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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 March 31, 2010
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.) |
55 Second Street
San Francisco, California 94105
(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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data file required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large-accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ¨ | Accelerated filer | ¨ | |||
| Non-accelerated filer | ¨ | Smaller reporting company | x | |||
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 April 30, 2010, there were 17,157,442 shares of the registrant’s common stock outstanding, par value $0.001 per share.
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| ITEM 1. | FINANCIAL INFORMATION |
LOOKSMART, LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)
| March 31, 2010 | December 31, 2009 | |||||||
| ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 20,192 | $ | 22,933 | ||||
Short-term investments | 4,473 | 4,780 | ||||||
Total cash, cash equivalents and short-term investments | 24,665 | 27,713 | ||||||
Trade accounts receivable, net | 5,111 | 3,990 | ||||||
Prepaid expenses and other current assets | 980 | 847 | ||||||
Total current assets | 30,756 | 32,550 | ||||||
Property and equipment, net | 4,286 | 3,717 | ||||||
Capitalized software and other assets, net | 2,112 | 2,080 | ||||||
Total assets | $ | 37,154 | $ | 38,347 | ||||
| LIABILITIES & STOCKHOLDERS’ EQUITY | ||||||||
Current liabilities: | ||||||||
Trade accounts payable | $ | 3,345 | $ | 2,918 | ||||
Accrued liabilities | 4,130 | 5,477 | ||||||
Deferred revenue and customer deposits | 1,062 | 1,113 | ||||||
Current portion of long-term obligations | 1,343 | 1,272 | ||||||
Total current liabilities | 9,880 | 10,780 | ||||||
Capital lease and other obligations, net of current portion | 1,689 | 1,646 | ||||||
Total liabilities | 11,569 | 12,426 | ||||||
Commitment and contingencies | ||||||||
Stockholders’ equity: | ||||||||
Convertible preferred stock, $0.001 par value; Authorized: 5,000 shares at March 31, 2010 and December 31, 2009; Issued and Outstanding: none at March 31, 2010 and December 31, 2009 | — | — | ||||||
Common stock, $0.001 par value; Authorized: 200,000 shares at March 31, 2010 and December 31, 2009; Issued and Outstanding: 17,157 shares and 17,145 shares at March 31, 2010 and December 31, 2009, respectively | 17 | 17 | ||||||
Additional paid-in capital | 261,164 | 260,981 | ||||||
Accumulated other comprehensive gain | 1 | 3 | ||||||
Accumulated deficit | (235,597 | ) | (235,080 | ) | ||||
Total stockholders’ equity | 25,585 | 25,921 | ||||||
Total liabilities and stockholders’ equity | $ | 37,154 | $ | 38,347 | ||||
The accompanying Notes are an integral part of these Unaudited Condensed Consolidated Financial Statements.
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LOOKSMART, LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
| Three Months ended March 31, | ||||||||
| 2010 | 2009 | |||||||
Revenue | $ | 13,286 | $ | 13,254 | ||||
Cost of revenue | 9,036 | 8,102 | ||||||
Gross profit | 4,250 | 5,152 | ||||||
Operating expenses: | ||||||||
Sales and marketing | 1,154 | 1,365 | ||||||
Product development and technical operations | 2,444 | 2,613 | ||||||
General and administrative | 1,239 | 3,369 | ||||||
Total operating expenses | 4,837 | 7,347 | ||||||
Loss from operations | (587 | ) | (2,195 | ) | ||||
Non-operating income (expense), net | (17 | ) | 54 | |||||
Loss from continuing operations before income taxes | (604 | ) | (2,141 | ) | ||||
Income tax expense | 6 | 8 | ||||||
Loss from continuing operations | (610 | ) | (2,149 | ) | ||||
Income from discontinued operations, net of tax | 93 | 109 | ||||||
Net loss | $ | (517 | ) | $ | (2,040 | ) | ||
Net loss per share - Basic and Diluted | ||||||||
Loss from continuing operations | $ | (0.04 | ) | $ | (0.13 | ) | ||
Income from discontinued operations, net of tax | 0.01 | 0.01 | ||||||
Net loss per share | $ | (0.03 | ) | $ | (0.12 | ) | ||
Weighted average shares outstanding used in computing basic and diluted net loss per share | 17,145 | 17,076 | ||||||
The accompanying Notes are an integral part of these Unaudited Condensed Consolidated Financial Statements.
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LOOKSMART, LTD. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
| Three Months Ended March 31, | ||||||||
| 2010 | 2009 | |||||||
Cash flows from operating activities: | ||||||||
Net loss | $ | (517 | ) | $ | (2,040 | ) | ||
Adjustment to reconcile net loss to net cash used in operating activities: | ||||||||
Depreciation and amortization | 658 | 716 | ||||||
Share-based compensation | 169 | 517 | ||||||
Gain from sale of assets and other non-cash charges | (97 | ) | (146 | ) | ||||
Changes in operating assets and liabilities: | ||||||||
Trade accounts receivable, net | (1,114 | ) | 1,801 | |||||
Prepaid expenses and other current assets | (259 | ) | 304 | |||||
Trade accounts payable | 427 | (1,014 | ) | |||||
Accrued liabilities | (561 | ) | (1,558 | ) | ||||
Deferred revenue and customer deposits | (51 | ) | 106 | |||||
Other long-term obligations | 83 | (297 | ) | |||||
Net cash used in operating activities | (1,262 | ) | (1,611 | ) | ||||
Cash flows from investing activities: | ||||||||
Purchase of short-term investments | (3,498 | ) | (1,019 | ) | ||||
Proceeds from sale of short-term investments | 3,794 | 6,200 | ||||||
Proceeds from sale of equipment | 17 | — | ||||||
Payments for property and equipment and capitalized software development | (1,546 | ) | (359 | ) | ||||
Proceeds from contingent purchase consideration of certain consumer assets | 86 | 131 | ||||||
Net cash provided by (used in) investing activities | (1,147 | ) | 4,953 | |||||
Cash flows from financing activities: | ||||||||
Principal payments of notes | — | (17 | ) | |||||
Principal payments of capital lease obligations | (332 | ) | (221 | ) | ||||
Net cash used in financing activities | (332 | ) | (238 | ) | ||||
Increase (decrease) in cash and cash equivalents | (2,741 | ) | 3,104 | |||||
Cash and cash equivalents, beginning of period | 22,933 | 22,393 | ||||||
Cash and cash equivalents, end of period | $ | 20,192 | $ | 25,497 | ||||
Supplemental disclosure of noncash activities | ||||||||
Assets acquired through capital lease obligations | $ | 363 | $ | 716 | ||||
Property and equipment received and liability accrued | $ | 74 | $ | 145 | ||||
The accompanying Notes are an integral part of these Unaudited Condensed Consolidated Financial Statements.
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LOOKSMART, LTD. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Nature of Business
LookSmart, Ltd. (“LookSmart” or the “Company”) is a search advertising network solutions company that provides relevant solutions for search advertisers and publishers. LookSmart was organized in 1996 and is incorporated in the State of Delaware.
LookSmart operates in a large online search advertising ecosystem serving ads that target user queries on partner sites. The Company operates in the middle of this ecosystem, acquiring search queries from a variety of sources and matching them with the keywords of its search advertising customers. The Company’s largest category of customers has been intermediaries, the majority of which purchase clicks to sell into the affiliate networks of the large search engine providers. Another category of customers are direct advertisers and their agencies, some of whom want conversions or sales from the clicks, while others want unique page views. The last category of customers is self-service advertisers that sign-up online and pay by credit card.
The Company offers search advertising customers targeted, pay-per-click (PPC) search via a monitored search advertising distribution network using the Company’s “AdCenter” platform technology. The Company’s search advertising network includes publishers and search advertising customers, including intermediaries and direct advertising customers and their agencies as well as self-service customers in the United States and certain other countries. The Company’s application programming interface (“API”) allows search advertising customers and their advertising agencies to connect any type of marketing or reporting software with minimal effort, for easier access, management, and optimization of search advertising campaigns.
The Company also offers publishers licensed private-label search advertiser network solutions based on its AdCenter platform technology (“Publisher Solutions”). Publisher Solutions consist of hosted auction-based ad serving with an ad backfill capability that allows publishers and portals to manage their advertiser relationships, distribution channels and accounts.
In the first quarter of 2008, the Company’s management made the decision to exit its remaining consumer products activities and to sell or otherwise dispose of the remaining consumer assets. During 2008, the Company sold the intellectual property rights to the “Wisenut” trademark and related domain names and decided to wind down the Furl operations. The Furl assets were accounted for under the guidance of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 360-10-40,Impairment or Disposal of Long-Lived Assets (“ASC 360-10-40”) as “assets held for sale” and a full impairment of these assets was recorded at December 31, 2008. In the first quarter of 2009, the Furl assets were sold. The results of operations of consumer product activities, including related gains (losses), have been classified as discontinued operations for all periods presented in the accompanying Unaudited Condensed Consolidated Statements of Operations (see Note 2). At March 31, 2010, the Company continues to own the Wisenut search engine technology, intellectual property rights in such technology, and other assets.
Principles of Consolidation
The Unaudited Condensed Consolidated Financial Statements as of March 31, 2010 and December 31, 2009, and for the three months ended March 31, 2010 and 2009, 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 March 31, 2010, and for the three months ended March 31, 2010 and 2009, reflect all adjustments that are normal and recurring in nature and, in the opinion of management, are necessary for a fair representation of the Company’s financial position as of March 31, 2010 and 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 year ended December 31, 2009 (“Annual Report”). The Unaudited Condensed Consolidated Balance Sheet as of December 31, 2009 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 periods ended March 31, 2010 are not necessarily indicative of results to be expected for the full year.
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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 (“GAAP”). 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, and current economic conditions, 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. In management’s opinion, all adjustments necessary for a fair statement are reflected in the interim periods presented.
Investments
The Company invests its excess cash primarily in debt instruments of high-quality corporate and government issuers. All highly liquid instruments with maturities at the date of purchase greater than ninety days are considered investments. All instruments with maturities greater than one year from the balance sheet date are considered long-term investments unless management intends to liquidate such securities in the current operating cycle. Such securities are classified as short-term investments. These securities are classified as available-for-sale and carried at fair value.
Changes in the value of these investments are primarily related to changes in interest rates and are considered to be temporary in nature. Except for declines in fair value that are not considered temporary, net unrealized gains or losses on these investments are reported as a component of other comprehensive income (loss) in stockholders’ equity. The Company recognizes realized gains and losses upon sale of investments using the specific identification method.
Fair Value of Financial Instruments
The Company’s estimate of fair value for assets and liabilities is based on a framework that establishes a hierarchy of the inputs used in valuation and gives the highest priority to quoted prices in active markets and requires that observable inputs be used in the valuations when available. The disclosure of fair value estimates is based on whether the significant inputs into the valuation are observable. In determining the level of the hierarchy in which the estimate is disclosed, the highest priority is given to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs that reflect our significant market assumptions. The three levels of the hierarchy are as follows:
Level 1: | Unadjusted quoted market prices for identical assets or liabilities in active markets that we have the ability to access. | |
Level 2: | Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets in inactive markets; or valuations based on models where the significant inputs are observable (e.g., interest rates, yield curves, default rates, etc.) or can be corroborated by observable market data. | |
Level 3: | Valuations based on models where significant inputs are not observable. The unobservable inputs reflect our assumptions about the assumptions that market participants would use. | |
Revenue Recognition
Online search advertising revenue is primarily composed of per-click fees that the Company charges customers. 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 revenue share from licensing of private-labeled versions of the Company’s products.
Revenues associated with online advertising products, including Advertiser Networks, are generally recognized once collectability is established, delivery of services has occurred, all performance obligations have been satisfied, and no refund obligations exist. The Company pays 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 (“TAC”) and are included in cost of revenues. 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 the Company is the primary obligor to the advertisers who are the customers of the advertising service.
The Company also enters into agreements to provide private-labeled versions of its products, including licenses to the AdCenter. These license arrangements include multiple elements: revenue-sharing based on the publisher’s customer’s monthly revenue generated through the AdCenter application; upfront fees; and other license fees. The Company recognizes upfront fees over the term of the arrangement or the expected period of performance, other 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 collectability of the resulting receivable is reasonably assured.
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The Company provides 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. The allowance for returns included in trade receivables, net is insignificant at March 31, 2010 and December 31, 2009.
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.
Allowance for Doubtful Accounts
The Company maintains an allowance for doubtful accounts for estimated losses resulting from customers failing 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 and economic conditions. The Company will record an increase or reduction of its allowance for doubtful accounts if collection rates or economic conditions are more or less favorable than it anticipated. Additional allowances for doubtful accounts may be required if there is deterioration in past due balances, if economic conditions are less favorable than the Company anticipated or for customer-specific circumstances, such as bankruptcy. The allowance for doubtful accounts included in trade accounts receivable, net is $0.1 million at March 31, 2010 and December 31, 2009. Bad debt expense (benefit) included in sales and marketing expense is insignificant and ($0.1) million for the three months ended March 31, 2010 and 2009, respectively.
Concentrations, Credit Risk and Credit Risk Evaluation
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash equivalents, investments, and accounts receivable. As of March 31, 2010 and December 31, 2009, the Company placed its cash equivalents and investments primarily through one financial institution, City National Bank (“CNB”), and mitigated the concentration of credit risk by placing percentage limits on the maximum portion of the investment portfolio which may be invested in any one investment instrument. These amounts exceed federally insured limits at March 31, 2010 and December 31, 2009. The Company has not experienced any credit losses on these cash equivalents and investment accounts and does not believe it is exposed to any significant credit risk on these funds. The fair value of these accounts is subject to fluctuation based on market prices.
Credit Risk, Customer and Vendor Evaluation
Accounts receivable are typically unsecured and are derived from sales to 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 receivables are past due. Historically, such losses have been within management’s expectations.
The following table reflects customers that accounted for more than 10% of gross accounts receivable:
| March 31, 2010 | December 31, 2009 | |||||
Company 1 | 12 | % | 16 | % | ||
Company 2 | 15 | % | * | * | ||
**Less than 10% |
| |||||
Revenue Concentrations
The following table reflects countries that accounted for more than 10% of net revenue:
| Three Months Ended March 31, | ||||||
| 2010 | 2009 | |||||
United States | 64 | % | 86 | % | ||
Canada | 14 | % | 10 | % | ||
United Kingdom | 10 | % | * | * | ||
**Less than 10% |
| |||||
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LookSmart derives its revenue from two service offerings, or “products”: Advertising Networks and Publisher Solutions. The percentage distributions between the two service offerings are as follows:
| Three Months Ended March 31, | ||||||
| 2010 | 2009 | |||||
Advertising Networks | 94 | % | 91 | % | ||
Publisher Solutions | 6 | % | 9 | % | ||
The following table reflects the percentage of revenue attributed to customers who accounted for 10% or more of net revenue:
| Three Months Ended March 31, | ||||||
| 2010 | 2009 | |||||
Company 1 | * | * | 20 | % | ||
Company 2 | 13 | % | * | * | ||
Company 3 | * | * | 10 | % | ||
Company 4 | 11 | % | * | * | ||
**Less than 10% |
| |||||
For the three months ended March 31, 2010, IAC Search and Media (“IAC” or “Company 1”) accounted for 9% of net revenue, and 74% of Publisher Solutions revenue. On May 19, 2009, Ask Sponsored Listings, a division of IAC, notified the Company that it did not intend to renew the May 2005 AdCenter License, Hosting and Support Agreement, which provides for certain Publisher Solutions services (the “Agreement”) upon its expiration. The Agreement, as amended, was scheduled to expire by its terms on December 31, 2009. On December 22, 2009, the Company and IAC further amended the Agreement, effective December 1, 2009, to extend the term through March 31, 2010 and to allow IAC to extend the term in one-month intervals up to a maximum period of six months. On March 17, 2010, IAC notified the Company that, in accordance with the December 2009 amendment to the Agreement, it intends to extend the term of the Agreement on a monthly basis up to June 30, 2010.
The Company derives its revenue primarily from its relationships with significant distribution network partners. The following table reflects the distribution partners that accounted for 10% or more of the total traffic acquisition costs (“TAC”):
| Three Months Ended March 31, | ||||||
| 2010 | 2009 | |||||
Distribution Partner 1 | * | * | 13 | % | ||
Distribution Partner 2 | 11 | % | 13 | % | ||
Distribution Partner 3 | * | * | 12 | % | ||
Distribution Partner 4 | 11 | % | * | * | ||
Distribution Partner 5 | * | * | 10 | % | ||
**Less than 10% |
| |||||
Internal Use Software Development Costs
The Company capitalizes external direct costs of materials and services consumed in developing and obtaining internal-use computer software and the payroll and payroll-related costs for employees who are directly associated with and who devote time to developing the internal-use computer software.
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Management exercises judgment in determining when costs related to a project may be capitalized, in assessing the ongoing value of the capitalized costs, and in determining the amortization period for the capitalized costs. The Company expects to continue to invest in internally developed software and to capitalize such costs.
Intangible Assets with Definite Lives
The Company amortizes acquired intangible assets with definite lives over periods from two to seven years and the amortization expense is primarily classified as cost of revenues in the Company’s Unaudited Condensed Consolidated Statements of Operations.
Impairment of Long-Lived Assets
The Company reviews long-lived assets held or used in operations, including property and equipment and capitalized software, for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable. Subject assets are tested for impairment at the lowest level of operations that generate cash flows that are largely independent of the cash flows from those of other groups of asset and liabilities. Management has determined that the equity of its single reporting unit is the lowest level of operation at which independent cash flows can be identified. An impairment loss is recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition is less than its carrying amount. Impairment, if any, is measured as the amount by which the carrying amount of a long-lived asset exceeds its fair value. Assets to be disposed of are reported at the lower of carrying amount or fair value less cost to dispose.
The Company tested its long-lived assets used in operations for impairment as of December 31, 2009, and determined they were not impaired.
Traffic Acquisition Costs
The Company enters into agreements of varying durations with its distribution network partners that display the Company’s listings ads on their sites in return for a percentage of the revenue-per-click that the Company receives when the ads are clicked on those partners’ sites.
The Company also enters into agreements of varying durations with third party affiliates. There are generally three economic structures of the affiliate agreements: guaranteed fixed payments which often carry reciprocal performance guarantees from the affiliate, variable payments based on a percentage of the Company’s revenue or based on a certain metric, such as number of searches or paid clicks, or a combination of the two.
The Company records TAC expenses as cost of revenue under two methods; agreements with fixed payments are expensed pro-rata over the term the fixed payment covers, and agreements based on a percentage of revenue, number of paid introductions, number of searches, or other metrics are expensed based on the volume of the underlying activity or revenue, multiplied by the agreed-upon price or rate.
Share-Based Compensation
The Company recognizes share-based compensation costs for all share-based payment transactions with employees, including grants of employee stock options and employee stock purchases related to the Employee Stock Purchase Plan, over the requisite service period based on their relative fair values. The Company estimates the fair value of share-based payment awards on the grant date using the Black-Scholes method. 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. Share-based compensation expense recognized for the three months ended March 31, 2010 and 2009, were $0.2 million and $0.5 million, respectively, which was related to stock grants, options and employee stock purchases.
Forfeitures are 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 end of each fiscal quarter, based on historical rates.
The Company elected to adopt the alternative transition method for calculating the tax effects of share-based compensation 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.
Income Taxes
The Company accounts for income taxes using the liability method. Under the liability method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. The Company records liabilities, where appropriate, for all uncertain income tax positions. The Company recognizes potential accrued interest and penalties related to unrecognized tax benefits within operations as income tax expense.
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Comprehensive Gain
Other comprehensive gain as of March 31, 2010 and December 31, 2009, consists of unrealized gains on marketable securities categorized as available-for-sale.
Net Income (Loss) per Common Share
Basic net income (loss) and diluted net loss per share is calculated using the weighted average shares of common stock outstanding. Diluted net income per share is calculated using the weighted average number of common and potentially dilutive common shares outstanding during the period, using the treasury stock method for stock options and warrants.
Segment Information
The Company has one operating segment, online advertising. While the Company operates under one operating segment, management reviews revenue under two product offerings—Advertiser Networks and Publisher Solutions
As of March 31, 2010 and December 31, 2009, all of the Company’s accounts receivable, intangible assets and deferred revenue related to the online advertising segment. All long-lived assets are located in the United States.
Recent Accounting Pronouncements
With the exception of those stated below, there have been no recent accounting pronouncements or changes in accounting pronouncements during the three months ended March 31, 2010, as compared to the recent accounting pronouncements described in the Company’s Annual Report that are of material significance, or have potential material significance, to the Company.
Effective April 1, 2009, the Company adopted FASB ASC 855-10, Subsequent Events – Overall (“ASC 855-10”). ASC 855-10 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. It required the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date – that is, whether that date represents the date the financial statements were issued or were available to be issued. This disclosure should alert all users of financial statements that an entity has not evaluated subsequent events after that date in the set of financial statements being presented. However, in February 2010, the FASB amended the guidance to remove the requirement for SEC filers to disclose the date through which an entity has evaluated subsequent events. Adoption of the updated guidance did not have a material impact on the Company’s results of operations, financial position or liquidity.
Effective January 1, 2010, the Company adopted the FASB’s updated guidance related to fair value measurements and disclosures, which requires a reporting entity to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and to describe the reasons for the transfers. In addition, in the reconciliation for fair value measurements using significant unobservable inputs, or Level 3, a reporting entity should disclose separately information about purchases, sales, issuances and settlements (that is, on a gross basis rather than one net number). The updated guidance also requires that an entity should provide fair value measurement disclosures for each class of assets and liabilities and disclosures about the valuation techniques and inputs used to measure fair value for both recurring and non-recurring fair value measurements for Level 2 and Level 3 fair value measurements. The guidance is effective for interim or annual financial reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances and settlements in the roll forward activity in Level 3 fair value measurements, which are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. Therefore, the Company has not yet adopted the guidance with respect to the roll forward activity in Level 3 fair value measurements. The Company has updated its disclosures to comply with the updated guidance (see Note 12), however, adoption of the updated guidance did not have a material impact on the Company’s results of operations, financial position or liquidity.
2. Discontinued Operations
Foreign Operations
In 2004, the Company’s management made the decision to cease operating and liquidate its then existing foreign legal entities, and reclassified its consolidated financial statements to reflect these foreign entity expenses as discontinued operations. The Company completed the dissolution of these entities in 2009. During the three months ended March 31, 2009, the loss related to the liquidation of the Company’s foreign legal entities was not significant. As of March 31, 2010 and December 31, 2009, there were no net assets related to the discontinued foreign legal entities.
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Consumer Products
In the first quarter of 2008, the Company’s management made the decision to exit the remaining consumer products activities and to sell or otherwise dispose of its remaining consumer assets. The various remaining related websites and assets associated with the consumer products activities met the criteria to be classified as discontinued operations. The results of operations related to assets to be disposed of, and of previously disposed assets, including any related gains and losses are classified as discontinued operations in the accompanying Unaudited Condensed Consolidated Statements of Operations.
As of March 31, 2010 and December 31, 2009, the Company owns the Wisenut search engine technology, intellectual property rights in such technology and other assets.
The following table reflects revenue, gross profit, operating expenses, gain on disposal and net income from discontinued operations for the three months ended March 31, 2010 and 2009 (in thousands):
| Three Months Ended March 31, | ||||||
| 2010 | 2009 | |||||
Revenue | $ | — | $ | 8 | ||
Gross profit | $ | — | $ | 8 | ||
Product development and technical operations expense | — | 36 | ||||
Total operating expenses | — | 36 | ||||
Gain on disposal | 93 | 137 | ||||
Net income from discontinued operations | $ | 93 | $ | 109 | ||
Furl
In the first quarter of 2008, the Company’s management made the decision to exit the remaining consumer products activities and to sell or otherwise dispose of the remaining consumer assets. As a result, beginning in the first quarter of 2008, Furl assets, consisting of property and equipment, capitalized software, goodwill and intangibles, were accounted for as “assets held for sale.” In the fourth quarter of 2008, the Company determined that the Furl assets were impaired due to the lack of marketability and the decision to wind down the Furl operations. As a result, the Company recognized an impairment charge of $1.4 million during 2008. On February 26, 2009, the Company sold the Furl assets and received a warrant to purchase 1.3 million shares of the acquirer’s non-marketable common stock at an exercise price of $0.30 per share (in each case, subject to certain adjustments in certain circumstances). The Company determined the warrant received had no significant value and did not record a gain on the disposal. The Furl assets had no net book value. The warrant expired unexercised in February 2010.
Net Nanny
On January 22, 2007, the Company completed the sale of Net Nanny to Content Watch, Inc. (“Content Watch”). The sale proceeds were comprised of contingent purchase consideration that may be realized at future dates based on the amount of revenue received by Content Watch. The Company recorded contingent purchase consideration of $0.1 million for both the three months ended March 31, 2010 and 2009. Under the terms of the Content Watch agreement, the contingent purchase consideration will end in 2010. Contingent purchase consideration has been classified as gain on disposal.
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3. Cash, Cash Equivalents and Short-Term Investments
The following table summarizes the Company’s cash and available-for-sale securities’ amortized cost, gross unrealized gains, gross unrealized losses and estimated fair value by significant investment category as of March 31, 2010 and December 31, 2009 (in thousands):
| March 31, 2010 | December 31, 2009 | |||||||||||||||||||||||
| Amortized Cost | Unrealized Gains | Unrealized Losses | Estimated Fair Value | Amortized Cost | Unrealized Gains | Unrealized Losses | Estimated Fair Value | |||||||||||||||||
Cash and cash equivalents: | ||||||||||||||||||||||||
Cash | $ | 6,375 | $ | — | $ | — | $ | 6,375 | $ | 4,460 | $ | — | $ | — | $ | 4,460 | ||||||||
Cash equivalents | ||||||||||||||||||||||||
Money market mutual funds | 73 | — | — | 73 | 10,074 | — | — | 10,074 | ||||||||||||||||
Certificates of deposit | 1,245 | — | — | 1,245 | 2,000 | — | — | 2,000 | ||||||||||||||||
Commercial paper | 12,499 | — | — | 12,499 | 6,399 | — | — | 6,399 | ||||||||||||||||
Total cash equivalents | 13,817 | — | — | 13,817 | 18,473 | — | — | 18,473 | ||||||||||||||||
Total cash and cash equivalents | 20,192 | — | — | 20,192 | 22,933 | — | — | 22,933 | ||||||||||||||||
Short-term investments: | ||||||||||||||||||||||||
Corporate bonds | 728 | 1 | — | 729 | 2,887 | 3 | — | 2,890 | ||||||||||||||||
Certificates of deposit | 1,745 | — | — | 1,745 | 490 | — | — | 490 | ||||||||||||||||
Commercial paper | 1,999 | — | — | 1,999 | 1,400 | — | — | 1,400 | ||||||||||||||||
Total short-term investments | 4,472 | 1 | — | 4,473 | 4,777 | 3 | — | 4,780 | ||||||||||||||||
Total cash, cash equivalents and short-term investments | $ | 24,664 | $ | 1 | $ | — | $ | 24,665 | $ | 27,710 | $ | 3 | $ | — | $ | 27,713 | ||||||||
Realized gains and realized losses were not significant for either of the three months ended March 31, 2010 and 2009. As of March 31, 2010 and December 31, 2009, there were no unrealized losses on investments. The cost of all securities sold is based on the specific identification method.
The contractual maturities of cash equivalents and short-term investments at March 31, 2010 and December 31, 2009 were less than one year.
The Company typically invests in highly-rated securities, and its policy generally limits the amount of credit exposure to any one issuer. When evaluating the investments for other-than-temporary impairment, the Company reviews such factors as the length of time and extent to which fair value has been below cost basis, the financial condition of the issuer, and the Company’s intent to sell, or whether it is more likely than not it will be required to sell, the investment before recovery of the investment’s amortized cost basis. During the three months ended March 31, 2010 and 2009, the Company did not recognize any impairment charges on outstanding investments. As of March 31, 2010, the Company does not consider any of its investments to be other-than-temporarily impaired.
4. Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets consisted of the following at March 31, 2010 and December 31, 2009 (in thousands):
| March 31, 2010 | December 31, 2009 | |||||
Other prepaid expenses | $ | 678 | $ | 538 | ||
Income taxes receivable | 172 | 172 | ||||
Other current assets | 130 | 137 | ||||
Total | $ | 980 | $ | 847 | ||
5. Property and Equipment
Property and equipment consisted of the following at March 31, 2010 and December 31, 2009 (in thousands):
| March 31, 2010 | December 31, 2009 | |||||||||||||||||||
| Cost | Accumulated Depreciation | Net Book Value | Cost | Accumulated Depreciation | Net Book Value | |||||||||||||||
Computer equipment | $ | 11,769 | $ | (7,797 | ) | $ | 3,972 | $ | 10,920 | $ | (7,516 | ) | $ | 3,404 | ||||||
Furniture and fixtures | 74 | (56 | ) | 18 | 74 | (55 | ) | 19 | ||||||||||||
Software | 1,260 | (1,249 | ) | 11 | 1,260 | (1,247 | ) | 13 | ||||||||||||
Leasehold improvements | 308 | (23 | ) | 285 | 288 | (7 | ) | 281 | ||||||||||||
Total | $ | 13,411 | $ | (9,125 | ) | $ | 4,286 | $ | 12,542 | $ | (8,825 | ) | $ | 3,717 | ||||||
Depreciation expense on property and equipment for the three months ended March 31, 2010 and 2009, including property and equipment under capital lease, was approximately $0.4 million and $0.5 million, respectively, and is recorded in operating expenses. Equipment under capital lease totaled $4.8 million and $4.4 million as of March 31, 2010 and December 31, 2009, respectively. Depreciation expense on equipment under capital lease was $0.3 million and $0.2 million for the three months ended March 31, 2010 and 2009, respectively. Additionally, accumulated depreciation on equipment under capital lease was $2.1 million and $1.8 million as of March 31, 2010 and December 31, 2009, respectively.
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6. Capitalized Software and Other Assets
The Company’s capitalized software and other assets are as follows at March 31, 2010 and December 31, 2009 (in thousands):
| March 31, 2010 | December 31, 2009 | |||||||||||||||||||
| Gross Amount | Accumulated Amortization | Net Book Value | Gross Amount | Accumulated Amortization | Net Book Value | |||||||||||||||
Capitalized software | $ | 5,688 | $ | (3,733 | ) | $ | 1,955 | $ | 5,499 | $ | (3,449 | ) | $ | 2,050 | ||||||
Amortizable purchased technology | 78 | (78 | ) | — | 78 | (78 | ) | — | ||||||||||||
Other assets | 157 | — | 157 | 30 | — | 30 | ||||||||||||||
| $ | 5,923 | $ | (3,811 | ) | $ | 2,112 | $ | 5,607 | $ | (3,527 | ) | $ | 2,080 | |||||||
Capitalized software consists of external direct costs of materials and services consumed in developing and obtaining internal-use computer software and the payroll and payroll-related costs for employees who are directly associated with and who devote time to developing the internal-use computer software and is amortized over three years. Amortization expense was $0.3 million for both the three months ended March 31, 2010 and 2009.
Amortizable purchased technology had an estimated useful life of three years. Amortization expense related to purchased technology was not significant for the three months ended March 31, 2009 and has been classified as discontinued operations.
7. Accrued Liabilities
Accrued liabilities consisted of the following as of March 31, 2010 and December 31, 2009 (in thousands):
| March 31, 2010 | December 31, 2009 | |||||
Accrued distribution and partner costs | $ | 2,499 | $ | 2,957 | ||
Accrued compensation and related expenses | 757 | 839 | ||||
Accrued legal costs and other professional service fees | 393 | 376 | ||||
Accrued legal proceedings liability | 339 | 339 | ||||
Accrued equipment purchases | 74 | 806 | ||||
Other | 68 | 160 | ||||
Total accrued liabilities | $ | 4,130 | $ | 5,477 | ||
See Note 10, Commitments and Contingencies, for complete discussion of the accrued legal proceedings liability.
8. Lease Restructuring
Between 2003 and 2006, the Company vacated portions of its leased headquarter office facilities that expired in November 2009, incurring lease restructuring costs related to closing these facilities and entering into various subleases. During the three months ended March 31, 2009, the Company amortized $0.3 million of accrued lease restructuring costs to operating expenses. The Company had no lease restructuring costs accrued at March 31, 2010 and December 31, 2009.
9. Capital Lease and Other Obligations
Capital lease and other obligations consist of the following at March 31, 2010 and December 31, 2009 (in thousands):
| March 31, 2010 | December 31, 2009 | |||||||
Capital lease obligations | 2,869 | 2,838 | ||||||
Deferred rent | 163 | 80 | ||||||
Total long-term obligations | 3,032 | 2,918 | ||||||
Less: current portion | (1,343 | ) | (1,272 | ) | ||||
Long-term obligations, net of current portion | $ | 1,689 | $ | 1,646 | ||||
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Capital Lease Obligations
City National Bank
On April 6, 2007, the Company entered into a master equipment lease agreement with CNB for an original amount of up to $5.0 million for the purchase of computer equipment. On April 30, 2009, the lease line was extended through April 30, 2010. As of March 31, 2010, the Company had drawn down approximately $4.9 million of the available lease line of credit. Interest on the capital leases was calculated using interest rates ranging from 4.32% to 7.95% per annum. As of March 31, 2010, there remained $0.1 million under the master lease agreement which was not utilized before it expired on April 30, 2010. Effective as of September 30, 2009, the master equipment lease agreement was amended to modify two financial covenants, with which the Company was in compliance as of March 31, 2010.
The agreements with CNB, consisting of the outstanding standby letters of credit (each an “SBLC”) and the master equipment lease agreement, contain cross-default provisions, whereby a default under one is deemed a default for the other. As of March 31, 2010 and December 31, 2009, the Company was not in default on either agreement with CNB (see Note 10).
Cisco Systems Capital Corporation
In December 2009, the Company entered into an Agreement to Lease Equipment (“Lease Agreement”) with Cisco Systems Capital Corporation (“Cisco”), whereby the Company was to lease from Cisco certain hardware, software and maintenance services. The Lease Agreement provided for the lease of $0.8 million of hardware and software and $0.2 million of maintenance services over a period of three years. In connection with the Lease Agreement, the Company provided Cisco a SBLC for $0.2 million. As of December 31, 2009, $0.5 million of the equipment and software had been received and is included in property and equipment with an offsetting amount in accrued liabilities in the Condensed Consolidated Financial Statements. In March 2010, prior to the commencement of the lease, the Company and Cisco agreed to cancel the Lease Agreement, and the Company paid the vendor $1.0 million for the hardware, software and maintenance services. No additional costs will be incurred by the Company. The SBLC provided to Cisco for $0.2 million will be released by Cisco and terminated.
10. Commitments and Contingencies
As of March 31, 2010, future minimum payments under all capital and operating leases are as follows (in thousands):
| CNB Capital Lease | Operating Leases | Total | ||||||||
Nine months ending December 31, 2010 | $ | 1,126 | $ | 405 | $ | 1,531 | ||||
Years ending December 31, | ||||||||||
2011 | 1,186 | 496 | 1,682 | |||||||
2012 | 617 | 517 | 1,134 | |||||||
2013 | 145 | 536 | 681 | |||||||
2014 | — | 557 | 557 | |||||||
Total minimum payments | 3,074 | $ | 2,511 | $ | 5,585 | |||||
Less: amount representing interest | (205 | ) | ||||||||
Present value of net minimum payments | 2,869 | |||||||||
Less: current portion | (1,343 | ) | ||||||||
Long-term portion of capital lease obligations | $ | 1,526 | ||||||||
Operating Lease
On August 31, 2009, the Company entered into an agreement to sublease office space for its headquarters in San Francisco, California, under an operating lease that commenced in November 2009 and expires on December 30, 2014. In addition to scheduled base rent payments, the Company will also be responsible for varying amounts of operating and property tax expenses.
Letters of Credit
At March 31, 2010 and December 31, 2010, the Company has outstanding SBLCs related to the security of a building lease for $0.3 million and security on an equipment lease for $0.2 million. Each of the SBLCs contains two financial covenants, which were amended as of September 30, 2009. In March 2010, the equipment lease requiring the $0.2 million SBLC was cancelled. The SBLC will be released by the vendor and terminated.
The agreements with CNB, consisting of the SBLCs and master equipment lease agreement, contain cross-default provisions, whereby a default under one is deemed a default for the other. As of March 31, 2010 and December 31, 2009, the Company was not in default on either agreement with CNB (see Note 9).
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Purchase Obligations
In October 2009, the Company entered into a Master Services Agreement and related Service Level Agreement for IT data center services for a two year term. In January 2010, the Company started the transition to the new facility and expects to complete the transition by the end of the second quarter of 2010. The contractual obligations under the agreement include non-recurring charges of $0.1 million and recurring charges of $0.9 million each year.
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 leases for certain claims arising from such facility or lease.
Officer and Director Indemnification
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.
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.
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 September 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 was 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 September 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 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,
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2006, the Court ordered the remaining defendants, including the Company, to mediation and further stayed the proceedings to September 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. On or about November 20, 2007, the Plaintiffs and the Company entered into a Stipulation and Settlement Agreement (the “Settlement Agreement”) to settle the matter in its entirety. On or about November 29, 2007, the Court preliminarily approved the Settlement Agreement and on February 29, 2008, the court entered an order to approve as final the Settlement Agreement. Pursuant to the Settlement Agreement, the Company has agreed to establish a Settlement Fund in the amount of up to approximately $2.5 million to be allocated as follows: (a) the Class Member Fund which should not exceed approximately $2.0 million in advertising credits, (b) the Fees Award to Class Counsel, which shall not exceed the amount of approximately $0.6 million; and (c) the Incentive Award (as hereinafter defined) to the three Class Representatives, which shall not exceed a collective immaterial amount. In the event that the total of the credit claims paid is less than approximately $0.8 million, the difference between the total amount of the credit claims paid and approximately $0.8 million will be paid to charities in the form of advertising credits. Should the total of the credit claims paid to the Settlement Class Members as a group plus any amounts allocated to charities be more than approximately $0.8 million but less than approximately $2.5 million, then the amount if any shall be retained by the Company. Settlement payments from the Class Member Fund will be paid out in advertising credits to members of the Class who file timely claims to participate in the settlement. On December 28, 2007, the Company provided the notices to class members required by the Settlement Agreement who had until February 11, 2008 to file claims. Upon the completion of the thirty day appeals period, which ended on March 30, 2008, the Company on April 7, 2008 paid approximately $0.6 million of legal fees to the plaintiff’s counsel representing the Fees Award to Class Counsel and the Incentive Award as is stipulated in the Settlement Agreement. On April 29, 2008, the Company began to issue advertising credits to the Class Members who filed timely claims. The deadline for submitting redemption credits expired on April 29, 2009. No charitable organization has submitted a claim for advertising credits to date. The Company recorded an estimate in accrued liabilities of the amount of the loss on settlement which management determined was probable and estimable during the year ended December 31, 2007. This estimate may change as a result of the cost of the final settlement arrangement. In addition, during 2007 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 remain as an accrued liability at March 31, 2010 and December 31, 2009. As of March 31, 2010, the Company has provided approximately $0.1 million of advertising credits to Class Members.
As of March 31, 2010 and December 31, 2009, the legal proceedings liability of $0.4 million is classified in accrued liabilities on the Company’s Unaudited Condensed Consolidated Balance Sheet (see Note 7).
11. Stockholders’ Equity
Share-Based Compensation
Stock Option Plans
In December 1997, the Company approved the 1998 Stock Option Plan (the “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”). On June 19, 2007, the stockholders approved the LookSmart 2007 Equity Incentive Plan (the “2007 Plan”). Under the 2007 Plan, the Company may grant incentive stock options, nonqualified stock options, stock appreciation rights and stock rights to employees, directors and consultants. Share-based incentive awards are provided under the terms of these four plans (collectively, the “Plans”).
The Company’s Plans are administered by the Compensation Committee of the Board of Directors. Awards under the Plans principally include at-the-money options and fully vested restricted stock. Except for the one time share grants to certain executive officers that become exercisable over a two year period, outstanding stock options generally become exercisable over a three or four year period from the grant date and have a term of seven or ten years. Beginning in 2008, the Company issued fully vested restricted stock to certain directors and executive officers. The number of shares reserved for issuance under the Plans was approximately 4.7 million and 4.8 million shares of common stock at March 31, 2010 and December 31, 2009, respectively. There were 2.2 million shares available to be granted under the Plans at March 31, 2010.
Share-based compensation expense recorded during the three months ended March 31, 2010 and 2009 was included in the Company’s Unaudited Condensed Consolidated Statement of Operations as follows (in thousands):
| Three Months Ended March 31, | ||||||
| 2010 | 2009 | |||||
Sales and marketing | $ | 20 | $ | 57 | ||
Product development and technical operations | 106 | 134 | ||||
General and administrative | 43 | 326 | ||||
Total share-based compensation expense | 169 | 517 | ||||
Amounts capitalized as software development costs | 14 | 24 | ||||
Total share-based compensation | $ | 183 | $ | 541 | ||
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Total unrecognized share-based compensation expense related to share-based compensation arrangements at March 31, 2010 was $0.9 million and is expected to be recognized over a weighted-average period of approximately 1.8 years. The total fair value of equity awards vested during the three months ended March 31, 2010 and 2009 was $0.2 million and $0.5 million, respectively.
Option Awards
Stock option activity under the Plans during the three months ended March 31, 2010 and the year ended December 31, 2009 is as follows:
| Shares | Weighted- Average Exercise Price Per Share | Weighted- Average Remaining Contractual Term | Aggregate Intrinsic Value | ||||||||
| (in thousands) | (in years) | (in thousands) | |||||||||
Options outstanding at December 31, 2008 | 3,818 | 4.05 | |||||||||
Granted | 328 | 1.22 | |||||||||
Expired/forfeited | (937 | ) | 3.55 | ||||||||
Options outstanding at December 31, 2009 | 3,209 | 4.05 | |||||||||
Granted | 7 | 0.96 | |||||||||
Expired/forfeited | (756 | ) | 3.88 | ||||||||
Options outstanding at March 31, 2010 | 2,460 | $ | 3.90 | 6.91 | $ | — | |||||
Vested and expected to vest at March 31, 2010 | 2,309 | $ | 3.97 | 6.85 | $ | — | |||||
Exercisable at March 31, 2010 | 1,977 | $ | 4.14 | 6.69 | $ | — | |||||
The aggregate intrinsic values in the table above represent the total pre-tax intrinsic value (the difference between the market price of the Company’s stock on the last trading day of the period and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holder had all option holders exercised their options at year-end. The intrinsic value amount changes with changes in the fair market value of the Company’s stock.
The following table summarizes information about stock options outstanding at March 31, 2010:
| Options Outstanding | Options Exercisable | |||||||||||||||||
Price Ranges | Shares | Weighted- Average Remaining Contractual Term | Weighted- Average Exercise Price Per Share | Shares | Weighted- Average Exercise Price Per Share | |||||||||||||
| (in thousands) | (in years) | (in thousands) | ||||||||||||||||
$0.91 | – | $3.19 | 801 | 7.53 | $ | 2.30 | 610 | $ | 2.36 | |||||||||
3.20 | – | 3.60 | 776 | 7.50 | 3.24 | 536 | 3.24 | |||||||||||
3.70 | – | 4.33 | 334 | 6.93 | 4.11 | 294 | 4.09 | |||||||||||
4.45 | – | 20.55 | 549 | 5.17 | 7.05 | 537 | 5.14 | |||||||||||
0.91 | – | 20.55 | 2,460 | 6.91 | 3.90 | 1,977 | 4.14 | |||||||||||
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Stock Awards
During the three months ended March 31, 2010 and 2009, the Company issued 13 thousand and 23 thousand shares, respectively, of fully vested restricted stock, with a weighted average grant date fair value of $1.03 and $1.02 per share, respectively, under the Plans.
Employee Stock Purchase Plan
Under the 1999 Employee Stock Purchase Plan (the “1999 ESPP”), which was approved by the shareholders in July 1999, the Company was authorized to issue up to 520 thousand shares of Common Stock to Employees of the Company. Under the 1999 ESPP, substantially all employees could purchase the Company’s common stock through payroll deductions at a price equal to 85 percent of the lower of the fair market value at the beginning of the offering period or at the end of each applicable purchase period. An offering period was 24 months, composed of four six-month purchase periods. ESPP contributions were limited to a maximum of 15 percent of an employee’s eligible compensation, and ESPP participants were limited to purchasing a maximum of 500 shares per purchase period. ESPP share-based compensation expense under the 1999 ESPP was not significant for three months ended March 31, 2009. As of June 8, 2009, when the 1999 ESPP expired, 490 thousand shares had been issued under the 1999 Plan.
On July 14, 2009, the 2009 Employee Stock Purchase Plan (the “2009 ESPP”) was approved by the shareholders. Under the 2009 ESPP, the Company is authorized to issue up to 500 thousand shares of Common Stock to employees of the Company. Under the 2009 ESPP, substantially all employees may purchase the Company’s common stock through payroll deductions at a price equal to 85 percent of the lower of the fair market value at the beginning of the offering period or at the end of each applicable purchase period. Each offering period is 6 months and consists of one purchase period. ESPP contributions are limited to a maximum of 15 percent of an employee’s eligible compensation, and ESPP participants are limited to purchasing a maximum of 5,000 shares per purchase period. Share-based compensation expense under the 2009 ESPP was not significant for three months ended March 31, 2010. As of March 31, 2010, no shares have been issued under the 2009 Plan.
Share-Based Compensation Valuation Assumptions
The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option valuation model with the following assumptions:
| • | 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 of the share-based awards. |
| • | 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 assumptions used in the Black-Scholes option valuation model and the weighted average grant date fair value per share for employee stock options were as follows:
| Three Months Ended March 31, | ||||||
| 2010 | 2009 | |||||
Volatility | 61.9 – 62.1% | 63.6 – 77.3% | ||||
Risk-free interest rate | 1.86 – 2.02% | 1.53 – 1.95% | ||||
Expected term (years) | 4.18 | 4.53 – 5.91 | ||||
Expected dividend yield | — | — | ||||
Weighted average grant date fair value | $ | 0.47 | $ | 0.63 | ||
As share-based compensation expense recognized in the Unaudited Condensed Consolidated Statement of Operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.
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Exercise of Employee Stock Options and Purchase Plans
There were no options exercised in the three months ended March 31, 2010 and 2009. The Company issues new shares of common stock upon exercise of stock options. No income tax benefits have been realized from exercised stock options.
12. Fair Value Measurements
Fair Value of Financial Assets
The Company’s financial assets measured at fair value on a recurring basis subject to disclosure requirements at March 31, 2010 and December 31, 2009 were as follows (in thousands):
| Balance at March 31, 2010 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | |||||||
Cash equivalents: | |||||||||
Money market mutual funds | $ | 73 | $ | 73 | $ | — | |||
Certificates of deposit | 1,245 | — | 1,245 | ||||||
Commercial paper | 12,499 | — | 12,499 | ||||||
| 13,817 | 73 | 13,744 | |||||||
Short-term investments: | |||||||||
Corporate bonds | 729 | — | 729 | ||||||
Certificates of deposit | 1,745 | — | 1,745 | ||||||
Commercial paper | 1,999 | 1,999 | |||||||
| 4,473 | — | 4,473 | |||||||
Total financial assets measured at fair value | $ | 18,290 | $ | 73 | $ | 18,217 | |||
| Balance at December 31, 2009 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | |||||||
Cash equivalents: | |||||||||
Money market mutual funds | $ | 10,074 | $ | 10,074 | $ | — | |||
Certificates of deposit | 2,000 | — | 2,000 | ||||||
Commercial paper | 6,399 | — | 6,399 | ||||||
| 18,473 | 10,074 | 8,399 | |||||||
Short-term investments: | |||||||||
Corporate bonds | 2,890 | — | 2,890 | ||||||
Certificates of deposit | 490 | — | 490 | ||||||
Commercial paper | 1,400 | 1,400 | |||||||
| 4,780 | — | 4,780 | |||||||
Total financial assets measured at fair value | $ | 23,253 | $ | 10,074 | $ | 13,179 | |||
The Company had an insignificant level 3 investment at December 31, 2009. In February 2010, the level 3 investment, a warrant, expired unexercised.
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The Company used the following methods and assumptions in estimating financial asset fair value:
Investments
For investments that have quoted market prices in active markets, the Company uses the quoted market prices as fair value and includes these prices in the amounts disclosed in Level 1 of the hierarchy. The Company receives the quoted market prices from a third party, nationally recognized pricing service (“pricing service”). When quoted market prices are unavailable, the Company utilizes a pricing service to determine a single estimate of fair value, which is mainly for its fixed maturity investments. The fair value estimates provided from this pricing service are included in the amount disclosed in Level 2 of the hierarchy. The Company bases all of its estimates of fair value for assets on the bid price as it represents what a third party market participant would be willing to pay in an arm’s length transaction.
The Company utilizes a pricing service to estimate fair value measurements of its fixed maturities investments. The pricing service utilizes market quotations for fixed maturity securities that have quoted prices in active markets. Since fixed maturities other than U.S. Treasury securities generally do not trade on a daily basis, the pricing service prepares estimates of fair value measurements for these securities using its proprietary pricing applications which include available relevant market information, benchmark curves, benchmarking of like securities, sector groupings and matrix pricing. Additionally, the pricing service uses an Option Adjusted Spread model to develop prepayment and interest rate scenarios.
The pricing service evaluates each asset class based on relevant market information, relevant credit information, perceived market movements and sector news. The market inputs utilized in the pricing evaluation, listed in the approximate order of priority, include: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data and industry and economic events. The extent of the use of each market input depends on the asset class and the market conditions. Depending on the security, the priority of the use of inputs may change or some market inputs may not be relevant. For some securities additional inputs may be necessary.
The pricing service utilized by the Company has indicated that they will only produce an estimate of fair value if there is objectively verifiable information to produce a valuation. If the pricing service discontinues pricing an investment, the Company would be required to produce an estimate of fair value using some of the same methodologies as the pricing service, but would have to make assumptions for market based inputs that are unavailable due to market conditions.
The fair value estimates of the Company’s fixed maturity investments are based on observable market information rather than market quotes. Accordingly, the estimates of fair value for such fixed maturities, other than money market securities, provided by the pricing service are included in the amount disclosed in Level 2 of the hierarchy. The estimated fair value of money market securities are included in the amount disclosed in Level 1 as the estimates are based on unadjusted market prices.
The Company validates the prices received from the pricing service using various methods including, applicability of FDIC or other national government insurance or guarantees, comparison of proceeds received on individual investments subsequent to reporting date, prices received from publically available sources, and review of transaction volume data to confirm presence of active markets. The Company does not adjust the prices received from the pricing service unless such prices are determined to be inconsistent. At March 31, 2010 and December 31, 2009, the Company did not adjust prices received from the pricing service.
Trade accounts receivable, net: The carrying value reported in the Consolidated Balance Sheets is net of allowances for doubtful accounts and returns which estimate customer non-performance risk.
Trade accounts payable and accrued liabilities: The carrying value reported in the Consolidated Balance Sheets for these items approximates their fair value, which is the likely amount which the liability with short settlement periods would be transferred to a market participant with a similar credit standing as the Company.
Fair Value of Non-Financial Assets
At March 31, 2010 and December 31, 2009, the Company had no non-financial assets to be measured at fair value on a non-recurring basis and subject to disclosure requirements.
13. Related Party Transactions
Jean-Yves Dexmier, as one of the Company’s Board of Directors members, was paid fees totaling $0.1 million during each of the three month periods ended March 31, 2010 and 2009, in connection with Dr. Dexmier’s services to the Company.
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| ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Forward-Looking Statements
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, the possibility that we may fail to maintain or grow our listings advertiser base and/or distribution network, 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, that we may be unable to grow our online search advertising revenue and/or find alternative sources of revenue, that we may be unable to attain or maintain customer acceptance of our publisher solutions products, that changes in the distribution network composition may lead to decreases in query volumes, that we may be unable to maintain or improve our query volume, match rate, number of paid clicks, average revenue per click, conversion rate or other ad network metrics, that we may be unable to achieve or maintain profitability, that we may be unable to retain our existing credit facilities or obtain new credit facilities, that we may be unable to attract and retain key personnel, that we may have unexpected increases in costs and expenses, or 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 a search advertising network solutions company that provides relevant solutions for search advertising customers. LookSmart was organized in 1996 and is incorporated in the State of Delaware.
LookSmart operates in a large online search advertising ecosystem serving ads that target user queries on partner sites. We operate in the middle of this ecosystem, acquiring search queries from a variety of sources and matching them with the keywords of our search advertising customers. Our largest category of customers has been intermediaries, the majority of which purchase clicks to sell into the affiliate networks of the large search engine providers. Another category of customers are direct advertisers and their agencies whose objective is to obtain conversions or sales from the clicks, while others want unique page views. The last category of customers is self-service advertisers that sign-up online and pay by credit card.
LookSmart offers search advertising customers targeted, pay-per-click (PPC) search via a monitored search advertising distribution network using the Company’s “AdCenter” platform technology. The Company’s search advertising network includes publishers and search advertising customers, including intermediaries and direct advertising customers and their agencies as well as self-service customers in the United States and certain other countries. The Company’s application programming interface (“API”) allows search advertising customers and their advertising agencies to connect any type of marketing or reporting software with minimal effort, for easier access, management, and optimization of search advertising campaigns.
LookSmart also offers publishers licensed private-label search advertiser network solutions based on its AdCenter platform technology (“Publisher Solutions”). Publisher Solutions consist of hosted auction-based ad serving with an ad backfill capability that allows publishers and portals to manage their advertiser relationships, distribution channels and accounts.
In the first quarter of 2008, management made the decision to exit its remaining consumer products activities and to sell or otherwise dispose of the remaining consumer assets. During 2008, we sold the intellectual property rights to the “Wisenut” trademark and related domain names and decided to wind down the Furl operations. The Furl assets were accounted for under the guidance of Accounting Standards Codification (“ASC”) 360-10-40, Impairment or Disposal of Long-Lived Assets (“ASC 360-10-40”) as “assets held for sale” and a full impairment of these assets was recorded at December 31, 2008. In the first quarter of 2009, the Furl assets
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were sold. The results of operations of consumer product activities, including related gains (losses), have been classified as discontinued operations for all periods presented in the accompanying Unaudited Condensed Consolidated Statements of Operations (see Note 2). At March 31, 2010, the Company continues to own the Wisenut search engine technology, intellectual property rights in such technology, and other assets.
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 circumstance, 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 periods 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.
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 (“GAAP”). 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. 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, and 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.
Investments
We invest our excess cash primarily in debt instruments of high-quality corporate and government issuers. All highly liquid instruments with maturities at the date of purchase greater than ninety days are considered investments. All instruments with maturities greater than one year from the balance sheet date are considered long-term investments unless management intends to liquidate such securities in the current operating cycle. Such securities are classified as short-term investments. These securities are classified as available-for-sale and carried at fair value.
Changes in value of these investments are primarily related to changes in interest rates and are considered to be temporary in nature. Except for declines in fair value that are not considered temporary, net unrealized gains or losses on these investments are reported as a component of accumulated other comprehensive income (loss) in stockholders’ equity. We recognize realized gains and losses upon sale of investments using the specific identification method.
Fair Value of Financial Instruments
Our estimates of fair value for assets and liabilities is based on a framework that establishes a hierarchy of the inputs used in valuation and gives the highest priority to quoted prices in active markets and requires that observable inputs be used in the valuations when available. The disclosure of fair value estimates is based on whether the significant inputs into the valuation are observable. In determining the level of the hierarchy in which the estimate is disclosed, the highest priority is given to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs that reflect our significant market assumptions. The three levels of the hierarchy are as follows:
| Level 1: | Unadjusted quoted market prices for identical assets or liabilities in active markets that we have the ability to access. | |
| Level 2: | Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets in inactive markets; or valuations based on models where the significant inputs are observable (e.g., interest rates, yield curves, default rates, etc.) or can be corroborated by observable market data. | |
| Level 3: | Valuations based on models where significant inputs are not observable. The unobservable inputs reflect our assumptions about the assumptions that market participants would use. | |
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Concentrations, Credit Risk and Credit Risk Evaluation
Concentration of Credit Risk
Financial instruments that potentially subject us to concentrations of credit risk consist primarily of cash equivalents, investments, and accounts receivable. As of March 31, 2010 and December 31, 2009, we placed our cash equivalents and investments primarily through one financial institution, City National Bank, and mitigated the concentration of credit risk by placing percentage limits on the maximum portion of the investment portfolio which may be invested in any one investment instrument. These amounts at times may exceed federally insured limits. We have not experienced any credit losses on these cash equivalents and investment accounts and do not believe we are exposed to any significant credit risk on these funds. The fair value of these accounts is subject to fluctuation based on market prices.
Credit Risk, Customer and Vendor Evaluation
Accounts receivable are typically unsecured and are derived from sales to customers. We perform ongoing credit evaluations of our customers and maintain allowances for estimated credit losses. We apply judgment as to our ability to collect outstanding receivables based primarily on our evaluation of the customer’s financial condition and past collection history and record a specific allowance. In addition, we record an allowance based on the length of time the receivables are past due. Historically, such losses have been within our expectations.
Revenue Concentrations
Our largest category of customers has been intermediaries, the majority of which purchase clicks to sell into the affiliate networks of the large search engine providers.
We derive our revenue from two service offerings, or “products”: Advertiser Networks and Publisher Solutions. For the three months ended March 31, 2010, IAC Search and Media (“IAC”) accounted for 9% of net revenue, and 74% of Publisher Solutions revenue. On May 19, 2009, Ask Sponsored Listings, a division of IAC, notified us that it did not intend to renew the May 2005 AdCenter License, Hosting and Support Agreement (“the Agreement”), which provides for certain Publisher Solutions services, upon its expiration. The Agreement, as amended, was scheduled to expire by its terms on December 31, 2009. On December 22, 2009, we further amended the Agreement, effective December 1, 2009, to extend the term through March 31, 2010, and to allow IAC to extend the term in one-month intervals up to a maximum period of six months. On March 17, 2010, IAC notified us that, in accordance with December 2009 amendment to the Agreement, it intends to extend the term of the Agreement on a monthly basis up to June 30, 2010.
Revenue Recognition
Our online search advertising revenue is primarily composed of per-click fees that we charge customers. 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 revenue share from licensing of private-labeled versions of our products.
Revenues associated with online advertising products, including Advertiser Networks, are generally recognized once collectability 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 (“TAC”) and are included in cost of revenue. 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.
We also enter into agreements to provide private-labeled versions of our products, including licenses to the AdCenter. These license arrangements include multiple elements: revenue-sharing based on the publisher’s customers monthly revenue generated through the AdCenter application; upfront fees; and other license fees. We recognize upfront fees over the term of the arrangement or the expected period of performance, other 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 collectability 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
We maintain an allowance for doubtful accounts for estimated losses resulting from customers failing 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 and economic conditions. We will record an increase or reduction of the allowance for doubtful accounts if collection rates or economic conditions are more or less 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.
Intangible Assets with Definite Lives
We amortize acquired intangible assets with definite lives over periods from two to seven years and the amortization expense is primarily classified as cost of revenues in our Unaudited Condensed Consolidated Statements of Operations.
Impairment of Long-Lived Assets
We review long-lived assets held or used in operations, including property and equipment and internally developed software, for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable. Subject assets are tested for impairment at the lowest level of operations that generates cash flows that are largely independent of the cash flows from those of other groups of assets and liabilities. We have determined that the equity of our single reporting unit to be the lowest level of operation at which independent cash flows could be identified. An impairment loss is recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition is less than its carrying amount. Impairment, if any, is measured as the amount by which the carrying amount of a long-lived asset exceeds its fair value. Assets to be disposed of are reported at the lower of carrying amount or fair value less cost to dispose.
We tested our long-lived assets used in operations for impairment as of December 31, 2009 and determined they were not impaired.
Internal Use Software Development Costs
We capitalize 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 developing internal-use computer software.
We exercise judgment in determining when costs related to a project may be capitalized, in assessing the ongoing value of the capitalized costs, and in determining the amortization period for the capitalized costs. We expect to continue to invest in internally developed software and to capitalize such costs.
Property and Equipment
Property and equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives of the assets.
Leasehold improvements are amortized on a straight-line basis over the shorter of their estimated useful lives or the lease term.
When assets are retired or otherwise disposed of, the cost and accumulated depreciation and amortization are removed from their respective accounts, and any gain or loss on such sale or disposal is reflected in operating expenses. Maintenance and repairs are charged to expense as incurred. Expenditures that substantially increase an asset’s useful life are capitalized.
Traffic Acquisition Costs
We enter into agreements of varying durations with our distribution network partners that display our listings ads on their sites in return for a percentage of the revenue-per-click that we receive when the ads are clicked on those partners’ sites.
We also enter into agreements of varying durations with third party affiliates. There are generally three economic structures of the affiliate agreements: guaranteed fixed payments which often carry reciprocal performance guarantees from the affiliate, variable payments based on a percentage of our revenue or based on a certain metric, such as number of searches or paid clicks, or a combination of the two.
We record TAC expense as a cost of revenue and is based on a percentage of revenue, number of paid introductions, number of searches, or other metrics.
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Share-Based Compensation
We recognize share-based compensation costs for all share-based payment transactions with employees, including grants of employee stock options and employee stock purchases related to the Employee Stock Purchase Plan, over the requisite service period based on their relative fair values. We estimate the fair value of share-based payment awards on the grant date using the Black-Scholes method. The value of the portion of the award that is ultimately expected to vest is recognized as expense in our Unaudited Condensed Consolidated Statement of Operations over the requisite service periods.
Forfeitures are 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 end of each fiscal quarter, based on historical rates.
We elected to adopt the alternative transition method for calculating the tax effects of share-based compensation 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 the Unaudited Condensed Consolidated Statement of Cash Flows of the tax effects of employee share-based compensation awards.
Income Taxes
We account for income taxes using the liability method. Under the liability method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. We record liabilities, where appropriate, for all uncertain income tax positions. We recognize potential accrued interest and penalties related to unrecognized tax benefits within operations as income tax expense.
Recent Accounting Pronouncements
For a description of recent accounting pronouncements, see Note 1 (Summary of Significant Accounting Policies) in the Notes to the Unaudited Condensed Consolidated Financial Statements.
Results of Operations
Overview of the Three Months Ended March 31, 2010
The following table sets forth selected information concerning our results of operations as a percentage of consolidated net revenue for the periods indicated:
| Three Months Ended March 31, | |||||||||||||||||||||
| 2010 | % of Revenue | 2009 | % of Revenue | Dollar Change | % Change | ||||||||||||||||
Revenue | $ | 13,286 | 100.0 | % | $ | 13,254 | 100.0 | % | $ | 32 | 0 | % | |||||||||
Cost of revenue | 9,036 | 68.0 | % | 8,102 | 61.1 | % | 934 | 12 | % | ||||||||||||
Gross profit | 4,250 | 32.0 | % | 5,152 | 38.9 | % | (902 | ) | (18 | )% | |||||||||||
Operating expenses: | |||||||||||||||||||||
Sales and marketing | 1,154 | 8.7 | % | 1,365 | 10.3 | % | (165 | ) | (12 | )% | |||||||||||
Product development and technical operations | 2,444 | 18.4 | % | 2,613 | 19.7 | % | (169 | ) | (6 | )% | |||||||||||
General and administrative | 1,239 | 9.3 | % | 3,369 | 25.4 | % | (2,147 | ) | (64 | )% | |||||||||||
Total operating expenses | 4,837 | 36.4 | % | 7,347 | 55.4 | % | (2,481 | ) | (34 | )% | |||||||||||
Loss from operations | (587 | ) | (4.4 | )% | (2,195 | ) | (16.5 | )% | 1,579 | (72 | )% | ||||||||||
Non-operating income (expense), net | (17 | ) | (0.2 | )% | 54 | 0.4 | % | (71 | ) | (131 | )% | ||||||||||
Loss from continuing operations before income taxes | (604 | ) | (4.6 | )% | (2,141 | ) | (16.1 | )% | 1,508 | (70 | )% | ||||||||||
Income tax expense | 6 | 0.0 | % | 8 | 0.1 | % | (2 | ) | (25 | )% | |||||||||||
Loss from continuing operations | (610 | ) | (4.6 | )% | (2,149 | ) | (16.2 | )% | 1,510 | (70 | )% | ||||||||||
Income from discontinued operations | 93 | 0.7 | % | 109 | 0.8 | % | (16 | ) | (15 | )% | |||||||||||
Net loss | $ | (517 | ) | (3.9 | )% | $ | (2,040 | ) | (15.4 | )% | $ | 1,494 | (73 | )% | |||||||
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Revenues
Revenue is derived from two service offerings or “products” of LookSmart Ltd. (the “Company”): Advertiser Networks and Publisher Solutions. Total revenue and revenue from Advertiser Networks and Publisher Solutions for the three months ended March 31, 2010 and 2009, were as follows (in thousands):
| Three Months Ended March 31, | |||||||||||||||||||
| 2010 | % of Revenue | 2009 | % of Revenue | Dollar Change | % Change | ||||||||||||||
Advertiser Networks | $ | 12,432 | 94 | % | $ | 12,015 | 91 | % | $ | 417 | 3 | % | |||||||
Publisher Solutions | 854 | 6 | % | 1,239 | 9 | % | (385 | ) | (31 | )% | |||||||||
Total revenue | $ | 13,286 | 100 | % | $ | 13,254 | 100 | % | $ | 32 | 0 | % | |||||||
We recognized $13.3 million of total revenue during the three months ended March 31, 2010, unchanged from the $13.3 million recognized during the three months ended March 31, 2009. Advertising Network revenue increased 3%, to $12.4 million, during the three months March 31, 2010, from the $12.0 million recognized during the three months ended March 31, 2009. Revenue from Advertiser Networks decreased by $0.4 million in the first quarter of 2010 compared to the same period in 2009.
The Advertising Network growth in paid clicks for the three months ended March 31, 2010 was partially offset by a decrease in the average revenue-per-click (“RPC”). Total paid clicks increased 33% to 244 million, compared to 184 million for the three months ended March 31, 2009. During the same period, average RPC decreased 22% from $0.065 to $0.051 compared to the previous year, while RPC increased 3% in the first quarter of 2010 compared to the fourth quarter of 2009.
We recognized Publisher Solutions revenue of $0.9 million during quarter ended March 31, 2010, a 31% decline from the $1.2 million recognized during the three months ended March 31, 2009. The decrease in Publisher Solutions revenue for the first quarter of 2010 as compared to the same period in 2009 is attributed to reduced revenue from IAC Search and Media, Inc. (“IAC”). IAC represented $0.6 million, or 74%, of Publisher Solutions revenue during the first quarter of 2010 compared to $1.1 million, or 89%, during the first quarter of 2009.
We continue to be dependent upon a few customers for a significant percentage of our revenue. For the three months ended March 31, 2010, three customers combined to account for 31% of revenue. One of these three customers, IAC, notified us in May 2009 that it did not intend to renew the May 2005 AdCenter License, Hosting and Support Agreement, which provides for certain Publisher Solutions services, upon expiration on December 31, 2009. On December 22, 2009, prior to the expiration date, IAC and the Company signed a Sixth Addendum (“Addendum”) to the May 2005 AdCenter License, Hosting and Support Agreement (the “Agreement”). The Addendum became effective December 1, 2009 and, among other things, extended the term of the Agreement through March 31, 2010. In addition, the Addendum allows IAC to extend the term in one-month intervals up to a maximum period of six months. On March 17, 2010, IAC notified the Company that, in accordance with the Addendum, it intends to extend the term of the Agreement on a monthly basis up to June 30, 2010.
Advertising Network revenue derived from IAC, which is covered under separate distribution agreements, was $0.5 million during the three months ended March 31, 2010, down 64% from the $1.4 million recognized during the same period in 2009. IAC has not indicated to us intent to terminate these separate distribution agreements.
Cost of Revenue and Gross Margin
Cost of revenue, consisting of traffic acquisition costs (“TAC”), costs paid to our distribution network partners, connectivity costs, hosting expenses, commissions paid to advertising agencies, and credit card fees were as follows for the three months ended March 31, 2010 and 2009 (in thousands):
| Three Months Ended March 31, | ||||||||||||||||||
| 2010 | % of Revenue | 2009 | % of Revenue | Dollar Change | % Change | |||||||||||||
Traffic acquisition costs | $ | 8,390 | 63 | % | $ | 7,587 | 57 | % | $ | 803 | 11 | % | ||||||
Other costs | 646 | 5 | % | 515 | 4 | % | 131 | 25 | % | |||||||||
Total cost of revenue | $ | 9,036 | 68 | % | $ | 8,102 | 61 | % | $ | 934 | 12 | % | ||||||
Traffic acquisition costs as percentage of Advertiser Network revenue | 67.5 | % | 63.1 | % | ||||||||||||||
Our total cost of revenue during the three months ended March 31, 2010 was $9.0 million, up $0.9 million, or 12% from the $8.1 million in the three months ended March 31, 2009.
Our TAC during the three months ended March 31, 2010 was $8.4 million, up $0.8 million, or 11% from the $7.6 million in the three months ended March 31, 2009. As a percentage of Advertising Network revenue, TAC for the three months ended March 31, 2010, was 67.5% compared to TAC of 63.1% during the same period in 2009. The increased TAC percentage during first quarter of 2010 was related to our continued focus on improving the quality of our traffic to better serve certain advertising customers on our Advertising Network.
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There is no TAC associated with Publisher Solutions revenue and, therefore, Publisher Solutions gross margin percentage is greater than that of Advertiser Network.
Our other costs of revenue, which consists primarily of co-location costs and credit card processing fees, increased 25% or $0.1 million in the first quarter of 2010 in comparison to the same period of 2009, primarily due to duplicate costs incurred during our move of co-location facilities. We anticipate additional duplicate co-location costs to be incurred in the second quarter of 2010 while we complete the move.
Gross profit for the three months ended March 31, 2010 declined seven percentage points to 32% from the 39% for the same period in 2009. The unfavorable gross profit trends are primarily the result of increasing TAC and decreasing Publisher Solutions revenue.
Operating Expenses
Operating expenses consist of sales and marketing, product development and technical operations and general and administrative as follows (in thousands):
| Three Months Ended March 31, | |||||||||||||||||||
| 2010 | % of Revenue | 2009 | % of Revenue | Dollar Change | % Change | ||||||||||||||
Sales and marketing | $ | 1,154 | 9 | % | $ | 1,365 | 10 | % | $ | (211 | ) | (15 | )% | ||||||
Product development and technical operations | 2,444 | 18 | % | 2,613 | 20 | % | (169 | ) | (6 | )% | |||||||||
General and administrative | 1,239 | 9 | % | 3,369 | 25 | % | (2,130 | ) | (63 | )% | |||||||||
Total operating expenses | $ | 4,837 | 36 | % | $ | 7,347 | 55 | % | $ | (2,510 | ) | (34 | )% | ||||||
Share-based compensation expense was allocated as follows (in thousands):
| Three Months Ended March 31, | ||||||
| 2010 | 2009 | |||||
Sales and marketing | $ | 20 | $ | 57 | ||
Product development and technical operations | 106 | 134 | ||||
General and administrative | 43 | 326 | ||||
Total share-based compensation expense | 169 | 517 | ||||
Amounts capitalized as software development costs | 14 | 24 | ||||
Total share-based compensation | $ | 183 | $ | 541 | ||
Sales and Marketing
Sales and marketing expenses include salaries, commissions, share-based compensation and other costs of employment for our sales force, sales administration and customer service staff and marketing personnel, overhead, facilities, allocation of depreciation and the provision for and reductions of the allowance 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.
Our sales and marketing expenses during the three months ended March 31, 2010, were $1.2 million, down 15% from $1.4 million in the same period of 2009. Sales and marketing expenses in the first quarter of 2010 decreased $0.2 million compared to the first quarter of 2009 primarily due to lower facilities costs attributed to our new headquarters and lower headcount, partially offset by higher commissions paid to a third party related to our increased revenue in the United Kingdom.
Product Development and Technical Operations
Product development and technical operations expense includes all costs related to the continued operations, development and enhancement of our core technology product, the AdCenter platform. The AdCenter is used to operate both our own Advertiser Network and other publishers’ client networks, and is licensed to publishers to operate their own network. These costs include salaries and associated costs of employment, including share-based compensation, overhead, and facilities. 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 and amortized over a three year period once the project is placed in service. Software licensing and computer equipment depreciation related to supporting product development and technical operations functions are also included in product development and technical operations expense.
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Capitalized software development costs include the costs to develop software for internal use, excluding costs associated with research, training and testing.
Product development and technical operations and capitalized software development costs were as follows:
| Three Months Ended March 31, | |||||||||||||||||||||
| 2010 | % of Revenue | 2009 | % of Revenue | Dollar Change | % Change | ||||||||||||||||
Product development and technical operations costs | $ | 2,633 | 19 | % | $ | 2,987 | 23 | % | $ | (354 | ) | (12 | )% | ||||||||
Capitalized software development costs | (189 | ) | (1 | )% | (374 | ) | (3 | )% | 185 | (49 | )% | ||||||||||
Total product development and technical operations expense | $ | 2,444 | �� | 18 | % | $ | 2,613 | 20 | % | $ | (169 | ) | (6 | )% | |||||||
Our product development and technical operations expense, net of capitalized software development costs, during the three months ended March 31, 2010, was $2.4 million, down 6% from $2.6 million for the three months ended March 31, 2009. Product development and technical operations expense, net of capitalized software development costs, for the first quarter of 2010 decreased $0.2 million compared to the comparable 2009 quarter primarily due to lower facilities costs attributed to our new headquarters and lower headcount, partially offset by reduced capitalized software development and increased severance costs.
General and Administrative
General and administrative expenses include costs of executive management, human resources, finance, 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.
Our general and administrative expenses during the three months ended March 31, 2010, were $1.2 million, down 63% from $3.4 million for the three months ended March 31, 2009. General and administrative expenses in first quarter of 2010 decreased $2.1 million compared to the first quarter of 2009 primarily due to lower staffing and temporary help costs of $1.0 million and $0.8 million of expenses in the first quarter of 2009 related to the evaluation of strategic growth alternatives that did not recur in the first quarter of 2010, combined with lower facilities costs attributed to our new headquarters and reduced legal and audit expenses. The lower staffing and temporary help costs are the result of reduced staff and decreased share-based compensation.
Loss from Operations
The table below sets forth loss from operations for the three months ended March 31, 2010 and 2009 (in thousands):
| Three Months Ended March 31, | ||||||||||||||||||||
| 2010 | % of Revenue | 2009 | % of Revenue | Dollar Change | % Change | |||||||||||||||
Loss from operations | $ | (587 | ) | (4 | )% | $ | (2,195 | ) | (17 | )% | $ | 1,608 | (73 | )% | ||||||
Our loss from operations for the three months ended March 31, 2010, was $0.6 million, a decrease from a loss of $2.2 million for the three months ended March 31, 2009. Loss from operations decreased $1.6 million due to the factors discussed above, including but not limited to, lower operating expenses, which were partially offset by decreased gross profit in the first quarter of 2010 as compared to the first quarter of 2009.
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Other Continuing Operations Items
The table below sets forth other continuing operations data for the three months ended March 31, 2010 and 2009 (in thousands):
| Three Months Ended March 31, | |||||||||||||||||||||
| 2010 | % of Revenue | 2009 | % of Revenue | Dollar Change | % Change | ||||||||||||||||
Non-operating income (expense), net | |||||||||||||||||||||
Interest income | $ | 17 | 0 | % | $ | 92 | 1 | % | $ | (75 | ) | (82 | )% | ||||||||
Interest expense | (42 | ) | 0 | % | (38 | ) | 0 | % | (4 | ) | 11 | % | |||||||||
Other income, net | 8 | 0 | % | — | 0 | % | 8 | ||||||||||||||
Total non-operating income (expense), net | $ | (17 | ) | 0 | % | $ | 54 | 1 | % | $ | (71 | ) | (131 | )% | |||||||
Income tax expense | $ | 6 | 0 | % | $ | 8 | 0 | % | $ | (2 | ) | (25 | )% | ||||||||
Interest Income and Expense
Interest income includes income from our cash, cash equivalents and investments, and decreased $0.1 million in the three months ended March 31, 2010 from the three months ended March 31, 2009. This decrease was primarily driven by a decrease in average yields earned on cash and investment balances in 2010 compared to 2009 combined with a moderate decrease in average cash and investment balance during the same periods.
Interest expense, primarily consisting of interest paid on capital leases and our note payable, increased an insignificant amount in the three months ended March 31, 2010 from the three months ended March 31, 2009 as a result of our increased use of capital leases in 2009 to finance asset additions.
Income Tax Expense
Due to our continued operating losses, our income tax expense primarily consists of minimum state taxes.
Income from Discontinued Operations, Net of Tax
In the first quarter of 2008, the Company’s management made the decision to exit the remaining consumer products activities and to sell or otherwise dispose of its remaining consumer assets. The various remaining related websites and assets associated with the consumer products activities met the criteria to be classified as discontinued operations. The results of operations related to assets to be disposed of, and of previously disposed assets, including any related gains and losses are classified as discontinued operations in the accompanying Unaudited Condensed Consolidated Statements of Operations.
Income from discontinued operations, net of tax, for the three months ended March 31, 2010 and 2009 was as follows (in thousands):
| Three Months Ended March 31, | |||||||||||||||||||
| 2010 | % of Revenue | 2009 | % of Revenue | Dollar Change | % Change | ||||||||||||||
Income from discontinued operations, net of tax | $ | 93 | 1 | % | $ | 109 | 1 | % | $ | (16 | ) | (15 | )% | ||||||
The following table reflects revenue, gross profit, operating expenses, gain on disposal, and net income from discontinued operations for the three months ended March 31, 2010 and 2009 (in thousands):
| Three Months Ended March 31, | ||||||
| 2010 | 2009 | |||||
Revenue | $ | — | $ | 8 | ||
Gross profit | $ | — | $ | 8 | ||
Product development and technical operations expense | — | 36 | ||||
Total operating expenses | — | 36 | ||||
Gain on disposal | 93 | 137 | ||||
Net income from discontinued operations | $ | 93 | $ | 109 | ||
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As a result of the Company’s decision in early 2008 to dispose of its consumer assets, the Furl assets, consisting of property and equipment, capitalized software, goodwill and intangibles were accounted for as “assets held for sale.” Later in 2008, the Company determined that the Furl assets were impaired and recognized an impairment charge of $1.4 million. In February 2009, the Company sold the Furl assets and received a warrant to purchase 1.3 million shares of the acquirer’s non-marketable common stock at an exercise price of $0.30 per share (in each case, subject to certain adjustments in certain circumstances). The Company determined the warrants received had no significant value and did not record a gain on the disposal. The warrant expired unexercised in February 2010.
In January 2007, the Company completed the sale of Net Nanny to Content Watch, Inc. (“Content Watch”). The sale proceeds were comprised of contingent purchase consideration that may be realized at future dates based on the amount of revenue received by Content Watch. The Company recorded contingent purchase consideration of $0.1 million for each of the three month periods ended March 31, 2010 and 2009. Under the terms of the Content Watch agreement, the contingent purchase consideration will end in 2010. Contingent purchase consideration has been classified as gain on disposal.
During 2008, we sold the Wisenut trademark and related domain names. As of March 31, 2010 and December 31, 2009, we continue to own the Wisenut search engine technology and its intellectual property rights in such technology and other assets.
Liquidity and Capital Resources
Cash flows were as follows (in thousands):
| Three Months Ended March 31, | ||||||||||||
| 2010 | 2009 | Change | ||||||||||
Net cash used in operating activities | $ | (1,262 | ) | $ | (1,611 | ) | $ | 349 | ||||
Net cash provided by (used in) investing activities | (1,147 | ) | 4,953 | (6,100 | ) | |||||||
Net cash used in financing activities | (332 | ) | (238 | ) | (94 | ) | ||||||
Increase (decrease) in cash and cash equivalents | $ | (2,741 | ) | $ | 3,104 | $ | (5,845 | ) | ||||
Cash, cash equivalent and short-term investment balances were as follows as of March 31, 2010 and December 31, 2009 (in thousands):
| March 31, | December 31, | |||||||||||
| 2010 | 2009 | Change | ||||||||||
Cash and cash equivalents | $ | 20,192 | $ | 22,933 | $ | (2,741 | ) | |||||
Short-term investments | 4,473 | 4,780 | (307 | ) | ||||||||
Total | $ | 24,665 | $ | 27,713 | $ | (3,048 | ) | |||||
% of total assets | 66 | % | 72 | % | ||||||||
Total Assets | $ | 37,154 | $ | 38,347 | ||||||||
At March 31, 2010, we had $24.7 million of cash, cash equivalents and short-term investments. Cash equivalents and short-term investments are comprised of commercial paper, time deposits, money market mutual funds and U.S. corporate securities. See Note 3 to the Unaudited Condensed Consolidated Financial Statements, “Cash, Cash Equivalents and Short-Term Investments,” which describes further the composition of our cash, cash equivalents and short-term investments.
Cash, cash equivalents and short-term investments decreased $3.0 million to $24.7 million at March 31, 2010, from $27.7 million at December 31, 2009, primarily due to the use of capital to acquire equipment, increased accounts receivable and payment of capital lease obligations.
Our primary sources of liquidity are our cash, cash equivalents and short-term investments, the cash flow that we generate from our operations, and to a limited extent capital lease lines. We believe that our existing cash, cash equivalents, short-term investments and cash generated from operations will be sufficient to satisfy our current anticipated cash requirements through at least the next 12 months, if not longer. Our liquidity could be negatively affected by an additional decrease in demand for our services beyond the impact of the loss of the IAC AdCenter License, Hosting and Support Agreement, which provides for certain Publisher Solutions services, and changes in customer buying behavior. In addition, our liquidity could be negatively affected if we are in default under our credit facilities and are required to pay the lenders cash in an amount equal to the capital lease balance, or are required to identify restricted cash equal to the capital lease balance, plus outstanding standby letters of credit. Also, if the banking system or the financial markets continue to remain volatile, our investment portfolio may be impacted and the values and liquidity of our investments could be adversely affected. In addition, we may seek to raise additional capital through public or private debt or equity financings in order
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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 requiring cash payments, including 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.
In the third quarter of 2009, we launched post-pay whereby self service customers pay for clicks after they occur rather than the prior practice of being billed in advance. The customer’s credit card is charged based on its history of activity and creditworthiness. Through December 31, 2009, this change resulted in a decrease in deferred revenue as those customers with prepaid balances used those funds in their account, and adversely affected our cash flow by $0.5 million as customer deferred balances were used up and new unpaid charges accumulated. The adverse cash flow affect of launching post-pay was substantially complete as of December 31, 2009, and had an insignificant impact on the liquidity and capital resources of the Company in the three months ended March 31, 2010.
Operating Activities
Cash used in operating activities in the three months ended March 31, 2010 consisted of our net loss adjusted for certain non-cash items, including depreciation, amortization, share-based compensation expense, gains on sale of assets, as well as the effect of changes in working capital and other activities. Cash used in operations in the first quarter of 2010 was $1.3 million and consisted of a net loss of $0.5 million, adjustments for non-cash items of $0.7 million and cash used by working capital and other activities of $1.5 million. Adjustments for non-cash items primarily consisted of $0.7 million of depreciation and amortization expense on property and equipment and internally developed software and $0.2 million of share-based compensation expense, partially offset by a $0.1 million gain on sale of assets. In addition, changes in working capital activities primarily consisted of a net increase of $1.1 million in accounts receivable and a $0.3 million increase in prepaid expenses and other current assets. The increase in account receivable is primarily attributed to an increase in revenue from invoiced customers and one customer paying just before the end of the fourth quarter of 2009, whereas this same customer paid shortly after the end of the first quarter of 2010.
Cash used in operating activities in the three months ended March 31, 2009 consisted of our net loss adjusted for certain non-cash items, including depreciation, amortization, share-based compensation expense, gains on asset sales, as well as the effect of changes in working capital and other activities. Cash used in operations in the first quarter of 2009 was $1.6 million and consisted of a net loss of $2.0 million, adjustments for non-cash items of $1.1 million and cash used by working capital and other activities of $0.7 million. Adjustments for non-cash items primarily consisted of $0.7 million of depreciation and amortization expense on property and equipment, intangible assets and internally developed software and $0.5 million of share-based compensation expense, partially offset by a $0.1 million gain on sale of assets. In addition, changes in working capital activities primarily consisted of a net decrease of $2.6 million in accounts payable and accrued liabilities partially offset by a $1.8 million decrease in accounts receivable. The decrease in accounts payable and accrued liabilities is due to the timing of vendor payments combined with the payment of legal fees and settlement expenses accrued in 2008 and paid in the first quarter of 2009 related to an indemnification claim. The decrease in accounts receivable is attributed to less revenue from invoiced customers as compared to the previous quarter, combined with successful collection efforts.
Investing Activities
Cash used in investing activities in the first quarter of 2010 of $1.1 million was primarily attributed to $1.5 million for capital expenditures, partially offset by net proceeds from investments of $0.3 million. Our first quarter of 2010 capital expenditures consisted of $0.7 million for equipment received in 2009, for which a liability was accrued in 2009, $0.6 million for equipment acquired during the quarter, and an investment of $0.2 million in internally developed software related to our core service offering. In addition, during the three months ended March 31, 2010, $0.2 million of computer equipment was acquired and financed with capital leases.
Cash provided by investing activities in the first quarter of 2009 of $5.0 million was primarily attributed to net proceeds of investments of $5.2 million, partially offset by $0.4 million for capital expenditures. Our first quarter of 2009 capital expenditures consisted of an investment of $0.4 million in internally developed software related to our core service offering. During the three months ended March 31, 2009, $0.4 million of computer equipment was financed with capital leases.
Financing Activities
Cash used by financing activities of $0.3 million and $0.2 million in the three months ended March 31, 2010 and 2009, respectively, is attributed to scheduled capital lease and note payable payments.
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Credit Arrangements
We have outstanding standby letters of credit (“SBLC”) issued by City National Bank (“CNB”) of approximately $0.5 million at March 31, 2010, related to security of a building lease and security on an equipment lease.
On April 30, 2009, we renewed our master equipment lease agreement with CNB to extend the period of availability of the original $5.0 million through April 30, 2010. As of March 31, 2010, we had drawn down approximately $4.9 million of the available lease line of credit. As of March 31, 2010, there remained $0.1 million under the master lease agreement which was not utilized before it expired on April 30, 2010. Effective as of September 30, 2009, the master equipment lease agreement was amended to modify two financial covenants, with which we were in compliance as of March 31, 2010.
Our agreements with CNB, consisting of the SBLC and master equipment lease agreement, contain cross-default provisions whereby a default under one is deemed a default for the other. As of March 31, 2010 we are in compliance with both agreements with CNB.
In December 2009, we entered into an Agreement to Lease Equipment (“Lease Agreement”) with Cisco Systems Capital Corporation (“Cisco”), whereby we were to lease from Cisco certain hardware, software and maintenance services. The Lease Agreement provided for the lease of $0.8 million of hardware and software and $0.2 million of maintenance services over a period of three years. In connection with the Lease Agreement, we provided Cisco a SBLC for $0.2 million. As of December 31, 2009, $0.5 million of the equipment and software had been received and is included in property and equipment with an offsetting amount in accrued liabilities in the Condensed Consolidated Financial Statements. In March 2010, we decided, and Cisco agreed, to cancel the Lease Agreement, and we paid the vendor $1.0 million for the hardware, software and maintenance services. No additional costs will be incurred by the Company. The SBLC provided to Cisco for $0.2 million will be released by Cisco and terminated.
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
In comparison with our Annual Report on Form 10-K for the year ended December 31, 2009, we believe that there have been no significant changes in contractual obligations or commercial commitments outside the ordinary course of business, during the three months ended March 31, 2010.
| ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
We believe that our market risk exposure is primarily related to interest rate risk and the market value of certain investments that we hold. We manage these market risks through our normal investing and operating activities. We do not enter into derivatives for trading or other speculative purposes, nor do we use leveraged financial instruments.
Uncertainties in Credit Markets
Interest Rate Risk
We invest our excess cash primarily in highly liquid debt instruments of the U.S. government and its agencies, municipalities in the U.S., commercial paper, time deposits, money market mutual funds and corporate securities. By policy, we limit the amount of credit exposure to any one issuer.
Investments in both fixed rate and floating rate interest earning securities carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than predicted if interest rates fall. Due in part to these factors, our income from investments may decrease in the future.
We considered the historical volatility of short term interest rates and determined that it was reasonably possible that an adverse change of 100 basis points could be experienced in the near term. A hypothetical 1.00% (100 basis-points) increase in interest rates would have resulted in a decrease in the fair values of our marketable securities that is not significant at March 31, 2010.
| ITEM 4. | CONTROLS AND PROCEDURES |
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
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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.
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 for the quarter ended March 31, 2010, there were no significant deficiencies identified in the design and operation of our internal controls.
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 |
None.
| ITEM 1A. | RISK FACTORS |
We have updated our risk factors regarding our revenue concentration, net losses, concentrations of search advertisers and distribution network partners, credit facilities, compliance with Nasdaq listing requirements, any failure in the performance of our key production systems, and current economic conditions set forth below, and included a risk factor regarding international sales. Other than the aforementioned changes, 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, 2009.
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 search advertising business; if we are unable to grow online search advertising revenues and find alternative sources of revenue, our financial results will suffer
Search advertising accounted for substantially all of our revenues for the year ended December 31, 2009 and three months ended March 31, 2010. Our success depends upon search advertising customers choosing to use, and distribution network partners choosing to distribute, our search advertising networks products. Search advertising customers and distribution network partners may not adopt our products at projected rates, or changes in market conditions, such as the current financial crisis, may adversely affect the use or distribution of search advertisements. Because of our revenue concentration in the online search 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 has been concentrated with one customer, IAC Search and Media (“IAC”), accounting for 16% of net revenue and 81% of Publisher Solutions revenue for the year ended December 31, 2009, and 9% of net revenue and 74% of Publisher Solutions revenue for the three months ended March 31, 2010. IAC notified us in May 2009 that it did not intend to renew the May 2005 AdCenter License, Hosting and Support Agreement (the “Agreement”), which provides for certain Publisher Solutions services, upon expiration on December 31, 2009. On December 22, 2009, we amended the Agreement, effective December 1, 2009, to extend the term through March 31, 2010, and to allow IAC to extend the term in one-month intervals up to a maximum period of six months. On March 17, 2010, IAC notified us that, in accordance with December 2009 amendment to the Agreement, it intends to extend the term of the Agreement on a monthly basis up to June 30, 2010. Advertiser Network revenue derived from IAC, which is covered under separate distribution agreements, totaled $4.9 million, or 10%, for the year ended December 31, 2009, and $0.5 million, or 4%, for the three months ended March 31, 2010. IAC has not indicated to us intent to terminate these separate distribution agreements. 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, or for some of our larger customers specifically, our results of operations, financial condition and/or liquidity will suffer.
Our largest category of customers are intermediaries, the majority of whom purchase clicks to sell into the affiliate networks of large search engine providers; changes in the purchasing patterns of these search engine providers could adversely affect our business and results of operations
We operate in a large online search advertising ecosystem serving ads that target user queries on partner sites. We operate in the middle of this ecosystem, acquiring search queries from a variety of sources and matching them with the keywords of our search advertising customers. Our largest category of customers are intermediaries, the majority of which purchase clicks to sell into the affiliate networks of large search engine providers. If these large search engine providers cease purchasing clicks from these intermediary customers, the intermediary customers could reduce the amount of clicks they purchase from us, or cease altogether purchasing clicks from us, and that could have a material adverse effect on our business and results of operations.
Our Future Success Depends on International Sales and the Management of International Customers
A growing portion of our revenue is derived from international sales. Non-U.S. sales accounted for approximately 36% of our revenue for the three month ended March 31, 2010, as compared to 14% in the three months ended March 31, 2009. Non-U.S. sales for the years ended December 31, 2009 and 2008 were 14% and 15%, respectively.
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Managing our growing group of customers outside the U.S., directly and through a relationship with a third party, presents various challenges, including, but not limited to:
| • | economic and political conditions; |
| • | longer payment cycles; |
| • | differences in the enforcement of intellectual property and contract rights in varying jurisdictions; |
| • | our ability to develop relationships with local accounts; |
| • | compliance with U.S. and international laws and regulations; |
| • | fluctuations in foreign currency exchange rates; and |
| • | our ability to secure and retain qualified people for the operation of our business. |
To date, foreign exchange exposure from sales has not been material to our operations. Our activities with customers outside the United States may be affected by changes in trade protection laws, policies and measures, and other regulatory requirements affecting trade and investment, including the Foreign Corrupt Practices Act and local laws prohibiting corrupt payments. In addition, the laws of some foreign countries may not protect our intellectual property rights to the same extent as do the laws of the United States, which increases the risk of unauthorized use of our technologies. Our business could be materially adversely affected if foreign markets do not continue to develop, if we do not maintain the relationship with our third party representatives, if we do not receive additional traffic suitable for our foreign accounts or if regulations governing our international businesses change.
We rely primarily on our distribution network partners to generate quality search queries and display advertisements that generate paid clicks; if we are unable to maintain or expand the scope and quality of this network, our ability to generate revenue may be seriously harmed
The success of our online search advertisement products depends in large part on the size and quality of our distribution network of search queries. 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 has been concentrated, with the five largest distribution network partners accounting for approximately 43% and 48% of our Advertiser Networks revenue for the three months ended March 31, 2010 and the year ended December 31, 2009, respectively. 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 and chose to remove those with poor quality. Although alternate sources of click traffic are currently available in the market, they may not be available at reasonable prices or may be of unacceptable quality. There is significant 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. In order to attract higher quality traffic, we may have to pay high traffic acquisition costs which may adversely affect our gross margin and other financial results. If we are unable to attract higher quality traffic, or if we are otherwise unsuccessful in maintaining and expanding our distribution network, then our ability to generate revenue may be seriously harmed.
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 net losses of approximately $0.5 million for the three months ended March 31, 2010, and as of March 31, 2010, our accumulated deficit was approximately $235.6 million. We may be unable to achieve and maintain profitability in the foreseeable future. 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 search advertising customers spend on our advertising network, expand our advertiser base and experience an increase in paid clicks across our network and publisher products. 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, and market our products. 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 match rate and/or revenue-per-click, or we are unable to rebuild our match rate, and/or revenue-per-click, our financial results will suffer
We have experienced, and may in the future experience, downward pressure on our average revenue-per-click (“RPC”) and
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average match rate, which is the rate at which our paid listings are matched against search queries from distribution network partners, due to various market segment, customer, and channel factors. We may experience decreases in RPC 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 search advertising customers, changes in the composition of our distribution network or other reasons. If our RPC or average match rate falls for any reason, or if we are unable to grow our RPC 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 search advertising customer base; if our search advertising customer base and average search advertising customer spend falls, our financial results will suffer
Our growth depends on our ability to build a search advertising customer base that corresponds with the characteristics of our distribution network. Our distribution network, which currently consists of a diversified network of distribution sources, may change as new distribution sources are added and old distribution sources are removed. Search advertising customers may view these changes to the distribution network negatively, and existing or potential search advertising customers may elect to purchase fewer or no advertisements for display on our distribution network. If this occurs, it is likely that our average RPC and average match rate may decline and our stock price would likely suffer.
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 online search advertising industry is rapidly evolving and very turbulent, and we will need to continue developing new and upgraded products and services, and adapt to new business environments and competition in order to maintain and grow revenue and reach our profitability goals. New search advertising technologies could emerge that make our services comparatively less useful or new business methods could emerge that divert web traffic away from our Advertising Network. 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 search 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 accurately anticipate customer needs for our products, 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 search advertising industry, which presents many uncertainties that could require us to further refine our business model. We compete with large companies that provide paid placement products, paid inclusion products, and other forms of search marketing as well as contextually-targeted advertising products and other types of online advertisements. We compete for search advertising customers on the basis of the quality and composition of our network, the price-per-click (“PPC”) charged to search advertising customers, the volume of clicks that we can deliver to search advertising customers, 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 PPC charged to search advertising customers. We also experience competition in offering our publisher products to website publishers. Some of our competitors have larger distribution networks and proprietary traffic bases, longer operating histories, greater brand recognition, higher RPC, 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, may make acquisitions of or significant investments in, complementary companies or technologies to increase our technological capabilities expand our service offerings, or extend the operating scale of our network businesses. The pursuit of acquisitions, whether or not completed, as well as the completion of any acquisitions and their integration may be expensive and 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 acquisitions, or divest non-performing assets at below-market prices, which would adversely affect our operating results. 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. The combination of depressed capital markets, stock volatility and small market capitalization may not allow us to offer competitive equity based compensation to attract and retain key personnel. In recent years, we have experienced significant restructurings and turnover in our management team that has placed additional burdens on our remaining personnel. Over the past seven months, our General Counsel, Chief Executive Officer and Vice President and General Manager, Advertising Platforms have all left the Company. We cannot insure 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 receive and analyze advertisements, campaigns and budgets, match search queries to advertising, analyze webpage information to match advertising to relevant content, integrate third-party ads, detect invalid clicks, serve ads in high volume, and track, analyze and report on advertising responses and campaigns. 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 service or the websites of our distribution network partners:
| • | customization of our matching algorithms and ad serving technologies, |
| • | substantial increases in the number of queries to our database, |
| • | substantial increases in the number of searches in our advertising 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 search 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.
Our ability to retain existing credit facilities or obtain new credit facilities may adversely affect the way we conduct our business
On April 30, 2009, we extended our bank lease line through April 30, 2010. As of March 31, 2010 there remained $0.1 million under the $5.0 million credit facility which was not utilized before it expired on April 30, 2010.
We may need to enter into additional credit facilities to operate the business. The recent global financial crisis, further financial institution failures, as well as our history of operating losses, may make it more difficult for us to obtain additional financing for our operations, investing activities, or financing activities. This difficulty or inability could materially limit our business operations and adversely affect our business performance.
If we do not comply with the financial covenants in our credit agreements, our financial condition could be adversely affected.
Our credit facilities contain provisions that could limit our ability to, among other things, incur, create or assume additional debt, sell or otherwise dispose of our or any of our subsidiary’s assets, or consolidate or merge with or into, or acquire the obligations or stock of, or any other interest in, another person. In addition, our credit facilities contain financial covenants that require us to maintain specified levels of tangible net worth and liquid assets. Our ability to meet those financial covenants can be affected by events beyond our control, and we may be unable to satisfy these covenants. If we fail to comply with these covenants, we may be required to identify restricted cash equal to our outstanding capital lease balance plus our outstanding standby letters of credit (“SBLC”) or, in the event of default, we may be required to pay the lenders cash in an amount equal to the capital lease balance. Paying such cash balances could have a material adverse effect on the Company’s financial condition.
Risks Related to Operating in our Industry
Economic conditions, political events, and other circumstances could materially adversely affect the Company
The Company’s operations and performance depend significantly on worldwide economic conditions and their impact on levels of consumer spending, which have recently deteriorated significantly in many countries and regions, including without limitation the United States, and may remain depressed for some time. Some of the factors that could influence the levels of consumer spending and,
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in turn, online advertising, include continuing volatility in fuel and other energy costs, conditions in the residential real estate and mortgage markets, labor and healthcare costs, access to credit, consumer confidence and other macroeconomic factors affecting consumer spending behavior and, in turn, online advertising. These and other economic factors could have a material adverse effect on demand for the Company’s products and services and on the Company’s financial condition and operating results.
Cyclical and seasonal fluctuations in the economy, in internet usage and in traditional retail shopping may have an effect on our business
Both cyclical and seasonal fluctuations in internet usage and traditional retail seasonality may affect our business. Internet usage generally slows during the summer months, and queries typically increase significantly in the fourth quarter of each year. These seasonal trends may cause fluctuations in our quarterly results, including fluctuations in sequential revenue growth rates.
If we fail to prevent, detect and remove invalid search queries and clicks, we could lose the confidence of our search advertisers, thereby causing our business to suffer
Invalid clicks are an ongoing problem for the Internet search advertising industry, and we are exposed to the risk of invalid clicks on our search advertising customers’ text advertisements coming from within our distribution network. 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. Invalid clicks are commonly referred to as “click fraud.” We continue to 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 be able to completely 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 search advertising customer complaints, claims, litigation or inquiries in the future. For example, in March 2005, the Company was served with the second amended complaint in a class action lawsuit (Lane’s Gifts and Collectibles, L.L.C., v. Yahoo! Inc.) alleging that the Company engaged in click fraud and seeking damages as a result. We have from time to time credited invoices or refunded revenue to our customers due to invalid 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 search 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 advertising network, the affected search advertising customers may experience a reduced return on their investment in our online advertising because the invalid clicks will not lead to conversions for the search advertising customers. This could lead the search advertisers to become dissatisfied with our products, which could lead to loss of search advertising customers and revenue and could materially and adversely affect our financial results.
Any failure in the performance of our key production systems could materially and adversely affect our revenues
Any system failure that interrupts our hosted products or services, 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. Moreover, our services are governed by Service Level Agreements that, if not met, require the payment of credits to our customers depending upon the level of service interruption.
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. A loss of data 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. Additionally, we are in the process of moving our data center to Sacramento, California which will be completed in the second quarter of 2010. This move could disrupt our operations. An interruption in our ability to serve advertisements, track paid clicks, bill and collect invoices, 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 distribution network partners and search advertising customers depend on Internet service providers, online service providers and other third parties for access to our services. 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 currently have agreements with Savvis Communications, Inc. and Raging Wire Enterprise Solutions, Inc. (“Raging Wire”)
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to house equipment for web serving and networking and to provide network connectivity services. We will be terminating our relationship with Savvis and completing a transition to Raging Wire for these services by the end of the second quarter of 2010. We also have agreements with third-party click tracking and ad-serving technology providers. 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 Raging Wire 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 Raging Wire guarantees that our Internet access will be uninterrupted, error-free or secure. Although we maintain property insurance and business interruption insurance, such insurance may not protect against some risks and 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, search advertisers, 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. As we enter foreign markets, our potential liability could increase. 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 services 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.
We could be subject to infringement claims that may be costly to defend, result in the payment of settlements or damages or cause us to change the way we conduct our business
Internet, technology and media companies, as well as patent holding companies often possess a significant number of patents. Further, many of these companies and other parties are actively developing online advertising, 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, acquire and maintain our customer base, and develop new technologies, products and services, we may become increasingly subject to intellectual property infringement claims. In the event that there is a claim or determination that we infringe 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. The occurrence of any of these results could harm our brand and negatively impact our operating results. 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 or determinations, which could increase our costs in defending such claims and our damages. For example, in October 2008, we agreed to indemnify one of our Publisher Solutions customers relating to a patent infringement suit filed against it pursuant to an AdCenter for Publishers’ agreement between it and the Company. The resulting settlement agreement between the Company and the plaintiffs required us to pay the plaintiffs $0.6 million and the Publisher Solutions customer’s defense costs of $0.4 million.
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 our publisher customers’ advertisers 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 or our publishers’ customers 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 the sale of pharmaceutical products over the Internet and the use of adware to distribute advertisements on the Internet. In 2007, the Federal Trade Commission proposed new
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regulations relating to online behavioral targeting. Moreover, as we enter into foreign markets, we may become subject to additional regulation and legislation. 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. As we continue our Section 404 compliance efforts we may identify significant deficiencies, or material weaknesses, in the design and operation of our internal control over financial reporting. 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 its 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 revenues or increase our costs
Internet user privacy has become an issue both in the United States and abroad. The United States Congress and Federal Trade Commission are considering new legislation and regulations to regulate Internet privacy. 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.
In addition, our search 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 search advertisers and sponsors, which could result in a decline in our revenue.
We, along with some of our distribution network partners or search advertising customers 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 search advertising customers 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 of confidential information over public networks. Although we have developed and use systems and processes that are designed to protect customer 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 customers 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 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 websites 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.
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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 search advertising customers 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 the Capital Market
Our securities may be delisted
The NASDAQ Stock Market requires us to satisfy certain continued listing requirements, including maintaining a minimum closing bid price for our common stock of at least $1.00 per share. On March 9, 2010, Nasdaq sent us a letter stating that we were out of compliance with that requirement and that we had until September 7, 2010 to regain compliance by having our common stock close at or above the $1.00 per share minimum closing bid price for 10 consecutive trading days. On April 26, 2010 we received a letter from Nasdaq stating that we had regained compliance with the minimum closing bid price requirement and that the matter was closed. However, should our stock price again close under the $1.00 per share minimum closing bid price for 30 consecutive days, we could again be deemed out of compliance with the minimum closing bid price requirement and be forced to consider various actions to regain compliance, including a reverse stock split of our common stock. No assurance can be given that we will remain in compliance with all of the NASDAQ Stock Market’s continued listing requirements. If delisting were to occur, our securities will not enjoy the same liquidity as shares that are traded on the NASDAQ Stock Market or a national U.S. securities exchange and investors may find that it is more difficult to obtain accurate and timely quotations. As a result, the price of our securities would likely decline.
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 without limitation:
| • | change in the composition of our Advertiser Network customer base, |
| • | change in composition of our AdCenter 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 search advertising customers who do business with us, or the amount of spending per customer, |
| • | the revenue-per-click we receive from search advertising customers, or other factors that affect the demand for, and prevailing prices of, Internet advertising and marketing services, |
| • | change in our traffic acquisition costs (TAC) related to our Advertiser Network, |
| • | systems downtime on our Advertiser Network, our website or the websites of our distribution network partners, or |
| • | the effect ASC 718, 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.
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Our long-lived assets may be subject to greater risk of impairment if we undergo a change of control limiting the use of our net operating losses
As of December 31, 2009, we had net operating losses (NOLs) amounting to approximately $175 million for federal income tax purposes. We can utilize these NOLs in certain circumstances to offset future U.S. taxable income and reduce our U.S. federal income tax liability, which may arise even in periods when we incur an accounting loss for reporting purposes. We also include these NOL benefits in the calculation associated with testing for impairment of our long-lived assets. However, our ability to utilize our NOLs for these purposes would be substantially limited if there were an “ownership change” as defined under Section 382 of the Internal Revenue Code. In general, an ownership change would occur if certain ownership changes related to our stock held by 5% or greater shareholders exceeded 50%, measured over a rolling three year period beginning with the last ownership change. These provisions can be triggered not only by merger and acquisition activity, but also by stock repurchases and normal market trading of our common stock. While we have not undergone a change of control under Section 382 since 2003, we were close to the threshold in 2008 and 2009, and no assurance can be given that such a change of control will not occur in the future. Should we undergo such a change of control, our ability to utilize our NOLs to offset future U.S. taxable income and reduce our U.S. federal income tax liability may be limited in certain circumstances. This, in turn, would affect our ability to utilize the NOLs in the calculations associated with testing for impairment of our long-lived assets used in operations, which could result in an increased likelihood of such impairment.
Our stock price is extremely volatile, and such volatility may hinder investors’ ability to resell their shares for a profit or avoid a 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. You should evaluate our business in light of the risks, uncertainties, expenses, delays and difficulties associated with managing and growing a business in a relatively new industry, 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 without limitation:
| • | 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, |
| • | the sales of substantial amounts of our common stock in the public market by our stockholders, or the perception that such sales could occur, or |
| • | 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 which 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, |
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| • | 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.
A significant market downturn may lead to a decline in the value of securities we hold in our investment portfolio
Beginning in 2008, the global markets for fixed-income securities, particularly the markets for financial instruments collateralized by sub-prime mortgages, experienced significant disruption. This disruption affected the liquidity and pricing of securities traded in these markets, as well as the returns of, and levels of redemptions in, investment vehicles investing in those instruments. Although we invest in short-term, highly liquid debt instruments of the U.S. government, commercial paper, time deposits, money market mutual funds and U.S. corporate securities, similar events in the future may adversely affect the value and liquidity of securities we hold in our investment portfolio.
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 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
None.
| ITEM 3. | DEFAULTS UPON SENIOR SECURITIES |
None.
| ITEM 4. | REMOVED AND RESERVED |
| ITEM 5. | OTHER INFORMATION |
None.
| 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.
Dated: May 7, 2010
By: | /s/ Stephen C. Markowski | |
Stephen C. Markowski Chief Financial Officer |
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Exhibits
Number | Description of Document | |
| 3.1 | Restated Certificate of Incorporation (Filed with the Company’s Quarterly Report on Form 10-Q (File No. 000-26357) filed with the SEC on November 14, 2005). | |
| 3.2 | Bylaws (Filed with the Company’s Quarterly Report on Form 10-Q (File No. 000-26357) filed with the SEC on August 14, 2000) (File No. 000-26357). | |
| 4.1 | Form of Specimen Stock Certificate (Filed with the Company’s Quarterly Report on Form 10-Q (File No. 000-26357) 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 (File No. 000-26357) 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 (File No. 000-26357) filed with the SEC on May 10, 2006). | |
| 4.4++ | 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 (File No. 000-26357) 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 September 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 September 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). | |
| 10.6++ | LookSmart, Ltd. 2008 Executive Team Incentive Plan (Filed with the Company’s Current Report on Form 8-K (File No. 000-26357) filed with the SEC on February 19, 2008). | |
| 10.7 | Zeal Media, Inc. 1999 Stock Plan (Filed with the Company’s Registration Statement on Form S-8 (File No. 333-51408) 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 (File No. 333-86436) filed with the SEC on April 18, 2002). | |
| 10.9++ | LookSmart 2007 Equity Incentive Plan (Filed with the Company’s Registration Statement on Form S-8 (File No. 333-144384) filed with the SEC on July 6, 2007). | |
| 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 September 14, 1999). | |
| 10.18++ | LookSmart, Ltd. Form Amended and Restated Change of Control/Severance Agreement (Filed with the Company’s Annual Report on Form 10-K (File No. 000-26357) filed with the SEC on March 16, 2009). | |
| 10.31 | Fourth Addendum to AdCenter License, Hosting and Support Agreement between the Registrant and IAC Search & Media dated September 14, 2007 (Filed with the Company’s Quarterly Report on Form 10-Q (File No. 000-26357) 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 (File No. 000-26357) filed with the SEC on August 9, 2007). | |
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| 10.33+ | LookSmart Reseller Terms and Conditions with MeziMedia dated September 7, 2005. (Filed with the Company’s Quarterly Report on Form 10-Q (File No. 000-26357) filed with the SEC on May 10, 2007). | |
| 10.34 | Co-Location Services Agreement between the Registrant and Savvis Communications Corporation dated March 29, 2008 (Filed with the Company’s Quarterly Report on Form 10-Q (File No. 000-26357) with the SEC on May 12, 2008). | |
| 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 (File No. 000-26357) with the SEC on August 8, 2006). | |
| 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 (File No. 000-26357) 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 (File No. 000-26357) 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 (File No. 000-26357) 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 (File No. 000-26357) 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 (File No. 000-26357) 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 (File No. 000-26357) with the SEC on September 12, 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 (File No. 000-26357) filed with the SEC on July 16, 2007). | |
| 10.47+ | Paid Listings License Agreement between the Registrant and Kontera Technologies, Inc. dated July 17, 2006. (Filed with the Company’s Quarterly Report on Form 10-Q (File No. 000-26357) with the SEC on November 9, 2007). | |
| 10.48+ | License Agreement between the Registrant and Oversee.net dated April 1, 2004 (Filed with the Company’s Quarterly Report on Form 10-Q (File No. 000-26357) filed with the SEC on November 9, 2007). | |
| 10.49 | Letter from Oversee.net to the Registrant dated January 21, 2008 terminating Agreement between Registrant and Oversee.net dated April 1, 2004 effective September 30, 2008 (Filed with the Company’s Annual Report on Form 10-K (File No. 000-26357) filed with the SEC on March 17, 2008). | |
| 10.50+ | Backfill Agreement between the Registrant and Internext Media Corp. dated February 8, 2008 (Filed with the Company’s Quarterly Report on Form 10-Q (File No. 000-26357) on May 12, 2008). | |
| 10.51* | Paid Listings License Agreement between the Registrant and PeakClick GMBH dated April 15, 2006. | |
| 10.52* | Advertiser Terms and Conditions between the Registrant and MeziMedia dated September 26, 2008. | |
| 10.53* | Paid Listings License Agreement between the Registrant and Wellbourne Limited dated March 15, 2006. | |
| 10.54 | Letter dated May 19, 2009 from IAC Search & Media (“IAC”) to the Registrant notifying the Registrant that IAC does not intend to renew the May 2005 AdCenter License, Hosting and Support Agreement (Filed with the Company’s Current Report on Form 8-K (File No. 000-26357) filed with the SEC on May 21, 2009). | |
| 10.55++ | July 13, 2009 Amendment to the Registrant’s Chief Financial Officer’s Offer Letter (Filed with the Company’s Current Report on Form 8-K (File No. 000-26357) filed with the SEC on July 13, 2009). | |
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| 10.56++ | Severance Agreement and General Release between the Registrant and its former Senior Vice President, Corporate Development (Filed with the Company’s Current Report on Form 8-K (File No. 000-26357) filed with the SEC on June 10, 2009). | |
| 10.60++ | Employment offer letter between the Registrant and its Chief Financial Officer dated August 1, 2008 (Filed with the Company’s Current Report on Form 8-K (File No. 000-26357) filed with the SEC on August 5, 2008). | |
| 10.61++ | Board Services Agreement between the Registrant and its Director dated July 1, 2008 (filed with the Company’s Amended Annual Report on Form 10-K/A (File No. 000-26357) on April 30, 2009) | |
| 10.62++ | Amendment to offer letter between Registrant and its Chief Financial Officer dated March 23, 2009 (filed with the Company’s Quarterly Report on Form 10-Q (File No. 000-26357) on May 5, 2009). | |
| 10.63 | Sublease Agreement with KPMG, LLP for property located at 55 Second Street, San Francisco, California (filed with the Company’s Quarterly Report on Form 10-Q (File No. 000-26357) on November 4, 2009). | |
| 10.64++ | Amendment to offer letter between the Registrant and its Chief Financial Officer dated July 13, 2009 (filed with the Company’s Current Report on Form 8-K (File No. 000-26357) filed with the SEC on July 13, 2008) | |
| 10.65 | Master Lease Agreement between the Registrant and City National Bank dated April 6, 2007 (Filed with the Company’s Annual Report on Form 10-K filed with the SEC on March 26, 2010). | |
| 10.66 | Covenants Rider to the Master Lease Agreement between the Registrant and City National Bank dated September 30, 2009 (filed with the Company’s Quarterly Report on Form 10-Q (File No. 000-26357) on November 4, 2009). | |
| 10.67 | Irrevocable Standby Letter of Credit Application and Letter of Credit Agreement between the Registrant and City National Bank dated August 14, 2009 (filed with the Company’s Quarterly Report on Form 10-Q (File No. 000-26357) on November 4, 2009). | |
| 10.68 | First Amendment to Supplemental Terms and Conditions Letter between the Registrant and City National Bank dated October 16, 2009 (filed with the Company’s Quarterly Report on Form 10-Q (File No. 000-26357) on November 4, 2009). | |
| 10.69‡ | Master Services Agreement #12223.0.1 between the Registrant and RagingWire Enterprise Solutions, Inc. effective as of October 30, 2009 (Filed with the Company’s Annual Report on Form 10-K (File No. 000-26357) filed with the SEC on March 26, 2010). | |
| 10.70++ | Severance Agreement and General Release dated October 15, 2009 (filed with the Company’s Current Report on Form 8-K (File No. 000-26357) filed with the SEC on October 19, 2009) | |
| 10.71++ | Separation Agreement between LookSmart, Ltd. and Edward F. West dated December 14, 2009 (filed with the Company’s Current Report on Form 8-K (File No. 000-26357) filed with the SEC on December 14, 2009) | |
| 10.72 | Agreement to Lease Equipment between the Registrant and Cisco Capital Corporation dated as of December 14, 2009 (Filed with the Company’s Annual Report on Form 10-K (File No. 000-26357) filed with the SEC on March 26, 2010) | |
| 10.73‡ | Sixth Addendum to the May 2005 AdCenter License, Hosting and Support Agreement between the Registrant and IAC Search & Media effective as of December 1, 2009 (Filed with the Company’s Annual Report on Form 10-K (File No. 000-26357) filed with the SEC on March 26, 2010). | |
| 10.74++ | Employment offer letter between the Registrant and its Vice President of Advertising Network Sales dated January 30, 2009 (together with summary of amendment thereto in connection with a salary decrease in June, 2009) (Filed with the Company’s Annual Report on Form 10-K (File No. 000-26357) filed with the SEC on March 26, 2010). | |
| 10.75++ | 2009 Employee Stock Purchase Plan (Filed with the Company’s Registration Statement on Form S-8 (File No. 333-165791) filed with the SEC on March 30, 2010). | |
| 10.76 | Separation Agreement between the Registrant and Michael Schoen dated February 17, 2010 (Filed with the Company’s Current Report on Form 8-K (File No. 000-26357) filed with the SEC on February 19, 2010) | |
| 10.77*(‡) | Sales Representation Agreement between Registrant and JW Digital, dated October 18, 2009. | |
| 31.1* | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
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| 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. |
| (++) | Management contract or compensatory plan or arrangement. |
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