Quarterly Report

---

---

---

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 June 30, 2011

 

OR

 

o	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  o

 

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   x      No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large-accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer		o		Accelerated filer		o
Non-accelerated filer		o		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   o     No   x

 

As of July 29, 2011 , there were 17,279,982 shares of the registrant’s common stock outstanding, par value $0.001 per share.

 

---

---

 

 

---

 

 

TAB LE OF CONTENTS

 

PART I			1
ITEM 1		FINANCIAL STATEMENTS	1
		UNAUDITED CONSOLIDATED BALANCE SHEETS	1
		UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS	2
		UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS	3
		NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS	4
ITEM 2.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	14
ITEM 3.		QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	20
ITEM 4.		CONTROLS AND PROCEDURES	20
PART II OTHER INFORMATION			20
ITEM 1.		LEGAL PROCEEDINGS	20
ITEM 1A.		RISK FACTORS	20
ITEM 2.		UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	20
ITEM 3.		DEFAULTS UPON SENIOR SECURITIES	21
ITEM 4.		(REMOVED AND RESERVED)	21
ITEM 5.		OTHER INFORMATION	21
ITEM 6.		EXHIBITS	21
SIGNATURE			21
EXHIBIT INDEX			21

 

 

---

Table of Contents

 

PART I

 

ITEM 1.

FINANCIAL INFORMATION

   

LOOKSMART, LTD. AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

(In thousands, except per share data)

		June 30, 2011				December 31, 2010
ASSETS		(Unaudited)
Current assets:
Cash and cash equivalents		$	11,228			$	22,119
Short-term investments			11,254				3,250
Total cash, cash equivalents and short-term investments			22,482				25,369
Trade accounts receivable, net			2,137				3,267
Prepaid expenses and other current assets			656				680
Total current assets			25,275				29,316
Long-term investments			3,528				1,577
Property and equipment, net			2,441				3,082
Capitalized software and other assets, net			1,453				1,750
Total assets		$	32,697			$	35,725
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable		$	1,330			$	2,503
Accrued liabilities			1,495				2,615
Deferred revenue and customer deposits			1,022				1,004
Current portion of capital lease obligations			856				1,048
Total current liabilities			4,703				7,170
Capital lease and other obligations, net of current portion			520				902
Total liabilities			5,223				8,072
Commitment and contingencies
Stockholders' equity:
Convertible preferred stock, $0.001 par value; Authorized: 5,000 shares at June 30, 2011 and December 31, 2010; Issued and Outstanding: none at June 30, 2011 and December 31, 2010			-				-
Common stock, $0.001 par value; Authorized: 80,000 shares at June 30, 2011 and December 31, 2010; Issued and Outstanding: 17,276 shares and 17,222 shares at June 30, 2011 and December 31, 2010, respectively			17				17
Additional paid-in capital			261,987				261,740
Accumulated other comprehensive gain			16				1
Accumulated deficit			(234,546	)			(234,105	)
Total stockholders' equity			27,474				27,653
Total liabilities and stockholders' equity		$	32,697			$	35,725

The accompanying Notes are an integral part of these Unaudited Consolidated Financial Statements.

 

1

---

Table of Contents

 

LOOK SMART, LTD. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF OPERATIONS

 

(In thousands, except per share data)

 

(Unaudited)

		Three Months Ended June 30,								Six Months Ended June 30,
		2011				2010				2011				2010
Revenue		$	6,605			$	13,017			$	14,994			$	26,303
Cost of revenue			3,439				7,525				8,094				16,561
Gross profit			3,166				5,492				6,900				9,742
Operating expenses:
Sales and marketing			554				1,275				1,202				2,429
Product development and technical operations			1,550				2,001				3,144				3,993
General and administrative			1,041				1,669				2,427				3,360
Restructuring charge			-				-				889				-
Total operating expenses			3,145				4,945				7,662				9,782
Income (loss) from operations			21				547				(762	)			(40	)
Interest income			24				16				47				33
Interest expense			(24	)			(41	)			(53	)			(83	)
Other income, net			333				44				326				52
Income (loss) from continuing operations before income taxes			354				566				(442	)			(38	)
Income tax benefit (expense)			-				1				1				(5	)
Income (loss) from continuing operations			354				567				(441	)			(43	)
Income from discontinued operations, net of tax			-				85				-				178
Net income (loss)		$	354			$	652			$	(441	)		$	135
Net income (loss) per share - Basic and Diluted
Income (loss) from continuing operations		$	0.02			$	0.04			$	(0.03	)		$	-
Income from discontinued operations, net of tax			-				-				-				0.01
Net income (loss) per share - Basic and Diluted		$	0.02			$	0.04			$	(0.03	)		$	0.01
Weighted average shares outstanding used in computing basic net income (loss) per share			17,274				17,157				17,255				17,151
Weighted average shares outstanding used in computing diluted net income (loss) per share			17,368				17,192				17,255				17,168

The accompanying Notes are an integral part of these Unaudited Consolidated Financial Statements.

 

2

---

Table of Contents

 

LOO KSMART, LTD. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

(In thousands)

 

(Unaudited)

		Six Months Ended June 30,
		2011				2010
Cash flows from operating activities:
Net income (loss)		$	(441	)		$	135
Adjustment to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization			1,409				1,433
Share-based compensation			165				332
(Gain) loss from sale of assets and other non-cash charges			46				(228	)
Deferred rent			(4	)			84
Gain on closure of settlement fund			(339	)			-
Changes in operating assets and liabilities:
Trade accounts receivable			1,039				(939	)
Prepaid expenses and other current assets			56				(20	)
Trade accounts payable			(1,173	)			(97	)
Accrued liabilities			(781	)			(531	)
Deferred revenue and customer deposits			18				(91	)
Net cash provided by (used in) operating activities			(5	)			78
Cash flows from investing activities:
Purchase of investments			(15,367	)			(4,498	)
Proceeds from sale of investments			5,397				8,262
Proceeds from sale of equipment			-				67
Payments for property, equipment, and capitalized software			(503	)			(1,863	)
Proceeds from contingent purchase consideration of certain consumer assets			91				178
Net cash provided by (used in) investing activities			(10,382	)			2,146
Cash flows from financing activities:
Principal payments of capital lease obligations			(570	)			(700	)
Proceeds from issuance of common stock			66				-
Net cash used in financing activities			(504	)			(700	)
Increase (decrease) in cash and cash equivalents			(10,891	)			1,524
Cash and cash equivalents, beginning of period			22,119				22,933
Cash and cash equivalents, end of period		$	11,228			$	24,457
Supplemental disclosure of noncash activities:
Assets acquired through capital lease obligations		$	-			$	363
Property and equipment received and liability accrued		$	-			$	38
Change in unrealized gain on investments		$	15			$	-

The accompanying Notes are an integral part of these Unaudited Consolidated Financial Statements.

 

3

---

Table of Contents

 

LOO KSMART, LTD. AND SUBSIDIARIES

 

NOTES TO UNAUDITED 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 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. The results of operations of consumer product activities, including related gains, have been classified as discontinued operations for all periods presented in the accompanying Unaudited Consolidated Statements of Operations (see Note 2). At June 30, 2011, the Company continues to own the Wisenut search engine technology, intellectual property rights in such technology, and other assets.

 

Principles of Consolidation

 

The Unaudited Consolidated Financial Statements as of June 30, 2011 and December 31, 2010, and for the three and six months ended June 30, 2011 and 2010, 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 Consolidated Financial Statements as of June 30, 2011, and for the three and six months ended June 30, 2011 and 2010, 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 June 30, 2011 and the results of operations for the periods shown. These Unaudited 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, 2010 (“Annual Report”). The Unaudited Consolidated Balance Sheet as of December 31, 2010 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 June 30, 2011 are not necessarily indicative of results to be expected for the full year.

 

Use of Estimates and Assumptions

 

The Unaudited 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 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. In management’s opinion, all adjustments necessary for a fair statement are reflected in the interim periods presented.

 

Reclassifications

 

Certain amounts in the financial statements for the prior periods have been reclassified to conform to the current presentation. These reclassifications did not change the previously reported net loss, net change in cash and cash equivalents or stockholders’ equity.

 

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.

 

4

---

Table of Contents

 

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 transaction fees that the Company charges customers. Revenue also includes revenue share from licensing of private-labeled versions of the Company’s AdCenter Platform.

 

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 that management is aware of. 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 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 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 AdCenter platform technology. These license arrangements may include some or all of the following elements: revenue-sharing based on the publisher’s customer’s monthly revenue generated through the AdCenter application; upfront fees; monthly minimum 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.

 

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 included in trade accounts receivable, net is not significant and $0.2 million at June 30, 2011 and December 31, 2010, respectively.

 

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 $0.2 million at June 30, 2011 and December 31, 2010. Bad debt allowance included in sales and marketing expense is not significant for the three and six months ended June 30, 2011 and 2010.

 

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 June 30, 2011 and December 31, 2010, 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 June 30, 2011 and December 31, 2010. 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.

 

One customer accounted for 15% and 21% of gross accounts receivable at June 30, 2011 and December 31, 2010, respectively.

 

5

---

Table of Contents

 

Revenue Concentrations

 

The following table reflects revenue from customers located in countries or regions that accounted for more than 10% of net revenue:

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2011				2010				2011				2010
United States			78	%			59	%			69	%			62	%
Europe, Middle East and Africa			13	%			24	%			24	%			21	%
Canada			**				12	%			**				13	%
** Less than 10%

 

LookSmart derives its revenue from two service offerings, or “products”: Advertiser Networks and Publisher Solutions. The percentage distributions between the two service offerings are as follows:

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2011				2010				2011				2010
Advertiser Networks			96	%			93	%			96	%			93	%
Publisher Solutions			4	%			7	%			4	%			7	%

 

The following table reflects the percentage of revenue attributed to customers who accounted for 10% or more of net revenue:

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2011				2010				2011				2010
Company 1			13	%			11	%			14	%			11	%
Company 2			11	%			11	%			**				11	%
Company 3			**				**				**				11	%
** Less than 10%

 

The Company derives its revenue primarily from its relationships with significant distribution network partners. The following table reflects the distribution partners that accounted for more than 10% of TAC:

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2011				2010				2011				2010
Distribution Partner 1			**				26	%			**				17	%
Distribution Partner 2			**				**				11	%			**
** Less than 10%

 

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 as follows:

 

Computer equipment	3 to 4 years
Furniture and fixtures	5 to 7 years
Software	2 to 3 years

 

Leasehold improvements are amortized on a straight-line basis over the shorter of their estimated useful lives or the lease term.

 

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.

 

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, which is generally 3 years. The Company expects to continue to invest in internally developed software and to capitalize such costs.

 

6

---

Table of Contents

 

Impairment of Long-Lived Assets

 

The Company reviews long-lived assets held or used in operations, including property and equipment and capitalized software development costs, 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.

 

As of June 30, 2011 and December 31, 2010, management believes long-lived assets 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. These affiliate agreements provide for 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.

 

The Company records TAC expenses as cost of revenue and TAC 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 Consolidated Statements of Operations over the requisite service periods. Share-based compensation expense recognized for the three and six months ended June 30, 2011 were $0.1 million and $0.2 million, respectively, and $0.2 million and $0.4 million for the three and six months ended June 30, 2010, 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.

 

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 interest and penalties related to unrecognized tax benefits within operations as income tax expense.

 

Comprehensive Gain

 

Other comprehensive gain as of June 30, 2011 and December 31, 2010, consists of unrealized gains on marketable securities categorized as available-for-sale.

 

Net Income (Loss) per Common Share

 

Basic and diluted net income (loss) per share is calculated using the weighted average shares of common stock outstanding.

 

Segment Information

 

The Company operates in a single segment, search advertising, and conducts business worldwide. While the Company operates under one operating segment, management reviews revenue under two product offerings—Advertiser Networks and Publisher Solutions.

 

As of June 30, 2011 and December 31, 2010, all of the Company’s accounts receivable, intangible assets and deferred revenue related to the search advertising segment. All long-lived assets are located in the United States or Canada.

 

Recent Accounting Pronouncements

 

With the exception of those stated below, there have been no recent accounting pronouncements or changes in accounting pronouncements during the six months ended June 30, 2011, as compared to the recent accounting pronouncements described in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010, that are of material significance, or have potential material significance, to the Company.

 

In May 2011, the Financial Accounting Standards Board (“FASB”) issued a new accounting standard on fair value measurements that clarifies the application of existing guidance and disclosure requirements, changes certain fair value measurement principles and requires additional disclosures about fair value measurements. This new guidance is to be applied prospectively. The Company is required to adopt this standard as of the beginning of 2012. Adoption of this new guidance is not expected to have a material impact on the Company’s results of operations, financial position or liquidity.

 

In June 2011, the FASB issued a new accounting standard on the presentation of comprehensive income. The new standard requires the presentation of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The new standard also requires presentation of adjustments for items that are reclassified from other comprehensive income to net income in the statement where the components of net income and the components of other comprehensive income are presented. This new guidance is to be applied retrospectively. The Company is required to adopt this standard as of the beginning of 2012. Adoption of this new guidance is not expected to have a material impact on the Company’s results of operations, financial position or liquidity.

 

 

7

---

Table of Contents

 

2. Discontinued Operations

 

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 was 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 and six months ended June 30, 2010 which has been classified as discontinued operations in the accompanying Unaudited Consolidated Statements of Operations. Under the terms of the Content Watch agreement, the contingent purchase consideration ended in 2010.

 

As of June 30, 2011 the Company owns the Wisenut search engine technology, intellectual property rights in such technology and other assets.

 

3. Cash, Cash Equivalents and Short-Term Investments

 

The following table summarizes the Company’s cash and available-for-sale securities’ amortized cost and estimated fair value by significant investment category as of June 30, 2011 and December 31, 2010 (in thousands):

 

		Amortized Cost and Estimated Fair Value
		June 30				December 31
		2011				2010
Cash and cash equivalents:
Cash		$	8,456			$	9,435
Cash equivalents
Money market mutual funds			973				35
Certificates of deposit			-				2,000
Commercial paper			1,799				10,649
Total cash equivalents			2,772				12,684
Total cash and cash equivalents			11,228				22,119
Short-term investments:
Corporate bonds			507				-
Certificates of deposit			5,050				2,250
Commercial paper			5,697				1,000
Total short-term investments			11,254				3,250
Long-term investments:
Corporate bonds			2,103				1,577
Certificates of deposit			1,425				-
Total long-term investments			3,528				1,577
Total cash and available-for-sale securities		$	26,010			$	26,946

 

Realized gains and realized losses were not significant for any of the three and six month periods ended June 30, 2011 and 2010. As of June 30, 2011 and December 31, 2010, there were no significant 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 June 30, 2011 and December 31, 2010 were less than one year. The contractual maturity of the long term investments is 1.30 years as of June 30, 2011 (see Note 11).

 

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 and six months ended June 30, 2011 and 2010, the Company did not recognize any impairment charges on outstanding investments. As of June 30, 2011, the Company does not consider any of its investments to be other-than-temporarily impaired.

 

4. Property and Equipment

 

Property and equipment consisted of the following at June 30, 2011 and December 31, 2010 (in thousands):

 

		June 30, 2011												December 31, 2010
		Cost				Accumulated Depreciation				Net Book Value				Cost				Accumulated Depreciation				Net Book Value
Computer equipment		$	9,443			$	(7,231	)		$	2,212			$	9,224			$	(6,411	)		$	2,813
Furniture and fixtures			75				(61	)			14				75				(59	)			16
Software			1,239				(1,225	)			14				1,239				(1,220	)			19
Leasehold improvements			308				(107	)			201				308				(74	)			234
Total		$	11,065			$	(8,624	)		$	2,441			$	10,846			$	(7,764	)		$	3,082

 

8

---

Table of Contents

 

Depreciation expense on property and equipment for the three and six months ended June 30, 2011, including property and equipment under capital lease, was $0.4 million and $0.9 million, respectively, and is recorded in operating expenses. Depreciation expense on property and equipment for the three and six months ended June 30, 2010, including property and equipment under capital lease, was $0.5 million and $0.9 million, respectively. Equipment under capital lease totaled $3.9 million and $4.3 million as of June 30, 2011 and December 31, 2010, respectively. Depreciation expense on equipment under capital lease was $0.3 million and $0.6 million for the three and six months ended June 30, 2011, respectively, and was $0.3 million and $0.7 million for the three and six months ended June 30, 2010, respectively. Additionally, accumulated depreciation on equipment under capital lease was $3.0 million and $2.8 million as of June 30, 2011 and December 31, 2010, respectively.

 

5. Capitalized Software and Other Assets

 

The Company’s capitalized software and other assets are as follows at June 30, 2011 and December 31, 2010 (in thousands):

 

		June 30, 2011												December 31, 2010
		Gross Amount				Accumulated Amortization				Net Book Value				Gross Amount				Accumulated Amortization				Net Book Value
Capitalized software		$	6,469			$	(5,077	)		$	1,392			$	6,206			$	(4,550	)		$	1,656
Amortizable purchased technology			78				(78	)			-				78				(78	)			-
Other assets			61				-				61				94				-				94
		$	6,608			$	(5,155	)		$	1,453			$	6,378			$	(4,628	)		$	1,750

 

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 and $0.5 million for the three and six months ended June 30, 2011, respectively, and $0.3 million and $0.6 million for the three and six months ended June 30, 2010, respectively.

 

6. Accrued Liabilities

 

Accrued liabilities consisted of the following as of June 30, 2011 and December 31, 2010 (in thousands):

 

		June 30,				December 31,
		2011				2010
Accrued distribution and partner costs		$	1,036			$	1,473
Accrued compensation and related expenses			345				513
Accrued professional service fees			112				222
Other			2				407
Total accrued liabilities		$	1,495			$	2,615

 

7. Restructuring Charges

 

In January 2011, the Company recorded $0.9 million in pre-tax restructuring charges associated with the termination of approximately 20 full-time positions. All restructuring charges have been classified as such on the Unaudited Consolidated Statement of Operations. The cash payments associated with the January 2011 restructuring liability were $0.8 million for both the three and six months ended June 30, 2011. The $0.1 million remaining cash payments associated with the restructuring liability is included in accrued compensation and related expenses and will be paid through the third quarter of 2011.

 

8. Capital Lease and Other Obligations

 

Capital lease and other obligations consist of the following at June 30, 2011 and December 31, 2010 (in thousands):

 

		June 30,				December 31,
		2011				2010
Capital lease obligations		$	1,214			$	1,784
Deferred rent			162				166
Total capital lease and other obligations			1,376				1,950
Less: current portion of capital lease obligations			(856	)			(1,048	)
Capital lease and other obligations, net of current portion		$	520			$	902

 

Capital Lease Obligations

 

City National Bank

 

In April 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. The lease expired on April 30, 2010, at which time 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. Effective as of September 30, 2009, the master equipment lease agreement includes two financial covenants, with which the Company was in compliance as of June 30, 2011.

 

 

9

---

Table of Contents

 

The agreements with CNB, consisting of an outstanding standby letter of credit (“SBLC”) and a master equipment lease agreement, contain cross-default provisions, whereby a default under one is deemed a default for the other, and are secured by a general lien on all assets of the Company. As of June 30, 2011 and December 31, 2010, the Company was not in default on either agreement with CNB (see Note 9).

 

9. Commitments and Contingencies

 

As of June 30, 2011, future minimum payments under all capital and operating leases are as follows (in thousands):

 

		CNB Capital Lease				Operating Leases				Total
Six months ending December 31, 2011			508				298				806
Years ending December 31,
2012			618				517				1,135
2013			144				537				681
2014			-				556				556
Total minimum payments			1,270			$	1,908			$	3,178
Less: amount representing interest			(56	)
Present value of net minimum payments			1,214
Less: current portion			(856	)
Long-term portion of capital lease obligations		$	358

 

Operating Lease

 

In August 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 the scheduled base rent payments, the Company is also responsible for varying amounts of operating and property tax expenses.

 

Letters of Credit

 

At June 30, 2011 and December 31 2010, the Company has an outstanding SBLC related to the security of a building lease for $0.3 million. The SBLC contains two financial covenants, with which the Company was in compliance as of June 30, 2011.

 

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, expiring January 2012. The contractual obligations under the agreement include 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 a lessor in connection with facility leases for certain claims arising from such facility or lease.

 

Officer and Director Indemnification

 

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 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

 

In 2008, the Company established a Settlement Fund related to a class action lawsuit in which the Company was named as a defendant, Lane’s Gifts and Collectibles, L.L.C., v. Yahoo! Inc (the “Fund”). In the second quarter of 2011, the Company determined that all settlements related to the Fund had been paid and reversed the balance recorded in accrued liabilities and recorded $0.3 million in non-operating income related to closure of the Settlement Fund. This amount is included in other income for the three and six months ended June 30, 2011.

 

10. Stockholders’ Equity

 

Share-Based Compensation

 

Stock Option Plans

 

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. The number of shares reserved for issuance under the Plans was approximately 4.3 million and 4.5 million shares of common stock at June 30, 2011 and December 31, 2010, respectively. There were 1.5 million shares available to be granted under the Plans at June 30, 2011.

 

10

---

Table of Contents

 

Share-based compensation expense recorded during the three and six months ended June 30, 2011 and 2010 was included in the Company’s Unaudited Consolidated Statement of Operations as follows (in thousands):

 

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2011				2010				2011				2010
Sales and marketing		$	2			$	18			$	2			$	38
Product development and technical operations			42				77				86				183
General and administrative			46				68				77				111
Total share-based compensation expense			90				163				165				332
Amounts capitalized as software development costs			6				10				16				24
Total share-based compensation		$	96			$	173			$	181			$	356

 

Total unrecognized share-based compensation expense related to share-based compensation arrangements at June 30, 2011was $0.9 million and is expected to be recognized over a weighted-average period of approximately 3.2 years. The total fair value of equity awards vested during the three and six months ended June 30, 2011 was $0.1 million and $0.2 million, respectively, and $0.2 million and $0.4 million during the three and six months ended June 30, 2010, respectively.

 

Option Awards

 

Stock option activity under the Plans during the three and six months ended June 30, 2011 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, 2010			2,922			$	3.20
Granted			227				1.78
Excercised			(30	)			1.15
Expired/forfeited			(442	)			2.46
Options outstanding at March 31, 2011			2,677			$	3.22
Granted			375				1.85
Excercised			(5	)			1.17
Expired/forfeited			(337	)			3.74
Options outstanding at  June 30, 2011			2,710			$	2.97				5.92			$	74
Vested and expected to vest at June 30, 2011			2,460			$	3.09				5.86			$	71
Exercisable at June 30, 2011			1,658			$	3.77				5.60			$	60

 

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 June 30, 2011:

 

												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)
$	1.02				-			$	1.51				659				6.26			$	1.40				272			$	1.29
	1.52				-				2.91				910				6.47				1.96				275				2.34
	3.07				-				4.33				824				5.88				3.46				794				3.47
	4.45				-				20.55				317				3.80				7.87				317				7.87
													2,710				5.92				2.97				1,658				3.77

 

11

---

Table of Contents

 

Stock Awards

 

The Company did not issue restricted stock during the three months ended June 30, 2011 and 2010 and the six months ended June 30, 2011. During the six months ended June 30, 2010, the Company issued 13 thousand shares of fully vested restricted stock, with a weighted average grant date fair value of $1.03 per share, under the 2007 Plan. The Company recorded share-based compensation for stock awards of zero for the three months ended June 30, 2011 and 2010 and the six months ended June 30, 2011 and $13 thousand for the six months ended June 30, 2010.

 

Employee Stock Purchase Plan

 

In July 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 2010 ESPP was not significant for three and six months ended June 30, 2011 and 2010. As of June 30, 2011, 61 thousand shares have been issued under the 2009 ESPP 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. The weighted average 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 June 30,								Six Months Ended June 30,
		2011				2010				2011				2010
Volatility			67.7	%			64.9	%			67.5	%			64.8	%
Risk-free interest rate			1.47	%			1.68	%			1.50	%			1.68	%
Expected term (years)			4.05				3.84				4.03				3.85
Expected dividend yield			-				-				-				-
Weighted average grant date fair value		$	0.93			$	0.71			$	0.92			$	0.71

 

As share-based compensation expense recognized in the Unaudited 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.

 

Exercise of Employee Stock Options and Purchase Plans

 

There were 5 thousand and 35 thousand options exercised in the three and six months ended June 30, 2011. There were no options exercised in the three and six months ended June 30, 2010. 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

---

Table of Contents

 

11. 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 June 30, 2011 and December 31, 2010 were as follows (in thousands):

 

		Balance at June 30, 2011				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)
Cash equivalents:
Money market mutual funds		$	973			$	973			$	-
Commercial paper			1,799				-				1,799
			2,772				973				1,799
Short-term investments:
Corporate bonds			507				-				507
Certificates of deposit			5,050				-				5,050
Commercial paper			5,697				-				5,697
			11,254				-				11,254
Long-term investments:
Corporate bonds			2,103				-				2,103
Certificate of deposit			1,425				-				1,425
			3,528				-				3,528
Total financial assets measured at fair value		$	17,554			$	973			$	16,581
		Balance at December 31, 2010				Quoted Prices In Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)
Cash equivalents:
Money market mutual funds		$	35			$	35			$	-
Certificates of deposit			2,000				-				2,000
Commercial paper			10,649				-				10,649
			12,684				35				12,649
Short-term investments:
Certificates of deposit			2,250				-				2,250
Commercial paper			1,000				-				1,000
			3,250				-				3,250
Long-term investments:
Corporate bonds			1,577				-				1,577
Total financial assets measured at fair value		$	17,511			$	35			$	17,476

 

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 validates the prices received from the pricing service using various methods including, applicability of Federal Deposit Insurance Corporation or other national government insurance or guarantees, comparison of proceeds received on individual investments subsequent to reporting date, prices received from publicly available sources, and review of transaction volume data to confirm the 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 June 30, 2011 and December 31, 2010, the Company did not adjust prices received from the pricing service.

 

Trade accounts receivable, net: The carrying value reported in the Unaudited 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 Unaudited 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.

 

12. Related Party Transactions

 

In addition to the fees paid as a director of the Company, Dr. Jean-Yves Dexmier was paid fees totaling $0.1 million and $0.2 million in each of the three and six month periods ended June 30, 2011 and 2010, respectively, in connection with his services as the Company’s Chief Executive Officer.

 

 

13

---

Table of Contents

 

ITEM 2.

MAN AGE MENT’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 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.

 

Critical Accounting Policies and Estimates

 

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of assets and liabilities. On an on-going basis, we evaluate our critical accounting policies and estimates. We base our estimates on historical experience and on various other assumptions that we believe 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 may differ from these estimates under different assumptions or conditions. Our critical accounting policies and estimates are discussed in our Annual Report on Form 10-K for the year ended December 31, 2010. As of June 30, 2011, there had been no material changes to our critical accounting policies and estimates.

 

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 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. The results of operations of consumer product activities, including related gains, have been classified as discontinued operations for all periods presented in the accompanying Unaudited Consolidated Statements of Operations (see Note 2). At June 30, 2011, the Company continues to own the Wisenut search engine technology, intellectual property rights in such technology, and other assets.

 

14

---

Table of Contents

 

Results of Operations

 

Overview of the Three and Six Months Ended June 30, 2011

 

The following table sets forth selected information concerning our results of operations for the periods indicated:

 

		Three Months Ended June 30,
		2011				% of Revenue				2010				% of Revenue				Dollar Change				% Change
Revenue		$	6,605				100.0	%		$	13,017				100.0	%		$	(6,412	)			(49	%)
Cost of revenue			3,439				52.1	%			7,525				57.8	%			(4,086	)			(54	%)
Gross profit			3,166				47.9	%			5,492				42.2	%			(2,326	)			(42	%)
Operating expenses:
Sales and marketing			554				8.4	%			1,275				9.8	%			(721	)			(57	%)
Product development and technical operations			1,550				23.5	%			2,001				15.4	%			(451	)			(23	%)
General and administrative			1,041				15.8	%			1,669				12.8	%			(628	)			(38	%)
Total operating expenses			3,145				47.7	%			4,945				38.0	%			(1,800	)			(36	%)
Income from operations			21				0.2	%			547				4.2	%			(526	)			(96	%)
Non-operating income, net			333				5.0	%			19				0.1	%			314				1653	%
Income from continuing operations before income taxes			354				5.2	%			566				4.3	%			(212	)			(37	%)
Income tax benefit			-				0.0	%			1				0.0	%			(1	)			(100	%)
Income from continuing operations			354				5.2	%			567				4.3	%			(213	)			(38	%)
Income from discontinued operations			-				0.0	%			85				0.7	%			(85	)			(100	%)
Net income		$	354				5.2	%		$	652				5.0	%		$	(298	)			(46	%)
		Six Months Ended June 30,
			2011			% of Revenue					2010			% of Revenue				Dollar Change				% Change
Revenue		$	14,994				100.0	%		$	26,303				100.0	%		$	(11,309	)			(43	%)
Cost of revenue			8,094				54.0	%			16,561				63.0	%			(8,467	)			(51	%)
Gross profit			6,900				46.0	%			9,742				37.0	%			(2,842	)			(29	%)
Operating expenses:
Sales and marketing			1,202				8.0	%			2,429				9.2	%			(1,227	)			(51	%)
Product development and technical operations			3,144				21.0	%			3,993				15.2	%			(849	)			(21	%)
General and administrative			2,427				16.2	%			3,360				12.8	%			(933	)			(28	%)
Restructuring charge			889				5.9	%			-				0.0	%			889				0	%
Total operating expenses			7,662				51.1	%			9,782				37.2	%			(2,120	)			(22	%)
Loss from operations			(762	)			(5.1	%)			(40	)			(0.2	%)			(722	)			1805	%
Non-operating income, net			320				2.1	%			2				0.0	%			318				15900	%
Loss from continuing operations before income taxes			(442	)			(3.0	%)			(38	)			(0.2	%)			(404	)			1063	%
Income tax benefit (expense)			1				0.0	%			(5	)			0.0	%			6				(120	%)
Loss from continuing operations			(441	)			(3.0	%)			(43	)			(0.2	%)			(398	)			926	%
Income from discontinued operations			-				0.0	%			178				0.7	%			(178	)			(100	%)
Net income (loss)		$	(441	)			(3.0	%)		$	135				0.5	%		$	(576	)			(427	%)

 

Revenue

 

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 and six months ended June 30, 2011 and 2010, were as follows (in thousands):

 

		Three Months Ended June 30,
		2011				% of Revenue				2010				% of Revenue				Dollar Change				% Change
Advertiser Networks		$	6,313				96	%		$	12,100				93	%		$	(5,787	)			(48	%)
Publisher Solutions			292				4	%			917				7	%			(625	)			(68	%)
Total revenue		$	6,605				100	%		$	13,017				100	%		$	(6,412	)			(49	%)
		Six Months Ended June 30,
			2011			% of Revenue					2010			% of Revenue				Dollar Change				% Change
Advertiser Networks		$	14,460				96	%		$	24,533				93	%		$	(10,073	)			(41	%)
Publisher Solutions			534				4	%			1,770				7	%			(1,236	)			(70	%)
Total revenue		$	14,994				100	%		$	26,303				100	%		$	(11,309	)			(43	%)

 

The decrease in Advertiser Networks revenue for the three and six months ended June 30, 2011 as compared to the same periods in 2010 is attributed to a decline in paid clicks and average revenue-per-click (“RPC”). RPC and paid click changes were the result of a continued decline in revenue from our intermediaries in the comparable periods. Yahoo! Partners, our largest customer group, continued to be affected significantly by reduced payments following the Yahoo!-Bing Search Alliance integration which consequently resulted in lower revenues to us. Total paid clicks decreased 23% to 146 million for the three months ended June 30, 2011, compared to 190 million for the three months ended June 30, 2010. During the same three month period, average RPC decreased 32%, from $0.064 to $0.043, while RPC decreased 22% in the second quarter of 2011 compared to the first quarter of 2011. Total paid clicks decreased 33% to 292 million for the six months ended June 30, 2011, compared to 434 million for the six months ended June 30, 2010. During the same six month period, average RPC decreased 12%, from $0.056 to $0.050. Going forward, we will continue to attempt to increase our revenue primarily with our intermediaries and through performance based pricing models targeting our direct advertising customers and their agencies.

 

15

---

Table of Contents

 

The decrease in Publisher Solutions revenue for the three and six months ended June 30, 2011 as compared to the same periods in 2010 is attributed to reduced revenue from IAC Search and Media, Inc. (“IAC”) related to the termination of an agreement with IAC on October 31, 2010. We did not record any Publisher Solutions revenue from IAC during the three and six months ended June 30, 2011, compared to $0.6 million, or 69% of Publisher Solutions revenue, and $1.3 million, or 71% of Publisher solutions revenue, during the three and six months ended June 30, 2010, respectively.

 

Cost of Revenue and Gross Margin

 

Cost of revenue, consisting of 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 and six months ended June 30, 2011 and 2010 (in thousands):

 

		Three Months Ended June 30,
		2011				% of Revenue				2010				% of Revenue				Dollar Change				% Change
Traffic acquisition costs		$	3,044				46	%		$	7,034				54	%		$	(3,990	)			(57	%)
Other costs			395				6	%			491				4	%			(96	)			(20	%)
Total cost of revenue		$	3,439				52	%		$	7,525				58	%		$	(4,086	)			(54	%)
Traffic acquisition costs as percentage of Advertiser Network revenue							48.2	%							58.1	%
		Six Months Ended June 30,
			2011			% of Revenue					2010			% of Revenue				Dollar Change				% Change
Traffic acquisition costs		$	7,303				49	%		$	15,424				59	%		$	(8,121	)			(53	%)
Other costs			791				5	%			1,137				4	%			(346	)			(30	%)
Total cost of revenue		$	8,094				54	%		$	16,561				63	%		$	(8,467	)			(51	%)
Traffic acquisition costs as percentage of Advertiser Network revenue							50.5	%							62.9	%

 

Our TAC decrease as a percentage of associated revenue in 2011 is primarily attributed to optimization of bids/prices paid for different sources of traffic and keywords.

 

Our other costs of revenue, which consists primarily of co-location costs and credit card processing fees, decreased due to the significant duplicate costs incurred during the first half of 2010 associated with the move to a new co-location facility.

 

Operating Expenses

 

Operating expenses for the three and six months ended June 30, 2011 as compared to the same period in 2010 decreased $1.8 million and $2.1 million, respectively. The decrease is largely due to lower headcount resulting from a reduction in workforce in the first quarter of 2011. For the remainder of 2011, planned headcount increases in sales, product development and account management may result in comparatively higher operating expenses, however, expenses will continue to be closely evaluated relative to operating margin.

 

 

16

---

Table of Contents

 

Operating expenses consist of sales and marketing, product development and technical operations, general and administrative, and restructuring charges for the three months ended June 30, 2011 and 2010; and were as follows (in thousands):

 

		Three Months Ended June 30,
		2011				% of Revenue				2010				% of Revenue				Dollar Change				% Change
Sales and marketing		$	554				8	%		$	1,275				10	%		$	(721	)			(57	%)
Product development and technical operations			1,550				24	%			2,001				15	%			(451	)			(23	%)
General and administrative			1,041				16	%			1,669				13	%			(628	)			(38	%)
Total operating expenses		$	3,145				48	%		$