Salaries and wages payable
   
321
   
290
 
Accrued services
   
5
   
88
 
Reserve for claims
   
98
   
75
 
Other accrued expenses
   
69
   
41
 
   
$
762
 
$
747
 
 
(1) Reflects loan outstanding to Salon’s former Chairman at an agreed 6.3% annual interest. During the year ended March 31, 2007, the loan was paid off in its entirety.

Depreciation expense for the years ended March 31, 2007, 2006 and 2005 was $89, $88, and $115 respectively.

Note 6. 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
 
52

SALON MEDIA GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data)