LOCAL Corp

U.S. GAAP requires that development costs incurred in the preliminary project and post-implementation stages of an internal use software project be expensed as incurred and that certain costs incurred in the application development stage of a project be capitalized. U.S. GAAP further requires that costs incurred in the preliminary project and operating stage of web site development be expensed as incurred and that certain costs incurred in the development stage of web site development be capitalized and amortized over its useful life. During the three months ended March 31, 2015, the Company capitalized $433,000 related to web site development. Amortization of capitalized web site costs was $613,000 for the three months ended March 31, 2015. During the three months ended March 31, 2014, the Company capitalized $565,000 related to web site development. Amortization of capitalized web site costs was $607,000 for the three months ended March 31, 2014. Capitalized web site costs are included in property and equipment, net on the accompanying condensed consolidated balance sheets.

The Company determined that the conversion options for the Series A and Series B Notes should be bifurcated and accounted for as a derivative liability. Using the Black-Scholes valuation model the Company determined the estimated fair value of the Series A and Series B conversion option liabilities to be $2.2 million and $1.0 million, respectively, at the date of the Agreement. The Company also issued warrants to purchase an aggregate of 7,708,091 shares of common stock at an exercise price of $0.65 per share that expire five years from the date of issuance. The estimated fair value of these warrants, using the Black-Scholes valuation model at the date of grant, was $2.7 million. The fair value of the Series A and Series B Notes were determined using the effective interest of the senior convertible notes for which the counter party was not a party to the convertible notes the Company entered into in 2013. Applying the effective interest rate to the total value of the Series A and Series B Notes resulted in a total debt discount of $3.9 million as of the date of the transaction, which will be amortized into interest expense over the life of the senior convertible notes using the effective interest rate method. The difference between the estimated fair value of the conversion option liabilities and warrant liability and the fair value of debt discount totaled $2.0 million and was recorded as interest expense in the accompanying condensed consolidated statement of operations. The conversion option liability and warrant liability are recorded at fair value each reporting period with changes in the fair value recorded in the condensed consolidated statement of operations. The fair value of the Series A and Series B conversion option liabilities relating to the Series A and Series B Notes was $1.3 million and $444,000, respectively, as of March 31, 2015, and included in the senior convertible notes in the accompanying condensed consolidated balance sheets. The fair value of the conversion option liability relating to the 2013 Notes was $13,000 as of December 31, 2014, and is included in the senior convertible notes in the accompanying condensed consolidated balance sheets. The fair value of the warrant liability was $1.8 and $156,000 at March 31, 2015 and December 31, 2014, respectively.

As part of a convertible note and warrant purchase agreement the Company entered into on April 10, 2013, the Company issued warrants to purchase 746,268 shares of common stock at an exercise price of $2.01 that expires five years from issuance (the “2013 Warrants”). The warrant purchase agreement includes certain anti-dilution provisions that provides for the adjustment of the exercise price as well as the issuance of additional warrants to purchase shares of common stock, should there be a subsequent sale of shares of common stock or instruments to purchase shares of common stock at a lower price.

On March 9, 2015 the Company entered into a Securities Purchase Agreement relating to the sale and issuance of Senior Convertible Notes that also included the issuance of warrants. As these instruments were issued at a lower price than the 2013 Warrants, the exercise price of the 2013 Warrants were adjusted down from $2.01 to $1.47 and an additional 275,529 warrants to purchase shares of common stock were issued. Total 2013 Warrants outstanding as of March 31, 2015 was 1,021,797 at an exercise price of $1.47.

General and administrative expenses for the three months ended March 31, 2015, decreased 39.8% compared to the same period in 2014. The decrease in general and administrative expenses are due to a decrease in personnel related costs, consulting and professional fees.

Research and development expenses for the three months ended March 31, 2015, decreased by 19.4%, compared to the same period in 2014. The decrease is due to a reduction in consulting fees as part of our continued cost savings efforts. We capitalized an additional $433,000 of research and development expenses for website development and amortized $613,000 of capitalized website development costs during the three months ended March 31, 2015. We capitalized an additional $565,000 of research and development expenses for website development and amortized $607,000 of capitalized website development costs during the three months ended March 31, 2014.

Interest and other income (expense), net was ($3.6) million for the three months ended March 31, 2015, compared to ($543,000) for the same period in 2014. The increase in interest expense is due to a $1.0 million premium paid by the Company related to the repayment of the 2013 Notes. We also recorded non-cash interest expense of $2.4 million of which $383,000 related to the remaining debt discount on the 2013 Notes, $60,000 of debt discount related to the 2015 Senior Secured Convertible Notes and $2.0 million related to a loss recorded due to debt extinguishment of the 2013 Notes and the issuance of the 2015 Senior Secured Convertible Notes.