Back to GetFilings.com

Table of Contents

SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

Commission file number 000-26521

5858 Horton St., Suite 350, Emeryville, CA 94608

(510) 985-7400

     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 of 1934 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 þ          No o

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).     Yes þ          No o

      The number of shares outstanding of the registrant’s Common Stock as of April 29, 2004 was 47,794,740.

The Exhibit Index begins on page 40.

ASK JEEVES, INC.

TABLE OF CONTENTS

Cautionary Note regarding Forward-Looking Statements

      In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Forward-looking statements are those that predict or describe future events or trends and that do not relate solely to historical matters. You can generally identify forward-looking statements as statements containing the words “believe,” “expect,” “will,” “anticipate,” “intend,” “estimate,” “project,” “assume” or other similar expressions, although not all forward-looking statements contain these identifying words. All statements in this report regarding our future strategy, future operations, projected financial position, estimated future revenues, projected costs, future prospects, and results that might be obtained by pursuing management’s current plans and objectives are forward-looking statements. You should not place undue reliance on our forward-looking statements because the matters they describe are subject to known and unknown risks, uncertainties and other unpredictable factors, many of which are beyond our control. Our forward-looking statements are based on the information currently available to us and speak only as of the date on which this report was filed with the SEC. We expressly disclaim any obligation to issue any updates or revisions to our forward-looking statements, even if subsequent events cause our expectations to change regarding the matters discussed in those statements. Over time, our actual results, performance or achievements will likely differ from the anticipated results, performance or achievements that are expressed or implied by our forward-looking statements, and such difference might be significant and materially adverse to our stockholders. Many important factors that could cause such a difference are described in this Quarterly Report under the caption “Risk Factors” as well as in our most recent Annual Report on Form 10-K under the captions “Competition,” “Proprietary Rights” and “Risk Factors,” all of which you should review carefully. Please consider our forward-looking statements in light of those risks as you read this report.

2

Table of Contents

PART I. FINANCIAL INFORMATION

ASK JEEVES, INC.

See accompanying notes to condensed consolidated financial statements.

3

Table of Contents

ASK JEEVES, INC.

See accompanying notes to condensed consolidated financial statements.

4

Table of Contents

ASK JEEVES, INC.

See accompanying notes to condensed consolidated financial statements.

5

Table of Contents

ASK JEEVES, INC.

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

      Ask Jeeves, Inc. (“Ask Jeeves” or the “Company”) is a provider of Web-based search technologies. The Company creates a search experience focused on understanding users’ specific needs and interests and connecting them to the most relevant information, products and services.

      The Company operates four proprietary Web sites dedicated to search; Ask.com, Ask.co.uk, Teoma.com and AJKids.com. The Company also delivers, or syndicates, its search technology and advertising products to third-party Web sites, including portals, infomediaries, and content and destination Web sites. The company provides search results and/or advertising for those Web sites to display in response to their users’ search queries. The company refers to these third-party Web sites as its syndication network.

      Until July 1, 2003, the Company operated through two divisions, Web Properties and Jeeves Solutions. On July 1, 2003, the Company sold certain assets used in the Jeeves Solutions business to Kanisa Inc. (“Kanisa”), at which time the Company ceased offering Jeeves Solutions software and services to corporate customers as described in Note 7 (Discontinued Operations). Jeeves Solutions’ core software application, JeevesOne, allowed corporate customers to add its intuitive search engine to their corporate Internet or intranet sites. With the purchase of additional modules, JeevesOne allowed users to search and access a variety of linked enterprise systems and legacy databases.

      The Company was incorporated in California in June 1996 and reincorporated in Delaware in June 1999.

Basis of Presentation

      The accompanying condensed consolidated financial statements as of March 31, 2004 and for the three months ended March 31, 2004 are unaudited, but include all adjustments (consisting of normal recurring adjustments and accruals) which, in the opinion of management, are necessary for a fair presentation of the consolidated financial position, operating results and cash flows as of the interim date and for the periods presented. Results for the three months ended March 31, 2004 are not necessarily indicative of results for the entire fiscal year or future periods. The condensed consolidated balance sheet at December 31, 2003 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

      The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. The investment in the Ask Jeeves Japan joint venture in which the Company has significant influence but does not have a controlling voting interest or a majority interest in the assets, obligations or results of operations is accounted for under the equity method. Investments in which the Company does not have the ability to exert significant influence are accounted for at cost. All significant intercompany transactions and balances have been eliminated upon consolidation.

Use of Estimates

      The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ materially from those estimates.

6

Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Concentrations of Revenue

      During the three months ended March 31, 2004 and 2003, paid placement revenues from one provider accounted for 69% and 44% of revenues from continuing operations, respectively. This provider accounted for 52% and 15% of gross accounts receivable as of March 31, 2004 and 2003, respectively. The Company’s U.S. agreement with this provider is scheduled to terminate in September 2005 (but allows for termination for convenience by either party during September or October of 2004), and the Company’s U.K. agreement with this provider is scheduled to terminate in May 2005.

Net Income Per Share

      Basic net income per share is computed by dividing net income for the period by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing net income by the weighted average number of common shares outstanding during the period, plus the dilutive effect of outstanding stock options, warrants, and convertible subordinated notes.

Stock-based Compensation

      The Company accounts for employee stock options using the intrinsic value method and makes the required pro forma disclosures as if the fair value method had been used. Compensation expense based on the difference, if any, on the measurement date (generally the date of grant), between the estimated fair value of the Company’s stock and the exercise price of options to purchase that stock is amortized over the vesting period of the related option using the graded vesting method.

      Had compensation cost for the Company’s stock-based compensation plans been determined using the fair value at the grant dates for awards under those plans calculated using the Black Scholes valuation model, the Company’s net income and basic and diluted net income per share would have been decreased to the pro forma amounts indicated below (in thousands, except per share amounts):

7

Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Reclassifications

      Certain prior period balances have been reclassified to conform to the current year presentation. The reclassifications did not affect previously reported net income.

2. COMMITMENTS AND CONTINGENCIES

      From time to time, the Company is subject to legal proceedings and claims in the ordinary course of business, including claims of alleged infringement of patents, trademarks, copyrights and other intellectual property rights, and a variety of claims arising in connection with its services, such as claims alleging defamation or invasion of privacy.

      On October 25, 2001, a putative class action lawsuit captioned Leonard Turroff, et al. vs Ask Jeeves, Inc., et al. was filed against the Company and two of the Company’s officers and directors (collectively the “Individual Defendants”) in the United States District Court for the Southern District of New York. Also named as defendants were Morgan Stanley & Co., Inc., FleetBoston Robertson Stephens, Goldman Sachs & Co., U.S. Bancorp Piper Jaffray, and Dain Rauscher, Inc., the underwriters of the Company’s initial public offering. The complaint alleges violations of Section 11 of the Securities Act of 1933 against all defendants, and violations of Section 15 of the Securities Act against the Individual Defendants in connection with the Company’s initial public offering (“IPO”). An amended complaint was filed on December 6, 2001, which includes the same allegations in connection with Ask Jeeves’ secondary offering in March 2000. The complaints seek unspecified damages on behalf of a purported class of purchasers of common stock between June 30, 1999 and December 6, 2000. The Company believes the claims are without merit and intends to defend the actions vigorously. On June 24, 2003, a special committee of our board of directors approved the settlement of this action, subject to certain conditions including that a sufficient number of the defendants participate in the settlement, and on July 9, 2003, the Individual Defendants approved the settlement of this action. It is anticipated that the settlement will be submitted to the Court for approval in the near future.

      On January 27, 2004, a lawsuit was filed in the United States District Court for the Southern District of New York captioned American Blind and Wallpaper, Inc. v. Google, Inc., et al., in which Ask Jeeves, Inc., America Online, Inc., Netscape Communications Corporation, Compuserve Interactive Services, Inc., and Earthlink, Inc. were also named as defendants. On February 27, 2004, the Company was served with an Amended Complaint in the matter. The Complaint alleges trademark infringement, false representation, and dilution under the Lanham Act and other claims arising from defendants’ alleged unlawful use of plaintiff’s trademarks. Plaintiff’s claims are based on the allegations that defendants sell keywords identical to plaintiff’s marks to various third parties and by manipulating search results, consumers are unwittingly diverted to competitors’ products and services. The plaintiff seeks injunctive relief and an unspecified amount of damages. The Company has tendered this suit to Google for indemnification pursuant to the terms of the Advertising Services Agreement, dated July 17, 2002, between Ask Jeeves and Google, and Google has agreed to indemnify the Company to the extent the claims relate to the Google paid listing.

      In management’s opinion, resolution of these matters is not expected to have a material adverse impact on the Company’s results of operations, cash flows or financial position. However, depending on the amount and timing, an unfavorable resolution of these matters could materially and adversely affect the Company’s future results of operations, cash flows or financial position in a future period.

8

Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Indemnifications

      While the Company has various guarantees included in contracts in the normal course of business, primarily in the form of indemnities, these guarantees do not represent significant commitments or contingent liabilities. Accordingly, the Company has not recorded a liability related to indemnification provisions.

3. CONVERTIBLE SUBORDINATED NOTES

      In June 2003, the Company issued $115.0 million aggregate principal amount of zero coupon convertible subordinated notes, due June 1, 2008. The notes were sold at face value and the net proceeds to the Company were $111.5 million, net of costs of issuance of $3.5 million, which have been recorded as other assets and are being amortized in the Consolidated Statements of Operations over the contractual term of the notes.

      The notes are convertible by the holders into shares of the Company’s common stock at any time at a conversion price of $16.90 per share, subject to certain adjustments. This is equivalent to a conversion rate of approximately 59.1716 shares per $1,000 principal amount of notes. Upon conversion, the Company has the right subject to certain conditions to deliver cash (or a combination of cash and shares) in lieu of shares of its common stock.

      The notes are subordinated in right of payment to all existing and future senior indebtedness, as defined in the indenture. The holders of the notes may require the Company to repurchase all or a portion of the notes, subject to specified exceptions, upon the occurrence of a change in control. The Company may choose to pay the repurchase price in cash, shares of its common stock, shares of the surviving corporation or a combination thereof. The Company may not redeem the notes prior to the maturity date.

4. RESTRUCTURING AND FACILITY EXIT COSTS

      In December 2000, the Company’s Board of Directors approved a restructuring program aimed at streamlining the Company’s underlying cost structure to better position the Company for growth and improved operating results. During the three months ended March 31, 2004, the Company reported no additional restructuring charges. The following table sets forth the restructuring activity during the three months ended March 31, 2004 and 2003, respectively (in thousands).

9

Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

5. LINE OF CREDIT

      The Company has a revolving line of credit with a bank in the amount of $15.0 million. The line of credit expires on July 1, 2005. Borrowings under the line of credit bear fixed rate interest from the date of borrowing at LIBOR plus 0.4%. All borrowings and letters of credit under the credit facility are collateralized by an equal amount of the Company’s marketable securities. Borrowings under the line are subject to various covenants. As of March 31, 2004, no borrowings were outstanding under the line of credit. Standby letters of credit of approximately $104,000, which are being maintained as security for performance under various obligations, were issued and outstanding under the credit facility.

6. BUSINESS SEGMENT AND GEOGRAPHIC INFORMATION

      The Company offers advanced Internet search technology to the public through advertiser-supported sites on the World Wide Web.

      The Company provides its search technologies and services internationally both directly and through its joint venture. Attribution of revenues by geographic region is based on the country in which the customer is domiciled. Geographic information on revenues of continuing operations is as follows:

7. DISCONTINUED OPERATIONS

      On May 28, 2003, the Company entered into an agreement to sell certain assets used in the Jeeves Solutions division to Kanisa Inc. (“Kanisa”). The sale of such assets closed on July 1, 2003 at which time the Company ceased offering Jeeves Solutions products and services to corporate customers. The assets sold

10

Table of Contents

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

included, among other things, tangible personal property, intellectual property and customer and business contracts.

      In the third quarter of 2003, the Company recorded a gain of approximately $2.5 million, net of estimated income taxes of $109,000, representing the excess of the purchase consideration received at closing over the book value of the assets sold, as well as the remaining amount of deferred license fees applicable to Jeeves Solutions. In exchange for the sale of such assets, the Company received $3.4 million in cash at the closing and a promissory note for up to $750,000, which is payable one year from the date of closing. The amount payable under the note is currently expected to be approximately $731,000, subject to certain upward or downward adjustments, but in no event shall the amount payable under the note exceed $750,000. The proceeds, if any, from the promissory note will be recorded as an additional gain on the transaction upon receipt.

      Total revenues related to the discontinued operations were $2.4 million for the three months ended March 31, 2003. No revenue from discontinued operations was recognized during the first quarter of 2004. The results of operations have been reclassified as loss from discontinued operations in the Condensed Consolidated Statement of Operations for all dates and periods presented.

8. COMPREHENSIVE INCOME

      The components of comprehensive income are as follows:

9. PENDING ACQUISITION

      On March 4, 2004, the Company announced it had signed a definitive agreement to acquire Interactive Search Holdings (ISH), a privately-held online search and media company. Under the terms of the agreement, the Company will issue 9.3 million shares of common stock and stock options, and pay $150.0 million in cash to complete the acquisition. The Company may pay up to an additional $17.5 million in cash based on various factors including ISH’s operating performance. The transaction is subject to certain closing conditions including regulatory approval.

11

Table of Contents

      The following discussion should be read in conjunction with our financial statements and the related notes contained elsewhere in this Quarterly Report on Form 10-Q. All statements in the following discussion that are not reports of historical information or descriptions of current accounting policy are forward-looking statements. Please consider our forward-looking statements in light of the risks referred to in this report’s introductory cautionary note.

EXECUTIVE OVERVIEW

      We offer advanced Internet search technology to the public through advertiser-supported sites on the World Wide Web (which is known as the Web). We seek to attract Web traffic by creating a distinctive search experience that users will find more intuitive and satisfying than other search alternatives. On our flagship Web sites, Ask.com in the U.S. and Ask.co.uk in the U.K., users submit their search requests, and our proprietary algorithmic search technology, Teoma, delivers a results list of Web pages likely to contain relevant and authoritative answers. The results page also displays advertiser-sponsored links to related products and services known as paid listings.

      We operate four proprietary Web sites dedicated to search: Ask.com, Ask.co.uk, Teoma.com and AJKids.com. We also deliver, or syndicate, our search technology and advertising products to approximately 38 third-party Web sites as of March 31, 2004, including portals, infomediaries, and content and destination Web sites. We provide search results and/or advertising for those Web sites to display in response to their users’ search queries. We refer to these third-party Web sites as our syndication network.

      Our focus is on increasing our Web traffic (i.e., the number of search queries on our proprietary Web sites) by attracting more users and getting them to use our search services more frequently. We generate advertising revenue every time users click on the paid listings, or as a result of graphic advertising and other advertising products we deliver in response to their queries. In this way, we monetize a portion of our Web traffic. Some of the advertisements are sold by our direct sales force while others are supplied to us by our paid listings provider, which currently is Google, Inc. We also earn revenue by licensing our search technology to our Japanese joint venture and to some of the sites in our syndication network.

Recent Events

      On March 4, 2004, we announced that we had signed a definitive agreement to acquire privately-held Interactive Search Holdings, Inc. Under the terms of the agreement, we will issue 9.3 million shares of common stock and options and pay $150.0 million in cash, reflecting an aggregate purchase price of $343.0 million based on our closing price on March 3, 2004. We may pay up to an additional $17.5 million in cash based on various factors including Interactive Search Holdings’ operating performance. We believe that this acquisition will result in a number of benefits, including the following:

	•	improving our ability to generate revenue by increasing web traffic volumes and market share;
	•	increasing the financial returns to stockholders;
	•	increasing the amount of resources available to invest in technology, site experiences and marketing; and
	•	benefits arising from the complementary nature of each company’s product offerings and the ability to offer multiple brands with different search experiences and applications.

Following completion of the acquisition, Interactive Search Holdings will become a wholly-owned subsidiary of Ask Jeeves and its operations will remain in Irvington, New York. The transaction is subject to customary closing conditions, including regulatory approval. It is expected the transaction will be completed in mid-May.

12

Table of Contents

Critical Accounting Policies

      Our condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States, which are known as GAAP. These accounting principles require us to make certain estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions upon which we rely are reasonable based upon information available to us at the time that these estimates, judgments and assumptions were made. 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 revenues and expenses during the periods presented. To the extent there are material differences between these estimates, judgments or assumptions and actual results, our financial statements will be affected. Our accounting policies that we believe are the most critical to a full understanding and evaluation of our reported financial results include those relating to:

	•	revenue;
	•	allowances for doubtful accounts;
	•	legal contingencies; and
	•	accounting for income taxes.

Each of these critical accounting policies is described in more detail below.

      In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application. There are also cases which require management’s judgment in selecting among available alternatives but none of the alternatives would produce a materially different result. Our management has reviewed these critical accounting policies and related disclosures with our Audit Committee. See the Notes to our Condensed Consolidated Financial Statements, which contain additional information regarding our accounting policies and other disclosures required by GAAP.

Revenue-Continuing Operations

      We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collectibility is probable. If we have doubt about the collectibility of revenue at the time it is earned, such revenue is deferred until cash has been received. Revenues are generated from four general sources:

	•	sales of premier listings and other paid placement products;
	•	sales of branded advertising products;
	•	sales of paid inclusion products; and
	•	licensing of our search technologies.

      Our premier listings and other paid placement products are textual, or Web links, that are designed to connect users interested in a particular product or service with an advertiser offering that product or service at the exact moment users need the information, much like a Yellow Pages listing. With these products, advertisers pay only for performance, so these revenues are generated when a user clicks on the link to the advertiser’s Web site on a cost per click, or “CPC,” basis. We recognize CPC revenue on a revenue-sharing basis if the paid placement was procured from our third-party provider.

      Our branded advertising ranges from highly targeted graphic units, which we offer as our Branded Response product, to traditional advertising units such as banners, towers and interstitials, which appear primarily on our syndicated sites. Branded advertising is generally sold on a cost per impression, or “CPM,” basis with the revenue derived from such arrangements recognized during the period that the service is provided, provided that no significant obligations remain outstanding from us to the advertiser at the end of the period. Our obligations typically include a guaranteed minimum number of “impressions” or times that an advertisement appears in pages viewed by users of our online properties. To the extent the minimum

13

Table of Contents

      Our paid inclusion products provide an opportunity for Web sites to ensure that they are included in our search index. We recognize paid inclusion revenue in two ways. First, on a “per URL” basis, in which the revenues are collected in advance and recognized over the appropriate service period, which is typically one year; and second on a CPC basis, in which the revenue is recognized when the click is delivered. We plan to discontinue sales of our CPC-based product.

      License payments received from our Japanese joint venture were initially recorded as deferred revenue and are recognized as revenues on a straight-line basis over a four-year period. The license revenue will terminate during the third quarter of 2004.

      Our syndication services include the sale of advertising and paid placement products, and the licensing of our search technology to third-party Web sites. Syndication license fees primarily arise from revenue-sharing arrangements, fixed fee arrangements or fee-per-use arrangements, and revenues are recognized as the service is delivered. We allocate our syndication revenues among three of our revenue categories, paid placement, branded advertising, and paid inclusion, as applicable, when reporting our results. Revenues from revenue-sharing arrangements are recorded gross, including amounts paid to syndication partners, in accordance with Emerging Issues Task Force Issue No. 99-19, because we act as the primary obligor in the arrangement, perform a significant portion of the service, have latitude in establishing pricing and bear credit risk.

Allowances for Doubtful Accounts

      We make judgments as to our ability to collect outstanding receivables and provide allowances for the portion of receivables when collection becomes doubtful. Provisions are made based upon a specific review of all significant outstanding invoices. For those invoices not specifically reviewed, provisions are provided at differing rates, based upon the age of the receivable. In determining these percentages, we analyze our historical collection experience and current economic trends. If the historical data we use to calculate the allowance provided for doubtful accounts does not reflect the future ability to collect outstanding receivables, additional provisions for doubtful accounts may be needed and our future results of operations could be adversely impacted.

      We also record a provision for revenue adjustments in the same period as the related revenues are recorded. These estimates are based on historical analysis of credit memo data and other factors. If the historical data we use to calculate these estimates does not properly reflect future uncollectible revenue, then a change in the allowances would be made in the period in which such a determination is made and revenues in that period could be impacted.

Legal Contingencies

      We are currently involved in various claims and legal proceedings. Periodically, we review the status of each significant matter and assess our potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be estimated, we accrue a liability for the estimated loss. Because of uncertainties related to these matters, accruals are based only on the best information available at the time. As additional information becomes available, we reassess the potential liability related to our pending claims and litigation and may revise our estimates. Such revisions in the estimates of the potential liabilities could have a material impact on our results of operations and financial position. See Note 2 of Notes to Condensed Consolidated Financial Statements for a description of our material legal proceedings.

Income Taxes

      We use significant judgment in determining our consolidated income tax provision. Uncertainties may arise with respect to the tax treatment of certain transactions, transfer pricing arrangements among related

14

Table of Contents

      Due to uncertainty surrounding when or if we will realize the benefits of our deferred tax assets (primarily from our net operating loss carryforwards), we have recorded a 100% valuation allowance on such amounts. Any decrease in the valuation allowance could materially reduce our income tax provision in the period in which such determination is made.

      We provide for United States income taxes on the earnings of our foreign subsidiaries unless they are considered indefinitely invested outside the United States. At March 31, 2004, the cumulative earnings upon which United States income taxes have not been provided are approximately $22.8 million. The income tax that would arise if these items were repatriated is approximately $9.1 million, some or all of which may be reduced by NOLs or foreign tax credits.

RESULTS OF OPERATIONS

      On May 28, 2003, we entered into an agreement to sell certain assets used in our Jeeves Solutions division to Kanisa Inc. (“Kanisa”). The sale of these assets closed on July 1, 2003, at which time we ceased offering Jeeves Solutions products and services to corporate customers. Accordingly, the results of operations presented below are on a continuing operations basis, and the results of the Jeeves solutions division are discussed in the section entitled “Discontinued Operations.”

Revenues

      Total revenues for the first quarter of 2004 grew 72.7% as compared with the first quarter of 2003. Generally, revenues were favorably affected by usage of our Web sites, which we refer to as our Web traffic. Traffic to our proprietary sites was strong, with queries growing 42% as compared with the first quarter of 2003. Contributing to the growth in queries, both unique users and average user site visit frequency per month increased, with unique users rising 20% and frequency increasing 14% when compared to the same period of 2003.

      Our revenues are related to our Internet search services and to our syndication of Web search services to third party Web sites. Our revenues consist of four main categories: (1) sales of paid placement products; (2) sales of branded advertising products; (3) paid inclusion products; and (4) licensing. Syndication revenues are included within each of the above categories, as applicable. The table below presents revenues for each category, split between the U.S., Europe and Japan.

15

Table of Contents

      Paid placement revenues in the first quarter of 2004 grew significantly over the first quarter of 2003. Relative to 2003, paid placement increased primarily due to overall increases in traffic to our Web sites. Additionally, paid placement revenues in the first quarter of 2004 benefited from improvements in the percentage of queries covered by paid placement advertisers as well as from improved performance by a new paid placement contract in the U.K., which we signed in May 2003.

      Branded advertising revenues increased modestly company-wide, with an increase in the U.K. partially offset by a slight decline in the U.S. Advertising sales in the U.S. were impacted by efforts to improve our site experience, which has resulted in decreases in the frequency with which we display ads to users. Partially offsetting this is an increase in the amount we receive for those ads that are displayed, as they are typically more targeted, and thus more valuable, to our advertisers. Advertising sales in the U.K. benefited from increases to both volume and pricing for the Branded Response product, as compared with the similar period in 2003.

      Revenues from paid inclusion grew as compared with the first quarter of 2003 when it had been recently launched.

      License revenues relate primarily to a technology license to our Japanese joint venture and are recognized ratably over the estimated service period applicable to this arrangement. Consequently, we expect to record approximately $1.1 million related to this license in the second quarter of 2004. The amortization period of this license ends during the third quarter of 2004.

      For the second quarter of 2004, we expect that a seasonal decrease in Web traffic will result in revenues that are slightly lower than those of the first quarter. We believe that our traffic generally corresponds with overall Internet usage, which historically has declined slightly in the second and third quarters during the summer months and returned in the fourth quarter. Additionally, we intend to continue to seek increased Web traffic by increasing our marketing efforts and by improving the relevance of our search results and, thereby, increasing user satisfaction and usage.

Gross Margin

16

Table of Contents

      Cost of revenues consists primarily of costs related to traffic acquisition for our syndicated sites and the delivery of our search results. Costs to acquire traffic for our syndicated sites include revenue-based payments and similar arrangements with third-parties who direct traffic to those sites. Costs related to delivering our search results include depreciation of Web site equipment, hosting and ad server management, salaries and related personnel costs and amortization charges related to technology acquired in some of our business combinations.

      Gross margin percentage increased in the first quarter of 2004 as percentage increases in revenues exceeded percentage increases in cost of revenues. On a dollar basis, cost of revenues increased $554,000 to $6.1 million in the first quarter of 2004 as compared with the first quarter of 2003, reflecting increased traffic acquisition costs associated with the higher levels of traffic.

      We expect gross margin in the second quarter of 2004 to be similar to the first quarter of 2004.

Operating Expenses

Product Development Expenses

      Product development expenses consist primarily of salaries and related personnel costs, consultant fees and expenses related to the design, development, testing and enhancement of our technology and services. To date, all software development costs have been expensed as incurred.

      Product development expenses increased on a dollar basis in the first quarter of 2004 as compared with the first quarter of 2003 due to increases in compensation and compensation-related expenses as we grew our research and development team in order to expand our Teoma technology and add new features on our Web sites.

      We expect product development expenses to increase on a dollar and percentage basis in the second quarter of 2004 as we continue to invest in our Teoma technology and new features on our Web sites.

Sales and Marketing Expenses

      Sales and marketing expenses consist primarily of advertising, promotional and public relations expenditures, as well as salaries, commissions and related personnel expenses of our sales force.

      Sales and marketing spending increased on a dollar basis as compared with the corresponding period in 2003 due to increasing advertising costs, but fell as a percentage of total revenues due to faster revenue growth. Our marketing campaigns were focused on promoting both branding and traffic generation.

      We expect sales and marketing expenses in the second quarter of 2004 to increase, both on a dollar basis and as a percentage of revenues, relative to the first quarter of 2004 as we plan to invest in marketing across all of our product lines.

General and Administrative Expenses

      General and administrative expenses consist of costs for general corporate functions, as well as depreciation and other facilities charges. Also included is the provision for doubtful accounts, various

17

Table of Contents

      The increase in general and administrative expenses in the first quarter of 2004 reflects an increase in salaries, employee-related benefits and incentive compensation as we expanded headcount to manage the growing business, and rewarded employees for the company’s performance. However, as a percentage of total revenue, general and administrative expenses have decreased as compared to the three months ended March 31, 2004.

      We expect general and administrative expenses in the second quarter of 2004 to be consistent with the first quarter.

Gain on Acquisition of Joint Venture

      During 2003, we recognized a gain of $6.1 million representing the fair value of net assets we recorded in excess of the consideration paid upon the acquisition of the remaining outstanding equity interests in our joint venture, Ask Jeeves U.K. This amount had been deferred due to a contingent payment obligation in our agreement with our former partners.

Interest and Other Income, net

      Interest income relates primarily to interest earned on fixed income securities and correlates with the average balance of those investments and prevailing interest rates. Interest expense arises primarily from interest accruing on outstanding borrowings under our line of credit and under our capital lease.

      Interest income was $442,000 and $269,000 for the three months ended March 31, 2004 and 2003 respectively. Interest income increased as our average balance of funds held in interest-earning investments increased. Net proceeds from the sale of the convertible subordinated notes are being held in marketable securities. Subsequently, our realized gains and losses on investments increased $129,000 for the first quarter of 2004 compared to the same period in 2003.

      Interest expense was $3,000 and $82,000 for the three months ended March 31, 2004 and 2003. During 2003 we repaid the outstanding borrowings under our line of credit, and paid off the remaining obligation under our capital lease. As a result, interest expense decreased.

Income Tax Provision

      We recorded an income tax provision in the amount of $1.1 million in the first quarter of 2004 relating primarily to income from our international operations. The provision differs from the amount computed by applying the statutory federal rate principally due to federal net operating loss carryforwards for which no tax benefit is provided, and foreign income taxed at rates below the federal statutory rate. The tax provision is based upon our estimate of the full year effective rate for the Company. The provision increased from the first quarter of 2003 due to an increase in taxable income in our international operations.

Loss from Discontinued Operations

      On July 1, 2003, we completed the sale of certain assets used in our Jeeves Solutions division to Kanisa, Inc. pursuant to an Asset Purchase Agreement dated May 28, 2003, by and between us and Kanisa. Accordingly, the results of operations relating to this division are presented in our Statements of Operations as discontinued operations.

18

Table of Contents

      During the first quarter of 2004, we did not record a loss on the discontinued operation, as the Jeeves Solutions division was sold as of July 1, 2003. In the first quarter of 2003, we recorded a loss of $761,000.

Seasonality and Quarterly Fluctuations In Operating Results

      Our operating results may fluctuate significantly in the future as a result of a variety of factors, many of which are beyond our control. Factors that may adversely affect our results of operations include:

	•	our ability to attract and retain advertisers and our ability to link our partners to potential customers;
	•	the number of queries on our Web sites;
	•	our ability to effectively manage our advertising inventory;
	•	rate changes for advertising on our Web sites;
	•	marketing expenses and technology infrastructure costs as well as other costs that we may incur as we expand our operation;
	•	seasonal and other fluctuations in demand for our services and for advertising space on our Web sites;
	•	our ability to develop and introduce new technology;
	•	announcements and new technology introductions by our competitors;
	•	our ability to attract and retain key personnel; and
	•	costs relating to possible acquisitions and integration of technologies or businesses;

      Because of the foregoing factors, we believe that period-to-period comparisons of our operating results should not be relied upon as an indicator of our future performance.

      As Internet advertising continues the transition from an emerging to a more developed market, seasonal and cyclical patterns may develop in our industry that may also affect our revenues. Similar to traditional media, this may result in our advertising sales being lower during the summer vacation period. Additionally, the seasonality of traffic on our proprietary sites corresponds with overall Internet usage. This may result in lower usage during holidays and the summer vacation period, as fewer people use the Internet. Seasonality in the retail industry and in Internet service usage is likely to cause quarterly fluctuations in our results of operations and could harm our business.

LIQUIDITY AND CAPITAL RESOURCES

*	Calculated excluding deferred revenue

      As of March 31, 2004, we had $193.7 million in cash and cash equivalents, and marketable securities, an increase of $13.0 million compared to the fiscal 2003 year end. Of this amount, $67.7 million was

19

Table of Contents

      Net cash provided by investing activities of $12.9 million resulted primarily from the proceeds from the redemption of marketable securities of $18.1 million. Partially offsetting these proceeds were investments in capital expenditures of $5.2 million.

      Net cash provided by financing activities of $3.5 million resulted from our issuance of common stock, primarily from the exercise of stock options.

      We have a revolving line of credit with a bank in the amount of $15.0 million. The line of credit expires on July 1, 2005. Borrowings under the line of credit bear interest at LIBOR plus 0.4%. All borrowings and letters of credit are collateralized by an equal amount of our marketable securities. The line of credit agreement contains various covenants. As of March 31, 2004, no borrowings were outstanding. Standby letters of credit of approximately $104,000 were issued and outstanding under the line of credit, which are being maintained as security for performance under lease obligations. Should we choose not to renew the line of credit, we do not believe our business would be harmed.

      In June 2003, we issued $115.0 million aggregate principal amount of zero coupon convertible subordinated notes, due June 1, 2008. The notes were sold at face value and our net proceeds were $111.5 million, net of costs of issuance of $3.5 million. We issued the notes for general corporate purposes, including potential future acquisitions. The notes are convertible by the holders into shares of our common stock at any time at a conversion price of $16.90 per share subject to certain adjustments. This is equivalent to a conversion rate of approximately 59.1716 shares per $1,000 principal amount of notes. Upon conversion, we have the right, subject to certain conditions, to deliver cash (or a combination of cash and shares) in lieu of shares of its common stock. The notes are subordinated in right of payment to all existing and future senior indebtedness, as defined in the indenture. The holders of the notes may require us to repurchase all or a portion of the notes, subject to specified exceptions, upon the occurrence of a change in control. We may choose to pay the repurchase price in cash, shares of its common stock, shares of the surviving corporation or a combination thereof. We may not redeem the notes prior to the maturity date.

      Our existing cash and marketable securities balances may decline during 2004 in the event of a weakening in our business, changes in our planned cash outlays, as well as our acquisition of ISH. However, based upon our current business plan and revenue prospects, we anticipate that our existing cash and marketable securities will be sufficient to fund our anticipated needs for working capital and capital expenditures for at least the next twelve months. Cash from operations could be affected by various risks and uncertainties, including, but not limited to the risks detailed in the section “Risk Factors”. Additionally, cash and marketable securities balances may be used to fund strategic acquisitions of other companies, products or technologies that are complimentary to our business.

      On an ongoing basis, we will need to generate sufficient cash flow from operations to meet our anticipated needs for working capital and capital expenditures, and repayment of our convertible notes if not converted into stock, or we will need to raise additional capital. However, if we are not successful in generating sufficient cash flow from operations or in raising additional capital when required in sufficient amounts and on terms acceptable to us, these failures could seriously harm our business. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our existing stockholders will be reduced.

20

Table of Contents

Off Balance Sheet Arrangements

      As of March 31, 2004, our only unconsolidated subsidiary is Ask Jeeves Japan, which generally provides Ask Jeeves’ services within a defined geographic region. We do not have majority voting rights or majority residual interests in the assets or income of any off balance sheet entities, including Ask Jeeves Japan. Further, we have not guaranteed any obligations of unconsolidated entities nor do we have any commitment or intent to provide additional funding to any such entities. Accordingly, we are not materially exposed to any market, credit, liquidity or financing risk that could arise from engaging in such relationships.

      We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Contractual Obligations, Contingent Liabilities and Commitments

      The following table summarizes our contractual obligations at March 31, 2004, and the effect such obligations are expected to have on our liquidity and cash flows in future periods:

*	The notes are convertible at any time prior to maturity into shares of our common stock at a conversion price of $16.90 per share, subject to certain adjustments. In the event of such conversion, we will have the right to deliver cash (or a combination of cash and shares of common stock) in lieu of shares of our common stock.

21

Table of Contents

RISK FACTORS

      Included below are other risk factors that may affect our future operating results.

Risks Related to our Company

Rapid industry change might affect our profitability.

      Although we first became profitable in the fourth quarter of 2002, and have remained profitable since that time, we cannot assure that we will remain profitable or cash flow positive. Moreover, we might not be able to increase our operating profitability on a quarterly or annual basis. The Internet industry is rapidly evolving and very turbulent. Rapid change may result in our being unable to forecast our results accurately or may cause our profitability to decline significantly. To increase profits, we will need to generate revenue growth from our advertising sales while continuing to control our expenses. We face the risk that our costs might increase substantially in the future. Indeed, we believe it is critical that we continue to expend financial and management resources to develop our brand loyalty through marketing and promotion, to enhance our search technologies and to expand our other services. If we fail to attract Web traffic or control costs, our annual net losses could resume, in which case we would eventually need to obtain additional financing or cease operations.

We derive a significant percentage of our revenue from our paid placement arrangement with Google, Inc.

      In July 2002, we entered into an agreement with Google, Inc., to participate in its sponsored links program, and our participation began in September 2002. Under this agreement, Google sells paid placements to tens of thousands of advertisers and we display their paid placements on our U.S. Web properties. We also syndicate Google’s paid placements, together with our search results, to third-party Web sites in our syndication network. In exchange for making our Web traffic available to Google’s advertisers, we share in the revenue generated from those advertisers. In the second quarter of 2003, the Ask Jeeves UK Partnership, our U.K. subsidiary, entered into an agreement with a Google subsidiary to display Google’s paid placements on our U.K. Web site, replacing a previous paid placement provider. For the three months ended March 31, 2004, our combined paid listings revenues from Google comprised 69% of our revenues from continuing operations. Our U.S. agreement with Google is scheduled to terminate in September 2005 (but allows for termination for convenience by either party during September or October of 2004), and our U.K. agreement with Google is scheduled to terminate in May 2005.

      If our contracts with Google are not renewed, or if Google fails to perform under these contracts or if they are terminated for any other reason, we would need to find another suitable paid placement provider or otherwise replace the lost revenues. Although alternate paid placement providers (such as Yahoo! Inc. and Espotting Media/ FindWhat.com) are currently available in the market, the paid placement market is consolidating, (for example, Espotting Media is merging with FindWhat.com), and we face the risk that we might be unable to negotiate equally advantageous terms with such providers. Further, if Google’s performance under these contracts unexpectedly deteriorates or our ability to generate traffic for paid placements decreases, our results of operations could be harmed.

Web-based business models are still evolving.

      Our advertising revenue will depend on our ability to achieve, measure and demonstrate to advertisers the breadth of Web traffic using our search service and the value of our targeted advertising. Currently, there are a variety of pricing models for selling advertising on the Internet, including models based on the number of impressions delivered, the number of click-throughs by users, the duration over which the advertisement is displayed or the number of keywords to which the advertisement is linked. It is still difficult to predict which pricing model, if any, will emerge as the industry standard. In addition, technological changes could impact the success of particular business models. Finally, we are constantly optimizing and changing the advertising implementation on our Web sites, which may reduce our advertising revenue. This uncertainty makes it

22

Table of Contents

We rely on DoubleClick for third-party advertising delivery.

      We rely on third-party advertising services, provided by DoubleClick, Inc. to deliver advertisements to our users. DoubleClick is currently the only provider available in the market that meets our delivery needs. If DoubleClick fails to deliver advertisements as contracted for, due to reliability or performance problems, or if advertisements cannot be targeted as promised to advertisers, our revenues may decrease.

      Both the U.S. and Europe DoubleClick, Inc. agreements will expire on February 27, 2007.

If we cannot maintain the popularity of our search engine among Internet users, our business will fail.

      We will be successful only if a critical mass of Internet users adopt our search technologies and services as a method of navigating the Internet. Internet users have a variety of other search techniques, including other search engines and subject-matter directories, available to them to find information on the Web. Users can also use non-Web-based methods of obtaining information through the Internet, including chat rooms and e-mail, rather than browsing through Web sites. Our search technologies, including our Teoma technology, are novel. It is difficult to predict the rate at which users will sample our services and the extent to which they will adopt them as their search technology. Even in the case of repeat users, it is difficult to know whether they return to our Web sites because they are satisfied with our offerings or because they are dissatisfied with the alternatives. At any time, users of our services might revert to prior search techniques or choose new search techniques altogether. We cannot assure you that widespread acceptance of our search technologies and services will occur. If we cannot maintain the popularity of our search engine among Internet users, our business plan will fail.

If high quality, third-party data ceases to be available, or directly accessible, on the Web, our business might fail.

      Our Internet search services are designed to directly link users to a page within a third-party Web site that contains an answer to the user’s question. We have little control over the content of these third-party Web sites. If these third-party Web sites do not contain high-quality, up-to-date information, the utility of our service to the user will be reduced. In addition, when our search engine attempts to direct the user to a page within a third-party company’s Web site, the company administering the site sometimes automatically redirects users to that company’s own home page. If third-party companies prevent us from directly linking our users to pages within their Web sites, and if there are no comparable alternative Web sites to which we can direct our users, the utility and attractiveness of our services to users will be reduced. If the utility of our services diminishes for either of the above reasons, traffic on our Web sites will likely fall, which would reduce our ability to charge for advertising and premium listings.

If we fail to compete effectively against our current and potential competitors, we will lose market share.

      We compete in markets that are intensely competitive and rapidly changing. Many of our competitors are bringing new search technologies to market, allocating extensive resources to product development and marketing and expanding their search offerings. We compete with search destinations, portals, and search technology providers.

	•	Search Destinations and Portals. In our efforts to attract search engine users, we compete against search destinations and portals such as Google, Inc., Yahoo! Inc., America Online (AOL) and Microsoft Network (MSN), and other smaller companies.
	•	Search Technology Providers. We also compete with search technology providers such as Google, Inc., Yahoo! Inc., and other smaller companies.

23

Table of Contents

      Some of our existing competitors (as well as potential new competitors), have longer operating histories, greater name recognition, larger customer bases and significantly greater financial resources than we do. Moreover, vertical integration appears to be increasing in the Internet search and advertising industry. For example, in 2003, Yahoo! acquired Inktomi and other search technology providers, and Overture Inc., a provider of search services, paid placements and related advertising. Vertically integrated search providers, like Yahoo! Inc. and Google, Inc., might have greater resources and functionality, and might be able to inhibit our access to advertisers or end users.

      We face the risk that operating system companies, ISPs or broadband providers may block or inhibit our ability to connect with our end users. If our competitors successfully divert search users away from our Web sites, we might lose market share.

Our growth will depend on our ability to attract and retain new users through effective promotional campaigns.

      We believe that favorable consumer and business community perceptions of the Ask Jeeves brands are essential to our future success. Accordingly, we intend to continue pursuing brand-enhancement strategies, which may include mass market and multimedia advertising, promotional programs and public relations activities. As with any public awareness campaign, we face the risk that our expenditures might not lead to the desired result; that is we might experience no net increase in our brand recognition or brand loyalty, our number of new users, or our Web site traffic. Furthermore, even if such increases occur, they might not be sufficiently large to justify the expenditures. If we are unable to promote brand awareness and loyalty in a cost-effective manner, we are unlikely to attract new users and our existing user base might shrink through attrition.

If we are unable to develop new products and new product enhancements rapidly and successfully, as well as to integrate acquired technologies, we might be unable to maintain user satisfaction.

      In the highly competitive, consolidating, and rapidly changing Internet search environment, our future success depends in large part on our ability to develop or acquire and introduce new search technology that meets the needs of our users more rapidly than our competitors, several of which are larger and may have significantly greater resources available for such investment in technology. For example, in 2001 we acquired Teoma Technologies, Inc. and in 2002 we acquired technology from Octopus Software, Inc. If we are unable to rapidly and successfully develop, acquire, or integrate new technology into the search services we offer, we might lose market share to our faster competitors and never recoup our development or acquisition costs.

Our pending acquisition of Interactive Search Holdings and any future acquisitions may disrupt our business, dilute stockholder value, divert management attention or be difficult to integrate.

      We have announced the pending acquisition of Interactive Search Holdings (ISH), which is expected to close in mid-May. This acquisition is expected to nearly double the size of the company. The integration of this operation might disrupt our internal operations or otherwise require the focus of management, which could negatively affect other corporate initiatives. We may in the future seek to acquire or invest in additional businesses, products or technologies that we believe could complement or expand our business, augment our market coverage, enhance our technical capabilities or that may otherwise offer growth opportunities. In addition, we may spend significant management time and costs in dealing with acquisitions that do not come to fruition. However, in doing so, we may encounter problems with the assimilation of ISH and other acquired businesses, products or technologies including:

	•	difficulties in assimilation of acquired personnel, systems, operations, technologies or products;
	•	adverse effects on our current employees and the inability to retain employees of acquired companies;
	•	unanticipated costs associated with acquisitions;
	•	diversion of management’s attention from other business concerns and potential disruption of our ongoing business;

24

Table of Contents

	•	adverse effects on our existing business relationships with our customers;
	•	potential patent or trademark infringement from acquired technologies;
	•	use of substantial portions of our available cash as all or a portion of the purchase price; and
	•	dilution of our current stockholders due to issuances of additional securities as consideration for acquisitions.

      If we are unable to integrate ISH or future acquired companies successfully or to create new or enhanced services, we might not achieve the anticipated benefits from our acquisitions. If we fail to achieve the anticipated benefits from the acquisitions, we might incur increased expenses and experience a shortfall in our anticipated revenues and we might not obtain a satisfactory return on our investment. In addition, if a significant number of employees of acquired companies fail to remain employed with us, we may experience difficulties in achieving the expected benefits of the acquisitions.

If we fail to maintain effective internal financial and managerial systems, controls and procedures, our results of operations may be harmed.

      Our past business realignment and reductions in workforce placed a significant strain on our managerial staff, financial controls and operational resources as our employees have assumed greater responsibilities and learned to manage their increased workload with reduced resources. We continue to evaluate our operational and financial systems and our managerial controls and procedures to determine what additional changes, if any, might help us to manage our current operations better. We face the risk that our systems, procedures and controls might not be adequate to support our operations or to maintain accountability for our assets. Any such failure could harm our results of operations.

Our international operations expose us to additional risks and additional international expansion efforts might lose money.

      The Company operates a separate Web site, located in Dublin, Ireland, that provides Internet search services to its customers in the United Kingdom, Ireland and elsewhere in Europe. In addition, we hold a 47% interest in Ask Jeeves Japan, a joint venture selling our Answers software product, as well as seeking to launch a Japanese language search site with Japan-specific content. As part of our corporate restructuring in 2001, we terminated our participation in projects seeking to launch versions of our search sites for Spanish speaking and Australian users. Any further expansion into international markets would require substantial management attention and financial resources. Establishing foreign operations is a significant investment that might not produce desired returns.

      Like our current foreign operations, any future expansion efforts would be subject to risks associated with international operations, including:

	•	the impact of business cycles and downturns in economies outside the United States;
	•	longer payment cycles and greater difficulty in accounts receivable collections;
	•	time and resources required to comply with foreign regulatory requirements;
	•	unexpected changes in regulatory requirements;
	•	difficulties and costs of staffing and managing foreign operations;
	•	potential tax liabilities if our transfer-pricing practices are successfully challenged by the tax authorities of the nations in which we operate;
	•	reduced protection for intellectual property rights in some countries;
	•	unanticipated tax costs associated with the cross-border use of intangible assets;
	•	political and economic instability;