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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
| x | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the Quarterly Period Ended September 30, 2007
OR
| ¨ | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
| For the Transition Period from to . |
Commission File Number: 000-26357
LOOKSMART, LTD.
(Exact Name of Registrant as Specified in its Charter)
| Delaware | 13-3904355 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
625 Second Street
San Francisco, California 94107
(415) 348-7000
(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)
NASDAQ Stock Market LLC
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $0.001 per share
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer, as defined in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨
Indicate by check mark whether the registrant is a shell company, as defined in Rule 12b-2 of the Exchange Act. Yes ¨ No x
As of November 7, 2007, there were 22,912,800 shares of the registrant’s common stock outstanding.
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FORM 10-Q
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PART I — FINANCIAL INFORMATION
| ITEM 1. | UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS |
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
(Unaudited)
| September 30, 2007 | December 31, 2006 | |||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 18,921 | $ | 32,901 | ||||
Short-term investments | 18,476 | 7,257 | ||||||
Total cash, cash equivalents and short-term investments | 37,397 | 40,158 | ||||||
Trade accounts receivable, net of allowance for doubtful accounts of $338 and $323 at September 30, 2007 and December 31, 2006, respectively, and allowance for returns of $27 and $14 at September 30, 2007 and December 31, 2006, respectively | 4,355 | 4,639 | ||||||
Prepaid expenses | 650 | 516 | ||||||
Other current assets | 513 | 308 | ||||||
Current assets held for sale | — | 31 | ||||||
Total current assets | 42,915 | 45,652 | ||||||
Long-term investments | — | 998 | ||||||
Property and equipment, net | 3,338 | 4,588 | ||||||
Capitalized software and other assets, net | 2,851 | 3,533 | ||||||
Intangible assets, net | 319 | 2,825 | ||||||
Goodwill | 10,296 | 14,422 | ||||||
Assets held for sale | 4,331 | 539 | ||||||
Total assets | $ | 64,050 | $ | 72,557 | ||||
LIABILITIES & STOCKHOLDERS’ EQUITY | ||||||||
Current liabilities: | ||||||||
Trade accounts payable | $ | 2,689 | $ | 2,576 | ||||
Accrued expenses and other current liabilities | 6,907 | 5,624 | ||||||
Deferred revenue and customer deposits | 1,691 | 2,278 | ||||||
Current portion of lease restructuring and other long-term liabilities | 1,348 | 1,391 | ||||||
Current liabilities held for sale | — | 263 | ||||||
Total current liabilities | 12,635 | 12,132 | ||||||
Lease restructuring and other long-term liabilities, net of current portion | 2,215 | 2,876 | ||||||
Total liabilities | 14,850 | 15,008 | ||||||
Commitments and contingencies (Note 8): | ||||||||
Stockholders’ equity: | ||||||||
Convertible preferred stock, $0.001 par value; Authorized: 5,000 at September 30, 2007 and December 31, 2006; Issued and Outstanding: none at September 30, 2007 and December 31, 2006 | — | — | ||||||
Common stock, $0.001 par value; Authorized: 200,000 at September 30, 2007 and December 31, 2006; Issued and Outstanding: 22,913 at September 30, 2007 and 22,974 at December 31, 2006, respectively | 23 | 23 | ||||||
Additional paid-in capital | 276,450 | 274,484 | ||||||
Other equity | 14 | 517 | ||||||
Accumulated deficit | (227,287 | ) | (217,475 | ) | ||||
Total stockholders’ equity | 49,200 | 57,549 | ||||||
Total liabilities and stockholders’ equity | $ | 64,050 | $ | 72,557 | ||||
The accompanying Notes are an integral part of these Unaudited Condensed Consolidated Financial Statements.
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CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share data)
(Unaudited)
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2007 | 2006 | 2007 | 2006 | |||||||||||||
Revenue | $ | 12,629 | $ | 12,150 | $ | 40,479 | $ | 33,823 | ||||||||
Cost of revenue | 7,061 | 7,568 | 22,901 | 21,907 | ||||||||||||
Gross profit | 5,568 | 4,582 | 17,578 | 11,916 | ||||||||||||
Operating expenses: | ||||||||||||||||
Sales and marketing | 1,880 | 2,076 | 6,232 | 5,933 | ||||||||||||
Product development | 3,914 | 4,005 | 11,970 | 12,393 | ||||||||||||
General and administrative | 3,208 | 2,831 | 9,146 | 7,799 | ||||||||||||
Restructuring charges | 224 | — | 224 | — | ||||||||||||
Impairment charges | 1,645 | — | 1,645 | — | ||||||||||||
Total operating expenses | 10,871 | 8,912 | 29,217 | 26,125 | ||||||||||||
Other operating income (loss), net | 24 | — | (99 | ) | — | |||||||||||
Loss from operations | (5,279 | ) | (4,330 | ) | (11,738 | ) | (14,209 | ) | ||||||||
Non-operating income, net | 489 | 501 | 1,522 | 1,473 | ||||||||||||
Loss from continuing operations before income taxes | (4,790 | ) | (3,829 | ) | (10,216 | ) | (12,736 | ) | ||||||||
Income tax expense | — | — | (6 | ) | (11 | ) | ||||||||||
Loss from continuing operations | (4,790 | ) | (3,829 | ) | (10,222 | ) | (12,747 | ) | ||||||||
Gain (loss) from discontinued operations, net of tax | 471 | (31 | ) | 410 | (31 | ) | ||||||||||
Net loss | $ | (4,319 | ) | $ | (3,860 | ) | $ | (9,812 | ) | $ | (12,778 | ) | ||||
Basic and diluted net loss per common share: | ||||||||||||||||
Loss from continuing operations | $ | (0.21 | ) | $ | (0.17 | ) | $ | (0.45 | ) | $ | (0.56 | ) | ||||
Gain (loss) from discontinued operations, net of tax | 0.02 | — | 0.02 | — | ||||||||||||
Net loss | $ | (0.19 | ) | $ | (0.17 | ) | $ | (0.43 | ) | $ | (0.56 | ) | ||||
Weighted average shares outstanding used in per share calculation | 22,913 | 22,828 | 22,899 | 22,816 | ||||||||||||
The accompanying Notes are an integral part of these Unaudited Condensed Consolidated Financial Statements.
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
| Nine Months Ended September 30, | ||||||||
| 2007 | 2006 | |||||||
Cash flows from operating activities: | ||||||||
Net loss | $ | (9,812 | ) | $ | (12,778 | ) | ||
Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||
Share of joint venture (income) loss | (24 | ) | — | |||||
Depreciation and amortization | 3,836 | 4,969 | ||||||
Share-based compensation | 1,735 | 1,794 | ||||||
Impairment charges | 1,645 | — | ||||||
Gain from sale of assets and other non-cash charges, net | (289 | ) | 88 | |||||
Changes in operating assets and liabilities: | ||||||||
Trade accounts receivable, net | 284 | (2,292 | ) | |||||
Prepaid expenses | (134 | ) | (159 | ) | ||||
Other assets | (79 | ) | (88 | ) | ||||
Trade accounts payable | (61 | ) | (606 | ) | ||||
Accrued expenses and other current liabilities | 1,190 | 2,092 | ||||||
Other long term liabilities | (659 | ) | (1,134 | ) | ||||
Deferred revenue and customer deposits | (514 | ) | (32 | ) | ||||
Net cash used in operating activities | $ | (2,882 | ) | $ | (8,146 | ) | ||
Cash flows from investing activities: | ||||||||
Purchase of investments | (25,096 | ) | (5,451 | ) | ||||
Proceeds from sale and maturity of investments | 14,908 | 13,165 | ||||||
Payments for property, equipment and capitalized software development | (1,620 | ) | (3,023 | ) | ||||
Distributions from joint venture | 434 | — | ||||||
Net cash provided by (used in) investing activities: | $ | (11,374 | ) | $ | 4,691 | |||
Cash flows from financing activities: | ||||||||
Repayment of notes | (42 | ) | (39 | ) | ||||
Principal payments under capital lease obligations | (54 | ) | — | |||||
Proceeds from the sale and lease back of equipment | 211 | — | ||||||
Proceeds from issuance of common stock | 161 | 84 | ||||||
Net cash provided by financing activities | $ | 276 | $ | 45 | ||||
Decrease in cash and cash equivalents | (13,980 | ) | (3,410 | ) | ||||
Cash and cash equivalents, beginning of period | 32,901 | 33,436 | ||||||
Cash and cash equivalents, end of period | $ | 18,921 | $ | 30,026 | ||||
Supplemental disclosure of noncash investing activities: | ||||||||
Equipment purchases financed by capital lease | $ | 173 | — | |||||
The accompanying Notes are an integral part of these Unaudited Condensed Consolidated Financial Statements.
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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business and Principles of Consolidation
LookSmart is an online advertising and technology company that provides relevant solutions for advertisers, publishers and consumers. LookSmart offers advertisers targeted, pay-per-click (PPC) search advertising and banners via a monitored ad distribution network; a customizable set of private-label solutions for publishers; and consumer websites and web tools.
The Unaudited Condensed Consolidated Financial Statements as of September 30, 2007 and for the three and nine months ended September 30, 2007 include the accounts of the Company and its subsidiaries. All significant inter-company balances and transactions have been eliminated in consolidation.
Unaudited Interim Financial Information
The accompanying Unaudited Condensed Consolidated Financial Statements as of September 30, 2007 and for the three and nine months ended September 30, 2007 reflect all adjustments that are normal and recurring in nature and, in the opinion of management, are necessary for a fair statement of the results of operations for the periods shown. These Unaudited Condensed Consolidated Financial Statements should be read in conjunction with the Company’s Consolidated Financial Statements and Notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006. The Unaudited Condensed Consolidated Balance Sheet as of December 31, 2006 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. The results of operations for the interim period ended September 30, 2007 are not necessarily indicative of results to be expected for the full year.
Use of Estimates and Assumptions
The Unaudited Condensed Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States. This requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenue, expenses, and contingent assets and liabilities during the reporting period. The Company bases its estimates on various factors and information which may include, but are not limited to, history and prior experience, experience of other enterprises in the same industry, new related events, current economic conditions and information from third party professionals that is believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates.
Reclassifications
Certain prior periods’ balances have been reclassified to conform to the current year’s presentation. These reclassifications did not change the previously reported net loss, net change in cash and cash equivalents or stockholders’ equity.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk comprise all or portions of cash equivalents, short-term investments, long-term investments and accounts receivable. As of September 30, 2007 and December 31, 2006, substantially all of the Company’s cash, cash equivalents and investments were managed by one financial institution. The fair value of these investments is subject to fluctuation based on market prices.
Credit Risk, Customer and Vendor Concentrations
Accounts receivable are typically unsecured and are derived from revenue earned from customers. The Company performs ongoing credit evaluations of its customers and maintains allowances for estimated credit losses. The Company applies judgment as to its ability to collect outstanding receivables based primarily on management’s evaluation of the customer’s financial condition and past collection history and records a specific allowance. In addition, the Company records an allowance based on the length of time the accounts receivables are past due. Historically, such losses have been within management’s expectations.
As of September 30, 2007, one customer accounted for 21% of accounts receivable. As of December 31, 2006, one customer accounted for 22% of accounts receivable.
The Company derives its revenue primarily from its relationships with significant distribution network partners. For the period ended September 30, 2007, three vendors each accounted for over 10% of total traffic acquisition costs, with these three vendors accounting for a total of 38% of the total traffic acquisition costs. For the period ended September 30, 2006, one vendor accounted for more than 10% of the total traffic acquisition costs, with the top three vendors accounting for a total of 33% of the total traffic acquisition costs.
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Revenue Concentrations
One customer represented 13% and 10% and another represented 12% and 9% of total revenue, respectively, for the three and nine months ended September 30, 2007. For the three and nine months ended September 30, 2006 another customer represented 12% and 12% of total revenue, respectively.
Net Loss per Common Share
Basic net loss per common share is computed by dividing net loss for the period by the weighted average number of common shares outstanding during the period. Diluted net loss per share is computed by dividing net loss by the weighted average number of common shares outstanding during the period, plus the dilutive effect of outstanding stock options and warrants. Potentially dilutive securities have been excluded from the computation of diluted net loss per share as their effect is anti-dilutive.
Share-Based Compensation
Share-based compensation expense recognized under SFAS 123R for the three and nine months ended September 30, 2007 was approximately $0.6 million and $1.8 million, respectively, and approximately $0.8 million and $1.9 million for the three and nine months ended September 30, 2006, respectively, which was related to stock options and employee stock purchases.
SFAS 123R requires companies to estimate the fair value of share-based payment awards on the grant date using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense in the Company’s Unaudited Condensed Consolidated Statements of Operations over the requisite service periods.
SFAS 123R requires forfeitures to be estimated at the time of grant in order to estimate the amount of share-based awards that will ultimately vest. The forfeiture rate is determined at the beginning of each fiscal year, based on historical rates, and reviewed on a periodic basis. Share-based compensation expense recognized in the Company’s Unaudited Condensed Consolidated Statements of Operations for the three and nine month ended September 30, 2007 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 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 SFAS 123R.
Under the provisions of SFAS 123R, the Company continues its use of the Black-Scholes method of valuation for share-based awards granted beginning in fiscal 2006, which was previously used for the Company’s pro forma information required under SFAS 123. On November 10, 2005, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position No. SFAS 123R-3,Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards (“SFASR-3”). The alternative transition method includes simplified methods to establish the beginning balance of the additional paid-in capital pool (“APIC pool”) related to the tax effects of employee share-based compensation, and to determine the subsequent impact on the APIC pool and Unaudited Condensed Consolidated Statements of Cash Flows of the tax effects of employee share-based compensation awards that are outstanding upon adoption of SFAS 123R. The Company has elected to adopt the alternative transition method provided in this FASB Staff Position for calculating the tax effects of share-based compensation pursuant to SFAS 123R-3.
Recently Issued Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157,Fair Value Measures (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measures required under other accounting pronouncements, but does not change existing guidance as to whether or not an instrument is carried at fair value. SFAS No. 157 is effective as of the beginning of the Company’s 2008 fiscal year. We are currently reviewing the provisions of SFAS 157 to determine the impact for the Company.
In February 2007, the FASB issued SFAS No. 159 (“SFAS 159”),The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115 . SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value, with changes in fair value recognized in earnings each reporting period. The election, called the fair value option, will enable entities to achieve an offset accounting effect for changes in fair value of certain related assets and liabilities without having to apply complex hedge accounting provisions. SFAS 159 is effective as of the beginning of the Company’s 2008 fiscal year. We are currently reviewing the provisions of SFAS 159 to determine the impact for the Company.
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2. DISPOSITIONS
Consumer Assets
In August, 2007 the Company’s management made a decision to exit the consumer products activities and sell or otherwise dispose of the various related websites and assets associated with the consumer properties revenue stream. The websites and assets underlying the consumer products are the Company’s consumer websites and the assets relating to Grub, Zeal, Wisenut, and FindArticles. The Company has made the decision to segregate these consumer assets where possible and sell off component parts or businesses separately.
Grub
The URL for Grub and certain source code were sold for $50,000 on July 12, 2007 A gain on sale of assets of $50,000 was recorded in the three months ended September 30, 2007, which is included in other operating income (loss), net.
Zeal
The URL and trademark for Zeal were sold for $50,000 on October 15, 2007. These assets were held for sale at September 30, 2007, but had no net book value. A gain on sale of assets of $50,000 will be recorded in the fourth quarter of the Company’s fiscal year 2007. See Footnote 13, Subsequent Events for further discussion.
Wisenut
The Company completed the shut down of the Wisenut website and search functionality in September, 2007. As a result of the abandonment of the Wisenut assets, the Company determined that the associated assets, consisting primarily of intangible assets and capitalized software, are impaired as of September 30, 2007. The assets were written down to their estimated net realizable value and an impairment charge in the amount of $1.6 million was recognized during the three months ended September 30, 2007.
FindArticles
On November 5, 2007, the Company entered into a definitive agreement to sell its FindArticles assets, brand and technology and certain intellectual property related to the assets and brand to an unrelated third party. The transaction closed on November 9, 2007, after completion of required and customary closing conditions.
At September 30, 2007, FindArticles assets have been accounted for under the guidance of SFAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”) as “assets held for sale,” and have been classified as such on the Company’s Condensed Consolidated Balance Sheet (in thousands):
| (In thousands): | ||
Property, plant and equipment, net | 55 | |
Capitalized Software, net | 150 | |
Goodwill | 4,126 | |
Total Assets | 4,331 | |
The FindArticles transaction will be accounted for as an asset sale in the fourth quarter of the Company’s fiscal year 2007. See Note 13, Subsequent Events for further discussion.
Net Nanny
On January 22, 2007, the Company completed the sale of Net Nanny to Content Watch, Inc. The Company recorded $248 thousand loss on the sale of Net Nanny in the first quarter of 2007, which is offset by $50 thousand income from the revenue sharing agreement with Content Watch. The sale proceeds are comprised of contingent purchase consideration of up to $3.5 million, which may be realized at future dates based on the amount of revenue of the buyer. As a result of the sale the following assets and liabilities were removed from the Company’s books:
| (In thousands): | |||
Other current assets | 30 | ||
Intangible assets | 1,450 | ||
Accumulated amortization | (910 | ) | |
Deferred revenue and customer deposits | (322 | ) | |
Loss on the sale of Net Nanny | 248 | ||
The loss on sale at date of sale and contingent purchase consideration realized in future periods are included in other operating income (loss), net in the Condensed Consolidated Statements of Operations.
At December 31, 2006 current assets held for sale of $31 thousand, non current assets held for sale of $0.5 million and current liabilities held for sale of $0.3 million related to the sale of Net Nanny.
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3. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following (in thousands):
| September 30, 2007 | December 31, 2006 | |||||||
Computer Equipment | $ | 14,582 | $ | 17,393 | ||||
Furniture and fixtures | 1,126 | 1,126 | ||||||
Software | 3,770 | 3,761 | ||||||
Leasehold improvements | 2,718 | 2,718 | ||||||
Total | 22,196 | 24,998 | ||||||
Less accumulated depreciation and amortization | (18,858 | ) | (20,410 | ) | ||||
Property and equipment, net | $ | 3,338 | $ | 4,588 | ||||
Property and equipment with the net book value of $55 thousand are classified as held for sale at September 30, 2007. Depreciation and amortization expense on property and equipment for the three and nine months ended September 30, 2007, including property and equipment under capital lease, was $0.6 million and $1.9 million, respectively. Depreciation and amortization expense on property and equipment for the three and nine months ended September 30, 2006 was $0.8 million and $2.3 million, respectively. Equipment under capital lease amounted to $0.6 million as of September 30, 2007 and $0 as of December 31, 2006. Depreciation expense on equipment under capital lease for the three and nine months ended September 30, 2007 was $38 thousand and $62 thousand, respectively. Additionally, accumulated depreciation on equipment under capital lease was $62 thousand as of September 30, 2007 and $0 as of December 31, 2006.
As a result of the impairment review of the Wisenut assets a portion of fixed assets was written off. See Footnote 4 for further disclosure.
4. GOODWILL AND INTANGIBLE ASSETS
The Company’s intangible assets consist primarily of purchased technology and have estimated useful lives of two to seven years. Goodwill and intangible assets are as follows (in thousands):
| September 30, 2007 | December 31, 2006 | |||||||
Goodwill | $ | 10,296 | $ | 14,422 | ||||
Intangible assets: | ||||||||
Purchased technology | $ | 1,998 | $ | 8,989 | ||||
Less accumulated amortization | (1,920 | ) | (7,092 | ) | ||||
Net purchased technology | 78 | 1,897 | ||||||
Trade names | 1,063 | 1,743 | ||||||
Less accumulated amortization | (822 | ) | (912 | ) | ||||
Net trade names | 241 | 831 | ||||||
Other intangibles | 1,830 | 2,170 | ||||||
Less accumulated amortization | (1,830 | ) | (2,073 | ) | ||||
Net other intangibles | — | 97 | ||||||
Intangible assets, net | $ | 319 | $ | 2,825 | ||||
For the purpose of assessing goodwill impairment, the Company regularly reviews the impact of any changes to its business. In the third quarter of 2007, the Company began the process to sell its FindArticles assets (see Footnote 2). $4.1 million of goodwill was assigned to the FindArticles assets based on the estimated relative fair value of the business and was reclassified to assets held for sale as of September 30, 2007. See Subsequent Events Footnote 13 for further discussion.
As a result of the impairment review of the Wisenut assets (see Footnote 2) approximately $6.4 million of related intangible assets and approximately $5.2 million of accumulated amortization, approximately $3.2 million of related fixed assets and accumulated depreciation and approximately $2.5 million of capitalized software, as well as approximately $2.1 million of accumulated depreciation were written off as of September 30, 2007, resulting in an impairment charge of $1.6 million.
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Intangible asset amortization expense was $0.3 million and $1.2 million for the three and nine months ended September 30, 2007, and $0.5 million and $1.7 million for the three and nine months ended September 30, 2006, respectively, and was recorded primarily in cost of revenue.
At December 31, 2006, intangible assets of $0.5 million relating to NetNanny were classified as held for sale (see Footnote 2).
5. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities consisted of the following (in thousands):
| September 30, 2007 | December 31, 2006 | |||||
Accrued compensation and related expenses | $ | 2,209 | $ | 1,620 | ||
Accrued distribution and partner costs | 2,358 | 2,631 | ||||
Accrued professional services | 1,636 | 497 | ||||
Customer refunds | 167 | 93 | ||||
Accrued equipment purchases | 154 | 336 | ||||
City business and personal property tax payable | 65 | 136 | ||||
Capital lease obligation, current portion | 137 | — | ||||
Other | 181 | 311 | ||||
Total accrued expenses and other current liabilities | $ | 6,907 | $ | 5,624 | ||
6. INCOME TAXES
The Company adopted the provisions of FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109, (“FIN 48”), on January 1, 2007. The Company did not have any unrecognized tax benefits and there was no effect on the Company’s financial condition or results of operations as a result of implementing FIN 48 during the current period.
The Company files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. The Company is no longer subject to U.S. federal tax examinations for years before 2003. State jurisdictions that remain subject to examination range from 2002 to 2003. Certain foreign jurisdictions remain open to examination by the major taxing jurisdictions for the tax years 2000 through 2006.
The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. As of the date of adoption of FIN 48, the Company did not have any accrued interest or penalties associated with unrecognized tax benefits, nor was any interest expense or penalties recognized during the three and nine months ended September 30, 2007.
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7. RESTRUCTURING CHARGES AND OTHER LONG-TERM LIABILITIES
Other Long-Term Liabilities
Other long-term liabilities consist of the following (in thousands):
| September 30, 2007 | December 31, 2006 | |||||||
Long-term liabilities | $ | 3,248 | $ | 4,267 | ||||
Capital lease obligation, net of current portion | 315 | — | ||||||
Total other liabilities | 3,563 | 4,267 | ||||||
Less: current portion | (1,348 | ) | (1,391 | ) | ||||
Lease restructuring and other long term liabilities | $ | 2,215 | $ | 2,876 | ||||
Long-term liabilities consist of the lease restructuring liability, notes payable and sublease deposits.
On April 6, 2007, the Company entered into a master equipment lease agreement with City National Bank (“CNB”) for an amount of up to $5 million for the purchase of technical equipment. This lease line of credit expires on January 30, 2008 and is available for equipment leases with rental terms from 36 to 48 months. Interest on the capital lease is calculated using an interest rate of 7.76% per annum. As of September 30, 2007 the Company drew down approximately $0.5 million on the lease line and repaid approximately $54 thousand for the nine months ended September 30, 2007.
Employee Severance Costs
In September 2007, the Company implemented a restructuring plan to eliminate 12 positions due to the Company’s decision to streamline the business. Severance charges associated with the reduction in force were $0.2 million. These costs were classified as restructuring charges on the Condensed Consolidated Statement of Operations and are included in Operating Expenses.
Lease Restructuring Charges
During 2003, the Company vacated portions of its leased headquarter office facilities, and incurred lease restructuring costs related to closing these facilities. These costs are classified as restructuring charges on the Unaudited Condensed Consolidated Statements of Operations, and are included in operating expenses.
As of September 30, 2007 and December 31, 2006, the lease restructuring liability was $3.1 million and $3.8 million, respectively. Of this amount, $1.3 million and $1.4 million were included in current portion of lease restructuring and other long-term liabilities as of September 30, 2007 and December 31, 2006, respectively. The Company does not currently expect to incur significant further restructuring charges or receive additional benefits related to closing redundant leased facilities in 2007 as it has sublet most of its unused space.
The following table sets forth lease restructuring activity during the period ended September 30, 2007 (in thousands):
| Lease Restructuring Costs | ||||
Balance at December 31, 2006 | $ | 3,858 | ||
Amounts paid and charged against the liability | (260 | ) | ||
Balance at March 31, 2007 | $ | 3,598 | ||
Amounts paid and charged against the liability | (257 | ) | ||
Balance at June 30, 2007 | $ | 3,341 | ||
Amounts paid and charged against the liability | (260 | ) | ||
Balance at September 30, 2007 | $ | 3,081 | ||
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8. COMMITMENTS AND CONTINGENCIES
Capital and Operating Leases
The Company leases office space under a non-terminable operating lease that expires in 2009.
Future minimum payments under all capital and operating leases and minimum sublease rental income, at September 30, 2007 are as follows (in thousands):
Period | Capital Lease | Operating Leases | Minimum Sublease Rental Income | ||||||
Three months ending December 31, 2007 | $ | 27 | $ | 1,177 | $ | 225 | |||
Fiscal years ending December 31: | |||||||||
2008 | 110 | 4,751 | 931 | ||||||
2009 | 110 | 4,412 | 866 | ||||||
Thereafter | 78 | — | — | ||||||
Total | $ | 325 | $ | 10,340 | $ | 2,022 | |||
The Company has outstanding standby letters of credit (“SBLC”) related to security of its building lease and security for payroll processing services of $1.1 million at September 30, 2007. The SBLC contains two financial covenants. As of September 30, 2007, the Company was in compliance with all required covenants.
Guarantees and Indemnities
During its normal course of business, the Company has made certain guarantees, indemnities and commitments under which it may be required to make payments in relation to certain transactions. These indemnities include intellectual property and other indemnities to the Company’s customers and distribution network partners in connection with the sales of its products, and indemnities to various lessors in connection with facility and other leases for certain claims arising from such facility or lease. Further, the Company has agreements whereby it indemnifies its officers and directors for certain events or occurrences while the officer or director is, or was, serving, at the Company’s request, in such capacity, to the maximum extent permitted under the laws of the State of Delaware. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited. However, the Company maintains directors and officers insurance coverage that may contribute, up to certain limits, a portion of any future amounts paid, for indemnification of directors and officers. The Company believes the estimated fair value of these indemnification agreements in excess of applicable insurance coverage is minimal. Historically, the Company has not incurred any losses or recorded any liabilities related to performance under these types of indemnities.
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Other
On July 27, 2007, David Hills, the President, Chief Executive Officer and a member of the board of directors of the Company, resigned as an employee and director of the Company effective as of August 1, 2007. Mr. Hills did not resign as a result of any disagreement with the Company on any matter relating to the Company’s operations, policies or practices. The Company’s board of directors has appointed Edward F. West, the Company’s current Chair of the Board of Directors, as interim President and Chief Executive Officer of the Company, to replace Mr. Hills, effective as of August 1, 2007.
On August 2, 2007, Mr. Hills and the Company entered into a Severance Agreement and General Release (the “Release Agreement”). The Release Agreement set forth the terms and provisions of termination of Mr. Hills’s employment with the Company as well as certain severance payments by the Company to Mr. Hills following such termination. Pursuant to the Release Agreement, among other terms and conditions, Mr. Hills executed a release with respect to any claims or causes of action relating to Mr. Hills’s employment by the Company, to the termination thereof or to the offer letter dated as of September 24, 2004 (the “Offer Letter”) under which Mr. Hills was employed. Further, the parties agreed to a twelve month non-solicitation agreement and a twelve month consulting arrangement. In consideration of a full and final settlement of any and all claims related to Mr. Hills’s employment at the Company, and subject to certain additional conditions which the Company expects will be satisfied, the Company has agreed to pay Mr. Hills a total sum of $496,640, less required withholdings and authorized deductions, representing twelve months of his annual base salary plus his actual, earned incentive bonus for the 2006 fiscal year.
Mr. Hills and the Company have also agreed that Mr. Hills will provide up to twelve months of consulting services to the Company to assist in the Company’s sales efforts. Pursuant to such agreement, Mr. Hills will be paid as follows for such consulting services: (a) a monthly retainer of $10,000, (b) a $5,000 per-transaction-closed fee for mutually agreed upon transactions in each quarter of the consulting period beginning with the third mutually agreed upon transaction in each quarter, and (c) for the first six months of the consulting period, a transaction fee equal to 2.5% of the Company's net revenues realized in the initial term of those transactions that Mr. Hills provides substantial assistance to the Company in identifying, bringing to the Company and closing. In the second six months of the consulting period, the 2.5% transaction fee referenced above will be modified based on mutual agreement, to an amount between 1% and 2%. No additional payments other than the monthly retainer were made to Mr. Hills under the consulting agreement in the third quarter of 2007.
During the consulting period, Mr. Hills’s stock options will continue to vest, and in the event there is a change of control of the Company during the consulting period, and within twelve (12) months thereafter the Mr. Hills’s consulting arrangement is terminated by the Company or a successor, then Mr. Hills shall be entitled to receive the accelerated vesting of the Options as originally set forth in his offer letter. However, upon any expiration of the consulting period without the Company’s (or its successor’s) termination thereof, and/or the expiration or termination of Mr. Hills’s options by their terms, Mr. Hills shall not receive any acceleration benefits.
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Legal Proceedings
The Company is involved, from time to time, in various legal proceedings arising from the normal course of business activities. Although the results of litigation and claims cannot be predicted with certainty, the Company does not expect resolution of these matters to have a material adverse impact on its consolidated results of operations, cash flows or financial position unless stated otherwise. However, an unfavorable resolution of a matter could, depending on its amount and timing, materially affect its future results of operations, cash flows or financial position in a future period. Regardless of the outcome, litigation can have an adverse impact on the Company because of defense costs, diversion of management resources and other factors.
Cisneros v. Yahoo! Inc
On August 3, 2004, Mario Cisneros and Michael Voight filed a private attorney general lawsuit on behalf of a proposed class in Superior Court in San Francisco County, California. The complaint names thirteen search engines or Web publishers as defendants, including the Company, and alleges unfair business practices, unlawful business practices, and other causes of action in connection with the display of advertisements from Internet gambling companies. The complaint seeks restitution, unspecified compensatory damages, declaratory and injunctive relief, and attorneys’ fees. Plaintiffs also filed a motion for preliminary injunction on August 3, 2004.
On January 3, 2005, the Company filed a demurrer to the complaint, which was overruled on January 27, 2005. On January 3, 2005, the Company also filed a motion to strike certain allegations regarding claims for restitution, which was denied in part and granted in part on May 9, 2005. The Company filed an answer to the complaint on February 28, 2005, consisting of a general denial of all allegations. On October 11, 2005, the court conducted a trial on two of the Company’s affirmative defenses. The court held that California public policy bars the plaintiffs from receiving a portion of their requested damages.
On December 2, 2005, plaintiffs filed a renewed motion for a preliminary injunction. Defendants responded on or around February 27, 2006. The Court has allowed certain discovery to proceed with respect to plaintiffs’ renewed motion. On or about May 23, 2006, plaintiffs were granted leave to amend their complaint to name additional plaintiffs. On or about September 8, 2006, plaintiffs served an amended complaint naming additional plaintiffs. The Company has since filed a general denial to the amended complaint. On April 13, 2007 the Court heard argument on defendants’ motion to dismiss for lack of subject matter jurisdiction and plaintiffs’ motion to allow non-restitutionary disgorgement. Both motions were denied. Subsequently, the parties entered into a Settlement Agreement and Release whereby (i) the Company agreed to make a payment of $15,000 to a designated charitable organization and continue its current policies banning acceptance of ads from gambling websites, and (ii) all plaintiffs would dismiss their claims against the Company with prejudice. On October 17, 2007, the amended complaint was dismissed with prejudice as to the Company.
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Lane’s Gifts and Collectibles, L.L.C., v. Yahoo! Inc
On March 14, 2005 the Company was served with the second amended complaint in a class action lawsuit in the Circuit Court of Miller County, Arkansas. The complaint names eleven search engines and web publishers as defendants, including the Company, and alleges breach of contract, restitution/unjust enrichment/money had and received, and civil conspiracy claims in connection with contracts allegedly entered into with plaintiffs for Internet pay-per-click advertising. The named plaintiffs on the second amended complaint are Lane’s Gifts and Collectibles, L.L.C., U.S. Citizens for Fair Credit Card Terms, Inc., Savings 4 Merchants, Inc., and Max Caulfield d/b/a Caulfield Investigations.
On March 30, 2005 the case was removed to United States District Court for the Western District of Arkansas. On April 4, 2005 plaintiffs U.S. Citizens for Fair Credit Card Terms, Inc. and Savings 4 Merchants, Inc. filed a motion of voluntary dismissal without prejudice. The motion was granted on April 7, 2005. Plaintiffs Lane’s Gifts and Collectibles, L.L.C. and Max Caulfield d/b/a Caulfield Investigations filed a motion to remand the case to state court on April 13, 2005, which was granted in June 2005. In July 2005, defendants, including the Company, petitioned the Eighth Circuit Court of Appeals for an appeal of the remand order, and moved to stay the proceedings while the appeal is pending. The petition was denied on September 8, 2005 and the case was remanded to the Circuit Court of Miller County, Arkansas. The Company was served with discovery requests on October 7, 2005. The Company has filed and/or joined motions to dismiss on the basis of failure to state a claim upon which relief can be granted, lack of personal jurisdiction, and improper venue. Pursuant to the court’s initial scheduling order, plaintiffs had until January 27, 2006 to respond to the motions to dismiss for lack of personal jurisdiction and improper venue; and until June 9, 2006 to respond to the motion to dismiss on the basis of failure to state a claim upon which relief can be granted. However the court entered an order staying all proceedings for a period of 60 days on January 9, 2006. On March 8, 2006, the Court entered an order extending the stay until March 31, 2006. On April 1, 2006, the Court further extended the stay until April 20, 2006. On April 20, 2006 the Court preliminarily approved a class settlement among plaintiffs, defendant Google, Inc., and certain defendants who display Google advertisements on their networks (the “Google Settlement”). The Google Settlement purports to release Google of all claims and also purports to release certain defendants, including the Company, for any claims associated with the display of Google advertisements on their networks. On July 24 and 25, 2006, the Court had a final settlement hearing on the Google Settlement, and on July 26, 2006, the Court approved the settlement. On April 21, 2006, the Court ordered the remaining defendants, including the Company, to mediation and further stayed the proceedings to June 21, 2006. The Court further extended the stay as to LookSmart until August 16, 2006. The parties thereafter stipulated that the stay would remain in effect while the parties continue to comply with the Court’s order regarding mediation. On January 10, 2007, the Court further extended the stay until May 1, 2007. Plaintiffs’ counsel have stipulated to extend the stay as to LookSmart. In April 2007, the Plaintiffs and the Company came to an agreement in principle to settle the matter in its entirety. Any eventual settlement with plaintiffs will be subject to court approval. The Company recorded an estimate of the amount of the loss on settlement which management has determined is probable and estimable during the quarter ended March 31, 2007. This estimate may change as a result of the final settlement arrangement. In addition, the Company recovered settlement proceeds from the insurance carrier, which exceeded the recorded estimate of the amount of loss on settlement. Due to the uncertainty relating to the ultimate settlement amount, the excess settlement proceeds have been recorded as an accrued liability at September 30, 2007. Accordingly, there is no impact on the Condensed Consolidated Statement of Operations for the three months ended September 30, 2007.
The nature of litigation is inherently uncertain and therefore the Company cannot predict the outcome of these proceedings or estimate the possible effects on our financial position, results of operations or cashflows.
JV Funding
Pursuant to the settlement agreement with British Telecommunications (“BT”) for the dissolution of the joint venture, LookSmart and BT are jointly liable for the costs incurred to shut down operations of the joint venture. The Company does not expect to incur significant additional expenses to shut down the joint venture. During the quarter ended September 30, 2007, the Company received a distribution from the joint venture of $0.4 million. As of September 30, 2007 the remaining investment balance is $18 thousand. The Company expects to record income or loss from its share of the joint venture as it moves to finalize its wind-down activities in 2007.
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9. SHARE-BASED COMPENSATION
Stock Option Plans
In December 1997, the Company approved the 1998 Stock Option Plan (the “Plan”). The 1998 Plan will expire on December 17, 2007. On June 19, 2007, the stockholders approved the LookSmart 2007 Equity Incentive Plan (the “2007 Plan”). In October 2000, the Company acquired Zeal Media, Inc. and assumed all the stock options outstanding under the 1999 Zeal Media, Inc. Stock Plan (the “Zeal Plan”). In April 2002, the Company acquired WiseNut, Inc. and assumed all the stock options outstanding under the WiseNut, Inc. 1999 Stock Incentive Plan (the “WiseNut Plan”). The Company has reserved 8,289,143 and 4,645,171 shares of common stock for issuance under its stock option plans at September 30, 2007 and 2006, respectively. Outstanding stock options generally become exercisable over a three or four year period from the grant date and have a term of ten years. Under the Plan and the 2007 Plan, the Company may grant incentive stock options, nonqualified stock options, stock appreciation rights and stock rights to employees, directors and consultants.
As of September 30, 2007, 3,356,137 options were outstanding and 4,933,006 shares remained available for grant under the Company’s plans.
Employee Stock Purchase Plan
In July 1999, the stockholders approved the 1999 Employee Stock Purchase Plan (the “ESPP Plan”). At September 30, 2007, a total of 520,000 shares of common stock were reserved for issuance under the ESPP Plan, plus annual increases at the Board’s discretion effective on January 1 of each year, beginning in 2000. As of September 30, 2007, 439,211 shares have been issued under the ESPP Plan and 80,789 shares remain available for issuance.
The Company accounts for employee stock options under SFAS 123R and related interpretations. For the three and nine months ended September 30, 2007, the Company recorded share-based compensation of approximately $0.6 million and $1.8 million, respectively, and approximately $0.8 million and $1.9 million for the three and nine months ended September 30, 2006. Of these amounts, approximately $17 thousand and $70 thousand, and $26 thousand and $61 thousand, respectively, was capitalized related to the development of internal-use software in accordance with American Institute of Certified Public Accountants (“AICPA”) Statement of Position No. 98-1,Accounting for the Costs of Computer Software Developed or Obtained for Internal Use (“SOP 98-1”).
Valuation Assumptions
As share-based compensation expense recognized in the Unaudited Condensed Consolidated Statement of Operations for the three and nine months ended September 30, 2007 and 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.
Volatility: The volatility factor was based on the Company’s historical stock prices over the most recent period commensurate with the estimated expected term of the stock options.
Risk-Free Interest Rate: The Company bases the risk-free interest rate used in the Black-Scholes valuation method on the implied yield currently available on U.S. Treasury issues with an equivalent remaining term.
Expected Term: The Company’s expected term represents the period that the Company’s share-based awards are expected to be outstanding and was determined based on historical experience of similar awards, giving consideration to the contractual terms of the share-based awards, vesting schedules and expectations of future employee behavior as influenced by changes to the terms of its share-based awards.
Expected Dividend: The Black-Scholes valuation model calls for a single expected dividend yield as an input. The Company has not issued any dividends, and does not expect to issue dividends in the foreseeable future.
Annual Forfeiture Rate: When estimating pre-vesting forfeitures, the Company considers voluntary termination behavior as well as potential future workforce reduction programs.
The weighted average grant-date fair value of options granted in the three and nine months ended September 30, 2007 was $1.87 and $2.38, respectively, and $1.83 and $2.83 for the three and nine months ended September 30, 2006.
The aggregate intrinsic value of options exercised for the three and nine months ended September 30, 2007 was approximately $1 thousand and $49 thousand, respectively, and approximately $3 thousand and $19 thousand, respectively, for the three and nine months ended September 30, 2006. The Company issues new shares of common stock upon exercise of stock options. No income tax benefits have been realized from exercised stock options.
Total unrecognized share-based compensation expense was approximately $10.5 million as of September 30, 2007, and the weighted average period over which it is expected to be recognized is 7.2 years.
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Stock option activity under the plans during the periods indicated is as follows:
| Outstanding Options Number of Shares | Weighted Average Exercise Price Per Share | |||||
Balance at December 31, 2006 | 2,741 | $ | 5.84 | |||
Granted | 910 | 4.32 | ||||
Exercised | (28 | ) | 3.42 | |||
Expired/forfeited | (160 | ) | 5.05 | |||
Balance at March 31, 2007 | 3,463 | $ | 5.50 | |||
Granted | 80 | 3.93 | ||||
Exercised | (7 | ) | 3.13 | |||
Expired/forfeited | (148 | ) | 6.09 | |||
Balance at June 30, 2007 | 3,388 | $ | 5.44 | |||
Granted | 255 | 2.70 | ||||
Exercised | (1 | ) | 3.10 | |||
Expired/forfeited | (286 | ) | 4.94 | |||
Balance at September 30, 2007 | 3,356 | $ | 5.27 | |||
The following table summarizes information about stock options outstanding at September 30, 2007:
| Outstanding | Exercisable | ||||||||||||||||||||
Range of Exercise Prices | Number Outstanding As of 09/30/07 | Weighted Average Remaining Contractual | Weighted Average Exercise Price | Aggregate Intrinsic Value | Number Exercisable As of 09/30/07 | Weighted Average Exercise Price | Aggregate Intrinsic Value | ||||||||||||||
| $ 1.25 | $ | 4.31 | 984,904 | 7.67 | $ | 3.16 | $ | 56,079 | 547,486 | $ | 3.19 | $ | 19,446 | ||||||||
| $ 4.32 | $ | 4.33 | 644,407 | 7.40 | $ | 4.32 | 105,151 | $ | 4.33 | ||||||||||||
| $ 4.36 | $ | 14.00 | 1,661,479 | 5.04 | $ | 6.43 | 1,001,536 | $ | 7.04 | ||||||||||||
| $14.31 | $ | 20.55 | 65,347 | 5.25 | $ | 16.89 | 65,347 | $ | 16.89 | ||||||||||||
| $ 1.25 | $ | 20.55 | 3,356,137 | 6.27 | $ | 5.27 | 1,719,520 | $ | 6.02 | ||||||||||||
Aggregate intrinsic value represents the total pretax intrinsic value, based on the Company’s closing stock price on September 30, 2007 $(2.83), which would have been received by option holders had all option holders exercised their options on that date.
As of September 30, 2006, there were 2,766,036 options outstanding and 801,067 options exercisable.
10. DISCONTINUED OPERATIONS
In the third quarter of 2007, the Company completed the substantial liquidation of its Australian subsidiary. As a result, the Company recorded the reversal of the cumulative translation adjustment of approximately $0.5 million. The Company also recorded additional amounts relating to the finalization of the liquidation of various foreign operations in the third quarter of 2007. The Company expects to finalize the dissolution of these entities by December 31, 2007.
Revenue and pretax net loss from the discontinued international operations (excluding gain on disposal), previously included in the online advertising business, reported in discontinued operations were as follows (in thousands):
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||
| 2007 | 2006 | 2007 | 2006 | |||||||||||
Revenue | $ | — | $ | — | $ | — | $ | — | ||||||
Pretax net loss (excluding gain on disposal) | — | — | — | — | ||||||||||
Tax benefit | — | — | — | — | ||||||||||
Gain (loss) on disposal | 471 | (31 | ) | 410 | (31 | ) | ||||||||
Net gain (loss) from discontinued operations, net of tax | $ | 471 | $ | (31 | ) | $ | 410 | $ | (31 | ) | ||||
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11. COMPREHENSIVE LOSS
The components of comprehensive loss are as follows (in thousands):
| Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
| 2007 | 2006 | 2007 | 2006 | |||||||||||||
Net loss | $ | (4,319 | ) | $ | (3,860 | ) | $ | (9,812 | ) | $ | (12,778 | ) | ||||
Other comprehensive gain (loss): | ||||||||||||||||
Change in unrealized gain on securities, net | 15 | 41 | 12 | 110 | ||||||||||||
Change in translation adjustment | 516 | — | 516 | — | ||||||||||||
Comprehensive loss | $ | (3,788 | ) | $ | (3,819 | ) | $ | (9,284 | ) | $ | (12,668 | ) | ||||
12. RELATED PARTY TRANSACTIONS
The Company has a related party investment in the BT LookSmart joint venture, which both the Company and British Telecommunications agreed to dissolve in December 2002. During the quarter ended September 30, 2007, the Company received a distribution from the joint venture of $0.4 million. The remaining investment balance is $18 thousand at September 30, 2007, which reflects the current estimated value upon final liquidation of the joint venture.
13. SUBSEQUENT EVENTS
Consumer Assets
In August, 2007 the Company’s management made a decision to exit the consumer products activities and sell or otherwise dispose of the various related websites and related assets associated with the consumer properties revenue stream. The websites and assets underlying the consumer products are the Company’s consumer websites, FindArticles, Furl, Grub, Wisenut, and Zeal. The Company has made the decision to segregate these consumer assets where possible and sell off component parts or businesses separately.
Zeal
The Company sold the URL and trademark for Zeal for $50,000 on October 15, 2007. A gain on sale of assets of $50,000 will be recorded in the fourth quarter of 2007.
FindArticles
In October 2007, the Company entered into a letter of intent to sell the assets and liabilities of the FindArticles product for approximately $20.5 million in cash. These assets met the definition of “assets held for sale” in accordance with the provision of SFAS 144 at September 30, 2007. On November 5, 2007, the Company entered into a definitive agreement to sell its FindArticles product. See Note 2 for further disclosure. The transaction closed on November 9, 2007 after completion of required and customary closing conditions.
On October 1, 2007 the Company was removed from the official list of ASX Limited under listing rule 17.11, following its announcement and letter to Chess Depository Interest (“CDI”) holders dated June 22, 2007, indicating the Company’s intention to be removed from the official list of ASX Limited. After the delisting the remaining CDIs were converted into 851,475 shares of the Company’s common stock at a ratio of 1:1.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the Unaudited Condensed Consolidated Financial Statements and the Notes to those statements which appear elsewhere in this Quarterly Report on Form 10-Q.
| • | The following discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. |
| • | We use words such as “believes,” “intends,” “expects,” “anticipates,” “plans,” “may,” “will” and similar expressions to identify forward-looking statements. |
| • | Discussions containing forward-looking statements may be found in the material set forth under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in other sections of this report. |
| • | All forward-looking statements, including, but not limited to, projections, expectations or estimates concerning our business, including demand for our products and services, mix of revenue sources, ability to control and/or reduce operating expenses, anticipated gross margins and operating results, cost savings, product development efforts, general outlook of our business and industry, future profits or losses, competitive position, share-based compensation, and adequate liquidity to fund our operations and meet our other cash requirements, are inherently uncertain as they are based on our expectations and assumptions concerning future events. |
| • | These forward-looking statements are subject to numerous known and unknown risks and uncertainties. |
| • | You should not place undue reliance on these forward-looking statements. |
| • | Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including but not limited to, |
| o | the possibility that we may fail to preserve our expertise in online advertising and social bookmarking product development, |
| o | that existing and potential distribution partners may opt to work with, or favor the products of, competitors if our competitors offer more favorable products or pricing terms, |
| o | that we may be unable to grow sources of revenue other than our listings revenue, |
| o | that we may be unable to attain or maintain customer acceptance of our publisher services products, |
| o | that changes in the distribution network composition may lead to decreases in traffic volumes, |
| o | that we may be unable to improve our match rate, average revenue per click, conversion rate or other advertiser metrics, |
| o | that we may be unable to achieve operating profitability, |
| o | that we may be unable to attract and retain key personnel, |
| o | that we may have unexpected increases in costs and expenses, or |
| o | that one or more of the other risks described below in the section entitled “Risk Factors” and elsewhere in this report may occur. |
| • | All forward-looking statements in this report are made as of the date hereof, based on information available to us as of the date hereof, and except as required by applicable law, we assume no obligation to update any forward-looking statements. |
BUSINESS OVERVIEW
LookSmart is an online advertising and technology company that provides relevant solutions for advertisers and publishers. LookSmart offers advertisers targeted, pay-per-click (PPC) search and contextual advertising and banners via a monitored ad distribution network and offers publishers a customizable set of private-label solutions.
The Company’s extensive ad distribution network includes syndicated publishers and search partners. The Company’s application programming interface (API) allows advertisers and agencies to connect any type of marketing or reporting software with minimal effort, for easier access and management of ad campaigns.
LookSmart’s publisher solutions consist of a hosted advertising sales and service platform with an ad backfill capability, which allows search engines, media companies, social networking sites, retail sites, directories, ISPs and portals to manage their advertiser relationships and accounts.
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CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our financial condition and results of operations are based upon certain critical accounting policies, which include estimates, assumptions, and judgments on the part of management. We base our estimates on various factors and information which may include, but are not limited to, history and prior experience, experience of other enterprises in the same industry, new related events, current economic conditions and information from third party professionals that is believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of revenue and expenses during the period presented. Actual results may differ from those estimates. The following discussion highlights those policies and the underlying estimates and assumptions, which we consider critical to an understanding of the financial information in this report.
Revenue Recognition
Our online advertising revenue is primarily composed of per-click fees that we charge customers. Customers set the per-click fee charged for inclusion-targeted listings when their account is established. The per-click fee charged for keyword-targeted listings is calculated based on the results of online bidding for keywords or page content, up to a maximum cost per keyword or page content set by the customer. Revenue also includes impression-based revenue from banner advertisements, as well as revenue share from licensing of private-labeled versions of our products.
Revenues associated with online advertising products, including Advertiser Solutions, FindArticles, our other consumer sites, and banner advertisements are generally recognized once collectibility is established, delivery of services has occurred, all performance obligations have been satisfied, and no refund obligations exist. We pay distribution network partners based on clicks on the advertiser’s ad that are displayed on the websites of these distribution network partners. These payments are called traffic acquisition costs and are included in cost of revenues. In accordance with Emerging Issues Task Force Issue No. 99-19,Reporting Revenue Gross as a Principal Versus Net as an Agent (“ EITF 99-19”), the revenue derived from these arrangements that involve traffic supplied by distribution network partners is reported gross of the payment to the distribution network partners. This revenue is reported gross due to the fact that we are the primary obligor to the advertisers who are the customers of the advertising service.
Affiliate revenue is included in online advertising revenue and is based on commissions received for participation in affiliate programs. Affiliate programs are programs operated by affiliate network services or online merchants, in which merchants pay traffic providers on a cost-per-acquisition basis. By participating in affiliate programs, we generate revenue when Internet consumers make a purchase from a participating merchant’s website after clicking on the merchant’s listing in our search results. Revenues from affiliates are earned on a per-sale basis or as a percentage of sales rather than a per-click basis. Revenue is recognized in the period in which a merchant finalizes a sale and reports to us via our affiliate network.
We also enter into agreements to provide private-labeled versions of our products, including the AdCenter for Publishers. These arrangements include multiple elements: revenue-sharing based on the publishers’ customer’s monthly revenue generated through the AdCenter application; upfront fees; and license fees. We recognize revenue in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 104,Revenue Recognition in Financial Statements (“SAB 104”), and Financial Accounting Standards Board Emerging Issues Task Force No. 00-21,Revenue Arrangements with Multiple Deliverables (“EITF 00-21”). We recognize upfront fees over the term of the arrangement or the expected period of performance, license fees over the term of the license, and revenue-sharing portions over the period in which such revenue is earned. In all cases, revenue is recognized only when the price is fixed or determinable, persuasive evidence of an arrangement exists, the service is performed, and collectibility of the resulting receivable is reasonably assured.
We provide a provision against revenue for estimated reductions resulting from billing adjustments and customer refunds. The amounts of these provisions are evaluated periodically based upon customer experience and historical trends.
Deferred revenue is recorded when payments are received in advance of performance in underlying agreements. Customer deposits are recorded when customers make prepayments for online advertising.
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Allowance for Doubtful Accounts
Determination of collectibility of payments requires significant judgment on the part of management and includes performing initial and ongoing credit evaluations of customers. We maintain an allowance for doubtful accounts for estimated losses resulting from the failure of our customers to make required payments. This valuation allowance is reviewed on a periodic basis to determine whether a provision or reversal is required. The review is based on factors including the application of historical collection rates to current receivables. We will record a reduction of our allowance for doubtful accounts if there is a significant improvement in collection rates or economic conditions are more favorable than we anticipated. Additional allowances for doubtful accounts may be required if there is deterioration in past due balances, if economic conditions are less favorable than we anticipated or for customer-specific circumstances, such as bankruptcy. Management’s judgment is required in the periodic review of whether a provision or reversal is warranted.
Valuation of Goodwill and Intangible Assets
We have recorded goodwill and intangible assets in connection with our business acquisitions. Management exercises judgment in the assessment of the related useful lives, fair value and recoverability of these assets. The majority of intangible assets are amortized over three to seven years, the period of expected benefit. Goodwill is not amortized. In accordance with Statement of Financial Accounting Standards No. 142,Goodwill and Other Intangible Assets (“SFAS 142”), we periodically re-assess the valuation and asset lives of intangible assets to conform to changes in management’s estimates of future performance. Management considers existing and anticipated competitive and economic conditions in such assessments. Goodwill is reviewed for impairment at least annually and as a result of any event that significantly changes our business. The Company uses market capitalization, as well as cash flow forecasts and other market value indicators to review goodwill for impairment. Cash flow forecasts used in evaluation of goodwill are based on trends of historical performance and management’s estimate of future performance.
Deferred Taxes
We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying values and the tax bases of assets and liabilities. We regularly review our deferred tax assets for recoverability and establish a valuation allowance based on historical taxable income, projected future taxable income, and the expected timing of the reversals of existing temporary differences. If we operate at a loss or are unable to generate sufficient future taxable income, or if there is a material change in the actual effective tax rates or time period within which the underlying temporary differences become taxable or deductible, we could be required to increase the valuation allowance against all or a significant portion of our deferred tax assets which could substantially increase our effective tax rate for such period. Alternatively, if our future taxable income is significantly higher than expected and/or we are able to utilize our tax credits, we may be required to reverse all or a significant part of our valuation allowance against such deferred tax assets which could substantially reduce our effective tax rate for such period. Therefore, any significant changes in statutory tax rates or the amount of our valuation allowance could have a material impact on the value of our deferred tax assets and liabilities, and our reported financial results.
Internal Use Software Development Costs
We account for internal use software in accordance with American Institute of Certified Public Accountants (“AICPA”) Statement of Position No. 98-1,Accounting for the Costs of Computer Software Developed or Obtained for Internal Use (“SOP 98-1”). In accordance with the capitalization criteria of SOP 98-1, we have capitalized external direct costs of materials and services consumed in developing and obtaining internal-use computer software and the payroll and payroll-related costs of employees who devote time to the internal use computer software project.
Management’s judgment is required in determining the point at which various projects enter the stages at which costs may be capitalized, in assessing the ongoing value of the capitalized costs, and in determining the estimated useful lives over which the costs are amortized. We expect to continue to invest in internally developed software and to capitalize costs in accordance with SOP 98-1.
Restructuring Charges
We have recorded a restructuring accrual related to closing certain leased facilities in accordance with Statement of Financial Accounting Standard No. 146,Accounting for Costs Associated with Exit or Disposal of Activities (“SFAS 146”). Management’s judgment is required in estimating when the redundant facilities will be subleased and at what rate they will be subleased.
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Share-Based Compensation
Effective January 1, 2006, we adopted Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004) (SFAS 123R),Share-Based Payment, which revised SFAS 123,Accounting for Share-based Compensation. SFAS 123R requires all share-based payment transactions with employees, including grants of employee stock options and employee stock purchases related to the Employee Stock Purchase Plan to be recognized as compensation expense over the requisite service period based on their relative fair values. SFAS 123R is a very complex accounting standard, the application of which requires significant judgment and the use of estimates, particularly surrounding Black-Scholes assumptions such as stock price volatility and expected option lives, as well as expected option forfeiture rates, to value equity-based compensation. SFAS 123R requires the recognition of the fair value of stock compensation in net income (loss).
Recent Accounting Pronouncements
For a description of recent accounting pronouncements, see Note 1 (Summary of Significant Accounting Policies) in the Notes to the Condensed Consolidated Financial Statements.
RESULTS OF OPERATIONS
Overview of the Three and Nine Months Ended September 30, 2007
During the three months ended September 30, 2007 we made a decision to align our business with greater strategic focus on meeting the performance advertising needs of advertisers and publishers within the Ad Center.
| • | Growing our ad network. Total paid clicks for the third quarter of 2007 were 84 million compared to 100 million in the third quarter of 2006, a decrease of 16%. On a year-to-date basis total paid clicks were 297 million in 2007 compared to 261 million in 2006, an increase of 14%. In the third quarter of 2007, our average revenue per click (“RPC”) was $0.12 per click, compared to $0.10 per click for the third quarter of 2006. On a year-to-date basis our average RPC for 2007 was $0.11 per click, compared to $0.10 per click for 2006. We continue to drive growth in paid clicks through our ad sales efforts and through our ongoing ad network optimization efforts as well as growth in our advertiser base. |
| • | Distributing syndicated solutions for publishers. We continue to focus on improving our private-labeled AdCenter for Publishers, and providing a tailored version of our Furl online book marking system for publishers. The release of LookSmart contextual in the second quarter of 2006, allowing listings ads to be contextually targeted, as well as a release of a solution for publishers’ unsold ad inventory known as “Platform Backfill,” are examples of improvements of the private-labeled AdCenter for Publishers. |
Revenues
| (in thousands) | Three Months Ended September 30, | Change | Nine Months Ended September 30, | Change | ||||||||||||||
| 2007 | 2006 | 2007 | 2006 | |||||||||||||||
Revenues | $ | 12,629 | $ | 12,150 | 4 | % | $ | 40,479 | $ | 33,823 | 20 | % | ||||||
Revenues are derived from Advertiser Solutions, Publisher Solutions, and Consumer Sites. Revenues increased in the third quarter of 2007 by approximately $0.5 million, primarily as a result of increase in revenue from an advertising customer, as well as up-selling on existing large advertisers. This was offset by a decrease in volume of total paid clicks, 84 million for the third quarter of 2007, as compared to 100 million for the third quarter of 2006, a decrease of 16%. Average RPC increased in the third quarter of 2007 to $0.12 from $0.10 in the third quarter of 2006. On a year-to-date basis, revenues increased by approximately $6.9 million. Total paid clicks increased 14% and average RPC increased to $0.11 during the nine month period. Growth in page views and page view yield for FindArticles also contributed to an increase in online advertising revenues.
Revenue growth decreased from 33% for three months ended September 30, 2006 as compared to the same period in 2005, to 4% for the three months ended September 2007 as compared to the same period in 2006.
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Cost of Revenues
(in thousands) | Three Months Ended September 30, | Change | Nine Months Ended September 30, | Change | ||||||||||||||||||
| 2007 | 2006 | 2007 | 2006 | |||||||||||||||||||
Traffic acquisition costs | $ | 5,874 | $ | 6,145 | (4 | )% | $ | 19,266 | $ | 17,564 | 10 | % | ||||||||||
Percentage of online advertising revenue | 59 | % | 64 | % | 59 | % | 65 | % | ||||||||||||||
Content costs | 392 | 290 | 35 | % | 1,192 | 906 | 32 | % | ||||||||||||||
Other costs | 795 | 1,133 | (30 | )% | 2,443 | 3,437 | (29 | )% | ||||||||||||||
Total cost of revenues | $ | 7,061 | $ | 7,568 | (7 | )% | $ | 22,901 | $ | 21,907 | 5 | % | ||||||||||
Percentage of total revenue | 56 | % | 62 | % | 57 | % | 65 | % | ||||||||||||||
For the three and nine months ended September 30, 2007 and 2006, approximately $0 and $4 thousand and $0 thousand and $10 thousand, respectively, of share-based compensation was included in cost of revenues.
Gross margin of 44% in the third quarter of 2007 was higher than gross margin of 38% in the third quarter of 2006. On a year-to-date basis gross margin improved to 43% compared to 35% for the same period in 2006. Traffic acquisition costs (TAC), the costs paid to our distribution network partners, decreased as a percentage of online advertising revenue in the third quarter of 2007 compared to the third quarter of 2006 and for the first nine months ended of 2007, compared to the first nine months of 2006, due to effective TAC management strategies. The presentation of traffic acquisition costs as a percentage of revenue in the above table was changed to conform to the current year’s presentation.
Content costs represent amounts paid to license searchable content that is displayed on our network of owned-and-operated consumer sites, primarily FindArticles. Content costs increased in the third quarter and first nine months of 2007 as compared to the third quarter and first nine months of 2006, due to increased costs charged by primary FindArticles content partners.
Other costs of revenue consist of connectivity costs, equipment depreciation, expenses relating to hosting advertising operations, commissions paid to advertising agencies and amortization of intangible assets. These costs decreased in the third quarter and first nine months of 2007 compared to the third quarter and first nine months of 2006 primarily due to a reduction in amortization as a result of the sale of Net Nanny in the first quarter of 2007 and full amortization of Furl in July of 2007, as well as a continuous, slight decline in connectivity costs resulting from cost efficiency efforts.
Operating Expenses
Operating expenses consist of sales and marketing, product development, general and administrative, restructuring charges and share-based compensation.
Sales and Marketing
| (in thousands) | Three Months Ended September 30, | Change | Nine Months Ended September 30, | Change | ||||||||||||||||||
| 2007 | 2006 | 2007 | 2006 | |||||||||||||||||||
Sales and marketing | $ | 1,880 | $ | 2,076 | (9 | )% | $ | 6,232 | $ | 5,933 | 5 | % | ||||||||||
Percentage of revenues | 15 | % | 17 | % | 15 | % | 18 | % | ||||||||||||||
For the three and nine months ended September 30, 2007 and 2006, approximately $41 thousand and $89 thousand and $126 thousand and $227 thousand, respectively, of share-based compensation was included in sales and marketing costs.
Sales and marketing expenses include salaries, commissions, share-based compensation and other costs of employment for our sales force, sales administration, customer service staff and marketing personnel, overhead, facilities, allocation of depreciation and the provision for doubtful trade receivables. Sales and marketing expenses also include the costs of advertising, trade shows, public relations activities and various other activities supporting our customer acquisition efforts.
Sales and marketing expenses in the third quarter of 2007 decreased compared to the third quarter of 2006 primarily due to lower marketing costs of approximately $0.2 million associated with a decrease in advertising to support the Company’s outbound marketing programs. For the nine months ended September 30, 2007, sales and marketing expenses increased compared to the same period in 2006 as a result of increased labor costs of approximately $0.3 million and online promotional and marketing costs of approximately $0.3 million. These increases are partially offset by decreases in temporary staff costs and other expenses of approximately $0.2 million.
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Product Development
| (in thousands) | Three Months Ended September 30, | Change | Nine Months Ended September 30, | Change | ||||||||||||||||||
| 2007 | 2006 | 2007 | 2006 | |||||||||||||||||||
Capitalized software development costs | $ | (291 | ) | $ | (355 | ) | (18 | )% | $ | (1,095 | ) | $ | (1,503 | ) | (27 | )% | ||||||
Other product development costs | 4,205 | 4,360 | (3 | )% | 13,065 | 13,896 | (6 | )% | ||||||||||||||
Total product development expenses | $ | 3,914 | $ | 4,005 | (18 | )% | $ | 11,970 | $ | 12,393 | (3 | )% | ||||||||||
Percentage of revenues | 31 | % | 52 | % | 30 | % | 37 | % | ||||||||||||||
For the three and nine months ended September 30, 2007 and 2006, approximately $160 thousand and $156 thousand, and $478 thousand and $470 thousand, respectively of share-based compensation was included in product development costs.
Product development costs include all costs related to the development and enhancement of our core technology products such as the Ad Center for Publishers, Furl.net and FindArticles.com. These costs include salaries and associated costs of employment, including share-based compensation, overhead, facilities and amortization of intangible assets. Costs related to the development of software for internal use in the business, including salaries and associated costs of employment are capitalized after certain milestones have been achieved. Software licensing and computer equipment depreciation related to supporting product development functions are also included in product development expenses.
Capitalized software development costs include the costs to develop software for internal use, excluding costs associated with research and development, training and testing. The decrease in the amount capitalized for the third quarter of 2007 compared to the third quarter of 2006 was primarily related to a decrease in new product development as the magnitude and number of ongoing capitalizable projects decreased in 2007. For the same reasons year-to-date expenses also decreased.
The decrease in other product development expenses in the third quarter of 2007 compared to the third quarter of 2006 primarily relates to the decrease in labor costs due the resignation of the Chief Technical Officer in August of 2007, as well as a decrease in depreciation expense of approximately $0.1 million. On a year-to-date basis other product development expenses decreased due to a decrease in depreciation of approximately $0.6 million caused by lower capital expenditures, a decrease in amortization of $0.2 million due to full amortization of certain intangible assets and a decrease in professional services of approximately $0.1 million. These decreases were partially offset by an increase in temporary help of $0.2 million and other expenses of $0.4 million.
General and Administrative
| (in thousands) | Three Months Ended September 30, | Change | Nine Months Ended September 30, | Change | ||||||||||||||||||
| 2007 | 2006 | 2007 | 2006 | |||||||||||||||||||
General and administrative | $ | 3,208 | $ | 2,831 | 133 | % | $ | 9,146 | $ | 7,799 | 17 | % | ||||||||||
Percentage of revenues | 25 | % | 23 | % | 23 | % | 23 | % | ||||||||||||||
For the three and nine months ended September 30, 2007 and 2006, approximately $429 thousand and $524 thousand and $1,127 thousand and $1,087 thousand, respectively, of share-based compensation was included in general and administrative costs.
General and administrative expenses include costs of executive management, human resources, finance, legal and facilities personnel. These costs include salaries and associated costs of employment, including share-based compensation, overhead, facilities and allocation of depreciation. General and administrative expenses also include legal, insurance, tax and accounting, consulting and professional services fees.
The increase in general and administrative expenses in the third quarter of 2007 compared to the third quarter of 2006 was driven by an approximate $0.5 million increase in labor costs due to a severance payment to our former Chief Executive Officer. In the third quarter of 2007 general and administrative expenses included professional and legal costs related to our planned delisting from the Australian Stock Exchange, the exploration of corporate opportunities and company restructuring activities. On a year-to-date basis general and administrative expenses increased primarily due to an increase in overall labor costs of $1.8 million due to replacement of temporary help with permanent employees within the finance department, partially offset by a decrease in temporary help of $0.3 million, as well as an approximately $0.3 million increase in subscriptions and registration fees.
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Restructuring Charges
| (in thousands) | Three Months Ended September 30, | Change | Nine Months Ended September 30, | Change | |||||||||||||||
| 2007 | 2006 | 2007 | 2006 | ||||||||||||||||
Restructuring charges | $ | 224 | $ | — | 100 | % | 224 | $ | — | 100 | % | ||||||||
Percentage of revenues | 2 | % | — | 1 | % | — | |||||||||||||
In September 2007, the Company implemented a restructuring plan to eliminate 12 positions due to the Company’s decision to streamline the business. Severance charges associated with the reduction in force were $0.2 million. These costs are classified as restructuring charges on the Condensed Consolidated Statement of Operations and are included in Operating Expenses.
Impairment Charges
| (in thousands) | Three Months Ended September 30, | Change | Nine Months Ended September 30, | Change | |||||||||||||||
| 2007 | 2006 | 2007 | 2006 | ||||||||||||||||
Impairment charges | $ | 1,645 | $ | — | 100 | % | 1,645 | $ | — | 100 | % | ||||||||
Percentage of revenues | 13 | % | — | 4 | % | — | |||||||||||||
The Company completed the shut down of the Wisenut website and search functionality in September, 2007. As a result of the abandonment of the Wisenut assets, the Company determined that the associated assets, consisting primarily of intangible assets and capitalized software, are impaired as of the end of September 30, 2007. The assets were written down to their estimated net realizable value and an impairment charge in the amount of $1.6 million was recognized during the three months ended September 30, 2007.
Other Operating Income
| (in thousands) | Three Months Ended September 30, | Change | Nine Months Ended September 30, | Change | ||||||||||||||
| 2007 | 2006 | 2007 | 2006 | |||||||||||||||
Other operating income (loss), net | $ | 24 | $ | — | 100 | % | (99 | ) | $ | — | (100 | )% | ||||||
Other operating income increased in third quarter of 2007 compared to the third quarter of 2006 due to contingent purchase consideration earned from revenue sharing under the sale agreement with Content Watch, as well as a gain on the sale of Grub, Inc. to Wikia. Other operating income is offset by a $0.1 million retainer fee. On a year-to-date basis other operating income (loss) consists of $248 thousand loss on the sale of Net Nanny to Content Watch in the first quarter of 2007 offset by the contingent purchase consideration earned from revenue sharing under the sale agreement with Content Watch of $198 thousand from the date of sale through September 30, 2007, as well as $50 thousand gain on the sale of Grub, Inc. to Wikia. Other operating income is offset by a $0.1 million retainer fee.
Non-Operating Income, net
| (in thousands) | Three Months Ended September 30, | Change | Nine Months Ended September 30, | Change | |||||||||||||
| 2007 | 2006 | 2007 | 2006 | ||||||||||||||
Non-operating income, net | $ | 489 | $ | 501 | (2 | )% | 1,522 | $ | 1,473 | (4 | )% | ||||||
Non-operating income, net is primarily comprised of interest income.
Interest income decreased in the third quarter and first nine months of 2007 compared to the third quarter and first nine months of 2006 primarily due to lower cash, cash equivalents and investments in 2007.
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Income Tax Expense
| (in thousands) | Three Months Ended September 30, | Change | Nine Months Ended September 30, | Change | ||||||||||||||||
| 2007 | 2006 | 2007 | 2006 | |||||||||||||||||
Income tax income (expense) | $ | — | $ | — | 0 | % | $ | (6 | ) | $ | (11 | ) | (45 | )% | ||||||
We adopted the provisions of FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109 (“FIN 48”) on January 1, 2007. We did not have any unrecognized tax benefits and there was no effect on our financial condition or results of operations as a result of implementing FIN 48 during the current period.
The effective tax rate in upcoming quarters and for the year ending December 31, 2007 may vary due to a variety of factors, including, but not limited to, the relative income contribution by tax jurisdiction, changes in statutory tax rates, the amount of tax exempt interest income generated during the year and any non-deductible items related to acquisitions or other non-recurring charges.
Gain (Loss) from Discontinued Operations, Net of Tax
| (in thousands) | Three Months Ended September 30, | Change | Nine Months Ended September 30, | Change | ||||||||||||||||
| 2007 | 2006 | 2007 | 2006 | |||||||||||||||||
Gain (loss) from discontinued operations, net of tax | $ | 471 | $ | (31 | ) | 1,619 | % | $ | 410 | $ | (31 | ) | 1,423 | % | ||||||
In the third quarter of 2007, the Company completed the substantial liquidation of its Australian subsidiary. As a result, the Company recorded the reversal of the cumulative translation adjustment of approximately $0.5 million. The Company also recorded additional amounts relating to the finalization of the liquidation of various foreign operations in the third quarter of 2007. The Company expects to finalize the dissolution of these entities by December 31, 2007.
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Liquidity and Capital Resources
The following table presents our cash flows provided by (used in) operating, investing and financing activities for the nine months ended September 30, 2007, and 2006 (in thousands):
| Nine Months Ended September 30, | ||||||||
| 2007 | 2006 | |||||||
Cash flows used in operating activities | $ | (2,882 | ) | $ | (8,146 | ) | ||
Cash flows provided by (used in) investing activities | $ | (11,374 | ) | $ | 4,691 | |||
Cash flows provided by financing activities | $ | 276 | $ | 45 | ||||
Our primary source of cash is receipts from revenue. The primary uses of cash are labor costs (salaries, benefits, and other employee compensation), general operating expenses (office rent, utilities, insurance and supplies), payments to distribution network partners related to traffic acquisition and content costs associated with our consumer sites, and professional services fees related to legal and audit costs. We ended the third quarter of 2007 with $37.4 million in cash, cash equivalents, and short and long-term investments, a decrease of $3.8 million from December 31, 2006 of $41.2 million.
The decrease in cash used in operating activities for the first nine months of 2007 compared to the first nine months of 2006 was primarily due to a decrease in net loss of approximately $2.8 million, a decrease of approximately $0.5 million in cash paid for accounts payable, a decrease in depreciation and amortization of approximately $1.1 million and a decrease of approximately $2.6 million in cash collected from accounts receivable. We received $1 million proceeds from the insurance carrier in relation to a settlement of a lawsuit, of which $0.6 million was applied to other current assets and $0.4 million to accrued expenses and other current liability.
Net cash used in investing activities for the first nine months of 2007 was higher than net cash provided by investing activities for the first nine months of 2006. We purchased approximately $19.6 million more investments during the first nine months of 2007. Further we sold $1.7 million more investments during the first nine months of 2007 than the same period of 2006. Additionally, we invested approximately $1.6 million in property, equipment and capitalized software development in the first nine months of 2007 compared to the same period in 2006, of which approximately $0.5 million was financed through a capital lease. The increase in cash used was partially offset by cash received from our joint venture in the amount of $0.4 million, as part of our liquidation process. We expect capital expenditures for technical equipment for the remainder of 2007 will be financed through a $5 million capital lease line of credit.
Net cash provided by financing activities during the first nine months of 2007 was higher than the same period of 2006 primarily due to approximately $77 thousand more in proceeds for the issuance of common stock related to our employee stock plans, as well as $0.2 million from the sale and lease back of equipment. This was offset by a $42 thousand of cash used in repayment of notes and $54 thousand of cash used for the repayment of our capital lease obligation.
We have outstanding standby letters of credit (“SBLC”) of $1.1 million at September 30, 2007 related to security of a building lease and security for payroll processing services. The SBLC contains two financial covenants. As of September 30, 2007, we were in compliance with all required covenants.
We believe that our working capital will provide adequate liquidity to fund our operations and meet other cash requirements for at least the next 12 months. We may seek to raise additional capital through public or private debt or equity financings in order to fund our operations and capital expenditures, take advantage of favorable business opportunities, develop and upgrade our technology infrastructure, develop new product and service offerings, take advantage of favorable conditions in capital markets or respond to competitive pressures. In addition, unanticipated developments in the short term, such as the entry into agreements requiring large cash payments or the acquisition of businesses with negative cash flows, may necessitate additional financing. We cannot be assured that additional financing will be available on terms favorable to us, or at all. If we issue additional equity or convertible debt securities, our existing stockholders may experience substantial dilution.
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Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements as defined in Regulation S-K Item 303(a)(4), investments in special-purpose entities or undisclosed borrowings or debt. Additionally, we are not a party to any derivative contracts or synthetic leases.
Contractual Obligations and Commercial Commitments
On April 6, 2007, the Company entered into a master lease agreement with City National Bank (“CNB”) for an amount of up to $5 million for the purchase of technical equipment. This lease line of credit expires on January 30, 2008 and is available for capital leases with rental terms from 36 to 48 months. Interest on capital leases is calculated using an interest rate of 7.76%. As of September 30, 2007 the Company drew down approximately $0.5 million on the capital lease line and repaid approximately $54 thousand for the nine months ended September 30, 2007.
On July 27, 2007, David Hills, the President, Chief Executive Officer and a member of the board of directors of the Company, resigned as an employee and director of the Company effective as of August 1, 2007, related to which the Company incurred obligations under a severance agreement. (See footnote 8, Commitments and Contingencies for further details).
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| ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
Interest Rate Risk
Our exposure to market risk for interest rate changes relates primarily to our short-term and any long-term investments. We had no derivative financial instruments as of September 30, 2007 or December 31, 2006. We invest our excess cash in debt and equity instruments of high-quality corporate issuers with original maturities greater than three months and effective maturities less than two years. The amount of credit exposure to any one issue, issuer and type of instrument is limited. These securities are subject to interest rate risk and vary in value as market interest rates fluctuate. During the three and nine months ended September 30, 2007, the effects of changes in interest rates on the fair market value of our marketable investment securities and our earnings were not material. Further, we believe that the impact on the fair market value of our securities and our net income/ (loss) from a hypothetical 10% change in interest rates would not be significant.
| ITEM 4. | CONTROLS AND PROCEDURES |
(a) Evaluation of disclosure controls and procedures. Our Chief Executive Officer and Chief Financial Officer are responsible for establishing and maintaining “disclosure controls and procedures” (as defined in rules promulgated under the Securities Exchange Act of 1934, as amended) for our company. Based on their evaluation as of the end of the period covered by this report, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective to ensure that the information required to be disclosed by us in this Quarterly Report on Form 10-Q is (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s (“SEC”) rules and Form 10-Q, and (ii) is accumulated and communicated to the Company’s management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.
(b) Changes in internal controls. During the period covered by this report, there were no changes in the Company’s internal control over financial reporting that have materially affected, or could be reasonably likely to materially affect, the registrant’s internal control over financial reporting. During the course of our general evaluation of internal controls and the 2006 close process, there were six significant deficiencies identified in the design and operation of our internal controls. We are in the process of remediating these significant deficiencies and will continue our work to reduce the occurrence of future significant deficiencies; however, our independent registered public accounting firm’s testing of the effectiveness of our remediation efforts has not been completed as of September 30, 2007.
(c) Limitations on the effectiveness of controls. Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all errors 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, within a company have been detected. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives, and the Chief Executive Officer and the Chief Financial Officer have concluded that these controls and procedures are effective at the “reasonable assurance” level.
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| ITEM 1. | LEGAL PROCEEDINGS |
Cisneros v. Yahoo! Inc
On August 3, 2004, Mario Cisneros and Michael Voight filed a private attorney general lawsuit on behalf of a proposed class in Superior Court in San Francisco County, California. The complaint names thirteen search engines or Web publishers as defendants, including the Company, and alleges unfair business practices, unlawful business practices, and other causes of action in connection with the display of advertisements from Internet gambling companies. The complaint seeks restitution, unspecified compensatory damages, declaratory and injunctive relief, and attorneys’ fees. Plaintiffs also filed a motion for preliminary injunction on August 3, 2004.
On January 3, 2005, the Company filed a demurrer to the complaint, which was overruled on January 27, 2005. On January 3, 2005, the Company also filed a motion to strike certain allegations regarding claims for restitution, which was denied in part and granted in part on May 9, 2005. The Company filed an answer to the complaint on February 28, 2005, consisting of a general denial of all allegations. On October 11, 2005, the court conducted a trial on two of the Company’s affirmative defenses. The court held that California public policy bars the plaintiffs from receiving a portion of their requested damages.
On December 2, 2005, plaintiffs filed a renewed motion for a preliminary injunction. Defendants responded on or around February 27, 2006. The Court has allowed certain discovery to proceed with respect to plaintiffs’ renewed motion. On or about May 23, 2006, plaintiffs were granted leave to amend their complaint to name additional plaintiffs. On or about September 8, 2006, plaintiffs served an amended complaint naming additional plaintiffs. The Company has since filed a general denial to the amended complaint. On April 13, 2007 the Court heard argument on defendants’ motion to dismiss for lack of subject matter jurisdiction and plaintiffs’ motion to allow non-restitutionary disgorgement. Both motions were denied. Subsequently, the parties entered into a Settlement Agreement and Release whereby (i) the Company agreed to make a payment of $15,000 to a designated charitable organization and continue its current policies banning acceptance of ads from gambling websites, and (ii) all plaintiffs would dismiss their claims against the Company with prejudice. On October 17, 2007, the amended complaint was dismissed with prejudice as to the Company.
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Lane’s Gifts and Collectibles, L.L.C., v. Yahoo! Inc
On March 14, 2005 the Company was served with the second amended complaint in a class action lawsuit in the Circuit Court of Miller County, Arkansas. The complaint names eleven search engines and web publishers as defendants, including the Company, and alleges breach of contract, restitution/unjust enrichment/money had and received, and civil conspiracy claims in connection with contracts allegedly entered into with plaintiffs for Internet pay-per-click advertising. The named plaintiffs on the second amended complaint are Lane’s Gifts and Collectibles, L.L.C., U.S. Citizens for Fair Credit Card Terms, Inc., Savings 4 Merchants, Inc., and Max Caulfield d/b/a Caulfield Investigations.
On March 30, 2005 the case was removed to United States District Court for the Western District of Arkansas. On April 4, 2005 plaintiffs U.S. Citizens for Fair Credit Card Terms, Inc. and Savings 4 Merchants, Inc. filed a motion of voluntary dismissal without prejudice. The motion was granted on April 7, 2005. Plaintiffs Lane’s Gifts and Collectibles, L.L.C. and Max Caulfield d/b/a Caulfield Investigations filed a motion to remand the case to state court on April 13, 2005, which was granted in June 2005. In July 2005, defendants, including the Company, petitioned the Eighth Circuit Court of Appeals for an appeal of the remand order, and moved to stay the proceedings while the appeal is pending. The petition was denied on September 8, 2005 and the case was remanded to the Circuit Court of Miller County, Arkansas. The Company was served with discovery requests on October 7, 2005. The Company has filed and/or joined motions to dismiss on the basis of failure to state a claim upon which relief can be granted, lack of personal jurisdiction, and improper venue. Pursuant to the court’s initial scheduling order, plaintiffs had until January 27, 2006 to respond to the motions to dismiss for lack of personal jurisdiction and improper venue; and until June 9, 2006 to respond to the motion to dismiss on the basis of failure to state a claim upon which relief can be granted. However the court entered an order staying all proceedings for a period of 60 days on January 9, 2006. On March 8, 2006, the Court entered an order extending the stay until March 31, 2006. On April 1, 2006, the Court further extended the stay until April 20, 2006. On April 20, 2006 the Court preliminarily approved a class settlement among plaintiffs, defendant Google, Inc., and certain defendants who display Google advertisements on their networks (the “Google Settlement”). The Google Settlement purports to release Google of all claims and also purports to release certain defendants, including the Company, for any claims associated with the display of Google advertisements on their networks. On July 24 and 25, 2006, the Court had a final settlement hearing on the Google Settlement, and on July 26, 2006, the Court approved the settlement. On April 21, 2006, the Court ordered the remaining defendants, including the Company, to mediation and further stayed the proceedings to June 21, 2006. The Court further extended the stay as to LookSmart until August 16, 2006. The parties thereafter stipulated that the stay would remain in effect while the parties continue to comply with the Court’s order regarding mediation. On January 10, 2007, the Court further extended the stay until May 1, 2007. Plaintiffs’ counsel have stipulated to extend the stay as to LookSmart. In April 2007 the Plaintiffs and the Company came to an agreement in principle to settle the matter in its entirety. Any eventual settlement with plaintiffs will be subject to court approval. The Company has recorded an estimate of the amount of the loss on settlement which management has determined is probable and estimable during the quarter ended March 31, 2007. This estimate may change as a result of the final settlement arrangement. In addition, the Company recovered settlement proceeds from the insurance carrier, which exceeded the recorded estimate of the amount of loss on settlement. Due to the uncertainty relating to the ultimate settlement amount, the excess settlement proceeds have been recorded as an accrued liability at September 30, 2007. Accordingly, there is no current impact on the Condensed Consolidated Statement of Operations for the three months ended September 30, 2007.
The nature of litigation is inherently uncertain and therefore the Company cannot predict the outcome of these proceedings or estimate the possible effects on our financial position, results of operations or cashflows.
Additionally, we are involved, from time to time, in various legal proceedings arising from the normal course of business activities. Although the results of litigation and claims cannot be predicted with certainty, we do not expect resolution of these matters to have a material adverse impact on our consolidated results of operations, cash flows or financial position unless stated otherwise. However, an unfavorable resolution of a matter could, depending on its amount and timing, materially affect our future results of operations, cash flows or financial position in a future period. Regardless of the outcome, litigation can have an adverse impact on us because of defense costs, diversion of management resources and other factors.
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| ITEM 1A. | RISK FACTORS |
Other than certain updates to our risk factors, including our risk factors regarding our ability to attract and retain key personnel, our potential liability for claims related to our products and services, and accounting for employee stock options using the fair value method as set forth below, there have been no material changes to the risk factors that are included in our Annual Report on Form 10-K for the year ended December 31, 2006 that could affect our business, results of operations or financial condition.
You should carefully consider the risks described below before making an investment decision regarding our common stock. If any of the following risks actually occur, our business, financial condition and results of operations could be harmed. In that case, the trading price of our common stock could decline and our investors could lose all or part of their investment. Additional risks not presently known to us or that we currently deem immaterial may also impair our business operations.
Risks Related to our Business
Our financial results are highly concentrated in the online advertising business; if we are unable to grow online advertising revenues and find alternative sources of revenue, our financial results will suffer
The display of listings advertisements accounted for substantially all of our revenues for the three and nine months ended September 30, 2007. Our success depends upon advertisers choosing to use, and distribution network partners choosing to distribute, our listings products. Advertisers and distribution network partners may not adopt our listings products at projected rates, or changes in market conditions may adversely affect the use or distribution of listings advertisements. Because of our revenue concentration in the online advertising business, such shortfalls or changes could have a negative impact on our financial results. Also, many of our products are offered to website publishers who use them to display or generate revenue from their online advertisements. Our overall revenue is concentrated with one advertiser representing 12% of overall revenue for the three months ended September 30, 2007. For the nine months ended September 30, 2007 the same advertiser represented 9% of total revenue. If we are unable to generate significant revenue from our online advertising business, or if market conditions adversely affect the use or distribution of online advertisements generally, our results of operations, financial condition and/or liquidity will suffer.
We rely primarily on our network of distribution network partners to generate paid clicks; if we are unable to maintain or expand this network, our ability to generate revenue may be seriously harmed
The success of our online advertisement products depends in large part on the size and quality of our distribution network. We may be unable to maintain or add distribution network partners of satisfactory quality in our distribution network at reasonable revenue-sharing rates, or at all. Our distribution network is concentrated, with one largest distribution network partner accounting for approximately 13% and 8% respectively, of our revenue for the three and nine months ended September 30, 2007. If we lose any significant portion of our distribution network, we would need to find alternative sources of quality click traffic to replace the lost paid clicks. In the past, we have lost portions of our distribution network, such as when our contract with Microsoft’s MSN expired in the first quarter of 2004. Although alternate sources of click traffic are currently available in the market, they may not be available at reasonable prices, they will likely be subject to competition from various paid search providers, and they may be of lower quality. There is fierce competition among advertising networks to sign agreements with traffic providers. We may be unable to negotiate and sign agreements with quality traffic providers on favorable terms, if at all. If we are unsuccessful in maintaining and expanding our distribution network, then our ability to generate revenue may be seriously harmed.
We rely on our AdCenter for Publisher customers to generate paid clicks; if we are unable to maintain these relationships or add additional customers, our ability to generate revenue may be seriously harmed
The success of our Company depends in large part on our ability to sign and maintain license and revenue share arrangements with our AdCenter for Publisher customers. We may be unable to maintain or add AdCenter for Publisher customers that generate a satisfactory volume of paid clicks at reasonable revenue-sharing rates, or at all. Our overall revenue is concentrated, with one AdCenter for Publisher customer accounting for approximately 13% and 10%, respectively of our revenue for the three and nine months ended September 30, 2007. If we lose this AdCenter for Publisher customer, we would need to find alternative sources of revenue to replace the lost revenue share on paid clicks. Other publishers who become our customers may not be available at reasonable revenue share rates, they will likely be subject to competition from various other online advertising service providers, and they may have smaller audiences or viewers that respond less to online advertisements. If we are unable to maintain or generate new AdCenter for Publisher arrangements, then our ability to generate revenue may be seriously harmed.
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We have generated significant losses in the past and we may be unable to achieve operating profitability in the foreseeable future, and if we achieve profitability, we may be unable to maintain it, which could result in a decline in our stock price
We had a net loss of approximately $4.3 million and $9.8 million for the three and nine months ended September 30, 2007 and as of September 30, 2007 our accumulated deficit was approximately $227.3 million. We may be unable to achieve profitability in the foreseeable future and, if we regain profitability, we may be unable to maintain it. Our ability to achieve and maintain profitability will depend on our ability to generate additional revenue and contain our expenses. In order to generate additional revenue, we will need to expand our network of distribution network partners, increase the amount our advertisers spend on our ad network, expand our advertiser base and offer our publisher products to additional publisher customers and experience an increase in paid clicks. We may be unable to accomplish some or any of these goals because of the risks identified in this report or for unforeseen reasons. Also, we may be unable to contain our costs due to the need to make revenue sharing payments to our distribution network partners, to invest in product development, marketing and search technologies (exemplified by our renewed focus on our vertical search business), and enhance our search services. Because of the foregoing factors, and others outlined in this report, we may be unable to achieve profitability in the future, which could result in a decline in our stock price.
If we experience downward pressure on our revenue per click and/or match rate, or we are unable to rebuild our revenue per click and/or match rate, our financial results will suffer
We have experienced, and may in the future experience, downward pressure on our average revenue per click and average match rate, or rate at which paid listings are matched against search queries, due to various factors. In the three and nine months ended September 30, 2007, for example, our average revenue per click was consistent with three and nine months ended September 30, 2006. We may experience decreases in revenue per click or average match rate in the future for many reasons, including the erosion of our advertiser base, the reduction in average advertiser spend, the reduction in the number of listings purchased by advertisers, or for other reasons. If our revenue per click or average match rate falls for any reason, or if we are unable to grow our revenue per click and average match rate, then we may be unable to achieve our financial projections and our stock price would likely suffer.
Our growth depends on our ability to retain and grow our advertiser base; if our advertiser base and average advertiser spend falls, our financial results will suffer
Our growth depends on our ability to build an advertiser base that corresponds with the characteristics of our distribution network. Our distribution network, which currently consists of a diversified network of small distribution sources, may change as new distribution sources are added and old distribution sources are removed. Advertisers may view these changes to the distribution network negatively, and existing or potential advertisers may elect to purchase fewer or no listings advertisements for display on our distribution network. If this occurs, it is likely that our average revenue per click and average match rate may decline, we may be unable to meet our financial guidance, and our stock price would likely suffer.
Our growth depends upon our ability to retain and grow our audience for our consumer sites, and there are risks associated with introducing new products and services
To maintain and grow our revenue, part of our strategy is to increase the amount, frequency and page views by consumers of our consumer sites. Our development, testing and implementation efforts for these products and services have required, and are expected to continue to require, substantial investments of our time. We recently began owning and operating our own consumer sites, and we may not gain enough of an audience for our consumer sites to generate any, or sufficient, revenue to justify our efforts, or we may gain a sufficient audience but be unable to gain advertiser acceptance of our consumer sites. Also, if we do not improve and enhance our consumer sites in a timely manner, we may lose existing users to our competitors or fail to attract new customers, which may adversely affect our performance and results of operations.
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Our growth depends upon our ability to offer and support our technology services to online publishers, and there are risks associated with introducing new products and services
To maintain and grow our revenue, part of our strategy is to offer and host syndicated technology services to online publishers. Our development, testing and implementation efforts for these products and services have required, and are expected to continue to require, substantial investments of our time. Also, we do not have significant experience offering services to online publishers, and we may not gain publisher acceptance of our offerings. We may be unable to successfully implement syndicated publisher solutions, or our implementation of a solution may interfere with our ability to operate our other products and services or other implementations, or a publisher customer may decide not to use or continue to use our solution or to increase their reliance on other online advertising service providers at the expense of our solution. These failures could have an adverse effect on our business and results of operations.
If we do not introduce new and upgraded products and services and successfully adapt to our rapidly changing industry, our financial condition may suffer
The Internet search industry is rapidly evolving and very turbulent, and we will need to continue developing new and upgraded products and services, adapt to new business environments and competition, and generate traffic to our consumer web properties in order to maintain and grow revenue and reach our profitability goals. New advertising technologies could emerge that make our services comparatively less useful or new business methods could otherwise emerge that divert web traffic away from our Ad Center for Publishers’ ad network and consumer web sites. Competition from other web businesses may prevent us from attracting substantial traffic to our services. Also, we may inaccurately predict the direction of the online advertising market, which could lead us to make investments in technologies and products that do not generate sufficient returns. We may face platform and resource constraints that prevent us from developing upgraded products and services. We may fail to successfully identify new products or services, or fail to bring new products or services to market in a timely and efficient manner. Rapid industry change makes it difficult for us to forecast our results accurately, particularly over longer periods.
We face intense competitive pressures, which could materially and adversely affect our financial results
We compete in the relatively new and rapidly evolving online advertising industry, which presents many uncertainties that could require us to further refine our business model. We compete with companies that provide paid placement products, paid inclusion products, and other forms of search marketing as well as contextually-targeted ad products and other types of online advertisements. We compete for advertisers on the basis of the quality and composition of our ad network, the price per click charged to advertisers, the volume of clicks that we can deliver to advertisers, tracking and reporting of campaign results, customer service and other factors. We also compete for distribution network partners and for ad placement on those partners’ sites on the basis of the relevance of our ads and the price per click charged to advertisers. We also experience competition for offering our technology to website publishers. Some of our competitors have larger distribution networks and proprietary traffic bases, longer operating histories, greater brand recognition higher price per clicks, better relevance and conversion rates, or better products and services than we have.
Our acquisition of businesses and technologies may be costly and time-consuming; acquisitions may also dilute our existing stockholders
From time to time we evaluate corporate development opportunities, and when appropriate, we intend to make acquisitions of, or significant investments in, complementary companies or technologies to increase our technological capabilities and expand our service offerings. Acquisitions may divert the attention of management from the day-to-day operations of LookSmart. It may be difficult to retain key management and technical personnel of the acquired company during the transition period following an acquisition. Acquisitions or other strategic transactions may also result in dilution to our existing stockholders if we issue additional equity securities and may increase our debt. We may also be required to amortize significant amounts of intangible assets, record impairment of goodwill in connection with future or past acquisitions, or divest non-performing assets at below-market prices, which would adversely affect our operating results.
We have acquired businesses and technologies in recent years, including the acquisition of Net Nanny from BioNet Systems, LLC in the second quarter of 2004, (which was sold in the first quarter of 2007) and from Furl, LLC in the third quarter of 2004, that is part of consumer products activities and assets, that the Company is in the process of divesting. Integration of acquired companies and technologies into LookSmart is likely to be expensive, time-consuming and strain our managerial resources. We may not be successful in integrating any acquired businesses or technologies and these transactions may not achieve anticipated business benefits.
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Our success depends on our ability to attract and retain key personnel; if we were unable to attract and retain key personnel in the future, our business could be materially and adversely impacted
Our success depends on our ability to identify, attract, retain and motivate highly skilled development, technical, sales, and management personnel. We have a limited number of key development, technical, sales and management personnel performing critical company functions, and the loss of the services of any of our key employees, particularly any of our executive team members or key technical personnel, could adversely affect our business. Also, our September restructuring has placed additional burdens on all remaining personnel, including our remaining Finance staff. In recent years, we have experienced significant turnover in our management team. For example, both our Chief Executive Officer and Chief Technical Officer resigned in August 2007 and in June 2007 our Chief Financial and Operating Officer announced his resignation as of November 2007. We expect the transition to a new Chief Financial Officer will also place an increased burden on our Finance staff. In addition, our interim CEO joined us in August 2007 and two of our sales vice presidents joined us in April 2007. Other members of management have also joined us in the last year, and the management team as a whole has had only a limited time to work together. We cannot assure you that we will be able to retain our key employees or that we can identify attract and retain highly skilled personnel in the future.
We face capacity constraints on our software and infrastructure systems that may be costly and time-consuming to resolve
We use proprietary and licensed software and databases to create and edit listings, compile and distribute our advertisement products, track paid clicks, and detect click fraud. Any of these software systems may contain undetected errors, defects or bugs or may fail to operate with other software applications. The following developments may strain our capacity and result in technical difficulties with our website or the websites of our distribution network partners:
| • | customization of our listings ads for distribution to particular distribution network partners, |
| • | substantial increases in the number of queries to our database, |
| • | substantial increases in the number of listings in our ad databases, or |
| • | the addition of new products or new features or changes to our products. |
If we experience difficulties with our software and infrastructure systems or if we fail to address these difficulties in a timely manner, we may lose the confidence of advertisers and distribution network partners, our revenue may decline and our business could suffer. In addition, as we expand our service offerings and enter into new business areas, we may be required to significantly modify and expand our software and infrastructure systems. If we fail to accomplish these tasks in a timely manner, our business will likely suffer.
Risks Related to Operating in our Industry
If we fail to prevent, detect and remove invalid clicks, we could lose the confidence of our advertisers, thereby causing our business to suffer
Invalid clicks, most often due to “click fraud”, are an ongoing problem for the Internet advertising industry, and we are exposed to the risk of invalid clicks on our paid listings. Invalid clicks occur when a person or robotic software causes a click on a paid listing to occur for some reason other than to view the underlying content. We invest significant time and resources in preventing, detecting and eliminating invalid traffic from our distribution network. However, the perpetrators of click fraud have developed sophisticated methods to evade detection, and we are unlikely to detect and remove all invalid traffic from our search network. We are subject to advertiser complaints and litigation regarding invalid clicks, and we may be subject to advertiser complaints, claims, litigation or inquiries in the future. We have from time to time credited invoices or refunded revenue to our customers due to suspicious traffic, and we expect to continue to do so in the future. If our systems to detect invalid traffic are insufficient, or if we find new evidence of past invalid clicks, we may have to issue credits or refunds retroactively to our advertisers, and we may still have to pay revenue share to our distribution network partners. This could negatively affect our profitability and hurt our brand. If traffic consisting of invalid clicks is not detected and removed from our search network, the affected advertisers may experience a reduced return on their investment in our online advertising because the invalid clicks will not lead to actual sales for the advertisers. This could lead the advertisers to become dissatisfied with our products, which could lead to loss of advertisers and revenue and could materially and adversely affect our financial results.
Any failure in the performance of our key operating systems could materially and adversely affect our revenues
Any system failure that interrupts our hosted products or services, including our search service, whether caused by computer viruses, software failure, power interruptions, intruders and hackers, or other causes, could harm our financial results. For example, our system for tracking and invoicing clicks is dependent upon a proprietary software platform. If we lose key personnel or experience a failure of software, this system may fail. In such event, we may be unable to track paid clicks and invoice our customers, which would materially and adversely affect our financial results and business reputation.
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The occurrence of a natural disaster or unanticipated problems at our principal headquarters or at a third-party facility could cause interruptions or delays in our business, loss of data or could render us unable to provide some services. Our California facilities exist on or near known earthquake fault zones and a significant earthquake could cause an interruption in our services. We do not have back-up sites for our main customer operations center, which is located at our San Francisco, California office. An interruption in our ability to serve search results, track paid clicks, and provide customer support would materially and adversely affect our financial results.
Our business and operations depend on Internet service providers and third party technology providers, and any failure or system downtime experienced by these companies could materially and adversely affect our revenues
Our consumers, distribution network partners and customers depend on Internet service providers, online service providers and other third parties for access to our search results. These service providers have experienced significant outages in the past and could experience outages, delays and other operating difficulties in the future. The occurrence of any or all of these events could adversely affect our reputation, brand and business, which could have a material adverse effect on our financial results.
We have an agreement with Savvis Communications, Inc. to house equipment for web serving and networking and to provide network connectivity services. We also have agreements with third-party click tracking and ad-serving technology providers. We also have an agreement with AboveNet Communications, Inc. to provide network connectivity services. We do not presently maintain fully redundant click tracking, customer account and web serving systems at separate locations. Accordingly, our operations depend on Savvis and AboveNet to protect the systems in their data centers from system failures, earthquake, fire, power loss, water damage, telecommunications failure, hackers, vandalism and similar events. Neither Savvis nor AboveNet guarantees that our Internet access will be uninterrupted, error-free or secure. We have developed a 30-day disaster recovery plan to respond in the event of a catastrophic loss of our critical, revenue-generating systems. We have an agreement with Raging Wire, Inc. in Sacramento, California to provide co-location and networking services for our critical systems in such an event. Although we maintain property insurance and business interruption insurance, we cannot guarantee that our insurance will be adequate to compensate us for all losses that may occur as a result of a catastrophic system failure. Also, if our third-party click tracking or ad-serving technology providers experience service interruptions, errors or security breaches, our ability to track, realize and record revenue would suffer.
We may face liability for claims related to our products and services, and these claims may be costly to resolve
Internet users, advertisers and other customers, and companies in the Internet, technology and media industries frequently enter into litigation based on allegations related to defamation, negligence, personal injury, breach of contract, unfair advertising, unfair competition, invasion of privacy or other claims. Lawsuits are filed against us from time to time, and we are currently subject to two purported class action lawsuits in connection with our listings services. In addition, we are obligated in some cases to indemnify our customers or distribution network partners in the event that they are subject to claims that our services infringe on the rights of others.
Litigating these claims could consume significant amounts of time and money, divert management’s attention and resources, cause delays in integrating acquired technology or releasing new products, or require us to enter into royalty or licensing agreements. Royalty or licensing agreements, if required, may not be available on acceptable terms, if at all. Our insurance may not adequately cover claims of this type, if at all. If a court were to determine that some aspect of our search services or listings infringed upon or violated the rights of others, we could be prevented from offering some or all of our services, which would negatively impact our revenue and business. For any of the foregoing reasons, litigation involving our listings business and technology could have a material adverse effect on our business, operating results and financial condition.
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We could be subject to infringement claims that may be costly to defend, result in the payment of settlements or damages or lead us to change the way we conduct our business
Internet, technology, media companies and patent holding companies often possess a significant number of patents. Further, many of these companies and other parties are actively developing search, indexing, electronic commerce and other Web-related technologies, as well as a variety of online business models and methods. We believe that these parties will continue to take steps to protect these technologies, including, but not limited to, seeking patent protection. As a result, we may face claims of infringement of patents and other intellectual property rights held by others. Also, as we expand our business, license or acquire content and develop new technologies, products and services, we may become increasingly subject to intellectual property infringement claims. In the event that there is a determination that we have infringed third-party proprietary rights such as patents, copyrights, trademark rights, trade secret rights or other third party rights such as publicity and privacy rights, we could incur substantial monetary liability, be required to enter into costly royalty or licensing agreements or be prevented from using the rights, which could require us to change our business practices in the future and limit our ability to compete effectively. We may also incur substantial expenses in defending against third-party infringement claims regardless of the merit of such claims. In addition, many of our agreements with our customers, partners and affiliates require us to indemnify them for certain third-party intellectual property infringement claims, which could increase our costs in defending such claims and our damages. The occurrence of any of these results could harm our brand and negatively impact our operating results.
Litigation, regulation, legislation or enforcement actions directed at or materially affecting us may adversely affect the commercial use of our products and services and our financial results
New lawsuits, laws, regulations and enforcement actions applicable to the online industry may limit the delivery, appearance and content of our advertising or consumer sites or otherwise adversely affect our business. If such laws are enacted, or if existing laws are interpreted to restrict the types and placements of advertisements we can carry, it could have a material and adverse effect on our financial results. For example, in 2002, the Federal Trade Commission, in response to a petition from a private organization, reviewed the way in which search engines disclose paid placement or paid inclusion practices to Internet consumers and issued guidance on what disclosures are necessary to avoid misleading consumers about the possible effects of paid placement or paid inclusion listings on the search results. In 2003, the United States Department of Justice issued statements indicating its belief that displaying advertisements for online gambling might be construed as aiding and abetting an illegal activity under federal law. In 2004, the United States Congress considered new laws regarding sale of pharmaceutical products over the Internet and the use of adware to distribute advertisements on the Internet, any of which could, if enacted, adversely affect our business. If any new law or government agency were to require changes in the labeling, delivery or content of our advertisements, or if we are subject to legal proceedings regarding these issues, it may reduce the desirability of our services or the types of advertisements that we can run, and our business could be materially and adversely harmed. In addition, many of our agreements with our customers, partners and affiliates require us to indemnify them for certain claims related to online advertising laws, regulations and enforcement actions, which could increase our costs in defending such claims and our damages.
In addition, legislation or regulations, including compliance with Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”), present ongoing compliance risks, and a failure to comply with these new laws and regulations could materially harm our business. For example, in the course of our general evaluation of our internal controls we identified certain deficiencies in the design and operation of such controls. We continue the process of remediating such deficiencies. It is possible that as we continue our Section 404 compliance efforts we will identify significant deficiencies, or material weaknesses, in the design and operation of our internal controls. We may be unable to remediate any of these matters in a timely fashion, and/or our independent registered public accounting firm may not agree with our remediation efforts in connection with their Section 404 attestation. Such failures could impact our ability to record, process, summarize and report financial information, and could impact market perception of the quality of our financial reporting, which could adversely affect our business and our stock price.
Privacy-related regulation of the Internet could limit the ways we currently collect and use personal information, which could decrease our advertising revenue or increase our costs
Internet user privacy has become an issue both in the United States and abroad. The United States Congress is considering new legislation to regulate Internet privacy, and the Federal Trade Commission and government agencies in some states and countries have investigated some Internet companies, and lawsuits have been filed against some Internet companies, regarding their handling or use of personal information. Any laws imposed to protect the privacy of Internet consumers may affect the way in which we collect and use personal information. We could incur additional expenses if new laws or court judgments, in the United States or abroad, regarding the use of personal information are introduced or if any agency chooses to investigate our privacy practices.
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Our advertisers and partners may place information, known as cookies, on a user’s hard drive, generally without the user’s knowledge or consent. This technology enables web site operators to target specific consumers with a particular advertisement, to limit the number of times a user is shown a particular advertisement, and to track certain behavioral data. Although some Internet browsers allow consumers to modify their browser settings to remove cookies at any time or to prevent cookies from being stored on their hard drives, many consumers are not aware of this option or are not knowledgeable enough to use this option. Some privacy advocates and governmental bodies have suggested limiting or eliminating the use of cookies. If this technology is reduced or limited, the Internet may become less attractive to advertisers and sponsors, which could result in a decline in our revenue.
We and some of our distribution network partners or advertisers retain information about our consumers. If others were able to penetrate the network security of these user databases and access or misappropriate this information, we and our distribution network partners or advertisers could be subject to liability. These claims may result in litigation, our involvement in which, regardless of the outcome, could require us to expend significant time and financial resources. In addition, many of our agreements with our customers, partners and affiliates require us to indemnify them for certain claims related to privacy laws, regulations and enforcement actions which could increase our costs in defending such claims and damages.
Online commerce security risks, including security breaches, identity theft, service disrupting attacks and viruses, could harm our reputation and the conduct of our business, which could have a material adverse effect on our financial results
A fundamental requirement for online commerce and communications is the secure storage, and transmission over public networks of confidential information. Although we have developed and use systems and processes that are designed to protect consumer information and prevent fraudulent credit card transactions and other security breaches, our security measures may not prevent security breaches or identity theft that could harm our reputation and business. Currently, a significant number of our consumers provide credit card and other financial information and authorize us to bill their credit card accounts directly for all transaction fees charged by us. We rely on encryption and authentication technology to provide the security and authentication to effect secure transmission of confidential information, including customer credit card numbers. Advances in computer capabilities, new discoveries in the field of cryptography or other developments may result in a compromise or breach of the technology used by us to protect transaction data. In addition, any party who is able to illicitly obtain a user’s password could access the user’s transaction data. An increasing number of websites have reported breaches of their security. Any compromise of our security could damage our reputation and expose us to a risk of loss or litigation and possible liability. The coverage limits of our insurance policies may not be adequate to reimburse us for losses caused by security breaches.
Additionally, our servers are vulnerable to computer viruses, physical or electronic break-ins, and similar disruptions, and we have experienced “denial-of-service” type attacks on our system that have made all or portions of our consumer sites unavailable for periods of time. We may need to expend significant resources to protect against security breaches or to address problems caused by breaches. Disruptions in our services and damage caused by viruses and other attacks could cause a loss of user confidence in our systems and services, which could lead to reduced usage of our products and services and materially adversely affect our business and financial results.
New tax treatment of companies engaged in Internet commerce may adversely affect the commercial use of our search service and our financial results
Tax authorities at the international, federal, state and local levels are currently reviewing the appropriate tax treatment of companies engaged in Internet commerce. New or revised state tax regulations may subject us or our advertisers to additional state sales, income and other taxes. We cannot predict the effect of current attempts to impose sales, income or other taxes on commerce over the Internet. New or revised taxes and, in particular, sales taxes, would likely increase the cost of doing business online and decrease the attractiveness of advertising and selling goods and services over the Internet. Any of these events could have an adverse effect on our business and results of operations.
Risks Related to Accounting Matters
Accounting for employee stock options using the fair value method could significantly reduce (increase) our GAAP net income (loss)
As described in Note 1 (Summary of Significant Accounting Policies) to the Unaudited Condensed Consolidated Financial Statements in this report, we adopted SFAS 123R starting January 1, 2006. Under SFAS 123R, we are required to account for the fair value of stock options granted to employees as compensation expense, which is likely to have a significant adverse impact on our GAAP results of operations and net income (loss) per share. If we reduce or alter our use of share-based compensation to minimize the recognition of these expenses, our ability to recruit, motivate and retain employees may be impaired, which could put us at a competitive disadvantage in the marketplace. In order to prevent any net decrease in their overall compensation packages, we might decide to make corresponding increases in the cash compensation we pay to current and prospective new employees. An increase in employee wages and salaries would diminish our cash available for marketing, product development and other uses and might adversely impact our GAAP results of operations.
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Risks Related to the Capital Market
Our quarterly revenues and operating results may fluctuate for many reasons, each of which may negatively affect our stock price
Our revenues and operating results will likely fluctuate significantly from quarter to quarter as a result of a variety of factors, including:
| • | change in the composition of our AdCenter customer base, |
| • | change in composition of our AdCenter for Publishers customer base, |
| • | changes in our distribution network, particularly the gain or loss of key distribution network partners, or changes in the implementation of search results on partner websites, |
| • | changes in the number of advertisers who purchase our listings, or the amount of spending per customer, |
| • | changes in the amount, frequency and page views by consumers of our consumer sites, |
| • | the revenue-per-click we receive from advertisers, or other factors that affect the demand for, and prevailing prices of, Internet advertising and marketing services, |
| • | systems downtime on our AdCenter, our website or the websites of our distribution network partners, |
| • | fluctuations in audience and page impressions, or |
| • | the effect of SFAS 123R, which became effective January 1, 2006, and requires that we account for the fair value of stock awards granted to employees as compensation expense. |
Due to the above factors, we believe that period-to-period comparisons of our financial results are not necessarily meaningful, and you should not rely on past financial results as an indicator of our future performance. If our financial results in any future period fall below the expectations of securities analysts and investors, the market price of our securities would likely decline.
Our stock price is extremely volatile, and such volatility may hinder investors’ ability to resell their shares for a profit or avoid loss
The stock market has experienced significant price and volume fluctuations in recent years, and the stock prices of Internet companies have been extremely volatile. The low trading volume of our common stock may adversely affect its liquidity and reduce the number of market makers and/or large investors willing to trade in our common stock, making wider fluctuations in the quoted price of our common stock more likely to occur. Also, because of our limited operating history and the significant changes we experienced as a result of the expiration of our contractual relationship with Microsoft’s MSN in the first quarter of 2004, it is extremely difficult to evaluate our business and prospects. Should our stock price drop below our book value for a sustained period, it may become necessary to record an impairment charge to goodwill which would reduce our results of operations. You should evaluate our business in light of the risks, uncertainties, expenses, delays and difficulties associated with managing and growing a relatively new business, many of which are beyond our control.
Our stock price may fluctuate, and you may not be able to sell your shares for a profit, as a result of a number of factors including:
| • | changes in the market valuations of Internet companies in general and comparable companies in particular, |
| • | quarterly fluctuations in our operating results, |
| • | the termination or expiration of our distribution agreements, |
| • | our potential failure to meet our forecasts or analyst expectations on a quarterly basis, |
| • | the relatively thinly traded volume of our publicly traded shares, which means that small changes in the volume of trades may have a disproportionate impact on our stock price, |
| • | the loss of key personnel, or our inability to recruit experienced personnel to fill key positions, |
| • | changes in ratings or financial estimates by analysts or the inclusion/removal of our stock from certain stock market indices used to drive investment choices, |
| • | announcements of new distribution network partnerships, technological innovations, acquisitions or products or services by us or our competitors, |
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| • | the sales of substantial amounts of our common stock in the public market by our stockholders, or the perception that such sales could occur, |
| • | conditions or trends in the Internet that suggest a decline in rates of growth of advertising-based Internet companies. |
In the past, securities class action litigation has often been instituted after periods of volatility in the market price of a company’s securities. A securities class action suit against us could result in substantial costs and the diversion of management’s attention and resources, regardless of the merits or outcome of the case.
We may need additional capital in the future to support our operations and, if such additional financing is not available to us, on reasonable terms or at all, our liquidity and results of operations will be materially and adversely impacted
Although we believe that our working capital will provide adequate liquidity to fund our operations and meet our other cash requirements for the foreseeable future, unanticipated developments in the short term, such as the entry into agreements that require large cash payments or the acquisition of businesses with negative cash flows, may necessitate additional financing. We may seek to raise additional capital through public or private debt or equity financings in order to:
| • | fund the additional operations and capital expenditures, |
| • | take advantage of favorable business opportunities, including geographic expansion or acquisitions of complementary businesses or technologies, |
| • | develop and upgrade our technology infrastructure beyond current plans, |
| • | develop new product and service offerings, |
| • | take advantage of favorable conditions in capital markets, or |
| • | respond to competitive pressures. |
The capital markets, and in particular the public equity market for Internet companies, have historically been volatile. It is difficult to predict when, if at all, it will be possible for Internet companies to raise capital through these markets. We cannot assure you that the additional financing will be available on terms favorable to us, or at all. If we issue additional equity or convertible debt securities, our existing stockholders may experience substantial dilution.
Provisions of Delaware corporate law and provisions of our charter and bylaws may discourage a takeover attempt
Our charter and bylaws and provisions of Delaware law may deter or prevent a takeover attempt, including an attempt that might result in a premium over the market price for our common stock. Our board of directors has the authority to issue shares of preferred stock and to determine the price, rights, preferences and restrictions, including voting rights, of those shares without any further vote or action by the stockholders. The issuance of preferred stock, while providing desirable flexibility in connection with possible acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock. In addition, our charter and bylaws provide for a classified board of directors. These provisions, along with Section 203 of the Delaware General Corporation Law, prohibiting certain business combinations with an interested stockholder, could discourage potential acquisition proposals and could delay or prevent a change of control.
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| ITEM 6. | EXHIBITS |
Please see the exhibit index following the signature page of this report.
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Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| LOOKSMART, LTD. | ||
| By: | /s/ JOHN SIMONELLI | |
John Simonelli, Chief Financial Officer (Principal Financial Officer) | ||
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Exhibit Number | Description of Document | |
| 3.1 | Restated Certificate of Incorporation (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on November 14, 2005). | |
| 3.2 | Bylaws (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on August 14, 2000). | |
| 4.1 | Form of Specimen Stock Certificate (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on November 14, 2005). | |
| 4.2 | Forms of Stock Option Agreement used by the Registrant in connection with grants of stock options to employees, directors and other service providers in connection with the Amended and Restated 1998 Stock Plan (Filed with the Company’s Current Report on Form 8-K filed with the SEC on October 22, 2004). | |
| 4.3 | Form of cover sheet for use with Stock Option Agreement for grants of stock options to executives in connection with the Company’s Executive Team Incentive Plan, Plan Year 2006 (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on May 10, 2006). | |
| 4.4 | Form of Indemnification Agreement entered into between the Registrant and each of its directors and officers (Filed with the Company’s Registration Statement on Form S-1 (File No. 333-80581) filed with the SEC on June 14, 1999). | |
| 4.5 | Form of cover sheet for use with stock option agreement for grants of stock options to executives in connection with the Company’s Executive Team Incentive Plan, Plan Year 2007 (Filed with the Company’s Current Report on Form 8-K filed with the SEC on March 2, 2007). | |
| 10.1 | Form of Indemnification Agreement entered into between the Registrant and each of its directors and officers (Filed with the Company’s Registration Statement on Form S-1 (File No. 333-80581) filed with the SEC on June 14, 1999). | |
| 10.2 | Amended and Restated 1998 Stock Plan (Filed with the Company’s Registration Statement on Form S-1 (File No. 333-80581) filed with the SEC on June 14, 1999). | |
| 10.3 | 1999 Employee Stock Purchase Plan as amended (Filed with the Company’s Registration Statement on Form S-8 (File No. 333-129987) filed with the SEC on November 29, 2005). | |
| 10.4 | LookSmart, Ltd. Executive Team Incentive Plan, Plan Year 2006 (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on May 10, 2006). | |
| 10.5 | LookSmart, Ltd. Executive Team Incentive Plan, Plan Year 2007 (Filed with the Company’s Current Report on Form 8-K filed with the SEC on March 2, 2007). | |
| 10.7 | Zeal Media, Inc. 1999 Stock Plan (Filed with the Company’s Registration Statement on Form S-8 filed with the SEC on December 7, 2000). | |
| 10.8 | WiseNut, Inc. 1999 Stock Incentive Plan (Filed with the Company’s Registration Statement on Form S-8 filed with the SEC on April 18, 2002). | |
| 10.9 | LookSmart 2007 Equity Incentive Plan (Filed with the Company’s Definitive Proxy Statement and Amended Definitive Proxy Statement with the SEC on April 30 and June 11, 2007, respectively). | |
| 10.12 | Lease Agreement with Rosenberg SOMA Investments III, LLC for property located at 625 Second Street, San Francisco, California, dated May 5, 1999 (Filed with the Company’s Registration Statement on Form S-1 (File No. 333-80581) filed with the SEC on June 14, 1999). | |
| 10.13* | LookSmart, Ltd. Form Change of Control/Severance Agreement. | |
| 10.31 | Fourth Addendum to AdCenter License, Hosting and Support Agreement between the Registrant and IAC Search & Media dated June 14, 2007 (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on August 9, 2007). | |
| 10.32 | Sponsored Links Master Terms and Conditions between the Registrant and eBay, Inc. dated March 12, 2007 (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on August 9, 2007). | |
| 10.33‡ | LookSmart Reseller Terms and Conditions with MeziMedia dated September 7, 2005. (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on May 10, 2007). | |
| 10.34+ | Co-Location Services Agreement between the Registrant and Savvis Communications Corporation dated February 19, 2004 (Filed with the Company’s Quarterly Report on Form 10-Q/A filed with the SEC on November 7, 2003). | |
| 10.35+ | Second Addendum to AdCenter License, Hosting and Support Agreement between the Registrant and IAC Search & Media dated May 16, 2006 (Filed with the Company’s Form 10-Q with the SEC on August 8, 2006). | |
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Exhibit Number | Description of Document | |
| 10.36‡ | Third Addendum to AdCenter License, Hosting and Support Agreement between the Registrant and IAC Search & Media dated January 1, 2007. (Filed with the Company’s Annual Report on Form 10-K on March 16, 2007). | |
| 10.37+ | AdCenter License, Hosting and Support Agreement between the Registrant and Ask Jeeves, Inc. dated May 16, 2005 (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on May 10, 2006). | |
| 10.38+ | Addendum to AdCenter License, Hosting and Support Agreement between the Registrant and Ask Jeeves, Inc. dated January 20, 2006 (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on May 10, 2006). | |
| 10.39+ | Paid Listings License Agreement between the Registrant and SearchFeed.com dated April 15, 2006 (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on May 10, 2006). | |
| 10.40+ | License Agreement between the Registrant and SearchFeed.com dated November 23, 2003, as Amended on March 29, 2004 and March 21, 2005 (Filed with the Company’s Annual Report on Form 10-K filed with the SEC on March 15, 2006). | |
| 10.41 | Promotion letter between the Company and its Vice-President, Technology dated September 7, 2007 (Filed with the Company’s Current Report on Form 8-K with the SEC on September 12, 2007). | |
| 10.42 | Amendment to employment offer between the Company and its Chief Financial Officer dated August 27, 2007 (Filed with the Company’s Current Report on Form 8-K with the SEC on September 4, 2007). | |
| 10.43 | Employment offer letter between the Registrant and its Vice President, East Coast dated March 22, 2007 (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on May 10, 2007). | |
| 10.44 | Employment offer letter between the Registrant and its Vice President, Publisher Sales dated March 23, 2007 (Filed with the Company’s Quarterly Report on Form 10-Q filed with the SEC on May 10, 2007). | |
| 10.45 | Promotion letter between the Registrant and its Vice President, Finance and Principal Accounting Officer dated July 10, 2007. (Filed with the Company’s Current Report on Form 8-K filed with the SEC on July 16, 2007). | |
| 10.46 | Severance Agreement and General Release between the Company and Dave Hills dated August 2, 2007 (Filed with the Company’s Current Report on Form 8-K filed with the SEC on August 7, 2007). | |
| 10.47*‡ | Paid Listings License Agreement between the Registrant and Kontera Technologies, Inc. dated July 17, 2006. | |
| 10.48*‡ | License Agreement between the Registrant and Oversee.net dated April 1, 2004. | |
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Exhibit Number | Description of Document | |
| 10.58 | Amendment to employment offer letter between the Registrant and its Chief Executive Officer dated June 21, 2005 (Filed with the Company’s Current Report on Form 8-K filed with the SEC on June 21, 2005). | |
| 10.59 | Employment offer letter between the Registrant and its General Counsel and Senior Vice President dated as of July 11, 2005 (Filed with the Company’s Current Report on Form 8-K filed with the SEC on July 14, 2005). | |
| 10.61 | Employment offer letter between the Registrant and its Chief Financial Officer dated October 20, 2005 (Filed with the Company’s Current Report on Form 8-K filed with the SEC on October 27, 2005). | |
| 10.62 | Employment offer letter between the Registrant and its Vice President, Marketing dated as of December 4, 2005 (Filed with the Company’s Current Report on Form 8-K filed with the SEC on December 23, 2005). | |
| 10.63 | Promotion letter between the Registrant and its Vice-President, Advertising Sales dated November 15, 2006 (Filed with the Company’s Current Report on Form 8-K filed with the SEC on November 21, 2006). | |
| 31.1* | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
| 31.2* | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
| 32.1* | Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
| (*) | Filed herewith |
| (‡) | Material in the exhibit marked with a “‡” has been omitted pursuant to a request for confidential treatment filed with the Securities and Exchange Commission. Omitted portions have been filed separately with the Securities and Exchange Commission. |
| (+) | Confidential treatment has been granted with respect to portions of the exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission. |
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