S-1 1 f54699orsv1.htm FORM S-1 sv1
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As filed with the Securities and Exchange Commission on February 22, 2010
Registration No. 333-          
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
 
Reply! Inc.
(Exact Name of Registrant as Specified in Its Charter)
 
         
Delaware   7389   94-3400697
(State or Other Jurisdiction of
Incorporation or Organization)
  (Primary Standard Industrial
Classification Code Number)
  (I.R.S. Employer
Identification Number)
 
12667 Alcosta Blvd., Suite 200
San Ramon, CA 94583
(925) 983-3400
(Address, Including Zip Code, and Telephone Number, Including Area Code, of Registrant’s Principal Executive Offices)
 
Payam Zamani
President and Chief Executive Officer
Reply! Inc.
12667 Alcosta Blvd., Suite 200
San Ramon, CA 94583
(925) 983-3400
(Name, Address, Including Zip Code, and Telephone Number, Including Area Code, of Agent For Service)
 
Copies to:
 
     
Peter M. Astiz, Esq.
Benjamin G. Griebe, Esq.
DLA Piper LLP (US)
2000 University Ave.
East Palo Alto, CA 94303
(650) 833-2000
  Andrew S. Williamson, Esq.
Wesley C. Holmes, Esq.
Latham & Watkins LLP
140 Scott Drive
Menlo Park, CA 94025
(650) 328-4600
 
Approximate date of commencement of proposed sale to the public:  As soon as practicable after this registration statement becomes effective.
 
If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  o
 
If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o
 
If this form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o
 
If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer o Accelerated filer o Non-accelerated filer þ Smaller reporting company o
(Do not check if a smaller reporting company)
 
CALCULATION OF REGISTRATION FEE
 
             
      Proposed Maximum
    Amount of
Title of Each Class of
    Aggregate Offering
    Registration
Security To be Registered     Price(1)     Fee(2)
Common Stock, par value $0.001 per share
    $60,000,000     $4,278
             
 
(1) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(o) under the Securities Act.
 
(2) Calculated pursuant to Rule 457(o) based on an estimate of the proposed maximum aggregate offering price, including the offering price of shares that the underwriters have the option to purchase to cover overallotments, if any.
 
The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), shall determine.
 


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The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and is not soliciting an offer to buy these securities in any jurisdiction where such offer or sale is not permitted.
 
SUBJECT TO COMPLETION, DATED FEBRUARY 22, 2010
Preliminary Prospectus
 
           Shares
 
(Reply Com Logo)
 
Common Stock
 
We are offering           shares of our common stock and the selling stockholders are offering an additional           shares of our common stock. This is our initial public offering, and no public market currently exists for our common stock. We expect the initial public offering price to be between $      and $      per share. We have applied for listing of our common stock on The NASDAQ Global Market under the symbol “RPLY.”
 
Investing in our common stock involves a high degree of risk. Please read “Risk Factors” beginning on page 10.
 
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.
 
                 
 
    PER SHARE     TOTAL  
 
Public Offering Price
  $           $                  
Underwriting Discounts and Commissions
  $           $        
Proceeds to Reply! Inc. (Before Expenses)
  $           $        
Proceeds to Selling Stockholders (Before Expenses)
  $           $        
 
Delivery of the shares of common stock is expected to be made on or about          , 2010. We and the selling stockholders have granted the underwriters an option for a period of 30 days to purchase, on the same terms and conditions set forth above, up to an additional           shares of our common stock (           shares to be provided by us and           shares to be provided by the selling stockholders) to cover overallotments. If the underwriters exercise the option in full, the total underwriting discounts and commissions payable by us and the selling stockholders will be $      and $      , respectively, and the total proceeds to us and the selling stockholders, before expenses, will be $      and $      , respectively.
 
Joint Book-Running Managers
 
Jefferies & Company Piper Jaffray
 
Co-Managers
 
Needham & Company, LLC ThinkEquity LLC
 
Prospectus dated          , 2010


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 EX-21.1
 EX-23.2
 
You should rely only on the information contained in this prospectus. Neither we, the selling stockholders nor the underwriters have authorized anyone to provide you with information different from that contained in this prospectus. We are offering to sell, and seeking offers to buy, shares of common stock only in jurisdictions where offers and sales are permitted. You should assume that the information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of common stock. Our business, financial condition, results of operations, and prospects may have changed since that date.
 
 
 
 
Some of the industry and market data contained in this prospectus are based on independent industry publications or other publicly available information, while other information is based on our internal sources. Although we believe that each source is reliable as of its respective date, the information contained in such sources has not been independently verified, and neither we, the selling stockholders nor the underwriters can assure you as to the accuracy or completeness of this information. As a result, you should be aware that the industry and market industry data contained in this prospectus, and beliefs and estimates based on such data, may not be reliable.
 
 
 
 
Our trademarks include Reply!tm, our company logo and Enhanced Clickstm. All other trademarks or service marks appearing in this prospectus are trademarks or service marks of their respective owners.
 


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Prospectus Summary
 
This prospectus summary highlights the key aspects of the offering. For a more complete understanding of the information that you may consider important in making your investment decision, we encourage you to read this entire prospectus. Before making an investment decision, you should carefully read and consider this entire prospectus, including our financial statements and the related notes included in this prospectus and the information set forth under the headings “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Unless otherwise indicated, the terms “Reply!,” “we,” “us” and “our” refer to Reply! Inc. and its consolidated subsidiary.
 
Business Overview
 
We operate a proprietary auction marketplace that facilitates online locally-targeted marketing. We aggregate customer prospects for advertisers from many different online traffic sources and categorize those customer prospects based on user-provided information regarding a product or service of interest to the user and the location at which the user desires to purchase the product or receive the service. Our marketplace provides locally-targeted advertisers with performance-based marketing solutions on a cost-per-“Enhanced Click” or cost-per-lead basis. Our Enhanced Clicks are generated by customer prospects and provide user-submitted category information and the location at which the product will be purchased or the service will be rendered. In addition to providing all of the information contained in an Enhanced Click, our leads also provide our advertisers with the customer prospect’s contact information. We rank the quality of each customer prospect based upon our historical experience and other factors regarding the propensity of the prospect to take action, which enables advertisers to differentiate their bids for Enhanced Clicks and leads based on the quality of the customer prospect.
 
Our marketplace simplifies online locally-targeted marketing by eliminating an advertiser’s need to develop and maintain complex, expensive infrastructure and teams of experts to source online consumer traffic from many different channels, including search engine marketing, display and email. Additionally, compared to traditional lead generation businesses, our marketplace provides advertisers greater control over quality, volume and price, and therefore enables our advertisers to optimize their marketing efforts and better manage their cost per transaction. Our marketplace allows advertisers to adjust their bids on a real-time basis. Regardless of the advertiser’s level of sophistication, our marketplace is designed to deliver customer prospects in the format that best addresses the advertiser’s needs. The customer prospects can take the form of an Enhanced Click delivered to an advertiser’s website, or the advertiser can choose to receive the customer prospect in the form of a ready-to-call lead, bypassing the need for the advertiser to develop the necessary infrastructure to convert Enhanced Clicks into ready-to-call leads. Our technology allows us to be industry-agnostic. We currently serve advertisers primarily in the automotive, home improvement, insurance and real estate industries.
 
In the quarter ended December 31, 2009, we generated over 4.9 million Enhanced Clicks and over 700,000 leads and served over 5,000 advertisers. In the year ended December 31, 2009, we generated $34.3 million in revenue, $2.5 million of net income, $4.9 million of operating income and $7.3 million of Adjusted EBITDA, compared to $23.3 million in revenue, $3.2 million of net loss, $2.5 million of operating loss and $1.3 million of Adjusted EBITDA in the year ended December 31, 2008, which represents growth in revenue of 47% and growth in Adjusted EBITDA of 452%, respectively.
 
Industry Overview
 
Businesses spent approximately $93.5 billion in 2009 on advertising and marketing related services to influence and acquire locally-targeted customers, according to Borrell Associates, Inc. A significant portion of this amount is from national advertisers that sell their products or services locally, such as automobile companies that sell through local dealerships. In addition, locally operated businesses, such as home improvement contractors, place their own advertisements for local customer prospects. Traditionally, these advertisers have used offline media formats including the Yellow Pages, newspapers, direct mail, radio stations and local television to reach their target audience. As consumers have shifted their media consumption to the Internet, locally-targeted advertisers have begun to slowly shift their marketing budgets online as well. According to a July 2009 Forrester Research, Inc.


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report titled Consumer Behavior Online: A 2009 Deep Dive, 33% of weekly media consumption by Americans was via the Internet, yet only 17% of the $218 billion in annual advertising in 2009 was spent online according to Borrell Associates, Inc.
 
Online locally-targeted advertisers use a variety of techniques to attract customer prospects. In addition to the placement of direct ads, such as display ads, a substantial portion of online advertising expenditures relate to search engine marketing, or SEM. SEM is the practice of purchasing key words from search engines to receive more clicks to a website. Display advertising and SEM are designed to result in customer prospects clicking on a link and being directed to the advertiser’s website. By their nature, clicks do not include any information confirming the specific product or service and locality of the customer prospect nor any information that would allow the advertiser to directly follow up with the customer prospect. As an alternative to seeking traffic only, many online advertisers also seek leads. Leads contain specific information about a customer prospect such as the customer prospect’s name, email address, telephone number, specific product or service that the customer prospect is interested in and the location of the customer prospect. Online locally-targeted advertisers ultimately balance the likelihood that a specific action will result in an actual customer against the cost in determining their advertising strategy.
 
We believe that the lack of an efficient and effective way for locally-targeted advertisers to obtain targeted customer prospects has slowed locally-targeted advertisers’ transition from offline to online advertising. The need for locally-targeted advertisers to make significant investments in hiring and infrastructure to advertise efficiently using major search engines, the fact that a significant portion of online marketing efforts result in wasted and unwanted traffic, a limited ability to acquire customer prospects with actionable information and the inefficiencies inherent in traditional lead generation, all make this challenge particularly acute for locally-targeted advertisers.
 
Our Solution
 
We have built a technology platform that is designed to address the needs of locally-targeted advertisers of all sizes and levels of sophistication. Major benefits of our solution include the following:
 
     Our technology platform enables us to categorize customer prospects based on specific user-provided information regarding the product or service in which they are interested as well as the relevant location. Our marketplace allows advertisers to control the specific characteristics of the customer prospects they seek to acquire and determine the optimal price, quality and volume in designing their advertising campaigns. Our Exchange service allows advertisers to resell unwanted traffic they may acquire from other sources which would otherwise be wasted advertising spending.
     We have designed our technology platform to meet the needs of both large national advertisers interested in locally-targeted traffic as well as other locally-targeted advertisers. National advertisers interested in locally-targeted traffic can use our marketplace to gain access to their desired customer prospects while maintaining their desired cost per transaction without needing to build expensive infrastructure or hire costly professionals. Other locally-targeted advertisers can easily set up accounts and define marketing campaigns with our easy-to-use Click Marketplace, or CMP, and Lead Marketplace, or LMP. All advertisers bid their desired price for their target customer prospects which allows them to generate transactions at prices that do not exceed an acceptable cost per transaction.
     Our technology platform is agnostic as to our sources of traffic, allowing us to acquire traffic from multiple sources based upon the cost and quality of the traffic and the needs of the advertisers in our auction marketplace. As a result, by placing orders with us, our advertisers gain access to customer prospects from many different sources of traffic in one marketplace.
     We have designed our technology platform to be agnostic as to industry categories, allowing us to enter into new industry categories without having to make significant technology investments. This allows us to offer our marketing solutions for a growing number of locally-targeted categories.


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Our Strategy
 
Our goal is to be the leader in locally-targeted online marketing solutions. Key elements to our strategy for achieving this goal include the following:
 
     Continue to grow existing categories. We intend to continue developing the industry categories we currently serve by adding new advertisers and growing our business with existing advertisers within those industry categories.
     Launch additional categories. We have designed our technology platform to address any industry category and we intend to continue to expand into new categories.
     Expand channel partnerships. We intend to expand the number of partnerships we have with advertising agencies and media groups. We intend to work with other businesses that address the locally-targeted advertising market and provide our Reply! Marketplace on a white-labeled basis to complement their offline and other online activities.
     Expand our Exchange service. We intend to continue to improve and expand our Exchange service to provide greater opportunities to our advertisers to sell unwanted traffic acquired from other sources.
     Expand internationally. We have designed our platform to allow us to expand into other geographic markets globally. We intend to leverage key national account advertiser relationships with global brands to penetrate new geographic markets.
     Pursue acquisitions. We intend to evaluate strategic acquisitions to enable us to increase our geographic presence, expand our advertiser relationships, expand into additional industry categories and further enhance our marketplace.
 
Risks Associated with Our Business
 
Our business is subject to numerous risks and uncertainties, including those highlighted in the section entitled “Risk Factors” immediately following this prospectus summary. In particular, the following factors could harm our business and cause the trading price of our common stock to decline, which in turn could cause you to lose all or part of your investment:
 
     we operate in a developing industry and only have limited history operating pursuant to our current business model, which makes it difficult to evaluate our business;
     we depend upon Google, Yahoo! and Bing for a substantial portion of the traffic that we convert into Enhanced Clicks and leads, and if our ability to obtain traffic from them is limited due to changes in their policies or practices, or if they increase their prices, it could harm our business;
     most of our revenue comes from a relatively limited number of customers;
     because we generally do not enter into contracts with advertisers that require them to make any specific purchase commitments to us, most advertisers can cease or reduce their spending with us at any time;
     our results of operations may be negatively impacted by investments we make as we enter new industry categories;
     if our technology platform becomes unavailable or otherwise fails to perform properly, it could harm our reputation and subject us to liability claims;
     we rely on a third-party provider to host our technology platform, and any interruptions or delays in services from this provider could impair our ability to provide our services and harm our business;
     our industry is highly competitive; and
     the loss of any of our key employees, particularly Payam Zamani, our Chief Executive Officer and Chairman, would materially affect our business.
 
Corporate Information
 
We were incorporated in California in June 2001. We intend to reincorporate in Delaware prior to the completion of this offering. Our principal executive offices are located at 12667 Alcosta Boulevard, Suite 200, San Ramon, CA 94583, and our telephone number is (925) 983-3400. Our website address is www.reply.com. The information on, or accessible through, our website does not constitute a part of, and is not incorporated into, this prospectus.


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The Offering
 
 
Common stock offered by us            shares (           shares if the underwriters exercise their overallotment option in full)
 
Common stock offered by the selling stockholders            shares (          shares if the underwriters exercise their overallotment option in full)
 
Common stock to be outstanding after this offering            shares
 
Overallotment option
 
We and the selling stockholders have granted the underwriters an option for a period of 30 days to purchase, on the same terms and conditions set forth above, up to an additional          shares of our common stock (           shares to be provided by us and           shares to be provided by the selling stockholders) to cover overallotments.
 
Use of proceeds
 
We estimate that the net proceeds to us from this offering will be approximately $      million, assuming an initial public offering price of $      per share, which is the midpoint of the price range set forth on the cover page of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. We intend to use the net proceeds from this offering as follows: (1) approximately $      million to repay certain of our existing indebtedness; (2) approximately $      million to fund capital expenditures, including establishing a redundant technology infrastructure facility; and (3) the balance for working capital and general corporate purposes. We, however, are not contractually obligated to use the proceeds in this manner or for any particular purpose.
 
We will not receive any proceeds from the sale of common stock by the selling stockholders.
 
See “Use of Proceeds.”
 
Risk factors
 
See “Risk Factors” immediately following this prospectus summary to read about factors you should consider before investing in our common stock.
 
NASDAQ Global Market listing
 
We have applied for listing of our common stock on The NASDAQ Global Market under the symbol “RPLY.”
 
Ownership after the offering
 
Our executive officers, directors and affiliates will own     % of our common stock after completion of the offering, and they will continue to have significant control over our affairs.
 
Dividend policy
 
We do not currently pay cash dividends on our outstanding common stock. We do not intend to pay cash dividends on our common stock in the foreseeable future.
 
The number of shares of our common stock expected to be outstanding after completion of this offering is based on 20,474,992 shares outstanding as of December 31, 2009, and excludes:
 
     1,473,850 shares of common stock issuable upon the exercise of options outstanding as of December 31, 2009 at a weighted average exercise price of $0.92 per share;


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     406,435 shares of common stock reserved for issuance upon the exercise of warrants outstanding as of December 31, 2009 at a weighted average exercise price of $1.97; and
 
     1,374,550 shares of common stock reserved for issuance under our stock option plans.
 
Unless otherwise indicated, this prospectus reflects and assumes the following:
 
     our planned reincorporation in Delaware to be effected prior to the completion of this offering;
 
     a          -for-          reverse split of our outstanding common stock and redeemable convertible preferred stock to be effected prior to the completion of this offering;
 
     the conversion of all outstanding shares of our redeemable convertible preferred stock into an aggregate of 5,887,109 shares of common stock upon the closing of this offering;
 
     the conversion of all outstanding warrants to purchase shares of our redeemable convertible preferred stock into warrants to purchase an aggregate of 406,435 shares of common stock upon the closing of this offering;
 
     the filing of our amended and restated certificate of incorporation immediately prior to the effectiveness of this offering; and
 
     no exercise by the underwriters of their overallotment option.


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Summary Consolidated Financial Data
 
We present below our summary consolidated financial data. The summary consolidated statements of operations and statements of cash flows data for the fiscal years 2007, 2008 and 2009, and the summary consolidated balance sheet data as of December 31, 2009, have been derived from our audited consolidated financial statements included elsewhere in this prospectus. The historical results presented below are not necessarily indicative of the financial results we will achieve in future periods. You should read this information together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements and related notes, each included elsewhere in this prospectus.
 
We use the other financial data presented below in addition to the financial measures reflected in the consolidated statements of operations, cash flows and balance sheet data to help us evaluate growth trends, establish budgets, measure the effectiveness of our sales and marketing efforts and assess operational efficiencies.
 
                         
 
    Year Ended December 31,  
    2007     2008     2009  
 
Consolidated Statement of Operations Data:
                       
Revenue:
                       
Marketplace
  $ 18,659     $ 18,646     $ 32,569  
Connecting Neighbors
    6,081       4,687       1,726  
                         
Total revenue
    24,740       23,333       34,295  
                         
Cost of revenue:
                       
Marketplace(*)
    11,571       9,959       16,333  
Connecting Neighbors
    1,590       1,365       502  
                         
Total cost of revenue
    13,161       11,324       16,835  
                         
Gross profit
    11,579       12,009       17,460  
Operating expenses:
                       
Sales and marketing(*)
    9,309       7,461       6,687  
General and administrative(*)
    2,936       2,583       3,864  
Technology(*)
    4,539       2,651       2,034  
Goodwill impairment
          1,793        
                         
Total operating expenses
    16,784       14,488       12,585  
                         
Operating income (loss)
    (5,205 )     (2,479 )     4,875  
Total other expense
    (847 )     (766 )     (2,066 )
                         
Income (loss) before income taxes
    (6,052 )     (3,245 )     2,809  
Provision for income taxes
                293  
                         
Net income (loss)
    (6,052 )     (3,245 )     2,516  
Accretion of preferred stock
    (84 )     (89 )     (89 )
                         
Net income (loss) available to common stockholders
  $ (6,136 )   $ (3,334 )   $ 2,427  
                         
(Dollars in thousands)


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    Year Ended December 31,  
    2007     2008     2009  
 
Net income (loss) per share available for common stockholders:
                       
Basic
  $ (0.48 )   $ (0.26 )   $ 0.19  
                         
Diluted
  $ (0.48 )   $ (0.26 )   $ 0.12  
                         
Weighted average shares used in computing basic net income (loss) per share
    12,783       12,785       12,812  
Weighted average shares used in computing diluted net income (loss) per share
    12,783       12,785       20,319  
Pro forma net income per share (unaudited)(1):
                       
Basic
                  $ 0.14  
                         
Diluted
                  $ 0.12  
                         
Weighted average shares used in computing basic net income per share (unaudited)
                    18,493  
Weighted average shares used in computing diluted net income per share (unaudited)
                    20,319  
(In thousands, except per share data)
 
(*) Includes stock-based compensation expense as follows:
 
                         
 
    Year Ended December 31,  
    2007     2008     2009  
 
Cost of revenue, Marketplace
  $ 7     $ 4     $ 13  
Sales and marketing
    213       207       355  
General and administrative
    177       181       329  
Technology
    53       58       65  
(In thousands)
 
                         
 
    December 31, 2009  
                Pro Forma as
 
    Actual     Pro Forma(2)     Adjusted(3)  
 
Consolidated Balance Sheet Data:
                       
Cash and cash equivalents
  $ 1,333     $ 1,333     $      —  
Working capital
    2,185       2,185        
Total assets
    7,773       7,773        
Total liabilities
    9,691       9,691        
Total debt
    1,971       459        
Redeemable convertible preferred stock
    16,780              
Total stockholders’ equity (deficit)
    (18,698 )     610        
(In thousands)
 


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    Year Ended December 31,  
    2007     2008     2009  
 
Consolidated Statement of Cash Flows Data:
                       
Net cash provided by (used in) operating activities
  $ (5,096 )   $ 276     $ 4,722  
Depreciation and amortization
    1,459       1,550       1,617  
Capital expenditures
    922       1,040       1,076  
Cash flows used in investing activities
    (822 )     (1,040 )     (1,076 )
Cash flows provided by (used in) financing activities
    5,084       (540 )     (2,338 )
(In thousands)
 
                         
 
    Year Ended December 31,  
    2007     2008     2009  
 
Other Financial Data:
                       
Adjusted EBITDA(4)
  $ (2,921 )   $ 1,332     $ 7,349  
(In thousands)
 
(1) The pro forma net income per share, basic and diluted, and pro forma weighted average shares outstanding give effect to the conversion of all of our outstanding redeemable convertible preferred stock into 5,887,109 shares of common stock upon the completion of this offering.
 
(2) The pro forma consolidated balance sheet data gives effect to the reclassification of the portion of the preferred stock warrant liability allocable to the warrants that convert to common shares or warrants to purchase common shares and the conversion of all of our outstanding redeemable convertible preferred stock into 5,887,109 shares of common stock upon the completion of this offering and the reclassification of the portion of the preferred stock warrant into common stock.
 
(3) The pro forma as adjusted consolidated balance sheet data gives effect to the conversion of all of our outstanding redeemable convertible preferred stock into 5,887,109 shares of common stock upon the completion of this offering and to the sale of shares of our common stock in this offering at an assumed initial public offering price of $      per share, which is the midpoint of the price range set forth on the cover page of this prospectus, after deducting the estimated underwriting discounts and commissions and estimated offering expenses payable by us. Each $1.00 increase (decrease) in the assumed initial public offering price of $      per share would increase (decrease) each of cash and cash equivalents, working capital, total assets and total stockholders’ equity (deficit) by $      , assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. The pro forma as adjusted information discussed above is illustrative only and will adjust based on the actual initial public offering price and other terms of this offering determined at pricing.
 
(4) We define Adjusted EBITDA as net income (loss) plus other expense, provision for income taxes, depreciation and amortization, stock-based compensation expense, impairment of goodwill, loss on disposal and abandonment of assets, and charitable contributions. Adjusted EBITDA is a key financial measure that our management uses to evaluate our operating performance but should not be construed as an alternative to operating income, cash flows from operating activities or net income (loss), as determined in accordance with accounting principles generally accepted in the United States of America, or GAAP. Adjusted EBITDA is not a measure defined in accordance with GAAP. We believe that Adjusted EBITDA is a standard performance measure commonly reported and widely used by analysts and investors in our industry. We also use Adjusted EBITDA for additional purposes such as assessing the performance of our executive officers for purposes of our executive compensation plan. A reconciliation of net income (loss) to Adjusted EBITDA is set forth in the table below.
 
Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation, or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
 
•  Adjusted EBITDA does not reflect our cash expenditures, or future requirements, for capital expenditures or contractual commitments;

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•  Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;
 
•  Adjusted EBITDA does not reflect the interest expense, or the cash requirements necessary to service interest or principal payments, on our debt;
 
•  Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for these replacements; and
 
•  Other companies in our industry may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure.
 
Because of these limitations, Adjusted EBITDA should not be considered as a measure of discretionary cash available to us to invest in the growth of our business. We compensate for these limitations by relying primarily on our GAAP results of operations and using Adjusted EBITDA only supplementally. See the Statements of Cash Flows included in our consolidated financial statements included elsewhere in this prospectus.
 
A reconciliation of net income (loss) to Adjusted EBITDA is as follows:
 
                         
 
    Year Ended December 31,  
    2007     2008     2009  
 
Reconciliation of Adjusted EBITDA to net income (loss)
                       
Net income (loss)
  $ (6,052 )   $ (3,245 )   $ 2,516  
Other expense(a)
    847       766       2,066  
Provision for income taxes
                293  
Depreciation and amortization
    1,459       1,550       1,617  
Stock-based compensation expense
    450       450       762  
Impairment of goodwill(b)
          1,793        
Loss on disposal and abandonment of assets(c)
    374       18       11  
Charitable contributions(d)
    1             84  
                         
Adjusted EBITDA
  $ (2,921 )   $ 1,332     $ 7,349  
                         
(In thousands)
 
(a) Includes interest expense, net, and increase (decrease) in fair value of warrants.
 
(b) Reflects the write-off of goodwill relating to our Connecting Neighbors segment. See Note 5 to the Notes to Consolidated Financial Statements.
 
(c) Reflects the write-off of capitalized website and internal use software development costs relating to an abandoned project.
 
(d) We currently expect to make charitable contributions in an aggregate amount equal to approximately 1% of our Adjusted EBITDA.


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Risk Factors
 
Investing in our common stock involves a high degree of risk. You should carefully consider all the risks described below before making a decision to invest in our common stock. Our business could be harmed by any of these risks at any time. The trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment.
 
Risks Relating to Our Business
 
Our quarterly operating results will likely fluctuate in the future, which could cause rapid declines in our stock price.
 
As our business continues to grow, we believe that our quarterly operating results will be subject to significant fluctuation due to various factors, many of which are beyond our control. Factors that may affect our quarterly operating results in the future include:
 
     our ability to attract new advertisers, retain existing advertisers and increase sales to such advertisers;
 
     our ability to introduce services focused on new industry categories and the impact of increased traffic costs and decreased operating margins that may coincide with new category launches;
 
     fluctuations based upon seasonality, including increased traffic acquisition costs and decreased participation in our auction marketplace that may occur toward the end of our fiscal year;
 
     the magnitude and timing of our future investments in technology and other capital expenditures;
 
     changes in practices, policies or pricing by search engine companies or other sources of our traffic;
 
     the portions of advertising budgets allocated to online marketing by locally-targeted advertisers;
 
     fluctuations in the prices our advertisers are willing to pay on our auction marketplace for Enhanced Clicks and leads;
 
     the amount of traffic we are able to acquire, the portion of it we are able to monetize and the mix of monetized traffic represented by Enhanced Clicks and leads;
 
     the loss of one or more significant advertisers during a period;
 
     variability of operating expenses as a percentage of revenue;
 
     the timing and success of new services and technologies introduced by us and our competitors;
 
     our ability to introduce new and innovative services that appeal to our advertisers;
 
     the effect of mergers and acquisitions among our competitors or partners;
 
     general economic conditions; and
 
     the impact of regulatory changes on our cost of doing business.
 
Accordingly, it is difficult for us to accurately forecast our results of operations on a quarterly basis. If we fail to meet expectations of investors or analysts, our stock price may fall rapidly and without notice. Furthermore, the fluctuation of our quarterly operating results may render less meaningful period-to-period comparisons of our operating results, and you should not rely upon them as an indication of our future performance.
 
We have had a history of losses.
 
We experienced net losses of $6.1 million in 2007 and $3.2 million in 2008 and achieved profitability and reported net income for the first time in 2009. We cannot predict if we will sustain this profitability or, if we fail to sustain this profitability, again attain profitability in the near future or at all. We expect to continue making significant future expenditures to develop and expand our business. In addition, as a public company, we will incur additional significant legal, accounting and other expenses that we did not incur as a private company. These


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increased expenditures will make it harder for us to maintain future profitability. Our recent growth in revenue may not be sustainable. We may incur significant losses in the future for a number of reasons, including due to the other risks described in this prospectus, and we may encounter unforeseen expenses, difficulties, complications and delays and other unknown events. Accordingly, we may not be able to maintain profitability.
 
We operate in a developing industry and have a limited history operating under our current business model, which makes it difficult to evaluate our business and prospects and may increase the risk of your investment.
 
Our current business is based on an online auction marketplace that we introduced in the fourth quarter of 2008. We also operate in the online marketing industry which is new and emerging. You must consider our business and prospects in light of our limited history of operating under our current business model and the risks and difficulties we encounter in the new and rapidly evolving online marketing industry.
 
If the market for online marketing services deteriorates, or develops more slowly than we expect, our business could suffer. Our future success is highly dependent on the commitment of our advertisers to the Internet as a marketing medium. The online marketing market is relatively new and rapidly evolving. As a result, future demand and market acceptance for online advertising, marketing and technology services is uncertain. Some of our current or potential advertiser customers have little or no experience using the Internet for marketing purposes and many have allocated only a limited portion of their marketing budgets to online marketing. There is no certainty that such businesses will continue to allocate more funds in the future.
 
Also, we must compete with traditional advertising media, including television, print, radio, and outdoor advertising, for a share of our advertisers’ total marketing budgets. Businesses, including current and potential advertisers, may find online marketing to be less effective than traditional marketing methods or other technologies for promoting their products and services, and therefore our relatively new online auction marketplace may deteriorate or develop more slowly than expected.
 
We depend upon Google, Yahoo! and Bing for a substantial portion of the traffic that we convert into Enhanced Clicks or leads. If our ability to obtain traffic through these Internet search engine companies is limited due to changes in their policies and practices, if the prices or other terms pursuant to which we do business with such search engine companies change, or if such search engine companies attempt to offer a service similar to ours, our business, financial condition and operating results may suffer.
 
Our success is dependent upon our ability to attract traffic that we can then convert into Enhanced Clicks, which are generated by customer prospects and provide user-submitted category information and the location at which the product will be purchased or the service will be rendered, or leads, which also provide our advertisers with a customer prospect’s contact information. A substantial majority of our traffic is generated from leading Internet search engine sites that provide users with a combination of paid and algorithmic listings. Paid search results are determined based upon the bid price for search words and other factors utilized by specific search engine sites. Our ability to obtain traffic from algorithmic based listings is dependent upon the ranking of our sites in accordance with algorithms used by each search engine site. Changes to our sites or in the algorithms used by search engine sites could negatively impact our listings in the search results and in turn reduce the amount of traffic to our sites. In such event, our dependence upon paid search results would increase. If we need to modify our sites or practices to improve our rankings, if the costs of obtaining paid search results increases generally or if we must pay higher prices for paid search results based upon other factors utilized by search engine sites, our cost of revenue could increase. Any such increases could adversely impact our business and results of operations. Although we are a customer of the search engine companies, it is possible that in the future they could decide to compete more directly with us, which could also adversely affect our business and results of operations.
 
A significant portion of our sales comes from a relatively limited number of advertisers.
 
Historically, we have relied on a limited number of advertisers for a substantial portion of our revenue. If we were to lose key advertisers, our financial results could be adversely affected. For the years ended December 31, 2009 and 2008, revenue from our 10 largest advertisers represented approximately 53% and 22% of our revenue, respectively, and Autobytel represented approximately 11% and 8% of our revenue, respectively. Significant


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reductions in revenue from any of these advertisers or the loss of any major advertisers could adversely affect our business.
 
We are dependent on two industry categories for a majority of our revenue.
 
To date, we have generated a majority of our revenue from advertisers in the automotive and real estate industries. We expect that a majority of our revenue in fiscal year 2010 will be generated from advertisers in these industries. Over the past two years, these industries have seen declines in marketing budgets given the difficult market conditions. These declines may continue or worsen. Future downturns in economic or market conditions adversely affecting theses industries would negatively impact our business and financial condition.
 
Because we generally do not enter into contracts with advertisers requiring any specific purchase commitments, most advertisers can cease or reduce their spending with us at any time, which could result in reduced revenues or otherwise adversely impact our results of operations.
 
We sell our Enhanced Clicks and leads through an auction system. Our advertiser contracts do not generally require minimum purchases or provide for ongoing commitments. If one or more collectively significant advertisers were to reduce or eliminate their participation in our auction marketplace, we could sell less of the traffic we acquire or sell the same traffic for a significantly lower yield to us. As a result, our revenue may be difficult to forecast. Because our expense levels are based on our expectations as to future revenue and to a large extent are fixed in the short term, we might be unable to adjust spending in time to compensate for any shortfall in revenue. Accordingly, any significant shortfall of revenue in relation to our expectations would harm our operating results.
 
Our results of operations may be negatively impacted by investments we make as we enter new industry categories.
 
From time to time, we begin offering services for new industry categories. For example, we entered into the home improvement category in the quarter ended June 30, 2009 and the insurance category in the quarter ending March 31, 2010. We make substantial investments in such new categories before we begin generating revenue. Historically, we have experienced material increases for traffic acquisition costs in the early stages of a newly launched industry category, and we expect to generate lower gross margin from revenue initially generated in new industry categories. If the launch of a new category requires investments greater than we expect, traffic acquisition costs outstrip our expectations or if the revenue generated from a new category grows more slowly than we expect, our results of operations could be adversely impacted.
 
The impact of worldwide economic conditions, including the resulting effect on advertising budgets, may adversely affect our business, operating results and financial condition.
 
Our performance is subject to worldwide economic conditions and their impact on levels of advertising. To the extent that the current economic recession continues, or worldwide economic conditions materially deteriorate, our existing and potential advertisers may no longer consider investment in our online marketing solutions a necessity, or may elect to reduce advertising budgets. Historically, economic downturns have resulted in overall reductions in advertising spending. In particular, online marketing advertising solutions may be viewed by some of our existing and potential advertisers as a lower priority and may be among the first expenditures reduced as a result of unfavorable economic conditions. These developments could have an adverse effect on our business, operating results and financial condition.
 
Our sales efforts require significant time and effort and could hinder our ability to expand our advertiser base and increase sales.
 
Attracting new advertisers and servicing existing advertisers requires substantial time and expense and we cannot assure you that we will be successful in establishing new relationships, or maintaining or advancing our current relationships. For example, it may be difficult to identify, engage and market to advertisers who do not currently perform online marketing or advertising or are unfamiliar with our current services or platform. Further, many of our advertisers, in particular locally-targeted national accounts and channel partners, typically require input from


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one or more internal levels of approval. As a result, during our sales effort, we must identify multiple people involved in the purchasing decision and devote a sufficient amount of time to presenting our marketplace to those individuals. The newness and complexity of our marketplace often requires us to spend substantial time and effort assisting potential advertisers in evaluating our services including providing demonstrations and benchmarking against other available technologies. This process can be costly and time consuming. We expect that our sales process will become less burdensome as our marketplace becomes more widely known and used. However, if this does not occur, we will not be able to expand our sales effort as quickly as anticipated and our sales will be adversely affected.
 
If our technology platform becomes unavailable or otherwise fails to perform properly, our reputation will be harmed, our market share would decline and we could be subject to liability claims.
 
Our technology platform is inherently complex and may contain material defects or errors. In addition, our technology infrastructure may not be able to meet increased demand. Any defects in functionality or that cause interruptions in the availability of our services could result in:
 
     lost or delayed market acceptance and sales;
 
     breach of warranty claims;
 
     sales credits or refunds to our advertisers;
 
     loss of advertisers;
 
     diversion of development and advertiser service resources; and
 
     injury to our reputation.
 
The costs incurred in correcting any material defects or errors might be substantial and could adversely affect our operating results. Our errors and omissions insurance may be inadequate or may not be available in the future on acceptable terms, or at all. In addition, our policy may not cover all claims against us and defending a suit, regardless of its merit, could be costly and divert management’s attention.
 
We rely on a third-party service provider to host our technology platform, and any interruptions or delays in services from this provider could impair the delivery of our services and harm our business.
 
We currently use one third-party data center to host our technology platform and do not have a fully redundant back-up system. This facility is vulnerable to damage or interruption from natural disasters, fires, power loss, telecommunications failures and similar events. It is also subject to break-ins, computer viruses, sabotage, intentional acts of vandalism and other misconduct. The occurrence of a natural disaster or an act of terrorism, a decision to close the facilities without adequate notice or other unanticipated problems could result in lengthy interruptions, which would have a serious adverse impact on our business. Additionally, our data center agreement is of limited duration and is subject to early termination rights in certain circumstances, and the provider of our data center has no obligation to renew its agreement with us on commercially reasonable terms, or at all. Although we have the ability to operate our service from our corporate headquarters in the event our hosting facility becomes unavailable, our ability to do so is unproven. Moreover, as our corporate headquarters and hosting facility are both located in the same regional area prone to seismic activity, an earthquake, other natural disaster or other event that causes disruptions at our hosting site could also adversely impact our ability to operate at our corporate headquarters.
 
If we fail to respond to technological developments, our services may become obsolete or less competitive.
 
Our future success will depend in part on our ability to modify or enhance our services to meet advertiser needs, to add functionality and to address technological advancements. To remain competitive, we will need to develop new services that address evolving technologies and standards. However, we may be unsuccessful in identifying new opportunities or in developing or marketing new services in a timely or cost-effective manner. In addition, our innovations may not achieve the market penetration or price levels necessary for profitability. If we are unable to develop enhancements to, and new features for, our existing services or if we are unable to develop new services


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that keep pace with rapid technological developments or changing industry standards, our services may become obsolete, less marketable and less competitive, and our business will be harmed.
 
Research and development investments may not yield profitable and commercially viable offerings and thus will not necessarily result in increases in revenue for us.
 
We invest significant resources in our research and development which may not yield commercially viable offerings. During each stage of research and development there is risk that we will have to abandon a potential service offering in which we have invested significant resources. In the event we are able to develop viable new service offerings, a significant amount of time may have elapsed between our investment in the necessary research and development effort and the receipt of any related revenue.
 
Our industry is highly competitive.
 
The market for locally-targeted advertising is highly competitive. We compete against both traditional offline advertising businesses as well as online services. As the locally-targeted online marketing industry is new and emerging, over time we may compete with a variety of online businesses, including:
 
     search engines such as Google, online portals and other heavily trafficked sites such as Facebook, all of which have substantially higher profiles and much lower costs of acquiring traffic than we do;
 
     businesses that focus on specific industry categories such as automotive or real estate or upon listings for locally-targeted business, such as Yelp and Craigslist;
 
     businesses that focus on delivering locally-targeted online marketing services, such as ReachLocal; and
 
     other companies providing online marketing services.
 
We currently or may in the future do business with many of these current or potential competitors, either as a source of the traffic we acquire or an advertiser purchasing Enhanced Clicks or leads from us. As a result, if any of these companies chooses to compete more directly with us, we may face the prospect of both the loss of business and increased competition.
 
Most of our competitors have substantially greater financial and other resources than we do. As a result, our competitors may be able to respond more quickly and effectively than we can to new or changing opportunities, technologies, standards or market requirements. We also compete with emerging companies. We expect to experience continuing competitive pressures in our markets from existing competitors and new entrants. Any consolidation among our competitors could enhance their product offerings and financial resources, further enhancing their competitive position. Our ability to compete effectively will depend on a number of factors, including:
 
     our ability to offer cost-effective and high-quality services on a timely basis;
 
     our ability to accurately identify and respond to emerging technological trends and demand for new features and performance characteristics;
 
     our ability to continue to rapidly introduce new services that are accepted by the market;
 
     our ability to adopt or adapt to emerging industry standards;
 
     the number and nature of our competitors and competitiveness of their products and services in a given market; and
 
     entrance of new competitors into our markets.
 
Many of these factors are outside of our control. For all of these reasons, we may not be able to compete successfully against our current or future competitors.


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Our recently introduced Reply! Exchange service may not achieve sufficient market acceptance.
 
Our Reply! Exchange service was first introduced in late 2008 to provide advertisers with a market to re-sell unwanted or poorly targeted traffic. In order for this service to be successful, we must attract a sufficient number of sellers and buyers such that there is sufficient liquidity in the exchange market. If we are unable to develop sufficient demand for this service, our business and results of operations could be adversely impacted.
 
Negative publicity regarding our industry or our services could harm our reputation and adversely affect our business, financial condition and results of operations.
 
Our business is dependent on developing and maintaining the confidence of our advertisers regarding the value of our services. From time to time we and other companies involved in online marketing services have been subject to advertiser complaints regarding matters such as the value of Enhanced Clicks and leads obtained through our marketplace, click-through fraud and other activities perceived as deceptive business practices. These activities have at times resulted in civil and governmental legal actions, governmental investigations and other proceedings that have had an adverse impact on the reputation of the industry. Any negative publicity regarding the industry in general, or our business in particular, could adversely affect our business, financial condition and results of operations.
 
We could lose clients if we fail to detect click-through or other fraud on advertisements in a manner that is acceptable to our advertisers.
 
We are exposed to the risk of fraudulent clicks or actions on our websites or our third-party publishers’ websites. We may in the future have to refund revenue that our advertisers have paid to us and that was later attributed to, or suspected to be caused by, fraud. Click-through fraud occurs when an individual clicks on an ad displayed on a website or an automated system is used to create such clicks with the intent of generating the revenue share payment to the publisher rather than to view the underlying content. Action fraud occurs when online forms are completed with false or fictitious information in an effort to increase the actions in respect of which a publisher is to be compensated. From time to time we have experienced fraudulent clicks or actions and we do not charge our advertisers for such fraudulent clicks or actions when they are detected. It is conceivable that this activity could hurt our reputation. If fraudulent clicks or actions are not detected, the affected advertisers may experience a reduced return on their investment in our marketing programs, which could lead the advertisers to become dissatisfied with our marketplace, and in turn, lead to loss of advertisers and the related revenue. Additionally, we have from time to time had to terminate relationships with web publishers who we believed to have engaged in fraud and we may have to do so in future. Termination of such relationships entails a loss of revenue associated with the legitimate actions or clicks generated by such publishers.
 
We are exposed to risks associated with credit card fraud and credit payment, and we may suffer losses as a result of fraudulent data or payment failure by advertisers.
 
We have suffered losses and may continue to suffer losses as a result of payments made with fraudulent credit card data. Our failure to adequately control fraudulent credit card transactions could reduce our revenue and gross margin and negatively impact our standing with applicable credit card authorization agencies. In addition, under limited circumstances, we extend credit to advertisers who may default on their accounts payable to us or fraudulently “charge-back” amounts on their credit cards for services that have already been delivered by us. If we suffer charge-backs or refunds at levels in excess of that permitted by our credit card processors, we could face penalties and may lose our rights to accept credit card payments from advertisers through one or more credit card processors. We could also be exposed to damages and loss of reputation if any of our employees misuse credit card information in violation of our policies.
 
The misappropriation, release, loss or misuse of consumer or other data could adversely affect our business.
 
In the operation of our business, we collect data about consumers in order to deliver our services. The misappropriation, release, loss or misuse of any consumer data, whether by accident, omission or as the result of criminal activity, computer hacking, natural disasters, terrorism or other events, could lead to negative publicity,


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harm to our reputation, advertiser dissatisfaction, regulatory enforcement actions, individual or class-action lawsuits or significant expenditures to recover the data or protect data from similar releases in the future, and may otherwise adversely affect our business.
 
Failure to comply with federal, state or international privacy laws or regulations, or the expansion of current or the enactment of new privacy laws or regulations, could adversely affect our business.
 
A variety of federal, state and international laws and regulations govern the collection, use, retention, sharing and security of consumer data. The existing privacy-related laws and regulations are evolving and subject to potentially differing interpretations. In addition, various federal, state and foreign legislative and regulatory bodies may expand current or enact new laws regarding privacy matters. We have posted privacy policies and practices concerning the collection, use and disclosure of user data on our websites. Several Internet companies have incurred penalties for failing to abide by the representations made in their privacy policies. In addition, several states have adopted legislation that requires businesses to implement and maintain reasonable security procedures and practices to protect sensitive personal information and to provide notice to consumers in the event of a security breach. Any failure, or perceived failure, by us to comply with our posted privacy policies or with any data-related consent orders, Federal Trade Commission requirements or orders or other federal, state or international privacy or consumer protection-related laws, regulations or industry self-regulatory principles could result in claims, proceedings or actions against us by governmental entities or others or other liabilities, which could adversely affect our business. In addition, a failure or perceived failure to comply with industry standards or with our own privacy policies and procedures could result in a loss of consumers or advertisers and adversely affect our business. Federal, state and international governmental authorities continue to evaluate the privacy implications inherent in the use of third-party web “cookies” for behavioral advertising. The regulation of these “cookies” and other current online advertising practices could adversely affect our business.
 
Government regulation of the Internet may adversely affect our business and operating results.
 
Online commerce and related businesses face uncertainty related to future government regulation of the Internet through the application of new or existing federal, state and international laws. Due to its rapid growth and widespread use, legislatures at the federal and state level have enacted and may continue to enact various laws and regulations relating to the Internet. Individual states may also enact consumer protection laws that are more restrictive than the ones that already exist.
 
Furthermore, the application of existing laws and regulations to Internet companies remains somewhat unclear. For example, as a result of the actions of our advertisers, we may be subject to existing laws and regulations relating to a wide variety of issues such as consumer privacy, gambling, sweepstakes, advertising, promotions, defamation, pricing, taxation, financial market regulation, quality of products and services, computer trespass, spyware, adware, child protection and intellectual property ownership and infringement. In addition, it is not clear whether existing laws that require licenses or permits for certain of our advertisers’ lines of business apply to us, including those related to insurance. Courts may apply existing and future laws or regulations in unintended and unexpected ways.
 
Many Internet services are automated, and companies such as ours may be unknowing conduits for illegal or prohibited materials. It is possible that some courts may impose a strict liability standard or require such companies to monitor their customers’ conduct.
 
Future taxes imposed upon Internet commerce may adversely impact our business and financial results.
 
We do not charge, collect or have imposed upon us sales or other transaction taxes related to the services we sell. However, state, local and other governmental authorities continue to seek ways to impose additional taxes on Internet commerce. Any new laws or regulations imposing such taxes may make electronic commerce transactions less attractive for advertisers and other businesses, which could result in a decrease in the level of usage of our services. In addition, any such laws or regulations could subject us to additional sales, income or other taxes and adversely impact our results of operations.


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The loss of our key employees would materially adversely affect our business, and we may not be able to attract or retain the technical or management employees necessary to compete in our industry.
 
Our key executives have substantial experience and have made significant contributions to our business, and our continued success is dependent upon the retention of our key management executives, including our Chief Executive Officer and Chairman, Payam Zamani and a number of other key managerial, marketing, financial, technical and operations personnel. We do not maintain “key man” insurance policies for any of our employees. The loss of such key personnel would have a material adverse effect on our business. Growth in our business is dependent, to a large degree, on our ability to retain and attract such employees. In addition, we depend on our ability to attract and retain skilled technical and managerial personnel. We could lose the services of, or fail to recruit, skilled personnel. Competition for qualified personnel is particularly intense in the San Francisco Bay Area. If and when economic conditions improve, retainment and recruiting efforts may be more challenging. This could hinder our research and product development programs or otherwise have a material adverse effect on our business.
 
We may incur costs to engage in future business combinations or strategic investments, and we may not realize the anticipated benefits of those transactions.
 
As part of our business strategy, we may seek to enter into business combinations, investments, joint ventures and other strategic alliances with other companies in order to maintain and grow our revenue and market presence as well as to provide us with access to technology, products and services. Any such transaction would be accompanied by risks that may harm our business, such as difficulties in assimilating the operations, personnel and products of an acquired business or in realizing the projected benefits; disruption of our ongoing business; potential increases in our indebtedness and contingent liabilities; and charges if the acquired company or assets are later determined to be worth less than the amount we paid for them. For example, in 2008 we recorded a $1.8 million charge as a result of the impairment of the goodwill acquired in connection with our acquisition of CN.
 
Our ability to compete successfully and achieve future growth will depend, in part, on our ability to protect our proprietary technology and know-how, as well as our ability to operate without infringing the proprietary rights of others.
 
We seek to protect our proprietary technologies and know-how through the use of patents, trade secrets, confidentiality agreements and other security measures. We do not currently have any patents. The process of seeking patent protection takes a long time and is expensive. We cannot assure you that patents will issue from pending or future applications or that, if patents issue, they will not be challenged, invalidated or circumvented, or that the rights granted under the patents will provide us with meaningful protection or any commercial advantage. Some of our technologies are not covered by any patent application. The confidentiality agreements on which we rely to protect these technologies may be breached and may not be adequate to protect our proprietary technologies. We cannot assure you that other countries in which we may market our services will protect our intellectual property rights to the same extent as the United States.
 
Our ability to compete successfully depends on our ability to operate without infringing the proprietary rights of others. We have no means of knowing what patent applications have been filed in the United States until they are published. In addition, the technology sector is characterized by frequent claims and litigation regarding patents, trademarks, URLs and other intellectual property rights. We may need to file lawsuits to enforce our intellectual property rights, and we may need to defend against claimed infringement of the rights of others. Any litigation could result in substantial costs to us and divert our resources. Despite our efforts in bringing or defending lawsuits, we may not be able to prevent third parties from infringing upon or misappropriating our intellectual property. In the event of an adverse outcome in any such litigation, we may be required to:
 
     pay substantial damages, indemnify advertisers or licensees for damages they may suffer if the technology they license from us violate the intellectual property rights of others;
 
     stop our use of infringing technologies, expend significant resources to develop or acquire non-infringing technologies; or
 
     obtain licenses to the intellectual property we are found to have infringed.


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We cannot assure you that we would be successful in such development or acquisition or that such licenses would be available under reasonable terms, or at all.
 
Our competitors may develop, patent or gain access to know-how and technology similar to our own.
 
Our long-term success depends, in part, on our ability to expand our business outside of the United States. As a result, our business will become increasingly susceptible to risks associated with international operations.
 
We currently operate only in the United States and have only recently begun to plan for international expansion. Our inexperience in operating our business outside of the United States may increase the risk that any international expansion efforts we undertake in the future will not be successful. In addition, conducting international operations will subject us to new risks that we have not generally faced in the United States. These risks include:
 
     different advertiser needs and buying behavior than we are accustomed to in the United States;
 
     difficulties and expenses associated with tailoring our services to local markets, including their translation into foreign languages;
 
     difficulties in staffing and managing international operations, including complex and costly termination requirements;
 
     potentially adverse tax consequences, including the complexities of foreign value-added taxes and restrictions on the repatriation of earnings;
 
     reduced or varied protection for intellectual property rights in some countries;
 
     the burdens of complying with a wide variety of foreign laws and regulations;
 
     fluctuations in currency exchange rates;
 
     increased accounting and reporting burdens and complexities; and
 
     political, social and economic instability abroad, terrorist attacks and security concerns.
 
The impact of any one or more of these risks could negatively affect or delay our plans to expand our business internationally and, consequently, our future operating results.
 
Maintaining and improving our financial controls and complying with rules and regulations applicable to public companies may be a significant burden on our management team and require considerable expenditures of our resources.
 
As a public company, we will incur additional legal, accounting and other expenses that we do not incur as a private company. The Securities Exchange Act of 1934, or the Exchange Act, the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, and The Nasdaq Marketplace Rules will apply to us as a public company. Compliance with these rules and regulations will necessitate significant increases in our legal and financial budgets and may also strain our personnel, systems and resources. The Exchange Act requires, among other things, filing of annual, quarterly and current reports with respect to our business and financial results and condition. The Sarbanes-Oxley Act requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. Satisfying these requirements involves a commitment of significant resources and management oversight. As a result of management’s efforts to comply with such requirements, other important business concerns may receive insufficient attention, which could have a material adverse effect on our business, financial condition and results of operations. Failure to meet certain of these regulatory requirements may also cause us to be delisted from The Nasdaq Global Market. In addition, we currently have a relatively small finance staff and may have difficulty recruiting additional legal, accounting and financial staff with appropriate public company experience and technical accounting knowledge. The hiring of such personnel will also increase our operating expenses in future periods.
 
We also expect these rules and regulations to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced coverage or incur substantially higher


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costs to maintain coverage. If we are unable to maintain adequate directors’ and officers’ insurance, it may be more difficult for us to attract and retain qualified persons to serve on our board of directors or as executive officers.
 
We may need additional capital in the future, and such capital may not be available on acceptable terms or at all.
 
We may require more capital in the future from equity or debt financings to fund our operations, finance investments in equipment and infrastructure, acquire complimentary businesses and technologies, and respond to competitive pressures and potential strategic opportunities. We believe that our cash and cash equivalents and funds generated from operations, together with the net proceeds of this offering, will be sufficient to fund our working capital and capital expenditure requirements for at least the next 12 months. We have based this estimate on assumptions that may prove to be wrong, and it is possible that we could utilize our available financial resources sooner than we currently expect. If we raise additional funds through further issuances of equity or other securities convertible into equity, our existing stockholders could suffer significant dilution, and any new shares we issue could have rights, preferences or privileges senior to those of the holders of our common stock, including the shares of common stock sold in this offering. In addition, additional capital may not be available when needed or, if available, may not be available on favorable terms. In addition, our current Master Security Agreement limits our ability to incur additional indebtedness under certain circumstances. If we are unable to obtain capital on favorable terms, or if we are unable to obtain capital at all, we may have to reduce our operations or forego opportunities, and this may have a material adverse effect on our business, financial condition and results of operations.
 
Investor confidence may be adversely impacted if we are unable to comply with Section 404 of the Sarbanes-Oxley Act.
 
We will be subject to rules adopted by the Securities and Exchange Commission, or SEC, pursuant to Section 404 of the Sarbanes-Oxley Act, which require us to include beginning with our Annual Report on Form 10-K for our fiscal year ending December 31, 2011, our management’s report on, and assessment of the effectiveness of, our internal controls over financial reporting. Beginning with our fiscal year ending December 31, 2011, our independent auditors will be required to attest to and report on the effectiveness of our internal control over financial reporting. If we fail to achieve and maintain the adequacy of our internal controls, there is a risk that we will not comply with all of the requirements imposed by Section 404. Moreover, effective internal controls, particularly those related to revenue recognition, are necessary for us to produce reliable financial reports and are important to helping prevent financial fraud. Any of these possible outcomes could result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our financial statements and could result in investigations or sanctions by the SEC, Nasdaq or other regulatory authorities or in stockholder litigation. Any of these factors ultimately could harm our business and could negatively impact the market price of our securities. Ineffective control over financial reporting could also cause investors to lose confidence in our reported financial information, which could adversely affect the trading price of our common stock.
 
Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives. However, our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been detected.
 
Risks Related to Our Common Stock
 
There is no existing market for our common stock, and we do not know if one will develop that will provide you with adequate liquidity.
 
Currently there is no public market for our common stock. Investor interest in us may not lead to the development of an active trading market. The initial public offering price for the shares will be negotiated between us and


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representatives of the underwriters and may not be indicative of prices that will prevail in the open market following this offering. You may not be able to resell our common stock at or above the initial public offering price.
 
The trading price of our common stock is likely to be volatile, and you might not be able to sell your shares at or above the initial public offering price.
 
Though our common stock has no prior trading history, the trading prices of technology company securities in general have been highly volatile. Accordingly, the trading price of our common stock is likely to be subject to wide fluctuations, and you may not be able to resell our common stock at or above the initial public offering price. Factors, in addition to those outlined elsewhere in this prospectus, that may affect the trading price of our common stock include:
 
     actual or anticipated variations in our operating results;
 
     announcements of technological innovations, new products or product enhancements, strategic alliances or significant agreements by us or by our competitors;
 
     changes in recommendations by any securities analysts that elect to follow our common stock;
 
     the financial projections we may provide to the public, any changes in these projections or our failure to meet these projections;
 
     the loss of a key advertiser;
 
     market conditions in industry categories that we serve and the economy as a whole;
 
     the loss of key personnel;
 
     technological advancements rendering our services less valuable;
 
     lawsuits filed against us;
 
     changes in operating performance and stock market valuations of other companies that provide similar services;
 
     price and volume fluctuations in the overall stock market; and
 
     other events or factors, including those resulting from war, incidents of terrorism or responses to these events.
 
Future sales of shares by existing stockholders could cause our stock price to decline.
 
Attempts by existing stockholders to sell substantial amounts of our common stock in the public market after the contractual lock-up and other legal restrictions on resale discussed in this prospectus lapse could cause the trading price of our common stock to decline significantly. Based on shares outstanding as of December 31, 2009, upon completion of this offering, we will have outstanding           shares of common stock, assuming no exercise of the underwriters’ overallotment option. Of these shares, only shares of common stock sold in this offering to investors other than those subject to a 180-day contractual lock-up will be freely tradable, without restriction, in the public market. Jefferies & Company, Inc. and Piper Jaffray & Co. may, in their sole discretion, permit our officers, directors, employees and current stockholders who are subject to a 180-day contractual lock-up to sell shares prior to the expiration of the lock-up agreements. The lock-up is subject to extension under certain circumstances. For additional information, see “Shares Eligible for Future Sale—Lock-up Agreements.”
 
After the lock-up agreements pertaining to this offering expire, substantially all of our shares will be eligible for sale in the public market, including           shares held by directors, executive officers and other affiliates, which will be subject to volume limitations under Rule 144 under the Securities Act. In addition, shares subject to outstanding options and reserved for future issuance under our stock option plan will become eligible for sale in the public market to the extent permitted by the provisions of various vesting agreements, the lock-up agreements and Rules 144 and 701 under the Securities Act. If these additional shares are sold, or if it is perceived that they will be sold, in the public market, the trading price of our common stock could decline. See “Shares Eligible for


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Future Sale” for more information regarding shares of our common stock that existing stockholders may sell after this offering.
 
If securities analysts do not publish research or reports about our business or if they downgrade our stock, the price of our stock could decline.
 
The research and reports that industry or financial analysts publish about us or our business will likely have an effect on the trading price of our common stock. If an industry analyst decides not to cover our company, or if an industry analyst decides to cease covering our company at some point in the future, we could lose visibility in the market, which in turn could cause our stock price to decline. If an industry analyst downgrades our stock, our stock price would likely decline rapidly in response.
 
The concentration of our capital stock ownership with insiders upon the completion of this offering will likely limit your ability to influence corporate matters.
 
We anticipate that our executive officers, directors, current 5% or greater stockholders and affiliated entities will together beneficially own approximately     % of our common stock outstanding after this offering, assuming full exercise of the underwriters’ overallotment option. As a result, these stockholders, acting together, will have significant influence over all matters that require approval by our stockholders, including the election of directors and approval of significant corporate transactions. Corporate action might be taken even if other stockholders, including those who purchase shares in this offering, oppose them. This concentration of ownership might also have the effect of delaying or preventing a change of control of our company that other stockholders may view as beneficial.
 
Our management will have broad discretion over the use of the proceeds from this offering and might not apply the proceeds of this offering in ways that increase the value of your investment.
 
Our management will have broad discretion to use the net proceeds from this offering. We expect to use the net proceeds from this offering to repay debt, for capital expenditures, including establishing a redundant technology infrastructure facility and for general corporate purposes, including working capital. We may also use net proceeds for other purposes, including capital expenditures, and for possible investments in, or acquisitions of, complementary products or technologies, although we have no specific plans at this time to do so. We may fail to use these funds effectively to yield a significant return, or any return, on any investment of these net proceeds.
 
You will incur immediate and substantial dilution and may experience further dilution.
 
The initial public offering price of our common stock is substantially higher than $      , the net tangible book value per share of our common stock as of December 31, 2009, calculated on a pro forma basis for this offering. Therefore, if you purchase our common stock in this offering, you will incur an immediate dilution of $      in net tangible book value per share from the price you paid, based on the initial offering price of $      per share. The exercise of outstanding options to purchase shares of our common stock at a weighted average exercise price of $0.92 per share will result in further dilution.
 
Provisions of our certificate of incorporation and bylaws and Delaware law might discourage, delay or prevent a change of control of our company or changes in our management and, as a result, depress the trading price of our common stock.
 
Our certificate of incorporation and bylaws contain provisions that could discourage, delay or prevent a change in control of our company or changes in our management that the stockholders of our company may deem advantageous. These provisions:
 
     establish a classified board of directors so that not all members of our board are elected at one time;
 
     require super-majority voting to amend some provisions in our certificate of incorporation and bylaws;


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     authorize the issuance of “blank check” preferred stock that our board could issue to increase the number of outstanding shares and to discourage a takeover attempt;
 
     limit the ability of our stockholders to call special meetings of stockholders;
 
     prohibit stockholder action by written consent, which requires all stockholder actions to be taken at a meeting of our stockholders;
 
     provide that the board of directors is expressly authorized to adopt, or to alter or repeal our bylaws; and
 
     establish advance notice requirements for nominations for election to our board or for proposing matters that can be acted upon by stockholders at stockholder meetings.
 
In addition, we are subject to Section 203 of the DGCL, which, subject to some exceptions, prohibits “business combinations” between a Delaware corporation and an “interested stockholder,” which is generally defined as a stockholder who becomes a beneficial owner of 15% or more of a Delaware corporation’s voting stock for a three-year period following the date that the stockholder became an interested stockholder. Section 203 could have the effect of delaying, deferring or preventing a change in control that our stockholders might consider to be in their best interests. See “Description of Capital Stock.”
 
These anti-takeover defenses could discourage, delay or prevent a transaction involving a change in control of our company. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors of your choosing and cause us to take corporate actions other than those you desire.
 
We do not intend to pay dividends for the foreseeable future.
 
We have never declared or paid any cash dividends on our common stock and do not intend to pay any cash dividends in the foreseeable future. We anticipate that we will retain all of our future earnings for use in the development of our business and for general corporate purposes. Any determination to pay dividends in the future will be at the discretion of our board of directors. Accordingly, investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investments.


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Forward-Looking Statements
 
This prospectus contains “forward-looking statements,” which include information relating to future events, future financial performance, strategies, expectations, competitive environment, regulation, and availability of resources. These forward-looking statements include, without limitation, statements concerning projections, predictions, expectations, estimates, or forecasts as to our business, financial and operational results, and future economic performance; and statements of management’s goals and objectives and other similar expressions concerning matters that are not historical facts. Words such as “may,” “should,” “could,” “would,” “predicts,” “potential,” “continue,” “expects,” “anticipates,” “future,” “intends,” “plans,” “believes,” “estimates” and similar expressions, as well as statements in future tense, identify forward-looking statements.
 
Forward-looking statements should not be read as a guarantee of future performance or results, and will not necessarily be accurate indications of the times at, or by, which such performance or results will be achieved. Forward-looking statements are based on information available at the time those statements are made or management’s good faith belief as of that time with respect to future events, and are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in or suggested by the forward-looking statements. Important factors that could cause such differences include, but are not limited to:
 
     general and economic conditions;
 
     our ability to manage future growth effectively, or the risk that we will need to reduce the scope of our operations;
 
     we operate in a highly competitive environment, and if we are unable to effectively compete, our business, financial condition, results of operations, cash flows and prospects could be materially adversely affected; and
 
     other factors discussed under the headings “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business.”
 
Forward-looking statements speak only as of the date the statements are made. You should not put undue reliance on any forward-looking statements. We assume no obligation to update forward-looking statements to reflect actual results, changes in assumptions, or changes in other factors affecting forward-looking information, except to the extent required by applicable securities laws. If we do update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect to those or other forward-looking statements.


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Use of Proceeds
 
We estimate that the net proceeds from the sale of the           shares of our common stock that we are selling in this offering will be approximately $      million, assuming an initial public offering price of $      per share, which is the midpoint of the price range set forth on the cover page of this prospectus, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. A $1.00 increase (decrease) in the assumed initial public offering price would increase (decrease) the net proceeds to us by $      million, after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same. If the underwriters’ overallotment option is exercised in full, we estimate that we will receive additional net proceeds of approximately $      million. We will not receive any proceeds from the sale of shares by any selling stockholder.
 
We intend to use the net proceeds from this offering as follows: (1) approximately $      million to repay certain of our existing indebtedness; (2) approximately $   million to fund capital expenditures, including establishing a redundant technology infrastructure facility; and (3) the balance for working capital and general corporate purposes.
 
Our expected use of net proceeds of this offering represents our current intentions based upon our present plans and business conditions. The amounts and purposes for which we allocate the net proceeds from this offering may vary significantly depending upon a number of factors, including the actual cost of capital expenditures, our future sales, our cash flows from operations and the growth of our business. As a result, we will retain broad discretion in the allocation of the net proceeds from this offering and could utilize the proceeds in ways that do not necessarily improve our results of operations or enhance the value of our common stock. Pending the uses described above, we intend to invest the net proceeds in short-term, interest-bearing, investment-grade securities.
 
Dividend Policy
 
We have never declared or paid any dividends on our common stock and do not anticipate that we will pay any dividends to holders of our common stock in the foreseeable future. Instead, we currently plan to retain any earnings to finance the growth of our business. Any future determination relating to dividend policy will be made at the discretion of our board of directors and will depend on our financial condition, results of operations and capital requirements as well as other factors deemed relevant by our board of directors.


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Capitalization
 
The following table sets forth our cash, cash equivalents and short-term investments, our long-term debt, and our capitalization as of December 31, 2009:
 
     on an actual basis;
 
     on a pro forma basis to give effect to (i) a     -for-     reverse split of our outstanding common stock and redeemable convertible preferred stock to be effected prior to the completion of this offering, (ii) the conversion of all of our outstanding redeemable convertible preferred stock into common stock upon the completion of this offering and (iii) the reclassification of the convertible preferred stock warrant liabilities to additional paid-in capital, each effective upon the closing of this offering; and
 
     on a pro forma, as adjusted basis, giving effect to (i) our sale of      shares of our common stock in this offering at an assumed initial public offering price of $      per share, which is the midpoint of the price range set forth on the cover page of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us), (ii) our repayment of all of our existing indebtedness with a portion of the net proceeds of this offering and (iii) the amendment and restatement of our certificate of incorporation in connection with the closing of this offering, which will increase our authorized capital stock.
 
You should read this table together with “Use of Proceeds,” “Selected Consolidated Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Description of Capital Stock” and our financial statements and related notes included elsewhere in this prospectus.
 


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    As of December 31, 2009  
                Pro Forma as
 
    Actual     Pro Forma(1)     Adjusted(1)(2)  
    (in thousands except share and per share data)  
 
Cash, cash equivalents and short-term investments
  $ 1,333     $ 1,333                
                         
Long-term debt, current portion
  $ 1,578     $ 1,620          
                         
Long-term debt
  $ 393     $ 393          
Preferred stock warrant liability
    1,308                
Redeemable Convertible Preferred Stock
                       
Series A, no par value, 3,865,368 shares authorized, 3,667,033 shares issued and outstanding, actual; no shares authorized, issued and outstanding, pro forma; no shares authorized, issued and outstanding, pro forma as adjusted
    9,952                
Series B, no par value, 2,428,176 shares authorized, 2,220,076 shares issued and outstanding, actual; no shares authorized, issued and outstanding, pro forma; no shares authorized, issued and outstanding, pro forma as adjusted
    6,828                
Stockholders’ deficit:
                       
Preferred stock, $0.001 par value, no shares authorized, issued and outstanding, actual; no shares authorized, issued and outstanding, pro forma; 5,000,000 shares authorized, no shares issued and outstanding, pro forma as adjusted.
                       
Common stock, no par value, 40,000,000 shares authorized, 14,587,883 shares issued and outstanding, actual; no par value, 40,000,000 shares authorized, 20,474,992 shares issued and outstanding, pro forma; $0.001 par value per share          shares authorized,           shares issued and outstanding, pro forma as adjusted
    5,846       23,934          
Additional paid-in capital
                   
Accumulated equity (deficit)
    (24,544 )     (24,544 )        
                         
Total stockholders’ equity (deficit)
    (18,698 )     (610 )      
                         
Total capitalization
  $ (217 )   $ (217 )   $  
                         
 
(1) The pro forma column and the pro forma as adjusted column of the table above do not include:
 
     1,473,850 shares of common stock issuable upon the exercise of options outstanding as of December 31, 2009 at a weighted average exercise price of $0.92 per share;
 
     406,435 shares of common stock reserved for issuance upon the exercise of warrants outstanding as of December 31, 2009 at a weighted average exercise price of $1.97 per share; and
 
     1,374,550 shares of common stock reserved for issuance under our stock option plans. 
 
(2) A $1.00 increase (decrease) in the assumed initial public offering price of $      per share, which is the midpoint of the price range set forth on the cover page of this prospectus, would increase (decrease) each of cash, cash equivalents and short-term investments, common stock, total stockholders’ equity (deficit) and total capitalization by $      million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same. The pro forma as adjusted information discussed above is illustrative only and will be adjusted based on the actual public offering price and terms of this offering determined at pricing.

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Dilution
 
Purchasers of the common stock in the offering will suffer immediate and substantial dilution in net tangible book value per share. As of December 31, 2009, our net tangible book value was $(1.9) million, or $(0.13) per share. Net tangible book value per share represents the amount of our total tangible assets reduced by our total liabilities, divided by the number of shares of our common stock outstanding.
 
As adjusted, net tangible book value per share represents the amount of total tangible assets reduced by our total liabilities, divided by the number of shares of common stock outstanding after giving effect to the sale of           shares of common stock in the offering at an initial public offering price of $      , which is the midpoint of the price range set forth on the cover page of this prospectus. Our as adjusted net tangible book value as of December 31, 2009 would have been $      million, or $      per share. This represents an immediate increase in net tangible book value of $      per share to existing stockholders and an immediate dilution of $      per share to new investors purchasing shares in the offering. The following table illustrates this per share dilution:
 
                 
Assumed initial public offering price per share of common stock
          $        
                 
Net tangible book value per share of common stock as of December 31, 2009
  $ (0.13 )        
Increase per share of common stock attributable to new investors
               
Decrease per share of common stock after payment of estimated underwriting discounts and commissions and estimated offering expenses payable by us
               
                 
As adjusted net tangible book value per share of common stock after this offering
               
                 
Dilution per share of common stock to new investors
          $    
                 
 
Our as adjusted net tangible book value will be $      , or $      per share, and the dilution per share of common stock to new investors will be $     , if the underwriters’ overallotment option is exercised in full.
 
Each $1.00 increase (decrease) in the assumed public offering price of $      per share, which is the midpoint of the price range set forth on the cover page of this prospectus, would increase (decrease) our pro forma as adjusted net tangible book value by approximately $      million, or approximately $      per share, and the pro forma dilution per share to investors in this offering by approximately $      per share, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. The pro forma as adjusted information discussed above is illustrative only and will be adjusted based on the actual public offering price and other terms of this offering determined at pricing.
 
The following table sets forth, as of December 31, 2009, on the as adjusted basis described above, the differences between our existing stockholders and new investors with respect to the total number of shares of common stock purchased from us, the total consideration paid, and the average price per share paid before deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us, at an assumed initial public offering price of $      per share of common stock, which is the midpoint of the price range set forth on the cover page of this prospectus:
 
                                         
   
                            Average
 
    Shares Purchased     Total Consideration     Price Per
 
    Number     Percent     Amount     Percent     Share  
 
Existing stockholders
                                       
New investors
                                       
Total
                                       


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Each $1.00 increase (decrease) in the assumed initial public offering price of $      per share, which is the midpoint of the price range set forth on the cover page of this prospectus, would increase (decrease) the total consideration paid to us by new investors and total consideration paid to us by all stockholders by $      million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. If the underwriters’ overallotment option is exercised in full, the number of shares held by existing stockholders after this offering would be          , or     %, and the number of shares held by new investors would increase to          , or     %, of the total number of shares of our common stock outstanding after this offering.


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Selected Consolidated Financial Data
 
The consolidated statement of operations data for each of the fiscal years ended December 31, 2007, 2008 and 2009 and the consolidated balance sheet data as of December 31, 2008 and 2009 are derived from our audited consolidated financial statements that are included in this prospectus. The consolidated statement of operations data for the years ended December 31, 2005 and 2006 and the consolidated balance sheet data as of December 31, 2005, 2006 and 2007 are derived from audited consolidated financial statements that are not included in this prospectus. The historical results presented below are not necessarily indicative of the results we will achieve in future periods.
 
We use the other financial data presented below in addition to the financial measures reflected in the consolidated statements of operations, statements of cash flows and balance sheet data to help us evaluate growth trends, establish budgets, measure the effectiveness of our sales and marketing efforts and assess operational efficiencies.
 
You should read this information together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes included elsewhere in this prospectus.
 
                                         
   
    Year Ended December 31,  
    $2005     2006     2007     2008     2009  
 
Revenue:
                                       
Marketplace
    13,902     $ 22,860     $ 18,659     $ 18,646     $ 32,569  
Connecting Neighbors
    3,957       6,627       6,081       4,687       1,726  
                                         
Total revenue
    17,859       29,487       24,740       23,333       34,295  
                                         
Cost of revenue:
                                       
Marketplace(*)
    8,763       13,223       11,571       9,959       16,333  
Connecting Neighbors
    761       1,727       1,590       1,365       502  
                                         
Total cost of revenue
    9,524       14,950       13,161       11,324       16,835  
                                         
Gross profit
    8,335       14,537       11,579       12,009       17,460  
Operating expenses:
                                       
Sales and marketing(*)
    9,128       13,586       9,309       7,461       6,687  
General and administrative(*)
    2,635       2,937       2,936       2,583       3,864  
Technology(*)
    3,402       4,828       4,539       2,651       2,034  
Goodwill impairment
                      1,793        
                                         
Total operating expenses
    15,165       21,351       16,784       14,488       12,585  
                                         
Operating income (loss)
    (6,830 )     (6,814 )     (5,205 )     (2,479 )     4,875  
Other income (expense):
                                       
Interest income
    98       126       98       2       2  
Interest expense
    (275 )     (608 )     (1,194 )     (998 )     (1,195 )
(Increase) decrease in fair value of warrants
          (27 )     249       230       (873 )
                                         
Total other expense
    (177 )     (509 )     (847 )     (766 )     (2,066 )
                                         
Income (loss) before income taxes and before cumulative effect of change in accounting principle
    (7,007 )     (7,323 )     (6,052 )     (3,245 )     2,809  
Provision for income taxes
                            293  
                                         
(In thousands)


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    Year Ended December 31,  
    2005     2006     2007     2008     2009  
 
Income (loss) before cumulative effect of change in accounting principle
  $ (7,007 )   $ (7,323 )   $ (6,052 )   $ (3,245 )   $ 2,516  
Cumulative effect of change in accounting principle
          (13 )                  
                                         
Net income (loss)
    (7,007 )     (7,336 )     (6,052 )     (3,245 )     2,516  
Accretion of preferred stock
    (24 )     (71 )     (84 )     (89 )     (89 )
                                         
Net income (loss) available to common stockholders
  $ (7,031 )   $ (7,407 )   $ (6,136 )   $ (3,334 )   $ 2,427  
                                         
Net income (loss) per share available to common stockholders:
                                       
Basic
  $ (0.55 )   $ (0.58 )   $ (0.48 )   $ (0.26 )   $ 0.19  
                                         
Diluted
  $ (0.55 )   $ (0.58 )   $ (0.48 )   $ (0.26 )   $ 0.12  
                                         
Weighted average shares used in computing basic net income (loss) per share
    12,770       12,794       12,783       12,785       12,812  
Weighted average shares used in computing diluted net income (loss) per share
    12,770       12,794       12,783       12,785       20,319  
Pro forma net income per share available to common stockholders (unaudited)(1):
                                       
Basic
                                  $ 0.14  
                                         
Diluted
                                  $ 0.12  
                                         
Weighted average shares used in computing basic net income per share (unaudited)
                                    18,493  
Weighted average shares used in computing diluted net income per share (unaudited)
                                    20,319  
(In thousands, except per share data)
 
(*) Includes stock-based compensation expense as follows:
 
                                         
   
    Year Ended December 31,  
    2005     2006     2007     2008     2009  
 
Cost of revenue, Marketplace
  $     $ 4     $ 7     $ 4     $ 13  
Sales and marketing
          164       213       207       355  
General and administrative
    811       119       177       181       329  
Technology
          21       53       58       65  
                                         
Total
  $ 811     $ 308     $ 450     $ 450     $ 762  
(In thousands)
 
                                         
   
    Year Ended December 31,  
    2005     2006     2007     2008     2009  
 
Consolidated Balance Sheet Data:
                                       
Cash and cash equivalents
  $ 7,146     $ 2,163     $ 1,329     $ 25     $ 1,333  
Working capital
    1,513       (4,737 )     (3,679 )     (5,419 )     (2,185 )
Total assets
    12,270       11,681       9,635       5,352       7,773  
Total liabilities
    8,570       15,545       12,931       11,175       9,691  
Total debt
    1,688       4,570       4,076       2,295       459  
Redeemable convertible preferred stock
    9,668       9,739       15,984       16,073       16,780  
Total stockholders’ deficit
    (6,355 )     (13,603 )     (19,280 )     (21,896 )     (18,698 )
(In thousands)


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    Year Ended December 31,  
    2005     2006     2007     2008     2009  
 
Consolidated Statement of Cash Flows Data:
                                       
Net cash provided by (used in) operating activities
  $ (2,746 )   $ (5,643 )   $ (5,096 )   $ 276     $ 4,722  
Depreciation and amortization
    1,058       1,069       1,459       1,550       1,617  
Capital expenditures
    250       3,784       922       1,040       1,076  
Cash flows used in investing activities
    (251 )     (3,784 )     (822 )     (1,040 )     (1,076 )
Cash provided by (used in) financing activities
    10,086       4,444       5,084       (540 )     (2,338 )
(In thousands)
 
(1) The pro forma net income per share, basic and diluted, and pro forma weighted average shares outstanding give effect to the conversion of all of our outstanding redeemable convertible preferred stock into 5,887,109 shares of common stock upon the completion of this offering.


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Management’s Discussion and Analysis of
Financial Condition and Results of Operations
 
You should read the following discussion of our financial condition and results of operations in conjunction with our consolidated financial statements and the notes thereto included elsewhere in this prospectus. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this prospectus, particularly in the sections titled “Risk Factors” and “Forward-Looking Statements.”
 
Overview
 
We operate a proprietary auction marketplace that facilitates online locally-targeted marketing. We aggregate customer prospects from many different online traffic sources and categorize those customer prospects based on user-provided information regarding a product or service of interest to the user and the location at which the user desires to purchase the product or receive the service. Our marketplace provides locally-targeted advertisers with performance-based marketing solutions on a cost-per-“Enhanced Click” or cost-per-lead basis. Our Enhanced Clicks are generated by customer prospects and provide user-submitted category information and the location at which the product will be purchased or the service will be rendered. In addition to providing all of the information contained in an Enhanced Click, our leads also provide our advertisers with the customer prospect’s contact information. We rank the quality of each customer prospect based on our historical experience regarding the propensity of the prospect to take action and other factors, which enables advertisers to differentiate their bids for Enhanced Clicks and leads based on the quality of the customer prospect.
 
We commenced operations in 2001 with a strategy of developing a lead generation business offering solutions in multiple industry categories. We launched our first lead generation services for the automotive industry in 2001 and launched our services for the real estate industry in 2003. In 2005, we acquired Connecting Neighbors, or CN, a service focused on developing, implementing and maintaining local neighborhood websites designed to promote local real estate agents. In response to the slowdown in the residential real estate market, beginning in the quarter ended September 30, 2006, we decided to change our strategy from a focus on building a traditional lead generation business for multiple industry categories to developing a scalable technology platform that we could offer to locally-targeted advertisers in the form of an auction marketplace. We began designing and developing the technology platform for our marketplace in the quarter ended September 30, 2006 and formally launched our marketplace in the quarter ended December 31, 2008 with an initial focus on the automotive and real estate industry categories. Since that time, we have continued to refine and enhance our technology platform.
 
We have designed our technology platform to be industry-agnostic. We currently derive almost all of our revenue from our automotive, real estate and home improvement categories. We launched our home improvement category in the quarter ended June 30, 2009 and we launched our insurance category in the quarter ending March 31, 2010.
 
We acquire online traffic from numerous sources, including pay-per-click advertisements, display advertisements, our advertiser-side exchange service, email lists and other sources. We manage our sources of traffic on a dynamic basis, balancing our desire to provide our advertisers with traffic that meets the volume, quality, locality and pricing that they seek while also meeting our financial objectives. We also seek to diversify our traffic sources to mitigate our dependence on any single source of traffic.
 
We market to advertisers primarily through a direct sales effort. We use both a business development group that targets larger, enterprise-level relationships and a telesales group that targets local advertisers in specific industry categories and geographies. We currently focus our enterprise sales efforts on three types of accounts: locally-targeted national accounts, aggregators that service multiple advertisers, and channel partners. As a supplement to our business development efforts, our in-house telesales team focuses its efforts on certain industry categories and geographic areas where we have an unsold volume of Enhanced Clicks or leads and where we believe that we can cost-effectively establish direct relationships with local advertisers.


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In order to continue to increase our revenue and maintain and increase our operating and net income, we believe that we must continue to enhance our technology platform, grow our existing industry categories by adding new advertisers and growing our business with our existing advertisers within those industry categories, and launch additional locally-targeted industry categories.
 
We measure our financial performance based on various indicators. We focus on the level of liquidity in our marketplace by tracking the number of customer prospects that we are able to generate and monetize, the number of advertisers that we serve and the portion of their advertising budget that they allocate for our marketplace. We evaluate our operating performance by monitoring our revenue, gross margin and Adjusted EBITDA. We monitor and analyze activity in our marketplace on a real-time and ongoing basis with the goal of improving the effectiveness of our marketplace in matching customer prospects and our advertisers.
 
We currently generate all of our revenue from sales to advertisers located in the United States.
 
Our future results of operations may be subject to fluctuation as a result of seasonality. In particular, we expect our results of operations for quarters ending December 31 may demonstrate seasonal weakness because a larger portion of online consumer traffic and advertising is typically focused on holiday gift purchases and there is less advertising for locally-focused services during those quarters. We also expect this impact to reverse during the quarters ending March 31, when we expect to benefit from a higher volume of locally-focused traffic and new advertising budgets.
 
Our business subjects us to a number of risks. We depend upon search engine sites for a majority of the traffic that we convert into Enhanced Clicks and leads. Changes by these search engine sites in the policies, practices or pricing they employ could harm our business. Historically, we have derived a substantial portion of our revenue from a limited number of advertisers, and we also depend upon avoiding any disruption to the operation of our technology infrastructure. Loss of any of these advertisers or any defects in the functionality of our technology infrastructure could have an adverse impact on our business and results of operations.
 
Basis of Presentation
 
General
 
We operate our business in two segments. Our primary business is our marketplace, which provides locally-targeted advertisers with Enhanced Clicks and leads. We refer to this segment of our business as our Marketplace segment. We also operate CN, which develops, implements and maintains local neighborhood websites designed to promote local real estate agents. We refer to this segment of our business as our CN segment. In 2008, we determined that the CN service is no longer core to our business, and although we continue to offer the service, we are no longer focused on developing, promoting or selling the service.
 
Revenue
 
We derive almost all of our revenue from sales of Enhanced Clicks and leads to our advertisers through our Marketplace segment. We recognize revenue from sales of Enhanced Clicks and leads when we deliver them to our advertisers through our marketplace.
 
We derive the balance of our revenue from hosting fees and initial set-up fees that we charge our customers through our CN segment. We recognize revenue from hosting fees in the period in which we provide the service and we defer our recognition of revenue from initial set-up fees and recognize them on a straight-line basis over the expected client relationship period.
 
Cost of Revenue and Gross Margin
 
Almost all of our cost of revenue is attributable to our Marketplace segment and consists primarily of traffic acquisition costs. Traffic acquisition costs consist of payments we make to search engine sites and other sources of our online traffic. A material increase in our traffic acquisition costs will materially increase our cost of revenue.
 
Cost of revenue also includes salaries, bonuses, benefits and stock-based compensation attributable to employees who are responsible for acquiring traffic, depreciation and amortization of capitalized equipment, and website development costs related to our technology platform that powers our marketplace.


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Cost of revenue attributable to our CN segment primarily consists of commissions and other costs we incur in connection with setting up hosted websites for realtors. We record direct incremental costs associated with the initial set-up fee as deferred costs and charge them to cost of revenue on a straight-line basis over the same time period that we record the associated initial set-up fee revenue.
 
Gross profit is revenue less cost of revenue. Gross margin is gross profit expressed as a percentage of revenue. Our gross margin is affected by both the prices that advertisers bid in our marketplace for Enhanced Clicks and leads as well as our traffic acquisition costs associated with acquiring customer prospects. Traffic acquisition costs are typically higher in the quarters ending December 31. Our gross margin is typically lower for new industry categories because our traffic acquisition costs are typically higher upon our initiation of a new industry category. In addition, as we gain experience and develop additional liquidity within a new industry category, our gross margin within that industry category typically improves. When we launch a new industry category, we also typically sell a greater proportion of Enhanced Clicks as compared to leads, and our gross margin for Enhanced Clicks is typically lower than our gross margin for leads.
 
Operating Expenses
 
Sales and Marketing
 
Sales and marketing expenses primarily consist of personnel and other costs associated with our sales and marketing efforts, including salaries, commissions, bonuses, benefits and stock-based compensation for our sales and marketing personnel, as well as advertising expenses to develop our corporate brand. We expense all of our commission expenses as we incur them, except for commission expenses that are associated with CN initial set-up fee revenue, which we record as deferred costs and charge to cost of revenue on a straight-line basis over the same time period that we record the associated initial set-up fee revenue. We expect our sales and marketing expenses to increase in absolute dollars as our business grows and as we launch new industry categories.
 
General and Administrative
 
General and administrative expenses consist primarily of personnel and other costs associated with our employees and contractors that perform executive, finance, accounting and human resources roles, including salaries, commissions, bonuses, benefits and stock-based compensation. In addition, general and administrative costs include consulting, legal, accounting and other professional fees and charitable contributions. We currently expect to make charitable contributions, principally supporting education of girls in third-world countries, in an aggregate amount equal to approximately one percent of our Adjusted EBITDA. We expect our general and administrative expenses to increase in absolute dollars in the near term as we transition to being a public company.
 
Technology
 
Technology expenses consist primarily of personnel and other costs, including communications, consulting, depreciation and amortization of non-revenue-generating capitalized equipment and systems infrastructure, and facilities costs, associated with the development of new technologies, which we expense as we incur them. We expect our technology expenses to increase in absolute dollars as our business grows.
 
Goodwill Impairment
 
In connection with our acquisition of CN in 2005, we recorded $1.8 million of goodwill, resulting from the excess of the price we paid to acquire CN over the fair value of the assets that we acquired and the liabilities that we assumed. The CN reporting unit was adversely affected by a significant decline in its revenue and operating results in the third quarter of fiscal 2008, which decline was projected to continue into future periods. As a result, in connection with our interim test at September 30, 2008, we estimated the fair value of the CN reporting unit using a projected discounted cash flow analysis and determined that the book value exceeded the estimated fair value, thus indicating a potential impairment of recorded goodwill. After conducting the second step of the impairment test as prescribed by ASC 350, Intangibles — Goodwill and Other, we determined that our goodwill relating to the CN reporting unit was fully impaired. The estimated fair value of the CN reporting unit was adversely affected by a significant decline in its revenue and operating results in 2008 and our estimates for its


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revenue and operating results for future periods. As of December 31, 2008 and 2009, we had no goodwill on our balance sheet.
 
Total Other Expense
 
Total other expense consists primarily of interest expense related to our credit facilities, equipment leases, loan and security agreement, and promissory notes outstanding and increase (decrease) in fair value of warrants. At December 31, 2009, the outstanding balance of our credit facilities, equipment leases and promissory notes was $1.5 million, $92,000 and $517,000. We expect our other expense to decline in the near term as the amounts related to the credit facility and equipment leases are fully amortized, and as we intend to repay $      of our outstanding indebtedness from the net proceeds of this offering.
 
Provision for Income Tax
 
We are subject to income tax in the United States. At December 31, 2009, we had federal and state net operating loss carryforwards of approximately $19.1 million and $19.8 million, respectively. These federal and state net operating loss carryforwards expire at various times starting in 2021 and 2013, respectively. In addition, at December 31, 2009, we had approximately $279,000 and $82,000 of federal and state tax credit carryforwards, respectively. The federal credit carryforwards expire at various times starting in 2022. The state tax credit carryforwards do not expire.
 
We periodically evaluate our ability to realize our deferred tax assets and recognize the tax benefit only as reassessment demonstrates that they are realizable. At such time, if we determine that it is more likely than not that our deferred tax assets are realizable, we adjust the valuation allowance. As of December 31, 2009, we established a full valuation allowance against our deferred tax assets due to the uncertainty as to whether we will ever be able to realize future tax benefits from our net operating loss carryforwards and other deferred tax assets. As a result, notwithstanding our operating losses in 2007 and 2008, we have not recorded any tax benefits in our consolidated financial statements.
 
The Internal Revenue Code imposes limitations on our ability to utilize net operating loss carryforwards and certain other tax attributes, including tax credit carryforwards, after an “ownership change,” as such term is defined in Section 382 of the Internal Revenue Code. California has similar rules. Due to these provisions and the fact that we believe that we have experienced and may experience in the future an “ownership change,” utilization of our net operating loss carryforwards and other tax attributes may be subject to limitations.
 
Critical Accounting Policies and Estimates
 
We prepare our consolidated financial statements in accordance with United States GAAP. This requires our management to make estimates and assumptions that affect our reported amounts of assets and liabilities and our disclosure of contingent assets and liabilities at the date of the financial statements and our reported amounts of income and expense during the reported period. We base our estimates on our historical experience and various assumptions about the future that we believe to be reasonable based on available information at the time we prepare our financial statements. Our actual results could differ materially from those estimates.
 
We believe that our assumptions and estimates associated with revenue recognition, website development costs, goodwill and intangible assets, income taxes and stock-based compensation have the greatest potential impact on our consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates. For further information about all of our significant accounting policies, please see Note 2 of the notes to our Consolidated Financial Statements included elsewhere in this prospectus.
 
Revenue Recognition
 
We derive our revenue from two sources: Marketplace and CN. Marketplace revenue, which constituted 75%, 80% and 95% of total revenue for the years ended December 31, 2007, 2008, and 2009, respectively, is derived primarily from fees which are earned through the delivery of qualified leads or clicks. In accordance with Accounting Standards Codification, or ASC, 605, Revenue Recognition, we recognize revenue when persuasive


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evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collectability is reasonably assured. Delivery is deemed to have occurred at the time a qualified lead or click is delivered to the advertiser.
 
From time to time, we may agree to credit certain leads or clicks if they fail to meet the contractual or other guidelines of a particular advertiser. We have established a sales reserve based on our historical experience. To date, such credits have been within our expectations.
 
For a portion of our revenue, we have agreements with providers of online media or traffic, which we refer to as publishers, used in the generation of leads or clicks. We receive a fee from our advertisers and pay a fee to publishers either on a cost per lead, cost per click or cost per thousand impressions basis. We are the primary obligor in the transaction. As a result, we recognize the fees paid by our advertisers as revenue and we include the fees we pay to our publishers in cost of revenue.
 
CN is a service focused on developing, implementing and maintaining local neighborhood websites designed to promote local real estate agents. CN revenue, which constituted 25%, 20% and 5% of our total revenue for the years ended December 31, 2007, 2008 and 2009 respectively, is comprised of set-up fees and hosting fees. Set-up fees are recognized over the expected client relationship period (generally 13 to 16 months) beginning when the hosted customer website is set up. Hosting fees are generally charged to customers on a month-to-month basis and the respective fees are recognized on a monthly basis as earned.
 
Deferred revenue consists of billings or payments received in advance of reaching all the above revenue recognition criteria.
 
Website Development Costs
 
We incur costs related to website and internal-use software development. Such software is primarily related to our website, including underlying support systems. In accordance with ASC 350-40, Internal Use Software, and ASC 350-50, Website Development Costs, we begin to capitalize costs to develop software when preliminary development efforts are successfully completed, our management has authorized and committed project funding, and it is probable that the project will be completed and the software will be used as intended. Such costs are amortized on a straight-line basis over the estimated useful life of the related asset, generally three years, commencing when the software is placed into service. Costs incurred prior to meeting these criteria are expensed as incurred and recorded within technology expenses within the accompanying consolidated statements of operations. Costs incurred for enhancements that are expected to result in additional features or functionality are capitalized and expensed over the estimated useful life of the enhancements, generally three years.
 
We capitalized $796,000, $1.0 million and $891,000 in website and internal-use software development costs, including stock-based compensation, during the years ended December 31, 2007, 2008 and 2009, respectively. Amortization expense totaled $146,000, $474,000 and $782,000 during the years ended December 31, 2007, 2008 and 2009, respectively. In addition, during the year ended December 31, 2007, we abandoned a previously capitalized project, resulting in a charge of $374,000. Amortization expense and impairment charges associated with website and internal-use software development costs are recorded in Marketplace cost of revenue within the accompanying consolidated statements of operations.
 
Goodwill and Intangible Assets
 
Goodwill – We account for goodwill in accordance with ASC 350, Intangibles—Goodwill and Other, or ASC 350. Goodwill is generated when the consideration paid for an acquisition exceeds the fair value of net assets acquired. We assess impairment of goodwill annually or whenever events or changes in circumstances indicate goodwill may be impaired. We have selected December 31 as the date to perform the annual impairment testing of goodwill. In valuation of our goodwill, we must make assumptions regarding estimated future cash flows to be derived from the reporting unit. If these estimates or their related assumptions change in the future, we may be required to record impairment for these assets. We perform a two-step test to assess our goodwill for impairment. The first step requires that we compare the estimated fair value of our reporting units to the carrying value of the reporting unit’s net assets, including goodwill. If the fair value of the reporting unit is less than the carrying value of its net


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assets, we are required to complete the second step of the impairment test to determine the implied fair value of goodwill. An impairment is recorded if the carrying value of the goodwill exceeds its implied fair value.
 
Long-Lived Assets – In accordance with ASC 360, Property, Plant and Equipment, we review long-lived assets, including property and equipment and certain intangible assets, for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. Acquired intangible assets are amortized over their useful lives unless these lives are determined to be indefinite. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition is less than its carrying amount. If such asset is considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the asset exceeds the fair value. If these estimates or their related assumptions change in the future, we may be required to record impairment for these assets.
 
Income Taxes
 
We account for income taxes using an asset and liability approach to record deferred taxes. Deferred income taxes reflect the impact of temporary differences between assets and liabilities recognized for financial reporting purposes, and such amounts recognized for income tax reporting purposes, net of operating loss carryforwards and other tax credits, measured by applying currently enacted tax laws. Valuation allowances are provided when necessary to reduce deferred tax assets to an amount that is more likely than not to be realized.
 
On January 1, 2007, we adopted the authoritative accounting guidance prescribing a threshold and measurement attribute for the financial recognition and measurement of a tax position taken or expected to be taken in a tax return. The guidance also provides for de-recognition of tax benefits, classification on the balance sheet, interest and penalties, accounting in interim periods, disclosure and transition. The guidance utilizes a two-step approach for evaluating uncertain tax positions. Step one, Recognition, requires a company to determine if the weight of available evidence indicates that a tax position is more likely than not to be sustained upon audit, including resolution of related appeals or litigation processes, if any. If a tax position is not considered “more likely than not” to be sustained then no benefits of the position are to be recognized. Step two, Measurement, is based on the largest amount of benefit, which is more likely than not to be realized on ultimate settlement.
 
Stock-Based Compensation
 
Prior to January 1, 2006, we accounted for stock-based awards to employees and directors using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25, or APB 25, Accounting for Stock Issued to Employees (now contained in ASC 718, Compensation—Stock Compensation, or ASC 718, and Financial Accounting Standards Board Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation—an interpretation of APB 25 (now contained in ASC 718), and had adopted the disclosure-only provisions of Statement of Financial Accounting Standards, or SFAS, No. 123, Accounting for Stock-Based Compensation, or SFAS 123 (now contained in ASC 718).
 
Effective January 1, 2006, we adopted SFAS No. 123(R), Share-Based Payments (now contained in ASC 718), which revised SFAS 123 and superseded APB 25, which requires compensation expense related to share-based transactions, including employee and director awards, to be measured and recognized in the financial statements based on fair value. Using the modified prospective approach, we recognize stock-based compensation expense for new awards granted or awards modified after January 1, 2006 and for any portion of an award that was granted prior to adoption that continues to vest. We recognize compensation expense over the vesting period using the straight-line method and classify these amounts in the consolidated statements of operations based on the department to which the related employee reports. We use the Black-Scholes valuation model to calculate the grant date fair value of stock options, utilizing various assumptions.
 
We account for equity instruments issued to non-employees, in accordance with the provisions of ASC 718 and Emerging Issues Task Force No. 96-18, Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, or EITF 96-18 (now contained in ASC 505-50, Equity-Based Payments to Non-Employees), as expense at their fair value over the related service period and periodically revalue the equity instruments as they vest.


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The cost of restricted stock awards is determined using the fair value of our common stock on the date of grant. Compensation expense is recognized for restricted stock awards on a straight-line basis over the vesting period.
 
Stock-based compensation expense recognized in our Consolidated Statement of Operations for 2007, 2008 and 2009 includes (i) compensation expense for share-based payment awards granted prior to, but not yet fully vested as of December 31, 2005, based on the grant-date fair value estimated in accordance with the pro forma provisions of SFAS 123, as adjusted for estimated forfeitures and (ii) compensation expense for the share-based payment awards granted subsequent to December 31, 2005, based on the grant-date fair value estimated in accordance with the provisions of ASC 718.
 
The following table summarizes stock-based compensation expense, by expense category in the consolidated statement of operations, for the years ended December 31, 2007, 2008, and 2009:
 
                         
   
    Years Ended December 31,  
    2007     2008     2009  
 
Cost of revenue
  $ 7     $ 4     $ 13  
Sales and marketing
    213       207       355  
General and administrative
    177       181       329  
Technology
    53       58       65  
                         
Total stock-based compensation expense
    450       450       762  
Effect of costs associated with capitalized software development
    7       7       9  
                         
Total stock-based compensation
  $ 457     $ 457     $ 771  
                         
(In thousands)
 
We estimated the fair value of each option granted using the Black-Scholes option-pricing method using the following assumptions for the periods presented in the table below:
 
             
 
    Years Ended December 31,
    2007   2008   2009
 
Expected dividend yield
     
Expected term (in years)
  9.15 - 10.00   9.89 - 10.00   6.35
Risk-free interest rate
  4.24 - 5.23%   2.23 - 4.09%   1.90 - 2.93%
Expected Volatility
  76 - 79%   66 - 77%   59 - 60%
Weighted average fair value per share
  $0.99   $0.40   $0.37
 
We derived the risk-free interest rate assumption from the United States Treasury’s rates for U.S. Treasuries with maturities similar to those of the expected term of the awards being valued. We based the assumed dividend yield on our expectation of not paying dividends in the foreseeable future. We calculated the weighted average expected life of options based on historical financial data and estimates of future option exercise activity. Due to our limited historical data, we estimate volatility by incorporating the historical volatility of comparable companies with publicly available share prices. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.


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Since the beginning of 2008 through December 31, 2009, we granted stock options with exercise prices as follows:
 
                                 
   
                Common Stock Fair
       
    Number of Shares
          Value per Share for
       
    Underlying Options
    Exercise Price
    Financial Reporting
    Aggregate
 
Grant Date
  Granted     per Share     Purposes at Grant Date     Fair Value  
 
January 25, 2008
    59,000     $ 3.00     $ 0.82     $ 31,453  
April 22, 2008
    57,000     $ 3.00     $ 0.73     $ 26,444  
July 29, 2008
    97,100     $ 3.00     $ 0.64     $ 38,430  
September 19, 2008
    15,000     $ 3.00     $ 0.59     $ 5,310  
November 18, 2008
    102,500     $ 3.00     $ 0.53     $ 30,637  
March 19, 2009
    46,500     $ 0.50     $ 0.60     $ 16,142  
April 23, 2009
    23,000     $ 0.50     $ 0.65     $ 9,539  
July 30, 2009
    115,500     $ 0.80     $ 0.97     $ 70,846  
September 17, 2009
    32,000     $ 0.80     $ 1.33     $ 29,386  
September 17, 2009(1)
    1,089,113     $ 0.80     $ 1.33     $ 193,998  
November 4, 2009
    130,000     $ 1.43     $ 1.99     $ 204,503  
 
(1)  On July 31, 2009, we offered holders of options with an exercise price equal to or greater than, $1.00 the opportunity to exchange their options based on an exchange ratio determined by the exercise price of the option held for new options having an exercise price of $0.80 per share. The exchange program was available through August 28, 2009, the time frame required by securities law, and was completed on September 17, 2009. As a result of the exchange, options to purchase 1,349,611 shares of common stock were exchanged for options to purchase 1,089,113 shares of common stock. The incremental fair value of the new options over the exchanged options was $194,000, of which $170,000 was immediately recognized as an expense for shares vested as of the exchange date. We will recognize the $24,000 incremental value relating to the unvested exchanged options over the remaining vesting period.
 
On February 4, 2010 we granted options to purchase an aggregate of 286,500 shares of common stock to non-executive officers at an exercise price of $3.56 per share.
 
Since the beginning of 2008 through December 31, 2009, we issued restricted stock as follows:
 
                         
   
          Common Stock Fair
       
          Value per Share for
       
    Number of Shares
    Financial Reporting
    Aggregate
 
Grant Date
  Granted     Purposes at Grant Date     Fair Value  
 
May 12, 2008
    305,000     $ 0.71     $ 216,550  
November 18, 2008
    125,000     $ 0.53     $ 66,250  
January 23, 2009
    603,989     $ 0.52     $ 314,074  
July 1, 2009
    228,989     $ 0.74     $ 169,452  
 
On February 12, 2010, we issued an aggregate of 725,000 shares of common stock to the following executive officers in the amounts specified: Payam Zamani (250,000), Brian Bowman (150,000), Sean Fox (150,000), W. Samuel Veazey (150,000) and Bill Perrault (25,000).
 
Because our common stock is not publicly traded, our board of directors exercises significant judgment in determining the fair value of our common stock on the date of grant based on a number of objective and subjective factors. Factors considered by our board of directors included:
 
     our recent and historical company performance;
 
     our liquidity and cash resources;
 
     our projections regarding our future financial results;


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     company developments since the last time option grants were approved by our board of directors;
 
     independent third-party valuations;
 
     market multiples of publicly traded companies considered peers; and
 
     the rights, preferences and privileges of our preferred stock relative to those of our common stock.
 
In January 2010, in connection with the preparation of our consolidated financial statements, we performed a retrospective analysis to reassess the fair value of our common stock at certain option grant dates for financial reporting purposes. This resulted in a difference between the fair value of the stock options and the previously granted exercise price.
 
During 2008, our board of directors determined the fair value of our common stock based on recent preferred stock transactions. In January 2009, the board of directors determined the fair value of our common stock based on the factors listed above as well as the broad public market decline. The fair value of our common stock from January to September 2009 reflected the improving public market conditions and our improved financial performance through those dates but also reflected our limited liquidity and cash resources, as well as the continuing uncertainty in the automotive and real estate industry categories. In December 2009, our management and board of directors initiated steps towards readying our company for an initial public offering of our common stock in the first half of 2010 and these actions were reflected in the fair value of our common stock.
 
Discussion of specific valuation inputs from December 31, 2008 through December 31, 2009
 
The following discusses the specific inputs used by our independent, third-party valuation experts for each of the periods specified.
 
December 31, 2008. The option pricing method was used for this valuation. The significant assumptions employed in this valuation were a risk-adjusted discount rate of 25%, a discount for lack of marketability of 30% and an estimated time to a liquidation event of 18 months. The valuation assumed a volatility of 80% and a weighted average cost of capital of 25%. A discounted cash flow analysis and a market based analysis using EBITDA and revenue multiples of comparable companies were used to determine the value of the business. The valuation methodologies were weighted 50% toward the discounted cash flow analysis, and 50% towards the market based approach. This valuation indicated a fair value of $0.49 per share for our common stock. The decline in valuation from December 31, 2007 reflected in part the broad public market decline in 2008.
 
June 30, 2009. The option pricing method was used for this valuation. The significant assumptions employed in this valuation were a risk-adjusted discount rate of 20%, a discount for lack of marketability of 25% and an estimated time to a liquidation event of 18 months. The valuation assumed a volatility of 77% and used a risk-free rate of 0.88%. Three methods were used to determine the business enterprise value of the company. This first method was a discounted cash flow analysis, which discounts future earnings forecasts at the risk-adjusted discount rate to obtain a present value of the company. A guideline public company analysis was employed that looked at the value of the company based on value to revenue and EBITDA multiples of comparable companies. A guideline transaction analysis was also employed, which utilized value to revenue and EBITDA multiples from comparable mergers and acquisitions over the past two years. The valuation methodologies were weighted 33% toward the discounted cash flow analysis, 33% towards the guideline public company analysis and 33% towards the guideline transaction method. This valuation indicated a fair value of $0.74 per share for our common stock. The increase in valuation from December 31, 2008 reflected our improved operating performance and improved public market conditions.
 
September 30, 2009. The option pricing method was used for this valuation. The significant assumptions employed in this valuation were a risk-adjusted discount rate of 20%, a discount for lack of marketability of 21%, a minority discount of 31% and an estimated time to a liquidation event of more than 12 months. The valuation assumed a volatility of 74% and used a risk free rate of 0.62%. Four methods were used to determine the business enterprise value of the company. This first method was a discounted cash flow analysis, which discounts future earnings forecasts at the risk-adjusted discount rate to obtain a present value of the company. A guideline public company analysis was employed that looked at the value of the company based on value to revenue and EBITDA multiples of comparable companies. A guideline transaction analysis was also employed, which utilized value to


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revenue and EBITDA multiples from comparable mergers and acquisitions over the past two years. The fourth method used to calculate the value of the company was based on a recent acquisition offer. The valuation methodologies were weighted 35% toward the discounted cash flow analysis, 25% towards the guideline public company analysis, 25% towards the guideline transaction method and 15% towards the acquisition scenario. This valuation indicated a fair value of $1.43 per share for our common stock. The increase in valuation from June 30, 2009 reflected continued improvements in our operating performance and in public market prices.
 
December 31, 2009. The probability-weighted expected return method, or P-WERM, valuation approach, which requires the consideration of various liquidity scenarios was used for this valuation. The significant assumptions employed in this valuation were a risk-adjusted discount rate of 20%, an estimated time to an initial public offering of less than six months and an estimated time to a strategic merger or sale of more than 18 months. The expected outcomes were weighted 20% toward an initial public offering, 10% towards a strategic merger or sale, 35% towards remaining a private company and 35% towards a downside scenario. This valuation indicated a fair value of $2.91 per share for our common stock. The increase in valuation from September 30, 2009 reflected our initial steps towards a potential initial public offering as well as our continued improvements in our operating performance and in public market prices.
 
January 31, 2010. The P-WERM method was used for this valuation. The significant assumptions employed in this valuation were a risk-adjusted discount rate of 20%, an estimated time to an initial public offering of less than six months and an estimated time to a strategic merger or sale of more than 18 months. The expected outcomes were weighted 30% toward an initial public offering, 10% towards a strategic merger or sale, 30% towards remaining a private company and 30% towards a downside scenario. This valuation indicated a fair value of $3.56 per share for our common stock. The increase in valuation from December 31, 2009 reflected our taking additional steps in preparation for a potential initial public offering as well as our continued improvements in our operating performance.
 
Accretion of Preferred Stock
 
The difference between the initial carrying amounts and redemption values of the redeemable convertible preferred stock represents issuance costs recorded as a reduction in the carrying amounts. We record periodic accretions to increase the initial carrying value of the redeemable convertible preferred stock so that the carrying amounts will equal the redemption amounts at the earliest redemption dates. Accretion is recorded as a reduction to common stock to the extent available and as an increase to stockholders’ deficit thereafter.
 
Preferred Stock Warrants
 
We account for freestanding preferred stock warrants for redeemable preferred stock as liabilities that are recorded at their fair value at the time of issuance and adjusted to fair value at each balance sheet date, with the change in the fair value being recorded as a component of other income (expense). The fair value of the preferred stock warrants is determined using the Black-Scholes option pricing model.


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Results of Operations
 
The following table sets forth our consolidated statement of operations for the periods indicated and as a percentage of our total revenue for such periods:
 
                                                 
   
    Years Ended December 31,  
    2007     2008     2009  
 
Revenue
                                               
Marketplace
  $ 18,659       75.4 %   $ 18,646       79.9 %   $ 32,569       95.0 %
Connecting Neighbors
    6,081       24.6 %     4,687       20.1 %     1,726       5.0 %
                                                 
Total revenue
    24,740       100.0 %     23,333       100.0 %     34,295       100.0 %
                                                 
Cost of revenue
                                               
Marketplace(1)
    11,571       46.8 %     9,959       42.7 %     16,333       47.6 %
Connecting Neighbors
    1,590       6.4 %     1,365       5.8 %     502       1.5 %
                                                 
Total cost of revenue
    13,161       53.2 %     11,324       48.5 %     16,835       49.1 %
                                                 
Gross profit
    11,579       46.8 %     12,009       51.5 %     17,460       50.9 %
                                                 
Operating expenses:
                                               
Sales and marketing(1)
    9,309       37.6 %     7,461       32.0 %     6,687       19.5 %
General and administrative(1)
    2,936       11.9 %     2,583       11.1 %     3,864       11.3 %
Technology(1)
    4,539       18.3 %     2,651       11.4 %     2,034       5.9 %
Goodwill impairment
          0.0 %     1,793       7.6 %           0.0 %
                                                 
Operating income (loss)
    (5,205 )     −21.0 %     (2,479 )     −10.6 %     4,875       14.2 %
                                                 
Other income (expense)
                                               
Interest income
    98       0.4 %     2       0.0 %     2       0.0 %
Interest expense
    (1,194 )     −4.9 %     (998 )     −4.3 %     (1,195 )     −3.5 %
(Increase) decrease in fair value of warrants
    249       1.0 %     230       1.0 %     (873 )     −2.5 %
                                                 
Total other expense
    (847 )     −3.4 %     (766 )     −3.3 %     (2,066 )     −6.6 %
                                                 
Income (loss) before income taxes
    (6,052 )     −24.5 %     (3,245 )     −13.9 %     2,809       8.2 %
Provision for income taxes
          0.0 %           0.0 %     293       0.9 %
                                                 
Net income (loss)
    (6,052 )     −24.5 %     (3,245 )     −13.9 %     2,516       7.3 %
Accretion of preferred stock
    84       0.3 %     89       0.4 %     89       0.2 %
                                                 
Net income (loss) available to common stockholder
  $ (6,136 )     −24.8 %   $ (3,334 )     −14.3 %   $ 2,427       7.1 %
                                                 
(In thousands)
 
(1) Includes stock-based compensation and depreciation and amortization expense as follows:
 
                                                 
 
 
Stock-based compensation
                                               
Cost of revenue, Marketplace
  $ 7       0.0 %   $ 4       0.0 %   $ 13       0.0 %
Sales and marketing
    213       0.9 %     207       0.9 %     355       1.0 %
General and administrative
    177       0.7 %     181       0.8 %     329       1.0 %
Technology
    53       0.2 %     58       0.2 %     65       0.2 %
Depreciation and amortization
                                               
Cost of revenue
  $ 73       0.3 %   $ 453       1.9 %   $ 854       2.5 %
Sales and marketing
    21       0.1 %     37       0.2 %     2       0.0 %
General and administrative
    203       0.8 %     204       0.9 %     255       0.7 %
Technology
    1,162       4.7 %     856       3.7 %     506       1.5 %
(In thousands)


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Comparison of Years Ended December 31, 2007, 2008 and 2009
 
Revenue
 
                                         
   
    Years Ended December 31,     2007-2008
    2008-2009
 
    2007     2008     2009     % Change     % Change  
 
Revenue
                                       
Marketplace
  $ 18,659     $ 18,646     $ 32,569       0 %     75 %
Connecting Neighbors
    6,081       4,687       1,726       −23 %     −63 %
                                         
Total revenue
    24,740       23,333       34,295       −6 %     47 %
Cost of revenue
                                       
Marketplace
    11,571       9,959       16,333       −14 %     64 %
Connecting Neighbors
    1,590       1,365       502       −14 %     −63 %
                                         
Total cost of revenue
    13,161       11,324       16,835       −14 %     49 %
                                         
Gross profit
  $ 11,579     $ 12,009     $ 17,460       4 %     45 %
                                         
(In thousands)
 
Total revenue increased $11.0 million, or 47%, from 2008 to 2009. The increase was attributable to a 75% increase in Marketplace revenue from $18.6 million to $32.6 million, partially offset by a 63% decrease in CN revenue from $4.7 million to $1.7 million. During 2009, Marketplace revenue grew primarily as a result of the launch of our new Marketplace platform in the quarter ended December 31, 2008 and related growth in our automotive and real estate industry categories. Marketplace revenue also grew, to a lesser degree, as a result of the launch of our home improvement category in the quarter ended June 30, 2009. Growth within each of our industry categories was primarily driven by an increase in the number of our advertisers and greater spending by existing advertisers. In 2008, we determined that the CN service was no longer core to our business, and although we continued to offer the service, we are no longer focused on developing, promoting or selling the service.
 
Total revenue decreased $1.4 million, or 6%, from 2007 to 2008. The decrease was primarily attributable to a 23% decrease in CN revenue from $6.1 million to $4.7 million. Marketplace revenue was relatively unchanged at $18.6 million in 2008 and $18.7 million in 2007. During 2008, revenue related to our real estate industry category decreased as the real estate industry was adversely impacted by general economic conditions. This decrease was offset by revenue related to our automotive industry category where we were able to gain additional advertisers and attract additional spending from our existing advertisers within that industry category.
 
Cost of Revenue and Gross Margin
 
Total cost of revenue increased $5.5 million, or 49%, from 2008 to 2009. Marketplace cost of revenue increased $6.4 million, or 64%, from 2008 to 2009 from $10.0 million to $16.3 million. The increase was primarily attributable to increased spending on traffic acquisition necessary to generate our increased Marketplace revenue and, to a lesser extent, increased payroll expenses. Gross margin remained unchanged at 51% from 2008 to 2009 notwithstanding reduced, higher margin, CN revenue. Marketplace gross margin increased in 2009 as a result of the launch of the new marketplace in the fourth quarter of 2008 which enabled us to sell previously unsold traffic as Enhanced Clicks. The 2009 gross margin percentage gains were partially offset by increased costs associated with the launch of our new home improvement category in the second quarter of 2009. CN cost of revenue decreased $863,000, or 63%, from 2008 to 2009 from $1.4 million to $502,000.
 
Total cost of revenue decreased $1.8 million, or 14%, from 2007 to 2008. Marketplace cost of revenue decreased $1.6 million, or 14%, from 2007 to 2008 from $11.6 million to $10.0 million. Gross margin increased from 47% to 52% from 2007 to 2008. The increase in gross margin was primarily attributable to improvements in our traffic acquisition strategies. CN cost of revenue decreased 14%, from 2007 to 2008 from $1.6 million to $1.4 million.


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Operating Expenses
 
                                         
 
    Years Ended December 31,     2007-2008
    2008-2009
 
    2007     2008     2009     % Change     % Change  
 
Sales and marketing
  $ 9,309     $ 7,461     $ 6,687       −20 %     −10 %
General and administrative
    2,936       2,583       3,864       −12 %     50 %
Technology
    4,539       2,651       2,034       −42 %     −23 %
Goodwill impairment
          1,793                     −100 %
                                         
Total operating expenses
  $ 16,784     $ 14,488     $ 12,585       −14 %     −13 %
                                         
 
(In thousands)
 
Sales and Marketing Expenses
 
Sales and marketing expenses decreased $774,000, or 10%, from 2008 to 2009. Sales and marketing expenses as a percentage of total revenue decreased from 32% to 19% from 2008 to 2009. The decrease in absolute dollars and as a percentage of total revenue was primarily attributable to our decision to leverage our technology platform and focus more on locally-targeted national advertisers and less on direct sales to local business advertisers and our CN service. During the quarter ended December 31, 2008, we changed our compensation plan for our telesales staff to reflect lower levels of base compensation and higher opportunities for performance-based compensation, which also reduced our sales and marketing expenses for 2009.
 
Sales and marketing expenses decreased $1.8 million, or 20%, from 2007 to 2008. Sales and marketing expenses as a percentage of total revenue decreased from 38% to 32% from 2007 to 2008. The decrease was attributable to reduced costs associated with our CN service following our determination that it was no longer a core service as well as lower payroll expenses due to reduced sales and marketing headcount.
 
General and Administrative Expenses
 
General and administrative expenses increased $1.3, or 50%, from 2008 to 2009. General and administrative expenses remained relatively flat as a percentage of total revenue in 2008 and 2009. The increase in absolute dollars was attributable to bonus compensation related to our financial performance. General and administrative expenses for 2009 included charitable contributions of approximately $80,000.
 
General and administrative expenses decreased $353,000, or 12%, from 2007 to 2008. General and administrative expenses as a percentage of total revenue decreased from 12% in 2007 to 11% in 2008. The decrease in absolute dollars and as a percentage of total revenue was primarily attributable to lower payroll expenses due to reduced general and administrative headcount.
 
Technology Expenses
 
Technology expenses decreased $617,000, or 23%, from 2008 to 2009. Technology expenses as a percentage of total revenue decreased from 11% in 2008 to 6% in 2009. Technology expenses grew marginally on an absolute basis because a greater proportion of our technology development payroll costs were attributable to our revenue generating platform and as a result, were capitalized. Technology expenses decreased $1.9 million, or 42%, from 2007 to 2008. Technology expenses as a percentage of total revenue decreased from 18% in 2007 to 11% in 2008. The decrease was primarily attributable to lower payroll expenses as a result of reduced technology headcount and a reduction in our use of outside contractor services.
 
Goodwill Impairment
 
During the third quarter of 2008 we determined that our CN reporting unit was no longer core to our offering and no further investment in developing and promoting the service continued. As a result, we reviewed the carrying value of our goodwill for potential impairment, and determined it exceeded its estimated fair value, thus indicating a potential impairment of recorded goodwill. We utilized the income approach to assess fair value of the


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reporting unit. The income approach provides an estimate of fair value based on discounted expected future cash flows. Estimates and assumptions with respect to the determination of the fair value of the CN reporting unit using the income approach include our operating forecasts, revenue growth rates, and risk-commensurate discount rates and costs of capital. Our estimates of revenue and costs are based on historical data, various internal estimates and a variety of external sources, and are developed as part of our routine long-range planning process.
 
After conducting the second step of the impairment test prescribed by ASC 350, we determined that goodwill relating to the CN reporting unit was fully impaired and recorded an impairment charge of $1.8 million. The estimated fair value of the CN reporting unit was adversely affected by a significant decline in its revenue and operating results in 2008 and which were projected to continue into future periods.


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Quarterly Results of Operations
 
The following table sets forth our unaudited quarterly consolidated statements of operations data for each of the quarters in 2008 and 2009. We have prepared the statements of operations data for each of these quarters on the same basis as our audited consolidated financial statements included elsewhere in this prospectus and, in the opinion of the management, this data includes all adjustments, consisting solely of normal recurring adjustments, necessary for the fair statement of the results of operations for these periods. This information should be read in conjunction with our audited consolidated financial statements and related notes included elsewhere in this prospectus. These quarterly operating results are not necessarily indicative of operating results to be expected for any future period.
 
                                                                 
 
    Three Months Ended  
    Mar. 31,
    June 30,
    Sept. 30,
    Dec. 31,
    Mar. 31,
    June 30,
    Sept. 30,
    Dec. 31,
 
    2008     2008     2008     2008     2009     2009     2009     2009  
 
Revenue
                                                               
Marketplace
  $ 4,520     $ 4,424     $ 4,921     $ 4,781     $ 6,504     $ 7,451     $ 8,813     $ 9,801  
Connecting Neighbors
    1,337       1,259       1,158       933       670       461       331       264  
                                                                 
Total revenue
    5,857       5,683       6,079       5,714       7,174       7,912       9,144       10,065  
                                                                 
Cost of revenue
                                                               
Marketplace
    2,323       2,348       2,512       2,776       3,044       3,546       4,480       5,263  
Connecting Neighbors
    362       383       339       281       191       159       97       55  
                                                                 
Total cost of revenue
    2,685       2,731       2,851       3,057       3,235       3,705       4,577       5,318  
                                                                 
Gross profit
    3,172       2,952       3,228       2,657       3,939       4,207       4,567       4,747  
Operating expenses:
                                                               
Sales and marketing
    2,098       1,944       1,680       1,739       1,563       1,590       1,768       1,766  
General and administrative
    461       646       672       804       847       858       1,205       954  
Technology
    734       680       659       578       498       538       507       491  
Goodwill impairment
                1,793                                
                                                                 
Operating income (loss)
    (121 )     (318 )     (1,576 )     (464 )     1,031       1,221       1,087       1,536  
                                                                 
Other income (expense)
                                                               
Interest income
    2                                           2  
Interest expense
    (220 )     (198 )     (289 )     (291 )     (309 )     (310 )     (364 )     (212 )
(Increase) decrease in fair value of warrants
    77       57       56       40       (119 )     (145 )     (318 )     (291 )
                                                                 
Total other expense
    (141 )     (141 )     (233 )     (251 )     (428 )     (455 )     (682 )     (501 )
                                                                 
Income (loss) before income taxes
    (262 )     (459 )     (1,809 )     (715 )     603       766       405       1,035  
Provision for income taxes
                            62       80       42       109  
                                                                 
Net income (loss)
    (262 )     (459 )     (1,809 )     (715 )     541       686       363       926  
Accretion of preferred stock
    22       23       22       22       22       23       22       22  
                                                                 
Net income (loss) available to common stockholders
  $ (284 )   $ (482 )   $ (1,831 )   $ (737 )   $ 519     $ 663     $ 341     $ 904  
                                                                 
Other Data:
                                                               
Adjusted EBITDA
  $ 311     $ 191     $ 745     $ 85     $ 1,581     $ 1,828     $ 1,836     $ 2,104  
                                                                 
 
(In thousands)


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Quarterly Trends
 
Our revenue remained relatively flat on a quarterly basis throughout 2008 as we focused on building our marketplace technology platform and then began to grow on a quarterly basis throughout 2009 following the launch of our marketplace. Our growth in revenue was primarily driven by the growth of our marketplace, offset in part by declines in our revenue from our CN service.
 
Our cost of revenue also remained relatively flat on a quarterly basis throughout 2008 before beginning to increase on a quarterly basis throughout 2009 as our revenue increased. Gross margin for the quarter ended December 31, 2008 was adversely impacted by the then current economic conditions and depressed spending and our gross margin for the quarter ended December 31, 2009 was adversely impacted by the lower margin associated with the launch of our home improvement category.
 
Sales and marketing expenses declined over the six quarters ended June 30, 2009 as we changed our strategy to focus on our technology platform and auction marketplace. As part of this change in focus, we increased our emphasis on sales to locally-targeted national advertisers. Sales and marketing expenses increased in the quarter ended September 30, 2009 as we increased our sales and marketing headcount to support our growth.
 
General and administrative expenses generally increased over the seven quarters ended September 30, 2009. General and administrative expenses increased in 2009 due to higher levels of bonus compensation payable as a result of our financial performance. General and administrative expenses declined slightly in the quarter ended December 31, 2009 due to audit related costs incurred in the quarter ended September 30, 2008 that did not recur in the following quarter.
 
Technology expenses remained relatively flat over the three quarters ended September 30, 2008 before declining slightly in the quarters ended December 31, 2008 and March 31, 2009. These declines were due to the fact that we capitalized a greater proportion of our technology costs being directed to and capitalized as website development costs in these quarters following the launch of our marketplace and as we continued to develop new functionality and enter into new industry categories. Technology expenses remained relatively flat over the three quarters ended December 31, 2009.
 
In connection with our annual impairment test at December 31, 2008, we determined that goodwill was fully impaired.
 
Adjusted EBITDA
 
See Note 3 to “Summary Consolidated Financial Data” beginning on page 8 for an explanation of why we use Adjusted EBITDA.
 
The following table presents a reconciliation of Adjusted EBITDA to net income, the most comparable GAAP measure, for each of the periods indicated:
 
                                                                 
 
    Three Months Ended  
    Mar. 31,
    June 30,
    Sept. 30,
    Dec. 31,
    Mar. 31,
    June 30,
    Sept. 30,
    Dec. 31,
 
    2008     2008     2008     2008     2009     2009     2009     2009  
 
Reconciliation of Adjusted EBITDA to net income (loss)
                                                               
Net income (loss)
  $ (262 )   $ (459 )   $ (1,809 )   $ (715 )   $ 541     $ 686     $ 363     $ 926  
Other expense
    141       141       233       251       428       455       682       501  
Provision for taxes
                            62       80       42       109  
Depreciation and amortization
    325       395       412       418       423       441       396       357  
Stock-based compensation expense
    107       114       116       113       127       166       320       149  
Impairment of goodwill
                1,793                                
Loss on disposal and abandonment of assets
                      18                         11  
Charitable contributions
                                        33       51  
                                                                 
Adjusted EBITDA
  $ 311     $ 191     $ 745     $ 85     $ 1,581     $ 1,828     $ 1,836     $ 2,104  
                                                                 
 
(In thousands)


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Liquidity and Capital Resources
 
Since our inception, we have financed our operations primarily with private sales of redeemable convertible preferred stock, funds generated from operations and loan proceeds from banks and our investors. Our cash and cash equivalents were $1.3 million, $25,000 and $1.3 million as of December 31, 2007, 2008 and 2009, respectively.
 
Operating Activities. Net cash provided by (used in) operating activities was $4.7 million for 2009 compared to $340,000 for 2008 and $(5.1) million for 2007. The increase in net cash provided by operating activities in 2009 was primarily due to net income of $2.5 million, depreciation and amortization of $1.6 million, provision for doubtful accounts of $1.2 million, increase in accrued compensation and benefits of $1.0 million, increase in the fair value of warrants of $873,000 and stock-based compensation of $762,000, offset in part by an increase in accounts receivable of $3.1 million, a decrease in accounts payable and accrued liabilities of $444,000 and a decrease in deferred revenue of $383,000. The increase in accrued compensation and benefits primarily resulted from higher levels of bonus compensation payable as a result of our financial performance. The increase in net cash provided by operating activities in 2008 was primarily due to a net loss of $3.2 million offset by impairment of goodwill of $1.8 million, depreciation and amortization of $1.6 million, an increase in accounts payable and accrued liabilities of $373,000, an increase in prepaid expenses of $755,000, provision for doubtful accounts of $1.3 million, and stock-based compensation of $450,000, offset in part by an increase in accounts receivable of $1.6 million and a decrease in deferred revenue of $1.1 million following our determination that the CN service was no longer core to our business. The use of cash in 2007 was primarily due to a net loss of $6.1 million and a decrease in accounts payable of $1.6 million offset in part by $1.5 million of depreciation and amortization and provision for doubtful accounts of $1.0 million.
 
Investing activities. Net cash used by our investing activities was $1.1 million, $1.0 million and $822,000 for 2009, 2008 and 2007, respectively. Investing activities related to our capital expenditures and capitalized development costs.
 
Financing activities. Net cash provided by (used in) our financing activities was $(2.3) million, $(540,000) and $5.1 million for 2009, 2008 and 2007, respectively. The use of cash in financing activities in 2009 primarily related to the repayment of outstanding notes of $2.1 million. The use of cash in 2008 consisted primarily of $1.1 million of net proceeds from the issuance of new notes offset by $1.9 million repayment of other notes. Net cash provided in 2007 consisted of $6.2 million of net proceeds from the sale of redeemable convertible preferred stock offset by $1.1 million in net repayment of notes.
 
We believe that our cash and cash equivalents and funds generated from our operations, together with the net proceeds from this offering, will be sufficient to meet our working capital and capital expenditure requirements for at least the next 12 months. If required, additional financing may not be available on terms that are favorable to us, if at all. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our stockholders will be reduced and these securities might have rights, preferences and privileges senior to those of our current stockholders. We cannot assure you that additional financing will be available or that, if available, such financing can be obtained on terms favorable to our stockholders and us.
 
Off-Balance Sheet Arrangements
 
During the periods presented, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purpose.


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Contractual Obligations
 
The following table summarizes our contractual obligations at December 31, 2009(1):
 
                                         
   
          Less Than
    1 to 3
    3 to 5
    More Than
 
    Total     1 Year     Years     Years     5 Years  
 
Notes payable to related parties
  $ 517     $ 86     $ 431     $     $  
2007 loan security agreement
    1,522       1,522                    
Equipment lines of credit
    169       169                    
Capital leases
    92       26       66              
Office facility leases
    2,845       1,281       1,564              
                                         
Total
  $ 5,145     $ 3,084     $ 2,061     $     $  
                                         
(In thousands)
 
(1) Excludes interest obligations.
 
Guarantees
 
We have agreements whereby we indemnify our officers and directors for certain events or occurrences while the officer or director is, or was serving, at our request in such capacity. The term of the indemnification period is for the officer or director’s lifetime. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we have a director and officer insurance policy that limits our exposure and enables us to recover a portion of any future amounts paid. As a result of our insurance policy coverage, we believe the estimated fair value of these indemnification agreements is minimal. Accordingly, we have not recorded any liabilities for these agreements.
 
In the ordinary course of our business, we enter into agreements with our advertisers which include indemnification provisions. Pursuant to these provisions, we sometimes indemnify our clients for losses suffered or incurred in connection with certain third-party claims that our product infringed any United States patent, copyright or other intellectual property rights.
 
The potential amount of future payments to defend lawsuits or settle indemnified claims under these indemnification provisions may be unlimited; however, we believe the estimated fair value of these indemnity provisions is minimal, and accordingly, we have not recorded any liabilities for these agreements.
 
Recent Accounting Pronouncements
 
In February 2008, the FASB issued an accounting standard update that delayed the effective date for the accounting for fair value measurements for all non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until the beginning of the first quarter of fiscal 2009. These include goodwill and other non-amortizable intangible assets. We adopted this accounting standard update effective January 1, 2009. The adoption of this update to non-financial assets and liabilities, as codified in ASC 820-10, did not have any impact on our consolidated financial statements.
 
Effective April 1, 2009, we adopted three accounting standard updates which were intended to provide additional application guidance and enhanced disclosures regarding fair value measurements and impairments of securities. They also provide additional guidelines for estimating fair value in accordance with fair value accounting. The first update, as codified in ASC 820-10-65, provides additional guidelines for estimating fair value in accordance with fair value accounting. The second accounting update, as codified in ASC 320-10-65, changes accounting requirements for other-than-temporary-impairment for debt securities by replacing the current requirement that a holder have the positive intent and ability to hold an impaired security to recovery in order to conclude an impairment was temporary with a requirement that an entity conclude it does not intend to sell an impaired security and it is more likely than not that it will be required to sell the security before the recovery of its amortized cost basis. The third accounting update, as codified in ASC 825-10-65, increases the frequency of fair


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value disclosures. These updates were effective for fiscal years and interim periods ended after June 15, 2009. The adoption of these accounting updates did not have a material impact on our consolidated financial statements.
 
Foreign Currency Exchange Risk
 
We currently only do business in the United States and are not currently subject to any foreign currency risks.


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Business
 
Business Overview
 
We operate a proprietary auction marketplace that facilitates online locally-targeted marketing. We aggregate customer prospects for advertisers from many different online traffic sources and categorize those customer prospects based on user-provided information regarding a product or service of interest to the user and the location at which the user desires to purchase the product or receive the service. Our marketplace provides locally-targeted advertisers with performance-based marketing solutions on a cost-per-“Enhanced Click” or cost-per-lead basis. Our Enhanced Clicks are generated by customer prospects and provide user-submitted category information and the location at which the product will be purchased or the service will be rendered. In addition to providing all of the information contained in an Enhanced Click, our leads also provide our advertisers with the customer prospect’s contact information. We rank the quality of each customer prospect based upon our historical experience and other factors regarding the propensity of the prospect to take action, which enables advertisers to differentiate their bids for Enhanced Clicks and leads based on the quality of the customer prospect.
 
Our marketplace simplifies online locally-targeted marketing by eliminating an advertiser’s need to develop and maintain complex, expensive infrastructure and teams of experts to source online consumer traffic from many different channels, including search engine marketing, display and email. Additionally, compared to traditional lead generation businesses, our marketplace provides advertisers greater control over quality, volume and price, and therefore enables our advertisers to optimize their marketing efforts and better manage their cost per transaction. Our marketplace allows advertisers to adjust their bids on a real-time basis. Regardless of the advertiser’s level of sophistication, our marketplace is designed to deliver customer prospects in the format that best addresses the advertiser’s needs. The customer prospects can take the form of an Enhanced Click delivered to an advertiser’s website, or the advertiser can choose to receive the customer prospect in the form of a ready-to-call lead, bypassing the need for the advertiser to develop the necessary infrastructure to convert Enhanced Clicks into ready-to-call leads. Our technology allows us to be industry-agnostic. We currently serve advertisers primarily in the automotive, home improvement, insurance and real estate industries.
 
In the quarter ended December 31, 2009, we generated over 4.9 million Enhanced Clicks and over 700,000 leads and served over 5,000 advertisers. In the year ended December 31, 2009, we generated $34.3 million in revenue, $2.5 million of net income, $4.9 million of operating income and $7.4 million of Adjusted EBITDA, compared to $23.3 million in revenue, $3.2 million of net loss, $2.5 million of operating loss and $1.3 million of Adjusted EBITDA in the year ended December 31, 2008, which represents growth in revenue of 47%, and growth of Adjusted EBITDA of 452%, respectively.
 
Industry Overview
 
Businesses spent approximately $93.5 billion in 2009 on advertising and marketing related services to influence and acquire locally-targeted customers according to Borrell Associates, Inc. A significant portion of this amount is from national advertisers that sell their products or services locally, such as automobile companies that sell through local dealerships. In addition, locally operated businesses, such as home improvement contractors, place their own advertisements for local customer prospects. Traditionally, these advertisers have used offline media formats including the Yellow Pages, newspapers, direct mail, radio stations and local television to reach their target audience. As consumers have shifted their media consumption to the Internet, locally-targeted advertisers have begun to slowly shift their marketing budgets online as well. According to a July 2009 Forrester Research, Inc. report titled Consumer Behavior Online: A 2009 Deep Dive, 33% of weekly media consumption by Americans was via the Internet, yet only 17% of the $218 billion in annual advertising in 2009 was spent online according to Borrell Associates, Inc.
 
Online locally-targeted advertisers use a variety of techniques to attract customer prospects. In addition to the placement of direct ads, such as display ads, a substantial portion of online advertising expenditures relate to search engine marketing, or SEM. SEM is the practice of purchasing key words from search engines to receive more clicks to a website. Display advertising and SEM are designed to result in customer prospects clicking on a link and being directed to the advertiser’s website. By their nature, clicks do not include any information confirming the specific product or service and locality of the customer prospect nor any information that would allow the


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advertiser to directly follow up with the customer prospect. As an alternative to seeking traffic only, many online advertisers also seek leads. Leads contain specific information about a customer prospect such as the customer prospect’s name, email address, telephone number, specific product or service that the customer prospect is interested in and the location of the customer prospect. Online locally-targeted advertisers ultimately balance the likelihood that a specific action will result in an actual customer against the cost in determining their advertising strategy.
 
We believe that the primary reasons for the slow transition of locally-targeted advertisers from offline to online advertising has been a lack of an efficient and effective way for locally-targeted advertisers to obtain targeted customer prospects. This challenge has been particularly acute for a number of reasons, including:
 
     Need for significant expertise and infrastructure: Advertising efficiently and in a scalable manner on major search engines and ad networks requires significant investments in hiring experts and infrastructure. This complexity makes it difficult for many businesses to engage in a meaningful way in online marketing.
 
     Wasted advertising dollars: Although many online advertising programs can be targeted to a greater degree toward identifying the desired consumer prospects than offline advertising opportunities, there is still a significant portion of the online marketing efforts that results is wasted and unwanted traffic. This is particularly true for locally-targeted advertisers due to the need for geographic proximity of the customer prospects to the service provider. In recent years a number of techniques have been developed to reduce the amount of wasted ad dollars spent by advertisers. These techniques, which include behavioral, contextual, demographic and Internet Protocol-based, or IP-based, geographic targeting, attempt to glean each online users near-term commerce intent and geographic location. Unfortunately these techniques still have a high level of imprecision resulting in a significant portion of traffic from online ad campaigns that is not actionable by the advertiser and as a result increases the overall cost.
 
     Inability to acquire customer prospects with actionable information: Most major search engines and ad networks offer their marketing opportunities primarily on a cost-per-click or cost-per-impression basis. This approach makes it more expensive for locally-targeted advertisers to acquire traffic and convert it into actionable customer prospects.
 
     Inefficient lead generation: Faced with the inefficiencies of direct online advertising, locally-targeted advertisers often utilize lead generation companies in order to gain access to online customer prospects. Lead generation traditionally has lacked controls over quality, volume and price. Advertisers generally must place bulk advance purchases for large quantities of leads and have limited ability to define the volume of leads that they will receive. The majority of lead generation companies provide limited visibility to the propensity of a customer prospect to transact and offer limited ability to the advertisers to segment their advertising investment into different marketing campaigns and bid in an auction format for these customer prospects based on their desired cost per transaction. We believe that the lack of access to these controls that have become expected in other forms of online marketing offered by major search engines and ad networks has made lead generation less attractive.
 
We also believe that there are issues particularly relevant to national advertisers that sell locally that have hindered their adoption of Internet advertising and lead generation, including:
 
     Inability to aggregate high-quality customer prospects across multiple sources: It is costly, time-consuming and a significant technical challenge for national advertisers to aggregate locally-targeted customer prospects from multiple sources and direct them to local affiliates in multiple locales, particularly on a real-time basis.
 
     Lack of confirmed product or service interest and location preferences: Major search engines and ad networks employ behavioral targeting, contextual targeting, demographic targeting and IP-based geographic targeting as proxies to determine the intent and the location of consumers. While all of these steps improve the chances that the advertiser will be more likely to get exposed to its target audience, these methodologies require significant investment in infrastructure and expertise and still result in significant unwanted traffic and wasted ad dollars.


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The Reply.com Solution
 
We have built a technology platform that is designed to address the needs of locally-targeted advertisers of all sizes and levels of sophistication. Major benefits of our solution include the following:
 
     Our technology platform enables us to categorize customer prospects based on specific user-provided information. We do this by directing the traffic that we acquire to a filter page that has been customized to request more specific, but not personally identifiable, information from the customer prospect, including information regarding the specific product or service that the customer prospect is seeking and the relevant geographic location. Our marketplace allows advertisers to control the specific characteristics of the customer prospects they seek to acquire and determine the optimal price, quality and volume in designing their advertising campaigns. Our Exchange service allows advertisers to resell unwanted traffic they may acquire from other sources which would otherwise be wasted advertising spending.
 
     We have designed our technology platform to meet the needs of both large national advertisers interested in locally-targeted traffic as well as other locally-targeted advertisers. National advertisers interested in locally-targeted traffic can use our marketplace to gain access to their desired customer prospects while maintaining their desired cost per transaction without needing to build expensive infrastructure or hire costly professionals. Other locally-targeted advertisers can easily set up accounts and define marketing campaigns with our easy to use Click Marketplace, or CMP, and Lead Marketplace, or LMP. All advertisers bid their desired price for their target customer prospects which allows them to generate transactions at prices that do not exceed an acceptable cost per transaction.
 
     Our technology platform is agnostic as to our sources of traffic, allowing us to acquire traffic from multiple sources based upon the cost and quality of the traffic and the needs of the advertisers in our auction marketplace. As a result, by placing orders with us, our advertisers gain access to customer prospects from many different sources of traffic in one marketplace.
 
     We have designed our technology platform to be agnostic as to industry categories, allowing us to enter into new industry categories without having to make significant technology investments. This allows us to offer our marketing solutions for a growing number of locally-targeted categories.
 
An additional benefit that is highly relevant to national advertisers that sell locally is:
 
     Ability to access high value customer prospects across multiple sources in different geographies: Our marketplace aggregates customer prospects from many sources with information regarding the product or service and relevant location preference. Locally-targeted national advertisers, as well as local advertisers, often seek different kinds of customer prospects for different markets due to time of the month, seasonality, supply management, competitive issues and other factors. With our marketplace, these advertisers can conveniently use our marketplace to bid for only the traffic they seek and to distribute these customer prospects to the appropriate local affiliates.
 
Our Strategy
 
Our goal is to be the leader in locally-targeted online marketing solutions. Key elements to our strategy for achieving this goal include the following:
 
     Continue to grow existing categories. We intend to continue developing the industry categories we currently serve by adding new advertisers and growing our business with existing advertisers within those industry categories.
 
     Launch additional categories. We have designed our technology platform to address any industry category and we intend to continue to expand into new categories.
 
     Expand channel partnerships. We intend to expand the number of partnerships we have with advertising agencies and media groups. We intend to work with other businesses that address the locally-targeted


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  advertising market and provide our Reply! Marketplace on a white-label basis to complement their offline and other online activities.
 
     Expand our Exchange Service. We intend to continue to improve and expand our Exchange service to provide greater opportunities to our advertisers to sell unwanted traffic acquired from other sources.
 
     Expand internationally. We have designed our platform to allow us to expand into other geographic markets globally. We intend to leverage key national account advertiser relationships with global brands to penetrate new geographic markets.
 
     Pursue acquisitions. We intend to evaluate strategic acquisitions to enable us to increase our geographic presence, expand our advertiser relationships, expand into additional industry categories and further enhance our marketplace.
 
Our Services
 
Reply! Marketplace – Advertisers
 
Our Reply! Marketplace serves advertisers seeking locally-targeted, category-specific customer prospects using the following steps:
 
Aggregation. We aggregate large volumes of customer prospects from multiple online sources such as search engines, display advertising, email, our proprietary Exchange and other sources.
 
Enhancement. We enhance these customer prospects and improve their value by determining the product or service that the customer prospect is seeking as well as their geographic preferences. We do this by directing the traffic that we acquire to a filter page that has been customized to request more specific, but not personally identifiable, information from the customer prospect, including information regarding the specific product or service that the customer prospect is seeking and the relevant geographic location. For example, in the case of our automotive category, the filter page may seek information regarding the brand and model of the automobile sought and the zip code of the city where the customer wants to purchase the automobile.
 
Categorization. We categorize our enhanced customer prospects based on the product or service and geographic preferences, thereby simplifying the acquisition of local customers. Given the level of information that we are able to obtain, we are able to categorize customer prospects based upon the actual and specific expressed intent of the customer prospect and their location.
 
Standardization. We standardize the buying process by allowing advertisers to bid for customer prospects based upon the specific characteristics of the customer prospects that they are seeking. Advertisers can establish any number of campaigns with different levels of specificity and bid prices. For example, a home improvement professional may be prepared to pay one price for a customer prospect seeking window replacement and a higher price for a customer seeking window repair and may want the ability to further differentiate its bids based on the geography communicated by the customer prospect. Advertisers can measure the effectiveness of each campaign and adjust their bidding strategy accordingly so they can manage their cost per transaction.
 
Quality Measurement. In addition to obtaining more detailed information regarding the specific interest and location of customer prospects, we use our proprietary algorithms to provide scoring and validation of customer-supplied information. In the case of Enhanced Clicks, we segment the Enhanced Clicks based upon our historical experience of the likelihood that the customer prospect will complete the advertiser’s desired action. In the case of leads, we score the leads based upon the extent to which we are able to validate the information supplied and the likelihood that the customer prospect will purchase the goods or services. Advertisers are able to factor in this scoring in determining the price they are willing to pay for leads.
 
Auction. We auction these customer prospects in our real-time online marketplace where advertisers place bids for Enhanced Clicks or leads. Advertisers are able to customize their bids balancing the factors deemed most important to them and the price they wish to pay. They are able to bid either for an Enhanced Click or an exclusive or non-exclusive lead. In the case of an Enhanced Click, the traffic is delivered to the advertiser’s desired website. The advertiser is able to acquire traffic knowing that the customer prospect has an expressed interest in a product or service at a location that the advertiser seeks, but the Enhanced Click does not include customer contact


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information. In the case of a lead, the advertiser is provided with the specific information that enables it to contact the customer prospect. Our system analyzes all of the bids on a real-time basis and delivers the customer prospect as an Enhanced Click or an exclusive or non-exclusive lead to the bidder or bidders that maximizes our return.
 
Our advertisers are able to submit bids and create advertising campaigns through our easy-to-use CMP, and LMP. Our CMP and LMP allow the advertiser to specify the type of Enhanced Click or lead that they are interested in acquiring based upon a range of information specific to the advertiser’s industry category. For example, in the case of an automotive advertiser, they can indicate interest in factors such as new or used, brands, and models. They can also set geography by state, metropolitan area, county or city. Advertisers are also able to establish a maximum budget by day, week or month. Based upon this information, advertisers then submit bids for Enhanced Clicks or leads with the characteristics specified. In making their bids, we provide information to the advertisers regarding minimum and average prices for the specific Enhanced Click or leads. We also provide advertisers with easy-to-use reporting dashboards to enable advertisers to monitor the status and results of their campaigns. For advertisers with more sophisticated automated systems, information regarding campaigns is exchanged through XML feeds and dynamic bids that may vary based on the characteristics of each Enhanced Click or lead.
 
Reply! Marketplace – Advertiser side Exchange
 
Given the nature of locally-targeted online advertising offered by major search engines and ad networks, a substantial amount of the traffic acquired by advertisers does not relate to the specific product, service, customer profile or locality that the advertiser is seeking to address. Without an opportunity to immediately re-sell this traffic, advertisers are not able to recover the expense of acquiring this traffic. Connecting advertisers to each other allows them to better recover their otherwise wasted advertising dollars. Our Exchange service provides an opportunity for advertisers to monetize clicks or leads that would otherwise be wasted. Advertisers utilize our Exchange by notifying us on a real time basis that they wish to sell a customer prospect with specific information regarding a product or service and location. We then run an auction on our platform that allows us to determine the price for which we are able to sell the click or lead and based upon such price, make an offer to purchase the click or lead. In addition to selling unwanted clicks and leads, advertisers can also use our Exchange service to improve the yield on traffic that they would otherwise sell to other parties for a lower price. By enabling advertisers to access high-quality customer prospects from other advertisers, we enable advertisers to improve their chances of acquiring customers in their desired categories of intent in the specific geographies where the advertisers have additional available capacity. The Exchange feature of our Reply! Marketplace serves advertisers that have unwanted traffic or leads and other advertisers that seek exact same customer prospects to participate in the exchange and create a highly efficient marketplace that benefits all participants.
 
Connecting Neighbors
 
Connecting Neighbors is a service whereby we develop, implement, and maintain local neighborhood websites designed for the promotion of real estate agents. Advertisers pay a monthly subscription fee for a presence on these websites. In 2008, we determined that this service is no longer core to our offering.
 
Traffic Sources
 
We acquire online traffic from numerous sources. We manage our sources of traffic on a dynamic basis, balancing our desire to provide our advertisers with traffic that meets the volume, quality, locality and pricing that they seek while also meeting our financial objectives. The percentage of our aggregate traffic that we acquire from each of our sources of traffic changes month to month based upon market demand, maturity of each of our industry categories and seasonality. For example, when we launch a new category, SEM typically accounts for a significant amount of our initial traffic in that category. However, as a new category matures, our traffic sources for that category typically become more diverse. We also seek to diversify our traffic sources to mitigate our dependence on any single source of traffic. All traffic that we acquire is processed through our filter page engine that customizes


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the experience for each user based on the specific industry category, design elements and copy, with the goal of optimizing conversion rates and our financial results. Our principal sources of traffic include the following:
 
     PPC advertisements. Our largest source of traffic is pay-per-click, or PPC, which we typically purchase from leading search engines such as Google, Yahoo! and Bing. For the quarter ended December 31, 2009, traffic generated from PPC advertisements represented approximately 67% of our total traffic. We have a proprietary system that connects into search engine application programming interfaces and updates our bids based on changing bids in our marketplace and our financial objectives. We utilize a third-party bid management system to automate our bidding, which helps us to expand across different industry categories more rapidly.
 
     Display advertisements. We also place display advertisements across advertising networks, advertising exchanges, social networks, affiliate networks and directly through large consumer portals. Display advertisements currently represents our fastest growing source of traffic.
 
     Advertiser-side exchange. Our Exchange service provides locally-targeted online advertisers the opportunity to sell unwanted or poorly targeted traffic acquired by them from any source to help recover what otherwise would be wasted advertising spend. We purchase traffic that we believe we can re-sell to other of our advertisers.
 
     Email lists. We utilize email lists that we own and have generated on an opt-in basis from consumers that have visited our websites for remarketing and cross-channel acquisition. We also utilize email lists owned by third parties and warranted by their owners to comply with the CANSPAM Act.
 
     Self-service affiliate platform. Publishers can sign up for our self-service affiliate program directly from our website. The platform has been designed to be easy-to-use and allows publishers to quickly connect to our marketplace, publish our customer prospect generation widgets and immediately start earning fees.
 
     Our Websites. Direct traffic to websites that we own and operate represents a small portion of our overall volume of customer prospects.
 
Sales and Marketing
 
We acquire advertisers primarily through a direct sales effort. We use both a business development group that targets larger, enterprise-level relationships and a telesales group that targets local advertisers in specific industry categories and geographies. Our business development team spends considerable time meeting directly with prospective advertisers on site or at trade shows. Autobytel, which bids for both Enhanced Clicks and leads, represented 11% of our 2009 revenue. Because of the auction nature of our marketplace, there are typically multiple bidders for our Enhanced Clicks and leads. As a result, although the loss of a significant advertiser can impact the number and price of bids in our marketplace, in more mature categories we typically would expect to sell the majority of our Enhanced Clicks and leads to the next highest bidder.
 
We currently focus our sales efforts on four types of accounts:
 
     Locally-Targeted National Accounts – Companies with nationwide coverage that seek to acquire locally-targeted Enhanced Clicks or leads for their own use. An example of a national account is an automobile manufacturer that is seeking customers that can be directed to local car dealerships.
 
     Aggregators – Companies that purchase locally-targeted Enhanced Clicks or leads on behalf of third-party local advertisers that they service. An example of an aggregator is a nationally marketed home repair company that is seeking customers that can be directed to local repair services.
 
     Channel Partners – Companies that rely on a customized version of our Reply! Marketplace to deliver Enhanced Clicks or leads to their advertisers. An example of a channel partner is a newspaper publisher that utilizes our service under their brand to develop online revenue complementary to their offline advertising.


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     Local Advertisers – Companies that are locally-based and only looking for locally-targeted potential customers. An example of a local advertiser is a local real estate broker looking for potential customers interested in local real estate.
 
Our business development team focuses primarily on the locally-targeted national accounts, aggregators and channel partners, which collectively accounted for approximately 65% of our revenue in 2009. Our business development team works closely with our advertisers to define their needs and establish campaigns that meet those needs. The goal of our collaborative approach is to allow us to deliver a specific and measurable return on investment for the advertiser. Many of these advertisers track customer conversions on a daily, weekly or monthly basis.
 
An emerging sales focus for the business development team is companies that want to provide locally-targeted leads or Enhanced Clicks to their advertisers through a white-labeled version of our systems. These companies, which we refer to as channel partners, typically have large sales forces and are able to extend their digital offering to Enhanced Clicks or leads with limited or no additional technical investment. This solution has been particularly attractive to traditional media companies that have a large installed base of advertisers and desire to expand the online marketing solutions they can offer.
 
As a supplement to our business development efforts, our in-house telesales team focuses its effort on certain industry categories and geographic areas where we have an unmonetized flow of Enhanced Clicks or leads and where we believe that we can cost-effectively establish direct relationships with local advertisers.
 
In addition to direct sales activity, our business development team actively participates in leading industry trade shows and events for our industry categories, such as AdTech, LeadsCon, J.D. Power Roundtable, Inman Conference and others.
 
All of our marketing solutions are offered through an easy-to-use self-service platform available on our website. Over time we believe that our self-service platform will act as a more significant channel for the acquisition of local advertisers.
 
Technology Platform and Infrastructure
 
We developed our technology platform internally and designed it to be highly scalable. Our technology platform consists of the following:
 
Core Platform Systems. We have developed proprietary systems designed to provide scalable and extensible platform functionality, software development and website updates for the core businesses on our network, including our Click Marketplace and Lead Marketplace. Our technology platform includes the following functionality:
 
     Processes for Enhanced Click and lead aggregation – A fully integrated landing page system designed to accommodate both Enhanced Click and lead buyers with components allowing for a dynamic, category specific customer experience.
 
     Enhanced Click and lead real-time auctions – The platform aggregates both fixed-price customers and dynamic pricing on a real-time basis into a single auction using proprietary filter sets that determine the outcome that maximizes our yields from the auction.
 
     Enhanced Click and lead delivery – Components designed to deliver Enhanced Clicks and leads in a seamless and customizable manner to our advertisers.
 
Within these main processes reside specialized, proprietary subsystems for the creation of accounts within the auction as well as filter sets customized for specific industry categories, which enable users to set quality ratings, set budgets and analyze buying or selling dynamics within the campaigns. We expect to continue to develop our CMP and LMP platforms to extend the ability of our buyers and sellers to take advantage of our proprietary quality rating systems to set parameters on Enhanced Click and lead quality.
 
Data Centers and Network Access. Our primary data center is hosted by XO Communications in Fremont, California, which hosts our websites, including our home page, several filter pages that supply the majority of our


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traffic flow, code and data structures of our platform, and our intranet and reporting code bases. The data center is designed to include load balancers, firewalls and routers that connect components and provide Internet connection. In addition, we maintain backup systems at our corporate headquarters in San Ramon.
 
Network Security. Our data center and back office systems maintain real-time communication with encrypted message protocols. We also use leading commercial antivirus software, real-time monitoring, firewall and patch-management technology to protect and maintain the systems at our data centers and within our office environment.
 
We devote a substantial portion of our resources to developing new solutions and enhancing existing solutions, handling quality assurance testing, improving our core technology and strengthening our technological expertise in online marketing. As of January 31, 2010, our technical group consisted of 16 employees focused on feature development of existing solutions and the design of new solutions.
 
Competition
 
The market for locally-targeted advertising is highly competitive. We compete against both traditional offline advertising businesses as well as online services. We believe that our principal competitive advantage is that we have designed our technology platform and business model to address the needs of locally-targeted advertisers. Our marketplace is easy-to-use and allows advertisers to design scalable marketing programs without the need to hire experts or build expensive infrastructure. As the locally-targeted online marketing industry is new and emerging, over time we may compete with a variety of online businesses, including:
 
     search engines, such as Google, online portals and other heavily trafficked sites, such as Facebook;
 
     businesses that focus on specific industry categories such as automotive or real estate or upon listings for locally-targeted business, such as Yelp and Craigslist;
 
     businesses that focus on delivering locally-targeted online marketing services, such as ReachLocal; and
 
     other companies providing online marketing services.
 
We currently or may in the future do business with many of these current or potential competitors, either as a source of the traffic we acquire or an advertiser purchasing Enhanced Clicks or leads from us. As a result, if any of these companies choose to compete more directly with us, we may face the prospect of both loss of business and increased competition.
 
Most of our competitors have substantially greater financial and other resources than we do. As a result, our competitors may be able to respond more quickly and effectively than we can to new or changing opportunities, technologies, standards or market requirements. We also compete with emerging companies. We expect to experience continuing competitive pressures in our markets from existing competitors and new entrants. Any consolidation among our competitors could enhance their product offerings and financial resources, further enhancing their competitive position. Our ability to compete effectively will depend on a number of factors, including:
 
     our ability to offer cost-effective and high-quality services on a timely basis;
 
     our ability to accurately identify and respond to emerging technological trends and demand for new features and performance characteristics;
 
     our ability to continue to rapidly introduce new services that are accepted by the market;
 
     our ability to adopt or adapt to emerging industry standards;
 
     the number and nature of our competitors and competitiveness of their products and services in a given market; and
 
     entrance of new competitors into our markets.


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Many of these factors are outside of our control. For all of these reasons, we may not be able to compete successfully against our current or future competitors.
 
Employees
 
As of January 31, 2010, we had 127 full-time employees, including 103 in sales and marketing, 14 in technology and 10 in general and administrative and other functions. None of our employees are covered by collective bargaining agreements.
 
Facilities
 
Our headquarters are located in a 39,413 square-foot facility in San Ramon, California that we lease. The lease expires in May 2012.
 
Legal Proceedings
 
We are not currently involved in any material legal proceedings.


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Management
 
Executive Officers and Directors
 
The following table sets forth information regarding our executive officers and directors:
 
             
Name
 
Age
 
Title
 
Payam Zamani
    39     President, Chief Executive Officer and Chairman of the Board
Sean Fox
    41     Chief Operating Officer
Brian Bowman
    42     Chief Marketing Officer
W. Samuel Veazey
    49     Chief Financial Officer
William Perrault
    48     Vice President, Information Technology
Deborah A. Coleman(1)(3)
    57     Director
Randy M. Haykin(1)(2)
    49     Director
Jordan M. Spiegel(1)(2)
    47     Director
John Truchard(3)
    37     Director
Sharon L. Wienbar(2)(3)
    48     Director
 
(1) Member of our audit committee.
 
(2) Member of our compensation committee.
 
(3) Member of our nominating and corporate governance committee.
 
Executive Officers
 
Payam Zamani founded the company and has served as President, Chief Executive Officer and Chairman of the Board since our inception in June 2001. Mr. Zamani was founder and served as President and Chief Executive Officer of PurpleTie, Inc., an online based apparel care service, from June 1999 to April 2001. He was also co-founder of Autoweb.com, Inc., an online car buying service, where he served as a director from October 1995 to October 1999, and in various executive level positions from October 1995 to June 1999. Mr. Zamani is a director of Les Concierges, Inc., a private concierge services company. Mr. Zamani holds a B.S. in Environmental Toxicology from the University of California at Davis. Our board of directors has concluded that Mr. Zamani should serve as a director and as Chairman of the board of directors based on his experience and insight as one of our founders and as our Chief Executive Officer.
 
Sean Fox has served as our Chief Operating Officer since May 2008. Prior to his promotion to that position, he served as our Executive Vice President of Business Development, from November 2007 to April 2008, as our Executive Vice President, Real Estate Division, from November 2005 to November 2007, and as our Executive Vice President from January 2005 to October 2005. Mr. Fox served as President of Real Estate on the Web, which did business as Connecting Neighbors and was an online neighborhood marketing program for real estate professionals, from February 2003 until our acquisition of Connecting Neighbors in January of 2005. Prior to that time, Mr. Fox served first as a Director of Sales and then Vice President of Strategic Alliances for bamboo.com, Inc., a virtual tour company, from October 1998 until January 2000. In January 2000, bamboo.com, Inc. merged with Internet Pictures Corporation to form Interactive Pictures Corporation, a provider of interactive visual content for the Internet, where Mr. Fox continued to serve as Vice President of Strategic Alliances until December 2000. Mr. Fox also served as a Vice President of Sales for Homestore, Inc., an online marketing company for the real estate industry, in 2001. Mr. Fox holds a J.D. from the Georgetown University Law Center, a M. Phil. in Economics from Cambridge University, and a B.A. in Economics and Political Science from Stanford University.
 
Brian Bowman has served as our Chief Marketing Officer since December 2007. Prior to his promotion to that position, he served as our Vice President of Product and Business Development from October 2006 to December 2007. From January 2006 to August 2006, he served as Vice President, Community for Yahoo! Inc. From January 2005 to November 2005, he served as Vice President of Marketing and Product Management for InfoSpace, Inc., a metasearch engine company. From April 2003 to November 2004, he served as Vice President of Product


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Development of Match.com, L.L.C., an online dating service and from March 1998 to September 2001 he was Vice President and General Manager for The Walt Disney Company’s ABC Television Network online division. Mr. Bowman holds a B.A. in Fine Art from Purdue University.
 
W. Samuel Veazey has served as our Chief Financial Officer since September 2007. Prior to his promotion to that position, he served briefly as our Executive Vice President of Finance and Controller and as our Vice President of Finance and Controller from May 2005 to July 2007. From October 2000 to June 2005, he was Vice President of Finance and Controller for CenterBeam, Inc., an information technology outsourcing services company. Prior to that time, he served in various financial and executive positions, including as Corporate Controller at Neoforma, Inc., a supply chain management software company, as Chief Financial Officer of Cambio, Inc., a network management and documentation software company, and as Chief Financial Officer of Sparta Surgical Corporation, a medical device company. Mr. Veazey holds a M.B.A. in Management and Finance, a M.S. degree in Biomedical Engineering, and a B.S. in Biology and Mathematics from the University of Miami.
 
William Perrault has served as our Vice President, Information Technology since December 2006. Prior to that time, he served as a project manager for us from March 2005 to November 2006. Previously, Mr. Perrault served as a project manager at Charles Schwab & Co., a financial services company, from November 1989 to November 2001.
 
Non-Management Directors
 
Deborah A. Coleman has served on our board of directors since December 2006. She has been General Partner of SmartForest Ventures LLC, a venture capital firm, since October 1999. From March 1994 to September 2001, Ms. Coleman was Chairperson of Merix Corporation, a manufacturer of circuit boards, where she also served as Chief Executive Officer from March 1994 to September 1999. From November 1992 to March 1994, she was Vice President of Materials/Operations at Tektronix, Inc., a test, measurement and monitoring solutions company. Ms. Coleman is a director and chair of the audit committee of Synopsys, Inc., an electronic design automation company. She is also a director and audit committee chair of several privately-held companies, including Kryptiq Corporation, a healthcare connectivity company, Concero Technology Corporation, an employee benefits software and administration company, and Phaseon Technology, a UV-LED technology company. Ms. Coleman previously served as a director and member of the audit committee of Applied Materials, Inc., a semiconductor manufacturing company, from March 1997 to March 2009. Ms. Coleman holds a B.A. in English Literature from Brown University and a M.B.A. from Stanford University. Ms. Coleman also received an honorary Ph.D. in engineering from Worcester Polytechnic Institute in 1987. Our board of directors has concluded that Ms. Coleman should serve on the board and as chair of the audit committee based upon her financial literacy developed as a result of her extensive experience as a chief financial officer and chief executive officer of public companies, as well as extensive public company board and audit committee experience.
 
Randy M. Haykin has served on our board of directors since March 2007. He is a Managing Director of Outlook Ventures, a venture capital firm which he co-founded in 1996, and Chairman of Haykin Capital, a mentor capital and consulting firm. Mr. Haykin also currently serves as a faculty member of the Haas School of Business at the University of California at Berkeley. Previously, Mr. Haykin served as the Vice President of Marketing and Sales at Yahoo! Inc. from 1995 to 1997. From 1997 to 1998, Mr. Haykin served as Vice President of Marketing at NetChannel, Inc., an Internet television services company, which was acquired by AOL, Inc. in 1998. From 1993 to 1994, Mr. Haykin served as Director, Business Development for The Media Kitchen, a division of Paramount Communications, Inc. From 1988 to 1993, Mr. Haykin served as Sales and Marketing Manager at Apple Inc. Mr. Haykin is a director of Les Concierges, Inc., a private concierge services company, and Embee Mobile, Inc., an information technologies services company. Mr. Haykin is also on the Governing Board of Opportunity International, Inc., a non-profit that provides micro-loans for third world countries, and the board of directors of the American Cancer Society. Mr. Haykin holds a B.A. in Organizational Behavior and Management from Brown University and a M.B.A. from Harvard Business School. Mr. Haykin serves as a board nominee of Outlook Ventures, which is one of our investors. Our board of directors has concluded that Mr. Haykin should serve on the board and as a member of our audit committee based upon his prior experience as an executive, investor and board member, and in particular his experience with online sales and marketing.


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Jordan M. Spiegel has served on our board of directors since August 2004. He is Managing Partner of Spiegel Partners, LLC, a private equity firm which he founded in June 2003. Prior to Spiegel Partners, he was a partner of GESD Capital Partners, LLC, a private equity firm which he co-founded, from June 1999 to March 2003. Prior to that time, Mr. Spiegel served in various executive positions, including as Managing Director at PreferredTrade, Inc., a boutique investment bank, as Executive Vice President of Laffer Associates, an economic research and corporate finance advisory firm, and as a securities analyst with Crowell, Weedon & Co. He currently serves on the board of directors of Bankserv, Inc., an electronic payments firm which provides banks and businesses with money transfer and payments technology. Mr. Spiegel holds a B.A. in cultural anthropology from the University of Southern California and an M.B.A. from Harvard Business School. Our board of directors has concluded that Mr. Spiegel should serve on the board, as chair of the compensation committee and as a member of the audit committee based upon his experience as an executive, investor and board member.
 
John Truchard is a co-founder of our company and has served on our board of directors since March 2007. Prior to that, he served on our board of directors from February 2002 to August 2005. Mr. Truchard also previously served in various positions with us from February 2002 to January 2010, including as Vice President, Automotive; Executive Vice President, Corporate Development; Executive Vice President, Automotive Division and Executive Vice President, Director. Mr. Truchard currently serves as chief executive officer and as a director of Vinewerkes, Inc. and Jam Cellars, Inc., each a wine related company. From February 2001 to January 2002, he served as Vice President of Automotive at Modulant Solutions, Inc., an enterprise information solutions company. From April 1996 to June 1998, he was Vice President, Sales of Autoweb.com, Inc., an online car buying service. From 1998 to 2000, he served as co-founder and President of OpenAuto, Inc., a vehicle configuration and inventory management software company. Our board of directors has concluded that Mr. Truchard should serve on the board and as a member of the corporate governance and nominating committee based upon his extensive experience in online marketing and his knowledge of the business as a co-founder of the company and as an executive.
 
Sharon L. Wienbar has served on our board of directors since August 2005. Since 2001, Ms. Wienbar has served first as a Director and later as a Managing Director at Scale Venture Partners, formerly BA Venture Partners, a venture capital firm. From 1999 to 2000, she served as Vice President, Marketing at Amplitude Software Corp., an internet resource scheduling software company, and then at Critical Path, Inc., a software-as-a-service company that acquired Amplitude. Prior to then, she worked in product marketing at Adobe Systems Incorporated from 1991 to 1998, and practiced strategy consulting at Bain & Company, a consulting firm, from 1984 to 1991. Ms. Wienbar also serves on the boards of directors of the following privately-held companies: Biz360, Inc., an information services company, FaceTime Communications, Inc., a company providing security, management and compliance of real-time communication, WYBS, Inc., which does business as MerchantCircle and is a social network of local business owners, Playphone, Inc., a global mobile media company and Everyday Health, Inc., an online consumer health solutions company. Ms. Wienbar also currently serves on the board of directors of the Myelin Repair Foundation and on the Advisory Committee of Microsoft, Inc. Ms. Wienbar previously served on the board of directors of GLU Mobile, Inc., a mobile games developer, from June 2004 to June 2008. Ms. Wienbar holds a B.A. in engineering from Harvard University, an M.A. in engineering from Harvard University and a M.B.A. from the Stanford Graduate School of Business. Ms. Wienbar serves as a board nominee of Scale Venture Partners, which is one of our investors. Our board of directors has concluded that Ms. Wienbar should serve on the board and as a member of our compensation and corporate governance and nominating committees based upon her experience as a consultant, executive, investor and board member, and in particular her extensive experience in marketing and her expertise in Internet-related businesses.
 
Board Composition and Independence
 
All of our current directors were elected pursuant to a voting agreement that we entered into with certain holders of our common stock and holders of our preferred stock, including entities with which certain of our directors are affiliated. The holders of a majority of our common stock, voting as a separate class, have designated Payam Zamani, Jordan M. Spiegel and John Truchard for election to our board of directors. The holders of a majority of our preferred stock, voting as a separate class, have designated Sharon L. Wienbar and Randy M. Haykin for election to our board of directors. Four members of our board of directors have designated Deborah A. Coleman for election to our board of directors. Upon the conversion of our outstanding preferred stock into common stock


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immediately prior to the consummation of this offering, the voting agreement and these board representation rights will terminate and none of our stockholders will have any special rights regarding the election or designation of members of our board of directors.
 
Upon the completion of this offering, our certificate of incorporation and bylaws will authorize a board of directors of six members. Our board of directors will be divided into three classes with staggered three-year terms as follows:
 
     Class I directors will be      and     , and their terms will expire at the annual general meeting of stockholders to be held in 2011;
 
     Class II directors will be      and     , and their terms will expire at the annual general meeting of stockholders to be held in 2012; and
 
     Class III directors will be      and     , and their terms will expire at the annual general meeting of stockholders to be held in 2013.
 
The authorized number of directors may be changed only by resolution of our board of directors. This classification of our board of directors into three classes with staggered three-year terms may have the effect of delaying or preventing changes in our control or management.
 
There are no family relationships among any of our current directors or executive officers. Our board of directors has determined that other than Mr. Zamani, our President and Chief Executive Officer, and Mr. Truchard, formerly our employee, each of the members of our board of directors is an “independent” director for purposes of the listing requirements and rules and regulations of The NASDAQ Global Market.
 
Board Committees
 
Our board of directors directs the management of our business and affairs, as provided by Delaware law, and conducts its business through meetings of our board of directors. Our board of directors has established three standing committees: an audit committee; a compensation committee; and a nominating and corporate governance committee. In addition, from time to time, special committees may be established under the direction of our board of directors when necessary to address specific issues. Our board of directors has adopted a written charter for each of the standing committees. These charters will be available on our corporate website at www.reply.com following the completion of the offering.
 
Audit Committee. Our audit committee is comprised of Deborah A. Coleman, Randy M. Haykin and Jordan M. Spiegel, each of whom satisfies the independence requirements of The Nasdaq Global Market and Rule 10A-3 of the Exchange Act. After the completion of this offering, our audit committee will be directly responsible for, among other things, the appointment, compensation, retention, and oversight of our independent registered public accounting firm. This oversight will include reviewing the plans and results of the audit engagement with the firm, approving any additional professional services provided by the firm and reviewing the independence of the firm. Commencing with our first report on internal control over financial reporting, the committee will also be responsible for discussing the effectiveness of our internal control over financial reporting with the firm and relevant financial management. Our board of directors has determined that all of the members of the audit committee possess the level of financial literacy required by the applicable rules of the SEC, and that Deborah Coleman is an audit committee financial expert as currently defined by SEC rules.
 
Compensation Committee. Our compensation committee is comprised of Jordan M. Spiegel and Sharon L. Wienbar, each of whom satisfies the independence requirements of The Nasdaq Global Market and John Truchard. In addition, each of Mr. Spiegel and Ms. Wienbar qualifies as a “non-employee director” under Section 16 of the Exchange Act and an “outside director” for purposes of Section 162(m) of the Internal Revenue Code of 1986, as amended, or the Code. After the completion of this offering, the compensation committee will be responsible for, among other things, supervising and reviewing our affairs as they relate to the compensation and benefits of our executive officers. In carrying out these responsibilities, the compensation committee will review all components of executive compensation for consistency with our compensation philosophy and with the interests of our stockholders.


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Nominating and Corporate Governance Committee. Our nominating and corporate governance committee is comprised of Deborah A. Coleman and Sharon L. Wienbar, each of whom satisfies the independence requirements of The Nasdaq Global Market, and John Truchard. After the completion of this offering, the nominating and corporate governance committee will be responsible for, among other things, identifying individuals qualified to become board members; selecting, or recommending to our board of directors, director nominees for each election of directors; developing and recommending to our board of directors criteria for selecting qualified director candidates; considering committee member qualifications, appointment and removal; recommending corporate governance principles, codes of conduct and compliance mechanisms; and providing oversight in the evaluation of our board of directors and each committee.
 
Compensation Committee Interlocks and Insider Participation
 
During 2009, our compensation committee was comprised of Randy M. Haykin, Jordan M. Spiegel and Sharon L. Wienbar. There are no interlocking relationships between our board of directors or compensation committee and the board of directors or compensation committee of any other entity, nor has any interlocking relationship existed in the past. None of our directors who served on our compensation committee during 2009 has served our company or any of our subsidiaries as an officer or employee. In addition, none of our executive officers serves as a member of the board of directors or compensation committee of any entity which has one or more executive officers serving as a member of our board of directors or our compensation committee.
 
Code of Business Conduct and Ethics
 
We have adopted a written code of business conduct and ethics, which outlines the principles of legal and ethical business conduct under which we do business. The code is applicable to all of our directors, officers and employees. This code will be available on our corporate website at website at www.reply.com following the completion of the offering. Any substantive amendment or waiver of the code relating to executive officers or directors will be made only after approval by a committee comprised of a majority of our independent directors and will be disclosed on our website identified above within four business days.
 
Limitation of Liability and Indemnification
 
For information concerning limitation of liability and indemnification applicable to our directors, executive officers and, in certain cases, employees, see “Description of Capital Stock - Limitations of Director Liability and Indemnification of Directors, Officers, and Employees” located elsewhere in this prospectus.
 
Director Compensation
 
The following table provides summary information concerning the compensation paid to or accrued in respect of our non-employee directors for services rendered in that capacity during the year ended December 31, 2009:
 
                         
 
    Option
    All Other
       
Name(1)
  Awards(2)(3)     Compensation     Total  
 
Deborah A. Coleman
  $ 6,051     $     $ 6,051  
Randy M. Haykin
  $     $     $  
Jordan M. Spiegel
  $ 13,415     $     $ 13,415  
John Truchard
  $ 24,222     $ 7,324(4 )   $ 31,458  
Sharon L. Wienbar
  $     $     $  
 
(1) See the Summary Compensation Table for disclosure related to Payam Zamani, our President, Chief Executive Officer and Chairman of the Board. Mr. Zamani is our only employee director and does not receive any additional compensation for his services as a member of our board of directors.
 
(2) Certain of our non-employee directors participated in our option exchange and re-pricing program, as described in the section entitled “Option Exchange and Re-pricing.” The below table sets forth (i) the aggregate number of shares underlying underwater options previously granted to such directors that were cancelled in the exchange program, (ii) the aggregate number of shares underlying options that were issued to such


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directors on September 17, 2009 in exchange for such cancelled options, and (iii) the aggregate incremental fair value, computed as of the grant date of and in accordance with FASB ASC Topic 718, of the options issued to such directors on September 17, 2009 in exchange for cancelled options. The incremental fair value amounts have been determined based upon the assumptions set forth in Note 8 to our consolidated financial statements for the year ended December 31, 2009 included elsewhere in this prospectus.
 
                         
 
          Aggregate Number of
    Total Incremental
 
          Securities
    Fair Value of
 
    Aggregate Number of
    Underlying Options
    Option Awards
 
    Securities
    Granted in Exchange
    Granted in Exchange
 
    Underlying Canceled
    for Canceled
    for Canceled
 
Name
  Options     Options     Options  
 
Deborah A. Coleman
    75,000       55,857     $           6,051  
Jordan M. Spiegel
    100,000       80,199     $ 13,415  
John Truchard
    100,000       91,155     $ 24,222  
 
(3) At December 31, 2009, our non-employee directors each held an aggregate number of shares subject to option awards as follows:
 
         
 
    Total Outstanding
 
    Stock Options
 
Name
  (in shares)  
 
Deborah A. Coleman
    55,857  
Randy M. Haykin
     
Jordan M. Spiegel
    80,199  
John Truchard
    91,155  
Sharon L. Wienbar
     
 
(4) Reflects the cost of health and dental insurance premiums paid by us.
 
In February 2010, each of our non-employee directors received an option grant to purchase 10,000 shares of our common stock at an exercise price equal to the fair market value of our common stock on the grant date, as determined by our board of directors. To date and other than as set forth in the preceding disclosure, we have not compensated our non-employee directors for their services. We do reimburse our non-employee directors for reasonable travel and lodging expenses incurred by them to attend our board and committee meetings.
 
Beginning upon the completion of this offering, we intend to pay each of our non-employee directors an annual cash retainer of $25,000. In addition, we intend to pay an annual audit committee chair retainer of $15,000, an annual compensation committee chair retainer of $10,000 and an annual nominating and corporate governance committee chair retainer of $5,000. An individual director may elect to waive his or her director compensation. All of our non-employee directors will also be eligible to receive awards under our 2004 Stock Plan. We will continue to reimburse all directors for reasonable travel and lodging expenses incurred by them to attend our board and board committee meetings.


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Executive Compensation
 
Compensation Discussion and Analysis
 
Objectives
 
The compensation committee of our board of directors has overall responsibility for our compensation program for our “named executive officers.” For 2009, our named executive officers were our Chief Executive Officer, Chief Operating Officer, Chief Marketing Officer, Chief Financial Officer and Vice President, Information Technology.
 
The committee’s objective is to provide a total compensation package for executives that is reasonable, competitive and reflective of corporate and individual performance. The committee’s decisions are driven by our desire to recruit and retain highly talented executives, and to incentivize and reward aggressive corporate growth, achievement of long-term corporate objectives and individual performance that meets or exceeds our expectations.
 
Role of Executives in Executive Compensation Decisions
 
Our compensation committee seeks input and specific recommendations from Payam Zamani, our chief executive officer, when discussing the performance of, and compensation levels for, executives other than himself. The committee also generally grants the chief executive officer the discretion to determine whether individual performance targets for executives other than himself have been met. However, he is not a member of the committee and does not have a vote. The compensation committee also works with our chief executive officer, our chief financial officer and the head of our human resources department in evaluating the financial, accounting, tax and retention implications of our various compensation programs. Neither our chief executive officer nor any of our other executives participates in deliberations relating to his own compensation.
 
Compensation Consultants
 
The compensation committee has the authority to retain the services of third-party executive compensation specialists in connection with the establishment of cash and equity compensation and related policies. The committee did not use a compensation consultant, or review any formal industry data, in connection with setting 2009 executive compensation. Instead, in making its decisions the committee relied primarily upon the professional and market experience of our committee members. In December 2009, we engaged Compensia, a national executive compensation consulting firm, solely to assist the committee with respect to our compensation strategies and decisions for 2010.
 
Timing of Compensation Decisions
 
At the end of each fiscal year, our chief executive officer reviews the performance of the other executive officers and presents his conclusions and recommendations to the compensation committee. At that time and throughout the year, the committee will also evaluate the performance of our chief executive officer, which is measured in substantial part against our financial performance. In January of the following fiscal year, the committee then assesses the overall functioning of our compensation plans against our goals, and determines whether any changes to the allocation of compensation elements, or the structure or level of any particular compensation element, are warranted.
 
In connection with this process, our compensation committee generally establishes the elements of its performance-based cash bonus plan and grants equity awards to our named executive officers in or around January of each fiscal year. With respect to newly hired employees, our practice is typically to approve equity grants at the first meeting of the compensation committee following such employee’s hire date. We do not have any program, plan or practice to time equity award grants award in coordination with the release of material non-public information. From time to time, additional equity awards may be granted to executive officers during the fiscal year. For example, in September 2009, our executive officers were granted new options in exchange for the cancellation of previously issued options, as further described below. Upon the recommendation of our chief executive officer, in September 2009 the board approved an additional stock option grant for Brian Bowman, our Chief Marketing Officer, in


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order to better align his long-term equity compensation opportunities with his recent performance and to provide him with an additional long-term retention incentive.
 
Elements of Compensation Program
 
Our 2009 compensation package for our named executive officers was composed of the following elements:
 
     annual base salary;
 
     short-term performance-based cash compensation;
 
     long-term equity compensation, in the form of restricted stock awards and stock option grants; and
 
     a benefits package that is generally available to all of our employees.
 
Determining the Amount of Each Element of Compensation
 
The compensation committee determines the appropriate allocation between cash and non-cash, and short-term and long-term incentive, compensation elements, and the amounts which may be earned under each element, on an annual basis. There is no pre-established plan or target for such allocation. Rather, the committee establishes an annual policy based on its goal to align our executive compensation program with factors such as:
 
     our short and long-term financial and strategic objectives;
 
     individual responsibilities and performance;
 
     the amounts earned by our officers in prior years;
 
     internal equity and, to a lesser extent, the external competitive market for our executives; and
 
     general economic factors and market outlook for the coming year.
 
The compensation committee believes that the most effective executive compensation program is one that delivers base salary and target bonus compensation at levels generally consistent with market competitive practice, but also provides for opportunities in the form of incremental bonus and long-term equity awards that may result in higher than competitive levels if aggressive company goals are exceeded and if executives become long-term service providers.
 
Base Salary. Base salaries represent compensation for performing the basic obligations expected of each executive. The committee generally sets annual base salaries at a level which it believes is sufficient for us to attract and retain the level of executive talent that we believe is necessary to manage and foster our growth and development. Base salary levels are not based upon any specific benchmarking or comparable company analysis. Any changes in base salary are discretionary, and are made by our compensation committee based upon our performance and the responsibilities and continued success of each of our named executive officers in contributing to that performance. For 2009, our compensation committee did not make any changes to the annual base salary of our named executive officers from the prior year.
 
Short-Term Performance-Based Cash Compensation. Our short-term performance-based cash compensation is designed to incentivize achievement of our shorter-term financial and strategic targets, and to reward exceptional financial performance. The elements of our short-term performance based cash compensation program are described below.
 
Target Bonus Plan. Pursuant to our employment agreements with them and except as otherwise noted below, each of our named executive officers is eligible to participate in a performance-based target bonus plan under which he may earn a quarterly target amount based upon our financial results and his achievement of individual performance goals. The aggregate annual target amounts are computed as a percentage target rate of annual base salary. The target amount for each quarter is equal to one-fourth of the officer’s annual base salary multiplied by the percentage target rate. After reviewing the results of its target bonus plan for the prior fiscal year, the committee determines annually whether any changes to percentage target rates are warranted. For 2009, the percentage target rates for our named executive officers ranged from 30% to 50%, and vary based upon individual responsibilities and roles within our


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company. These percentage target rates did not change from the prior year, other than for Mr. Perrault. For 2009, Mr. Perrault’s target rate increased from 20% to 30% in light of an increase in his responsibilities relating to the enhancements required for our auction marketplace. At the beginning of each fiscal year, the committee establishes quarterly financial goals under the target bonus plan. For 2009, financial goals under the target bonus plan were based upon quarterly Adjusted EBITDA targets under our financial plan. We define Adjusted EBITDA as earnings before interest, taxes, depreciation and amortization, stock based compensation, impairment of goodwill, charitable donations and adjusted for one-time items such as the disposal or sale of assets, year-end audit fees, or litigation gains or expenses. The committee selected Adjusted EBITDA because it considers this to be an appropriate indicator of our success in achieving the profitability objectives reflected in our annual plan. The 2009 targets were based upon expected growth from the prior year, but were set at an amount the compensation committee believed to be reasonably attainable in light of our performance in prior years and our strategic and market outlook for 2009. Individual performance goals, which vary based upon our progress and goals, are established by the chief executive officer and regularly reviewed with the executive officers on an ongoing basis. Following each quarter, our chief executive officer determines whether and to what extent our executives have met these goals.
 
If earned, bonuses are generally payable quarterly based upon on the target amount for the applicable quarter. For named executive officers other than Brian Bowman, bonuses are earned for a quarter only if both the financial and individual performance goals for that quarter have been achieved. Under Mr. Bowman’s plan, a monthly bonus is payable to Mr. Bowman in an amount equal to one-third of his quarterly target amount, and subject only to his achievement of individual performance goals. Bonuses for a period will be accrued upon determination that they have been earned, but will not be paid for such period until our monthly ending cash balance exceeds $500,000. Subject to this condition, bonuses will generally be paid within 90 days after the end of the quarter. Bonuses under the target bonus plan are not adjusted upward or downward from applicable target amounts for variations in financial performance. If both financial and individual performance goals have been met, an executive will earn the target bonus for the quarter. If financial goals are met, and some but not all of the individual goals for an executive other than the chief executive officer have been met, our chief executive officer has the discretion to adjust downward the target bonus amount payable to such executive. In the case of our chief executive officer, the compensation committee may adjust his bonus downward based upon individual performance. Any such downward adjustment is not based upon any formula, but is a result of the subjective determination of our chief executive officer or compensation committee, as applicable. Bonus are not adjusted upward from applicable target amounts for individual performance.
 
Incremental Bonus Plan. For 2009, the compensation committee also established an additional incremental bonus plan for our named executive officers. This incremental plan was designed to incentivize our executives to exceed our financial objectives for 2009 and to enable them to earn higher overall compensation than in prior years upon achieving corporate financial performance beyond our plan targets. This plan was approved by the committee in January 2009 following a year in which our primary focus was on building the auction marketplace rather than growing revenues and profits, and given the dismal economic outlook at that time. It also reflected the considerable strategic and operational risks that we were facing, including the recent introduction of a new technology platform and limited cash resources. When it established the incremental bonus plan, the compensation committee believed that, given that we had recently launched our auction marketplace and faced significant recessionary headwinds, the achievement of Adjusted EBITDA in excess of quarterly plan targets would be a significant accomplishment for us, and would warrant a significant short-term cash reward. There was no maximum pay-out under the incremental bonus plans for any of the named executive officers. Under the incremental bonus plan, our named executive officers, other than Mr. Zamani, were eligible to earn quarterly incremental amounts equal to a percentage of the amount by which our Adjusted EBITDA for each quarter exceeded our quarterly financial plan targets. The percentage rates under the incremental bonus plan for our named executive officers other than Mr. Zamani ranged from 0.93% to 1.32%, and were allocated to enable each such officer to earn double his target amount for a quarter under the target bonus plan if our Adjusted EBITDA for such quarter doubled the corresponding quarterly plan target. Bonuses otherwise payable under the incremental bonus plan were subject to downward adjustment based upon achievement of individual performance objectives, as determined by and subject to the discretion of our chief executive officer or compensation committee, as applicable, and in the same proportion as any downward adjustment applied to the target bonus amount otherwise earned for the same quarter. If earned, these bonuses were paid at the same time as the target bonus for the corresponding quarter. Mr. Zamani was eligible to earn an


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annual incremental target amount equal to 25% of the amount by which our Adjusted EBITDA for the year exceeded our annual plan target, subject to our achievement of revenue for the year of the lesser of at least four times revenue for the first quarter of 2009 or approximately $25.8 million. These metrics were designed in light of Mr. Zamani’s ultimate accountability for our financial performance, and were intended to incentivize him to achieve sustained growth over the course of the entire year and significantly reward him for high success levels. If earned, this bonus was payable in the first quarter of 2010.
 
Bonus Plan Rates. The following table sets forth the target rates and aggregate annual target amounts, assuming 100% achievement of all quarterly goals, payable under our target bonus plan, and the target rates under the incremental bonus plans. The amounts actually earned by our named executive officers under each of these plans is reported in the Summary Compensation Table.
 
                                     
 
        Target Bonus Plan        
                    2009
    Incremental
 
        2009
    2009
    Aggregate
    Bonus Plan  
        Base
    Percentage
    Annual
    2009
 
        Salary Rate
    Target
    Target
    Incremental
 
Name
  Title   (Annualized)     Rate     Amount     Target Rate  
 
Payam Zamani
  President and Chief Executive Officer   $ 308,550       50 %   $ 154,275       25 %
Sean Fox
  Chief Operating Officer   $ 208,000       30 %   $ 62,400       1.248 %
Brian Bowman
  Chief Marketing Officer   $ 220,000       30 %   $ 66,000       1.32 %
W. Samuel Veazey
  Executive Vice President and Chief Financial Officer   $ 185,000       30 %   $ 55,500       1.11 %
William Perrault
  Vice President, Information Technology   $ 155,000       30 %   $ 46,500       0.93 %
 
Discretionary Bonus. In addition to payments made under our 2009 executive target bonus plan and our incremental bonus plan, in 2009 the board also awarded discretionary bonuses for 2009 performance. In November 2009, W. Samuel Veazey, our chief financial officer, received a one-time discretionary bonus of $25,000. This bonus was recommended by our chief executive officer and approved in recognition of the contributions made by Mr. Veazey in 2009 in connection with our preparation for our initial public offering. Upon the recommendation and voluntary election of the chief executive officer, the compensation committee approved the reallocation of an aggregate of $205,000 otherwise payable to Mr. Zamani in connection with the incremental bonus plan, including $130,000 reallocated to the named executive officers upon the recommendation of the chief executive officer in light of his assessment of their individual contributions to our financial performance, $50,000 reallocated to mid-level management and $25,000 reallocated as a donation to the Mona Foundation for relief and reconstruction of schools in Haiti. The amount allocated to each named executive officers is set forth under the heading “Summary Compensation Table.”
 
2010 Short-Term Performance-Based Cash Compensation. In February 2010, the compensation committee approved a new bonus plan for our executives. Under the plan, which continues and combines elements of the 2009 plans, each of the executives will again be eligible to earn a target bonus based upon a percentage of his salary based upon the achievement of financial and individual performance targets. Unlike prior years, however, amounts payable under the plan will be determined on a sliding scale relative to target levels based upon both financial and individual performance.
 
Long-Term Equity Compensation. Our equity-based compensation is designed to motivate executive behavior that results in long-term increased stockholder value and the alignment of our executives’ interest with those of our stockholders. Our equity program is also intended to reward the achievement of long-term corporate objectives and provide an additional long-term retention incentive for our executives.
 
Options. In the past, upon hire our executives generally received an equity award in the form of a stock option that vests over five years following commencing of their employment, with twenty percent vesting after 12 months of


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service and the balance vesting quarterly over the following four years. The committee generally believed that a five year vesting schedule for options was appropriate in order to engender long-term service from our executives and to incentivize and reward appreciation of the market value of our common stock over the option term. In some cases, the compensation committee granted options with different vesting schedules based upon the circumstances unique to the hire or grant. For example, upon acquisition of Connecting Neighbors in 2005, we granted Sean Fox, previously the President of Connecting Neighbors and currently our Chief Operating Officer, an option subject to vesting over two and one half years in recognition of his prior service to Connecting Neighbors. In prior years, our executives also received additional grants of stock options from time to time after their hire, based upon our chief executive officer’s recommendations as to each individual’s performance and contributions relative to their existing equity holdings and the holdings of other executive team members.
 
In June 2009, we obtained a third party valuation of our common stock that valued our common stock at $0.74 per share. Upon review, our board of directors determined that a substantial number of then outstanding options were significantly underwater. In order to retain and motivate performance of our service providers by providing them with the benefit of options that over time would have a greater potential to increase in value, and to create incentives which it believed would more effectively result in maximizing stockholder value, our board approved an option exchange and re-pricing program in July 2009. Pursuant to this program, the board offered all of our employees and directors the opportunity to exchange previously granted options for new options with an exercise price based upon the fair market value of our common stock as of the grant date of the new options. This program is further described below under the heading “Option Exchange and Re-Pricing.” Executive officers were eligible to participate in the exchange and re-pricing program, and each of our executive officers elected to exchange each of his outstanding options for new options granted in September 2009, as further described under the heading “Outstanding Equity Awards at Fiscal Year End” below.
 
Restricted Stock Awards. Beginning in December 2006, our compensation committee started granting our executive officers restricted stock awards. With the exception of the options granted pursuant to the option exchange and re-pricing program, and the option granted to Mr. Bowman as described above under the heading “Timing of Compensation Decisions,” the committee has not granted stock options to executives since 2008. In developing the restricted stock award program, the committee focused on long-term executive retention and the achievement of our long-term strategic goals. The committee also sought to design an equity award that would not require expenditures by, or result in tax liability for, the executives prior to the vesting of the award.
 
Under the restricted stock awards, restricted shares of our common stock are issued to executives in consideration of services rendered. Grants generally are subject to one-time vesting on the four year anniversary of the date of grant. To date, executives that have received restricted stock awards have not filed Section 83(b) elections under the Code. Accordingly, executives will be subject to tax at ordinary income rates only upon a vesting event and based upon the fair market value of the shares at the time of such event.
 
In January 2009, the committee approved the grant of additional restricted stock awards to each of our named executive officers. The vesting of these awards is subject to acceleration in various circumstances, including:
 
     partial acceleration upon the death or disability of the executive, based upon the number of months that have elapsed since the vesting commencement date divided by 48;
 
     for our named executive officers other than Mr. Zamani, full acceleration upon a involuntary termination of employment, or a voluntary resignation/forced termination for good reason, within twelve months after our change in control or initial public offering of our securities, or, in the absence of a termination or resignation, upon the date twelve months after such change in control or initial public offering ; and
 
     for Mr. Zamani, full acceleration upon a involuntary termination of employment, or a voluntary resignation/forced termination for good reason, within six months after our change in control or the initial public offering of our securities, or, in the absence of a termination or resignation, upon the date six months after such change in control or initial public offering.
 
See “Potential Payments Upon Termination or Change in Control” below for more information regarding the acceleration terms of the restricted stock awards.


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The size of the restricted stock awards granted to each executive officer in 2009 were not based upon any formula, benchmark or market comparisons, but rather were based upon the committee’s subjective judgment and set on a case-by-case basis. The number of shares subject to each award amount was set by the compensation committee at a level that was intended to create a meaningful opportunity for stock ownership based upon the executive’s position, the level of contribution expected of him in future periods, his personal performance in recent periods and a comparison of award and compensation levels in prior years. The committee also specifically sought to engender long-term retention and to motivate executives to contribute to the achievement of our strategic goals of a change in our control at an appreciated valuation, or the initial public offering of our securities. Accordingly, the committee took into account the number of unvested options and restricted stock awards held by the officer, and the acceleration terms applicable to those awards, in order to maintain an appropriate level of retention and incentive value for the individual. The relative weight given to each of these factors varied from individual to individual.
 
In January 2009, the committee also determined to grant Mr. Zamani an additional restricted stock award for 228,989 shares of our common stock, effective upon completion of the first half of our fiscal year, if our EBITDA for such period exceeded our plan targets for the first half of the fiscal year. The compensation committee approved this award, which vests four years from the grant date and has the same acceleration terms as the grant he received in January 2009, after considering Mr. Zamani’s compensation levels in prior periods, his prior performance and the committee’s expectations for him with respect to achieving significant and sustained levels of financial growth in the first half of the year. Based on our financial performance, this grant was made in July 2009.
 
2010 Equity Program. In February 2010, the committee approved the grant of additional restricted stock awards to our executive officers. The committee determined that, assuming the successful completion of this offering and the retention of our named executive officers throughout the following year period thereafter, the primary goals of the prior restricted stock award program had been achieved. The committee sought to continue to incentivize our executives to remain with us over the long-term, however, and to enable our executives, along with our stockholders, to recognize the value of their equity holdings over a significant period of time based upon our long-term successful financial performance and growth. The committee determined that granting additional restricted stock awards with a four-year vesting schedule that is not subject to any acceleration and in which the shares subject to the awards will vest 50% two years from the vesting commencement date, with the remaining 50% vesting annually over the following two years, would meet these objectives. The grants were issued in consideration of prior services rendered and are subject to the terms of a restricted stock award agreement entered into with each executive.
 
Exercise/Purchase Price of Equity Awards. The exercise price of stock options, and the deemed purchase price of restricted stock awarded in consideration of services rendered, granted to our executives in 2009 was equal to or greater than the fair market value of our common stock on the grant date. As a privately held company, our board of directors has historically determined the fair market value of our common stock based on various factors, including (i) our recent and historical company performance; (ii) our liquidity and cash resources; (iii) our projections regarding our future financial results; (iv) company developments since the last time option grants were approved by our board of directors; (v) independent third party valuations; (vi) the value of peer companies; and (vii) the rights, preferences and privileges of our preferred stock relative to those of our common stock. In addition, our board has obtained valuations from independent, third party valuation experts for purposes of determining the fair market value of our common stock. See “Management Discussion and Analysis” for further information. Upon the completion of this offering, we will utilize the trading price of our common stock on the date of grant.
 
Executive Equity Ownership. We encourage our executives to hold a significant equity interest in our company. However, we do not have specific share retention and ownership guidelines for our executives. We have a policy that, once we become a publicly traded company following this offering, we will not permit our executives to sell short our stock, will prohibit our executives from holding our stock in a margin account, and will discourage the purchase and sale of exchange-traded options on our stock by our executives.


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Compensation Committee Philosophy on Change in Control and Severance Benefits
 
Pursuant to our employment agreements with them, our named executive officers may receive certain cash payments, continuation of insurance benefits, and acceleration of vesting under outstanding equity awards granted prior to 2010 in connection with a termination of employment or a change in control. See “Executive Employment Agreements” and “Potential Payments Upon Termination or Change in Control” below for more information. When establishing these arrangements, the compensation committee believed that they were necessary to attract or retain qualified executives who may have attractive alternatives absent these benefits. With respect to benefits related to our change of control specifically, the committee elected to provide for these benefits in order to mitigate some of the risk that existed for executives working in an environment where there was a meaningful likelihood that we might have been acquired. The committee sought to provide change of control-related arrangements which would allow executives to focus on the value of strategic alternatives to stockholders without concern for the impact of a change of control on their continued employment.
 
Although the terms of each arrangement were not based on any set formula or plan and were determined in negotiation with the applicable named executive officer, for officers other than Mr. Zamani the range of the terms are generally consistent with some variation. For example, cash severance payments for such officers range in amount from three months to six months of annual base salary. Mr. Zamani’s arrangements generally differ from and may exceed those of the other executive officers. For example, his cash severance payment is equal to his annual salary and target bonus amount. The committee felt that these terms were appropriate for the chief executive officer based upon his role as a founder, his prior experience, the responsibilities of his position and general market terms for lead executives. Our restricted stock awards also include terms which provide for potential acceleration upon death or disability, or in connection with a change of control or an initial public offering of our securities, as described under and for the reasons provided above under the heading “Restricted Stock Awards.”
 
Effect of Accounting and Tax Treatment on Compensation Decisions
 
We consider the anticipated accounting and tax implications to us and our executives in determining our compensation programs. However, these factors alone are not dispositive, and we also consider the cash and non-cash impact of the programs and whether a program is consistent with our overall compensation philosophy and objectives. Section 162(m) of the Code imposes a limit on the amount of compensation that we may deduct in any one year with respect to our chief executive officer and each of our next three most highly compensated executive officers, unless specific and detailed criteria are satisfied. Performance-based compensation, as defined in the Internal Revenue Code, is fully deductible if the programs are approved by stockholders and meet other requirements. We believe that grants of equity awards under our existing stock plans qualify as performance-based for purposes of satisfying the conditions of Section 162(m), thereby permitting us to receive a federal income tax deduction in connection with such awards. In general, we have determined that we will not seek to limit executive compensation so that it is deductible under Section 162(m). However, from time to time, we monitor whether it might be in our interests to structure our compensation programs to satisfy the requirements of Section 162(m). We seek to maintain flexibility in compensating our executives in a manner designed to promote our corporate goals and therefore our compensation committee has not adopted a policy requiring all compensation to be deductible. Our compensation committee will continue to assess the impact of Section 162(m) on our compensation practices and determine what further action, if any, is appropriate.


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Summary Compensation Table
 
The following table sets forth the total compensation earned for services rendered by our principal executive officer, our principal financial officer, and our three other most highly compensated executive officers whose total compensation for the year ended December 31, 2009 was in excess of $100,000 and who were serving as executive officers at the end of that fiscal year. The listed individuals are referred to herein as the “named executive officers.”
 
                                                         
   
                                  Non-Equity
       
Name and Principal
                    Stock
    Option
    Incentive Plan
       
Position
  Year     Salary     Bonus(1)     Awards(2)     Awards(3)     Compensation(4 )     Total  
 
Payam Zamani
    2009     $ 308,550     $     $ 288,526     $     $ 703,276     $ 1,300,352  
President, Chief Executive Officer and Chairman
                                                       
Sean Fox
    2009     $ 208,000     $ 40,000     $ 39,000     $ 81,478     $ 96,432     $ 464,910  
Chief Operating Officer
                                                       
Brian Bowman
    2009     $ 220,000     $ 40,050 (5)   $ 78,000     $ 28,607 (6)   $ 110,990     $ 477,647  
Chief Marketing Officer
                                                       
W. Samuel Veazey
    2009     $ 185,000     $ 65,000 (7)   $ 26,000     $ 13,846     $ 85,334     $ 375,180  
Chief Financial Officer
                                                       
William Perrault
    2009     $ 155,000     $ 10,050 (8)   $ 26,000     $ 5,791     $ 35,505     $ 232,346  
Vice President, Information Technology
                                                       
 
(1) Unless otherwise noted, represents amounts otherwise payable to Mr. Zamani, our chief executive officer, as non-equity incentive plan compensation in the aggregate amount of $130,000 pursuant to his incremental bonus plan for 2009, but which were approved by the compensation committee for reallocation to named executive officers as discretionary bonus. This reallocation was made upon the recommendation and voluntary election of Mr. Zamani, and was in addition to the reallocation of additional amounts otherwise payable to him as non-equity incentive plan compensation pursuant to his incremental bonus plan for 2009 in the amounts of $50,000 to mid-level management and $25,000 to the Mona Foundation for relief and reconstruction of schools in Haiti.
 
(2) With respect to stock awards, reflects the grant date fair value, which was calculated by multiplying the fair market value of a share of our common stock on the grant date, as determined by our board of directors, by the number of shares awarded.
 
(3) Unless otherwise noted, reflects the incremental fair value, calculated as of the grant date in accordance with FASB ASC Topic 718, of options issued to the named executive officers in exchange for the cancellation of a certain number of underwater options previously granted to them in prior years, as described below in “Option Exchange and Re-pricing.” These amounts have been determined based upon the assumptions set forth in Note 8 to our consolidated financial statements for the year ended December 31, 2009 included elsewhere in this prospectus.
 
(4) Represents performance-based bonuses paid to our named executive officers under our performance-based cash target bonus plan and our incremental bonus plan for the year ended December 31, 2009.
 
(5) Represents (a) a discretionary bonus in the amount of $40,000 granted in connection with the reallocation of non-equity incentive plan compensation otherwise payable to Mr. Zamani pursuant to his incremental bonus plan for 2009, as further described in footnote (1) to this table, and (b) a discretionary bonus in the amount of $50 granted under our employee spot bonus program.
 
(6) Of this amount, $11,479 reflects the fair value, calculated as of the grant date in accordance with FASB ASC Topic 718, of a new options issued to Mr. Bowman. This amount has been determined based upon the assumptions set forth in Note 8 to our consolidated financial statements for the year ended December 31, 2009.
 
(7) Represents (a) a discretionary bonus in the amount of $40,000 granted in connection with the reallocation of non-equity incentive plan compensation otherwise payable to Mr. Zamani pursuant to his incremental bonus


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plan for 2009, as further described in footnote (1) to this table, and (b) a discretionary bonus in the amount of $25,000 granted by our board of directors upon the recommendation of our chief executive officer for contributions made during the year ended December 31, 2009 in connection with our preparation for our initial public offering.
 
(8) Represents (a) a discretionary bonus in the amount of $10,000 granted in connection with the reallocation of non-equity incentive plan compensation otherwise payable to Mr. Zamani pursuant to his incremental bonus plan for 2009, as further described in footnote (1) to this table, and (b) a discretionary bonus in the amount of $50 granted under our employee spot bonus program.
 
Grants of Plan-Based Awards
 
The following table sets forth certain information with respect to stock and option awards and other plan-based awards granted during the year ended December 31, 2009 to our named executive officers:
 
                                                 
   
          Estimated Future
                         
          Payouts Under
    All Other Stock
    All Other Option
             
          Non-Equity
    Awards:
    Awards: Number of
    Exercise or Base
    Grant Date Fair
 
          Incentive Plan
    Number of
    Securities
    Price of Option
    Value of Stock and
 
Name
  Grant Date     Awards(1)     Shares of Stock     Underlying Options(2)     Awards(3)     Option Awards(4)  
          Target                          
 
Payam Zamani
    01/23/2009     $ 154,275 (5)               $     $  
      01/23/2009     $ (6)               $     $  
      01/23/2009     $       228,989           $     $ 119,074  
      07/01/2009 (7)   $       228,989           $     $ 169,452  
Sean Fox
    01/23/2009     $ 62,400 (5)               $     $